Financial Institutions (Part of Module 1) PDF

Financial Institutions ( Part of Module 1) Sem 5 Finance Elective (FMI) V. Ravichandran Outline for discussion Financial Intermediaries Financial Institutions - Types Banks -Functions Non Banking Financial Institutions –Functions Differences between NBFCs...

Financial Institutions ( Part of Module 1) Sem 5 Finance Elective (FMI) V. Ravichandran Outline for discussion Financial Intermediaries Financial Institutions - Types Banks -Functions Non Banking Financial Institutions –Functions Differences between NBFCs and Banks The Indian Financial System COMPONENTS OF THE FORMAL FINANCIAL SYSTEM The formal financial system consists of four segments or components. These are: 1.financial institutions, 2.financial markets, 3.financial instruments, and 4.financial services What is a Financial Intermediary? A financial intermediary refers to an institution that acts as a middleman between two parties in order to facilitate a financial transaction. The institutions that are commonly referred to as financial intermediaries include commercial banks, investment banks, mutual funds, and pension funds. They reallocate uninvested capital to productive sectors of the economy through debts and equity. Financial Intermediaries Importance of Financial Intermediaries Financial intermediaries hold the middle position between two parties and manage the financial transaction. The financial intermediaries are commercial banks, investment banks, stock exchanges, insurance companies, etc. and these institutions play a vital role in the economy. By the help of financial intermediaries individuals can get fixed income at low cost. When an individual uses financial intermediaries, he doesn’t require to spend time and money to find good borrowers. He doesn’t have to bear the risk of loss as the risks are borne by the financial intermediaries. Financial Institutions Financial Institutions These are intermediaries that mobilise savings and facilitate the allocation of funds in an efficient manner. Financial institutions can be classified as banking and non-banking financial institutions. Banking institutions are creators and purveyors of credit while non-banking financial institutions are purveyors of credit. Financial Institutions While the liabilities of banks are part of the money supply, this may not be true of non-banking financial institutions. In India, non-banking financial institutions, namely, the developmental financial institutions (DFIs), and non-banking financial companies (NBFCs) as well as housing finance companies (HFCs) are the major institutional purveyors of credit. Financial Institutions Financial institutions can also be classified as term-finance institutions such as the Industrial Development Bank of India (IDBI), the Industrial Credit and Investment Corporation of India (ICICI), the Industrial Financial Corporation of India (IFCI), the Small Industries Development Bank of India (SIDBI), and the Industrial Investment Bank of India (IIBI). Classification of Financial Institutions Banking and non-banking Term finance Specialised Sectoral Investment What are Regional Rural Banks? Regional Rural Banks (RRB) are Indian Scheduled Commercial Banks ( Government Banks) operating at regional level in different states of India. They have been created with a view of serving primarily the rural areas of India with basic banking and financial services. Some examples of RRBs – Next slide Urban vs Rural Cooperative banks The Co-operative Banks are registered under Co operative Societies Act and also regulated by RBI. They are governed by Banking Regulation Act 1949 and Banking Laws( Co Operative Societies) Act 1965. They are are small sized units organized in urban and non urban (rural) areas. Rural Co-operative Banks mainly finance agricultural based activities including farming, dairy, fishi culture, along with some small scale industries and self employment activities. Urban Co-operative Banks mainly finance various categories of people for self employment, industries, small scale units and home finance. Banking Institutions Bank’s Characteristics: Characteristics of the banking business as defined in Section 5(b) of the Banking Regulation Act are as follows. Acceptance of deposits from the public For the purpose of lending or investment Repayable on demand or otherwise Withdrawable by means of any instrument whether a cheque or otherwise Meaning of Commercial Banks A commercial bank is a financial institution which performs the functions of accepting deposits from the general public and giving loans for investment with the aim of earning profit. The two most distinctive features of a commercial bank are borrowing and lending, i.e., acceptance of deposits and lending of money to projects to earn Interest (profit). In short, banks borrow to lend. The rate of interest offered by the banks to depositors is called the borrowing rate while the rate at which banks lend out is called lending rate. Banking Institutions These institutions mobilize the savings of 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, cooperative banks and developmental banks. Banking Institutions Commercial banks in India carry more than two-thirds of the assets of all financial institutions. Commercial banking can be further divided into four parts as follows: I. Public sector banks II. Private sector banks III. Foreign banks IV. Regional rural banks Banks functions Accepting of Deposits Savings deposits , Current Deposit, Fixed deposits, Recurring deposits Lending Loans and Advances Over Draft (OD) , Cash Credit (CC) , Loans, Discounting of Bill of Exchange Secondary Functions Agency Functions The banks act as agent of their customers and perform a number of agency functions which include transfer of funds, collection of cheques, periodic payment, periodic collections, portfolio management and other agency functions. Ancillary Functions of Banks Banks provide a range of ancillary services, including transfer of funds, collection, foreign exchange, safe deposit locker, gift cheques, and merchant banking. Thus, banks provide a wide variety of banking and ancillary services. Broad Sectors for Priority Sector Lending Agriculture Small Enterprises Retail Trade Micro Trade Education Loans Housing Loans Banks are creators of credit Banks are a special type of financial intermediaries which not only accept and deploy large amounts of uncollateralised deposits in a fiduciary capacity, but also leverage such funds through credit creation The creation of credit is an important function of a bank and this function distinguishes banks from the non-banking institutions What is Credit Creation by Banks? Credit creation is the expansion of deposits. Banks can expand their demand deposits as a multiple of their cash reserves because demand deposits serve as the principal medium of exchange. Credit creation separates a bank from other financial institutions Credit creation & Money Supply Suppose you deposit Rs. 10,000 in a bank A, which is the primary deposit of the bank. The cash reserve requirement of the central bank is 10%. In such a case, bank A would keep Rs. 1000 as reserve with the central bank and would use remaining Rs. 9000 for lending purposes. The bank lends Rs. 9000 to Mr. X by opening an account in his name, known as demand deposit account. However, this is not actually paid out to Mr. X. The bank has issued a check-book to Mr. X to withdraw money. Now, Mr. X writes a check of Rs. 9000 in favour of Mr. Y to settle his earlier debts. Credit creation & Money Supply The check is now deposited by Mr. Y in bank B. Suppose the cash reserve requirement of the central bank for bank B is 10%. Thus, Rs. 900 (10% of 9000) will be kept as reserve and the remaining balance, which is Rs. 8100, would be used for lending purposes by bank B. Thus, this process of deposits and credit creation continues till the reserves with commercial banks reduce to zero. Process of credit creation formula The process of credit creation can also be learned with the help of following formulae: Total Credit Creation = Original Deposit * Credit Multiplier Coefficient Credit multiplier coefficient= 1 / r where r = cash reserve requirement also called as Cash Reserve Ratio (CRR) Credit multiplier co-efficient = 1/10% = 1/ (10/100) = 10 Total credit created = 10,000 *10 = 100000 If CRR changes to 5%, Credit multiplier co-efficient = 1/5% = 1/ (5/100) = 20 Total credit creation = 10000 * 20 = 200000 Refer * Excel worksheet for additional examples Cash Reserve Ratio vs Credit Creation Thus, it can be inferred that lower the CRR, the higher will be the credit creation, whereas higher the CRR, lesser will be the credit creation. With the help of credit creation process, money multiplies in an economy. What is DICGC? Deposit Insurance and Credit Guarantee Corporation (DICGC) is a wholly-owned subsidiary of the Reserve Bank of India (RBI). It provides deposit insurance that works as a protection cover for bank deposit holders when the bank fails to pay its depositors. The agency insures all kinds of deposit accounts of a bank, such as savings, current, recurring, and fixed deposits up to a limit of Rs. 5 lakh per account holder per bank. In case an individual's deposit amount exceeds Rs.5 lakh in a single bank, only Rs.5 lakh, including the principal and interest, will be paid by DICGC if the bank becomes bankrupt. NBFC Introduction NBFC is a registered company which is regulated by the Reserve Bank of India under RBI Act, 1934. NBFCs are not banks, but their activities are related to lending and other activities such as providing loans and advances, credit facility, savings and investment products, trading in the money market, managing portfolios of stocks, transfer of money, etc. For commencing the activities of NBFCs, NBFC Registration is mandatory. Their activities are concerned with hire purchasing, leasing, infrastructure finance, venture capital finance, housing finance, etc. NBFC can accept deposits, but only term deposits and deposits repayable on demand are not accepted by NBFC. RBI on NBFCs A company which does not have financial assets which is more than 50% of its total assets and does not derive at least 50% of its gross income from such assets is not an NBFC. Its principal business would be non-financial activity like agricultural operations, industrial activity, purchase or sale of goods or purchase/construction of immoveable property, and will be a non- banking non-financial company. Acceptance of deposits by a Non-Banking Non-Financial Company are governed by the rules and regulations issued by the Ministry of Corporate Affairs. What are the different types/categories of NBFCs registered with RBI? NBFCs are categorized a) in terms of the type of liabilities into Deposit and Non-Deposit accepting NBFCs, b) non deposit taking NBFCs by their size into systemically important and other non-deposit holding companies (NBFC-NDSI and NBFC-ND) and c) by the kind of activity they conduct. Non-banking Institutions Non-banking financial institutions (NBFIs) also mobilize financial resources directly or indirectly from people. They lend funds but do not create credit. Companies such as LIC, GIC,UTI, Development Financial Institutions, Organization of Pension and Provident Funds fall into this category. Non-banking financial institutions can be categorized as investment companies, housing companies, leasing companies, hire purchase companies, specialized financial institutions (EXIM Bank, etc.), investment institutions, state level institutions, etc. Non-banking Institutions The largest component of NBFIs, can be distinguished from banks with regard to the degree and nature of regulatory and supervisory controls. Firstly, the regulations governing these institutions are relatively lighter as compared to those of banks. Secondly, they are not subject to certain regulatory prescriptions applicable to banks. The different types of NBFCs Asset Finance Company. Loan Company. Mortgage Guarantee Company. Investment Company. Core Investment Company. Infrastructure Finance Company. Micro Finance Company. Housing Finance Company. Fund Based Financial services include Involve provision of funds against assets, bank deposits, etc. Major part of the income is earned through fund-based activities. At the same time, it involves a large share of expenditure also in the form of interest and brokerage. Typical examples of fund based facilities are term loan, cash credit and overdraft Fund based vs Non-Fund Based Fund based credit facilities are those where, upon sanction, there is an actual outflow of funds from the bank to the borrower, whereas non-fund based facilities are those, at the time of sanction which do not involve such outflow of the bank’s funds. Typical examples of fund based facilities are term loan, cash credit and overdraft and that of non-fund based facilities are letters of credit, bank guarantees, letter of comfort, etc. Non-fund based facility may turn into a fund based facility on due date / occurrence of the specified event like devolvement of bills under LC, invocation of Bank Guarantee, etc. Difference between Banks and NBFCs Banks are the government authorized financial intermediary that aims at providing banking services to the general people. Whereas NBFCs provides banking services to people without carrying a bank license. An NBFC is incorporated under the Companies Act whereas a bank is registered under the Banking Regulation Act, 1949 NBFCs are not allowed to accept deposits which are repayable on demand whereas banks accept demand deposits. * Read RBI FAQ In NBFC, foreign Investments up to 100% is allowed. Whereas in the case of private sector banks they are eligible for foreign investment, but which would be no more than 74%. Difference between Banks and NBFCs Banks are an integral part of the payment and settlement cycle while NBFC is not a part of this system. It is mandatory for banks to maintain reserve ratios like CRR or SLR. Whereas in the case of NBFC it is not required to maintain reserve ratios. Deposit insurance facility is allowed to the depositors by Deposit Insurance and Credit Guarantee Corporation (DICGC). In the case of NBFC, this type of facility shall not be available. Difference between Banks and NBFCs Banks can create credit whereas in case of NBFC they are not involved in the creation of credit. Banks can provide transaction services to its customers such as providing overdraft facility, issue of traveller’s cheque, transfer of funds, etc. Whereas these type of services cannot be provided by NBFC. Some examples of NBFCs Power Finance Corporation Limited.... Shriram Transport Finance Company Limited.... Bajaj Finance Limited.... Mahindra & Mahindra Financial Services Limited.... Muthoot Finance Ltd.... HDB Finance Services.... Cholamandalam Finance Tata Capital Financial Services Ltd. LIC housing finance Ltd Summary on NBFCs The main objective for which NBFC’s are established is to grant credit to the poor section of the society whereas the banks are the financial intermediaries authorized by the government to receive deposits and grant credit to the public. Licensing of banks and NBFCs also differ in terms that licensing requirements of a bank are more stringent in comparison to NBFC. Banks cannot operate any business other than the banking business whereas an NBFC can operate such businesses. For further reading RBI on FAQ on NBFCs & Deposit insurance https://www.rbi.org.in/Scripts/FAQView.aspx?Id=92 https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/dicgc_act.pdf What are payment banks? Payments banks are new model of banks, conceptualised by the Reserve Bank of India (RBI), which cannot issue credit. These banks can accept a restricted deposit, which is currently limited to ₹200,000 per customer and may be increased further These banks cannot issue loans and credit cards. Both current account and savings accounts can be operated by such banks. Payments banks can issue ATM cards or debit cards and provide online or mobile banking. What are payment banks? Bharti Airtel set up India's first payments bank, A payments bank is like any other bank, but operating on a smaller scale without involving any credit risk. In simple words, it can carry out most banking operations but can't advance loans or issue credit cards. Services Offered By Payment Banks In India Payment banks are restricted to offer only a bunch of services. These services are: You can open a Savings account or a current account in payment banks. Payment bank also pays interest on deposited money just like traditional banks. Payment banks can issue debit/ATM cards to the customers. You can access payment banks services through Mobile banking. Services Offered By Payment Banks In India A payment bank can accept deposits up to Rs.1 lakh only per individual. You can use a payment bank app to transfer money and make utility bill payments as well. Payment banks provide internet banking services including payment transfer services such as /NEFT/IMPS. Payment banks can transfer payments through any channels like Branches, ATMs, mobile apps, or business correspondents. A payment bank also provides other financial services like mutual funds, insurance products, pension products, and forex services. Services That Payment Banks Don’t Provide Payment banks can’t provide loans to their customers Similarly, Payment banks can’t issue credit cards to their customers. NRIs can’t deposit in Payment banks. Regulations of Payment banks The minimum capital requirement is ₹100 crore. For the first five years, the stake of the promoter should remain at least 40%. Foreign share holding will be allowed in these banks as per the rules for FDI in private banks in India. The voting rights will be regulated by the Banking Regulation Act, 1949. The voting right of any shareholder is capped at 10%, which can be raised to 26% by the Reserve Bank of India. Any acquisition of more than 5% will require approval of the RBI. The majority of the bank's board of directors should consist of independent directors, appointed according to RBI guidelines Regulations of Payment banks The bank should be fully networked from the beginning. The bank can accept utility bills. It cannot form subsidiaries to undertake non-banking activities. Initially, the deposits will be capped at ₹100,000 per customer, but it may be raised by the RBI based on the performance of the bank. Payment Banks are not permitted to lend to any person including their directors. 25% of its branches must be in the unbanked rural area. The bank must use the term "payments bank" in its name to differentiate it from other types of bank. The banks will be licensed as payments banks under Section 22 of the Banking Regulation Act, 1949, and will be registered as public limited company under the Companies Act, 2013. List of Best Payment Banks in India 2022 Airtel M Commerce Services Limited Aditya Birla Nuvo Limited (Idea Cellular)** Fino PayTech Limited Reliance Industries National Securities Depository Limited (NSDL) Department of Posts (India Post) PayTM Cholamandalam Distribution Services Limited * Sun Pharma* Tech Mahindra Limited * Vodafone M-Pesa Limited*** Surrendered their licensees ** discontinued the operations *** did not start the. operations What are Small finance banks? Small finance banks are a type of niche banks in India. Banks with a small finance bank license can provide basic banking service of acceptance of deposits and lending. The aim behind these is to provide financial inclusion to sections of the economy not being served by other banks, such as small business units, small and marginal farmers, micro and small industries and unorganized sector entities Small Finance Bank's category is absolutely different from that of commercial bank. Small Finance Bank is called Differentiated Bank whose concept first came in the year 2007. What is a Small Finance Bank? Small Finance Banks is a specific segment of banking created by RBI under the guidance of Government of India with an objective of furthering financial inclusion by primarily undertaking basic banking activities to un-served and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganized entities. Like other commercial banks, these banks can undertake all basic banking activities including lending and taking deposits. Small finance banks will be established with the goal of increasing financial inclusion by (1) providing savings vehicles and (2) providing credit to small businesses, small and marginal farmers, micro and small industries, and other unorganised sector entities through high-tech, low-cost operations. Do small finance banks come under RBI? The small finance banks will come under the purview of RBI's Banking Ombudsman Scheme, 2006, as amended from time to time. The compliance of terms and conditions laid down by RBI is an essential condition of grant of license. Commercial Bank Vs Small Finance Banks Commercial Banks deal with activities such as granting loans, accepting deposits, and providing financial assistance to public, corporates and the government. These banks are regulated under the Banking Regulation Act, 1949. A Small Finance Bank is a segment under the banking system, and every bank under this segment is regulated by the Reserve Bank of India (RBI). The banks are set up to promote the objective of financial inclusion by offering basic banking facilities to the un-served and underserved sections. These sections comprise of small business owners, small and marginal farmers, unorganised entities, and micro, small and medium enterprises (MSMEs). List of Small Finance Banks In India Ujjivan Small Finance Bank. Janalakshmi Small Finance Bank. Equitas Small Finance Bank. A U Small Finance Bank. Capital Small Finance Bank. ESAF Small Finance Bank. Utkarsh Small Finance Bank. Suryoday Small Finance Bank. Fincare Small Finance Bank. Summary of regulations of Small Finance Banks Existing non-banking financial companies (NBFC), microfinance institutions (MFI) and local area banks (LAB) can apply to become small finance banks. They can be promoted either by individuals, corporate, trusts or societies. They are established as public limited companies in the private sector under the Companies Act, 2013. They are governed by the provisions of Reserve Bank of India Act, 1934, Banking Regulation Act, 1949 and other relevant statutes. The banks will not be restricted to any region. They were set up with the twin objectives of providing an institutional mechanism for promoting rural and semi urban savings and for providing credit for viable economic activities in the local areas. Summary of regulations of Small Finance Banks 75% of its net credits should be in priority sector lending and 50% of the loans in its portfolio must in ₹25 lakh (US$34,000) range. The firms must have a capital of at least ₹200 crore (US$13 million). The promoters should have 10 years' experience in banking and finance. The promoters stake in the paid-up equity capital will be at least 40% initially but must be brought down to 26% in 12 years. Joint ventures are not permitted. Foreign share holding will be allowed in these banks as per the rules for FDI in private banks in India. At net worth of ₹500 crore (US$67 million), listing will be mandatory within three years. Small finance banks having net worth of below ₹500 crore (US$67 million) could also get their shares listed voluntarily