FINANCIAL INSTITUTIONS

Financial Institutions

“A financial institution is an institution that provides financial services for its clients or members.”

Act as financial intermediaries.

OBJECTIVE OF FINANCIAL INSTITUTIONS

To transform financial assets acquired through the market and constitute them into a different, and more widely preferable, type of asset-which becomes their liability. This is the function performed by financial intermediaries, the most important type of financial institution.

To exchange financial assets on behalf of customers.

To exchange of financial assets for their own accounts.

To assist in the creation of financial assets for their customers, and then selling those financial assets to other market participants.

To provide investment advice to other market participants.

To manage the portfolios of other market participants.

Examples of financial institutions

Banks Stock Brokerage Firms Non Banking Financial Institutions Building Societies Asset Management Firms Credit Unions Insurance Companies

FUNCTIONS OF FINANCIAL INSTITUTIONS

Financial institutions offer various types of transformation services :

Liability-Asset transformation - They issue claims to their customers that have characteristics different from those of their own assets. For example, banks accept deposits as liability and convert them into assets such as loans.

Size- transformation – They choose and manage portfolios whose risk and return they alter by applying resources to acquire better information and to reduce or overcome transaction costs. They provide large volumes of finance on the basis of small deposits or unit capital.

Risk–transformation - They distribute risk through diversification and thereby reduce it for savers as in the case of mutual funds.

Maturity transformation – They offer savers alternate forms of deposits according to their liquidity preferences, and provide borrowers with loans of requisite maturities.

Classification

Banking

Non-banking

Financial

Institutions

Intermediaries Regulators

IMPORTANCE OF FINANCIAL INSTITUTIONS

Financial intermediaries convert the money given by savers to investment by borrowers, such as banks, UTI, NBFIs, etc.

Non-intermediaries give loans but do not collect deposits or funds from savers.

Regulators watch the markets, players and modes of transactions.

Regulators design the market system, create and enforce regulations and rules for the market.

FINANCIAL INTERMEDIARIES

Financial intermediaries are a special group of financial institutions that obtain funds by issuing claims to market participants and use these funds to purchase financial assets. Intermediaries transform funds they acquire into assets that are more attractive to the public. By doing so, financial intermediaries do one or more of the following:

Provide maturity intermediation Provide risk reduction via diversification at lower cost Reduce the cost of contracting and information processing Provide a payments mechanism.

What is a Bank ?

A bank as an institution which accepts deposits from the public and in turn advances loans by creating credit. It is different from other financial institutions in that they cannot create credit though they may be accepting deposits and making advances.

Functions of Banks

Primary Functions Acceptance of deposits Lending money Making investments Borrowing money

Functions of Banks

Agency Functions Collection and payment of cheques Collection and payment of bills Remittance of funds Collections of government taxes Undertaking administration of estates

as executors and trustees

Functions of Banks

General Utility Functions Issues of guarantees, letters of credit,

cheques, credit and debit cards Dealing with bullion, foreign exchange,

merchant banking, safe custody of articles, etc,

OVERVIEW OF IMPORTANT FINANCIAL INSTITUTIONS

There are various kinds of financial institutions performing their role in financial intermediation and infrastructural development, differing on the basis of their inception and operations. Broadly, the existing financial institutions may be classified as

(a) All India institutions like Industrial Development Bank of India (lDBI), Industrial Finance Corporation Industrial Finance Corporation of India (IFCI) etc.,of India (IFCI) etc.,

(b) Regional/State level institutions like the State Financial Corporation (SFC)

(c) Other Institutions like DICGC etc.

Industrial Finance Corporation Industrial Finance Corporation of Indiaof India

The Industrial Finance Corporation of India (IFCI) , The Industrial Finance Corporation of India (IFCI) , the first All-India term-lending institution was set up the first All-India term-lending institution was set up in 1948 with the primary objective of providing in 1948 with the primary objective of providing medium and long-term credit to industry.medium and long-term credit to industry.

It is headquartered in New Delhi. It is headquartered in New Delhi.

The sources of funds for IFCI are Paid-up capital, The sources of funds for IFCI are Paid-up capital, reserves, repayment of loans, market borrowings, reserves, repayment of loans, market borrowings, loans from the Government of India, advances from loans from the Government of India, advances from the Industrial Development Bank of India and the Industrial Development Bank of India and foreign lines of credit from KfW (West Germany), foreign lines of credit from KfW (West Germany), BFCE (France), ODA(UK) and others.BFCE (France), ODA(UK) and others.

IFCI -FunctionsFunctionsFunctions : : The main functions of IFCI are To provide various kinds of financial services to the industries. Primarily, its services focus on project finance as it provides

assistance to all viable industrial projects above Rs.50m. IFCI provides assistance industrial concerns for their new

projects, expansion, diversification and modernization schemes.

Loans are generally extended for a period of 5-7 years with a moratorium of 2-3 years. Loans are extended both in rupee and foreign currency.

Loans are provided after a detailed project appraisal.

Future : In order to tap on the other financial services that offer greater

scope for the corporation, IFCI is diversifying into bill discounting, trade bills important financing and working capital financing.

Industrial Credit and Industrial Credit and Investment Corporation of IndiaInvestment Corporation of India

The Industrial and Investment Corporation of India (ICICI) was The Industrial and Investment Corporation of India (ICICI) was founded in 1955. founded in 1955.

It is owned and financed mainly by the private sector.It is owned and financed mainly by the private sector.

It is headquartered in Bombay.It is headquartered in Bombay.

It provides assistance to units in the private sector, particularly It provides assistance to units in the private sector, particularly to meet their foreign exchange requirements.to meet their foreign exchange requirements.

The resources of ICICI consist of Paid-up capital, reserves, The resources of ICICI consist of Paid-up capital, reserves, repayment of loans, market borrowings, loans from the repayment of loans, market borrowings, loans from the Government of India, advances from the Industrial Development Government of India, advances from the Industrial Development Bank of India, market borrowings and foreign lines of credit from Bank of India, market borrowings and foreign lines of credit from World Bank, USAID, KFW, UK government and others.World Bank, USAID, KFW, UK government and others.

Industrial Development Bank of Industrial Development Bank of IndiaIndia

The Industrial Development Bank of India (IDBI) was established in The Industrial Development Bank of India (IDBI) was established in 1964 as a subsidiary of the Reserve Bank of India. 1964 as a subsidiary of the Reserve Bank of India.

Industrial Development Bank of India (IDBI) is the largest financial institution in India, with assets at the end of 1999 approximating to Rs.600 billion.

It is headquartered in Bombay.It is headquartered in Bombay.

This apex financial institution in India, is also the 10th largest development bank in the world.

The resources of IDBI consist of Paid-up capital, reserves, The resources of IDBI consist of Paid-up capital, reserves, repayment of loans, market borrowings both within and outside the repayment of loans, market borrowings both within and outside the country, temporary credit from the Reserve Bank of India, foreign country, temporary credit from the Reserve Bank of India, foreign lines of credit from the World Bank, ADB and others. lines of credit from the World Bank, ADB and others.

Role of IDBI

Planning, promoting and developing industries to fill the gaps in the industrial sector.

Co-coordinating the working of institutions engaged in such activities and assisting in their development.

Providing technical and administrative assistance for promotion, management or expansion of industry.

Undertaking market and investment research and techno-economic studies to contribute to the development of industry.

IDBI - Operations IDBI initially provided long-term assistance to industries such as textiles, fertilizers,

chemicals products and machinery. The assistance was mainly in the form of long-term loans or in the form of project lending.

In 1964, IDBI also began a role in assisting the State Finance Corporations (SFCs) of various states.

By 1965, IDBI entered into rediscounting of -machinery bills to promote the sale of indigenous machinery on deferred payment basis.

Subsequently, IDBI entered into finanancing exports on a different payment basis, till the time Export- Import (Exim) Bank of India was formed in 1982.

In 1986, IDBI created a Small Industries Development Fund (SIDF) to provide a special focus to the needs of the small scale sector. This fund is intended to provide financial inputs catered to the specific needs of the small scale sector.

Through the late ’80s and the early ’90s IDBI played a significant role in the

development of financial markets - it played a major role in setting up of the Stock Holding Corporation of India Limited (SHCIL)

Non Banking Financial Institutions [NBFC]

NBFCs help to bridge the credit gaps in several sectors which traditional institution are unable to fulfill.

NBFCs are more flexible in their operations and quick in decision-making.

Activities of NBFCs

Fund-Based Activities Fee-Based Activities1. Equipment leasing 1. Issue Management2. Hire Purchase 2. Portfolio Management3. Bill discounting 3. Corporate Counseling 4. Loan and Investment 5. Venture Capital 4. Project Counseling 6. House Finance 5. Arranging Foreign Collaboration7. Factoring 6. Advising on acquisitions

&mergers8. Equity Participant 7. Advising on Capital restructuring9. Short-term loans10. Inter-Corporate Loans

Life Insurance Corporation of Life Insurance Corporation of IndiaIndia

The Life Insurance Corporation of India (LIC) came into being in 1955 The Life Insurance Corporation of India (LIC) came into being in 1955 after the nationalization and merger of about 250 independent life after the nationalization and merger of about 250 independent life insurance societies. insurance societies.

It is headquartered in Bombay. It is headquartered in Bombay.

The primary activity of LIC is to carry on life insurance business, but it has The primary activity of LIC is to carry on life insurance business, but it has gradually developed into an important all-india financial institution which gradually developed into an important all-india financial institution which provides substantial support to industry. provides substantial support to industry.

It works in close liaison with the other all-india financial institutions in It works in close liaison with the other all-india financial institutions in providing finance directly and in helping industrial concerns by its providing finance directly and in helping industrial concerns by its underwriting support. underwriting support.

Thanks to its massive resources, LIC is one of the two largest institutional Thanks to its massive resources, LIC is one of the two largest institutional investors in the country. By law it is required to invest 25 percent of its investors in the country. By law it is required to invest 25 percent of its funds in government securities and a further 25 percent in “approved funds in government securities and a further 25 percent in “approved securities”. securities”.

General Insurance CorporationGeneral Insurance Corporation

The General Insurance Corporation (GIC) was The General Insurance Corporation (GIC) was founded when the management of general insurances founded when the management of general insurances business in india was taken over by the government in business in india was taken over by the government in 1971 and subsequently nationalized in 1973.1971 and subsequently nationalized in 1973.

It is headquartered in Bombay.It is headquartered in Bombay.

In addition to investing in “socially-oriented” sectors, In addition to investing in “socially-oriented” sectors, where the bulk of its inevitable resources are required where the bulk of its inevitable resources are required to be Invested, GIC provides substantial assistance to to be Invested, GIC provides substantial assistance to industrial projects by way of term loans, subscription industrial projects by way of term loans, subscription to equity capital and debentures, and underwriting of to equity capital and debentures, and underwriting of securities. securities.

Unit Trust of IndiaUnit Trust of India

The Unit Trust of India (UTI) was set up in 1964 with the The Unit Trust of India (UTI) was set up in 1964 with the principal objective of mobilizing public savings and channeling principal objective of mobilizing public savings and channeling them into productive corporate investments. them into productive corporate investments.

UTI raises its resources primarily through the sale small UTI raises its resources primarily through the sale small denomination units. denomination units.

UTI subscribes to industrial securities and also purchases UTI subscribes to industrial securities and also purchases outstanding securities in the secondary market, in its investment outstanding securities in the secondary market, in its investment activity. activity.

UTI is naturally governed by considerations of yield and security UTI is naturally governed by considerations of yield and security as it has an obligation to earn a responsible rate of return for its as it has an obligation to earn a responsible rate of return for its unit holders in its various schemes, without exposing them to unit holders in its various schemes, without exposing them to undue risks. UTI has emerged as one of the two largest undue risks. UTI has emerged as one of the two largest institutional investors in India.institutional investors in India.

State Financial CorporationsState Financial Corporations

The State Financial Corporation (SFC), set up The State Financial Corporation (SFC), set up under the State Financial Corporations Act, 1951, under the State Financial Corporations Act, 1951, render assistance to medium and small scale render assistance to medium and small scale industries to their respective states.industries to their respective states.

Their shareholders are the respective state Their shareholders are the respective state governments, IDBI, insurance companies, credit governments, IDBI, insurance companies, credit cooperatives, and private shareholders. cooperatives, and private shareholders.

The financial resources of SFCs consist of Paid-up The financial resources of SFCs consist of Paid-up capital, reserves, market borrowings, refinance from capital, reserves, market borrowings, refinance from IDBI and borrowings from the Reserve Bank of IDBI and borrowings from the Reserve Bank of India and the Government of India. India and the Government of India.

State Industrial and State Industrial and Development CorporationsDevelopment Corporations

The state Industrial and Development Corporations (SIDCs), were set The state Industrial and Development Corporations (SIDCs), were set up by the state Governments during the 1960s to serve as catalytic up by the state Governments during the 1960s to serve as catalytic agents in the industrialization process of their respective states. agents in the industrialization process of their respective states.

Presently almost every state has an SIDC which is fully owned by the Presently almost every state has an SIDC which is fully owned by the respective state government. In addition to providing term finance to respective state government. In addition to providing term finance to industry, SIDCs perform a variety of other functions. industry, SIDCs perform a variety of other functions.

In particular, their role in sponsoring joint sector projects with the In particular, their role in sponsoring joint sector projects with the participation of private entrepreneurs need to be emphasized. participation of private entrepreneurs need to be emphasized.

The major resources of the SIDCs areThe major resources of the SIDCs are

Paid-up capital reservesPaid-up capital reserves Market borrowings Market borrowings Loans from the government. Loans from the government. In addition, SIDCs get funds from IDBI under its refinancing scheme.In addition, SIDCs get funds from IDBI under its refinancing scheme.

Direct Financial AssistanceDirect Financial Assistance

Financial institutions provide direct financial Financial institutions provide direct financial assistance in the following ways:assistance in the following ways:

Rupee term loansRupee term loans Foreign Currency term loansForeign Currency term loans Subscription to equity sharesSubscription to equity shares Seed capital – Seed capital – Money used for the initial Money used for the initial

investment in a project or start-up company,for investment in a project or start-up company,for proof of concept or market research or product proof of concept or market research or product development. Also called as seed money or seed development. Also called as seed money or seed financing.financing.

Indirect Financial Indirect Financial AssistanceAssistance

Besides providing direct financial assistance, Besides providing direct financial assistance, financial institutions extend help to industrial financial institutions extend help to industrial units in obtaining finance/credit through the units in obtaining finance/credit through the following ways:following ways:

Deferred Payment guarantee - Deferred Payment guarantee - A deferred payment guarantee is a contract under which a bank promises to pay the supplier the price of machinery supplied by him on deferred terms, in agreed installments with stipulated interest in the respective due dates, in case of default in payment there of by the buyer.

Guarantee for foreign currency loans Guarantee for foreign currency loans UnderwritingUnderwriting

Advantages of financial institutions

Reduction of information and transaction costs

Grant long-term loans Provide liquid claims and pool risks. Financial intermediaries economize costs of

borrowers and lenders. Banks are set up to mobilize savings of

many small depositors, which are insured.

Investment strategy

The nature of their liabilities determines the investment strategy pursued by all financial institutions. The liabilities of all financial institution will generally fall into one of the four types shown in the adjacent Table :

Nature of Liabilities of financial institutions

Liability type Amount of cash outlay

Timing of cash outlay

Type I Known Known

Type II Known Uncertain

Type III Uncertain Known

Type IV Uncertain Uncertain

Conclusion

Thus, it can be concluded that a financial institution is that type of an institution, which performs the collection of funds from private investors and public investors and utilizes those funds in financial assets. The functions of financial institutions are not limited to a particular country, instead they have also become popular in abroad due to the growing impact of globalization.