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Chapter 1 financial system and markets
1. FINANCIAL SYSTEM AND MARKETS
DISCOVER . LEARN . EMPOWER
University School of Business
Bachelor of Commerce
Management of Financial Institutions and services
(CMT-224)
2. 2
Financial System
and Markets
CO
Number
Title Level
CO1 The students will be able to understand the financial
system of India.
Remember
CO2 The students would be able to understand the
functioning of various financial institutions of India.
Understand
CO3 The students would be able to gain knowledge about
the financial services in India.
Understand
Course Outcome
3. • Space for visual (size 24)
Write your content here ( font size16)
3
Financial System
and Markets
7. FINANCIAL INSTITUTION
Meaning-
•Financial institutions are businesses which offer multiple services in banking and finance.
•The services customers receive may include savings and checking accounts, loans, investments, and financial counseling.
•The benefits consumers gain by using financial institutions includes convenience, cost savings, safety, and security.
•Financial institutions are regulated to control the supply of money in the market and protect consumers.
Definition:
•A financial institution is an intermediary between consumers and the capital or the debt markets providing banking and
investment services.
•An organization, which may be either for-profit or non profit, that takes money from clients and places it in any of a
variety of investment vehicles for the benefit of both the client and the organization.
8. FUNCTIONS OF FINANCIAL
INSTITUTION
A. Accepting Deposits
B. Providing AgriculturalLoans
C. Providing Commercial Loans
D. Providing Real Estate Loans
E. Agency Functions
F. Utility Functions
G. Borrowing by government
H. Mobilization of funds
I. Maintaining Liquidity and safety
J. Managing the Banking risk
Credit Risk
Market RISK
Operational Risk
Liquidity Risk
Business Risk
System Risk
Reputational Risk
Moral Hazards Risk
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9. TYPES OF FINANCIAL INSTITUTION
Wecan divide financial institution in two major parts as following:
1. Banking financial company(BFCs)
2. Non banking financial company(NBFCs)
Banking institution can use banking instruments like cheque ,draft ,pay order but non banking institution can not use these
instruments.
10. BANKING INSTITUTION
Banking institution are those institution who is provide banking and other financial services to their customers and society
such as :
• Accept deposits
• Provide loans
• Cash management services
• Portfolio management services
11. CONTINUE…
Wecan divide Indian banking system in following ways:
I. Commercial bank
A)Public sector bank
1) State bank
2) Nationalized bank
B)Private sector bank
a) Indian private bank
b) Foreign private bank
13. CONTINUE…
A)Public sector bank- public sector bank is divided into two group:-
• State bank of India- State bank of India was established under SBI act 1955,initialy 100% stake of SBI owner was
Reserve bank of India .
• Nationalized banks- Nationalized bank was established under banking company act 1970 initially 100% ownership of 20
nationalized bank was hold by government of India.
14. CONTINUE…
B) Private sector bank- Private bank can be divided into two parts;
1)Indian private bank- This type of bank governed by Indian financial institution like ICICI bank
,HDFC bank
2)Foreign private bank- this type banks governed by foreign institution like STANDARD CHARTED(USA) bank , HSBC
15. CONTINUE
C) Co-operative bank- These type bank are governed by co-operative societies:
1)Urban co-operative societies- These type bank are governed by urban co-operative society.
2)State co-operative banks- These type bank work on state level,
3)Central co-operative banks- These type bank work on district level
16. CONTINUE…
D) Regional rural banks-
RRB banks were established under RRB act 1976 these bank are closely related with the commercial bank which are specified
by the central government with lead bank scheme.
17. Non banking financial Institutions(NBFIs)
•NBFIs at present consist of a heterogeneous group of institutions that cater to a wide range of financial requirements.
•These type company are involved in promoting new company ,expansion and meeting the financial requirement of the
company for economic development
18. Non banking financial Institutions(NBFIs)
1.Development Financial Institutions:
A. At India level: It consists of IDBI,ICICI, IIBI, IRDC.
B. At state level: It consists of SFCs, SIDCs
2. Investment Institutions: It consists of LIC, GIC. UTI, MUTUAL FUND etc.
3. Specialized Institutions: like EXIM Bank, NABARD, HDFC, HUDFC, FFC, RECetc.
4. Non Banking Financial Entities
A. Non banking financial Companies: Equity leasing co., Hire purchase co., Investment Co., Loan Co., RNBCs.
B. Mutual Non banking Companies: Chit Fund
C. Mutual Benefit Financial Companies: NIDHIs
19. CONTINUE….• Industrial development bank of India(IDBI)- It is apex institution in the field of long term industrial finance it was set in
1964 as wholly subsidiary of RBI
• Industrial finance corporation of India(IFCI)-It was established in 1948, it provide assistance in long term loan,
underwriting of equity and guarantee of loans in foreign exchange.
• Export Import Bank of India (EXIM Bank)-it facilitates export and import trading in India.
• Small Industries Development Bank of India (SIDBI)-It provide assistance in small scale industry
• Life insurance corporation of India(LIC)-It provide all type insurance.
• Security and exchange board of India(SEBI)- It regulate all the activity in the Indian capital market
• NABARD (National bank for agriculture and rural development) – Nabard is working in India to promote
agricultureand rural development.
20. Financial Markets
It consists of institutional arrangements for dealing in financial assets and credit instruments of different types i.e.
currency, cheques, bank deposits, bills and bonds etc.
+Division of Financial Markets:
1. Capital Market:- It works for meeting Long term financial needs. It consists of Primary market and secondary
market
2. Money Market: It works for meeting short term financial needs. It consists of Commercial bill, treasury bills,
call money etc.
22. How is capital transferred between savers and
borrowers ?
• Direct transfers – stocks and bonds,
securities
• Investment banking house -
Underwriting
• Financial intermediaries – banks and
mutual funds
23. Financial Markets
It consists of institutional arrangements for dealing in financial assets and credit instruments of different types i.e. currency,
cheques, bank deposits, bills and bonds etc.
23-23
25. RISK MANAGEMENT IN FINANCIAL
INSTITUTION
23-25
• Financial risk management is the practice of economic value in a firm by using financial instruments to manage exposure
to risk: operational risk, credit risk and market risk, foreign exchange risk, shape risk, volatility risk, liquidity risk, inflation
risk, business risk, legal risk, reputational risk, sector risk etc.
•Similar to general risk management, financial risk management requires identifying its sources, measuring it, and plans to address
them
•Financial risk management can be qualitative and quantitative.
•As a specialization of risk management, financial risk management focuses on when and how to hedge using financial instruments to
manage costly exposures to risk
26. RISK MANAGEMENT IN FINANCIAL
INSTITUTION
23-26
• Financial risk management is the practice of economic value in a firm by using financial instruments to manage exposure
to risk: operational risk, credit risk and market risk, foreign exchange risk, shape risk, volatility risk, liquidity risk, inflation
risk, business risk, legal risk, reputational risk, sector risk etc.
•Similar to general risk management, financial risk management requires identifying its sources, measuring it, and plans to address
them
•Financial risk management can be qualitative and quantitative.
•As a specialization of risk management, financial risk management focuses on when and how to hedge using financial instruments to
manage costly exposures to risk
27. Managing Credit Risk
23-27
• A major part of the business of financial institutions is making loans, and the major risk with loans is that the
borrow will not repay.
• Credit risk is the risk that a borrower will not repay a loan according to the terms of the loan, either defaulting entirely
or making late payments of interest or principal.
• the concepts of adverse selection and moral hazard will provide framework to understand the principles to financial
managers and they must follow to minimize credit risk, yet make successful loans.
28. Managing Credit Risk
23-28
I. Solving Asymmetric Information Problems:
1. Screening and Monitoring:
─ collecting reliable information about prospective borrowers. This has also lead some institutions to specialize in
regions or industries, gaining expertise in evaluating particular firms
─ also involves requiring certain actions, or prohibiting others, and then periodically verifying that the borrower is complying
with the terms of the loan contract.
2. Specialization in Lending helps in screening. It is easier to collect data on local firms and firms in specific
industries. It allows them to better predict problems by having better industry and location knowledge
3. Monitoring and Enforcement also helps Financial institutions to write protective covenants into loans contracts and actively
manage them to ensure that borrowers are not taking risks at their expense.
29. Managing Credit Risk
23-29
II. Long-term Customer Relationships: past information contained in checking accounts, savings accounts, and previous
loans provides valuable information to more easily determine credit worthiness.
II. Loan Commitments: arrangements where the bank agrees to provide a loan up to a fixed amount, whenever the firm
requests the loan.
III. Collateral: a pledge of property or other assets that must be surrendered if the terms of the loan are not met ( the loans are
called secured loans).
IV. Compensating Balances: reserves that a borrower must maintain in an account that act as collateral should the
borrower default.
V. Credit Rationing:
• lenders will refuse to lend to some borrowers, regardless of how much interest they are willing to pay, or
• lenders will only finance part of a project, requiring that the remaining part come from equity financing.
30. Managing Interest-Rate Risk
23-30
• Financial institutions, banks in particular, specialize in earning a higher rate of return on their assets relative to the interest paid
on their liabilities.
• As interest rate volatility increased in the last 20 years, interest-rate risk exposure has become a concern for financial
institutions.
31. FINANCIAL SECTOR REFORMS
• Financial sector reforms refer to the reforms in the banking system and capital market.
• An efficient banking system and a well-functioning capital market are essential to mobilize savings of the households and
channel them to productive uses. The high rate of saving and productive investment are essential for economic growth.
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32. • Prior to 1991 while the banking system and the capital market had shown impressive growth in the volume of operations,
they suffered from many deficiencies with regard to their efficiency and the quality of their operations.
• The weaknesses of the banking system was extensively analyzed by the committee (1991) on financial sector reforms,
headed by Narasimham.
• The committee found that banking system was both over-regulated and under-regulated.
• Prior to 1991 system of multiple regulated interest rates prevailed. Besides, a large proportion of bank funds was preempted
by Government through high Statutory Liquidity Ratio (SLR) and a high Cash Reserve Ratio (CRR).
• As a result, there was a decrease in resources of the banks to provide loans to the private sector for investment.
• This preemption of bank funds by Government weakened the financial health of the banking system and forced banks to
charge high interest rates on their advances to the private sector to meet their needs of credit for investment purposes.
• This was prominently revealed by 1992 scarcity scam triggered by Harshad Mehta. In this situation the quality of
investment portfolio of the banks deteriorated and culture of’ non-recovery’ developed in the public sector banks which
led to a severe problem of non-performing assets (NPA) and low profitability of banks.
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33. • Financial sector reforms aim at removing all these weaknesses of the financial system.
• Under these reforms, attempts have been made to make the Indian financial system more viable, operationally efficient,
more responsive and improve their allocative efficiency.
• Financial reforms have been undertaken in all the three segments of the financial system, namely banking, capital market
and Government securities market.
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34. TYPES OF FINANCIAL SECTOR
REFORMS:
• Reduction in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR)
• End of Administered Interest Rate Regime
• Prudential Norms: High Capital Adequacy Ratio
• Competitive Financial System
• Non-Performing Assets (NPA) and Income Recognition Norm
• Elimination of Direct Credit Controls
• Promoting Micro-Finance to Increase Financial Inclusion
• Setting up of Rural Infrastructure Development Fund (RIDF)
• Pension Reforms
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35. CONCLUSION….
• Financial institution is very essential part of financial system.
• Financial institution play a vital role in economic development
• Indian financial institutions are very strong but its operation is very poor quality we, Indian make very good plan but in
implication we are lacking in somewhere.
• Wehave full range of financial institution bur we can not use in effective manner.
• Managing Credit Risk: basic techniques for managing relationships and rationing credit were reviewed.
• Managing Interest-Rate Risk: the essential techniques of measuring interest-rate risk for both income and
capital affects were presented
36. ASSESSMENT PATTERN
• MST-1 : 36
• MST-2 : 36
• FINAL EXAM: 60
• INTERNAL MARKS (40) COMPRISES OF:
1. MST-1
2. MST-2
3. SURPRISE TEST
4. PRESENTATION BY STUDENT
5. ASSIGNMENT
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38. BIBILOGRAPHY
• WWW.WIKIPEDIA.COM
• THE INDIAN BANKING SECTOR ON THE ROAD TO PROGRESS- G. H. DEOLALKAR
• COUNCIL ON FOREIGN RELATIONS, IIGG INTERACTIVE GUIDE TO GLOBAL FINANCE
–ARTICLE
• NON BANKING INSTITUTION –PROJECT REPORT