Module 1

A. Evolution of Financial System

In the 1950s and 1960s, Gurley and Shaw (1955, 1960, 1967) and Goldsmith (1969) discussed
the stages in the evolution of financial systems. According to them, there is a link between
per capita income and the development of a financial system. At low levels of development,
most investment is self-financed and financial intermediaries do not exist, as the costs of
financial intermediation are high relative to benefits. As countries develop and per capita
income increases, bilateral borrowing and lending take place leading to the birth of financial
intermediaries. The number of financial intermediaries grows with further increases in per
capita income. Among the financial intermediaries, banks-tend to become larger and
prominent in financial investment. As countries expand economically, non-bank financial
intermediaries and stock markets grow in size and tend to become more active and efficient
relative to banks. There is a general tendency for financial systems to become more market-
oriented as countries become richer.

In pre-industrial economies, finance was largely concerned with the development of a

medium of exchange. Barter was inefficient, transaction costs were high, and the lack of a
medium of exchange limited the extent of the market and the opportunities for specialisation.
With the growth of nonlocal trade, the development of payment media became linked to the
financing of trade. Otherwise, apart from the financing of governments and seaborne trade,
borrowing and lending were mostly informal and on a small scale.

The advent of large-scale industrialisation in the second half of the nineteenth century,
altered the role that finance had to play. Finance was now concerned with mobilising
resources for large infrastructure projects and for investments with heavy capital
requirements that exceeded the capabilities of small family firms. The systems that emerged
often suffered from fraud and mismanagement. They proved unstable and experienced
frequent crises. Speculative manias, furled by financial institutions, caused mounting concern,
and after the Great Depression of the 1930s governments began to supervise their financial
systems more closely. But government intervention was by no means entirely successful. It
made the financial system less flexible, and although it reduced fraud it did not eliminate it.
Moreover, economic agents proved adept at getting around the regulations.

In recent years the focus has shifted back to deregulation, partly in response to financial
innovation and partly to promote competition and efficiency. Deregulation was prompted by
the growing realisation that direct controls had become less effective over time. The growth
of the Euromarkets, the development of new financial instruments, and the advent of
electronic technology all made it easier to bypass the restrictions. Governments also
recognised that the prolonged use of directed and subsidised credit programs would lead to
the inefficient use of resources and hinder the development of better systems. Financial
systems are undoubtedly more efficient as a result. However, some changes have caused
concerns too. Financial institutions are exposed to greater risks as the potential for conflicts
of interest between institutions and their customers has increased.
 B. MEANING

A FINANCIAL SYSTEM is a complex well integrated set of financial institutions, financial

markets, financial instruments and financial services. It facilitates the transfer and allocation
of funds efficiently and effectively from savers to investors.

The Indian financial system can be broadly classified into ORGANISED and UN-ORGANISED
sectors. The organised financial system comes under the purview of the MINISTRY OF
FINANCE, RBI, SEBI and under other regulatory bodies. The unorganised financial system
consist of money lenders, landlords, groups of people operating as funds or association,
partnership firms consisting of local brokers and non-banking financial intermediaries, etc.

Key elements required for a well-functioning financial system

1. Strong legal system- Enforce strict laws to protect the interests of the investors.
2. Stable money- Especially for exchange (large fluctuations and depreciation)
3. Sound public finance- Raising revenue and paying off debts
4. Operations of the Central Bank- It is the banker to the banks, banker to the government,
lender of last resort etc.
5. Ability to withstand adverse shocks- Bank runs etc.

C. Characteristics of Financial System:

1. It plays a vital role in economic development of a country
2. It encourages both savings and investment
3. It links savers and investors
4. It helps in capital formation
5. It helps in allocation of risk
6. It facilitates expansion of financial markets
7. It aids in Financial Deepening and Broadening

D. FUNCTIONS OF THE FINANCIAL SYSTEM

The financial system acts as a channel for the transfer of financial resources. Financial system
helps in transformation of savings into investment. To play these crucial roles the financial
system has to perform inter –related functions.

1] Providing an efficient payment system – In any transaction, payments are either made in
ready cash or is promised to pay in future. Future payments are backed by credit instruments.
Payment and settlement system plays an important role to ensure that funds flow quickly and
in timely manner. They are the main arteries of the financial system. Banks provide this
mechanism by offering a means of payment facility based upon cheque, promissory notes,
credit and debit cards. This payment mechanism is now run through electronic means.

2] Promoting savings and investments – For capital formation, funds have to flow from savers
to investors engaged in production. It is the function of financial system to ensure that savers
are induced to direct their surplus into the financial securities and create assets to meet short
term and long term needs of the real sector. The transfer of funds into financial securities is
done by the various financial institutions, which act as a link between the savers and
investors.

3] Mechanism for transfer of resources – The savings of people are the prime source of
finance required by the real sector production units. This transfer is done by the financial
system. The financial system provides a mechanism for direct and indirect transfer resources.
When the savers buy equity and debentures issued directly by the investors in the primary
market then it is a direct transfer of resources. However, when banks, financial institutions
mobilise resources from savers by selling secondary securities in the secondary market and
provides funds to the investors it is an indirect transfer of funds.

4] Provides ways and means of managing uncertainty and controlling risk – One of the most
important functions of financial system is to achieve optimum allocation of risk bearing. It
lowers the risk involved in mobilising savings and allocating credit. It reduces risk by a) laying
down rules. b) governing the operating of the system. c) diversifying portfolio. d) screening of
borrowers. Market participants are also offered financial insurance services for transaction
against unexpected losses.

5] Generating and disseminating information for co-ordination – The financial system makes
available information for enabling participant to develop an informed opinion on investment,
dis-investment, re-investment or holding particular assets. This distribution of information
enables a quick and correct valuation of financial assets. It helps to minimise the situation
where one party has the information and other party does not.

6] Lowers transaction cost – A financial system helps in the creation of financial structure that
lowers the cost of transaction. This reduces the cost of borrowing. Thus the system generates
an impulse among the people to save more.

7] Promotes the process of financial deepening and broadening- Financial deepening means
an increase in the variety of financial assets as a percentage of GDP. Financial broadening on
the other hand means building an increase-number of participants. Thus an efficient financial
system will provide a variety of financial asset and also ensure that the number of participants
in the organised financial system increases.

E. RELATIONSHIP BETWEEN FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT

An economic system has to undergo varied and comprehensive economic changes so as to

achieve rapid economic development. The financial system, as a part of the economic system
has to gear up to meet the prime need of economic development. It has to ensure of a
continuous and increased flow of funds by way of capital for investment. The financial system
which plays a role of mobilising saving, generating a pool of financial resources and their
transfer for investment purposes could be viewed as a key factor in strengthening the pace
of economic development. The financial system promotes economic development in the
following manner :-

1. PROMOTE REAL SECTOR ACTIVITIES: In a modern economy, financial system

contributes significantly through its variety of financial institution which deal in an
 array of financial assets. It is obvious that financial resources by themselves cannot
bring about economic development yet they are a crucial factor, as the financial
system by using the financial resources can promote real sector activities any
produce greater output of goods and services.

2. FACILITATES PRODUCTION AND EXCHANGE OF GOODS AND SERVICES: One

significant aspect of the financial system is that it has a mechanism to facilitate both
production and exchange of goods and services. This is done not only by transferring
resources for lending funds and supplying credit but also by creating credit. Thus the
financial system is able to accelerate economic development by pooling and
transferring financial resources through increased mobilisation of savings and also
by creating credit.

3. PROVIDES A SPECTRUM OF FINANCIAL ASSETS: An active and broad based financial

system is essential for economic development which in turn nourishes further
progress in activities and performance of the financial system. The growing
requirements in finance i.e, funds for investment, in the course of the economic
development act as a stimulator to the financial system. As different new financial
institutions come up and a wide range of financial assets are introduced, it increases
the number and volume of transactions. This means that a wide range of financial
assets help the market participant to park their surplus funds in various forms which
help to maintain a balance between liquidity, profitability and risk.

4. PROVIDES A SYSTEM FOR EFFICIENT ALLOCATION OF RESOURCES: For mobilising

financial resources efficiently and allocating them effectively, the financial system
should be such that it is adequately developed. There are 2 mechanisms operating
in the financial system. a) the bank based system which includes the bank and
financial institutions and b) the market based system which includes the stock
markets. In the initial stage of economic development of an economy, the bank
based system is more active acting as an effective channel between the borrowers
and lenders. As the financial system develops, the market based system also
becomes more effective. In the market based system, the stock markets gain
importance as they provide companies and firms long term assets and thereby
facilitate economic growth. In the bank based system provision and allocation of
resources is better whereas in market based transaction cost is lower. Therefore, it
is desirable that both the system co- exist.

5. ACTS AS A BRIDGE BETWEEN SAVERS AND INVESTORS: In an economy, there are

some people with surplus and some with deficit amount of money. The former called
SURPLUS SPENDING UNIT or savers and the latter are called DEFICIT SPENDING UNIT
or investors.

a) Surplus-spending Economic Units are units whose consumption and planned

investment are less than their income. The surplus savings that they have is held in
the form of cash balances or financial assets. The acquisition of financial assets or
making of loans is, in fact, lending for productive investment. Such lending by the
 surplus-spending sector can be termed as demanding financial assets or supplying
loanable funds. In India, the household sector is a net-surplus spending economic
unit.
b) Deficit-spending Economic Units are units whose consumption and planned
investment exceeds income. The deficit-spending economic units have negative
savings; they finance their needs by borrowing or by decreasing their stock of
financial assets. Borrowing by deficit-spending units creates a supply of financial
securities or demand for loanable funds. In India, the government and the corporate
sector are deficit-spending economic units.

The surplus savings of the surplus-spending household units have to be transferred to

the deficit-spending economic units. A link in the form of a financial system is necessary
to transfer surplus savings to deficit units. The surplus and deficit units can be brought
together either directly through external financing or indirectly through intermediation
(banks and other financial institutions). Figure 1 illustrates how surplus-spending
economic units lend funds to financial intermediaries and financial markets—two
important components of the financial system. Financial intermediaries issue secondary
securities like deposits, insurance policies, and units to the ultimate lenders. The
ultimate borrowers may acquire funds either by issuing primary securities to financial
intermediaries or by issuing primary securities in the financial markets. This transfer of
funds from the surplus-spending sector to the deficit-spending sector through the
financial system leads to capital formation and economic growth. Economic growth, in
simple terms, is the increase in the real national product or output over time. Besides
linking savings and investment, the financial system helps in accelerating the rate of
savings and investment by offering diversified financial services and instruments. This
promotes a larger production of goods and services in the economy, leading to
economic growth.

6. HELPS IN PROJECT APPRAISAL: A financial system not only encourages investment it

also efficiently allocates resources in different investment channels. The financial
system helps to sort out and rank investment project by sponsoring and supporting
good projects and keeping a check over its management.

Thus the relationship between economic development and financial development is

symbiotic. While financial market accelerates development, it in turn grows with
economic development.
F. Reforms and trends/ turns in Indian financial sector: 1991-2019.

An efficient financial system is essential to mobilise savings of the households and

channel them to productive uses. The high rate of saving and productive
investment are-essential for economic growth. 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. A slew of measures were taken since 1991 to reform the financial system.
The first in this series was Financial sector reforms of 1991 headed by M. Narasimham.
Financial sector reforms aimed 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.

1. Reduction in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR):
An important financial reform has been the reduction in Statutory Liquidity Ratio (SLR)
and Cash Reserve Ratio (CRR) so that more bank credit is made available to the
industry, trade and agriculture. The statutory liquidity ratio (SLR) which was as high as
39 per cent of deposits with the banks has been reduced in a phased manner to 24 per
cent by 2008. Similarly, cash reserve ratio (CRR) which was 15 per cent was reduced over
phases. The reduction in CRR and SLR has made available more lendable resources for
industry, trade and agriculture. Reductions in CRR and SLR also made possible for
Reserve Bank of India to use open market operations and changes in bank rate as tools
of monetary policy to achieve the objectives of economic growth, price stability and
exchange rate stability.

2. End of Administered Interest Rate Regime:

The structure of administered rates has been almost totally done away with in a phased
manner. RBI no longer prescribes interest rates on fixed or time deposits paid by their
banks to their depositors. Banks have also been freed from any prescribed conditions of
premature withdrawal by depositors. Individual banks are free to determine their
conditions for premature withdrawal. Lending rates of interest for different categories
which were earlier regulated have been gradually deregulated. However, RBI insists
upon transparency in this regard. Each bank is required to announce prime lending rates
(PLRs) and the maximum spread it charges. Maximum spread refers to the difference
between the lending rate and bank’s cost of funds. Except prescribed lending rates for
exports and small loans up to Rs. 2, 00,000, the lending rates have been freed from
control. Banks can now fix their lending rates as per their risk reward perception of
borrowers and purposes for which bank loans are sought.

3. Prudential Norms: High Capital Adequacy Ratio:

In order to ensure that financial system operates on sound and competitive basis,
prudential norms, especially with regard to capital-adequacy ratio, have been gradually
introduced to meet the international standards. Capital adequacy norm refers to the
ratio of paid-up capital and reserves to deposits of banks. As a part of financial sector
reforms, capital adequacy norm of 10 per cent based on risk-weighted asset ratio system
has been introduced in India. Banks were advised by RBI to review their existing level of
capital funds as compared to the prescribed capital adequacy norm and take steps to
increase their capital base in a phased manner to achieve the prescribed norm by the
stipulated date.

4. Competitive Financial System:

After nationalisation of 14 large banks in 1969, no bank had been allowed to be set up
in the private sector. While the importance and role of public sector banks in Indian
financial system continued to be emphasised, it was however recognised that there was
urgent need for introducing greater competition in the Indian money market which
could lead to higher efficiency of the financial system. Accordingly, private sector banks
such as HDFC, Corporation Bank, ICICI Bank, UTI Bank, IDBI Bank and some others have
been set up. Establishment of these banks has made substantial contribution to housing
finance, car loans and retail credit through credit card system. They have made possible
the wider use of what is often called plastic money, namely, ITM cards, Debit Cards, and
Credit Cards. In addition to the setting up of private sector Indian banks, competition
has also sought to be promoted by permitting liberal entry of branches of foreign banks,
therefore, CITI Bank, Standard Chartered Bank, Bank of America, American Express,
HSBC Bank have opened more branches in India, especially in the metropolitan cities

5. Non-Performing Assets (NPA) and Income Recognition Norm:

Non-performing assets of banks have been a big problem of commercial banks. Non-
performing assets mean bad loans, that is, loans which are difficult to recover. A large
quantity of non-performing assets also lowers the profitability of bank. In this regard, a
norm of income recognition introduced by RBI is worth mentioning. According to this,
income on assets of a bank is not recognised if it is not received within two quarters
after the last date. In order to-improve the performance of commercial banks recovery
management has been greatly strengthened in recent years. Measures taken to reduce
non-performing assets include restructuring at the bank level, recovery of bad debt
through Lok Adalats, Civil Courts, setting up of Recovery Tribunals and compromise
settlements. The recovery of bad debt got a great boost with the enactment of
‘Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest’ (SARFAESI). Under this Act, Debt Recovery Tribunals have been set up
which will facilitate the recovery of bad debts by the banks.

6. Elimination of Direct Credit Controls:

Another significant financial sector reform is the elimination of direct or selective credit
controls. Selective credit controls have been done way with. Under selective credit
controls RBI used to control through the system of changes in margin for provision of
bank credit to traders against stocks of sensitive commodities and to stock-
brokers against shares. As a result, there is now greater freedom to both the banks and
borrowers in respect of credit. But it is worth mentioning that banks are required to
observe the guidelines issued by RBI regarding lending to priority sectors such as small-
scale industries and agriculture. The advances eligible for priority sectors lending have
been increased at deregulated interest rates.

7. Promoting Micro-Finance to Increase Financial Inclusion:

To promote financial inclusion the government has started the scheme of micro finance.
Though there are different models for pursuing micro-finance, the Self-Help Group
(SHG)-Bank Linkage Programme has emerged as the major micro-finance programme in
the country. It is being implemented by commercial banks, regional rural banks (RRBs),
and cooperative banks.

8. Non Banking Finance Companies:

To curb financial irregularities RBI Act made it mandatory for every NBFC to have
minimum net owned funds and obtain a certificate of registration from the RBI for
carrying on business. NBFCs are also subject to prudential regulations such as capital
adequacy requirements and provisioning norms along with reporting requirements.

9. Pension Funds: To reduce the fiscal burden the GOI moved from a defined-benefit
pension system to a defined contribution pension system called the “New
Pension System” (NPS) in 2004. The Pension Fund Regulatory and Development
Authority started functioning as the regulator for the NPS.

10. Capital market reforms:

SEBI was given an autonomous status to protect the interest of the investors and
promote development of this market and regulate the working of the stock exchanges.
SEBI to oversee the constitution and operation of mutual funds following the decision
to allow the entry of private sector. Stock exchanges now follow stringent regulation
to curb the practice of insider trading. It ensures compliance by issuer of capital and
intermediaries regarding proper disclosure of pricing of the issues, credit rating etc.
The capital market was opened for Foreign Institutional Investors.

11. Foreign Exchange Market reforms:

Flexible exchange rate system was introduced and FIIs were allowed to access to capital
market. Rupee was made convertible on current a/c and gradually to be converted on
capital a/c. Indian companies were permitted to access international market.
 Deepening of the foreign exchange market was enabled by introducing a large number
of-products and (ADR, GDR, FCCBs, ECBs) allowing the entry of new players.

Module 2
1. Types of NBFIs

Classification and Types

NBFCs are categorized

a) in terms of the type of liabilities into non-deposit and deposit accepting NBFCs,
b) Non-deposit taking NBFCs by their size into systemically important and other non-deposit
holding companies (NBFC-NDSI and NBFC-ND). NBFCs whose asset size is of Rs 500 crore or
more as per the last audited balance sheet are considered as systemically important NBFCs.
c) by the kind of activity they conduct.

Within this broad categorisation, the different types of NBFCs are as follows:

I. Asset Finance Company (AFC): An AFC is a company which is a financial institution

carrying on as its principal business the financing of physical assets supporting
economic activity, such as automobiles, tractors, lathe machines, generator sets,
earth moving and material handling equipment, moving on own power
and general purpose industrial machines. The assets and income arising
therefrom is not less than 60 per cent of its total assets and total income
respectively.

II. Investment Company (IC): IC is a financial institution carrying on as its principal

business the acquisition of securities. Most of the investment companies are
controlled by large business or industrial groups and the investment are
concentrated in the company of industrial group which they belong.

III. Loan Company (LC): Loan companies are generally small partnership concerned
with obtaining funds in the form of deposits from the public and give loans to
wholesale and retail traders, small scale industries and self employed persons.
These companies attract deposits from public by offering higher rate of interest
along with various kinds of prices. These companies offer loans at relatively higher
rate of interest.

In 2018-19, three categories of NBFCs namely, asset finance companies (AFCs), loan
companies (LCs) and investment companies (ICs) were merged into a new category
called investment and credit companies (ICCs) for harmonisation and operational flexibility

IV. Infrastructure Finance Company (IFC): IFC is a non-banking finance company a) which
deploys at least 75 per cent of its total assets in infrastructure loans, b) it has minimum net
owned funds of Rs 300 crore, c) it has a minimum credit rating of ‘A ‘or equivalent d) and a
CRAR of 15%.

V. Systemically Important Core Investment Company (CIC-ND-SI): CIC-ND-SI is an NBFC

carrying on the business of acquisition of shares and securities. It holds not less than 90 per
cent of its total assets in the form of investment in equity shares, preference shares, debt or
loans in group companies. Its asset size is Rs100 crore or above.

VI. Non-Banking Financial Company - Micro Finance Institution (NBFC-MFI): NBFC-MFI is a

non-deposit taking NBFC having not less than 85% of its assets in the nature of
qualifying assets. Loan can be disbursed to rural households with annual income less than Rs
60,000 and to a semi urban and urban household of income upto Rs 1,20,000. A collateral
free loan is given to a borrower for a minimum 24 month period.

VII. Residuary Non-banking Companies: RNBCs are a class of NBFCs that tap public savings by
operating various deposit schemes, akin to recurring deposit schemes of banks. Residuary Non-
banking Companies (RNBCs) are required to be mandatorily register with Reserve Bank of India. They
mobilized a large amount of deposits from the rural population. The RNBCs are the only class of
NBFCs for which the floor rate of interest for deposits is specified by the RBI while there is no upper
limit prescribed for them. The RBI has also prescribed prudential norms for RNBCs.

VIII. Mutual Benefit Financial Companies or NIDHIS: These companies can accept and renew
deposits only from shareholders. They tap public savings by operating various deposit
schemes. NIDHIS offer loans to their members for several purposes like house construction
and repairs, redemption of old debt, meeting medical expanses etc. These are generally for
consumption purpose and are mostly secured. The floor level of interest is determined by the
RBI. NIDHIS charge interest rate which are reasonable and are comparable to those of
commercial banks.

IX. Miscellaneous Non-banking Companies: Miscellaneous Non-banking Companies (MNBCs)

are companies engaged in the chit fund business. They can be further classified on the basis
of their functions.
• They have to mandatorily register with RBI to carry out their businesses of leasing, hire
purchase (financing physical assets) loan company etc.
• If they carry insurance business they have to register with IRDA.
• Venture capital funds, merchant banking companies, stock broking companies have
to register with SEBI.

X. Housing finance companies (HFCs) are specialised lending institutions which, along with
SCBs, are the main purveyor of housing credit.

2. Regulations on NBFIs

The core principles of NBFCs regulation are a) protection of depositors (in case of deposit-
accepting companies) and customers; and, b) preserving financial stability. The varying
emphasis on these objectives at different points in time has led RBI to deploy different policy
tools as appropriate.

1. In the 1960s, the RBI made an attempt to regulate NBFCs by issuing directions relating
to the maximum amount of deposits, the period of deposits, and rate of interest they
could offer on the deposits accepted. Norms were laid down regarding maintenance of
certain percentage of liquid assets, creation of reserve funds, and transfer there to
every year a certain percentage of profit, and so on. These directions and norms were
revised and amended from time to time.

2. In 1977, the RBI issued two separate sets of guidelines, namely, (i) NBFC Acceptance of
Deposits Directions, 1977, for NBFCs and (ii) MNBD Directions, 1977, for MNBCs. These
directions were related to deposit-taking activities of NBFCs.

3. NBFCs became prominent in the first half of the 1990s. The growth in aggregate
deposits of NBFCs outpaced that of banks. However, bank finance to NBFCs dried up in
1995 after the RBI cautioned banks against such lending. Therefore, NBFCs had to
depend on fixed deposits often at rates up to 26 per cent. To service high-cost deposits,
NBFCs invested in bought-out deals, shares, real estate and corporate financing, the
areas in which they had little experience. The slackness in the capital and real estate
markets and general industrial activities resulted in sharp deterioration in NBFC’s
quality of assets. Crores of rupees of small investors disappeared overnight as NBFCs
like CRB Capital Markets, JVG Finance, and Prudential Capital Markets failed in 1997.
This shook the investor confidence which resulted in a rush of withdrawals of public
deposits. This is the only sector which had a number of committees trying to
regulate its working. The first was the Shah Committee in 1992. It was followed by
the Shree Committee, Khanna Committee and various committees of the RBI.

4. In 1997, the RBI Act was amended and the Reserve Bank was given comprehensive
powers to regulate NBFCs. The amended act made it mandatory for every NBFC to
obtain a certificate of registration and have minimum net owned funds. Ceilings were
prescribed for acceptance of deposits, capital adequacy, credit rating and net-owned
funds. Norms relating to capital adequacy, credit rating exposure, asset classification
and so on were laid down.

5. According to the Financial Companies Regulation Bill 2000 all the NBFCs will be known
as financial companies instead of NBFCs.

6. The Reserve Bank of India prescribed guidelines

i. All NBFCs have to comply with norms related to income recognition, asset
classification and provisioning requirements, exposure, disclosures in the
balance sheet, requirement of capital adequacy, restrictions on investments
in land and building and unquoted shares, loan to value (LTV) ratio for NBFCs
predominantly engaged in business of lending against gold jewellery, besides
others.
ii. Deposit accepting NBFCs have also to comply with the statutory liquidity
requirements.
 iii. NBFC shall maintain a minimum capital ratio of 15% consisting of Tier I and
Tier II capital.
iv. Non-deposit accepting NBFCs with asset size of less than Rs 500 crore will
not be subjected to any regulation if they have not accessed any public funds
and do not have a customer interface. Those who have customer interface
only will be subjected to business regulations like KYC only. Those accepting
public funds will be subjected to limited prudential regulations but not
conduct of business regulations. Where both public funds are accepted and
customer interface exist, such companies will be subjected both to limited
prudential regulations and conduct of business regulations.

3. Venture capital fund (roles and types)

Venture capital funds(VCFs) are investment instruments through which individuals can park
their money in newly-formed start-ups as well as small and medium-sized companies. These
are types of investment funds that primarily target firms that have the potential to deliver
high returns. Nonetheless, investing in these companies also involves considerable risk. Here
investors can refer to individuals with high net worth, companies, or even other funds. VCFs
invest in multiple companies at once. This is done by having confidence that at least a few
among the lot will be able to produce high returns and assuage the losses, if any, incurred by
the others. A VCF is managed by a venture capital firm. A venture capital firm identifies
investment areas that can generate lucrative returns. It not only acts as the fund manager but
also as an investor. Generally, a venture capital firm will also invest its own money as a form
of commitment and assurance to its clients. In lieu of investment, a venture capital firm may
seek a chair amongst the directors at the company, and offer expertise and intelligence for
better management.

Types of Venture Capital Fund

1. Early-stage funding: It is the fund invested to help a company establish itself and start
manufacturing its products or delivering its services.
• Seed funding – A small amount offered to help a business qualify for a loan.
• Start-up funding – Offered to help companies develop their products or services.
• First-stage funding – Offered to companies that require funding to start their operations.

2. Expansion funding: this funding is offered to companies expanding their

operations on various stages.
• Second-stage funding – Provided to firms that are seeking to begin their expansion.

• Bridge funding – A form of immediate financing option that helps a company address its
short-term expenditures until long-term funding is availed.

• Mezzanine funding – Offered to aid companies during mergers and acquisitions.

3. Acquisition or buyout funding is categorised into the following –

• Acquisition funding – Provided to help firms acquire certain areas of another business.
 • Management or leveraged buyout funding – Offered to assist companies in acquiring
another company or a product.

ROLE of VCF
• Beneficial for creating networks and connections: Venture capital firms have a
widespread network, which can help a start-up get the much-needed marketing and
promotion that can eventually help to establish itself.
• Paves the way for expansion: VCFs can help a company to expand quickly and
exponentially. This may not be the case in any other type of funding.
• Offers crucial business expertise: Not only investment but VCFs bring years of
expertise to the table. This proves crucial in human resource management, financial
management, and business decisions, which young entrepreneurs may lack.

4. Commercial banking in india / Development of Commercial Banking in India

Pre-Independence Period:
The history of banking dates back to-the thirteenth century when the first bill of exchange
was used as money in medieval trade. Banking in India has its origin in Vedic times, i.e., 2000–
1400 BC. Modern banking in India emerged between the eighteenth and the beginning of the
nineteenth centuries when European agency houses erected a structure of European
controlled banks with limited liability. The first ‘Presidency bank’—the Bank of Bengal—was
established in Calcutta on June 2, 1806 followed by The Bank of Bombay in 1840 and Bank of
Madras in July 1843. These Presidency banks were amalgamated into the Imperial Bank of
India in 1921. The role of the Imperial bank was that of a commercial bank,
a banker’s bank and a banker to the government. Reserve Bank of India Act, 1934 was
enacted and the Reserve Bank of India was set up in 1935.

Post Independence:
a) Pre Nationalisation: (1947-1968)
The government enacted the Banking Companies Act in 1949 (later renamed as the Banking
Regulation Act) giving extensive powers to the Reserve Bank for banking supervision as the
central banking authority of the country. It included various powers such as protecting the
interests of depositors, organisation, management, audit and liquidation of the banking
companies, control over opening of new banks and branch offices, powers to inspect books
of accounts of the banking companies, and preventing voluntary winding up of licensed
banking companies. Through elimination and mergers, the number of banking institutes was
reduced. Between 1954 and 1966, 217 weak banks were either amalgamated or liquidated or
their liabilities and assets transferred to other banks. In order to-enlarge the reach of banking
services, the Government nationalised the Imperial Bank of India by converting it into the
State Bank of India in 1955. The objective of nationalisation was ‘extension of banking
facilities on a large scale, more particularly in the rural and semi-urban areas, and for diverse
other public purposes’.

In order to ensure the safety of deposits of small depositors in banks in India, the Deposit
Insurance Corporation Act, 1961 was enacted and the Deposit Insurance Corporation of India
was set up in January 1962. The deposit insurance increased the trust of the depositors in the
banking system which enabled higher deposit mobilisation. The number of bank branches
rose significantly between 1951 and 1967, as a result of which the average population per
branch fell from 1,36,000 in 1951 to 65,000 in 1969. Inspite of increase in number of branches,
the rural population could not avail banking services on account of concentration of branches
in urban areas, and a higher credit flow directed to industrial houses. To break the nexus
between industrial houses and banks and improve the flow of credit to agriculture, the
government once again used the tool of nationalisation of major banks in the country.

Nationalisation of Banks 1969

In 1969, 14 banks were nationalised to promote macro-economic objectives such as economic
growth, better regional balance of economic activities, and the diffusion of economic
power. Fourteen erstwhile private sector banks were nationalised on July 19, 1969, and
another six, viz, Andhra Bank, Corporation Bank, New Bank of India, Oriental Bank of
Commerce, Punjab and Sind Bank, and Vijaya Bank, with deposit liabilities of Rs 200 crore and
above in 1980. Objectives of nationalization

i. extend the reach of organised banking services to rural areas and to the neglected
sections/sectors of society.
ii. Diversion of funds at concessional rates
iii. Prevent monopolies from the use of banks by a few private entrepreneurs.
iv. Increase agricultural credit

The Reserve Bank also launched the Lead Bank Scheme (LBS) in December 1969, to mobilse
deposits and to step up lending to weaker sections of the economy. Under this scheme, a
‘lead bank’ designated for the district was responsible for taking lead role in surveying the
credit needs of the population, development of banking and of credit facilities in the district
allotted to it. Inspite of these measures, the commercial banks failed to cater the needs of
rural people, especially the small and marginal farmers. Hence, a separate banking structure
known as the Regional Rural Banks was set up on February 9, 1976.

b) Post Nationalisation (1969-1992):

Between 1969 and 1992, there was a rapid expansion of branch network. The number of
bank branches increased from 8,262 to 60,570, deposits rose from Rs 4,646 crore
to Rs 2,37,566 crore, advances from Rs 3,599 crore to Rs 1,31,520 crore in 1991 reflecting
a rapid growth of banking activity. The banking system spread to rural areas. Small-scale,
tiny, and cottage industries, and small entrepreneurs benefited from the spread of the
banking system. The significance of the informal (unorganized) sector declined with the
spread of the banking system. The share of priority sector in the total banking grew. In
1969, 14 per cent of bank credit was apportioned to priority sectors whereas by 1990, this
share had gone up to 43 per cent. Banking density improved from 64,000 people per
branch in 1969 to just 14,000 people per branch in 1991. India’s gross domestic savings
(GDS) rose from 15.7 per cent in 1970 to 24.20 per cent in 1991 and banking deposits grew
at a rapid 19 per cent compounded annual growth rate.

However, the government also had easy access and control over public funds. As banks were
merely tools in the hands of the government, banks had no incentive to make profits and
improve the financial health. Nationalisation killed competition and stifled innovations in
banking. Trade unions became strong in banks with political patronage and they resisted any
form of change in the banking system. Banks functioned in a regulated environment with
administered interest rate structure, quantitative restrictions on credit flows, fairly
high reserve requirements, and pre-emption of significant proportion of lendable resources
for the priority and the government sectors. These resulted in sub-optimal use of credit, low
levels of investment and growth, decline in productivity, and erosion of profitability of the
banking sector in general. The government realised the need to upgrade the operating
standards, health, and financial soundness of banks to internationally accepted levels.

Post Financial Sector Reforms:

Although a series of reforms were undertaken from 1985 onwards, the first phase of
comprehensive reforms in the banking sector was undertaken in June 1992 by implementing
the recommendations of the Narasimham Committee I (1991) on the financial system. The
recommendations of the committee were a fundamental departure from the then existing
banking sector regulations. The major objective of the reforms was to create a viable and
efficient banking system, which would thereby improve the productivity and efficiency of the
financial sector. The major policy changes brought about emphasized deregulation and
liberalisation. The first phase of reforms focused on cleaning up bank balance sheets and
bringing about greater disclosure and transparency in accounting. The RBI laid down clear
policies for asset classification, income recognition, loan-loss provisioning, and investment
valuation with mandatory compliance of the Bank for International Settlements (BIS) capital
adequacy standards.

The initial years of these reforms were very painful for banks. Twelve of the 27 public sector
banks reported losses. To overcome the crisis, the financially weak New Bank of India was
merged with the large profitable Punjab National Bank in the early nineties. As a group, public
sector banks turned around from a net loss position of 0.99 per cent of total assets in the
fiscal year 1993 to a net profit position of 0.25 per cent of total assets in 1995. Two public
sector banks, the State Bank of India-and the Oriental Bank of Commerce, came out with their
maiden initial public offerings (IPOs) which led to a dilution of government ownership in banks
for the first time. Competition was infused in the banking system for the first time in 1993
when the RBI granted permission to set up private sector banks and foreign banks were
allowed to open branches. Despite competition, banks were in a position to post higher
profits due to volume expansion and fewer poor quality loans. The second phase of reforms
aim to strengthen the banking sector through rigorous operational, prudential, and
accounting norms, improvement in the credit delivery system and gradual narrowing of the
divergences in regulatory framework of different types of institutions. It is expected that the
Indian banking system will emerge as strong and efficient in the new millennium.

Structure of Commercial Banks in India

Banks in India are classified into Scheduled and non-Scheduled Banks. Scheduled banks are
those included in the second schedule of the Reserve Bank of India Act, 1934. These banks
should have a paid-up capital and reserves of at least Rs 5 lakhs and have to conduct their
affairs in a manner not detrimental to the interests of the depositors. Scheduled banks
include Commercial Banks and Co-operative Banks. Non-scheduled banks are subject to
maintain an average daily balance of cash reserves with the RBI. They cannot borrow from RBI
except under abnormal circumstances.

Scheduled Commercial Banks: In terms of ownership and function, Scheduled commercial

banks can be classified into four categories: public sector banks, private sector banks,
foreign banks in India, and regional rural banks. At present (2021) there are 139 scheduled
commercial banks—19 public sector banks, 21 in the private sector, and 43 foreign banks and
56 Regional Rural Banks. RBI gave in-principle licences to 11 payments banks, out of which 3
backed out and in-principle licences to 10 small finance banks with the objective of deepening
financial inclusion.

A) Public Sector Banks

Public sector banks are banks in which the government has a major holding. These can be
classified into two groups:
(i) the State Bank of India group and
(ii) (ii) 17 nationalised banks and
(iii) iii) public sector bank (IDBI)

i) SBI and all its associates were gradually merged resulting in the first ever large-scale
consolidation within the Indian banking industry and catapulted SBI, India’s largest
lender, into one of the Top 50 global banks.
ii) Nationalised Banks : In 1969, fourteen big Indian joint stock banks in the private sector
were nationalised. Six more were nationalized in 1980. In all, 28 banks were
nationalised from 1955–1980. At present there are 17 nationalised banks.
iii) IDBI which is classified as other public sector bank.
Public sector banks dominate with 75 per cent of deposits and 71 per cent of advances in the
industry.

B) Private Sector Banks

In the pre-reforms period, there were only 24 banks in the private sector. The Narasimham
Committee, in its first report, recommended the freedom of entry into the financial system.
Today, there are 21 private sector banks in the banking sector: 12 old private sector banks
and 9 new private sector banks. These new banks have brought in state-of-the-art technology
and aggressively marketed their products. These banks reported profits in the very first year
of their existence. The public sector banks are facing a stiff competition from the new private
sector banks.

C) Regional Rural Banks

In 1975, 6 regional rural banks (RRBs) came into existence under the Regional Rural Banks
Regional Rural Banks Act, 1976. The objective of RRBs were
• Development of agriculture, trade, commerce industry, and other productive activities in
rural areas.
• Provide credit and other facilities to the small and marginal farmers,
agricultural labourers and small entrepreneurs.

D) Foreign banks
These are a type of International Bank that is obligated to follow the regulations of both the
home and host countries. Because the foreign banks’ loan limits are based on the parent
bank’s capital, foreign banks can provide more loans than subsidiary banks. Foreign Banks are
present in India either as representative offices or as branches. A bank may choose to open
foreign bank branches to meet the needs of multinational corporate customers. Foreign
banks are defined as banks from a foreign country working in India through branches. RBI has
provided rules and guidelines for a foreign bank to establish and operate in India.

5. PFRDA

The Pension Fund Regulatory and Development Authority (PFRDA) was established
by the Government of India through the enactment of the PFRDA Act in 2013. Its
primary purpose is to regulate, promote, and ensure the growth of the pension
sector in India, with a particular focus on the National Pension System (NPS). The
NPS, initially launched in 2004 for government employees, was extended to all
citizens in 2009. It offers a long-term investment option for retirement savings,
allowing individuals to contribute to a pension fund during their working years and
draw a steady income post-retirement.

Functions of the PFRDA:

1. **Regulation and Supervision**: PFRDA regulates pension fund managers (PFMs)

who are responsible for investing the contributions of NPS subscribers. It ensures
these managers adhere to guidelines and that investments are made in a safe and
secure manner, balancing returns with the risk appetite of subscribers.

2. **Transparency and Accountability**: PFRDA ensures transparency in the pension

management process by mandating strict reporting standards and regular disclosure
of portfolio performance. This builds trust and confidence among subscribers in the
system.

3. **Intermediaries' Role**: Besides PFMs, PFRDA oversees various intermediaries,

including central record-keeping agencies (CRAs), trustee banks, custodian banks,
and annuity service providers (ASPs). These intermediaries help in managing and
maintaining records, safeguarding funds, and ensuring smooth transitions from
accumulation to pension disbursement.

4. **Expansion of Coverage**: PFRDA actively works towards expanding pension

coverage across different sectors, particularly targeting the unorganised workforce,
which constitutes a significant part of India’s labor market. Schemes such as the Atal
Pension Yojana (APY) are designed for the unorganised sector, offering pension
benefits at affordable contribution levels.

5. **Subscriber Protection**: The authority is responsible for safeguarding the

interests of subscribers by setting up grievance redressal mechanisms, reviewing
policy changes, and taking action to maintain fairness and transparency in the
system. It also ensures that the investment risks are communicated clearly, and
subscribers are informed about the returns and potential risks associated with their
investments.

Importance of PFRDA:

- **Long-Term Financial Security**: By regulating the pension market, PFRDA ensures

that individuals have a reliable, regulated option for long-term financial security post-
retirement, especially in a country where traditional pension systems are not
available to the majority of the population.

- **Capital Market Development**: The authority also indirectly contributes to the

development of capital markets, as pension funds are long-term investors in equity
and debt markets. This provides a stable pool of capital, contributing to the overall
growth of the financial markets.

- **Pension Reforms**: PFRDA is instrumental in pushing for pension reforms in

India, making the pension sector more inclusive and accessible, and working on the
constant evolution of the NPS to meet changing economic and demographic needs.

In conclusion, the PFRDA plays a vital role in ensuring that India's pension system is
robust, transparent, and accessible, contributing significantly to the socio-economic
security of citizens, particularly in their old age. Through the regulation of the NPS
and other pension schemes, PFRDA helps individuals build a sustainable financial
future while fostering long-term savings and investments across the country.

Module 3
1. Structure of debt market

The structure of the debt market is organized into different segments based on
the types of securities, issuers, and the nature of trading. Broadly, the debt
market is divided into the following categories:

1. **Primary Market**
- **Definition**: In the primary market, new debt securities are issued and sold
for the first time.
- **Participants**: Governments, corporations, and financial institutions issue
bonds, and investors buy these bonds directly from the issuers.
- **Process**: Underwriting institutions, such as investment banks, may help in
the issuance process by setting prices, organizing bond auctions, and marketing
to investors.
- **Examples**: Treasury auctions, initial offerings of corporate bonds.

2. **Secondary Market**
- **Definition**: Once bonds are issued in the primary market, they are traded
among investors in the secondary market.
 - **Participants**: Investors, broker-dealers, and market makers.
- **Function**: This market provides liquidity to bondholders, enabling them to
buy and sell previously issued debt securities before maturity.
- **Examples**: Trading platforms like stock exchanges or over-the-counter
(OTC) markets.

3. Type of Debt Instruments

Listed below are the different types of debt instruments you can find in India:

#1. Bonds
These are the most common and are created through bond indenture. The investor buys
corporate or government bonds for a fixed return. Bonds are backed by collateral and
physical assets. Generally, they have a maturity range of 5 to 40 years. They are appreciated
when the market rate is low. Governments, corporations, and local governments all issue
bonds.
Corporate bonds, government securities bonds, convertible bonds, RBI bonds, sovereign
gold bonds, inflation-linked bonds, and zero-coupon bonds are among the several bond
categories in India that you can invest in.

#2. Debentures
They are similar to bonds, but their securitisation differs as they are unsecured and rely on
the issuer’s creditworthiness. They are not backed by any collateral and physical assets.
Major corporations and the government issue them to raise funds. Since it hardly creates
any claim on the assets, it is a significant advantage to the issuer. Hence leaving them
available for future funding. They appear on the balance sheet and are included in share
capital.

#3. T-Bills
The government and RBI issue T-bills, or treasury bills, which are money market instruments.
It is a liability to the Indian government and is paid within a fixed time. With a maximum
maturity of up to 364 days, it carries no risk and may be quickly turned into cash in an
emergency.
These bills are auctioned weekly by non-competitive bidding, creating a higher cash flow to
the capital market. The tenure structure of these bills determines their discount rates and
face value. These are subject to fluctuations based on financing requirements, reserve bank
policies, and the total number of bids received.

#4. Certificates of Deposits

CDs or certificates of deposits are time-specific deposits and are provided by banks. They are
equivalent to conventional bank savings accounts. They are risk-free, insurance-covered, and
cannot be issued for less than one year or more than three years. CDs have fixed interest
rates mostly and differ from savings as they have a set term period.

#5. Commercial Papers

CPs are issued when organisations have to raise capital over one year, hence short-term
instruments. These are unprotected instruments issued as promissory notes with a
minimum of seven days and a maximum one-year maturity period from the issue date. They
are available for INR 5 lakh or in their multiples and are issued by financial institutions to
help companies raise money.

#6. Mortgages
A mortgage is a type of loan backed by real estate. People usually use these loans to
purchase homes, commercial buildings, land, and other real estate. They are annualised over
time, allowing borrowers to pay until the debt is paid. On the other hand, the lenders
receive interest until it is paid. If the borrower defaults, the lender seizes and sells the assets
to get its funds.

#7. Government Securities

These are issued on behalf of the government by RBI and include State and Central
government securities and treasury bills. To cover its budgetary shortfalls, the Central
government takes out loans. The issuance of dated securities and 364-day treasury bills,
either by loan floatation or auction, increases the government's market borrowing.
In addition, 91-day treasury notes are created to help the government easily handle short-
term cash imbalances. There is no default risk since government securities are issued at face
value and are backed by a sovereign guarantee. Interest payments are provided on a half-
yearly basis at face value.

The investor has the option to sell the asset on the secondary market. Investors can redeem
the securities at face value at maturity, and tax is not withheld at the source. Two to thirty
years is the maturity range.

4. **Market Segments**
- **Money Market**:
- Focuses on short-term debt instruments with maturities of one year or less
(e.g., Treasury bills, commercial paper).
- **Capital Market**:
- Deals with longer-term debt instruments with maturities of more than one
year (e.g., long-term government and corporate bonds).

5. **Modes of Trading**
- **Over-the-Counter (OTC) Market**:
- Most debt securities are traded in OTC markets, where participants trade
directly, often through intermediaries like brokers or dealers.
- **Exchange-Traded Market**:
- Some debt securities (especially corporate bonds and government bonds in
certain countries) can be traded on organized exchanges like the New York Stock
Exchange (NYSE) or Nasdaq.

6. **Yield Curve and Pricing**

- **Yield Curve**:
 - A graphical representation of interest rates across different maturities,
showing how the yield on bonds changes with the length of time until maturity.
- **Pricing**:
- Bond prices are influenced by factors such as credit rating, prevailing interest
rates, market conditions, and inflation expectations.

7. **Participants in Debt Market (Supporting Infrastructure)

- **Central Banks**:
- Regulate and stabilize the debt market through monetary policy.
- **Rating Agencies**:
- Provide credit ratings to assess the risk level of issuers.
- **Clearing and Settlement Systems**:
- Ensure that trades are settled smoothly, such as through systems like the
Depository Trust & Clearing Corporation (DTCC) in the U.S.

8. **Regulatory Environment**
- **Regulatory Bodies**:
- The debt market is regulated by financial authorities such as the U.S.
Securities and Exchange Commission (SEC) and the Federal Reserve in the U.S.,
the Financial Conduct Authority (FCA) in the UK, and other national financial
regulators.
- **Regulations**:
- Governing rules are designed to ensure transparency, fairness, and liquidity
in bond issuance and trading.

This structured framework allows the debt market to facilitate the movement of
capital from investors to issuers, with varying risk levels and maturities to meet
the needs of both sides.

2. components of organised money market

The organised money market in India consists of several components that

facilitate short-term borrowing and lending, typically for periods of one year or
less. These markets help in maintaining liquidity in the financial system and are
regulated by the Reserve Bank of India (RBI). The major components are:

1. **Call Money Market**

- **Definition**: A market for extremely short-term funds, where banks borrow
and lend overnight or for a short duration, up to 14 days.
- **Participants**: Banks, financial institutions, mutual funds, and insurance
companies.
- **Purpose**: Provides immediate liquidity to banks, and the interest rates
here serve as a key indicator of liquidity conditions in the market.

2. **Treasury Bills Market**

 - **Definition**: Treasury Bills (T-bills) are short-term government securities
issued by the Government of India, typically with maturities of 91 days, 182 days,
and 364 days.
- **Participants**: Banks, financial institutions, primary dealers, and individual
investors.
- **Purpose**: These are used by the government to manage short-term
funding needs, and they are considered risk-free instruments since they are
backed by the government.

3. **Commercial Paper (CP) Market**

- **Definition**: CPs are unsecured, short-term promissory notes issued by
corporations and financial institutions to meet short-term funding requirements.
- **Maturity**: Usually between 7 days and 1 year.
- **Participants**: Large corporations, financial institutions, mutual funds, and
banks.
- **Purpose**: Corporates use CPs to raise short-term funds at competitive
rates, while investors get an opportunity to invest in low-risk instruments with
relatively higher yields compared to Treasury Bills.

4. **Certificates of Deposit (CD) Market**

- **Definition**: CDs are negotiable money market instruments issued by
banks and financial institutions, offering higher interest rates than savings
accounts, with maturities ranging from a few weeks to a year.
- **Participants**: Banks, financial institutions, mutual funds, and individual
investors.
- **Purpose**: CDs provide a way for banks to raise short-term funds and offer
a secure investment for participants looking for low-risk options.

5. **Repo and Reverse Repo Market**

- **Repurchase Agreement (Repo)**:
- In a repo transaction, a seller sells securities (usually government bonds) with
an agreement to repurchase them at a future date and a predetermined price.
- **Participants**: Banks, primary dealers, and financial institutions.
- **Purpose**: It provides short-term borrowing and liquidity, with the
government securities acting as collateral.

- **Reverse Repo**:
- In a reverse repo, the buyer of the securities agrees to sell them back to the
original seller at a future date.
- **Purpose**: Used by the RBI to absorb excess liquidity from the banking
system.

6. **Inter-Bank Term Money Market**

- **Definition**: A market where banks lend and borrow funds from each other
for a period of more than one day and up to 90 days.
- **Participants**: Banks and financial institutions.
 - **Purpose**: This market helps banks manage their short-term liquidity
needs, allowing them to borrow or lend for a fixed term.

7. **Discount and Finance House of India (DFHI)**

- **Definition**: DFHI is an important institution in the Indian money market,
set up to develop an active secondary market in money market instruments,
particularly for rediscounting Treasury Bills, commercial paper, and other short-
term instruments.
- **Role**: It acts as a market maker and helps provide liquidity to participants
in the money market.

8. **Money Market Mutual Funds (MMMFs)**

- **Definition**: MMMFs are mutual funds that invest in short-term money
market instruments such as Treasury Bills, commercial papers, and certificates of
deposit.
- **Participants**: Retail investors, institutional investors, and high-net-worth
individuals.
- **Purpose**: MMMFs offer a safe and liquid investment option for investors
looking to park surplus funds for short durations.

9. **Reserve Bank of India (RBI)**

- **Role**: The RBI is the central regulator of the money market in India and
influences the market through its monetary policy, such as setting repo rates and
reverse repo rates, open market operations (OMO), and liquidity adjustment
facilities (LAF).

10. **Primary Dealers (PDs)**

- **Definition**: Primary dealers are financial institutions authorised by the RBI
to act as intermediaries in the government securities market.
- **Role**: They participate in auctions of government securities and provide
liquidity in the secondary market for T-bills and other instruments.

These components collectively form the organised money market in India,

offering a range of instruments for short-term liquidity needs and enabling
efficient financial operations. The market is regulated primarily by the RBI to
ensure stability and smooth functioning.

3. Role of debt market

The debt market, also known as the bond market, plays a crucial role in the financial system
and the broader economy. It involves the buying and selling of debt instruments like bonds,
debentures, and other fixed-income securities. Here are the key roles it plays:

1. **Funding for Governments and Corporations**:

- **Governments**: The debt market allows governments to raise funds to finance their
expenditures, such as infrastructure projects, social programs, or budget deficits, by issuing
bonds.
 - **Corporations**: Companies can raise capital to expand operations, invest in projects,
or refinance debt by issuing corporate bonds, providing an alternative to equity financing.

2. **Risk Management**:
- Debt instruments can offer stability to investors looking for lower-risk investments.
Bonds, especially government bonds, are often seen as safer compared to stocks.
- They provide predictable returns through fixed interest payments, which makes them
attractive for risk-averse investors.

3. **Interest Rate Benchmarking**:

- Bond yields, especially government bond yields, are used as benchmarks for setting
interest rates across the economy. For example, mortgage rates, loan rates, and savings rates
often track government bond yields.
- Central banks, through their monetary policy, influence bond yields by setting short-term
interest rates and engaging in open market operations.

4. **Liquidity for the Economy**:

- The debt market provides liquidity to financial institutions and investors, allowing them to
convert their investments into cash relatively quickly by buying and selling bonds in the
secondary market.
- This liquidity supports the functioning of other financial markets and economic stability.

5. **Economic Indicators**:
- The bond market is often seen as a reflection of the health of the economy. Rising
interest rates on bonds may indicate inflationary pressures, while falling rates may suggest
economic slowdown or deflation.
- Bond spreads (the difference in yields between different bonds) can signal investor
sentiment about credit risk or economic outlook.

6. **Foreign Investment**:
- Foreign investors often buy government and corporate bonds, bringing capital into the
economy and influencing exchange rates and monetary policy.
- It also allows countries to finance their external deficits by borrowing from international
markets.

7. **Wealth Management**:
- For pension funds, insurance companies, and long-term investors, bonds provide a stable
source of income and are a key part of a diversified investment strategy.

In summary, the debt market is essential for capital raising, risk management, economic
stability, and providing signals about the broader economic environment. Its effective
functioning is crucial for both private and public sectors.

4. Features of Indian money market. Explain treasury bills

Following are the features of money market:

 1. Money market has no geographical constraints as that of a stock exchange. The
financial institutions dealing in monetary assets may be spread over a wide
geographical area.
2. Even though there are various centres of money market such as Mumbai, Calcutta,
Chennai, etc., they are not separate independent markets but are inter-linked and
interrelated.
3. It relates to all dealings in money or monetary assets.
4. It is a market purely for short-term funds.
5. It is not a single homogeneous market. There are various sub-markets such as Call
money market, Bill market, etc.
6. Money market establishes a link between RBI and banks and provides information
of monetary policy and management.
7. Transactions can be conducted without the help of brokers.
8. Variety of instruments are traded in money market

Treasury bills

 Treasury Bills or T-Bills refer to short-term securities issued by the RBI on behalf
of the Central Government.
 They act as short-term fundraising tools for the government.
 Treasury Bills (T-Bills) are one of the two types of Government Securities (G-Secs).
o One other type of Government Securities (G-Secs) is Government
Bonds, which have a maturity period of more than 1 year and hence
are Capital Market instruments.

Features of Treasury Bills (T-Bills)

 Treasury bills are issued at a discount to the original value and the buyer gets the
original value upon maturity.
o For example, a Rs 100 treasury bill can be availed of at Rs 95, but the
buyer is paid Rs 100 on the maturity date. This is called redemption at
par or face value.
o Thus, they are non-interest bearing i.e. 0 coupon or 0 interest, and
hence are also called 0 coupon bonds.
 Being backed by the Government, these bills are considered risk-free and are
highly liquid.
 These bills are issued only by the Central Government (through the RBI).
o The State Governments do not issue T-Bills.
 Instead of direct selling, T-Bills are auctioned in the market, wherein each buyers
submit their bids and the bill is sold to the buyer willing to pay the highest price.
o The option of bidding ensures the highest revenue for the government
as well as transparency in the issuing process.
  T-Bills are available for a minimum amount of ₹ 25,000 or in multiples of ₹
25,000.
 As of now, there are 3 types of T-Bills auctioned by the RBI:
o 91-day T-Bills – Have a maturity period of 91 days.
o 182-day T-Bills – Have a maturity period of 182 days.
o 364-day T-Bills – Have a maturity period of 364 days.
 T-Bills can be used by the Banks for:
o Keeping as part of their SLR requirements.

o Providing as collateral to the RBI for getting loans under Repo.

5. Participants of debt market

Participants in the debt market (or bond market) include various entities that buy,
sell, issue, or trade debt securities. Key participants are:

1. **Governments**:
- Issue bonds (e.g., treasury bonds, municipal bonds) to fund public spending.

2. **Corporations**:
- Issue corporate bonds to raise capital for expansion or operational needs.

3. **Investors**:
- Can be individuals, institutional investors (e.g., mutual funds, pension funds,
insurance companies), or sovereign wealth funds. They purchase bonds to earn
interest income.

4. **Banks and Financial Institutions**:

- Play a role in underwriting bonds, market making, and trading debt securities.

5. **Central Banks**:
- Buy and sell government bonds to manage monetary policy and control interest
rates (e.g., through open market operations).

6. **Bond Rating Agencies**:

- Agencies like Moody’s, S&P, and Fitch assess and rate the creditworthiness of
bond issuers, helping investors gauge risk.

7. **Broker-Dealers**:
- Facilitate the buying and selling of bonds on behalf of clients or for their own
accounts.

These participants play interconnected roles in facilitating the functioning of the debt
market, influencing interest rates, risk management, and investment flows.

6. Treasury bills, repo, call market

 Treasury bills

 Treasury Bills or T-Bills refer to short-term securities issued by the RBI on behalf
of the Central Government.
 They act as short-term fundraising tools for the government.
 Treasury Bills (T-Bills) are one of the two types of Government Securities (G-Secs).
o One other type of Government Securities (G-Secs) is Government
Bonds, which have a maturity period of more than 1 year and hence
are Capital Market instruments.

Features of Treasury Bills (T-Bills)

 Treasury bills are issued at a discount to the original value and the buyer gets the
original value upon maturity.
o For example, a Rs 100 treasury bill can be availed of at Rs 95, but the
buyer is paid Rs 100 on the maturity date. This is called redemption at
par or face value.
o Thus, they are non-interest bearing i.e. 0 coupon or 0 interest, and
hence are also called 0 coupon bonds.
 Being backed by the Government, these bills are considered risk-free and are
highly liquid.
 These bills are issued only by the Central Government (through the RBI).
o The State Governments do not issue T-Bills.
 Instead of direct selling, T-Bills are auctioned in the market, wherein each buyer
submit their bids and the bill is sold to the buyer willing to palllllllllllllllllllllly the
highest price.
o The option of bidding ensures the highest revenue for the government
as well as transparency in the issuing process.
 T-Bills are available for a minimum amount of ₹ 25,000 or in multiples of ₹
25,000.
 As of now, there are 3 types of T-Bills auctioned by the RBI:
o 91-day T-Bills – Have a maturity period of 91 days.
o 182-day T-Bills – Have a maturity period of 182 days.
o 364-day T-Bills – Have a maturity period of 364 days.
 T-Bills can be used by the Banks for:
o Keeping as part of their SLR requirements.

o Providing as collateral to the RBI for getting loans under Repo.

o
 Call market

 Call Money refers to inter-bank borrowing and lending for a very short
period, typically overnight to upto 14 days.
 The Call Money or Money at Call enables banks and financial institutions to
manage their short-term liquidity requirements.
 The rate at which money is borrowed in these markets is called the Call Money
Rate.
o The Call Money Rate keeps changing on an hourly basis, depending on
the demand and supply.
 Call Money Market has 2 segments:

Call Market or Overnight Market

It refers to the market for borrowing and lending of money between banks for 1 day.

Short Notice Market

It refers to the market for borrowing and lending of money between banks for upto 14 days.

Repo

**Repo (Repurchase Agreement) in Indian Money Market**

- A Repo is a short-term borrowing tool where a seller agrees to repurchase a
security at a future date, typically overnight or for a short term, at a predetermined
price.
- The borrower (seller of securities) provides government securities as collateral to
the lender and promises to buy them back at a slightly higher price.
- The difference between the repurchase price and the original sale price is called the
Repo Rate, which represents the cost of borrowing.
- The Repo Rate is an important tool used by the Reserve Bank of India (RBI) to
control liquidity in the banking system.
- Repo transactions are commonly used by banks to meet short-term liquidity needs
while ensuring that they have adequate collateral.

Module 4
1. IRDA
The IRDA or Insurance Regulatory and Development Authority came into being in 1999 after
the Government of India felt the necessity to bring the insurance industry to par with the
structural changes that were taking place in the financial sector. Hence, the IRDA was
formed to bring in a higher degree of regulation and

IRDA Overview

India saw the advent of the insurance business with the establishment of Oriental Life
Insurance Company in Calcutta. Ever since various insurance companies came into being,
however, after India’s independence, the Government of India nationalized all the insurance
companies to curb unfair trade practices.

After Liberalization was introduced in India in 1990, the “Malhotra Committee” was formed
to examine the structure of the Insurance Industry and recommend changes to make it
more efficient and competitive. Based on the recommendations of the “Malhotra
Committee”, IRDA (Insurance Regulatory and Development Authority) was formed in 1999
after going through various transformations. The IRDA was incorporated as a statutory body
in April 2000.

What is IRDA?

The IRDA (Insurance Regulatory and Development Authority) is a statutory body meant to
regulate, promote and ensure the orderly growth of insurance and reinsurance business in
India. The IRDA Act, of 1999 also paves the way for opening up of the insurance sector to
private Indian Companies, LIC and GIC will no longer have monopolies and they will have to
work under the directions of the IRDA and compete with other companies that may be set
up in private sector.

Objective of IRDA

The basic objective and the aim of IRDA, 2000 is “Insurance for All by 2047” which means
that every citizen shall have required life, health and property insurance coverage and every
organisation is supported by appropriate insurance solutions.

Features of IRDA

The salient features of the IRDA Act (1999) are as follows;

The IRDA Act (1999) marks the opening of India’s insurance sector to private entities. The
Act’s second and third schedules outline the removal of existing corporations or companies
that engage in life and non-life insurance business in India.
An Indian insurance company is defined as a company registered under the Companies Act,
of 1956, where foreign equity does not exceed 26% of the total equity shareholding,
including that of NRIs, FIls, and OCBs.

After the ten-year period, excess equity above the 26% limit will be divested according to a
phased program outlined by IRDA. The Central Government has the authority to extend the
ten-year period on a case-by-case basis and set higher ceilings for Indian promoter
shareholding.

Foreign promoters are subject to a maximum operational limit of 26% equity and cannot
hold equity beyond this threshold at any stage.

The Act grants statutory status to the Interim Insurance Regulatory Authority (IRA), which
was established by the Central Government through a Resolution in January 1996.

All the powers currently exercised by the Controller of Insurance (Col) under the Insurance
Act, 1938, will be transferred to IRDA.
The IRDA Act also allows for the appointment of a Controller of Insurance by the Central
Government when the Regulatory Authority is superseded.

The minimum required paid-up equity capital is Rs. 100 crore for both life and general
insurance and Rs. 200 crore for reinsurance.

The solvency margin, which represents the surplus of assets over liabilities, is mandated to
be at least Rs. 50 crore for life and general insurance and Rs. 100 crore for reinsurance in
each case.
Insurance companies are required to deposit Rs. 10 crore as a security deposit before
commencing operations.

In the non-life insurance sector, preference is given to companies that offer health
insurance.

Safeguards for policyholders’ funds include a prohibition on investing these funds outside
India and adherence to IRDA policy guidelines for investments, including those in social and
infrastructure projects.

Every insurer must offer life insurance or general insurance policies, including crop
insurance, to individuals in rural areas, workers in the unorganized or informal sector,
economically vulnerable or disadvantaged groups, and other categories specified by IRDA
regulations.

Failure to meet these social obligations may result in a Rs. 25 lakh fine, and persistent non-
compliance could lead to license cancellation.
Functions of IRDA

The Principal Functions of IRDA are suggested as follows:

• One of its key roles is to establish capital adequacy and solvency margin requirements,
as well as other prudent standards for entities engaged in insurance activities.
• Examine, in the light of the prescribed criteria, applications for grant of registration for
transacting insurance business and to grant such registration where appropriate.
• In the interest of consumer protection, set standards for insurance products. There
should be a system of “file and use’ for insurance products subject to the power of the
IRA to modify the rates, terms and conditions thereof within a prescribed time limit.
• Ensure compliance with the prescribed ceiling for management expenses of insurance
and agency commissions.
• Monitor the performance and quality of reinsurance ceded and accepted.
• Ensuring the proper maintenance of adequate technical reserves by the insurers.
• Review the insurer’s asset distribution and management and particularly monitor
compliance with prescribed prudential norms and patterns of investment.
• Ensure high standards of accounting and transparency of the balance sheet of
insurance companies and scrutinize and accept annual accounts, valuation reports and
solvency margin statements.
• Detect badly managed unhealthy or failing insurers and take suitable corrective action,
including the appointment of administrators to temporarily manage such companies
and where warranted, cancellation of registration.
• Where necessary to act as a ‘dispute resolution forum for consumer grievances.
• Create and release an annual report detailing the condition of the insurance sector.
• Powers of IRDA
• The IRDA has been given wide-ranging powers in the matter of promoting and
regulating the orderly growth of business and exercising control over agents and other
intermediaries. The following are some of the powers of IRDA.

• Granting permission for the establishment of new Insurance Companies.

• Protecting the interests of policyholders in all matters.
• IRDA specifies the qualifications, code of conduct and training required for insurance
agents and other intermediaries.
• Promoting efficiency in the conduct of the insurance business.
• Encouraging and overseeing professional associations which are connected with the
insurance and reinsurance industries.
• Inspection, investigation and audit of the insurers and intermediaries.
• Prescribing principles of maintenance of accounts.
• Regulating and directing the investment of funds by the Insurance Companies.
• Adjudicating the disputes between insurers and intermediaries. Specifying the
minimum quantum of rural business to be procured by Life and General Insurance
Companies and imposing penalties for non-compliance with provision.
Conclusion
In summary, the Insurance Regulatory and Development Authority (IRDA) plays a crucial role
in the insurance industry by regulating and promoting its orderly growth. It manages
registrations, sets ethical standards for industry intermediaries, exercises key powers under
relevant acts, and protects policyholders’ interests, ensuring a fair and transparent
insurance environment. IRDA’s multifaceted functions are essential for the industry’s
integrity and policyholder security.

2. Fintech in india

Introduction

India's financial sector is experiencing a profound transformation, thanks to the rapid

growth of fintech innovation. Fintech, a portmanteau of "financial technology," refers to the
integration of technology into financial services, revolutionizing traditional banking,
payments, investments, and insurance. As the fintech landscape in India continues to
expand, there is a surging demand for digital talent to drive these innovations. In this article,
we explore the evolution of fintech in India and the need for skilled professionals to cater to
the growing demands of the financial sector.

The Fintech Revolution in India

Over the past decade, India has witnessed a massive surge in fintech adoption, driven by a
growing middle class, increasing smartphone penetration, and government initiatives
promoting digital transactions. Fintech startups and established financial institutions have
leveraged technology to offer innovative and convenient financial services to millions of
Indians.

Mobile payment platforms, such as Paytm, Google Pay, and PhonePe, have revolutionized
the way people conduct transactions, enabling seamless and cashless payments across the
country. Digital lending platforms are providing quick and accessible credit to individuals
and small businesses, driving financial inclusion. Robo-advisors are transforming investment
advisory services, making them more affordable and personalized. Insurance companies are
using data analytics to customize policies and streamline claims processing.

The Impact of Fintech Innovation on the Financial Sector

Fintech innovation has disrupted the traditional financial sector by providing customer-
centric solutions and enhancing efficiency. The key areas of impact include:

1. Financial Inclusion: Fintech has played a crucial role in bridging the gap between the
unbanked and the formal banking system. Through mobile banking and digital wallets,
even those in remote areas can access basic financial services and participate in the
digital economy.
 2. Enhanced Customer Experience: Fintech companies have introduced user-friendly
interfaces, quicker onboarding processes, and 24/7 customer support, improving
overall customer experience and satisfaction.
3. Lower Costs: By eliminating the need for physical infrastructure and manual processes,
fintech solutions have reduced operational costs for financial institutions, leading to
more cost-effective services for consumers.
4. Data-Driven Decision Making: Fintech platforms gather vast amounts of data, which
can be analyzed to gain insights into customer behavior, assess risk, and tailor financial
products to meet specific needs.
5. Innovation in Investment and Savings: Fintech platforms have democratized
investment opportunities, making it easier for individuals to invest in diverse assets
and grow their savings.

The Rising Demand for Digital Talent

As fintech continues to disrupt the financial sector, there is an increasing need for digital
talent that can drive innovation, develop cutting-edge technologies, and ensure the security
of financial systems. The demand for skilled professionals in fintech is growing in various
domains:

1. Software Development and Engineering: Fintech companies require skilled software

developers and engineers proficient in coding languages, data structures, and software
architecture to build robust and secure applications.
2. Data Science and Analytics: Fintech platforms heavily rely on data analytics to gain
insights into customer behaviour, optimize processes, and identify potential risks. Data
scientists and analysts play a vital role in transforming raw data into valuable business
insights.
3. Cybersecurity: With the rise in digital transactions, the importance of cybersecurity has
grown significantly. Fintech companies need experts to safeguard sensitive financial
data and protect their systems from cyber threats and attacks.
4. UX/UI Design: Creating user-friendly and intuitive interfaces is crucial for fintech
platforms to attract and retain customers. UX/UI designers are responsible for crafting
seamless user experiences that facilitate easy navigation and enhance customer
engagement.
5. Blockchain and Cryptocurrency Experts: The emergence of blockchain technology and
cryptocurrencies has opened up new opportunities in fintech. Professionals with
expertise in blockchain development and cryptocurrency trading are in high demand.

Conclusion

Fintech innovation has ushered in a new era of convenience, accessibility, and efficiency in
India's financial sector. As the fintech landscape continues to evolve, the demand for digital
talent in the financial industry is on the rise. Professionals with skills in software
development, data science, cybersecurity, UX/UI design, and blockchain are essential to
drive fintech growth and address the challenges of the digital financial ecosystem.
To fully capitalize on the opportunities presented by fintech, educational institutions,
policymakers, and the private sector must work together to foster a conducive environment
for the development of digital skills. By investing in digital education and encouraging
innovation, India can create a talented pool of fintech professionals, positioning itself as a
global leader in the ever-evolving world of financial technology.

The financial technology (FinTech) sector in India has experienced remarkable growth and
evolution over the past decade. From humble beginnings to becoming a global FinTech hub,
India has demonstrated its prowess in leveraging technology to disrupt traditional financial
services. In this article, we will delve into the evolution of FinTech products in India,
exploring key milestones, trends, and notable examples that have shaped the industry.

The Genesis of FinTech in India

The story of FinTech in India can be traced back to the early 2000s when the first online
payment gateways and digital wallets emerged. The introduction of the Unified Payments
Interface (UPI) in 2016 was a game-changer, allowing seamless peer-to-peer
transactions and becoming the backbone of many FinTech innovations. With the
government’s push for financial inclusion and digitization through initiatives like Jan Dhan
Yojana and Aadhaar, the stage was set for a FinTech revolution.

Key Milestones in the Evolution of FinTech Products

1. Digital Payments Revolution

One of the most significant developments in the Indian FinTech space was the rise of digital
payment platforms. Companies like Paytm, PhonePe, and Google Pay transformed the way
Indians transact, making cashless payments the norm.

A prime example is Paytm, which evolved from a simple mobile recharge platform to a full-
fledged digital wallet and financial services provider.

2. Peer-to-Peer Lending

The emergence of peer-to-peer (P2P) lending platforms, such as LendingClub and Faircent,
allowed individuals to lend and borrow money without the involvement of traditional banks.
These platforms facilitated easier access to credit for borrowers and attractive returns for
lenders.

3. Robo-Advisors
Robo-advisors, like Zerodha’s Coin and Groww, introduced automated investment advisory
services. They provided an affordable and accessible way for Indians to invest in mutual
funds and equities. These platforms use algorithms to recommend personalized investment
portfolios.

4. InsurTech Innovations

Companies like PolicyBazaar and Digit Insurance leveraged technology to simplify the
insurance buying process. They offered easy comparisons, affordable premiums, and quick
claims settlement, revolutionizing the insurance sector.

5. Neo-Banking

Neo-banks like Niyo and Open introduced digital banking services that catered to the
specific needs of businesses and startups. They offered features like expense management,
corporate cards, and simplified international transactions.

Case Studies of Notable FinTech Products

Paytm: From Mobile Recharge to Financial Super App

Paytm, founded in 2010, started as a mobile recharge platform. It quickly expanded to
include bill payments, online shopping, and a digital wallet. Today, Paytm is a financial super
app offering services such as payments, banking, wealth management, and insurance.

PhonePe: UPI-Powered Payment Giant

PhonePe, launched in 2016, capitalized on the UPI infrastructure and quickly gained
popularity. It offers a wide range of financial services, including mutual funds, insurance,
and gold purchases. In 2020, it became one of the first payment apps to enable the
purchase of digital gold.

Zerodha: Democratizing Investment

Zerodha, founded in 2010, revolutionized the stockbroking industry with its discount
brokerage model. It introduced the Coin platform, a robo-advisory service, making it easy
for retail investors to invest in mutual funds with no commissions.

Niyo: Neo-Banking for the Workforce

Niyo provides a neo-banking platform for salaried employees. It offers features like salary
advances, meal cards, and forex cards, catering to the financial needs of modern workers.

PolicyBazaar: Simplifying Insurance Buying

PolicyBazaar, established in 2008, became India’s largest insurance aggregator. It provides a
platform for comparing and buying insurance policies, making the process transparent and
convenient.

The Road Ahead

The Indian FinTech ecosystem is still evolving, with new players entering the market and
established ones diversifying their offerings. However, there are challenges to address,
including regulatory concerns, data security, and ensuring financial literacy among users. As
the industry continues to mature, innovations will likely revolve around blockchain,
cryptocurrency, and deeper financial inclusion.

In conclusion, the evolution of FinTech products in India showcases a remarkable journey of

innovation, from digital payments to comprehensive financial services. The sector has not
only made financial services more accessible but has also positioned India as a global
FinTech hub. As the industry matures, witnessing the next wave of FinTech innovations in
the country will be exciting.

3. Credit rating agencies

What are Credit Rating Agencies?

▪ A credit rating agency (CRA) is a company that assigns credit ratings, which rate a
debtor's ability to pay back debt by making timely principal and interest payments and
the likelihood of default.

▪ There are six credit rating agencies registered under SEBI namely, CRISIL, ICRA, CARE,
SMERA, Fitch India and Brickwork Ratings.

▪ CRAs were set up to provide independent evidence and research-based opinion on the
ability and willingness of the issuer to meet debt service obligations, quintessentially
attaching a probability of default to a specific instrument.

▪ Evaluating the creditworthiness of an instrument comprises of both qualitative and

quantitative assessments, making credit rating far from a straightforward
mathematical calculation.

Importance

▪ For The Money Lenders

o Better Investment Decision: With credit rating, lenders get an idea about the
credit worthiness of an individual or company (who is borrowing the money) and
 the risk factor attached with them. By evaluating this, they can make a better
investment decision.
o Safety Assured: High credit rating means an assurance about the safety of the
money and that it will be paid back with interest on time.
▪ For Borrowers
o Easy Loan Approval: With high credit rating, banks will approve loan application of
borrowers easily.
o Credit ratings will enable independent benchmarks for pricing debt, ushered in a
culture of financial discipline, helped allocate capital efficiently by pricing risk
appropriately, and supported financial innovation.

Issues

▪ No uniformity among rating companies in India: An average investor in India is not able
to understand the different credit ratings prevailing in India as there is no uniformity
among the credit rating agencies.

▪ No standardization in rating and no standardized fee structure for rating agencies in

India is one of the other issues.

▪ Distinction between equity instruments and mutual funds is not provided which is one
of the major drawback of credit ratings in India.

▪ Lack of reliability of Credit rating in India: Even credit-rated companies have failed in
India and there is no remedy for this. Example CRB Capital Markets, which had a
turnover of Rs.1,000 crores per year and with a credit rating of 'A', failed, and neither
SEBI nor RBI could come to the rescue of investors.

▪ The credit rating agency in India lacks transparency.

▪ After the creation of credit rating agencies, the country has witnessed stock scam and
the failure of CRB Capital Markets. This only reflects poorly on functioning credit rating
agencies.

▪ It is the duty of credit rating agencies to forewarn the regulating authorities about the
weaknesses and drawbacks, if any, of the companies they are rating and they should
ensure to do so at all costs.

▪ There is conflict of interest with "issuer-pays" model, wherein the fees to the
CRA is paid by issuer himself. This has to be switched to investor-pays model. Issue of
rate-shopping, pick and choose.

▪ Because of high entry barriers for entering credit rating, there are not sufficient CRAs in
India, hence there is no competition.

▪ There is no method to seek the accountability of CRAs – "who will rate the rating
agency".
Way Forward

▪ CRAs should refrain from providing advisory services to the rated companies, even via
subsidiaries, as this entails conflict of interest. SEBI may look into this as part of its
regulatory practices for protecting investors.
▪ Rating Agencies should avoid arriving at ratings with limited information, even if it
means foregoing that mandate.
▪ CRAs should operate on fixed fee structure, restricting competition to quality and not
pricing, increase objectivity of rating models, thereby reducing subjectivity and
cognitive bias.
▪ Government should build a surveillance policy, imposing stringent monitoring of an
outstanding rating.
▪ Increase accountability of CRAs to provide better protection to consumers; this one will
need intervention by Sebi by affixing some monetary or business implications. For
example, restricting a particular CRA from re-rating an entity that defaulted above a
threshold for a certain period of time.

4. Role of insurance services

Role of Insurance Sector in Indian Economy

• Mobilization of resources: The premium collected is pooled and invested in projects

which reduces the transaction cost of financing and eases the pressure on the financial
intermediaries.
• Employment opportunities: Alongside regular jobs in insurance, it employs a range of
associated professionals such as brokers, insurance
advisors, agents, underwriters, claims managers and actuaries.
• Provides security to businesses: It provides financial support and reduces uncertainties
that businesses face at every step of their lifecycles & provides an ideal risk mitigation
mechanism against events that can potentially cause financial distress.
• Generates long-term financial resources: Due to the long-term nature of premium
funds, these are invested in building long-term infrastructure assets that are significant
to nation-building.
• Spreads risk: Insurance facilitates the moving of risk of loss from the insured to the
insurer.
• Contribution to GDP: The industry’s direct contribution to India’s GDP is approximately
3.5%.

5. Types of hybrid instruments

Types of Hybrid Financial Instruments in India

India’s financial markets offer several hybrid instruments that combine features of both debt
and equity, providing a balance of risk and return. Here are the primary types of hybrid
financial instruments in India:

1. Convertible Debentures
- Fully Convertible Debentures (FCDs): These convert into equity shares of the issuing
company after a specified period. They carry no interest after conversion.
- Partially Convertible Debentures (PCDs): A portion of the debenture converts into equity,
while the remaining part continues as debt, paying interest.
- Non-Convertible Debentures with Warrants: These debentures remain as debt, but the
holder has the option to buy shares of the company using attached warrants.

2. Convertible Preference Shares

- Preference shares that give the holder the right to convert them into equity shares at a
specified date or upon the occurrence of certain conditions.
- These combine the fixed income from preference shares with the potential equity upside
upon conversion.

3. Perpetual Bonds
- Perpetual bonds do not have a maturity date and pay interest indefinitely. In India, these
are commonly used by banks to raise Tier-1 capital under Basel III norms.
- Although they function like debt, they are considered equity from a regulatory
perspective due to their perpetual nature.

4. Warrants
- Warrants are instruments that give the holder the right, but not the obligation, to
purchase a company’s equity shares at a pre-determined price within a specified time
period.
- They are often issued as sweeteners along with bonds or debentures to make the overall
investment more attractive.

5. Hybrid Mutual Funds

- These funds invest in a mix of debt and equity instruments to provide diversification.
- Examples include Balanced Funds, Arbitrage Funds, and Dynamic Asset Allocation Funds.
They provide a blend of income stability and growth potential.

6. Mezzanine Financing
- A type of financing that involves a mix of debt and equity features. It is typically
subordinated debt (less priority than traditional loans) and may include an equity
component like warrants or options.
- Mezzanine financing is often used by Indian companies for expansion or acquisition
purposes.

7. Infrastructure Investment Trusts (InvITs)

- InvITs are a hybrid between equity and debt, used primarily for infrastructure projects.
 - Investors receive income in the form of dividends (equity-like returns) and interest (debt-
like returns), making it a hybrid instrument that provides cash flow with long-term capital
appreciation potential.

8. Real Estate Investment Trusts (REITs)

- REITs allow investors to pool funds for investment in income-generating real estate assets.
They provide regular income like debt instruments but also have potential for capital
appreciation like equity.
- Returns from REITs come from rental income and capital gains from the sale of
properties.

9. Preference Shares with Redeemable and Convertible Features

- Redeemable Preference Shares: These can be bought back by the issuing company after a
specified period.
- Convertible Preference Shares: These provide the option to convert into equity shares
after a certain period, offering both fixed income (until conversion) and equity participation.

10. Non-Convertible Debentures (NCDs) with Call/Put Options

- NCDs are a form of debt instrument, but in some cases, they come with embedded
options such as call (issuer can redeem early) or put (investor can demand early redemption)
features, offering flexibility and hybrid characteristics.

11. Step-Up or Step-Down Bonds

- These are bonds with interest rates that can increase (step-up) or decrease (step-down)
over time, depending on certain conditions, blending features of fixed-rate and floating-rate
debt instruments.

12. Compulsorily Convertible Debentures (CCDs)

- These are debentures that are mandatorily converted into equity shares of the company
after a specified period.
- CCDs provide the fixed-income feature of debt in the initial phase and the equity upside
once converted.

13. Participatory Notes (P-Notes)

- P-Notes are derivative instruments used by foreign investors to invest in Indian securities
without registering with SEBI. They offer the advantages of equity investment, but with the
flexibility of indirect participation.

14. Tax-Free Infrastructure Bonds

- These bonds provide fixed interest income (debt feature) and are used to finance
infrastructure projects. They offer tax benefits, making them attractive to investors looking
for hybrid returns (tax savings and interest income).

These instruments allow Indian companies and investors to balance risk and return,
providing flexibility in managing capital and generating diverse income streams.

6. Bonds
https://www.bankersadda.bonds /what-are-bonds-and-different-types-of-bonds/
https://www.bankersadda.bonds /what-are-bonds-and-different-types-of-bonds/