FinancialInstitutionsNotesSemesterIII.pdf

KSD’s MODEL COLLEGE (EMPOWERED AUTONOMOUS) PROGRAM: B.COM BANKING AND FINANCE SEM: III COURSE TITLE: FINANCIAL INSTITUTIONS COURSE CODE: BCAF-MNR02-233 COURSE CONTENT PREPARED BY ASST. PROF.USHA GUPTA (B. Com, M...

KSD’s MODEL COLLEGE (EMPOWERED AUTONOMOUS) PROGRAM: B.COM BANKING AND FINANCE SEM: III COURSE TITLE: FINANCIAL INSTITUTIONS COURSE CODE: BCAF-MNR02-233 COURSE CONTENT PREPARED BY ASST. PROF.USHA GUPTA (B. Com, M. Com -Bus. Management, SET-Commerce, M. Phil- Commerce)  Unit 1 Introduction to Financial Institution Meaning of finance Finance is a term for matters regarding the management, creation and study of money and investments. Financial system It is defined as the composition of different financial institutions, markets, regulators, transactions, agencies and fund managers. It can be formal (organized) or informal (unorganized). The financial system enables lenders and borrowers to exchange funds. Historical development and Evolution of financial institutions in India The historical development and evolution of financial institutions in India have been shaped by colonial legacies, post-independence economic policies, liberalization, and technological advancements. This development can be categorized into several key phases: 1. Pre-Independence Era (Before 1947) Colonial Banking System:  The first bank in India, the Bank of Hindostan, was established in 1770, followed by the General Bank of India in 1786.  The three Presidency Banks—Bank of Bengal (1806), Bank of Bombay (1840), and Bank of Madras (1843)—were established by the British East India Company and served European commercial interests.  These banks later merged to form the Imperial Bank of India in 1921, which was the precursor to the State Bank of India (SBI). Indigenous Banking:  Indigenous bankers, known as "Shroffs," "Seths," or "Sahukars," played a critical role in providing credit to small traders and agriculturists. Development of Cooperative Banking:  The Cooperative Credit Societies Act of 1904 marked the beginning of the cooperative banking movement, aiming to provide financial services to rural and semi-urban populations. Legislation and Regulation:  The Reserve Bank of India (RBI) was established in 1935 as the central bank of India, under the Reserve Bank of India Act, 1934. It was given the responsibility of regulating the banking sector and managing the currency. 2. Post-Independence Era (1947-1991) Nationalization and Expansion:  In 1949, the Banking Regulation Act was enacted, providing a framework for the regulation and supervision of commercial banks.  In 1955, the Imperial Bank of India was nationalized to create the State Bank of India (SBI), which was tasked with expanding banking services to rural areas.  The nationalization of 14 major commercial banks in 1969 and another 6 banks in 1980 aimed to extend banking services to underserved sectors and regions. This was driven by the goal of aligning the banking sector with the government's socioeconomic priorities, including poverty alleviation and rural development. Development Financial Institutions (DFIs):  The Industrial Finance Corporation of India (IFCI) was established in 1948 to provide long-term finance to industrial projects.  Other DFIs like the Industrial Development Bank of India (IDBI) (1964), the National Bank for Agriculture and Rural Development (NABARD) (1982), and the Small Industries Development Bank of India (SIDBI) (1990) were set up to cater to specific sectors. Insurance Sector:  The Life Insurance Corporation of India (LIC) was formed in 1956 by nationalizing the life insurance sector, consolidating over 245 private insurance companies.  The general insurance sector was nationalized in 1972, leading to the creation of four subsidiaries of the General Insurance Corporation of India (GIC). 3. Liberalization Era (1991-2010) Economic Reforms and Deregulation:  The economic liberalization of 1991 marked a shift towards a market-oriented economy. The financial sector reforms aimed to improve efficiency, competitiveness, and integration with global markets.  Measures included deregulating interest rates, reducing statutory liquidity ratio (SLR) and cash reserve ratio (CRR) requirements, and allowing private and foreign banks to operate more freely. Establishment of New Financial Institutions:  The National Stock Exchange (NSE) was established in 1992, introducing electronic trading and increasing market efficiency.  SEBI, established in 1988 and given statutory powers in 1992, began to play a more active role in regulating and developing the securities market. Expansion of Non-Banking Financial Companies (NBFCs):  The liberalization era saw significant growth in the number of NBFCs providing diverse financial services, including leasing, hire purchase, and investment. Mutual Funds and Insurance Sector Reforms:  The mutual fund industry opened to private and foreign players, leading to a variety of schemes and increased competition.  The Insurance Regulatory and Development Authority (IRDA) was established in 1999, leading to the entry of private companies and foreign direct investment (FDI) in the insurance sector. 4. Modern Era (2010-Present) Technological Innovations:  Advances in technology have transformed the financial sector, with the introduction of digital banking, mobile payments, and fintech startups revolutionizing service delivery.  Initiatives like the Unified Payments Interface (UPI), launched in 2016, have enhanced digital transactions. Financial Inclusion Initiatives:  The Pradhan Mantri Jan Dhan Yojana (PMJDY) launched in 2014 aimed to provide universal access to banking services, especially for the unbanked population, by opening zero-balance accounts. Regulatory Developments:  The Insolvency and Bankruptcy Code (IBC) of 2016 provided a framework for resolving corporate insolvency.  The Financial Stability and Development Council (FSDC) was set up to strengthen financial regulation and supervision. Emergence of New Institutions:  Small Finance Banks and Payments Banks were introduced to promote financial inclusion and cater to small businesses and low-income households. Challenges and Reforms:  Non-Performing Assets (NPAs) became a significant challenge, leading to measures for better asset quality and risk management.  Efforts to strengthen the regulatory framework and enhance governance have been ongoing to address issues like fraud, systemic risk, and customer protection. Challenges of Financial System 1. Regulatory and compliance issues 2. Banking sector challenges 3. Technological and digital transformation 4. Economic and market crisis 5. Financial inclusion and access 6. Capital market and investment 7. Sustainable finance  1. Regulatory and Compliance Issues  Complex Regulatory Framework: India’s financial system is governed by multiple regulators such as the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), and Insurance Regulatory and Development Authority of India (IRDAI), leading to overlapping and sometimes conflicting regulations.  Compliance Burden: Frequent changes in regulations increase compliance costs and operational complexities for financial institutions.  Regulatory Arbitrage: Differences in regulations across sectors can lead to regulatory arbitrage, where entities exploit regulatory gaps. 2. Banking Sector Challenges  Non-Performing Assets (NPAs): High levels of NPAs remain a significant issue, affecting banks' profitability and their ability to lend. As of recent estimates, NPAs in public sector banks are particularly concerning.  Public Sector Bank Reforms: Many public sector banks face issues related to governance, operational inefficiency, and the need for recapitalization.  Financial Inclusion: Despite efforts, large segments of the rural population remain outside the formal banking system, hindering financial inclusion. 3. Technological and Digital Transformation  Legacy Systems: Many financial institutions rely on outdated technology, making it difficult to adopt new digital solutions and maintain cybersecurity.  Cybersecurity Threats: Increasing digitization exposes the financial system to cyber threats and data breaches, necessitating robust cybersecurity measures.  Fintech Disruption: The rapid growth of fintech companies poses competitive challenges to traditional banks but also drives innovation in financial services. 4. Economic and Market Risks  Economic Volatility: Fluctuations in economic growth, inflation, and interest rates create uncertainties for financial planning and stability.  Credit Risk: Economic downturns and sectoral slowdowns, like in real estate or agriculture, lead to increased credit risk and potential defaults.  Liquidity Issues: Periodic liquidity crunches in the market can strain the financial system, affecting credit availability and overall financial stability. 5. Financial Inclusion and Access  Rural Banking Challenges: Reaching the rural population remains challenging due to inadequate infrastructure, low financial literacy, and higher costs of operation.  Digital Divide: The gap in digital access and literacy between urban and rural areas limits the reach of digital financial services.  6. Capital Markets and Investment  Market Depth and Liquidity: Indian capital markets are relatively shallow compared to global standards, with lower liquidity and fewer diverse investment instruments.  Corporate Governance: Weak corporate governance practices in some sectors affect investor confidence and market integrity.  Foreign Investment: Regulatory hurdles and market volatility can deter foreign investment, impacting market growth and stability. 7. Sustainable Finance  Environmental Risks: The financial system needs to integrate environmental risks into decision-making processes to support sustainable development.  ESG Criteria: Incorporating Environmental, Social, and Governance (ESG) criteria into lending and investment practices is still in the nascent stages, requiring more robust frameworks and incentives. Role and Importance of financial system in economic development: Following points indicate the role and importance of financial system: 1. 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. 2. It helps to monitor corporate performance. 3. It provides a mechanism for managing uncertainty and controlling risk. 4. It provides a mechanism for the transfer of resources across geographical boundaries. 5. It offers portfolio adjustment facilities (provided by financial markets and financial intermediaries). 6. It helps in lowering the transaction costs and increase returns. This will motivate people to save more. It promotes the process of capital formation. 8. 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. Components of Financial system 1. Financial market: A Financial Market is referred to space, where selling and buying of financial assets and securities take place. It allocates limited resources in the nation’s economy. It serves as an agent between the investors and collector by mobilising capital between them. In a financial market, the stock market allows investors to purchase and trade publicly companies share. The issue of new stocks are first offered in the primary stock market, and stock securities trading happens in the secondary market. 2. Financial instruments: A financial instrument is an agreement between two parties with monetary value. In other words, any asset that holds capital and which can be traded is a financial instrument. It is noteworthy that financial instruments can be palpable or virtual documents representing a legal agreement of any monetary value.Some examples of  financial instruments include life insurance policies, shares, bonds, stocks, SIPs, etc. Now, let us understand more about the different types of financial instruments that are popular in India. 3. Financial services: In general, all types of activities which are of financial nature may be regarded as financial services. In a broad sense, the term financial services means mobilisation and allocation of savings. Thus, it includes all activities involved in the transformation of savings into investment. Financial services refer to services provided by the finance industry. The finance industry consists of a broad range of organisations that deal with the management of money. These organisations include banks, credit card companies, insurance companies, consumer finance companies, stock brokers, investment funds and some government sponsored enterprises. Financial services may be defined as the products and services offered by financial institutions for the facilitation of various financial transactions and other related activities. Financial services can also be called financial intermediation. Financial intermediation is a process by which funds are mobilised from a large number of savers and make them available to all those who are in need of it and particularly to corporate customers. There are various institutions which render financial services. Some of the institutions are banks, investment companies, accounting firms, financial institutions, merchant banks, leasing companies, venture capital companies, factoring companies, mutual funds etc. These institutions provide variety of services to corporate enterprises. Such services are called financial services. Thus, services rendered by financial service organisations to industrial enterprises and to ultimate consumer markets are called financial services. These are the services and facilities required for the smooth operation of the financial markets. In short, services provided by financial intermediaries are called financial services. 4. Financial regulators: A system of checks and balances helps keep the stability of our financial markets. In charge of the system are various regulating bodies, known as financial regulators. Financial Regulatory Bodies are the public authorities or government agency that is responsible for exercising autonomous authority over specific areas. Wherein, individuals are engaged in any activity, supervisory, or regulatory capacity. Financial Regulatory Bodies is hence a crucial topic for general banking awareness preparation of various competitive exams. Different financial regulatory agencies set up the regulatory framework of the Indian financial system. They are entrusted with the responsibility to ensure equality and responsibility among the participants in that specific financial domain. Each financial regulator plays a key role in making sure that the interests of the investors and all other stakeholders are not adversely affected and that there is fairness in the financial system of the country.The major financial regulators of banks and financial institutions in India are the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Insurance Regulatory and Development Authority (IRDA), Pension Funds Regulatory and Development Authority (PFRDA), and Ministry of Corporate Affairs (MCA) Overview of Financial Institutions Meaning: Financial institutions are organizations that provide financial services to their clients. These include banks, credit unions, insurance companies, brokerage firms, and asset management companies. Financial institutions are also termed as financial intermediaries because they act as an intermediary between savers by accumulating funds from them and  borrowers by lending these funds. They play a crucial economic role by facilitating monetary transactions, lending, investment, and risk management thereby fostering economic growth and financial stability. Functions of financial institutions Financial institutions perform several key functions essential to the economy and financial system. Here are the primary functions of financial institutions: 1. Intermediation Financial institutions act as intermediaries between savers and borrowers. They collect funds from individuals and businesses as deposits and then lend them to borrowers who need capital for various purposes, such as starting a business or purchasing a home. 2. Depository Services Financial institutions provide depository services by accepting deposits from individuals and businesses. They offer checking accounts, savings accounts, and other deposit products where customers can securely store their money. These deposits may also earn interest. 3. Credit Provision Financial institutions extend credit to individuals and businesses through loans and credit lines. They evaluate the creditworthiness of borrowers, determine interest rates, and provide financial support for various needs, such as personal loans, mortgages, business loans, and working capital. 4. Investment Services Financial institutions offer investment services to help individuals and businesses manage and grow wealth. They provide access to investment products such as stocks, bonds, mutual funds, and other securities. They also offer advisory services to guide clients in making informed investment decisions. 5. Risk Management Financial institutions assist individuals and businesses in managing financial risks. They provide insurance products, such as life insurance, health insurance, property insurance, and liability insurance, to protect against potential losses and unforeseen events. 6. Payment and Settlement Services Financial institutions facilitate payment transactions between individuals and businesses. They provide payment and settlement services such as processing electronic fund transfers, issuing credit and debit cards, and managing payment systems to enable smooth and secure transactions. 7. Asset Management Financial institutions offer asset management services, where they manage investment portfolios on behalf of clients. They provide expertise in selecting investment options, diversifying portfolios, and monitoring market conditions to optimize returns and meet clients’ financial goals. 8. Financial Advisory Financial institutions provide financial advisory services to individuals and businesses. They offer guidance on financial planning, retirement planning, tax planning, estate planning, and overall wealth management. They assist clients in making informed financial decisions based on their goals and risk tolerance. Importance of Financial institutions in the economy Financial institutions are the key institutions which provide fund for economic activities. There are many advantages for having sound and healthy financial institutions in a country. The importance of financial institutions is as follows: 1. Provide funds: financial institutions provide funds for the investment and industrial activities. 2. Infrastructural facilities: financial institutions also offer basic infrastructural facilities needed for the development and promotion of lucrative ventures. Infrastructural facilities involve development of industrial estates tech parks, road and water etc. 3. Promotional activities: promotional activities are undertaken by the financial institutions to mobilize the funds, reduce the risk of selling financial securities, arrangement of working and long-term capital of the business. 4. Development of backward areas: apart from the financial activities, financial institutions also take some social responsibilities of developing the backward areas at free of cost by offering credit facilities, free education, employment creation etc. 5. Planned development: financial institutions initiate all planned developments in the view of economic growth of the state. All planned developments are coordinated with the government plan and social welfare. 6. Accelerating industrialization: since the financial institutions are established to earn the profit and safeguard interest of its members, they accelerate the industrialization to contribute industrial growth. They support industries by granting finance, project development and consultancy. 7. Employment generation: channelizing the funds for investment, building of infrastructural facilities, and acceleration of industries generates employment to the educated and qualified people of the state. 8. Mobilizing Savings: One of the most important functions of financial institutions is to mobilize savings. Financial institutions accept deposits from individuals and businesses and use those funds to provide loans and other financial services. This helps to channel savings into productive investments, which can help to stimulate economic growth. 9. Managing risk: Financial institutions also play a vital role in managing risk. This includes managing credit risk, market risk, and operational risk. Financial institutions use a range of tools and techniques to manage risk, including diversification, hedging, and risk management systems. This helps to ensure the stability of the financial system and protect investors and depositors. 10. Financial advice: financial institutions also provide financial advice to individuals and businesses. This includes advice on investments, retirement planning, and other financial matters. Financial institutions have a wealth of expertise and resources that they can share with their clients to help them make informed financial decisions. Classification of financial institutions The financial institutions are classified into- banking and non-banking institutions. Banking Institutions: These are the type of financial institutions which involve in accepting public deposits and lending the same to the needy customers. These are primarily established to earn profit, secondarily to safeguard the interest of the members. The banking institutions ensure that deposits accumulated from people are productively utilized. The following are the types of banking institutions which are running their business in India. A) Commercial banks: These are also called as business banks. The following are the types of commercial banks. i. Public sector. ii. Private sector. iii. Regional Rural Banks (RRB`s) iv. Foreign banks. B) Cooperative Banks: These are established to safeguard the interest of its members. These are organized on a co-operative basis, accept deposits and lend money to the required members. Non-banking Institutions: These are the financial institutions that provide banking services without meeting the legal definition of a bank. The non-banking financial institutions also mobilize financial resources directly or indirectly from the people. They lend the financial resources mobilized. The non-banking institutions are classified into: i) organized financial institutions. ii) unorganized financial institutions The following are examples of non-banking institutions: ii. Provident and pension fund. iii. Small Saving organization. iv. Life Insurance Corporation (LIC). v. General Insurance Corporation (GIC). vi.Unit Trust of India (UTI). vii. Mutual funds. viii. Investment Trust, etc. Non-banking financial institutions can also be categorized as investment companies housing companies, leasing companies, hire purchase companies, specialized financial institutions (EXIM Bank), Investment Institutions, State level institutions etc. ************************************************************* Sample Questions A) Answer the following questions 1. Explain the role played by Indian financial system in economic development of the country. 2. Explain the following concepts a) Financial Markets b) Financial Services c) Financial Institutions d) Financial Instruments 3. Briefly explain the structure of Financial System. 4. Discuss the evolution of financial institutions in India. 5. Explain the functions of financial institutions. B) Choose the correct option and fill in the blanks: 1. ___________type of deposits earns higher interest rate. a. current account b. savings account c. FD account d. recurring account 2. ______________allocates efficient saving in an economy to public either for investment or for consumption a. economic system b. financial system c. banking system d. market system 3. ______________is not a regulatory institution in the Indian financial system. a. RBI b. SEBI c. IRDAI d. CARE 4. All financial intermediary institutions in the intermediation market __________ a. Buy primary securities and sell secondary securities b. Borrow short and lend long c. Borrow in small denominations and lend in large d. Buy from brokers and dealers and sell to the public 5. Currency notes are issued by __________ a. RBI b. NABARD c. Commercial banks d. Central government ********************************************************  Unit 2- Banking Institutions COURSE OUTCOME: Analyze the structure and operations of Financial Institutions Banks and financial institutions play a crucial role in economic growth by providing a range of financial services that support economic activities, such as borrowing and lending, investing, and savings. Access to banking is essential for financial inclusion, which is the process of providing everyone, regardless of their income level, with access to basic financial services such as savings accounts, credit, and insurance. Meaning: Banking financial institutions are engaged in the business of accepting deposits from the public and advancing loans. In addition, they provide other services such as investment banking, foreign exchange, and safe deposit facility. These institutions are stringently regulated by government / RBI to protect consumers interest and ensure that the banking system is stable. Definitions: 1. Bank is a financial intermediary institution which deals in loans and advances” - Cairn Cross. 2. “Bank is an institution which collects idle money temporarily from the public and lends to other people as per need.”- R.P. Kent. 3. “Bank provides service to its clients and in turn receives perquisites in different forms.”- P.A. Samuelson. 4. “Bank is such an institution which creates money by money only.”-W. Hock. 5. “Bank is such a financial institution which collects money in current, savings or fixed deposit account; collects cheques as deposits and pays money from the depositors‟ account through cheques.”-Sir John Pagette. 6. Indian Company Law 1936 defines Bank as “a banking company which receives deposits through current account or any other forms and allows withdrawal through cheques or promissory notes.” Structure of Banking Institutions The banking system plays an important role in promoting economic growth not only by converting savings into investments but also by improving efficient allocation of resources. Through mobilization of resources and their better allocation, banks play an important role in the development process of underdeveloped countries. An efficient banking system is regarded as a necessary precondition for economic growth. The banking system of India consists of the RBI, commercial banks, cooperative banks and development banks (development finance institutions). Banks that are included in the second schedule of the Reserve Bank of India Act, 1934 are considered to be scheduled banks. All scheduled banks enjoy the following facilities:  Such a bank becomes eligible for debts/loans on bank rate from the RBI  Such a bank automatically acquires the membership of a clearing house. All banks which are not included in the second section of the Reserve Bank of India Act, 1934 are Non-scheduled Banks. They are not eligible to borrow from the RBI for normal banking purposes except for emergencies. Scheduled banks are further divided into commercial and cooperative banks. A) Commercial Banks: The institutions that accept deposits from the general public and advance loans with the purpose of earning profits are known as Commercial Banks. Commercial banks can be broadly divided into public sector, private sector, foreign banks and RRBs.  In Public Sector Banks the majority stake is held by the government. An example of Public Sector Bank is State Bank of India.  Private Sector Banks are banks where the major stakes in the equity are owned by private stakeholders or business houses. A few major private sector banks in India are HDFC Bank, Kotak Mahindra Bank, ICICI Bank etc. Commercial bank Meaning: 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. They generally finance trade and commerce with short-term loans. They charge high rate of interest from the borrowers but pay much less rate of Interest to their depositors with the result that the difference between the two rates of interest becomes the main source of profit of the banks. Functions of Commercial Banks 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). 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. (A) Primary Functions: 1. It accepts deposits: A commercial bank accepts deposits in the form of current, savings and fixed deposits. It collects the surplus balances of the Individuals, firms and finances the temporary needs of commercial transactions. The first task is, therefore, the collection of the savings of the public. The bank does this by accepting deposits from its customers. Deposits are the lifeline of banks. Deposits are of three types as under: (a) Current account deposits: Such deposits are payable on demand and are, therefore, called demand deposits. These can be withdrawn by the depositors any number of times depending upon the balance in the account. The bank does not pay any Interest on these deposits but provides cheque facilities. These accounts are generally maintained by businessmen and Industrialists who receive and make business payments of large amounts through cheques. (b) Fixed deposits (Time deposits): Fixed deposits have a fixed period of maturity and are referred to as time deposits. These are deposits for a fixed term, i.e., period of time ranging from a few days to a few years. These are neither payable on demand nor they enjoy cheque facilities. They can be withdrawn only after the maturity of the specified fixed period. They carry higher rate of interest. They are not treated as a part of money supply Recurring deposit in which a regular deposit of an agreed sum is made is also a variant of fixed deposits. (c) Savings account deposits: These are deposits whose main objective is to save. Savings account is most suitable for individual households. They combine the features of both current account and fixed deposits. They are payable on demand and also withdrawable by cheque. Interest paid on savings account deposits in lesser than that of fixed deposit. 2. It gives loans and advances: The second major function of a commercial bank is to give loans and advances particularly to businessmen and entrepreneurs and thereby earn interest. This is the main source of income of the bank. A bank keeps a certain portion of the deposits with itself as reserve and gives (lends) the balance to the borrowers as loans and advances in the form of cash credit, demand loans, short-run loans, overdraft as explained under. (a) Cash Credit: An eligible borrower is first sanctioned a credit limit and within that limit he is allowed to withdraw a certain amount on a given security. The withdrawing power depends upon the borrower’s current assets, the stock statement of which is submitted by him to the bank as the basis of security. Interest is charged by the bank on the drawn or utilized portion of credit (loan). (b) Demand Loans: A loan which can be recalled on demand is called demand loan. There is no stated maturity. The entire loan amount is paid in lump sum by crediting it to the loan account of the borrower. Those like security brokers whose credit needs fluctuate generally, take such loans on personal security and financial assets. (c) Short-term Loans: Short-term loans are given against some security as personal loans to finance working capital or as priority sector advances. The entire amount is repaid either in one instalment or in a number of instalments over the period of loan. (B) Secondary Functions: Apart from the above-mentioned two primary (major) functions, commercial banks perform the following secondary functions also. 1.Discounting bills of exchange or bundles: A bill of exchange represents a promise to pay a fixed amount of money at a specific point of time in future. It can also be encashed earlier through discounting process of a commercial bank. Alternatively, a bill of exchange is a document acknowledging an amount of money owed in consideration of goods received. 2. Overdraft facility: An overdraft is an advance given by allowing a customer keeping current account to overdraw his current account up to an agreed limit. It is a facility to a depositor for overdrawing the amount than the balance amount in his account. (C) Agency functions of the bank: The bank acts as an agent of its customers and gets commission for performing agency functions as under: 1. Transfer of funds: It provides facility for cheap and easy remittance of funds from place- to-place through demand drafts, mail transfers, telegraphic transfers, etc. 2. Collection of funds: It collects funds through cheques, bills, bundles and demand drafts on behalf of its customers. 3. It makes payment of taxes. Insurance premium, bills, etc. as per the directions of its customers. 4. Purchase and sale of shares and securities: It buys sells and keeps in safe custody securities and shares on behalf of its customers. 5. Collection of dividends, interest on shares and debentures is made on behalf of its customers. 6. Acts as Trustee and Executor of property of its customers on advice of its customers. 7. Letters of References: It gives information about economic position of its customers to traders and provides similar information about other traders to its customers. (D)General utility services: The banks provide many general utility services, some of which are as under: 1. Traveller’s cheques: The banks issue traveller’s cheques and gift cheques. 2. Locker facility: The customers can keep their ornaments and important documents in lockers for safe custody.  3. Underwriting securities issued by government, public or private bodies. 4. Purchase and sale of foreign exchange (currency). Significance of Commercial Banks: Commercial banks play such an important role in the economic development of a country that modern industrial economy cannot exist without them. They constitute nerve centre of production, trade and industry of a country. The following points highlight the significance of commercial banks: (I) They promote savings and accelerate the rate of capital formation. (II) They are source of finance and credit for trade and industry. (III) They promote balanced regional development by opening branches in backward areas. (IV) Bank credit enables entrepreneurs to innovate and invest which accelerates the process of economic development. (V) They help in promoting large-scale production and growth of priority sectors such as agriculture, small-scale industry, retail trade and export. (VI) They create credit in the sense that they are able to give more loans and advances than the cash position of the depositor’s permits. (VII) They help commerce and industry to expand their field of operation. (VIII) Thus, they make optimum utilization of resources possible. Cooperative Banks A Cooperative Bank is a financial entity that belongs to its members, who are also the owners as well as the customers of their bank. They provide their members with numerous banking and financial services. Cooperative banks are the primary supporters of agricultural activities, some small-scale industries and self-employed workers. An example of a Cooperative Bank in India is Mehsana Urban Co-operative Bank. At the ground level, individuals come together to form a Credit Co-operative Society. The individuals in the society include an association of borrowers and non-borrowers residing in a particular locality and taking interest in the business affairs of one another. As membership is practically open to all inhabitants of a locality, people of different status are brought together into the common organization. All the societies in an area come together to form a Central Cooperative Banks. Meaning: Cooperative bank is an institution established on the cooperative basis and dealing in ordinary banking business. Like other banks, the cooperative banks are founded by collecting funds through shares, accept deposits and grant loans. Types of Co-operative Banks: There are three types of co-operative banks operating in our country. They are primary credit societies, central co-operative banks and state co-operative banks. These banks are organized at three levels, village or town level, district level and state level. (i) Primary Credit Societies: These are formed at the village or town level with borrower and non-borrower members residing in one locality. The operations of each society are restricted to a small area so that the members know each other and are able to watch over the activities of all members to prevent frauds. (ii) Central Co-operative Banks: These banks operate at the district level having some of the primary credit societies belonging to the same district as their members. These banks provide loans to their members (i.e., primary credit societies) and function as a link between the primary credit societies and state co-operative banks. (iii) State Co-operative Banks: These are the apex (highest level) cooperative banks in all the states of the country. They mobilise funds and help in its proper channelization among various sectors. The money reaches the individual borrowers from the state co-operative banks through the central co-operative banks and the primary credit societies. Importance of Cooperative Banks: The cooperative banking system has to play a critical role in promoting rural finance and is especially suited to Indian conditions. Various advantages of cooperative credit institutions are given below: 1. Alternative Credit Source: The main objective of cooperative credit movement is to provide an effective alternative to the traditional defective credit system of the village money lender. The cooperative banks tend to protect the rural population from the clutches of money lenders. The money lenders have so far dominated the rural areas and have been exploiting the poor people by charging very high rates of interest and manipulating accounts. 2. Cheap Rural Credit: Cooperative credit system has cheapened the rural credit both directly as well as indirectly: (a) Directly, because the cooperative societies charge comparatively low interest rates, and (b) Indirectly, because the presence of cooperative societies as an alternative agency has broken money lender’s monopoly, thereby enforcing him to reduce the rate of interest. 3. Productive Borrowing: An important benefit of cooperative credit system is to bring a change in the nature of loans. Previously the cultivators used to borrow for consumption and other unproductive purposes. But, now, they mostly borrow for productive purposes. Cooperative societies discourage unproductive borrowing. 4. Encouragement to Saving and Investment: Cooperative credit movement has encouraged saving and investment by developing the habits of thrift among the agriculturists. Instead of hoarding money the rural people tend to deposit their savings in the cooperative or other banking institutions. 5. Improvement in Farming Methods: Cooperative societies have also greatly helped in the introduction of better agricultural methods. Cooperative credit is available for purchasing improved seeds, chemical fertilizers, modern implements, etc. The marketing and processing societies have helped the members to purchase their inputs cheaply and sell their produce at good prices.  Development Banks Financial institutions that provide long-term credit in order to support capital intensive investments spread over a long period and yielding low rates of return with considerable social benefits are known as Development Banks. The major development banks in India are; Industrial Finance Corporation of India (IFCI Ltd), 1948, Industrial Development Bank of India' (IDBI) 1964, Export-Import Banks of India (EXIM) 1982, Small Industries Development Bank of India (SIDBI) 1989, National Bank for Agriculture and Rural Development (NABARD) 1982. (i) Export Import Bank of India (EXIM Bank): If you want to set up a business for exporting products abroad or importing products from foreign countries for sale in our country, EXIM bank can provide you the required support and assistance. The bank grants loans to expo The bank grants loans to exporters and importers and also provides information about the international market. It gives guidance about the opportunities for export or import, the risks involved in it and the competition to be faced, etc. (ii) Small Industries Development Bank of India (SIDBI): If you want to establish a small- scale business unit or industry, loan on easy terms can be available through SIDBI. It also finances modernisation of small-scale industrial units, use of new technology and market activities. The aim and focus of SIDBI is to promote, finance and develop small-scale industries. (iii) National Bank for Agricultural and Rural Development (NABARD): It is a central or apex institution for financing agricultural and rural sectors. If a person is engaged in agriculture or other activities like handloom weaving, fishing, etc. NABARD can provide credit, both short-term and long-term, through regional rural banks. It provides financial assistance, especially, to co-operative credit, in the field of agriculture, small-scale industries, cottage and village industries handicrafts and allied economic activities in rural areas. The banking system of a country has the capability to heavily influence the development of a country’s economy. The organized financial system comprises Commercial Banks, Regional Rural Banks (RRBs), Urban Co-operative Banks, Primary Agricultural Credit Societies, etc. caters to the financial service requirement of the people. The initiatives taken by the Reserve Bank and the Government of India in order to promote financial inclusion have considerably improved the access to the formal financial institutions. Thus, the banking system of a country is very significant not only for economic growth but also for promoting economic equality. Regional Rural Banks In India, Regional Rural Banks (RRBS) was established with a view to supplement the efforts of the commercial banks and the co-operative societies in extending credit to weaker sections of the rural community i.e. small and marginal farmers, landless labourers, artisans and other rural residents of small means. Based upon the recommendations of the working group on Rural Banks, 5 RRBs were initially set up in 1975. Objectives and Functions of Regional Rural Banks The major functions and objectives of RRBs are as under: 1. To grant loans and advances to the weaker sections of the rural population specially to the small and marginal farmers, agricultural labourers, artisans and small entrepreneurs who are engaged in agriculture, trade, commerce, industry and other productive activities. 2. To grant loans and advances to co-operative societies, including marketing societies, agricultural processing societies, cooperative farming societies, primary agriculture credit societies or farmers service societies for agricultural purpose. 3. To take banking services to the doorsteps of the rural masses, particularly in hitherto unbanked rural areas. 4. To mobilize rural savings by accepting deposits and channelizing them for productive activities in the rural areas. 5. To create a supplementary channel for flow of credit from the urban money market to the rural areas. 6. To generate employment opportunities in rural areas. 7. To bring down the cost of supplying credit in rural areas. Payment Banks Definition: 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. It can accept demand deposits (up to Rs 1 lakh), offer remittance services, mobile payments/transfers/purchases and other banking services like ATM/debit cards, net banking and third party fund transfers. Description: In September 2013, the Reserve Bank of India constituted a committee headed by Dr Nachiket Mor to study 'Comprehensive financial services for small businesses and low income households'. The objective of the committee was to propose measures for achieving financial inclusion and increased access to financial services. The committee submitted its report to RBI in January 2014. One of the key suggestions of the committee was to introduce specialised banks or ‘payments bank’ to cater to the lower income groups and small businesses so that by January 1, 2016 each Indian resident can have a global bank account. The main objective of payments bank: 1. To widen the spread of payment and financial services to small business, low-income households, migrant labour workforce in secured technology-driven environment. 2. With payments banks, RBI seeks to increase the penetration level of financial services to the remote areas of the country. 3. Specialize in providing basic banking services such as savings accounts, payments, and remittances.  Features of Payment Banks 1. Not permitted to open fixed or recurring deposits. 2. Limited to accept deposits up to a maximum of 1 lakh rupees per customer. 3. Not permitted to issue loans or credit cards. 4. Offer interest rates on savings accounts comparable to those offered by regular banks. ********************************************************************** Sample Questions: A. Answer the following questions: 1. Define the term ‘Bank’. 2. What is meant by ‘Banking’? 3. Give two examples each of (a) Private Sector Commercial Banks; and (b) Foreign Banks, in India. 4. Give any four secondary functions of a commercial bank. 5. Explain the primary functions of a commercial bank. 6. Describe the functions performed by a commercial bank. 7. What is meant by co-operative bank? Explain the types of co-operative banks in India. B. Choose the correct answer from the given options 1. Bank does not give loan against _____________. a) Gold Ornaments b) LIC policy c) Lottery ticket d) NSC 2. _____________ has maximum number of branches in India. a) Reserve Bank of India b) State Bank of India c) Punjab National Bank d) Bank of Baroda. 3. Current deposit is also known as ______________. a) Savings deposit b) demand deposit c) time deposit d) recurring deposit 4. ____________deposits are repayable after the expiry of the fixed period. a) demand deposit b) time deposit c) savings deposit d) recurring deposit 5. _____________is a credit facility granted by commercial banks to current account holders. a) Cash credit b) overdraft c) discounting of BOE d) demand loans  Unit 3- Non-Banking and Developmental Financial Institutions COURSE OUTCOME: Analyze the structure and operations of Financial Institutions An Overview of NBFC’s: Financial Institutions can be classified as banking and non-banking financial institutions. Banking institutions are formulator as well as supplier of credit, while non- banking financial institutions are only supplier of credit. A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 / Companies Act 2013 involved in dealing with loans and advances, acquisition of securities issued by the Government or local authority, hire purchase, leasing, insurance services, and chit fund business. But the activity of NBFCs does not include agricultural activity, industrial activity, trading of any goods and transfer of immovable property. The functions of NBFCs are categorically restricted as per the guidelines of the Reserve Bank of India. These functions include those of hire-purchase financing companies, equipment leasing companies, and loan or mutual benefit financial companies but do not include an insurance company, a stock exchange, a stock broking company and a merchant banking company. Section 45-I (b) of third chapter of Reserve Bank of India Act 1934, defines a Non-Banking Financial Company as: (a) a financial institution, which is a company, (b) a financial institution company, having its principal business of accepting deposits under any scheme of arrangement or advancing and financing in any manner, (c) any other institution that may function as banks with the previous approval of Central Government and notification in this regard in the official gazette. NBFCs are performing functions similar in nature to that of banks; however, there are certain differences between these two that are as follows: 1. a NBFC cannot accept demand deposits 2. a NBFC is not a part of the payment and settlement system. 3. as such a NBFC cannot issue any payment order, like a Banker’s Cheque issued by a Commercial bank 4. unlike banks Deposit Insurance offered by Credit Guarantee Corporation is not applicable for the depositors of a NBFC. Examples of NBFCs include investment banks, mortgage lenders, money market funds, insurance companies, equipment leasing companies, infrastructure finance companies, hedge funds, private equity funds, and P2P lenders.  The activities of NBFCs are in many cases similar to those of the commercial banks and other financial institutions which are involved in the financing business.  Basically NBFCs act as an intermediary between the final depositors and the final borrowers. The rationale of the existence of NBFCs is derived from the concept of saving of surplus and earnings from the same and deficit if any can be financed by sacrifice of some additional payments in respect to the unorganised sector.  To balance between these two in an organised manner is the main objective of the NBFCs. NBFCs generally grant loans for transport, acquisition of durable consumer goods, trading, purchase of houses, repair of houses, and purchase of household consumption goods.  The activities of NBFCs are not extensively managed by monetary authorities, so the credit extended by these institutions may not necessarily be in accordance with the unorganised sectors’ needs and priorities.  The major function of these financial intermediaries is to shift the savings of surplus units to deficit units in micro perspective and unreached areas of commercial banks. Hence, these institutions can play a vital role in the economy of the country for financing in a small scale.  Basically the activities of these institutions can help in monetizing the financing stream of economy and transferring unproductive financial assets into productive assets.  The NBFCs can contribute through their financing schemes in the country’s urban economic development. The expert committees of RBI recognized the need of NBFCs in the following areas:  Development and control of transport and infrastructure sectors.  Substantial employment generation  Sustainable increase in wealth creation.  Economic development in the county in a broad perspective.  Distinctive supplement to the conventional bank credit in rural segments.  Major driving force in semi-urban, rural areas, and new entrant buyers and users.  Need based finance in the economically weaker sections of the country.  Significant contribution to the state specific sustainable development in the country. The Role of NBFC's in the Financial Ecosystem: 1. Bridging the Credit Gap: NBFCs help to fill the credit gap by providing loans, banker’s acceptances, and other services to those who cannot access bank services. In this way, NBFCs help in the generation of wealth  and extension of credit to the corporate houses, unincorporated retail traders, and local small business borrowers in addition to the structured credit market. 2. Supporting MSMEs and Start-ups: MSMEs and start-ups are two promising segments that play a crucial role in the Indian economy. Among these enterprises, those that cannot obtain funding from commercial banks can turn to NBFCs that offer the same service. This support improves the business capacity, creates employment opportunities and boosts the economy. 3. Infrastructure Development: They have the major role of providing funds for large infrastructure projects which are very crucial in the development of a country. As opposed to the conventional banking systems that avoid high-risk, long-term investment, NBFCs provide the funding needed for infrastructure creation and, consequently, economic progress. Importance of NBFCS in Economic Growth: 1. Promoting Inclusive Growth: NBFCs are involved in offering credit facilities to both the urban and the rural clientele for the development of the economy. It helps micro-businesses and build low-cost houses, promoting the economic growth of the countryside, and providing microcredit for women. 2. Enhancing Financial Market Stability: Being able to manage various risks and also operate as strong financial intermediaries, NBFCs have a significant impact on the stability of the financial market. They offer product and service differentiation which assists in reducing the risks and enhancing the stability of the financial system. 3. Job Creation and Economic Development: NBFCs help in the growth of small scale industries and trading companies which in turn leads to the creation of more employment opportunities and thereby enhancing the standards of living and thus the economic growth. 4. Mobilization of Resources: In return, NBFCs provide higher deposit rates and mobilize the public’s savings, turning it into investments. This capital deployment fosters the growth of trade and industries, which are key players in the economic transformation process. Types of NBFC’s NBFCs registered with RBI are categorized as follows: (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 (those with asset size of Rs500 crs or more) (NBFC NDSI) and non-deposit taking non- systemically important (those with asset size of less than Rs500 crs). NBFCs whose asset size is ₹500 crore or more as per the last audited balance sheet are considered systemically important NBFCs. The rationale for such classification is that the activities of such NBFCs will have a bearing on the financial stability of the overall economy. (c) by the kind of activities they conduct the different types of NBFCs are as follows: The different types of NBFC's are: 1. Investment companies (IC): IC means any company that is a financial institution carrying on as its principal business the acquisition of securities. 2. Loan companies (LC): LC means any company that is a financial institution carrying on as its principal business the providing of finance, whether by making loans or advances or otherwise, for any activity other than its own but does not include an Asset Finance Company. 3. Asset Finance companies: An AFC is a company that is a financial institution carrying on as its principal business the financing of physical assets supporting productive/economic activity, such as automobiles, tractors, generator sets, earth moving and material handling equipment, moving on own power and general purpose industrial machines. Principal business for this purpose is defined as the aggregate of financing tangible/physical assets supporting economic activity. The income arising therefrom is at least 60% of its total assets and revenue. 4. Systematically Important Core Investment companies (CIC-ND-SI): A CIC-ND-SI is a Non-Banking Financial Company (i) with asset size of Rs 100 crore and above (ii) carrying on the business of acquisition of shares and securities and which satisfies the following conditions as on the date of the last audited balance sheet :- (iii) it holds not less than 90% of its net assets in the form of investment in equity shares, preference shares, bonds, debentures, debt or loans in group companies; (iv) its investments in the equity shares (including instruments compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issue) in group companies constitutes not less than 60% of its net assets as mentioned in clause (iii) above; (v) it does not trade in its investments in shares, bonds, debentures, debt or loans in group companies except through block sale for the purpose of dilution or disinvestment; (vi) it does not carry on any other financial activity referred to in Section 45I(c) and 45I(f) of the RBI act, 1934 except investment in bank deposits, money market instruments, government securities, loans to and investments in debt issuances of group companies or guarantees issued on behalf of group companies. (vii) it accepts public funds 5. Infrastructure Finance companies (IFC): IFC is a non-banking finance company a) which deploys at least 75 percent of its total assets in infrastructure loans, b) has a minimum Net Owned Funds of 300 crore, c) has a minimum credit rating of ‘A ‘or equivalent d) and a CRAR of 15%. 6.Micro Finance companies (NBFC-MFI): Such institutions provide short term credit facilities to low income groups. An NBFC can be categorised as an NBFC-MFI subject to the following conditions:  A minimum of 85% of the assets of such an institutions in the form of microfinance  Such microfinance shall be provided subject to the following conditions  In rural areas loand should be given to people with an income of Rs. 60000/-  In urban areas loans should be given to peole with an income of Rs. 120000/-  Such loans should not exceed Rs.50000/-  The term of such loans should not be less than 24 months.  Such loans should be given without collaterals.  The borrowers should be given the choice of payment on a weekly, fortnightly or monthly basis. 7. Mortgage Guarantee companies (MGC): MGC are financial institutions for which at least 90% of the business turnover is mortgage guarantee business or at least 90% of the gross income is from mortgage guarantee business and the net owned fund is 100 crores. 8. Housing Finance companies (HFC): Housing Finance Companies are corporate entities that operate under the Companies Act of 1956. Their primary focus is providing housing loans or  finance through various direct or indirect means. While they were initially regulated by the National Housing Bank (NHB), the responsibility of handling HFCs was transferred to the Reserve Bank of India (RBI) in 2019. However, certain regulatory powers remain with the NHB. The introduction of HFCs aimed to ease the growing demand for housing loans and give credit access to different income groups. Currently, HFCs disburse a more significant number of home loans compared to banks, primarily due to their greater flexibility. Difference between a bank and a NBFC- Banks NBFCs Banks are incorporated under the NBFCs are incorporated under the Companies Act of 1956. Banking Regulations Act of 1949. They need a full banking license to They need a limited/ no banking license for operation. operate. They offer services like checking They offer services similar to banks, excluding demand accounts, savings accounts, debit cards, drafts, checking accounts, and debit cards. loans, investments, etc. They have a broad customer base. They can cater to niche markets or underserved segments. They have more stringent regulations. They have varied regulations compared to the banks. They are mostly private or government- They can be private companies, government-owned, or joint owned. ventures. Regulation and Supervision of NBFC’s: Scale-based framework – the revised regulatory framework for NBFCs. Non-Banking Financial Companies (NBFCs) have increasingly been playing a significant role in financial intermediation by complementing and competing with banks, and by bringing in efficiency and diversity into the financial ecosystem. NBFCs enjoy greater operational flexibility to take up wider scale of activities, enter into new geographies and sectors and thus grow their operations. This is mainly due to less stringent regulatory provisions applicable to NBFCs as compared to banks (often referred to as the regulatory arbitrage in favour of NBFCs). Over the years, the NBFC sector has evidenced tremendous growth. However, due to the recent stress observed in the NBFC sector, and the contagion risk it posed to other entities due to the interconnectedness of NBFCs in the financial system, there was a need to protect the deposits that investors placed with the NBFCs. Accordingly, the regulatory approach adopted for NBFCs was reexamined in order to reorient it to keep pace with the changing realities in the financial sector. With a view to develop a strong and resilient financial system, in October 2021, the Reserve Bank of India (RBI) had prescribed a ‘scale-based regulation’ for the NBFC sector. The Scale-Based Regulatory (SBR) approach renders the regulation and supervision of the NBFCs to be a function of their size, activity and perceived riskiness. The SBR framework can be visualized as a pyramid with regulatory intervention being the least at the bottom of the pyramid and increasing as one moves up. This is depicted in the figure below: 1. The regulatory structure Base layer (NBFC-BL) The base layer will be equivalent to the existing non-deposit taking non-systemically important NBFCs (NBFC-NDs) Systemically important, non-deposit taking NBFCs having asset size of INR500 crore and above but below INR1,000 crore (except those necessarily featuring in the middle layer) will be part of NBFC- BL. It will specifically include NBFC-P2P (NBFC-Peer to Peer lending platform) NBFC- AA (NBFC-Account Aggregator) NOFHC (Non-Operative Financial Holding Company) and NBFCs without public funds and customer interface. While higher level of prudential regulations will not be applicable to such entities, there will be an increase in the transparency requirements through additional disclosures and improved governance standards. 2. Middle layer (NBFC-ML) The middle layer will be equivalent to the existing deposit taking NBFCs (NBFC-D) and systemically important non-deposit taking NBFCs (NBFC-ND-SI). It will specifically include the SPD (i.e. Standalone Primary Dealers) and IDF (Infrastructure Debt Funds) (which will always remain in the middle layer). It will also include NBFC-D, irrespective of their asset size, NBFC-ND-SI with asset size greater than INR1,000 crores. There will be a higher level of regulatory supervision in this layer, which aims to plug the areas of regulatory arbitrage between banks and NBFCs. 3. Upper layer (NBFC-UL) The upper layer has been conceived as a new category of NBFCs, in which a chosen few, systemically significant NBFCs would be specifically identified by RBI through parametric analysis of certain quantitative and qualitative criteria which will be reviewed periodically. Accordingly, entities that meet the specified criteria will move from the middle layer to the upper layer of the scale-based framework. The top 10 eligible NBFCs in terms of their asset size will always reside in the upper layer, irrespective of any other factor.  Higher prudential regulations and intensive supervision will be applicable for such entities proportionate to their systemic significance. 4. Top layer The top layer would ideally remain empty and NBFCs will be slotted into this layer from the upper layer of the scale-based framework at the discretion of RBI if it is of the opinion that the entity is contributing significantly to the systemic risk. Such entities would be required to comply with significantly higher regulatory and supervisory requirements. Development Banks Development Banks are also known as Term-Lending Institutions (TLIs) or Development Finance Institutions (DFIs). They are specialized financial institutions under the Banking System in India that provide long-term finance and support to the sectors of the Indian economy which possess higher risks and cannot have access to adequate loans from Commercial Banks. Objectives of Development Banks in India Development banks in India have been established with several key objectives as can be seen below: 1. Promoting Economic Growth: They are primarily aimed at fostering economic growth by financing long-term investments in key sectors like infrastructure, agriculture, and industry. 2. Facilitating Infrastructure Development: They play a key role in financing the construction and development of essential infrastructure projects such as roads, bridges, power plants, and irrigation systems. 3. Supporting Strategic Sectors: They also aim to support the development of strategic sectors that are critical for a nation’s economic well-being, such as renewable energy, transportation networks, etc. 4. Encouraging Entrepreneurship and SMEs: By offering loans, equity investments, and advisory services, they help entrepreneurs and SMEs grow and create jobs. 5. Balanced Regional Development: They strive to bridge regional disparities by directing investments towards underdeveloped or lagging regions. Types of Development Banks a) Small Industries Development Bank of India (SIDBI)  Small Industries Development Bank of India (SIDBI) was set up in 1990 as an independent financial institution under the Banking System in India to aid the growth and development of Micro, Small and Medium Enterprises (MSMEs) in India.   It acts as the principal financial institution for the promotion, financing, and development of the MSME sector in India, as well as for coordinating the functions of institutions engaged in similar activities. Functions of SIDBI 1. Indirect Lending Indirect Lending is when SIDBI offers loans to banks, and then banks lend money to MSMEs. SIDBI does indirect Lending to banks, Non-Banking Financial Companies(NBFCs), Small Finance Banks(SFBs) and Micro Financial Institutions(MFIs). 2. Direct Lending SIDBI also offers direct Lending, which means financial support is directly given to MSMEs in the form of soft loans, working capital and equipment finance. Recently, SIDBI assisted MSME through its Covid Emergency response programme. 3. Promotional and Development of MSME SIDBI aims to help MSME, and for this SIDBI scheme has its initiatives, some of which are:  Sampark (customer connect)  It also arranges exposure visits to MSMEs for budding or emerging organisations.  It also has an award system known as SIDBI-ET India MSE Award, which appreciates emerging MSMEs.  SIDBI has an entrepreneurship awareness program and has partnerships with top institutes like IIM for entrepreneurship and leadership development.  It also has a Women Entrepreneurship Program (WEP) in collaboration with Nitti Aayog. 5. Provides a platform to help MSMEs Udyami Mitra is an aggregator platform to provide financial and non-financial services in one place. 5. Indirect funding SIDBI gives venture capitalists (VCs) money, and these VCs, in turn, help new startups grow without having to worry about funding. 6. Contributes to the marketing sector It helps SSI increase the networking channels to market its products and services. 7. Helps create employment opportunities The SIDBI scheme expands employment opportunities by supporting industries focusing on employment, particularly in semi-urban areas. b) National Bank for Agriculture and Rural Development (NABARD) National Bank for Agriculture and Rural Development (NABARD) was established on the recommendations of the B. Srivaraman Committee in 1982 with the primary responsibility of matters concerning policy, planning, and operations in the field of credit for agriculture and other economic activities in the rural areas of India. NABARD is the main agency for implementing the Rural Infrastructure Development Fund (RIDF) scheme. In this capacity, it performs the following roles:  Serves as an apex financing agency for the institutions providing investment and production credit for promoting the various developmental activities in rural areas.  Refinances the financial institutions that finance the rural sector, including State Cooperative Agriculture and Rural Development Banks (SCARDBs), State Cooperative Banks (SCBs), Regional Rural Banks (RRBs), Commercial Banks, and other financial institutions approved by the RBI.  Supervises the Regional Rural Banks (RRBs). Objectives of NABARD The main objectives of National Bank for Agriculture and Rural Development has been provided below: 1. Promotion of Agriculture and Rural Development: NABARD aims to accelerate agricultural production and rural development by providing financial support, promoting institutional development, and implementing various development schemes. 2. Facilitating Credit for Agriculture: It plays a crucial role in channeling credit to the agriculture sector. It refinances commercial banks, regional rural banks, and other financial institutions to provide loans for agricultural and rural development activities. 3. Institutional Development: It focuses on strengthening and developing rural financial institutions to improve their efficiency and outreach. It provides assistance for capacity building, training, and technology adoption to enhance the functioning of cooperative banks, regional rural banks, and microfinance institutions. 4. Promoting Rural Infrastructure Development: Nabard Bank supports the development of rural infrastructure by providing financial assistance for irrigation projects, rural roads, rural markets, and other agricultural infrastructure facilities. It aims to improve connectivity and access to markets for farmers and rural communities. 5. Promoting Sustainable Agriculture: It encourages the adoption of sustainable agricultural practices and technologies to enhance productivity, conserve natural resources, and promote climate resilience. It supports projects related to organic farming, watershed management, renewable energy, and agricultural research and development. 6. Rural Innovation: National Bank for Agriculture and Rural Development promotes innovation and entrepreneurship in rural areas. It provides funding and support for rural  startups, agri-businesses, and rural artisans to encourage economic diversification and employment generation. 7. Financial Inclusion: It actively works towards promoting financial inclusion in rural areas. It supports initiatives to provide banking services, credit, and insurance products to underserved sections of the rural population, including small farmers, rural women, and marginalized communities Functions of NABARD Bank 1. Credit Functions: NABARD is the primary provider of credit facilities in rural areas. It offers, controls, and monitors credit flow in rural areas of the country. 2. Development Activities: The major objective of the National Bank for Agriculture and Rural Development is to focus on creating sustainable agriculture and promoting rural development. It also provides development functions which includes assisting rural banks in creating action plans for developmental activities. 3. Financial transactions: NABARD has a number of customer banks and institutions that help and support rural development projects. Through financial functions, NABARD provides loans to various banks and financial institutions, such as handicraft enterprises, food parks, processing units, artisans, and others. c) Export – Import Development Banks (EXIM Bank) They are specialized financial institutions under the Banking System in India, that facilitate and promote the country’s international trade by providing financial assistance to exporters and importers. Export-Import Bank (EXIM Bank) was set up in 1982 to take over the operations of the international financing wing of the IDBI. It provides Indian exporters with financial assistance, overseas investment credit, and technology and import finance, among other services. Objectives of EXIM Bank: 1. Providing financial assistance to importers and exporters, and functioning as the financial institution for coordinating the work of institutions engaged in financing import and export of goods and services with a view to promote India’s international trade. 2. The EXIM Bank of India is encrusted to act on business principles in the best regards of the public interest. 3. The EXIM bank’s vision has transformed from being product-centric with Export Capability Creation and Export Credits, to a more customer-centric approach by providing a wide array of products and services to empower businesses at all stages of a company’s business operations. 4. The bank aims to develop commercially cordial relationships with a target set of externally oriented companies by way of a wide array of products and services that are aimed at improving their internationalization efforts. 5. It aims to utilize the leadership and expertise in Export Finance to strike a lasting difference to India-based companies with global aspirations. The bank also aims to facilitate globalization of the Indian businesses. Functions of EXIM Bank The major functions of the EXIM Bank include: 1. Financing exports and imports of goods and services from India 2. Financing the import and export of goods and services other countries as well 3. Underwriting shares/ stocks/ debentures/ bonds of companies that carry out foreign trade 4. Financing the import and/ or export of machinery and equipment on lease or hire-purchase basis 5. Undertaking functions of a merchant bank for the importer or exporter in transactions of foreign trade 6. Providing refinancing services to banks and other financial institutions for their capital requirements of foreign trade 7. Offering short-term loans or lines of credit to foreign banks and governments. ***************************************************************** Sample Questions A) Answer the following questions: 1. What is the role of NBFC’s in the development of the economy? 2. Write a short note on the importance of NBFC’s on economic growth. 3. What are the financial activities of NBFC’s? 4. What are the functions of development financial institutions? 5. Write a note on EXIM bank 6. Explain the Scale Based Regulatory Framework of NBFC’s 7. Describe the functions of SIDBI. 8. Briefly explain the different types of NBFC’s functioning in India. 9. State the objectives and functions of NABARD. 10. Write a note on micro financial institution. B) Choose the correct answer and fill in the blank: 1. NBFC performs great role for finance in _______ a. Wholesale sector b. Big Scale industries c. Small scale and Retail sector d. Medium Scale industries 2. NBFC is a company registered under _________. a. The Indian Contract Act b. The Companies Act, 1956 c. The RBI Act d. The SEBI Act 3. _________________ is not a type of NBFC Bank. a. Investment company b. Asset finance company c. Mortgage company d. Payments Bank 4. NBFC Mortgage Financial Institution is required to maintain not less than __________ of its net assets as qualifying assets. a. 50% b. 85% c. 75% d. 25% 5. NBFC’s in India are registered under _____________act. a. Indian Companies Act,2013 b. RBI Act,1934 c. SEBI Act,2002 d. GOI Act, 1935 6. ________ is an example of NBFC. a. RBI b. SBI c. LIC d. Indian Overseas bank 7. _____________ is the apex institution for rural development and rural credit a. RBI b. IDBI c. NABARD d. IRBI  Unit 4: Insurance and other Financial Intermediaries Course outcome: Analyze the structure and operations of Financial Institutions Overview of Insurance Industry Insurance is a secured policy through which a person can manage their risks. It is a type of protection and security against unexpected losses, like financial or health. Insurance is a contract in which an individual or an organization receives financial protection and a fixed reimbursement against losses from an insurance company. Insurance policies are used to secure one against the risk of financial losses; losses can be like property loss or injuries, etc. Insurance can also be called a financial product sold by insurance companies to safeguard an individual or an organization from unexpected dangers like fire, damage to goods, theft, or an accident. The Indian insurance sector has grown significantly in the last decade. This has led to strong competition among Indian insurance companies. The Indian insurance sector plays a major role in the economy’s growth. Indian insurance indulges the habit of saving and investing in individuals, and helps them secure and safeguard their future. The Indian insurance sector contributes a large pool of funds, which are raised through individuals’ savings. Insurance is the backbone of a country’s risk management system. Risk, that can be insured, has increased enormously in every walk of life. This has led to growth in the insurance business and evolution of various types of insurance covers, that provides protection from risk and ensure financial security. The insurance sector acts as a mobilizer of savings and a financial intermediary and is also a promoter of investment activities. It can play a significant role in the economic development of a country. Types of Insurance products: Insurance can be classified broadly into: (a) Life insurance- life assurance is a contract between the policy owner and the insurer, where the insurer agrees to pay the designated beneficiary a sum of money upon the occurrence of the insured individual’s death or other event, such as terminal or critical illness. In return, the policy owner agrees to pay a stipulated amount at regular intervals or in lump sums b) General insurance- General insurance or non-life insurance policies, including automobile and homeowners’ policies, provide payments depending on the loss from a particular financial event. General insurance typically comprises any insurance cover that is not deemed to be life insurance. Some categories of general insurance policies are: vehicle, home, health, property, accident, sickness and unemployment, casualty, liability, and credit A. Types of Life Insurance: 1. Term Insurance: Term insurance is a type of life insurance that provides life cover in case of death. You have to pay premiums for a specific duration and in case of the unfortunate event your nominee with get the sum assured. Term insurance is the purest form of life insurance and thus comes at very affordable premium. Term insurance can also we availed along with add-on riders such as –  Term Insurance with Critical Illness rider- With nominal incremental premium you have the option to avail a critical illness rider along with your term insurance. In case you are detected with a critical illness you can avail the sum assured under the critical illness insurance for your treatment and the life cover of your base policy continues as is.  Term Insurance with return of premium- With term insurance return of premium if you survive the term of your policy then you are entitled to get your premiums back at the end of policy tenure. 2. Unit Linked Insurance Plans (ULIPs) Unit Linked Insurance Plan (ULIP) is a type of life insurance plan that combines life cover and investment option. ULIP plan allows you the avenue to invest in a variety of asset classes, such as equity, debt, and money market funds, depending on your risk appetite. ULIPs come with a lock- in period of 5 years but since every individual has different financial goals it provides the flexibility to choose your own funds. A unique feature that ULIP provides is the ability to switch funds as per the investor’s choice. Since these are market linked financial products it gives the opportunity to growth your investment but the investment risk in the investment portfolio is borne by the policyholder. 3. Endowment Plans Endowment plans are life insurance that provides life cover against death or a maturity benefit at the end of the policy tenure. You are paid a lump sum after a specific period called the maturity period. For an endowment policy the insurance company will pay your nominee in case you are no more or will pay you after the maturity period if you survive the policy term. 4. Child Insurance Plans Child insurance plans are a type of life insurance for securing a child's financial future, especially for education needs. These life insurance plans combine life insurance with savings, where parents have to pay premiums that accumulate into a maturity benefit for their child's education. 5. Whole Life Insurance Whole life Insurance provides financial protection to you till the age of 99 years. The objective of this type of life insurance is to provide life cover to the policyholder’s nominee/family in case the policyholder passes away before the age of 99 years. Usually the features of a whole life insurance is similar to a life insurance expect for the fact that it covers you till the age of 99 years.  6. Money Back Policy Money Back Policy is a type of life insurance that offers the benefit of financial cover as well as investments. A money back policy can help you to generate income at regular intervals throughout the policy tenure. With it, a policyholder gets to provide financial security to his or her loved ones in the event of death and on survival the policyholder gets back the maturity amount after the policy term. 7. Retirement Plans Retirement plans are financial instruments that are designed primarily to build a corpus for your retirement needs. The financial benefit from such type of life insurance helps you in retirement planning by providing an adequate retirement corpus so that you can maintain your standard of living post retirement with any stress. 8. Pension Plans Pension plans are type of life insurance that is designed to ensure a regular income on specific intervals during your retirement. There are 2 phases in a pension plan - accumulation phase and the distribution phase. During the accumulation phase, the premiums get invested in a fund or asset of your choice for a pre-determined period helping you build your retirement fund. In the Distribution phase you can start receiving your benefits or withdraw the accumulated funds and purchase an annuity plan. 9. Group Insurance Plans Group Insurance Plans are life insurance solutions designed to provide life cover to collective group of individuals, such as employees of a company, under a single policy. These type life insurance offer uniform benefits to all members of the group, irrespective of individual characteristics. B. Types of General Insurance 1. Motor / Vehicle insurance- It is mandatory to take motor insurance policy for all vehicle owners as per Motor Vehicle Act 1988.It safeguard against accidental damage or theft of the vehicle and also safeguard against third party legal liability for bodily injury and/or property damage. It also provides Personal Accident cover for owner driver/ occupants of the vehicle. Vehicle insurance covers the risk of financial loss due to accidents & other damages to the vehicle. It helps to avoid unnecessary & unexpected expenses on vehicles. Also called motor insurance, it is mandatory in India. There are two types of vehicle insurance available in India:  Third-party Insurance: It basically covers harm caused to third parties by the insured vehicle.  Comprehensive Insurance: It covers third party liability as well as any damage done by the vehicle owner. 2. Travel Insurance All of us love to travel, but the unexpected loss can occur anytime, anywhere. Travel insurance takes care of all issues such as:  Delayed trips  Cancelled flights  Unexpected hotel reservation cancellation.  Lost luggage and,  Stolen passport. 3. House Insurance Owning a house is a dream for all. Yet, having a house is a job half done. Home insurance is a necessity in today’s time. It protects your house structure & its contents. The protection is available not only against natural disasters but also man-made disasters such as fire, theft, etc. Moreover, a sense of security gives you mental peace & happiness. Home insurance policies divide the insurance coverage into two parts: house structure and its content. It is necessary to understand the difference between the two. A structure-only policy will insure only the structure of the house while a content-only policy will cover just the content. Therefore, a comprehensive policy covering both the structure and content must be chosen. A fully furnished house is an expensive asset, the cost of repairing or refurbishing a house is high. It is always advisable to choose a comprehensive house insurance plan to avoid any risk related to a house. Benefits and Features of General Insurance in India The features and benefits of general insurance policies in India are enumerated below:  In many cases, opting for general insurance policies are compulsory by law. For example, Motor Vehicles Act, 1988, has made motor insurance plans compulsory. One fulfils legal obligations after buying mandated insurance policies. Moreover, this also acts as a protection from the offence of violation.   General insurance plans provide compensation if anyone suffers a loss. Thus, they protect one’s savings in case an emergency arises and serve as an added layer of financial protection.  There are many general insurance plans which provide tax benefits. For example, Section 80C of ITA allows tax deductions for premiums paid for health insurance policies. It helps a person to save tax by lowering the taxable portion of the income. Role of Intermediaries A financial intermediary is an entity who performs intermediation between two parties This means that the lender gives money to the borrower indirectly as the financial intermediary sits in between. It is typically an institution that allows funds to be moved between lenders and borrowers. The Roles include: 1. Aggregating investments to meet needs of borrowers-To provide a link between many investors who may have small amounts of surplus cash and fewer borrowers who may need large amounts of cash 2. Risk transformation- Intermediaries offer low-risk securities to primary investors to attract funds, which are then used to purchase higher -risk securities issued by the ultimate borrowers 3. Maturity transformation- Investors can deposit funds for a long period of time while borrowers may require funds on a short-term basis only, and vice versa. In this way the needs of both borrowers and lenders can be satisfied. Other Financial Intermediaries Mutual Fund A mutual fund is a pool of money managed by a professional Fund Manager. It is a trust that collects money from a number of investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities. And the income / gains generated from this collective investment is distributed proportionately amongst the investors after deducting applicable expenses and levies, by calculating a scheme’s “Net Asset Value” or NAV. The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV). Mutual funds invest the money collected from the investors in securities markets. In simple words, Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is Rs 200 lakhs and the mutual fund has issued 10 lakhs units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs.20. NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme. Role of Mutual Funds in the Economic Development  It helps in arranging the money for investment purposes in the economy.  It mobilise the small savings of the public through investment.  We know that developing countries like India lacks capital accumulation. So mutual funds help in capital accumulation which is crucial for the development of a developing country like India.  It discourages the idle hoarding of the money in the house.  It helps in creating an environment of investment in the country.  It is helpful in employment generation. Products / Types of Mutual Funds a. Schemes according to Maturity Period: A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period. 1. Open-ended Fund/ Scheme An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity. 2. Close-ended Fund/ Scheme A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges. These mutual funds schemes disclose NAV generally on weekly basis. b. Schemes according to Investment Objective: A scheme can also be classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows: 1. Growth / Equity Oriented Scheme The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time. 2. Income / Debt Oriented Scheme The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations. 3. Balanced Fund The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds. 4. Money Market or Liquid Fund These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods. Gilt Fund These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes. 5. Index Funds Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme. There are also exchange traded index funds launched by the mutual funds which are traded on the stock exchanges. Pension Funds Pension funds are long-term investment vehicles that offer comparatively high returns upon reaching maturity. These plans are regulated by the Pension Fund Regulatory & Development Authority (PFRDA). You can choose to invest either a lump-sum amount or smaller amounts, after you will receive a consistent income stream in your post-retirement phase. Functions / Roles of Pension Funds 1. Management of Pension Schemes- The function of a Pension Fund is to manage pension schemes in your best interest as per the regulations, guidelines and circulars issued by PFRDA. The service levels of pension funds are monitored by NPS Trust. 2. Rendering high standards of services-The Pension Fund is responsible for provid