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Page 1: Financial Institutions and Banking - jnujprdistance.comjnujprdistance.com/assets/lms/LMS JNU/MBA/MBA... · I/JNU OLE Index I. Content .....II II. List of Figures .....VIII III. List

Financial Institutions and Banking

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This book is a part of the course by Jaipur National University, Jaipur.This book contains the course content for Financial Institutions and Banking.

JNU, JaipurFirst Edition 2013

The content in the book is copyright of JNU. All rights reserved.No part of the content may in any form or by any electronic, mechanical, photocopying, recording, or any other means be reproduced, stored in a retrieval system or be broadcast or transmitted without the prior permission of the publisher.

JNU makes reasonable endeavours to ensure content is current and accurate. JNU reserves the right to alter the content whenever the need arises, and to vary it at any time without prior notice.

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Index

ContentI. ............................................II

List of FiguresII. .................................VIII

List of TablesIII. ...................................IX

Case StudyIV. .......................................139

BibliographyV. ....................................146

Self Assessment AnswersVI. ................149

Book at a Glance

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Contents

Chapter I ...................................................................................................................... 1Financial System ........................................................................................................ 1Aim ............................................................................................................................... 1Objectives ..................................................................................................................... 1Learning outcome ....................................................................................................... 11.1 Evolution of Development Financial Institutions in India ................................ 21.2 Overview of Formal and Informal Financial Systems ....................................... 21.3 Indian Financial System ....................................................................................... 3 1.3.1 Components of the Formal Financial System ......................................... 3 1.3.2 Financial Regulators ............................................................................... 6 1.3.3 Functions of the Financial System .......................................................... 6 1.3.4 Nature and Role of Financial Institutions and Financial Markets .......... 61.4 The Financial System and Economic Growth .................................................... 71.5 Evolution of Financial Institutions in India........................................................ 7 1.5.1 Pre-reforms Period .................................................................................. 8 1.5.2 Post Reforms Period ............................................................................. 10 1.5.3 Challenges Ahead ................................................................................. 111.6 Evolution of Development Financial Institutions............................................. 14 1.6.1 Organisational Structure ....................................................................... 14 1.6.2 Financial Institutions ............................................................................. 15 1.6.2.1 All India Financial Institutions .............................................. 15 1.6.2.2 State Level Financial Institutions ........................................... 21Summary .................................................................................................................... 22References .................................................................................................................. 22Recommended Reading ............................................................................................ 23Self Assessment .......................................................................................................... 24

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Chapter II .................................................................................................................. 26Banking Institutions.................................................................................................. 26Aim ............................................................................................................................. 26Objectives ................................................................................................................... 26Learning outcome ..................................................................................................... 262.1 Definition of Non Banking Financial Companies (NBFCs) ............................ 27 2.1.1 Types of NBFCs .................................................................................... 27 2.1.2 Growth of NBFCs ................................................................................. 27 2.1.3 Regulation of NBFCs ............................................................................ 28 2.1.4 Supervision and Control ....................................................................... 292.2 Development of Banking in India ...................................................................... 29 2.2.1 Functions of Commercial Banks ........................................................... 31 2.2.2 Scheduled Commercial Banks .............................................................. 32 2.2.3 Reforms in the Banking Sector ............................................................. 38 2.2.4 Housing Finance System in India ......................................................... 412.3 Housing and Urban Development Corporation (HUDCO) ............................ 412.4 State Housing Finance Societies (SHFSs) ......................................................... 432.5 Housing Development Finance Corporation Ltd. (HDFC) ............................. 432.6 National Housing Bank....................................................................................... 442.7 Economic Development and Housing Finance ................................................. 472.8 Growth Trends in Housing Finance .................................................................. 48Summary ................................................................................................................... 50References .................................................................................................................. 51Recommended Reading ............................................................................................ 51Self Assessment .......................................................................................................... 52

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Chapter III ................................................................................................................. 54Mutual Funds ............................................................................................................ 54Aim ............................................................................................................................. 54Objectives ................................................................................................................... 54Learning outcome ..................................................................................................... 543.1 Definition of Mutual Fund ................................................................................. 55 3.1.1 Advantages of Mutual Funds ................................................................ 57 3.1.2 Disadvantages of Investing in Mutual Funds ....................................... 57 3.1.3 Types of Mutual Funds ......................................................................... 583.2 Organisation of a Mutual Fund ......................................................................... 633.3 Association of Mutual Funds in India (AMFI) ................................................. 643.4 Control and Supervision ..................................................................................... 653.5 Unit Trust of India (UTI) .................................................................................... 653.6 Growth and Development of Mutual Funds in India ...................................... 67Summary .................................................................................................................... 71References .................................................................................................................. 71Recommended Reading ............................................................................................ 72Self Assessment .......................................................................................................... 73

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Chapter IV ................................................................................................................. 75Insurance companies and Financial Regulators ................................................... 75Aim ............................................................................................................................ 75Objectives .................................................................................................................. 75Learning outcome .................................................................................................... 754.1 Opening up of the Insurance Sector Life Insurance ........................................ 764.2 General Insurance ............................................................................................... 764.3 Health Insurance ................................................................................................. 784.4 Insurance Intermediaries ................................................................................... 794.5 Reserve Bank of India ........................................................................................ 80 4.5.1 Need for Financial Regulation .............................................................. 814.6 Securities and Exchange Board of India (SEBI) .............................................. 814.7 National Bank for Agriculture and Rural Development (NABARD) ............ 834.8 Insurance Regulatory and Development Authority (IRDA). .......................... 85 4.8.1 Insurance Regulatory and Development Authority (IRDA) in India .... 87Summary .................................................................................................................... 91References .................................................................................................................. 92Recommended Reading ........................................................................................... 92Self Assessment .......................................................................................................... 93

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Chapter V .................................................................................................................. 95Personnel Banking ................................................................................................... 95Aim ............................................................................................................................. 95Objectives .................................................................................................................. 95Learning outcome ..................................................................................................... 955.1 Introduction to Personal Banking .................................................................... 965.2 Electronic Banking .............................................................................................. 96 5.2.1 Cards ..................................................................................................... 96 5.2.2 Electronic Purse .................................................................................... 97 5.2.3 Electronic Clearing Service .................................................................. 97 5.2.4 ECS Credit ............................................................................................ 98 5.2.5 ECS Debit ............................................................................................. 985.3 Bank Teller Machines ...................................................................................... 1005.4 Automated Teller Machines ............................................................................. 1005.5 Internet Banking .............................................................................................. 1025.6 Telephone Banking ............................................................................................ 1035.7 Electronic Funds Transfer ................................................................................ 1035.8 Resident Foreign Currency Accounts ............................................................. 1065.9 Foreign Currency Accounts ............................................................................. 107 5.9.1 Foreign Currency (Non-resident) Deposit Accounts (FCNR (B)) ...... 107 5.9.2 Temporary Foreign Currency Accounts .............................................. 1125.10 NRI’s return to India ...................................................................................... 113Summary ................................................................................................................. 115References ................................................................................................................ 116Recommended Reading ........................................................................................ 117Self Assessment ........................................................................................................ 118

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Chapter VI ............................................................................................................... 120Loan Products and Dematerialization of Shares ................................................. 120Aim .......................................................................................................................... 120Objectives ................................................................................................................ 120Learning outcome .................................................................................................. 1206.1 Retail Loans ....................................................................................................... 1216.2 Personal Loans .................................................................................................. 1226.3 Consumer Durable Loans ................................................................................ 1226.4 Loans to Professionals and Self Employed Persons ....................................... 1236.5 Vehicle Loans ..................................................................................................... 1246.6 Educational Loan .............................................................................................. 1256.7 Housing Finance ................................................................................................ 1326.8 Dematerialisation of Shares ............................................................................. 1336.9 Meaning of a Depository .................................................................................. 1336.10 Operations of a Depository System ............................................................... 133Summary ................................................................................................................. 134References ................................................................................................................ 136Recommended Reading .......................................................................................... 136Self Assessment ........................................................................................................ 118

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List of Figures

Fig. 1.1 Types of Financial System ............................................................................... 2Fig. 1.2 Components of the Formal Financial System .................................................. 4Fig. 1.3 Main elements of the financial organisations .................................................. 8Fig. 1.4 Components of financial institutions in India. ............................................... 15Fig. 1.5 Product and services of SIDBI ...................................................................... 18Fig. 2.1 Phases in Development of Banking ............................................................... 30Fig. 2.2 The Indian banking structure (March 2006) (a) ............................................ 31Fig. 2.3 The Indian banking structure (March 2006) (b) ............................................ 32Fig. 2.4 Categories of Scheduled Commercial Banks ................................................ 32Fig. 2.5 Organisational structure of cooperative credit institutions (a) ...................... 37Fig. 2.6 Organisational structure of cooperative credit institutions (b) ...................... 37Fig. 2.7 Objectives of National Housing .................................................................... 44Fig. 3.1 Mutual fund operation flow chart .................................................................. 56Fig. 3.4 Growth of mutual funds in India ................................................................... 68Fig. 5.1 Types of cards ................................................................................................ 97Fig. 6.1 Types of retail loans ..................................................................................... 121

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List of Tables

Table 1.1 Financial institutions/ financial development banks ................................... 10Table 1.2 Resource mobilisations by financial institutions ........................................ 12Table 1.3 Select financial parameters of financial institutions ................................... 13Table 2.1 Profile of non banking financial companies................................................ 28Table 2.2 Progress of Commercial Banks in India ..................................................... 36Table 2.3 Evolution of Indian banking ....................................................................... 40Table 2.4 Financial indicators of regional rural banks ................................................ 42Table 2.5 HUDCO’s performance at a glance............................................................. 43Table 2.6 Refinance disbursements of National Housing Bank.................................. 45Table 2.7 Financial performance of the National Housing Bank ................................ 46Table 2.8 Financial indicators of reporting HFCs ....................................................... 47Table 2.9 Housing loan disbursements by various institutions ................................... 48Table 3.1 Types of Mutual Funds Schemes ................................................................ 58Table 3.2 Assets under management of mutual funds ................................................. 70Table 4.1 Premium underwritten by non life insurance companies in 2005-06 ......... 78

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Abbreviations

NAV - Net Asset ValueNBFCs - Non Banking Financial CompaniesADB - Asian Development BankAFC - Asset Finance CompanyAMC - Asset Management CompanyAMFI - Association of Mutual Funds in IndiaBFS - Board for Financial SupervisionIFCI - Industrial Finance Corporation of IndiaIIBI - Industrial Investment Bank of IndiaILFS - Infrastructure Leasing and Financial ServicesIRBI - Industrial Reconstruction Bank of IndiaBIM - Bank Insurance ModelBoS - Board of SupervisionCAMELSC - Capital Adequacy, Asset Quality, Management Earnings, Liquidity and Systems ComplianceCB - Commercial BankCCB - Central Cooperative BanksCoI - Controller of InsuranceCRISIL - Credit Rating and Information Services LtdDBS - Department of Banking SupervisionDCCB - District Central Cooperative BanksDFI - Development Financial InstitutionsDHFCL - Dewan Housing Finance Corporation LimitedDNBS - Department of Non-Banking SupervisionDRIP - District Rural Industries ProjectEDP - Entrepreneurship Development ProgrammeELSS - Equity-Linked Savings SchemesEMG - Environmental Management GroupEOU - Export Oriented UnitsETF - Exchange Traded FundEWS - Early Warning SystemEWS - Economically Weaker SectionsEXIM Bank - Export Import Bank of IndiaFID - Financial Institutions DivisionFrMC - Fraud Monitoring CellGIC - General Insurance CorporationGICHFL - General Insurance Corporation and Housing Finance LimitedHDFC - Housing Development Finance Corporation LtdHUDCL - Housing and Urban Development Corporation LimitedIC - Investment CompanyICRA - Investment and Credit Rating AgencyIDFC - Infrastructure Development Finance Company LimitedLC - Loan company

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LICHF - Life Insurance Corporation Housing Finance LtdLIG - Lower Income GroupLOC - Lines of CreditNABARD - National Bank for Agricultural and Rural DevelopmentNEDFCL - North-Eastern Development Finance Corporation LtdNEP - New Economic PolicyNGO - Non Governmental OrganisationNHB - National Housing BankNPA - Non Performing AssetsNSDL - National Securities Depository LtdOCEI - Over the Counter Exchange of India LtdOSMOS - Off site Monitoring and SurveillanceP&D - Promotional and DevelopmentalPNBHFL - Punjab National Bank Housing Finance LimitedPRI - Panchayati Raj InstitutionRIDF - Rural Infrastructure Development FundRIP - Rural Industries ProgrammeRNBCs - Residuary Non Banking CompaniesRoA - Return on Average Total AssetsRRB - Regional Rural BankSCARDB - State Cooperative Agriculture and Rural Development BankSEBI - Securities and Exchange Board of IndiaSFC - State Finance CorporationsSHCIL - Stock Holding Corporation of India LtdSHFS - State Housing Finance SocietiesSIDBI - Small Industries Development Bank of IndiaSIDC - State Industrial Development CorporationsSIMAP - Small Industries Management ProgrammeSLR - Statutory Liquidity RatioGDP - Gross Domestic ProductSME - Small and Medium EnterprisesSSI - Small Scale IndustrySTUP - Skill-cum-Technology Upgradation ProgrammeTAC - Tariff Advisory CommitteeTDCIL - Technology Development Corporation of India LtdTFCI - Tourism Finance Corporation of IndiaTPA - Third Party AdministratorUCB - Urban Co-operative BanksUTI - Unit Trust of India

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Chapter I

Financial System

Aim

The aim of this unit is to:

explain the evolution and development of financial institutions in India•

explain the formal and informal institutions •

explore the Indian financial system•

Objectives

The objectives of this unit are to:

enlist the importance of financial system of India in its economic growth •

explain the pre-reform growth and post reform growth •

enlist the challenges post liberalisation •

Learning outcome

At the end of this unit, you will be able to:

understand the evolution in development of financial institutions•

enlist the objectives of Indian financial system•

enumerate the pre-reform period and post reform period•

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1.1 Evolution of Development Financial Institutions in IndiaThe need for development of financial institutions was felt very strongly immediately after India attained independence. The pace of industrialisation needed to be accelerated for the overall growth of the economy. The existing industries needed long term funds for their reconstruction, modernisation, expansion and diversification whereas new industries required enormous investments for setting up gigantic projects in the capital goods sector. The capital markets were relatively underdeveloped and incapable of meeting the long term requirements of the economy adequately. Commercial banks had traditionally confined themselves to financing working capital requirements of trade and industry and abstained from supplying long term finance. Over the years, a wide range of FIs came into existence to cater to the medium and long term financing requirements of different sectors of the economy.

1.2 Overview of Formal and Informal Financial SystemsA financial system plays a vital role in the economic development of a country. It acts as an intermediary between those who save a part of their income and those who need resources for investment in productive assets. The formal financial sector consists of an organised, institutional and regulated system which caters to the financial needs of the modern spheres of economy; the informal financial sector is an unorganised, non-institutional, and non- regulated system dealing with the traditional and rural spheres of the economy. In most of the developing countries, both formal and informal financial sectors co-exist. This co-existence of two sectors is commonly referred to as “Financial dualism”. High priority should be accorded to the development of an efficient formal financial system as it offers lower intermediation costs and services to the savers as well as entrepreneurs.

The financial system can also be broadly classified into the formal and the informal financial system

Fig. 1.1 Types of Financial System

Financial System

Formal Financial System

Informal Financial System

Financial Institutions and Banking

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1.3 Indian Financial SystemThe Indian financial system can also be broadly classified into the formal and the informal financial system. The formal financial system consists of four components and regulators.

The informal financial system in India consists of:Individual moneylenders such as neighbours, relatives, landlords, traders and • so on.Groups of persons operating as “funds” or “associations.” These groups • function under a system of their own rules. These groups use names such as “fixed fund”, “association,” “saving club,” and so on.Partnership firms consisting of local brokers, pawnbrokers, and nonbank • financial intermediaries such as finance, investment and chit-fund companies.In the past, the informal system predominantly prevailed in rural India due to • the absence of a widespread formal system. However, the spread of banking in rural areas has helped in enlarging the scope of the formal financial system.

1.3.1 Components of the Formal Financial System

The formal financial system consists of four components and regulators.

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Fig.1.2 Components of the Formal Financial System

The formal financial system in India consists of four segments or components.These are:

Financial Instruments

Financial Services

Financial Markets

Financial Institutions

Scheduled Co-operative

Bank

Development Financial

Institutions

Scheduled Commercial

Bank

Public sector

Public sector banks

Private sector banks

Foreign Banks in

India

State level

institutions

All India Financial Institution

Regional Rural bank

Other Institutions

Private sector

Banking Institutions

Non Banking Finance

companies

Non Banking

Institutions Mutual Funds

Insurance & Hsg. Finance

companies

Indian Financial System

Financial Institutions and Banking

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Financial Institutions (Intermediaries)Financial institutions are intermediaries that mobilise savings and facilitate allocation of funds in an efficient manner.

Financial institutions can be classified as banking and non-banking financial institutions. Financial institutions can also be classified as term-finance institutions such as the Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), Industrial Finance Corporation of India (IFCI), Small Industries Development Bank of India (SIDBI) and Industrial Investment Bank of India (IIBI). However, ICICI and IDBI are now converted into universal banks and are no more treated as term lending institutions alone. Financial institutions can be specialised finance institutions like the Export Import Bank of India (EXIM), Tourism Finance Corporation of India (TFCI),Infrastructure Development Finance Company (IDFC), National Bank of Agricultural and Rural Development (NABARD) and National Housing Bank (NHB). Investment institutions in the business of mutual funds (UTI), Public Sector and Private Sector Mutual Funds and insurance activity (LIC, GIC and its subsidiaries) are classified as financial institutions.

There are state-level financial institutions such as the State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs) which are owned and managed by the State governments.

Financial MarketsFinancial markets are a mechanism enabling participants to deal in financial claims. The main organised financial markets in India are the money market and capital market. The money market is meant for trading in short term securities whereas the capital market is for trading in equity instruments and long term securities that is securities having a maturity period of one year or more.

Financial InstrumentsA financial instrument is a claim against a person or an institution for the payment at a future date, a sum of money and / or periodic payment in the form of interest or dividend. Financial securities may be primary or secondary securities. Primary securities are directly issued by the ultimate borrowers of funds to the ultimate savers such as equity shares and debentures. Secondary securities are indirect securities issued by the financial intermediaries to the ultimate savers such as bank deposits, mutual fund units and insurance policies. Financial instruments help financial markets and financial intermediaries to perform the important role of channelising funds from lenders to borrowers.

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Financial ServicesFinancial services are provided by financial intermediaries to bridge the gap between lack of knowledge on the part of investors and increasing sophistication of financial instruments and markets. Merchant banking, leasing, hire purchase, credit rating are some examples of financial services. These financial services are vital for the creation of firms, industrial expansion and economic growth.1.3.2 Financial RegulatorsThe investors need to be reassured about the safety of their money before they lend it. This reassurance is provided by the financial regulators who regulate the conduct of the financial market and intermediaries to protect investors’ interests. The Reserve Bank of India regulates the money market; The Securities and Exchange Board of India (SEBI) regulates the capital market and The Insurance & Regulatory Development Authority of India (IRDA) regulates the insurance sector.

1.3.3 Functions of the Financial System

The important functions of a financial system are as follows:It acts as a link between savers and investors thereby helping and mobilising • savings efficiently and effectively.It provides a payment mechanism for the exchange of goods and services and • transfers economic resources through time and across geographical regions and industries.It limits, pools and trades the risks involved in mobilising savings and • allocating credit.It helps in lowering the cost of transactions and promotes savings.• It helps in financial deepening and broadening.•

1.3.4 Nature and Role of Financial Institutions and Financial Markets

Financial institutions (intermediaries) are business organisations serving as a link between savers and investors and so help in the credit allocation process. Good financial institutions are vital to the functioning of an economy. They make decisions that tell scarce capital where to go and ensure that it is used most efficiently. It has been confirmed by research that, countries with developed financial institutions grow faster and countries with weak ones are more likely to undergo financial crisis. Financial institutions provide three transformation services:

Financial Institutions and Banking

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Liability, asset and size transformation consisting of mobilisation of funds, • and their allocation by providing large loans on the basis of numerous small deposits.Maturity transformation by offering savers tailor-made short-term claims or • liquid deposits and so offering the borrowers long-term loans matching the cash-flows generated by their investments.Risk transformation by transforming and reducing the risk involved in direct • lending by acquiring diversified portfolios.

The role of financial institutions has undergone tremendous transformation in the 1990s. Besides providing direct loans, many financial institutions have diversified themselves into areas of financial services such as merchant banking, underwriting, issuing guarantees, and so on.

1.4 The Financial System and Economic GrowthThe existence of an efficient financial system facilitates economic activity and growth. The growth of the financial structure is a precondition to economic growth. In other words, markets, institutions and instruments are the prime movers of economic growth. The financial system of a country diverts the country’s savings towards more productive uses and so it helps to increase the output of the economy. McKinnon and Shaw (1973) laid the theoretical grounds for the relationship between financial development and economic growth. According to them, government restrictions on the banking system (such as interest rate ceilings, high reserve requirements, and directed credit programmes – defined as financial repression) impede the process of financial development and, consequently, reduce economic growth. Hence, they advocated liberalisation of financial markets and it was their work which encouraged financial liberalisation in developing countries as a part of economic reforms

1.5 Evolution of Financial Institutions in IndiaThe organisation of the Indian Financial system before 1951 resembled a theoretical model of a financial organisation in a traditional economy wherein the per capita output was low and constant. The market was underdeveloped and devoid of issuing institutions. The intermediary financial institutions were virtually absent in the long term financing of industry. As a result, the industry had very little access to outside savings. The financial system was not responsive to opportunities for industrial investment.

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1.5.1 Pre-reforms Period

The organisation of the Indian financial system during the post -1951 period evolved in response to the imperatives of planned economic development. Planning signified the distribution of resources to be in conformity with the priorities of the five year plans. It implied Government control over distribution of credit and finance. The main elements of the financial organisation in planned economic development could be categorised into four broad groups:

Fig 1.3 Main elements of the financial organisationsOne aspect of this evolution was the progressive transfer of its important constituents from private ownership to public control. Important segments of the financial mechanism were assigned to the control of public authorities through nationalisation measures as well as through the creation of entirely new institutions in the public sector. The following events took place during this period:

The nationalisation of the Reserve Bank of India in 1948.• Setting up of the State Bank of India in 1956 by taking over the then Imperial • Bank of India.Nationalisation and merger of 245 life insurance companies in 1956 to form • the Life Insurance Corporation of India.Nationalisation of fourteen major commercial banks in 1969.Nationalisation • of general insurance companies and setting up of the General Insurance Corporation (GIC) in 1972. Nationalisation of six more commercial banks in 1980.

Public / Government ownership of financial institutions

Fortification of the institutional structure

Protection to investors

Participation of financial institutions in corporate management.

Financial Institutions and Banking

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In addition to nationalisation, a number of powerful special purpose financial institutions designated as development banks / development finance institutions / term lending institutions were set up.

S R . NO.

Name of the Institutions

Year Objectives

1 Industrial Finance Corporation of India (IFCI)

1948 To give medium and long term credit to industrial enterprises

2 State Financial Corporations (SFCs)

1951 To assist small and medium enterprises

3 National Industrial DevelopmentCorporation (NIDC)

1954 Financing agency for modernisation of cotton and jute textiles

4. Industrial Credit and Investment

1955 Underwriting of capital issues andCorporation of India (ICICI) channelising of foreign currency loans

5 Refinance Corporation of Industry (RCI)

1958 To provide refinance to the banksagainst term loans

6 Industrial Development Bank of India (IDBI)

1964 To provide industrial finance and coordinate activities of all financial

7 Industrial Reconstruction Corporation of India (IRCI)later named as IndustrialInvestment Bank of India (IIBI)

1971 Rehabilitation of sick mills

8 Small Industrial Bank of India (SIDBI)

1990 To provide refinance for term loans to small and medium enterprises

9 Unit Trust of India 1964 To mobilise savings of small investorsand channelize them for industrial development

10 Export Import Bank of India (EXIM Bank)

1981 To provide finance to exporters and importers

11 National Housing Bank (NHB)

1988 To promote a healthy housing financesystem in the country

12 Export Credit Guarantee Corporation (ECGC)

1983 To offer protection to exporters against payment risks (commercial and political)

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13 Deposit Insurance & Credit Guarantee Cor-poration (DICGC)

1978 To provide guarantee for priority sector loans and insurance cover for depositsof banks to a specified limit

Table 1.1 Financial institutions/ financial development banks

1.5.2 Post Reforms Period

During the pre-reforms period, India adopted a state-dominated development strategy wherein all allocation decisions were made by the government and its agencies. Banks and financial institutions merely acted as deposit agencies. The period witnessed administered interest rates, industrial licensing and controls, dominant public sector and limited competition. This led to the emergence of an economy characterised by uneconomic and inefficient production systems with high costs.

For 40 years, India’s growth rate averaged less than 4 percent per annum while other less developed countries achieved a growth rate of over 5 per cent per annum. The world oil crisis in the beginning of 1990 coupled with a sharp decline in NRI remittances to India created a foreign exchange crisis which led the government to initiate economic reforms in June 1991. Financial institutions were functioning in a highly regulated regime up to 1991. The DFIs were mostly engaged in consortium lending and they offered similar services at uniform prices. In the administered interest rate regime, the costs of borrowings of DFIs were substantially lower than the returns on financing (lending).

The Reserve Bank and the Central Government used to finance these institutions by subscribing to the Share Capital, allowing them to issue government guaranteed bonds and extending long-term loans at concessional rates. However, this concessional lending was phased out in the ‘nineties’ with the initiation of financial sector reforms. Interest rates were deregulated and the facility of issuing bonds eligible for SLR investments was withdrawn. Now, these financial institutions have to rely on equity and debt markets for financing their needs. These DFIs have resorted to market-based financing by floating a number of innovative debt and equity issues. They also raise resources by way of term deposits, certificates of deposits and borrowings from the term money market within the umbrella limit fixed by the Reserve Bank in terms of net owned funds.

More stringent provisioning norms have come into operation. Many of the DFIs including IDBI have lost their tax-exempt status. Moreover, with de-regulation, the distinction between segments of financial intermediaries has blurred. Commercial

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banks are now financing the medium and long-term capital needs of the corporate sector and the DFIs have started extending short-term /working capital finance. This has led to a stiff competition between banks and DFIs. As a result, the focus of DFIs has shifted from the purpose for which they were set up.

With globalisation and liberalisation; the financing requirements of the corporate sector have undergone a tremendous change. Financial institutions have started providing a wide range of new products and services. These DFIs set up several subsidiaries/associate institutions which offer services such as commercial banking, consumer finance, investor and custodial services, broking, venture capital finance, infrastructure financing, registrar and transfer services and e-commerce.

1.5.3 Challenges Ahead

Several steps were taken during the liberalisation process to improve the efficiency of financial institutions. The interest rates are now de-regulated. Advances in technology, reduction in reserve requirements, increasing Evolution of Financial Institutions in India Financial Institutions competition by allowing private sector players, introduction of prudential norms, provisioning and capital adequacy and laying down of standards for corporate governance are some other steps taken to improve efficiency. An increase in foreign investment flows has increased cross border financial integration. We can now say that the Indian financial system is fairly integrated, stable and efficient.

Resources Mobilised by Financial Institutions[Amount in Rs. Crore]

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Institution Total Resources Raised Total Outstanding as at end-MarchLong-term Short Term Foreign Cur-

rencyTotal

2004-05 2005-06 2004-05 2005-06 2004-05 2005-06 2004-05 2005-06 2005 2006

1 2 3 4 5 6 7 8 9 10 11

IIBI1. - - - - - - - - 2.008 1.576

IFCI2. - - - - - - - - 15.025 13.678

TFCI3. 23 71 - - - - 23 71 429 390

EXIM 4. Bank

1.480 3.260 1.632 1.124 2.189 2.814 5.301 7.198 11.771 15.836

SIDBI5. 1.607 2.610 799 420 28 459 2.434 3.489 9.346 11.030

NAB-6. ARD

10.642 8.105 - - - - 10.642 8.194 26.429 27.303

NHB7. 2.419 2.631 1.063 199 - - 3.482 2.830 12.395 14.365

Total (1 to 7) 16.171 16.767 3.494 1.743 2.217 3.273 21.882 21.782 77.403 84.176

Table 1.2 Resource mobilisations by financial institutionsSource: RBI report on trend and progress of banking in India 2005-06

However, certain weaknesses still exist and need to be addressed. A high level of non-performing assets in some banks and financial institutions and capital adequacy issues are yet to be tackled. The crisis in financial institutions such as UTI, IFCI and IDBI unfolded the failure of prudential regulations and the government had to bail them out by refinancing them. Such incidences shake investor confidence and need to be avoided by proper control and monitoring. The banking sector needs to be revamped with merger of banks to form large banks to face global competition

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Select Financial Parameters of Financial Institutions(As at end – March)[Amount in Rs. Crore]

Institution Total Resources Raised Total Outstanding as at end-March

Long-term Short Term Foreign Cur-rency

Total

2004-05 2005-06 2004-05 2005-06 2004-05 2005-06 2004-05 2005-06 2005 2006

1 2 3 4 5 6 7 8 9 10 11

IFCI1. 7.4 11.3 1.5 2.3 1.8 6.7 -2.2 -0.6 -0.6 -0.2

IIBI2. 11.1 11.0 7.5 8.4 -7.5 -1.4 .. .. -0.8 -0.1

TFCI3. 11.4 10.2 0.2 0.2 3.8 4.0 2.0 1.0 0.4 0.4

EXIM 4. Bank

6.1 7.6 0.5 0.8 2.0 2.1 1.5 1.5 1.3 1.4

SIDBI5. 6.9 6.3 - 0.1 3.2 2.1 1.8 1.8 0.2 0.2

NAB-6. ARD

6.7 6.2 0.4 0.2 0.5 1.1 0.3 0.5 0.5 1.1

NHB7. 5.8 6.2 0.6 0.2 3.0 3.4 1.7 2.0 0.3 0.3

−: Nil/ Negligible .. :Not Available*:Position as on end – June Source Balance Sheet of respective FIs.

Table 1.3 Select financial parameters of financial institutionsSource: RBI, Report on trend and progress of banking in India, 2005-06

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1.6 Evolution of Development Financial InstitutionsThe need for development financial institutions was felt very strongly immediately after India attained independence. The pace of industrialisation needed to be accelerated for the overall growth of the economy. The existing industries needed long term funds for their reconstruction, modernisation, expansion and diversification whereas new industries required enormous investments for setting up gigantic projects in the capital goods sector. The capital markets were relatively underdeveloped and incapable of meeting the long term requirements of the economy adequately. Commercial banks had traditionally confined themselves to financing working capital requirements of trade and industry and abstained from supplying long term finance. Over the years, a wide range of FIs came into existence to cater to the medium and long term financing requirements of different sectors of the economy.

1.6.1 Organisational Structure

Based on their major activity undertaken, all Indian financial institutions can be classified as:

Term Lending Institutions (IIBI Ltd., IFCI Ltd., EXIM Bank and TFCI).They • extend long term finance to different industrial sectors.Refinance Institutions – (National Bank for Agriculture and Rural Development • (NABARD), Small Industries Development Bank of India (SIDBI), National Housing Bank (NHB)).- They extend refinance to banks as well as non-banking financial intermediaries for on-lending to agriculture, small scale industries (SSIs) and housing sector respectively.

Investment Institutions (LIC)They deploy their assets largely in marketable securities. State / regional level institutions are a distinct group and comprise various State Finance Corporations (SFCs), State Industrial and Development Corporations (SIDCs) and North Eastern Development Finance Corporation Limited (NEDFi). The Reserve Bank of India currently regulates IFCI, IIBI, EXIM Bank, TFCI, SIDBI, NABARD and NHB. The regulatory/ supervisory domain of NHB covers housing finance companies, SIDBI supervises State Financial Corporations and State Industrial Development Corporations, and NABARD supervises cooperative banks and regional rural ban

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Fig. 1.4 Components of financial institutions in India.

1.6.2 Financial Institutions

Financial Institutions can be classified further as follows

1.6.2.1 All India Financial Institutions

The following would be examples of All India Financial InstitutionsIndustrial Finance Corporation of India Limited (IFCI)Industrial Finance Corporation of India Ltd. was the first development finance institution established on July 01, 1948. It was later converted into a public limited company on July 01, 1993 with a view to impart greater operational flexibility and to enable it respond better to the changing needs of the financial system. IFCI’s principal activities include:

Project financing �

Financial services �

Corporate advisory services �

Corporate advisory services to foreign investors �

Promotional activities through subsidiaries such as custodial services, �investor services, rating service and venture capital services.

Industrial Investment Bank of India Limited (IIBI)Industrial Investment Bank of India Ltd. (IIBI) was set up as a company under the Companies Act, 1956 in March 1997 by converting the erstwhile Industrial Reconstruction Bank of India (IRBI). The IRBI was set up in 1985 under the IRBI Act, 1984, as the principal credit and reconstruction agency for the rehabilitation of sick and closed industrial units. IIBI was incorporated into a full-fledged DFI

Financial Institutions

All India Financial

Institutions

State Level Financial

Institutions Other

Institutions

All India Development Bank IFCI (1948)IIBI (1997)

Specialised Financial Institiution s EXIM Bank(1982)

Investment Institutions UTI(1964)LIC(1956)GIC & Subsidiaries(1972)

Refinance InstitutionsNABARD (1982)NHB(1980)

SFCs ECGC(1967)SIDCs DICGC

(1962)

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in 1997 by providing the management operational and financial autonomy. The Industrial Investment Bank of India Ltd. is India’s only all-India public financial institution headquartered in Kolkata. The services provided by IIBI include acquire and/or trade in varied financial instruments from term loans, equity or debentures and bonds, structured products besides providing various services like deferred payment guarantee, Loan Syndication, Merchant Banking services such as issue management, underwriting and guarantees, Project /reconstruction / one-time-settlement consultancy/appraisal. IIBI had a track record of profitability since inception in 1997 till 2002-03. However, its health deteriorated rapidly thereafter. The net non-performing assets increased from 22.9 per cent as on March 31, 2001 to 32.90 per cent as on March 31, 2005. It incurred a net loss of Rs.151.95 crores and its net worth became negative by Rs. 343.28 crore as on March 31, 2005. It could neither redeem preference shares nor pay preference dividend due to negative net worth. In view of the financial position, the Government issued directions to the company, restricting disbursement of fresh loans and on raising resources by fresh borrowings, introduction of the voluntary retirement scheme and merger of its branches. In spite of these measures, the auditors have expressed doubts about its continuance as a going concern. This is yet another institution which the Ministry of Finance wanted to be merged with the Industrial Development Bank of India Ltd. (IDBI). But the same could not happen. It is now felt that IIBI may soon be closed down.

Tourism Finance Corporation of India (TFCI)The Government of India had, pursuant to the recommendations of the National Committee on Tourism, viz. Yunus Committee set up under the aegis of the Planning Commission, decided in 1988, to promote a separate All-India Financial Institution for providing financial assistance to tourism-related activities/projects. In accordance with the above decision, the IFCI Ltd. Along with other All-India Financial/Investment Institutions and Nationalised Banks promoted a Public Limited Company under the name of “Tourism Finance Corporation of India Ltd. (TFCI)” to function as a specialised All-India Development Financial Institution to cater to the financial needs of the tourism industry. TFCI was incorporated as a Public Limited Company under the Companies Act, 1956 on 27th January 1989 and became operational with effect from Development Financial Institutions in India Financial Institutions 1st February 1989. TFCI has been notified as a Public Financial Institution under section 4A of the Companies Act, 1956. TFCI’s registered office is located in New Delhi.

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Small Industries Development Bank of IndiaThe Small Industries Development Bank of India (SIDBI) was set up in 1990 under the SIDBI Act, 1989. It commenced operations on April 02, 1990 by taking over the outstanding portfolio and activities of IDBI pertaining to the small scale sector. Of the total issued capital of Rs.450 crore subscribed by IDBI, while setting up of SIDBI, 19.21% has been retained by it and the balance 80.79% has been transferred / divested in favour of banks / institutions / insurance companies owned and controlled by the Central Government. SIDBI retained its position in the top 30 Development Banks of the World in the latest ranking of The Banker, London. As per the May 2001 issue of The Banker, London, SIDBI ranked 25th both in terms of Capital and Assets SIDBI was established with the objective of promotion, financing and development of industries in the small scale sector and to coordinate the functions of other institutions engaged in similar activities. Small scale industries are the industrial units in which the investment in plant and machinery does not exceed Rs.10 million. In addition, SIDBI’s assistance flows to the transport, health care and tourism sectors and also to professional and self-employed persons setting up small-sized professional ventures. Four basic objectives are set out in the SIDBI Charter. They are:

Financing �Promotion �Development �Co-ordination �

SIDBI offers a chain of financial products covering micro-finance, business incubation, venture capital, project finance, assistance for technology development and marketing of small scale industries products, export finance, bill finance, factoring, guarantees for loans, and so on. The products and services include:

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Fig 1.5 Product and services of SIDBI

Infrastructure Development Finance Company LimitedInfrastructure Development Finance Company Ltd. (IDFC) was incorporated on January 30, 1997, with an initial paid up capital of Rs.1,000 crores. The entire capital initially contributed by the government was subsequently divested. The shareholding pattern as on March 31, 2007 was: GOI/IDBI –26.3 percent, FIs/Insurance Cos. / Banks and MFs – 13.8 percent, FII – 32.8 percent, FDI – 15.2 percent and others 11.9 percent .IDFC was set up to facilitate the flow of private finance to commercially viable infrastructure projects. The traditional sources of finance could not meet the financing needs of such projects as the risk profile of infrastructure projects is unique. IDFC has designed innovative products and services to address the specific needs of infrastructure financing. The mission of IDFC is leading private capital to commercially viable infrastructure projects by advocating solutions that deliver efficient services to consumers. Initially, IDFC focused on power, roads and ports, and telecommunications. Now it has broadened this focus to the framework of energy, telecommunications and information technology, integrated transportation, urban infrastructure, and food and agri-business infrastructure.

Direct Finance Schemes

Bills Finance Schemes

Re-finance Schemes

International Finance Schemes

Marketing Schemes

SIDBI Foundation for Micro Credit

Scheme for Domestic Factoring

Scheme for Invoice Discounting

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The Export Import Bank of IndiaThe Export Import Bank of India (Exim Bank) is an apex financial institution created by an Act of Parliament - Export Import Bank of India Act, 1981. It commenced its business operations in March 1982. It is wholly owned by the Government of India and was set up for the purpose of financing, facilitating, and promoting foreign trade in India. Exim bank is the principal institution in the country for coordinating working of institutions engaged in financing exports and imports Exim Bank’s head office is located in Mumbai. It has a network of 14 offices in India and overseas.

The Bank’s objectives, as stated in The Export Import Bank of India Act, 1981 are for providing financial assistance to exporters and importers, and for functioning as the principal financial institution for coordinating the working of institutions engaged in financing export and import of goods and services with a view to promoting the country’s international trade shall act on business principles with due regard to public interest.

The Bank’s functions are segmented into several operating groups including: Corporate Banking Group - which handles a variety of financing programmes • for Export Oriented Units (EOUs), Importers, and overseas investment by Indian companies.Project Finance/ Trade Finance Group - handles the entire range of export • credit services such as supplier’s credit, pre-shipment credit, buyer’s credit, and finance for export of projects and consultancy services, guarantees, forfeiting, etc.Lines of Credit Group - Lines of Credit (LOC) is a financing mechanism that • provides a safe mode of non-recourse financing option to Indian exporters, especially to SMEs, and serves as an effective market entry tool.Agri Business Group - to spearhead the initiative to promote and support Agri-• exports. The Group handles projects and export transactions in the agricultural sector for financing.Small and Medium Enterprises Group to the specific financing requirements • of export oriented SMEs. The group handles credit proposals from SMEs under various lending programmes of the Bank.Export Services Group offers a variety of advisory and value-added information • services aimed at investment promotion.Fee based Export Marketing Services - Bank offers assistance to Indian • companies, to enable them establish their products in overseas markets

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National Bank for Agriculture and Rural DevelopmentThe National Bank for Agriculture and Rural Development (NABARD) came into existence on July 12, 1982 under an Act of Parliament. NABARD is set up by the Government of India as a development bank with the mandate of facilitating credit flow for the promotion and development of agriculture and integrated rural development. The mandate also covers supporting all other allied economic activities in rural areas, promoting sustainable rural development and ushering in prosperity in the rural areas. With a capital base of Rs.2,000 crores provided by the Government of India and Reserve Bank of India, it operates through its head office at Mumbai, 28 regional offices situated in state capitals and 391 district offices in districts. It is an apex institution handling matters concerning policy, planning and operations in the field of credit for agriculture and for other economic and developmental activities in rural areas. Essentially, it is a re-financing agency for financial institutions offering production credit and investment credit for promoting agriculture and developmental activities in rural areas. In discharging its role as a facilitator for rural prosperity, NABARD is entrusted with:

Providing re-finance to lending institutions in rural areas• Bringing about or promoting institutional development and• Evaluating, monitoring and inspecting the client banks•

Besides this pivotal role, NABARD also:Acts as a coordinator in the operations of rural credit institutions• Extends assistance to the government, the Reserve Bank of India and other • organisations in matters relating to rural developmentOffers training and research facilities for banks, cooperatives and organisations • working in the field of rural developmentHelps state governments in reaching their targets of providing assistance to • eligible institutions in agriculture and rural developmentActs as a regulator for cooperative banks and RRBs•

NABARD was established in terms of the Preamble to the Act, “for providing credit for the promotion of agriculture, small scale industries, cottage and village industries, handicrafts and other rural crafts and other allied economic activities in rural areas with a view to promoting IRDP and securing the prosperity of rural areas and for matters connected therewith and incidental thereto”.

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1.6.2.2 State Level Financial Institutions

State Industrial Development CorporationsThe State Industrial Development Corporations (SIDCs) were established under the Companies Act, 1956, as wholly owned undertakings of the state governments. They act as nodal agencies of state governments for the promotion of industrial growth and development of infrastructure facilities in the state. There are 28 SIDCs in the country. Of them, 11 also function as State Financial Corporations (SFCs) to provide assistance and act as promotional agencies for small and medium enterprises. Their main functions are:

To provide risk capital by way of equity participation and seed capital • assistanceTo give term loans, guarantees and lease finance• To administer incentive schemes of the Central and State Governments• To conduct industrial potential surveys, to identify project areas, prepare • feasibility reports, and select and train entrepreneursTo develop industrial areas, plots, sheds, and estates• To set up industrial projects in the joint sector i.e. in partnership with private • entrepreneurs or as wholly owned subsidiaries

State Financial CorporationsThe State Financial Corporations (SFCs) are set up under the State Financial Corporation Act, 1951. There are 18 SFCs in the country today. They play an effective role in the development of small and medium enterprises and in bringing about regionally balanced economic growth. They aim at wider dispersion of small and medium units within each state.

The SFCs provide financial assistance by way of term loans, direct subscription to equity/debentures, guaranteeing loans/ deferred payments of industrial concerns, discounting of bills of exchange and seed/special capital. The SFCs operate a number of schemes of re-finance and equity-type assistance on behalf of SIDBI. SFCs have special schemes to assist rural artisans, tiny industries, ex-servicemen, physically handicapped persons, etc. SFCs are authorised to raise resources by issue of capital, issue bonds and debentures guaranteed by state governments, accept medium and long term deposits from the public and borrow from other financial institutions. SFCs come under the purview of SIDBI.

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Summary

During the pre-reforms period, which is until early nineties, the Indian financial • system witnessed a progressive transfer of its important constituents from private ownership to public control. Such a control was viewed as an integral part of the strategy of planned economic development.

However, economic development was either slow or constant. With the • launching of the new economic policy in 1991, India shifted its focus to a free market economy with liberalisation/ deregulation/ globalisation of the economy.

The concept of a financial system and its components is defined.•

A financial system is a vertical arrangement of a well-integrated chain • of financial markets and financial institutions for providing financial intermediation.

Financial institutions are a part of the financial system and play an important • role in the economic progress of the country

The need for development financial institutions was felt ver y strongly • immediately after India attained independence. The pace of industrialisation needed to be accelerated for the overall growth of the economy.

The existing industries needed long term funds for their reconstruction, • modernisation, expansion and diversification whereas new industries required enormous investments for setting up gigantic projects in the capital goods sector

References

Machiraju, H. R., 2010, • Indian Financial System., 4th ed., Vikas Publishing House Pvt. Ltd.Venugopal and Murthy, 2006, • D. K., Indian Financial Systems, I K International Publishing House.Financial Grant from NABARD on Tailoring Trade• , [Video Online] Available at: <http://www.youtube.com/watch?v=XCPnVMHWEY8&feature=related>[Accessed 19 July 2011].Ndtvprofit• ,Indiamustmovefasteronfinancialsectorreform:Virmani, [Video Online] Available at: <http://www.youtube.com/watch?v=wQH55v1HyUY>[Accessed 19 July 2011]

Financial Institutions and Banking

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Maps of the world finance, • Financial Institutions in India, [Online] Available at <http://finance.mapsofworld.com/financial-institutions/india/> [Accessed 19 July 2011]Business maps of India, • Financial Institutions in India, [Online] Available at <http://business.mapsofindia.com/finance-commission/institutions//> [Accessed 19 July 2011]

Recommended Reading

Thomas, S., Shah, A., and Gorham. M., 2008. • India’sFinancialMarkets:AnInsider’s Guide to How the Markets Work (Elsevier and IIT Stuart Center for Financial Markets Press), Elsevier Science.

Bhasin, N., 2004, • IndianFinancialSystem:Reforms,PoliciesandProspects, New Century Publications.

Tarapore, S. S., 2011, Financial• Policies andEverydayLife: The IndianContext, Academic Foundation.

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Self Assessment

How many components are there in the formal financial system?1. 3a. 6b. 1c. 4d.

“Financial dualism” means:2. Co-existence of formal and informal financial sectorsa. Co-existence of formal and informal financial instrumentsb. Co-existence of financial sector and financial marketsc. Co-existence of financial institutions and financial servicesd.

____________are directly issued by the ultimate borrowers of funds to the 3. ultimate savers

Primary securitiesa. Secondary securitiesb. Dual securitiesc. Financial securitiesd.

______________witnessed the following events for planned economic 4. development

The pre-reforms perioda. The post-reforms periodb. The pre-independence periodc. The post- independence periodd.

_____________________is an apex financial institution created by an Act 5. of Parliament

SIDBIa. IIBIb. ICICIc. EXIMd.

_________________ were established under the Companies Act, 19566. IIBIa. ICICIb. SIDCc. EXIMd.

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The National Bank for Agriculture and Rural Development () came into 7. existence on July 12, 1982 under an Act of Parliament

EXIMa. NABARDb. SIDCc. EXIMd.

_____________was set up as a company under the Companies Act, 1956 in 8. March 1997 by converting the erstwhile Industrial Reconstruction Bank of India

ICICIa. SIDCb. IIBIc. EXIMd.

____________regulates the capital market9. SEBIa. IRDAb. ICICIc. IIBId.

________________ regulates the insurance sector.10. SEBIa. IRDAb. ICICIc. IIBId.

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Chapter II

Banking Institutions

Aim

The aim of this unit is to:

explain in brief the history and development of banking institutions in India•

identify the functions of various types of banks•

define the various reforms in banking in India•

Objectives

The objectives of this unit are to:

discuss the importance of the banking sector• in India

demonstrate the role of different banking institutions in India•

introduce the impact of the development of banking in India’s economic •

growth

Learning outcome

At the end of this unit, you will be able to:

understand the structure of the banking sector in India and its evolution since •

independence

enlist the functions and categories of scheduled commercial banks•

enumerate the reforms in the banking sector•

Financial Institutions and Banking

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2.1 Definition of Non Banking Financial Companies (NBFCs)A Non Banking Financial Company (NBFC) has been defined vide clause (b) of Section 45- I of Chapter IIIB of the Reserve Bank of India Act, 1934 as:

A financial institution, which is a company.• A non banking institution, which is a company and which has as its principal • business, the receiving of deposits under any scheme or arrangement or in any other manner or lending in any other manner.Such other non-banking institutions or class of such institutions, as the bank • may with the previous approval of the central government and by notification in the official gazette, specify.

2.1.1 Types of NBFCsThough heterogeneous, NBFC could be broadly classified into four categories which are equipment leasing, hire purchase, loan companies and investment companies. A separate category of NBFCs called the residuary non banking companies (RNBCs) also exists as they could be categorised into any one of the four categories. Besides, there are miscellaneous non banking companies (Chit Fund), mutual benefit financial companies (Nidhis and unnotified Nidhis) and housing finance companies. It is noteworthy that Nidhi companies are not regulated by the Reserve Bank as they come under the purview of the Ministry of Company Affairs, while the Chit Companies, although governed by the Miscellaneous Non Banking Companies (MSNBC’s) (Reserve Bank) Directions, 1977, issued by the Reserve Bank with regard to acceptance of deposits, are regulated by the Registrar of Chits of the respective State Governments.

2.1.2 Growth of NBFCsNBFCs are financial intermediaries engaged primarily in the business of accepting deposits and delivering credit. They supplement the role of the banking sector in meeting the increasing financial needs of the corporate sector, delivering credit to the unorganised sector and small borrowers. NBFCs in India have existed since long. NBFCs flourished during the stock market boom of the early 1990s. They became prominent in the initial years of liberalisation so much so that their growth in aggregate deposits outpaced that of the banks. However, the restrictions placed on bank lending to NBFCs by RBI during 1995 landed many of them in serious problems as they were required to depend on high cost deposits. Subsequent slackness in the capital market and industrial activities resulted in sharp deterioration of their assets. The period witnessed closure of many NBFCs. With the introduction of comprehensive regulatory measures initiated by the Reserve Bank of India since 1997, only the financially strong NBFCs have survived and the weak and unhealthy players have been weeded out.

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Amount in Rs.croresItem As At End March

2005 2006NBFCs Of Which

RNBCsNBFCs Of Which

RNBCs1 2 3 4 5Number of reported companies

703 3 466 3

Total Assets 55,059 19,056 57,453 21,891(34.6) (38.1)

Public De-posits

20,526 16,600 22,842 20,175

(80.9) (88.3)Net Owned Funds

6,101 1,065 6,663 1,183

(17.5) (17.8)

Table 2.1 Profile of non banking financial companiesSource: RBI, Report on Trend and Progress of Banking in India, 2005-06

Includes miscellaneous, Non-Banking Companies, unregistered and unnotified Nidhis.

Note: Figures in brackets indicate percentages to respective total of NBFCs.

2.1.3 Regulation of NBFCsPrior to 1997, the Reserve Bank of India had powers to regulate deposit-taking activities of NBFCs but not the asset side activities. With the amendment of the RBI Act in 1997, the Reserve Bank was given comprehensive powers to regulate NBFCs.

An NBFC must obtain a certificate of registration from the RBI before commencement of business. Ceilings are prescribed for acceptance of deposits, capital adequacy, credit rating and net owned funds for registration of new NBFCs.

The Reserve Bank of India is further empowered to regulate functions of NBFCs:

The RBI can issue directions to furnish information relating to, or concerned • with, deposits.

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The RBI can ask information relating to, as well as issue directions for the • conduct of, their business.The RBI can by general/special order regulate or prohibit the issue of any • prospectus or advertisement soliciting deposits of money from the public and specify conditions subject to which they can be issued. The RBI can determine policy and give directions relating to:

Income recognition, accounting standards, provisioning for bad and �doubtful debts and capital adequacy.The purpose for which advances can be made. �The maximum amount of advances/ deployment of funds that can be �made.

2.1.4 Supervision and ControlIn order to ensure that NBFCs function on sound lines and avoid excessive risk taking, the RBI has developed a four pronged supervisory framework based on:

On-site inspection structured on the basis of assessment and evaluation of • CAMELS (Capital, Assets, Management, Earnings, Liquidity, and Systems) approach.

Off-site monitoring supported by state-of-the-art technology.•

Use of Market Intelligence System.•

Exception reports of statutory auditors of NBFCs•

2.2 Development of Banking in IndiaBanking in India dates back to the Vedic times. Until the eighteenth century, money lenders and indigenous bankers played a key role. Modern banking was introduced in India by European agency houses. Three Presidency Banks were set up between 1809 and 1843 which were later amalgamated into the Imperial Bank of India in 1921.Development of banking, post-independence, can be divided into three broad phases:

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Fig 2.1 Phases in Development of BankingBanking Consolidation Phase (1951-1964) witnessed the evolution of a • banking structure to prevent bank failures and to restore public confidence. The enactment of the Banking Regulation Act in 1949 and empowering of the Reserve Bank of India led to the emergence of a strong, unified and compact banking system. The Deposit Insurance Corporation of India was set up in January 1962 to provide protection to depositors

The Revolutionary phase (1964-1990) witnessed the introduction of policies • that aimed at equitable distribution of bank credit among various classes of borrowers. The scheme of social control was introduced at the end of 1967. It sought to remove the control of the business houses over banks and the distribution of bank credit in rural areas. The Lead Bank Scheme (LBS) was introduced in all the districts at the end of 1969. Earlier on 19 July 1969, 14 major private banks in the country were nationalised for the effective implementation of social control objectives. The Prudential banking phase started with the deregulated/ liberalised/• globalised economic environment since the early nineties. The Narsimham

Banking Consolidation Phase

Revolutionary Phase

Prudential Banking Phase

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Committee was set up in 1991 to transform Indian banking from serious deficiencies in the system in the post nationalisation era. Banking sector reforms were undertaken as per the committee’s recommendations so as to ensure that the system operates on the basis of operational flexibility and functional autonomy with a view to enhance efficiency, productivity and profitability. With the Narsimham Committee II recommendations in 1998, further banking sector reforms were introduced to meet the challenges of global competition in an expanding economy.

2.2.1 Functions of Commercial BanksBanks are one of the oldest financial intermediaries in the financial system and are regarded as the lifeline of any modern economy. Section 5(1) (b) of the Banking Regulation Act defines banking as: “The accepting for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise and with drawable by cheque, draft, and order or otherwise.”

From the definition, two important functions of commercial banks emerge acceptance of deposits and lending of funds. For centuries, banks have borrowed and lent money to business, trade and people charging interest on loans and paying interest on deposits. Thus, these two functions are the core activities of banking. Besides the above core activities, banks offer a wide range of services including transfer of funds, collection, safe deposit lockers, merchant banking, foreign exchange and other ancillary services.

Fig.2.2 The Indian banking structure (March 2006) (a)

Reserve Bank of India ( RBI)

Scheduled commercial bank

SBI & Associates- 8Shares in

Branches -24.9%Business -24.8%Capital-20.6%

Foreign banks-29 Share in

Branches -0.5%Business -5.7%Capital-13.3%

SBI & Associates- 8Shares in

Branches -24.9%Business -24.8%Capital-20.6%

Regional Rural bank

Scheduled co- operative bank

Private sector Bank 28 Share s in

Branches -12.3%

Business -5.7%

Capital-13.3%

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Fig. 2.3 The Indian banking structure (March 2006) (b)

2.2.2 Scheduled Commercial BanksThe banks included in the Second Schedule of the Reserve Bank of India Act, 1934 are classified as Scheduled Commercial Banks. They are further classified into the following four categories in terms of their ownership and function:

Fig. 2.4 Categories of Scheduled Commercial Banks

Public Sector BanksPublic sector banks are banks in which the government has a major holding.These can be classified into

State Bank of India and its associates �Nationalised Banks. �

Reserve Bank of India (RBI)

Scheduled commercial bank

(218)

Scheduled Co-operative banks

(71)

State co-operative banks (16)

Urban Co-operative banks (55)

Scheduled Commercial Banks

Public Sector Banks

Private Sector Banks

Foreign Banks in India

Regional Rural Banks

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The State Bank of IndiaThe history of the State Bank of India (SBI) dates back to the British Raj. Three Presidency Banks namely Bank of Bombay, Bank of Madras and Bank of Bengal were set up between 1809 and 1843 mainly to deal in bills of exchange payable in India and were an integral part of the Indian treasury. They were taken over by the Imperial Bank of India under a special legislation in 1920. The Imperial Bank of India acted as a banker to the Government until the establishment of the Reserve Bank of India in 1935. Thereafter, it was authorised to act as the sole agent of the Reserve Bank in places where the latter did not have its own branches.

The Imperial Bank was nationalised under the State Bank of India Act, 1955, which was passed on May 08, 1955. The State Bank of India came into existence on July 01, 1955. Though SBI was the first bank to be nationalised in 1955, it was allowed to raise funds through equity-cum-bond issue in 1993 and in 1996 to meet capital adequacy norms. Consequently, the shareholding of the Reserve Bank of India in the equity of the Bank came down from 98.20 percent to 59.70 percent. The Bank has seven associate banks and several other subsidiaries. It is the world’s largest commercial bank in terms of branch network with over 13,000 branches and 45 foreign branches as on Sept. 30, 2006. It is also the country’s largest bank with 100 million accounts and a workforce of 2, 78,269 as on 31.03.2005.

Nationalised BanksAlthough the banking system during the revolutionary phase took several measures to attain the objectives of social justice, there were serious concerns amongst a sizable section of the political leadership about the profit oriented private ownership structure of banks. To satisfy this radical ideology, 14 major banks with individual deposits exceeding Rs.50 crores were nationalised on 19 July 1969. Six more commercial banks in the private sector with individual deposits of over Rs.200 crores were nationalised on Aug. 15, 1980. At present, there are 27 nationalised banks (New Bank of India was merged with the Punjab National Bank). Soon after nationalisation, these banks launched a massive branch expansion programme particularly in semi-urban and rural areas so as to mobilise savings and increase the flow of credit to the hitherto neglected sectors. Nationalised banks today have a huge network of 33,937 branches. Nationalised banks were also allowed to access the capital market to raise funds to meet capital adequacy norms. 24 of the 27 nationalised banks have so far approached the market which has led to the dilution of the shareholding of the government.

Private Sector BanksIn the pre-reforms period, there were only 24 banks in the private sector. For over two decades, no bank was allowed to be set up in the private sector after the nationalisation of 14 larger banks in 1969. However, the Narasimhan Committee, in its first report, recommended freedom of entry for the private sector, provided they conform to the minimum start up capital and other requirements. The Reserve Bank of India; considering the need to introduce greater competition and efficiency

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in the banking system; accepted the recommendations and allowed banks to be set up in the private sector. Today there are 27 banks in the private sector of which 8 are new private sector banks. These new banks have brought in state-of-the art technology and aggressively marketed their products. The public sector banks are today facing stiff competition from these new private sector banks.

Foreign Banks in IndiaThere are 29 foreign banks operating in India with 258 branches as on September 30, 2006. The branches of these banks are spread over 25 centres in 15 states/union territories. The foreign banks were allowed to operate only through branches till 2000-01. However, they are now allowed to set up subsidiaries in India. New foreign banks are allowed to conduct business in India after taking into consideration the financial soundness of the bank, international and home country ranking, rating, international presence, economic and political relations between the two countries. The minimum capital requirements are stipulated and additional branches are permitted after monitoring the performance of existing branches. The number of licenses is fixed at 12 per year, both for new and the expansion of existing banks.

1951 1969 1984 1992 1996 1999Number of commercial banks

n.a 99 n.a 276 293 301

Total branches in India

4151 9202 45332 60570 64937 67.157

Rural- - 1633 25372 35269 32982 32859Semi – urban- - 3342 9262 11358 13832 14462Urban- - 1503 4929 5666 8159 8995

Population per branch (in ‘000)

75 55 15 14 15 15

Deposits in India (Rs. Crore)

909 4646 63852 237566 432819 722203

Deposits as a per-centage of national Income

9.0 15.5 37.9 49.5 46.1 50.3

Per Capita deposits ( Rs.)

0 98 940 2738 4544 7359

Deposits per Branch ( Rs. Crore )

0.2 0.5 1.4 3.9 6.7 10.8

Total bank credit (Rs. Crore)

727 3599 43058 131520 254015 368837

Credit per branch (Rs. Crore)

0.2 0.4 0.9 2.2 3.9 5.5

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Bank credit to priority sectors(Rs.crore)

- 504 14834 47316 80821 125309

Share of priority sector advances in gross credit

- 14.0 34.5 36.0 31.3 34.2

Credit-deposit ratio (percent)

80.0 77.5 67.4 55.4 58.6 51.1

Investment-deposit ratio (percent)

- 29.3 35.3 38.0 38.0 25.2

Cash-deposit ratio (percent)

- 8.2 14.5 18.2 12.4 9.4

2000 2001 2002 2003 2004 2005Number of com-mercial banks

298 300 297 292 290 284

Total branches in India

67968 67937 68195 68500 69170 70324

-Rural 32852 32585 32503 32283 32227 32115-Semi urban 14841 14843 14962 15135 15288 15851Urban 10994 11193 11328 11586 11808 12368Metropolitan 9181 9316 9402 9516 9750 10190Population per branch (in ‘000)

15 15 15 16 16 16

Deposits in India (Rs. crore)

851592 989141 131188 1311761 1604418 1700198

Deposits as a per-centage of national Income

53.6 56.0 54.4 58.8 60.0 60.4

Per capita deposits (Rs.)

8542 9770 11,008 12,253 14,089 18,281

Deposits per branch (Rs. crore)

12.5 14.8 18.8 19.1 21.7 24.2

Total bank credit (Rs. crore)

454,069 528,271 609,053 748,432 840,785 1,100,428

Credit per branch (Rs. crore)

5.7 7.8 8.9 10.9 12.2 15.6

Bank credit to pri-ority sectors ( Rs. Crore )

155,779 182,255 205,608 254,648 283,834 345,827

Share of priority sectoradvances in gross credit

34.3 34.4 33.8 34.1 31.4 31.4

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Credit-deposit ratio (percent)

53.3 53.5 53.8 58.9 55.9 64.7

Investment-deposit ratio (percent)

36.6 37.1 38.7 42.7 45 43.5

Cash-deposit ratio (percent)

9.8 8.4 7.1 8.5 7.2 6.4

Table 2.2 Progress of Commercial Banks in IndiaSource: Statistical Tables Relating to Banks in India 2004-2005

Regional Rural BanksThe cooperative banks and commercial banks after nationalisation, achieved a high degree of penetration in rural areas in the country. However, a vast gap existed in the area of rural credit. A new category of scheduled banks came into existence in 1975 when 6 Regional Rural Banks (RRBs) were set up under the Regional Rural Banks Ordinance, 1975. RRBs were set up as institutions which combine the local feel and familiarity with rural problems and modernised outlook. The major objective of setting up RRBs was to develop the rural economy by providing credit and other facilities to agriculture and agro based industries, particularly to the small and marginal farmers, agricultural labourers, artisans and small enterprises. The number of RRBs rose from 6 in 1975 to 196 in 2001. The number of RRBs has come down to 133 as on March 31, 2006 on account amalgamation, which began in September 2005. RRBs have carved out a niche for themselves in terms of geographical coverage, clientele outreach, business volume and contribution for the development of the rural economy. But they are also characterised by low productivity, high transaction costs, negative margins, low recovery rates and high non performing assets (NPAs).

Cooperative BanksCooperative Banks came into existence with the enactment of the Cooperative Credit Societies Act, 1904. Subsequently, a new act was passed in 1912 which provided for the establishment of cooperative central banks. A cooperative bank is member promoted and has to be registered with the state based Registrar of Cooperative Societies. It functions with the rule of one member one vote’ and on ‘no profit, no loss basis. The cooperative credit sector in India comprises rural cooperative credit institutions and urban cooperative banks. Urban Cooperative Banks (UCBs) are mostly engaged in retail banking. However, they are not permitted to deal in specialised areas such as foreign exchange, wholesale banking, etc. in view of their small size and inadequate expertise. Cooperative banks came under the purview of the Banking Regulation Act in 1966. UCBs are supervised by the Reserve Bank whereas rural cooperatives are supervised by the NABARD. State Registrars of Cooperative Societiesalso regulate certain functions of both urban and rural cooperative banks/soci-eties. The organisational structure of cooperative credit institutions is presented below which reveals that they have a predominant presence in rural areas.

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Fig.2.5 Organisational structure of cooperative credit institutions (a)Source: RBI Report on Trend and Progress of Banking in India 2005-06

Fig.2.6 Organisational structure of cooperative credit institutions (b)Source: RBI, Report on Trend and Progress of Banking in India 2005-06

SCARDBS: State Co-Operative Agriculture and Rural Development Banks

PCARDBS: Primary Co-Operative Agriculture and Rural Development Banks

Co- Operative Credit

Institutions

Urban Co-operative Banks (1853)

Urban Co-operative Banks (1853)

Scheduled UCBs (55)

Multi-state(24)

Operating in single state

(31)

Operating in single state

(31) Multi-state

Non -Scheduled UCBs(1798)

Co- Operative Credit Institutions

Short term

State Cooperative Banks(31)

Primary Agricultural

Credit societies(1,08,779)

District Central Co-operative Bank(367)

SCARDBS PCARDBS

Long Term

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UCBs are included in the second schedule of the RBI Act, 1934, if their Net Demand and Time Liabilities (NDTL) are at least Rs. 100 Crores. UCBs’ area of operation is usually confined to a district or adjoining districts. However, UCBs with net owned funds of over Rs.50 crores can operate all over the country. UCBs have played a key role in creating banking awareness among the lower and middle income groups. There are 1853 UCBs in the country of which 55are scheduled cooperative banks and 1798 are non-scheduled cooperative banks. Almost one third of cooperative banks are from Maharashtra and Goa (630).However, the financial health of some UCBs has deteriorated due to high nonperforming assets. Lack of professionalism, low capital base, increasing political interference, mounting overdues, non-adherence to norms and regulations are some other important reasons for their problems. During the recent past, many UCBs were either closed or merged with other strong UCBs due to above problems. An effective and coordinated regulation and supervision with a single regulatory authority is essential to bring back the health of UCBs.

2.2.3 Reforms in the Banking SectorBanking sector reforms were initiated to upgrade the operating standards, health, and financial soundness of Indian banks to internationally accepted levels in an increasing globalised market. The Government of India set up the Narasimhan Committee I (1991) to examine all aspects relating to structure, organisation and functioning of the Indian banking system. The reform measures were undertaken gradually and cautiously in two phases.

The first phase as per 1991 recommendations included liberalisation of branch expansion policy and entry norms, deregulation of interest rates, introduction of prudential norms and others. The first phase of banking reforms is complete. The second generation reforms were undertaken after accepting many of the Narasimhan Committee II (1998) recommendations. The second phase of reforms is underway and concentrates on strengthening the foundation of the banking system by structure, technological up gradation and human resource development.

The key areas of the second phase are:Rigorous prudential accounting norms relating to credit and investment • portfolio and capital adequacyExposure norms• Asset reconstruction and enforcement of security interest to ensure speedy • recovery / NPA managementAsset Liability management• Credit risk management• Country risk management.•

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Thus, the first phase of reforms until 1997 concentrated on the functioning and regulatory compliance of banks, whereas the second phase aims at strengthening internal financial management of the banks in India to make them internationally competitive.

Period Event The British Raj

Commercial banks (entities with unlimited liability) established.

1800s Banks specialised in providing short-term credit for trade.1896 The presidency Act allowed the establishment of state-partnered

banks.1921 Four large banks were merged to form the imperial Bank of

India (which later became State Bank of India).1934. The Reserve Bank of India Act was passed1935 The RBI came into existencePost- Independence era.

The Indian banking system progressed in terms of functions and geographic coverage. The proportion of industrial credit was higher than agricultural credit

1949. The Banking Regulation Act, 1949, gave RBI the powers to regulate, supervise and develop the banking system

After 1949 There was consolidation in the banking industry, and large commercial banks emerged through mergers and amalgamations

1955 The Imperial Bank of India was rescheduled as the State Bank of India

1967 A scheme for social control on banks was introduced in order to increase the availability of banking facilities and change the uneven distribution of lending by banks

Jul 1969 14 major banks, each with deposits of over Rs. 500 crore, were nationalised by the Ministry of Finance.

1974 Targets for priority sector lending were set.1980 The government further nationalised six banks.Aug 1991 The Narasimham Committee was formed in order to re-examine

the financial system1992-93 Income recognition and capital adequacy norms were

introduced and interest rates were nationalised. Losses of public sector banks amounted to Rs. 3,648 crore

1993 Public sector banks accounted for 93 percent of the total branches inIndia, 87 percent of the total deposits, and 89 percent of the total loans.

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1994 199596

Private sector banks were permitted to commence operations. The interest rates on loans of over Rs. 200,000 were deregulated, allowing banks to fix prime lending rates. Banks were allowed to issue capital, up to 49 percent of the equity, from the capital markets, by amending the Banking Companies (Acquisition and Transfer of Undertakings) Act 1970/80.19 of the 27 scheduled commercial banks were able to achieve the stipulated capital adequacy ratio.

1997 Limited and conditional autonomy was provided to public sector banks.

1998 The committee on financial sector reforms (Narasimham Committee II)reviewed the progress of reforms, and recommended a plan for the implementation of second generation reforms. Norms for capital adequacy and a reduction in non-performing assets were evolved. Interest rates on term deposits of over 15 days were deregulated

1999 Guidelines on asset-liability management and risk management were issued.

2000 In Union Budget, the government announced its intention to reduce its equity in public sector banks to 33 percent. HDFC Bank acquired Times Bank; the first private sector merger in India.

2001 RBI issued licences to 2 new banks, Kotak Mahindra and Rabo Bank. FDI limit in the banking sector increased to 51 percent.

2002 Union Government allows the conversion of the branch operations of foreign banks into subsidiaries. RBI approves the merger of ICICI and ICICI Bank, making it the second largest bank in India. In terms of assets. Kotak Mahindra Finance, an NBFC, announces its intention to convert itself into a bank

2003 Kotak Mahindra Bank commenced operations of March 24, 2003.

2004 HSBC acquired 20 percent in UTI Bank.FDI limit in private banks increased from 49 percent to 74 percent.RBI placed moratorium on GTB’s operations on July 24, 2004.RBI announced the merger of GTB with OBC on July 26, 2004

Table 2.3 Evolution of Indian banking

2.2.4 Housing Finance System in IndiaHousing is one of the basic necessities and the capital required for construction of a house is so large that few can think of raising resources out of own savings for constructing a house. During the pre-reforms era, few could dream of borrowing funds for housing as the Indian financial system was utterly underdeveloped for

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supply of credit to housing. However, in the recent past, the authorities have initiated certain steps to bridge this gap. Finance for housing is provided in the form of mortgage loans, i.e., it is provided against the security of immovable property of land and buildings. The suppliers of house mortgage loans in India are the following:

The Housing and Urban Development Corporation (HUDCO),• The apex Co-operative Housing Finance Societies Housing Boards in different • states,Central and state governments,• LIC, GIC, and a few private housing finance companies• Commercial banks• Nidhis.•

The participation of commercial and urban co-operative banks in direct mortgage loans has been marginal till recently. However, after the setting up of National Housing Bank and particularly during post-reforms period, housing finance witnessed tremendous growth after the entry of private sector banks which aggressively marketed their home loan schemes.

2.3 Housing and Urban Development Corporation (HUDCO)The Housing and Urban Development Corporation Ltd. (HUDCO) was incorporated on April 25, 1970 under the Companies Act, 1956, as a fully owned enterprise of the Government of India. It is one of the important institutions in the housing finance area and it focuses on the social aspects of housing and utility infrastructure provision. It also makes preferential allocation of resources to the socially disadvantaged. Reduction in number of RRBs was due to amalgamation, which began in September 2005.

Indicator 2000-01 2001-02 2002-03

2003-04 2004-05

2005-06

1 2 3 4 5 6 7No. of RRBs 196 196 196 196 196 133*Net Profile (Rs. Crore)

600.6 607.9 519.3 768.7 748.2 510.3

Per Branch Produ-tivity1 (Rs.crore)

3.8 4.4 5.0 5.7 6.6 7.7

Per Employee Productivity2 (Rs.crore)

0.8 0.9 1.0 1.2 1.4 1.6

Accumulated Loss as percentage to assets

5.6 4.7 4.4 3.9 3.5 2.9

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Financial Return3 (percent)

2.0 2.2 2.3 2.6 2.0 1.8

Financial Cost4 (percent)

9.4 10.6 9.6 8.9 8.2 6.6

Financial margin5

(percent)6.0 6.8 6.1 5.4 4.6 3.5

Risk operational and other cost (percent)

3.4 3.8 3.5 3.5 3.6 3.1

Risk operational and other cost (percent)

2.1 2.6 2.6 2.2 2.3 2.9

Net Marging6(percent)

1.2 1.2 0.9 1.3 1.3 0.7

Table 2.4 Financial indicators of regional rural banksSource: NABARD.

**Reduction in number of RRBs was due to amalgamation, which began in September 2005.

NoteAverage level of business (in terms of total deposits and gross advances) per • branch during the reporting year.Average level of business (in terms of total deposits and gross advances) per • employee of RRBs during the year.Percentage of total income from both advances and investments against • average working funds during the year.Percentage of total interest expended from deposits, borrowings etc. against • average working funds during the year.Difference between the financial return and financial cost.• Difference between the financial margin and risk, operational and other costs, • plus miscellaneous income.

Performance at a Glance (As on 30-Apr-07)

Number of Schemes Sanctioned 15759No. of Schemes Completed 12228Project Cost (Rs. in Crores) 228784Loan Amount (Rs. in Crores) 75570Amount Released (Rs. in Crores) 56901Residential Dwellings 14194535

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Economically Weaker Section 11718481Lower Income Group 1377790Middle Income Group 423912Higher Income Group 293615HUDCO Niwas 380737Non Residential Buildings 36057Number of Plots 537798Sanitation Units 6707739

Table 2.5 HUDCO’s performance at a glance

2.4 State Housing Finance Societies (SHFSs)The State Housing Finance Societies constitute another major source of funds in the residential mortgage market. These societies advance loans to affiliated Primary Cooperative Housing Societies for the construction of dwelling houses, purchase of land, additions and improvements to existing houses, purchase of houses, and repayment of earlier mortgage debt. The terms and conditions of loans vary somewhat from state to state; they also vary with the location of the house, the borrower’s income group and the purpose of loan within the state. The maximum amount of loan varies between 65 to 80 percent of the value of land and buildings, or some specified maximum amount, whichever is lower. The amount of loan is also linked with the primary society’s shareholdings in the apex society. The maturity period varies from 15 to 30 years, but 20 to 25 years is more common. The rate of interest charged is linked with the bank rate, and/ or the respective societies’ own borrowing rate.

2.5 Housing Development Finance Corporation Ltd. (HDFC)The private sector Housing Development Finance Corporation Ltd. (HDFC) has been playing a key role in meeting housing finance requirements. The HDFC was set up in 1977 by the ICICI out of the consideration that a specialised institution was needed to channel household savings as well as funds from the capital market into the housing sector. HDFC’s loans are linked with planned saving. Given the sum needed for a house, a part of it is in the form of saving contribution, and the rest is given by the HDFC in the form of a loan.

2.6 National Housing BankThe National Housing Bank (NHB) was established on 9th July 1988 under an Act of the Parliament, viz. the National Housing Bank Act, 1987 to function as a principal agency to promote Housing Finance Institutions and to provide financial and other support to such institutions. NHB has been established to achieve, , the following objectives:

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Fig.2.7 Objectives of National Housing

NHB, as the Apex level financial institution for the housing sector in the country, performs the following roles:

Promotion and Development:NHB operates as a multifunctional Development Finance Institution (DFI) for the housing sector. The Bank’s policies are directed towards promotion and development of housing finance institutions. NHB has framed guidelines for HFCs with a view to promoting their development on sound and healthy lines. The guidelines are reviewed and modified from time to time in the light of developments in the financial and housing sectors.

All HFCs registered with the National Housing Bank u/s 29A of the National Housing Bank Act, 1987 and inter alia having minimum net owned funds of Rs.10.0 crores are eligible for refinance support. It has also contributed to the equity capital of five HFCs. NHB has a dedicated Training Division which organises regular training programmes in areas relating to housing and housing finance for the development of management capabilities of officials working in the sector. NHB’s promotional endeavours are also directed towards capacity building for the housing finance system besides enlarging the credit absorption capacity.

To promote a sound, healthy, viable and cost effective housing finance system to cater to all segments of the population and to integrate the housing finance system with the overall financial system

To promote a network of dedicated housing finnace institutions to adequately serve various regions and different income groups

To augment resources for the sector and channelise them for housing

To make housing credit more affordable

To regulate the activities of housing finance companies based on regulatory and supervisory authority derived under the Act

To encourage augmentation of supply of buildable land and also building materails for housing and to upgrade the housing stock in the country

To encourage public agencies to emerge as facilitators and suppliers of serviced land, for housing

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Regulation and Supervision:NHB exercises regulatory and supervisory authority over the HFCs in the matter of acceptance of deposits by them pursuant to the powers vested in it under the Act. As per the amendments to certain provisions of the Act, which came into effect from June 12, 2000, NHB is vested with powers to grant Certificate of Registration to companies for commencing/carrying on the business of a housing finance institution.

Besides, NHB regulates the deposit acceptance activities in accordance with the Housing Finance Companies (NHB) Directions, 2001, amended from time to time, in the matter of ceiling on borrowings (including public deposits, rate of interest, period, liquid assets, etc). NHB has also issued Directions on prudential norms in regard to capital adequacy, asset classification, concentration of credit, income recognition, provisioning for bad and doubtful debts, etc. NHB supervises the working of HFCs through on-site inspection and off-site surveillance.

Financing:NHB raises resources for the housing sector towards increasing new housing stock and provides refinance to a large set of retail lending institutions. These include scheduled commercial banks, scheduled state cooperative banks, scheduled urban cooperative banks, specialised housing finance institutions, apex co-operative housing finance societies and agriculture and rural development banks.

Re-finance is provided by NHB under various schemes, which are formulated taking into account several aspects of the National Housing Policy, the constraints facing the sector, etc. NHB has also a window for direct lending to Public Agencies such as, State Level Housing Boards and Area Development Authorities for large scale integrated housing projects and slum redevelopment projects. NHB is also operating a special window for extending financial assistance to people affected by natural calamities viz. earthquake, cyclone, etc.

Institution Category 30-6-2004 30-6-2005 GrowthPercent

Housing Finance Companies (HFCs)

9164.87 11141.82 21.6

Scheduled Commercial Bank

2516.63 7920.72 214.7

Co-operative Sector 1543.76 1578.76 2.2Total 13225.26 20641.30 56.1

Table 2.6 Refinance disbursements of National Housing Bank

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Resources of NHB:NHB raises resources from diversified sources, both domestic and external by issuing bonds/ debentures, borrowing from RBI and financial institutions/organisations, etc. Under the Act, NHB is authorised to issue and sell bonds with or without the guarantee of the Central Government for the purpose of carrying on its functions.

Rural Housing:NHB launched the “Swarna Jayanti Rural Housing Finance Scheme” to mark the golden jubilee of India’s Independence. The Scheme seeks to provide improved access to housing loans to borrowers for construction/acquisition/ up gradation of a house in rural areas of the country.

Recent Initiatives:Securitisation of mortgage loans of the retail lending institutions facilitates which channelizing household savings into the housing sector is seen as a potentially viable market oriented alternative. Support to Mortgage backed securitisation is a major policy initiative of the Government as manifested in its National Housing and Habitat Policy announced in 1998.

In order to resolve the twin problems of affordability and accessibility affecting the growth of the housing finance business and the prospect of home ownership, NHB has been entrusted with the responsibility of launching a Mortgage Credit Guarantee Scheme for protecting lenders against default.NHB continued its support and assistance in promoting a healthy housing finance sector in the country. The extent of financial assistance to the sector continued to steadily grow and the refinance disbursement during the year 2004-05 was Rs. 8088.73 crores.

Type 2003-04 2004-051. Net Owned Fund 1656.78 1652.002. Disbursements 3297.38 8088.733. Total Assets 13107.51 18947.914. Profit before Tax 155.46 77.635. Profit After Tax 118,13 44,046. Capital Adequacy Ration (percent) 30.05 22.487. Return on Equity (percent) 26.25 9.79

Return on Average Working Funds 1.03 0.03-

Table 2.7 Financial performance of the National Housing BankNegative return is due to the Deferred Tax provision of Rs. 48.84 crore in

respect of earlier years.Source - NHB Annual Report 2004-05

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2.7 Economic Development and Housing FinanceHousing is a significant engine for the growth and development of the economy. The growth in housing and housing finance activities in recent years reflect the buoyant state of the housing finance market in the country. The proportion of outstanding housing loans as percentage of GDP increased from 3.4 percent in 2001 to 7.25 percent by 2005. Housing constitutes an important component and a measure of socio-economic status of people. With a growing number of players and increased competition, the housing sector is becoming increasingly market driven. However, there is a felt need for standardisation and uniformity in practices in order to improve transparency in the market and bring greater efficiency.

Type Outstanding as on 31st March2003 2004 Growth % 2005 Growth %

Paid up capital*

2761.77 2941.31 6.5 3148.68 7.05%

Free Reserves

5476.73 6255.67 14.22 7152.17 14.33%

Net owned Fund

7757.93 8565.27 10.41 9304.74 8.63%

Public deposits

12760.32 13534.71 6.07 12422.00 (8.22%)

Housing Loans

49237.97 59111.44 20.05 70533.88 19.32%

Table 2.8 Financial indicators of reporting HFCsSource: Annual returns submitted by HFCs to NHB

* Including preference shares which are compulsorily convertible into equity.NOF = the aggregate of paid up capital and free reserves reduced by accumu-lated losses, deferred revenue expenditure and other tangible assets.Minus amounts representing investments in shares of its subsidiaries, companies of the same group and other housing finance companies, book value of debentures, bonds, outstanding loans and advances made to and deposits with subsidiaries and with companies of the same group; to the extent such amount exceeds 10% of the aggregate of paid up capital and free reserves reduced by accumulated losses, deferred revenue expenditure and other tangible assets.

2.8 Growth Trends in Housing FinanceThe Indian housing finance industry has grown by leaps and bounds in the past few years. The total housing loan disbursements by banks and housing finance companies (HFCs) has risen from Rs.19,059 crore in 2000-01 to Rs.76,819 crore in 2004-05. Banks, even though late entrants in the housing loan market, have taken over HFCs.

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Primary Lending Institutions (PLIs)

2000-01 2001-02 2002-03 2003-04 2004-05

Commercial 1. Banks

5553 8566 23553 32816 60398

Housing Finance 2. 12638 14614 17832 20862 26000

Co-operative 3. Institutions

868 678 642 623 **421

Total4. 19059 23858 42027 54301 76819

Annual Growth 5. (%)

35.07 25.18 76.15 29.21 41.47

Table 2.9 Housing loan disbursements by various institutions*Source RBI, NHB (for 2004-05)

** Disb. by Apex Co-operative Housing Finance Societies only

The robust growth experienced by the industry in the last few years is triggered by several factors, some of which are listed below:

Higher level of disposable incomes among the earners.• Tax rebates announced in the recent budgets.• Lowering of real estate prices at affordable levels until last year.• Slashing of interest rates from as high as 16 per cent in 1996-97 to around 9 • per cent in 2005-06

Housing finance companies and banks are bringing out innovative schemes for selling their housing loan portfolio. Additionally, flexibility in terms and conditions such as repayment period, rate of interest, etc. induces people to plan for the purchase of houses. The latest innovative product on the anvil is “Reverse Mortgage”. The genesis of reverse mortgage can be traced to developed countries where, due to higher standards of living, better access to health care and higher life expectancy, people above 65 years constitute a major chunk of the population. The ever-rising cost of pensions and health care for the old led insurance companies to introduce the reverse mortgage in the US, the UK and Australia. In reverse mortgage, the capital value of a home is converted into an annuity over the homeowner’s lifetime. The annuity may be designed to rise, fall or stay steady over the lifetime. The period of such payments is not ‘a specified number of years’, but ‘the remaining lifetime of the owner (and his/her spouse) of the property’. Simply put, reverse mortgage is a life annuity. Thus by investing in a house through a housing loan and repaying the loan during his working lifetime, one will not only have a roof over his head throughout his lifetime, but also secure a joint life pension, that keeps in step with inflation, after

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retirement. Seen in this perspective, reverse mortgage would motivate people to build or buy their homes and, thereby, save for their retirement voluntarily. Hence reverse mortgage results in a double whammy: it spurs economic activity and provides economic security. Dewan Housing Finance Corporation Limited, India’s second-largest private housing finance company, has launched a reverse mortgage scheme called ‘Saksham’ that is targeted at retired senior citizens above 60 years of age.

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Summary

Non Banking Financial Companies (NBFCs) constitute an important segment • of the financial system. They play an important role in channelising the scarce financial resources to capital formation. Of the four main categories of NBFCs, lease finance and hire purchase finance companies are an important source of finance for the industries and services sectors.The Reserve Bank of India partially controlled the activities of NBFCs prior • to 1997. Many companies failed during this period and depositors lost their valuable money. The RBI now regulates and supervises the activities of NBFCs with a view to ensure their growth on sound lines.Housing finance in India was in a nascent stage until the liberalisation of the • economy and introduction of reforms. The growth in housing and ho using finance activities in recent years reflects the buoyant state of housing finance market in the country. Housing loans now have become affordable to the common man. The setting up of the National Housing Bank encouraged banks and housing • finance companies to lend more for housing as the refinance window was made available to them. The commercial banks, particularly private sector banks added momentum to this growth by marketing housing loans aggressively. The multiplier effect of investment in housing has grown over the past years and housing has become a significant engine for the growth and development of the economy.The commercial banks in India have evolved in three phases since • Independence.The first and second phase successfully achieved larger geographical • penetration of banking throughout the country, instilled investor confidence and assisted in meeting major developmental objectives against the background of reasonable stability. The third phase now underway will make India’s banking system stronger • and better equipped to compete effectively in a fast changing international economic environment.

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References

Mindmap, 2010, • Overview of the Banking System of India, [Video Online] Available at: <http://www.youtube.com/watch?v=PcysuzxkqJo> [Accessed 20 July 2011]

Ndtvprofit,2008,• Bank status likely for NBFCs, [Video Online] Available at: <http://www.youtube.com/watch?v=AdMNjVQlkXA> [Accessed 20 July 2011]

Reserve Bank of India [Online] Available at: <http://www.rbi.org.in/• commonman/English/scripts/nbfcs.aspx> [Accessed 20 July 2011]

Amendments to NBFC Regulations, [Online] Available at: <http://rbidocs.rbi.• org.in/rdocs/notification/PDFs/14935.pdf> [Accessed 20 July 2011]

Akhan, J., 2010. • Non-banking Financial Companies (Nbfcs) in India:Functioning and Reforms, New Century Publications.

Bhattacharya, H., 1999. • BankingStrategy,CreditAppraisal andLendingDecisions:ARisk-ReturnFramework, Oxford University Press, USA.

Recommended Reading

Roland, C., 2010. • Banking Sector Liberalization in India: Evaluationof Reforms andComparative Perspectives onChina (Contributions toEconomics), Physica-Verlag HD.

Subburaj, V. K., 2004. • RBI, Reserve Bank of India, Sura College of Competition.

2006• , Reserve Bank of India, Foundation Books.

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Self Assessment

Non Banking Financial Companies are defined vide1. Chapter IVC of the Reserve Bank of India Act, 1934a. Chapter IIIB of the Reserve Bank of India Act, 1934b. Chapter IVE of the Reserve Bank of India Act, 1934c. Chapter VE of the Reserve Bank of India Act, 1934d.

Non Banking Financial Company is2. A financial institutiona. A banking institutionb. A depository institutionc. A non financial institutiond.

Nidhi Companies are regulated by which of the following?3. Ministry of Finance, Government of Indiaa. Reserve Bank of Indiab. State Bank of Indiac. Ministry of Company Affairs, Government of Indiad.

The supervisory and regulatory authority for housing finance companies is4. Reserve Bank of Indiaa. State Bank of Indiab. National Housing Bankc. Housing and Urban Development Corporation (HUDCO)d.

Swarna Jayanti Rural Housing Finance Scheme was launched by which of 5. the following?

Housing and Urban Development Corporation (HUDCO)a. Housing Development Finance Corporation (HDFC)b. National Housing Bankc. Reserve Bank of India d.

Housing Development Finance Corporation Ltd. was set up in 1977 as 6. _________

Public sector companya. Private sector companyb. Central government undertakingc. Financial Institution d.

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The total number of nationalised banks in the country are ____________7. 25a. 20b. 26c. 27d.

The cooperative banks are under the regulatory control 8. of_______________

Reserve Bank of Indiaa. State Registrar of Cooperative Societiesb. Government of Indiac. State Bank of India d.

The Narasimhan Committee recommendations relate to _______________9. Banking Sector Reformsa. Financial System Reformsb. Restructuring of Banksc. Merger of Banks in Indiad.

____________________ has been playing a key role in meeting housing 10. finance requirements

HDFCa. ICICIb. IDBIc. RBId.

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Chapter III

Mutual Funds

Aim

The aim of this unit is to:

explain and discuss the concept of mutual funds •

identify the types of mutual funds•

understand in detail the growth of mutual funds in India•

Objectives

The objectives of this unit are to:

discuss in detail the classification of mutual funds •

demonstrate the various schemes offered by mutual funds for the purpose of •

investment by individuals

introduce the composition of a mutual fund and performance of mutual funds •

in India

Learning outcome

At the end of this unit, you will be able to:

enlist the concept of a mutual fund•

differentiate between different types of mutual funds•

enumerate the importance of mutual fund investments•

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3.1 Definition of Mutual FundAccording to Investment Company Institute (lCI) a world MF tracker total assets under management of mutual funds across the world stood at $21.8 trillion at the end of 2006. The India mutual funds industry had funds under management were to the tune of $88 billion giving India the ranking of 24 in the world order. US of course is the leader with AUM of 10,414 billions followed by Luxemburg with $ 2.188 billions, France with $ 1,769 billions. In comparison India lags far behind, though the industry is growing at a healthy pace here as well. It is believed that once the Pension reforms in India are put on track the MF industry is likely to see more growth. The growth in US essentially comes from the Pension fund contribution.

Depending upon the risk profile, one should look at investing some part of the savings or earnings in the stock market. But direct investing puts a person at great risk. So, the next best alternative is going for ‘mutual fund’. One can define a mutual .fund as a trust that pools in the savings and funds from a large number of investors who have a common financial goal.

Mutual funds issue units to investors, which represent equitable rights in the assets of the mutual fund. Mutual fund by its nature is diversified i.e. it assets securities. Investments in the mutual funds may market securities or combination of these be in the are invested inform of stocks, many different bonds or money These are professionally managed on the behalf of the shareholders and each investor holds a ‘ pro-rata share of the portfolio entitled to any profits when the securities are sold, but subject to any losses as well. There is character and number objective of schemes of Mutual fund and all of them have different skill of the investor to keep in view the objective and then take decision where to invest. For e.g. in the wake of boom in the software sector, the Indian Mutual fund launched various sector specific schemes that entailed only to software stocks for that period.

Mutual funds are investment companies that pool money from investors and offer to sell and buy back its shares on a continuous basis and use the capital thus raised to invest in securities of different companies. A fund is “mutual” as all of its returns, minus its expenses, are shared by the fund’s investors.

The Securities and Exchange Board of India (SEBI) Regulations, 1996 define a mutual fund as a “fund established in the form of a trust to raise money through the sale of units to the public or a section of public under one or more schemes for investing in securities, including money market instruments”.

In the case of mutual funds, savings of small investors are pooled under a scheme and the returns are distributed in the same proportion in which the investments are made by the investors/ unit- holders. A mutual fund is a collective savings scheme. Mutual funds play an important role in mobilising the savings of small investors and channelizing the same for productive ventures in the Indian economy.

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The mutual funds are the natural answer to many of these problems. It is thought to be much better for the investors to invest in capital markets, through the mutual funds. Professional portfolio managers, who can spread the risks inherent in these investments, manage the mutual funds. The small investors thus get to invest their money in many companies as, members of the funds, something they are unable to do, due to their limited resources.

Mutual funds are defined by SEBI regulations as funds’ established in the form of a trust to raise money through the sale of units that is; the interest of the unit holders in a scheme, which consists of each unit representing one undivided share in the assets of a scheme-to public under one/more scheme’ for investing in securities including money market instruments consisting of commercial papers, commercial bills, etc. According to the procedure laid down by SEBI, mutual funds have to be registered with SEBI.

The application for registration together with a non-refundable fee should be made in the prescribed form. A mutual fund can be constituted in the form of a trust and the instrument of trust should be in the form of a deed, duly registered under the Indian Registration Act, executed by the sponsor in favour of the trustees named in the instrument. The Trustees mean the Board of trustees or the Trustee Company who hold the property of mutual fund in trust for the benefit of the unit holder.

Concept

Fig. 3.1 Mutual fund operation flow chart

Returns

GeneratorsFund

Manager

Investors

Securities

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3.1.1 Advantages of Mutual FundsFor investments in mutual fund, one must keep in mind about the advantages of investments in mutual fund.

Professional Management The basic advantage of funds is that mutual funds are always professionally managed by well qualified professional. Investors purchase funds because they do not have the time or the expertise to manage their own portfolio. A mutual fund is considered to be relatively less expensive way to make and monitor their investments.

DiversificationPurchasing units in a mutual fund instead of buying individual stocks or bonds, the investors risk is spread out and minimized up to certain extent. The idea behind diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains in others.

Economies of Scale - Mutual fund buy and sell large amounts of securities at a time, thus help to reducing transaction costs, and help to bring down the average cost of the unit for their investors.

Liquidity - Just like an individual stock, mutual fund also allows investors to liquidate their holdings as and when they want.

Simplicity -Investments in mutual fund is considered to be easy, compare to other available instruments in the market, and the minimum investment is small. Most AMC also have automatic purchase plans whereby as little as Rs. 2000, where SIP start with just Rs.50 per month basis.

3.1.2 Disadvantages of Investing in Mutual FundsFor investments in mutual fund, one must keep in mind about the disadvantages of investments in mutual fund.

Professional ManagementSome funds doesn’t perform in neither the market, as their management is not dynamic enough to explore the available opportunity in the market, thus many investors debate over whether or not the so-called professionals are any better than mutual fund or investor him self, for picking up stocks.

CostsThe biggest source of AMC income is generally from the entry and exit load which they charge from investors, at the time of purchase. The mutual fund industries are thus charging extra cost under layers of jargon.

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Dilution - Because funds have small holdings across different companies, high returns from a few investments often don’t make much difference on the overall return. Dilution is also the result of a successful fund getting too big. When money pours into funds that have had strong success, the manager often has trouble finding a good investment for all the new money.

Taxeswhen making decisions about your money, fund managers don’t consider your personal tax situation. For example, when a fund manager sells a security, a capital-gain tax is triggered, which affects how profitable the individual is from the sale. It might have been more advantageous for the individual to defer the capital gains liability.

3.1.3 Types of Mutual FundsThe objectives of mutual funds are to provide continuous liquidity and higher yields with high degree of safety to investors. Based on these objectives, different types of mutual fund schemes have evolved.

Functional Portfolio Geographical OtherOpen Ended Scheme

Income Funds Domestic Sectoral specific

Close-Ended Scheme

Growth Funds Off-shore Tax Saving

Interval Scheme Balanced Funds ELSSMoney MarketMutual Funds

Special

Gilt FundsLoad FundsIndex FundsETFsP/E Ratio Funds

Table 3.1 Types of Mutual Funds Schemes

Functional Mutual Funds.This is one of the types of Mutual fund which can be explained as under

Open-ended Schemes: In case of open-ended schemes, a mutual fund continuously offers to sell and

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repurchase its units at Net Asset Value (NAV) or NAV- related prices. Unlike close-ended schemes, open-ended ones do not have to be listed on the stock exchange and can also offer • repurchase soon after allotment. Investors can enter and exit the scheme any time during the life of the fund .Liquidity is the key feature of open-ended schemes.

Net Asset ValueThe net asset value of the fund is the cumulative market value of the .assets fund net of its liabilities: In other words, if the fund is dissolved or liquidated, by selling off all the assets in the fund, this is the amount that the shareholders would collectively own. This gives rise to the concept of net asset value per unit, which is the value, represented by the ownership of one unit in the fund. It is calculated simply by dividing the net asset value of the fund by the number of units. However, most people refer to the ‘NAV per unit ‘as’ NAV’, ignoring the “per unit”.

The net asset value of a fund is the market value of the assets minus the liabilities on the day of valuation. In other words, it is the amount which the shareholders will collectively get if the fund is dissolved or liquidated.

Thus

NAV = Market Price of Securities + Other Assets – Total Liabilities

Number of Units outstanding as at NAV Date

Close-ended SchemesClose-ended schemes have a fixed corpus and a stipulated maturity period ranging between two to fifteen years. Investors can invest in the scheme when it is launched. The scheme remains open for a period not exceeding forty-five days Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed. In order to provide an exit route to the investors, some lose-ended funds give an option of selling back the units to the Mutual Fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor.

Open-ended vs. Close-ended SchemesAn open-ended scheme is a scheme, in which an investor can buy and sell units on daily basis; the scheme has a perpetual existence and a flexible, ever changing corpus. The investors are free to buy and sell any number of units, any point of time, at prices that are linked to the NA V of the units. In these schemes the investor can invest or disinvest any amount, any time after the initial lock in period. These schemes are extremely liquid and the funds announce sale and repurchase prices from time to time.These are not listed in stock exchanges and can be only bought and sold to the mutual fund. A close-ended scheme is one in which, the subscription period

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for the mutual fund remains only for the specific period, called the redemption period. At the end of this period, the entire corpus is disinvested and the proceeds distributed to the various unit holders. Thus, after final distribution, the scheme ceases to exist. However, such schemes can be rolled over with the approval of the unit holders. They can be listed on the stock exchanges.

Interval SchemesThe Interval scheme combines the features of the open-ended and close-ended schemes. They are open for sale or redemption during predetermined intervals at NAV- related prices.

Portfolio Mutual FundsMutual funds are also classified based on their individual portfolios. A brief description of each of these is discussed below.

Income FundsThe aim of income funds is to provide safety of investments and regular income to investors. Such schemes invest predominantly in income bearing instruments like bonds, debentures, government securities and commercial paper. The return as well as the risk is lower in income funds as compared to growth funds. Income funds are ideal for capital stability and regular income.

Growth FundsThe main objective of growth funds is capital appreciation over a medium-to-long-term.

They invest most of the corpus in equity shares with significant growth potential and offer a higher return to investors in the long-term. They assume the risks associated with equity investments. There is no guarantee or assurance of returns. These schemes are usually close-ended and listed on stock exchanges.

Balanced FundsThe aim of balanced funds is to provide both capital appreciation and regular income.

They divide the investment between equity shares and fixed income-bearing instruments in a proportion indicated by their offer documents. They generally invest 40-60 per cent in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. The portfolio of such funds usually comprises of companies with good profit and dividend track records. Their exposure to risk is moderate and they offer a reasonable rate of return.

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Money Market Mutual FundsThese funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. They specialise in investing in short-term money market instruments like treasury bills, certificates of deposits. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.

Geographical Mutual FundsThere are several Mutual funds classified based on their geographical executions. A few of these are discussed below

Domestic FundsFunds which mobilise resources from a particular geographical locality like a country or region are regarded as domestic funds.

Offshore FundsOffshore funds attract foreign capital for investment in the country of the issuing company. They facilitate cross-border fund flow which leads to an increase in foreign currency and foreign exchange reserves. Such mutual funds can invest in securities of foreign companies.

Other Mutual FundsThere are several other classifications of Mutual funds beyond Functional, Portfolio and Geographical classification of Mutual funds. These are given below.

Sector Specific Funds These funds invest in specific core sectors like, energy, telecommunications, IT, construction, transportation and financial services. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.

Tax Saving SchemesTax-savings schemes are designed on the basis of tax policy with special tax incentives to investors. These are close-ended schemes and investments are made for ten years, although investors can avail of encashment facilities after three years. These schemes are growth oriented and predominantly invest in equities. Their growth opportunities and risks associated are like any equity-oriented scheme. Pension schemes launched by the mutual funds also offer tax benefits.

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Equity-Linked Savings Schemes (ELSS)In order to encourage investors to invest in the equity market, the government has given tax concessions through special schemes. Investment in these schemes entitles the investor to claim an income tax rebate, but these schemes carry a lock in period before the end of which funds cannot be withdrawn.

Special SchemesMutual funds have launched special schemes to cater to the special needs of investors. UTI has launched special schemes such as Children’s Gift Growth Fund, 1986, Housing Unit Scheme, 1992 and Venture Capital Funds

Gilt FundsMutual funds which deal exclusively in gilts are called gilt funds. With a view to creating a wider investor base for government securities, the Reserve Bank of India encouraged setting up of gilt funds. These funds are provided liquidity support by the Reserve Bank.

Load FundsSome asset management companies (AMC) levy service charges for allowing subscribers entry into or exit from mutual fund schemes. With the vibrancy of capital markets in India and the returns available in these markets, it was natural that more and more people wanted to enter these markets However during the bad times in stock markets the small investors did suffer heavy losses, mainly because of their lack of knowledge about the working of these markets. These investors also are unable to spread the risks across securities and are carried away by market gossip, rather than the knowledge that is essential to make investments in these markets.

Mutual funds incur certain expenses such as brokerage, marketing expenses, and communication expenses. These expenses are known as ‘load’ and are recovered by the fund when it sells the units to investors or repurchases the units from withholders. In other words, load is a sales charge, or commission, assessed by certain mutual funds to recover their selling costs.

Index FundsAn index fund is a mutual fund which invests in securities in the index on which it is based-BSE Sensex or S & P CNX Nifty. It invests only in those shares which comprise the market index and in exactly the same proportion as the companies/weight age in the index so that the value of such index funds varies with the market index. There are also exchange traded index funds launched by the mutual funds which are traded on the stock exchanges.

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P/E Ratio FundsP/E (Price/Earnings) Ratio is the ratio of the price of the stock of a company to its earnings per share (EPS).The P/E Ratio of the index is the weighted average price-earnings ratio of all its constituent stocks. The P/E Ratio fund invests in equities and debt instruments wherein the proportion of the investment is determined by the ongoing price earnings multiple of the market.

Exchange Traded FundsExchange Traded Funds (ETFs) are a hybrid of open-ended mutual funds and listed individual stocks. They are listed on stock exchanges and trade like individual stocks on the stock exchange. ETFs do not sell their shares directly to investors for cash. The shares are offered to investors over the stock exchanges.

Net Asset ValueThe net asset value of a fund is the market value of the assets minus the liabilities on the day of valuation. In other words, it is the amount which the shareholders will collectively get if the fund is dissolved or liquidated.

Thus: NAV = Market Price of Securities + Other Assets – Total Liabilities Number of Units outstanding as at NAV Date

Assured Return SchemeAssured return schemes are those schemes that assure a specific return to the unit holders irrespective of performance of the scheme. A scheme cannot promise returns unless such returns are fully guaranteed by the sponsor or an AMC (Asset Management Company) and this is required to be disclosed in the offer document. Investors should carefully read the offer document whether return is assured for the entire period of the scheme or only.

3.2 Organisation of a Mutual FundThe organisation of a Mutual Fund is as follows:

SponsorSponsor means any person who while acting alone or with some other corporate establishes a mutual fund. The sponsor of a fund is similar to the promoter of a company as he gets the fund registered with SEBI.

Mutual Fund TrustA mutual fund in India is constituted in the form of a Public Trust created under the Indian Trusts Act; 1882.The sponsor forms the trust and registers it with SEBI. The fund sponsor acts as the settler of the Trust, contributing to its initial capital and appoints a trustee to hold the assets of the Trust for the benefit of the unit holders, who are the beneficiaries of the Trust.

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Asset Management CompanySome asset management companies (AMC) levy service charges for allowing subscribers entry into or exit from mutual fund schemes. The service charge is termed as entry/exit load and such schemes are called “load “schemes

The AMC is formed by a-group of trustees, directors which has been formed; AMC has to have net worth not less than 10 crores. Every Mutual Fund on behalf of the unit holders Company (AMC) or assigns its fund to a AMC for sets up an managing its funds by the board of Asset Management The AMC invests on behalf of the respective schemes. Regular expenses like, Custodial fees Cost of dividend warrants, registrar fees, AMC Fee are borne by the individual schemes. However, these regular expenses cannot exceed 3% of the assets of a scheme in a year.

The Trustees appoint the Asset Management Company (AMC) with the prior approval of the SEBI .An AMC is a company formed and registered under the Companies Act, 1956, to manage the affairs of the mutual fund and operate the schemes of such mutual funds.

It charges a fee for the services it renders to the mutual fund trust. It acts as the investment manager to the Trust under the supervision and direction of the trustees. The AMC, in the name of the Trust, floats and then manages the different investment schemes as per SEBI regulations and the Trust Deed. The AMC should be registered with the SEBI.

3.3 Association of Mutual Funds in India (AMFI)The Association of Mutual Funds in India (AMFI) was established in 1993 when all the mutual funds, except the UTI, came together realising the need for a common forum for addressing the issues that affect the mutual fund industry as a whole. The AMFI is dedicated to developing the Indian Mutual Fund Industry on professional and ethical lines and to enhance and maintain standards in all areas with a view to protect and promote the interests of mutual funds and their unit-holders. The objectives of AMFI are as follows:

To define and maintain high professional and ethical standards in all areas of • operation of the mutual fund industry.To recommend and promote best business practices and code of conduct to • be followed by members and others engaged in the activities of mutual fund and asset management, including agencies connected or involved in the field of capital markets and financial services.To interact with the Securities and Exchange Board of India (SEBI) and to • represent to SEBI all matters concerning the mutual fund industry.To represent to the Government, Reserve Bank of India and other bodies on • all matters relating to the Mutual Fund Industry.

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To develop a cadre of well trained Agent distributors and to implement a • programme of training and certification for all intermediaries and other engaged in the industry.To undertake nation wide investor awareness programme so as to promote • proper understanding of the concept and working of mutual funds.To disseminate information on Mutual Fund Industry and to undertake studies • and research directly and/or in association with other bodies.

3.4 Control and SupervisionThe Securities and Exchange Board of India (SEBI) supervises and controls the functioning of both, the mutual fund itself and the Asset Management Company (AMC) of the mutual fund. The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996.The industry now functions under the SEBI (Mutual Fund) Regulations, 1996.SEBI Regulations (2001) provide for exercise of due diligence by AMCs in their investment decisions. They also provide for maintenance of records, publication of annual accounts, etc. The contents and disclosures of offer documents are prescribed by SEBI. The directions are issued and revised by SEBI from time to time keeping in view the interests of common investors.

3.5 Unit Trust of India (UTI)Unit Trust of India (UTI) is India’s first mutual fund organisation which came into existence with the enactment of the UTI Act in 1964.The regulations passed by the Ministry of Finance (MOF) and the Parliament from time to time regulated the functioning of UTI. Different provisions of the UTI Act laid down the structure of management, scope of business, powers and functions of the Trust as well as accounting disclosures, and regulatory requirements for the Trust.UTI was set up as a trust without ownership capital and with an independent Board of Trustees.

The Board of Trustees manages the affairs and business of UTI.UTI was the first mutual fund to launch ‘India Fund’, an offshore mutual fund in 1986.In February 2003, following the repeal of the Unit Trust of India Act, 1963, UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India, representing broadly, the assets of the US 64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit Trust of India, functions under an administrator and under the rules framed by the Government of India and does not come under the supervision of the Mutual Fund Regulations.

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The second is the UTI Mutual Fund Ltd., sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations. It was created resulting from the bifurcation of the erstwhile UTI and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations.UTI has set up the following associate companies in the fields of banking, securities trading, investor servicing, investment advice and training, towards creating a diversified financial conglomerate and meeting investors’ varying needs under a common umbrella.

UTI Bank Ltd.• UTI Securities Exchange Ltd.• UTI Investor Services Ltd• UTI Institute of Capital Markets.• UTI Investment Advisory Services Ltd.•

UTI has helped in promoting/ co-promoting the following institutions for the healthy development of the financial sector:

Infrastructure Leasing and Financial Services (ILFS).• Credit Rating and Information Services Ltd. (CRISIL).• Stock Holding Corporation of India Ltd. (SHCIL).• Technology Development Corporation of India Ltd. (TDCIL).• Over the Counter Exchange of India Ltd. (OCEI).• National Securities Depository Ltd. (NSDL).• North-Eastern Development Finance Corporation Ltd. (NEDFCL)•

Until 1987 UTI was the only mutual fund sector banks’ subsidiaries were allowed to start the run insurance companies. The early entrants in Canara Bank, Bank of India and Life Insurance Corporation. Post 1992, mutual funds sponsored in India. This was the year when public mutual funds, followed by the state this field were led by State bank, Corporation and General Insurance by other public and private sector

The US 64 Scheme The US 64 is the largest mutual fund scheme of the Unit Trust of India (UTI) having about 20 million investors. In its peak days, it had a corpus exceeding Rs300 Billion while now its corpus is, about Rs200bn. The US 64 invests in GOI Securities, shares and debentures of corporate, provides term loans to corporate and also participates in the call money market. About 65% of its investments (at investment price or “book value”) are in shares while the rest are in various income/interest-bearing instruments.US 64 earns dividends on its share investments and interest income on bonds/debentures/loans. It also earns profits/incurs losses on sale and purchase of shares and debentures. The net earnings through dividends,

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interest and profits on sale less losses on sale is the “distributable income” of the scheme i.e. it is this component which the US 64 can distribute to its unit holders. Any undistributed part out of this distributable income is reinvested/ redeployed in assets and ads to the holdings.”

UTI’s WeaknessesIt also has certain pronounced weaknesses:

Being the largest player in the mutual fund industry, UTI also has large • investments in individual companies. Its ability to turnaround its portfolio quickly is therefore somewhat limited.The fact that it combines within itself the roles of an AMC and the trustee results • in the absence of a degree of accountability, which an AMC normally owes to the trustee and the control which the latter enforces upon the former.There is a lack of transparency, particularly with regard and repurchase price • are not linked to the NAV and the unit holder to US-64 where the sale NAV is not disclosed to the unit holder.The fact that UTI is perceived as one that has a pseudo Government character • ‘is as much its weakness as it is .its strength, particularly in respect of US-64. While it enhances its ability to sell the units, it also gives a false sense of comfort which may not be true or even desirable.Moreover, in a highly competitive market, public perception of UTI as a • pseudo – Government institution may affect its ability to attract professional talent or to adequately motivate it.

3.6 Growth and Development of Mutual Funds in IndiaThe mutual fund industry in India started in 1963 with the formation of the Unit Trust of India, at the initiative of the Government of India and Reserve Bank of India. 1987 marked the entry of non-UTI, public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). At the end of 1993, the mutual fund industry had assets under management of Rs.47, 004 crores. With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed.

The Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993.The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1, 21,805 crores.

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The Unit Trust of India with Rs.44, 541 crores of assets under management was way ahead of other mutual funds. As at the end of September, 2004, there were 29 funds, which manage assets of Rs.1, 53,108 crores under 421 schemes. The industry has also witnessed several mergers and acquisitions recently, examples of which are acquisition of schemes of Alliance Mutual Fund by Birla Sun Life, Sun F&C Mutual Fund and PNB Mutual Fund by Principal Mutual Fund. Simultaneously, more international Mutual Fund players have entered India like Fidelity, Franklin Templeton Mutual fund etc. There were 29 funds as at the end of March 2006. This is a continuing phase of growth of the industry through consolidation and entry of new international and private sector players.

The graph below indicates the growth of assets over the years.

(Note: Erstwhile UTI was bifurcated into UTI Mutual Fund and the Specified Undertaking of the Unit Trust of India effective from February 2003. The Assets under management of the Specified Undertaking of the Unit Trust of India have therefore been excluded from the total assets of the industry as a whole from February 2003 onwards.)

Fig. 3.4 Growth of mutual funds in IndiaSource: AMFI

Assets under Management as on December 31, 2006

36000034000032000030000028000026000024000020000018000016000014000012000010000080000600004000020000

Mar

-65

Phas

e I

Mar

- 87

Phas

e II

Mar

- 93

Phas

e II

IJa

n - 0

3

Feb-

03

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

YEARS Phase IV Since Feb 03

Rs.

In c

rore

s

25 4564

47000

121805 139616

149554

231862

326388

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Sr.No.

Name of the Asset Management Company Assets Under

Manage-ment

A BANK SPONSORED(i) Joint Ventures - Predominantly Indian1 SBI Funds Management Pvt. Ltd. 15,086

Total A (i) 15,086(ii) Others1 BOB Asset Management Co. Ltd2 Canbank Investment Management Services Ltd. 1,9563. UTI Asset Management Co. Pvt. Ltd 38,100

TOTAL A (ii) 40,188TOTAL A (i + ii) 55,274

B INSTITUTIONS1 LIC Mutual Fund Asset Management Co. Ltd. 11,599

TOTAL B 11,599C PRIVATE SECTOR(i) INDIAN1 Benchmark Asset Management Co. Pvt. Ltd. 7,9382 DBS Cholamandalam Asset Management Ltd. 2,0823 Escorts Asset Management Ltd. 1394. J.M. Financial Asset Management Pvt. Ltd 3,7215. Kotak Mahindra Asset Management Co. Ltd 12,0626 Quantum Asset Management Co. Pvt. Ltd. 577. Reliance Capital Asset Management Co. Pvt. Ltd 36,9258 Sahara Asset Management Co. Pvt. Ltd. 1839 Tata Asset Management Ltd. 12,17710. Taurus Asset Management Co. Ltd 265

TOTAL C (i) 75,552(ii) JOINT VENTURES - PREDOMINANTLY INDIAN1 Birla Sun Life Asset Management Co. Ltd. 17,0542 DSP Merill Lynch Fund Managers Ltd. 13,5173. HDFC Asset Management Co. Ltd 29,6354. Prudential ICICI Asset Management Co. Ltd 33,3055 Sundaram BNP Paribas Asset Management Co. Ltd. 6,528

TOTAL C (ii) 100,339(iii) JOINT VENTURES - PREDOMINANTLY FOREIGN

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1 ABN AMRO Asset Management (India) Ltd. 5,128 (India) Ltd.

5,128

2. Deutsche Asset Management (India) Pvt. Ltd 6,4143. Fidelity Fund Management Pvt. Ltd 5,7524. Franking Templeton Asset Management (India) Pvt. Ltd. 23,4035 HSBC Asset Management (India) Pvt. Ltd. 10,4506. ING Investment Management Co 2,9457. Lotus India Asset Management Co. Pvt. Ltd. 6048. Morgan Stanley Investment Management Pvt. Ltd 2,9909 Principal PNB Asset Management Co. Pvt. Ltd. 10,52210. Standard Chartered Asset Management Co. Pvt. Ltd 12,625

TOTAL C (iii) 80,833TOTAL C (i+ii+iii) 256,724TOTAL (A +B+C) 323,597

Association of Mutual Funds in IndiaTable 3.2 Assets under management of mutual funds

Source: AMFI

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Summary

A Mutual Fund is a trust that pools the savings of a number of investors who • share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities.The income earned through these investments and the capital appreciation • realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. Mutual Funds provide the investor with a significant amount of tax benefits. • Mutual funds offer various schemes to suit every need of the common man to save for his future. SEBI regulates the functioning of mutual funds in India. The last decade has seen an exponential growth in mutual fund investments in IndiaUnit Trust of India (UTI) is India’s first mutual fund organisation which came • into existence with the enactment of the UTI Act in 1964.The regulations passed by the Ministry of Finance (MOF) and the Parliament from time to time regulated the functioning of UTI.The US 64 is the largest mutual fund scheme of the Unit Trust of India (UTI) • having about 20 million investors. In its peak days, it had a corpus exceeding Rs300 Billion while now its corpus is ,about Rs200bn

References

Market VisionVideo,• 2011,Introduction to Mutual Funds in India,[Video Online] Available at: <http://www.youtube.com/watch?v=mInPCUXo0lw> [Accessed 20 July 2010]

Market VisionVideo• , 2011, OpenandClosedEndedMutualFunds[Video Online] Available at: <http://www.youtube.com/watch?v=FedXFIf2oJY&feature=related> [Accessed 20 July 2010]

Sadhak, H., 2003, • MutualFunds inIndia(ResponseBooks), 2nd ed., Sage Publications Pvt. Ltd.

Parker, P. M., 2006. • The 2007-2012 Outlook for Mutual Funds in India, ICON Group International, Inc.

ICRA Online MutualFundsIndia.comMutual• , Funds Basics [Online] Available at: <http://www.mutualfundsindia.com/mfbasic.asp> [Accessed 20July 2011]

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Recommended Reading

Sekhar, G.V., 2011. • PerformanceAppraisalofMutualFundsinIndia:ACaseStudyofPublicVsPrivateSectorMutualFunds,VDM Verlag. Gupta, S• ., 2011.MutualFundIndustry-GrowthandFutureProspects:(ACase Study of Indian Mutual Fund Industry), LAP LAMBERT Academic PublishingDr.Mishra, D. C., and Metilda, M. J., 2010. • The Retail Investor and the MutualFundIndustryinIndia:ChallengesandProspects, LAP LAMBERT Academic Publishing.

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Self Assessment

_______________ have a fixed corpus and a stipulated maturity period ranging 1. between two to fifteen years.

Special Schemesa. .Close-ended Schemesb. .Open-ended Schemesc. .Index Fundsd. .

Open2. -ended mutual fund schemes are listed on ______________Stock exchanges in Indiaa. Securities and Exchange Control Board of Indiab. Reserve Bank of India c. State Bank of India d.

Gilt Funds are provided liquidity support by ___________.3. RBIa. . SEBIb. UTIc. LICd. .

An Asset Management Company needs to be registered with the ________.4. RBIa. UTIb. SEBIc. AMFId.

Open-ended mutual fund schemes are listed on5. __________Stock exchanges in Indiaa. . Securities and Exchange Control Board of Indiab. RBIc. UTId.

Gilt Funds exclusively invest in6. Equity shares of blue chip companiesa. . Equity shares of infrastructure companiesb. Debt instrumentsc. . Government securitiesd.

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Close ended schemes have7. A fixed corpus and a stipulated maturity perioda. A fixed corpus but no maturity periodb. . No fixed corpus but a stipulated maturity periodc. . No fixed corpus and no maturity periodd. .

A fund is __________ as all of its returns, minus its expenses, are shared by 8. the fund’s investors.

Profitablea. . Bankableb. . Mutualc. Manageabled.

The ______________is the largest mutual fund scheme of the Unit Trust of 9. India (UTI) having about 20 million investors.

US 64a. US 46b. US 56c. US 65d.

The 10. functioning of is ____________ regulated by the Ministry of Finance (MOF) and the Parliament from time to time

UTIa. US-64b. RBIc. SBId.

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Chapter IV

Insurance companies and Financial Regulators

Aim

The aim of this unit is to:

discuss opening of the insurance sector life insurance •

explain general insurance •

describe health insurance •

Objectives

The objectives of this unit are to:

discuss tariff advisory committee •

enlist a key distribution channels to an insurer•

explain the working of reserve bank of India •

Learning outcome

At the end of this unit, you will be able to:

explain Securities and Exchange Board of India (SEBI)•

discuss National Bank for Agriculture and Rural Development (NABARD)•

understand Insurance Regulatory and Development Authority (IRDA)•

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4.1 Opening up of the Insurance Sector Life Insurance

The insurance industry till the nineties had only two nationalised players: • LIC and GIC and its four subsidiaries. These two players had a monopolistic control over the market.These nationalised insurance companies did a commendable job in terms of • high business growth. However, they were not consumer oriented, unwilling to adopt modern practices and technology to upgrade technical skills, and inefficient in operations. The growth in volume was mainly driven by income tax considerations and • hence the major portion of rural India was untapped. Recognising the global trend of competitive, market driven, insurance industry • and the recommendations of the Malhotra Committee, the insurance industry was opened. There are at present 12 life insurance and 11 general insurance companies operating in India with more players expected to come in. IRDA is vested with the power to regulate and develop the insurance and reinsurance business. Most of the foreign insurers have preferred to form joint ventures with Indian • companies. Banks, financial institutions and NBFCs are permitted to enter the insurance sector. The Reserve Bank has issued guidelines regulating the degree of participation • of banks, financial institutions and NBFCs in the insurance business depending on balance sheet strength.

4.2 General InsuranceGeneral (Non Life) insurance provides short-term coverage, usually for a period of one year. General insurers transact fire insurance, motor insurance, and marine insurance and miscellaneous insurance business. Motor Vehicle insurance is compulsory in India. There are four nationalised and eleven private sector general insurance companies.

The four public sector companies are:The Oriental Insurance Company Limited• The New India Assurance Company Limited• The National Insurance Company Limited• The United India Insurance Company Limited•

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The private sector companies are:

Royal Sundaram Alliance Insurance Company Limited•

Reliance General Insurance Company Limited•

IFFCO Tokio General Insurance Company Limited•

Tata AIG General Insurance Company Limited•

Bajaj Alliance General Insurance Company Limited•

ICICI Lombard General Insurance Company Limited•

Cholamandalam MS General Insurance Company Limited•

Export Credit Guarantee Corporation Limited•

HDFC - Chubb General Insurance Company Limited•

Agriculture Insurance Co. of India Ltd.•

Star Health and Allied Insurance Company Limited•

Gross Direct premium income underwritten by non life insurers 2005-06 Sr. No

Insurer Fire Misc Marine Total Premium in India

Total Premium in-cluding busi-ness outside India

1 National 483.94 2866.3 173.43 3523.67 3536.342 New India 839.63 3652.08 299.78 4791.5 5675.543 Oriental 546.89 2655.11 325.11 3527.11 3609.774 United 645.48 2305.33 203.97 3154.78 3154.78

Sub Total 2515.94 11478.8 1002.29 14997.06 15976.44

5 ROYAL SUNDARAM 91.74 348.61 18.29 458.64 458.64

6 RELIANCE 47.76 103.83 10.74 162.33 162.33

7 IFFCO- TOKIO 263.29 583.3 46.13 892.72 892.72

8 TATA AIG 116.27 408.54 47.88 572.7 572.7

9 ICICI LOM-BARD 308.47 1188.68 85.71 1582.86 1582.86

10 BAJAJ ALLI-ANZ 351.4 866.56 54.33 1272.29 1272.29

11 CHOLAMAN-DALAM 72.83 130.35 17 220.18 220.18

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12 HDFC CHUBB 5.82 192.28 1.72 199.81 199.81

Sub Total 1257.59 3822.14 281.8 5361.53 5361.53Grand Total 3773.53 15301 1284.09 20358.59 21337.97

13 ECGC 577.3314 AIG 555.83

Table .4.1 Premium underwritten by non life insurance companies in 2005-06

4.3 Health InsuranceHealth Insurance, or Health Cover, is defined in the Registration of Indian Insurance Companies Regulations, 2000, as the effecting of contracts which provide sickness benefits or medical, surgical, or hospital expense benefits, whether in–patient or out-patient, on an indemnity, reimbursement, service, prepaid, hospital or other plans basis, including assured benefits and long term care. IRDA has encouraged both life and general insurance companies, old and new, to go in for rider policies offering health cover. Many new companies have gone in for riders offering a variety of health products. Riders are add-on benefits attached to the main life policy.

Tariff Advisory CommitteeThe Tariff Advisory Committee is a statutory body created under the Insurance Act, 1938. The TAC determines the tariff of the insurance industry except for marine cargo and various personal lines of business. The tariff mechanism provides floor rates for various products. It prevents uneconomic competition and facilitates classification of risks according to their special characteristics. The TAC has now been broad based with representatives from various faculties besides the insurance industry.

ReinsuranceIn insurance, the insured transfers his risk to the insurer. This primary insurer transfers a part or all of the risks he has insured to another insurer to reduce his own liability (the risk he has assumed). This is known as reinsurance. Reinsurance is primarily an insurance of risks assumed by the primary insurer known as the ceding company. This risk is shifted to another insurer. The ceding company may shift part or all of the insurance originally written to the reinsurer. The amount of the insurance retained by the ceding company for its own account is called the retention. Retention is the amount of risk that an insurer is prepared to take on his own account. The amount of insurance ceded to the reinsurer is known as the cession. The proportion of risk to be retained by the ceding company depends

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on factors such as company’s assets and investment income, portfolio of the risk premium levels, inflation, and reinsurance market conditions. Reinsurance operates on the same principles as direct insurance.

4.4 Insurance IntermediariesIntermediaries are a vital link between the insurer and the insured. They act as a bridge between the insurer and the insured and thereby help in increasing the breadth and depth of the insurance market. They are a key distribution channel to an insurer.

AgentsAgents are just like retailers of any consumer product who help in selling and distributing the product. After obtaining the license, agents have to enrol with the insurance company to be authorised to work as agents.

Surveyors and Loss AssessorsSurveyors and loss assessors are independent professionals appointed by an insurance company to assess the loss and damage when a claim is notified under a policy issued by them. An insurance surveyor must be duly licensed by IRDA.

BrokersIRDA has allowed brokers to enter the insurance industry. To ensure the quality of service provided to the end customer, IRDA has created four categories of brokers and specified the minimum capital requirement for each of the category.

Third Party Administrators (TPAs)Third party administrators (TPA) are distributors of insurance products in the health insurance sector. They facilitate the smooth operation of a health cover by acting as a link between the insurance companies, and their clients and hospitals. All new medi-claim policies will be serviced by TPAs. They will man 24-hour call centres and direct the insured to suitable hospital, with which they have a tie-up, in the event of an ailment.

BancassuranceBancassurance is insurance companies tying up with banks to sell insurance products. Bancassurance is an innovative distribution channel in India. Over 20 banks have tied up with public and private sector insurance companies to sell their products. Cooperative banks cover more than 65 per cent of rural population. These banks can serve as important vehicles for distributing insurance products in rural areas.

4.5 Reserve Bank of IndiaThe Reserve Bank of India monitors macro-prudential indicators and makes them publicly available through its reports to enhance the disclosure of key financial information to markets.

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The macro-economic indicators include trends in balance of payments position, • inflation volatility, interest and exchange rate changes, growth of credit, etc. Micro-prudential indicators include indicators on capital adequacy, asset • quality of lending and borrowing entities, management soundness, liquidity, sensitivity to market risk, etc. The macro approach to financial supervision has helped the Reserve Bank • to refine its regulatory as well as monetary policy stance so as to achieve the fine balance between growth and financial stability.The Board for Financial Supervision (BFS) was constituted on Nov. 16, 1994 • by the Central Board of Directors of the Reserve Bank as a committee of the Central Board to pay undivided attention to supervision. The Board exercises its supervisory role over the financial system encompassing • banks, both commercial and urban cooperative, financial institutions, NBFCs and primary dealers over which the Reserve Bank has direct supervisory jurisdiction. The Board has issued several important guidelines on credit cards, mergers, • disclosures, and outsourcing of services and purchase/sale of NPFA by banks. In addition to on-site inspections, the Reserve Bank had instituted a state-• of-the-art Off-site Monitoring and Surveillance (OSMOS) system for banks in 1995 as part of crisis management framework for Early Warning System (EWS) of vulnerable institutions. A separate Fraud Monitoring Cell (FrMC) was constituted on June 01, • 2004 under the overall administrative control of the Department of Banking Supervision to closely monitor the frauds in the financial sector. The Reserve Bank has been making constant efforts to upgrade and strengthen • the legal framework in tune with the changing environment. The Central Government, on the recommendation of the Reserve Bank, has • initiated a number of measures in this respect over the past few years. Some of the recent Acts enacted by the Parliament are: •

The Reserve Bank of India Act, 1934 was amended to empower the Reserve �Bank to determine the Cash Reserve Ratio (CRR) (without any ceiling or floor rate) to be maintained by banks. The Credit Information Companies (Regulation) Act, 2005 has been �enacted for the establishment, supervision and regulation of a credit information company. The Banking Regulation (Amendment) Bill, 2005 seeks to amend some �of the provisions of the Banking Regulation Act, 1939 with a view to strengthening the regulatory powers of the Reserve Bank. The Payment and Settlements Bill, 2006 seeks to designate the Reserve �Bank as the authority to regulate payment and settlement systems.

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The Government Securities Act, 2006 proposes to consolidate and amend �the law relating to issue and management of Government securities by the Reserve Bank. The Banking Companies (Acquisition and Transfer of Undertakings) and �Financial Institutions Laws (Amendment) Act, 2005, mainly seeks to amend the Banking Companies (Acquisition and Transfer of Undertakings) Act,1970 and The Banking Companies ( Acquisition and Transfer of Undertakings) Act, 1980 to provide for changes such as election, nomination, and appointment of directors on the boards of nationalised banks, issue of preference capital and appointment of an administrator and creation of Investor Education and Protection Fund.

4.5.1 Need for Financial RegulationA financial system’s efficiency is reflected in the efficiency of both, financial • markets and financial institutions. Several steps have been undertaken to improve the efficiency of financial • institutions such as liberalisation of interest rates, reduction in reserve requirements, increasing competition by allowing new private sector players and so on. With the reforms undertaken and globalisation, the mobility of international • capital is increased so also the risk of contagion of financial crisis among countries. Financial instability arises due to weak fundamentals and institutional failures, • resulting in panic and information asymmetry. Hence the need for close supervision and suitable regulators to monitor the functioning of financial institutions. The same is done by assessing financial soundness and stability by developing • macro-prudential indicators.These indicators are quantitative variables which comprise both micro-• prudential indicators of the health of individual financial institutions and macro-economic variables related with financial system soundness. Macro-prudential indicators can help a country to assess a banking system’s • vulnerability to crises.

4.6 Securities and Exchange Board of India (SEBI)The Reserve Bank of India (RBI) had issued a set of guidelines in 1987 for bank sponsored mutual funds. This was followed, in 1990, by stipulations for mutual funds from the Ministry of Finance, Government of India. In 1991, the Government of India initiated the process of creating a common regulation for all mutual funds and to permit the entry of private mutual funds.

The Dave Panel submitted its recommendations regarding the regulation of • mutual funds in 1991.

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In October 1991, the Securities and Exchange Board of India (SEBI) issued • guidelines for the formation of Asset Management Companies (AMCs) for mutual funds. A comprehensive set of guidelines was issued by the Ministry of Finance in • February 1992. In 1993, the SEBI issued comprehensive mutual funds regulations. These • were replaced by a more rigorous SEBI framework in 1996, which have been amended from time to time.The main elements of the SEBI regulatory mechanism of mutual funds are:•

Registration of mutual funds with the SEBI �Constitution and management of mutual funds, and operation of trusts �Constitution and management of asset Management Company and �custodianSchemes of mutual funds �Investment objectives and management policies �General obligations �Inspection and audit �Procedure for action in case of default. �

The SEBI on the advice of the AMFI, has prescribed a code of conduct for • the mutual fund intermediaries that are agents and distributors. The mutual fund should monitor their activities to ensure that they do not • indulge in any kind of malpractice or unethical practice while selling/ marketing mutual fund units. If any intermediary does not comply with the code of conduct, the mutual • fund should report it to the AMFI/ SEBI. No mutual fund should deal with intermediaries who do not follow the code • of conduct.

Functionality and responsibility SEBI has to be responsive to the needs of three groups, which constitute the market:

the issuers of securities• the investors• the market intermediaries•

SEBI has three functions rolled into one body:Quasi-legislative, quasi-judicial and quasi-executive. •

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It drafts regulations in its legislative capacity, it conducts investigation and • enforcement action in its executive function and it passes rulings and orders in its judicial capacity.Though this makes it very powerful, there is an appeals process to create • accountability.There is a Securities Appellate Tribunal which is a three-member tribunal and • is presently headed by a former Chief Justice of a High court - Mr. Justice NK Sodhi.A second appeal lies directly to the Supreme Court. • SEBI has enjoyed success as a regulator by pushing systemic reforms • aggressively and successively (e.g. the quick movement towards making the markets electronic and paperless rolling settlement on T+2 basis). SEBI has been active in setting up the regulations as required under law.• SEBI has also been instrumental in taking quick and effective steps in light • of the global meltdown and the Satyam fiasco. It had increased the extent and quantity of disclosures to be made by Indian • corporate promoters. More recently, in light of the global meltdown, it liberalised the takeover • code to facilitate investments by removing regulatory structures. In one such move, SEBI has increased the application limit for retail investors to Rs 2 lakhs, from Rs 1 lakh at present

4.7 National Bank for Agriculture and Rural Development (NABARD)As an apex bank involved in refinancing credit needs of major financial institutions in the country engaged in offering financial assistance to agriculture and rural development operations and programmes, NABARD has been sharing with the Reserve Bank of India certain supervisory functions in respect of cooperative banks and Regional Rural Banks (RRBs).

As part of these functions, it• Undertakes inspection of Regional Rural Banks (RRBs) and cooperative �banks (other than urban/primary cooperative banks) under the provisions of Banking Regulation Act, 1949. Undertakes inspection of State Cooperative Agriculture and Rural Development Banks (SCARDBs) and apex non-credit cooperative societies on a voluntary basis.Undertakes portfolio inspections, systems study, besides off-site �surveillance of cooperative banks and Regional Rural Banks (RRBs).

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Provides recommendations to Reserve Bank of India on opening of �new branches by State Cooperative Banks and Regional Rural Banks (RRBs).Administering the Credit Monitoring Arrangements in SCBs and CCBs. �

A Board of Supervision (for SCBs, DCCBs and RRBs) has been constituted • by NABARD under Section 13(3) of the NABARD Act, 1981 as an Internal Committee to the Board of Directors of NABARD. The Board of Supervision, since its formation on 20th November 1999, has • held 31 meetings till 10th January 2007 and reviewed the financial position of Cooperative Banks and RRBs. Based on the observations of the BoS, the authorities concerned have been • apprised of the weaknesses.Periodic on-site inspection of 31 SCBs, 366 DCCBs, 20 SCARDBs and 102 • RRBs and other apex level cooperative institutions is done by NABARD. As a part of the new strategy of supervision, a system of ‘Off-site Surveillance’ • has been introduced as a supplementary tool to the on-site inspection. Its objectives are to obtain and analyse critical data on a continuous basis, to • identify areas of supervisory concern and to identify early warning signals and risky areas requiring further probe. The system basically envisages desk scrutiny of operations of cooperative • banks and RRBs through a set of statutory and non-statutory returns. While the periodical statutory on-site inspections attempt an overall evaluation • of the performance of the banks with a stipulated period, off-site surveillance envisages continuous supervision supplementing the on-site inspections with additional instruments of supervision. In the wake of banking sector reforms, a new set of international norms/• practices were made applicable to Commercial Banks (CBs) to make them more competitive and sustainable in the changing scenario. The co-operative banks and RRBs were also to function in the general banking • environment, emerging out of the financial sector reforms, introduced by the GOI/RBI.Accordingly, the prudential norms were extended to them in phases.• While the capital adequacy norm has not yet been made applicable to these • banks, the other prudential norms, viz. income recognition, asset classification and provisioning, which were made applicable by RBI to the commercial banking sector, had been extended to cover RRBs in 1995-96, SCBs and DCCBs in 1996-97 and to SCARDBs in 1997-98.NABARD, through a concrete and time-bound supervision strategy, facilitates • these banks to adjust to the new financial discipline so as to internalise the prudential norms stipulated.

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Under the revised strategy, a sharper focus of NABARD’s inspection was made • on the core areas of the functioning of banks pertaining to Capital Adequacy, Asset Quality, Management Earnings, Liquidity and Systems Compliance (CAMELSC). Thus, NABARD’s focus in its statutory ‘on-site’ inspections is on core assessments leaving the collateral appraisals to supplementary inspections. The micro level aspects are to be taken care of by the banks themselves by • way of internal inspections or by other agencies such as auditors. In this direction, through a series of workshops and meetings held with the • Chief Executives and the Chief Auditors of cooperative banks, NABARD attempted to ensure that the other areas, particularly relating to the internal checks and controls, revenue and income realisation by way of interest on loans and deposits and other routine features of carrying out general banking transactions, were suitably taken care of by the respective banks and their concurrent/statutory audit systems.

PowersFor the discharge of its functions efficiently, SEBI has been invested with the necessary powers. SEBI is invested with the following powers:

to approve by−laws of stock exchanges• to require the stock exchange to amend their by−laws• inspect the books of accounts and call for periodical returns from recognised • stock exchangesinspect the books of accounts of a financial intermediaries• compel certain companies to list their shares in one or more stock • exchangeslevy fees and other charges on the intermediaries for performing its • functionsgrant licence to any person for the purpose of dealing in certain areas• delegate powers exercisable by it• prosecute and judge directly the violation of certain provisions of the • companies Act

4.8 Insurance Regulatory and Development Authority (IRDA).Following the recommendations of the Malhotra Committee, pending the enactment of a comprehensive legislation, on January 23, 1996, the Government of India to regulate the insurance sector, approved the setting up of the interim Insurance Regulatory Authority (IRA) that would replace the controller of Insurance (COI) and be under the overall control of the Ministry of Finance. It had been entrusted with the task of preparing a comprehensive legislation to establish a statutory, autonomous IRA on the pattern of the Securities and Exchange Board of India (SEBI).

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The powers and functions of IRDA, inter-alia, are stated below:Issue to the applicant a certificate of registration ; to renew, modify, withdraw, • suspend or cancel such registration; preference in registration to be given to companies providing with health insurance.Protection of the interests of policyholders in matters concerning assigning • of policy, nomination by policy-holders, insurable interest, settlement of insurance claim, surrender value of policy , and other terms and conditions of contract of insurance.Specifying requisite qualifications and practical training for insurance • intermediaries and agents.Specifying the code of conduct for surveyors and loss assessors.• Promoting efficiency in the conduct of insurance business.• Promoting and regulating professional organisations connected with the • insurance and reinsurance business; levying fees and other charges for carrying out the purposes of the IRDA Act.Calling for information from, undertaking inspection of, conducting enquiries • and investigations, including audit of insurers, insurance, intermediaries and other organisations connected with the insurance business.Control and regulations of the rates, terms and conditions that may be offered • by insurers in respect of the general insurance business not so controlled and regulated by the Tariff Advisory Committee under Section 64U of the Insurance Act, 1938.Specifying the form and manner in which books of account would be • maintained and statements of accounts rendered by insurers and insurance intermediaries.Regulating investment of funds by insurance companies; regulating • maintenance of margin of solvency.Adjudication of disputes between insurers and intermediaries or insurance • intermediaries.Supervising the functioning of the Tariff Advisory Committee.• Specifying the percentage of premium income of the insurer to finance schemes • for promoting and regulating professional organisations referred to above.Specifying the percentage of life insurance and general insurance business to • be undertaken by the insurer in the rural or social sector.Exercising such other powers as may be prescribed.•

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The powers and functions mentioned above would enable the IRDA to perform the role of an effective watchdog and regulator for the insurance sector in India.

4.8.1 Insurance Regulatory and Development Authority (IRDA) in India

The Insurance Regulatory and Development Authority (IRDA) is a national • agency run by the Government of India. IRDA is based in Hyderabad and was formed by an act of Indian Parliament • called as IRDA Act of 1999. Considering some of the emerging requirements of the Indian insurance • industry, IRDA was amended in 2002. As stated in the act mission of IRDA is “to protect the interests of the • policyholders, to regulate, promote and ensure orderly growth of the insurance industry and for matters connected therewith or incidental thereto.” Indian insurance industry is regulated by the terms and conditions of the • IRDA.Indian law has certain expectations from the IRDA to perform in the Indian • insurance industry. IRDA should protect the interest of policyholders by ensuring fair treatment • by the insurance companies. The growth of insurance companies in a speedy and orderly manner should • be taken care by the IRDA. It should monitor and implement quality competence and fair dealing of the • insurance companies in the industry. IRDA should make sure that the insurers are providing precise and • correct information about the products offered by them for the insurance customers. IRDA should also ensure speedy settlement of genuine claims of the • policyholders and prevent malpractices in the process of claims settlement. According to the Section 14 of IRDA Act of 1999 there are certain duties, • powers and functions laid down for the IRDA and they are as follows:

Subject to the provisions of this Act and any other law for the time being �in force, the Authority shall have the duty to regulate, promote and ensure orderly growth of the insurance business and re-insurance business.Without prejudice to the generality of the provisions contained in sub- �section (1), the powers and functions of the Authority shall include,

Issue to the applicant a certificate of registration, renew, modify, −withdraw, suspend or cancel such registration;protection of the interests of the policy holders in matters concern-−ing assigning of policy, nomination by policy holders, insurable interest, settlement of insurance claim, surrender value of policy and other terms and conditions of contracts of insurance;

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Specifying requisite qualifications, code of conduct and practical −training for intermediary or insurance intermediaries and agents;Specifying the code of conduct for surveyors and loss assessors;−Promoting efficiency in the conduct of insurance business;−Promoting and regulating professional organizations connected with −the insurance and re-insurance business;Levying fees and other charges for carrying out the purposes of this −Act; calling for information from, undertaking inspection of, conducting enquiries and investigations including audit of the insurers, interme-diaries, insurance intermediaries and other organizations connected with the insurance business;control and regulation of the rates, advantages, terms and conditions −that may be offered by insurers in respect of general insurance busi-ness not so controlled and regulated by the Tariff Advisory Commit-tee under section 64U of the Insurance Act, 1938 (4 of 1938);Specifying the form and manner in which books of account shall be −maintained and statement of accounts shall be rendered by insurers and other insurance intermediaries;Regulating investment of funds by insurance companies;−Regulating maintenance of margin of solvency;−Adjudication of disputes between insurers and intermediaries or −insurance intermediaries;Supervising the functioning of the Tariff Advisory Committee;−Specifying the percentage of premium income of the insurer to −finance schemes for promoting and regulating professional organi-zations referred to in clause (f);Specifying the percentage of life insurance business and general −insurance business to be undertaken by the insurer in the rural or social sector; andExercising such other powers as may be prescribed−

Insurance Regulatory and Development Authority (IRDA) in India consists a Chairman and some permanent and part time members in the administration. However, the regulations are enacted under the guidance of a statutory advisory committee. IRDA regulates private insurance companies in India such as;

Royal Sundaram Alliance Insurance Company Limited• Reliance General Insurance Company Limited.• IFFCO Tokio General Insurance Co. Ltd• TATA AIG General Insurance Company Ltd.• Bajaj Allianz General Insurance Company Limited• ICICI Lombard General Insurance Company Limited.•

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Apollo DKV Insurance Company Limited• Future General India Insurance Company Limited• Universal Sompo General Insurance Company Ltd.• Cholamandalam General Insurance Company Ltd.• Export Credit Guarantee Corporation Ltd.• HDFC-Chubb General Insurance Co. Ltd.• Bharti Axa General Insurance Company Ltd.• Raheja QBE General Insurance Co. Ltd.• Shriram General Insurance Co. Ltd.•

Financial SupervisionThe Reserve Bank of India performs this function under the guidance of the Board for Financial Supervision (BFS). The Board was constituted in November 1994 as a committee of the Central Board of Directors of the Reserve Bank of India.

ObjectivePrimary objective of BFS is to undertake consolidated supervision of the financial sector comprising commercial banks, financial institutions and non-banking finance companies.

ConstitutionThe Board is constituted by co-opting four Directors from the Central Board as members for a term of two years and is chaired by the Governor. The Deputy Governors of the Reserve Bank are ex-officio members. One Deputy Governor, usually, the Deputy Governor in charge of banking regulation and supervision, is nominated as the Vice-Chairman of the Board.

BFS meetingsThe Board is required to meet normally once every month. It considers inspection reports and other supervisory issues placed before it by the supervisory departments.

BFS through the Audit Sub-Committee also aims at upgrading the quality of the statutory audit and internal audit functions in banks and financial institutions. The audit sub-committee includes Deputy Governor as the chairman and two Directors of the Central Board as members.

The BFS oversees the functioning of Department of Banking Supervision (DBS), Department of Non-Banking Supervision (DNBS) and Financial Institutions Division (FID) and gives directions on the regulatory and supervisory issues.

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FunctionsSome of the initiatives taken by BFS include:

restructuring of the system of bank inspections• introduction of off-site surveillance,• strengthening of the role of statutory auditors and• strengthening of the internal defences of supervised institutions•

The Audit Sub-committee of BFS has reviewed the current system of concurrent audit, norms of empanelment and appointment of statutory auditors, the quality and coverage of statutory audit reports, and the important issue of greater transparency and disclosure in the published accounts of supervised institutions.

Current Focus

supervision of financial institutions•

consolidated accounting•

legal issues in bank frauds•

divergence in assessments of non-performing assets and•

supervisory rating model for banks.•

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SummaryThe insurance industry till the nineties had only two nationalised players: • LIC and GIC and its four subsidiaries. These two players had a monopolistic control over the market. These nationalised insurance companies did a commendable job in terms of high business growth. However, they were not consumer oriented, unwilling to adopt modern practices and technology to upgrade technical skills, and inefficient in operationsGeneral (Non Life) insurance provides short-term coverage, usually for a • period of one year. General insurers transact fire insurance, motor insurance, and marine insurance and miscellaneous insurance business.

The four public sector companies are: �The Oriental Insurance Company Limited �The New India Assurance Company Limited �The National Insurance Company Limited �The United India Insurance Company Limited �

Health Insurance, or Health Cover, is defined in the Registration of Indian • Insurance Companies Regulations, 2000, as the effecting of contracts which provide sickness benefits or medical, surgical, or hospital expense benefits, whether in–patient or out-patient, on an indemnity, reimbursement, service, prepaid, hospital or other plans basis, including assured benefits and long term care.Reinsurance is primarily an insurance of risks assumed by the primary insurer • known as the ceding company. This risk is shifted to another insurer.Intermediaries are a vital link between the insurer and the insured. They act • as a bridge between the insurer and the insured and thereby help in increasing the breadth and depth of the insurance market. They are a key distribution channel to an insurer.Agents are just like retailers of any consumer product who help in selling and • distributing the product.Surveyors and loss assessors are independent professionals appointed by an • insurance company to assess the loss and damage when a claim is notified under a policy issued by them. IRDA has allowed brokers to enter the insurance industry.• Third party administrators (TPA) are distributors of insurance products in • the health insurance sector. They facilitate the smooth operation of a health cover by acting as a link between the insurance companies, and their clients and hospitals.Bancassurance is insurance companies tying up with banks to sell insurance • products. Bancassurance is an innovative distribution channel in India.The Reserve Bank of India monitors macro-prudential indicators and makes • them publicly available through its reports to enhance the disclosure of key financial information to markets.

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References

Black, K., and Skipper, H, D., 1987. • Life insurance. Prentice Hall. pp. 10-29. Norton, B. C., .• Life insurance: its nature, origin and progress; a plainexpositionoftheprinciplesoflifeinsurance.Business and economics. Pp. 87. Investopedia, • Health Insurance [Online] Available at: <http://www.investopedia.com/terms/h/healthinsurance.asp> [Accessed 22 July 2011]Investorwords.com, • Health Insurance [Online] Available at: <http://www.investorwords.com/2289/health_insurance.html> [Accessed 22 July 2011]eHow,2008, • InsuranceInformation:HowtoSellInsurance [Video Online]Available at: <http://www.youtube.com/watch?v=mglc11qx1Gc&feature=fvsr> [Accessed 22 July 2011]Insurancewebsales,2007,• Selling Insurance on the Internet -by Gary Savelli [Video Online] Available at: <http://www.youtube.com/watch?v=b4OjNxkFRN0&feature=related> [Accessed 22 July 2011]

Recommended Readings

Belth, M. J., 1985. • Life insurance:aconsumer’shandbook.Business and Economic.Cummins, D. J., 1999. • Changes in the life insurance industry: efficiency,technology, and risk management. Business and Economic. Steuer, A., 2007. • QuestionsandAnswersonLifeInsurance:TheLifeInsuranceToolbook. Iuniverse Inc.

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Self Assessment

_____ is vested with the power to regulate and develop the insurance and 1. reinsurance business.

IRDAa. IBDAb. IRDDc. IRAAd.

Motor Vehicle insurance is compulsory in ________.2. USAa. UK b. India c. Australia d.

The TAC determines the ___________ of the insurance industry except for 3. marine cargo and various personal lines of business.

taska. collectb. tariffc. ratesd.

Which is the vital link between the insurer and the insured?4. Intermediariesa. memberb. partisanc. adherentd.

__________are just like retailers of any consumer product who help in selling 5. and distributing the product.

Mediatorsa. Agentsb. Instrumentsc. Managersd.

An insurance surveyor must be duly licensed by which of the following? 6. IRDAa. IBDAb. IRDDc. IRAAd.

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Third party administrators (TPA) are ___________ of insurance products in 7. the health insurance sector.

distributorsa. vendor b. broker c. supplierd.

Bancassurance is insurance companies tying up with banks to sell _________8. products.

sales a. insuranceb. shopping c. beauty d.

The micro level aspects are to be taken care of by the banks themselves by 9. way of internal inspections or by other agencies such as__________.

inspectorsa. examinersb. assessorsc. auditorsd.

The co-operative banks and RRBs were also to function in the general banking 10. environment, emerging out of the _____sector reforms, introduced by the GOI/RBI.

fashion a. financialb. furnishing c. foodd.

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Chapter V

Personnel Banking

Aim

The aim of this unit is to:

highlight the concept of personal banking •

explain electronic banking technique in detail •

discuss concept and features of various types of teller machine •

Objectives

The objectives of this unit are to:

discuss internet banking •

describe telephone banking •

explain the resident foreign currency accounts •

Learning outcome

At the end of this unit, you will be able to:

explain concept of foreign currency accounts •

discuss temporary foreign currency accounts •

understand banking facilities available foe NRI’s•

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5.1 Introduction to Personal Banking Many banks offer a wide range of services in the Personal Banking Segment. We will study each of them in short details. These banking products are designed with flexibility to suit the customers’ personal requirements like 24 hour facility through the ATM service.

Wide competition has made banking sector more service oriented towards customers. Many banks have employed customer friendly knowledgeable staff to cater to all financial requirements of the customer with speed and efficiency. This also implies that in modern times, more and more banks are trying to attract more and more customers towards them.

5.2 Electronic BankingFor many people, electronic banking means 24-hour access to their banking accounts through an automated teller machine (ATM) or Internet. But electronic banking now involves many different types of transactions. Electronic banking, also known as electronic fund transfer (EFT), uses computer and electronic technology as a substitute for checks and other paper transactions. EFT’s are initiated through devices like cards or codes that let you, or those you authorize, access the account.

Many financial institutions use ATM or debit cards and Personal Identification Numbers (PIN’s) for this purpose. Some use other forms of debit cards such as those that require, at the most, your signature or a scan.

Types and Features of Electronic BankingShared payment network arrangements allow participating banks to issue universal cards that can be used on the electronic banking services shared by the different banks.

Electronic banking now involves many different types of transactions.Bank Teller Machines;• Automated Teller Machines;• Internet Banking;• Telephone Banking.•

5.2.1 CardsThere are various types of banking cards issued to customers to facilitate electronic transaction activities. These cards are in plastic and usually about 8.5 cm by 5.5 cm in size. The name of the holder is embossed as is the number of the card. It also has an expiry date. Following are different types of cards:

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Fig.5.1 Types of cards

5.2.2 Electronic PurseAn electronic purse is a smart card that has transferred into it an amount of money.Every time a transaction is entered into, the purse is depleted by the money taken out. Once empty it can be electronically replenished.

5.2.3 Electronic Clearing Service

Electronic Clearing Service is a facility of electronically sending payment • instructions. The objective is to provide an alternate method of effecting bulk payment • transactions which would obviate the need for issuing and handling paper instruments thereby facilitating customer service. This service is in operation in 15 centres where clearing-houses are managed by the Reserve Bank of India and 31 centres where they are being managed by the State Bank of India and its associates. The scheme is designed for high volume transactions and to discourage • low volume presentations. This is further divided into ECS Credit and ECS debit.

Charge card is similar to credit card. In these cards transac-tions are accumulated over a period of time (generally a month) and then the total is debited to the account. The card- holder is given 25 to 50 days to pay.

Credit cards are similar to charge cards. At the end of a month details of all amounts purchased are sent to the card- holder who is required to pay a minimum amount (if he does not wish to pay the entire amount).

Debit cards are dissimilar to charge and credit cards as the holder receives no credit. As soon as a transaction is undertaken, the customer’s account is debited with the amount of the purchase. If the customer does not have sufficient balance the transaction is rejected.

Smart card is like any credit card. It however has an integrated circuit (IC) chip installed in it. The chip contains memory, may contain a processor and communicates through contacts on the surface of the card. As these are difficult to copy there is a move to make credit cards and other cards smart cards.

Charge Card

Credit Card

Debit Card

Smart Card

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5.2.4 ECS Credit

ECS is a method of payment whereby the institutions having to make a large • number of payments can directly deposit the amount electronically into the bank accounts of those they need to make the payment to. The scheme covers bulk payment transactions like periodic payments of salary, • interest, dividends and the likes and obviates the need to prepare a large number of warrants, dispatching them by post and reconciling the payments later. Often each individual payment is of a repetitive nature and of a relatively • small amount. The system works on the basis of one debit transaction triggering a large • number of credit entries. These credits or electronic payment instructions which possess details of the beneficiaries account number, amount and branch bank are communicated to the bank branches through their respective service branches for crediting the accounts of the beneficiaries either through magnetic media duly encrypted or through hard copy. Electronic clearing has been facilitated by MICR and the fact that several • companies issue cheques that are payable at par at many locations (such as dividend cheques).ECS credit can only be given to customers who have accounts in banks that • participate in this form of settlement. The magnetic tape/ floppy is the basis for the sponsor bank to debit the users • account and the destination banks to credit the destination account holders accounts. National clearing cell (NCC) would process the transaction. The minimum • number of transactions per user institution is 2500. The maximum value of any single item should not be more that 100,000 in a • day at a centre. It is safe as there is no chance of the payment going astray. A deficiency is that sometimes the customer is not advised of the credit to his • account by the recipient bank even though beneficiaries are to be informed of credits to their account and the nature of the credit.

5.2.5 ECS Debit

ECS debit is a scheme which facilitates payment of charges to utility services • such as electricity, telephone companies, payment of insurance premia, loan instalments etc. By customers. ECS envisages a large number of debits resulting in a single credit • simultaneously.

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It works on the principle of pre-authorized debit systems under which the • account holders’ account is debited on the appointed date and the amounts are passed onto the utility companies.The scheme thus facilitates faster collection of bills by companies• The scheme enables better cash flow management• It eliminates the need to go to collection centres/ designated banks by • customers.The individual transaction limit under the scheme is Rs. 50,000 (Rs. 25,000 • earlier).The amount may vary from month to month.• The benefits include faster collection of bills by companies, better cash flow • management and eliminate the need for customers to go to collection centres/banks to make payment. Additionally it ensures that a facility is not cut off for non-payment.The concern many consumers have in accepting this is giving a blanket • permission to debit their account on the assumption that the bill amount is correct. If there is an error then the consumer has to expend considerable effort in getting the excess repaid.To address this concern, an ECS variant called ECS Utility Bills Payment • RAPID(Receipts and Payments Instruments/ Documents) has been introduced in • Mumbai for BEST customers.

RAPID is a post verification scheme. The consumer verifies the bill and �the customer has the option to pay the bill in cash or have the bank debit his account.In this the utility department prepares the bill in three parts – receipt to �the customer, voucher for the collecting bank and the third containing an MICR band is sent to the service branch.The first part of the receipt is returned to the customer by the collecting �branch duly affixing the paid stamp.The collecting bank’s service branches need to have a personal computer �attached to a small MICR Reader/ Encoder to enable them to capture the data in the third part of the bill which has the MICR read band. The service branch transmits the data to the National Clearing Cell (NCC).

At the NCC, the accounts of the various collecting banks are debited and the • account of the sponsor bank is credited.The scheme is beneficial to corporate as they get the amounts due to them • on the stipulated date and is useful to customers as they are able to verify the accuracy of the billed amounts before effecting payment.

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5.3 Bank Teller Machines Bank Teller Machines are installed at fully automated bank premises. Unlike ATMs they require the presence of an employee of the bank to operate.

5.4 Automated Teller MachinesAutomated Teller Machines or 24-hour Tellers are electronic terminals that • allow a person to bank almost any time. There are two types – interior and exterior.• Interior are those in banking premises whereas exterior are in malls/ shopping • centres and other locations. Automated Teller Machines (ATMs) facilitate the withdrawal of money at • times when banks are not open (outside banking hours) and are primarily used for performing some of the banking functions such as withdrawal of cash or deposit of cash/cheque etc., by using an ATM card. Each customer is provided with an ATM card with a unique Personal • Identification Number (PIN). Whenever a customer performs a transaction, the person has to key in the PIN • which is validated by the ATM, before the machine permits any transaction. The PIN has to be kept secret by the customer, to prevent any misuse or fraudulent transactions in the event of loss of the card. Stand-alone ATMs made their appearance in India, in the early 1990s. These • were mostly installed by foreign banks in their branch premises, as per the then existing policy. Easing of restrictions on the location of ATMs has led to their being installed at • convenient places such as airports, central business districts, hospitals etc.IBA has set up a Shared Payment Network System (SPNS) or SWADHAN • network of ATMs of its member banks in Mumbai. The network went live on February 1, 1997.The objective behind the SWADHAN network is to provide 24 hours, 7 days • in a week and 365 days in a year, electronic banking service to the customer of a member bank anywhere in the city of Mumbai. The member banks which participate in the network issue cards to their • customers for transacting on SWADHAN network. The customer is free to conduct transactions at the ATMs of any of the member • banks located in the neighbourhood. The services offered under SPNS are cash withdrawal, balance enquiry, cash/• cheque deposit, and transfer of funds, request for cheque book, standing instructions and statement of account, and change of PIN. The ATMs of member banks are connected to a Central Switch through MTNL • leased lines.

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The Central Switch which is the heart of the SWADHAN network is located • in Dadar and is connected to three zonal hubs. These hubs are located in Chembur, Fort and Andheri. The ATM in a particular area is connected to the nearest zonal hub. • The card holders database is kept at the Central Switch. • Banks update the balances at the Switch at pre-determined frequencies. • On a daily basis the Switch provides settlement reports necessary for arriving • at inter-bank settlement. Bank of India, a public sector commercial bank, acts as the settlement bank • for all inter-bank transactions in SWADHAN. Every member bank has to maintain a deposit of Rs.25,000/- with the settlement • bank. Generally, ATMs must tell you they charge a fee and its amount on or at the terminal screen before you complete the transaction. Most commercial banks have their own ATMs. • In the case of smaller banks they piggyback, at times, on the ATMs of larger • banks to allow their customers access to money outside banking hours.An automatic teller machine or ATM allows a bank customer to conduct their • banking transactions from almost every other ATM machine in the world. As is often the case with inventions, many inventors contribute to the history • of an invention, as is the case with the ATM. Read each page of this article to learn about the many inventors behind the automatic teller machine or ATM.

Luther Simjian vs John Shepherd-Barron vs Don WetzelIn 1939, Luther Simjian patented an early and not-so-successful prototype • of an ATM. However, some experts have the opinion that James Goodfellow of Scotland • holds the earliest patent date of 1966 for a modern ATM, and John D White (also of Docutel) in the US is often credited with inventing the first free-standing ATM design. In 1967, John Shepherd-Barron invented and installed an ATM in a Barclays • Bank in London. Don Wetzel invented an American made ATM in 1968. However, it wasn’t • until the mid to late 1980s that ATMs became part of mainstream banking.

Luther Simjian’s ATMLuther Simjian came up with the idea of creating a “hole-in-the-wall machine” • that would allow customers to make financial transactions. In 1939, Luther Simjian applied for 20 patents related to his ATM invention • and field tested his ATM machine in what is now Citicorp. After six months, the bank reported that there was little demand for the new • invention and discontinued its use.

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Luther Simjian Biography 1905 - 1997Luther Simjian was born in Turkey on January 28, 1905. While he • studied medicine at school, he had a life-long passion for photography. In 1934, the inventor moved to New York.• Luther Simjian is best known for his invention of the Bankmatic automatic • teller machine or ATM, however, Luther Simjian’s first big commercial invention was a self-posing and self-focusing portrait camera. The subject was able to look a mirror and see what the camera was seeing • before the picture was taken.Luther Simjian also invented a flight speed indicator for airplanes, an automatic • postage metering machine, a colored x-ray machine, and a teleprompter. Combining his knowledge of medicine and photography, Luther Simjian • invented a way to project images from microscopes, and methods of photographing specimens under water.Luther Simjian started his own company called Reflectone to further develop • his inventions.

5.5 Internet Banking Internet Banking permits an account holder to access his account by a computer from home or other remote location and issue instructions. The account is accessed by the account holder stating a unique identification customer number and a password.

Customers can:Ascertain their account balance;• Transfer amounts from one account to another;• Arrange for the issuance of a cheque;• Instruct payments to be made;• Request for a cheque book;• Request for a statement of their account;• Make a fixed deposit.• There is a confidentiality issue as hackers could get vital numbers and then • withdraw amounts.The integrity of the system is extremely important.• Once the transaction instructions are issued, it is very difficult to repudiate • them.

5.6 Telephone BankingTelephone banking is a facility offered to customers whereby they can, by dialling a number, issue instructions or seek information. The customer when he makes a call is answered by an operator in a call centre. This person has access

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to the customer’s account. To ensure that it is indeed an authorized person who is seeking information, the customer would be required to state an identifying number Telephone Identification Number (TIN), date of birth, billing address or any other unique information. On being satisfied that it is indeed the customer, the transaction required is carried out.

FeaturesTransfers to a fixed deposit• Balance enquiry• Request for a cheque book• Request for a statement• Payment of a bill•

This type of banking is matter of concern sometimes, where this confidential information is easily available. Hence anybody can fake the identity and can cheat the bank as well as the customer. In such cases the bank authorities need to be extra cautious while authenticating the customer information.

5.7 Electronic Funds TransferElectronic banking, also known as electronic fund transfer (EFT), uses computer and electronic technology as a substitute for cheques and other paper transactions. They refer to any transfer of funds that is initiated by electronic means such as an electronic terminal, telephone, computer, ATM or magnetic tape. Efts are initiated through devices like cards or codes that permit account holders to authorize payments and access their account.

RBI EFTRBI EFT is a Scheme introduced by Reserve Bank of India (RBI) to help • banks offering their customers money transfer service from account to account of any bank branch to any other bank branch in places where EFT services are offered. The EFT system presently covers nearly 5000 branches of the 27 public • sector banks and 55 scheduled commercial banks at the 15 centres (viz., Ahmedabad, Bangalore, Bhubneshwar, Kolkata, Chandigarh, Chennai, Guwahati, Hyderabad, Jaipur, Kanpur, Mumbai, Nagpur, New Delhi, Patna and Thiruvananthpuram).Funds transfer is possible from any branch of these banks at these centres to • other branch of any bank at these centres both inter-city and intra-city. A customer can to avail of these services approaches the bank can issue • instructions to make a payment either by making a cash payment or authorizing his account to be debited. He has to give full details regarding whose account is to be credited including • his bank account and bank.

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If the remitting bank transmits the funds transfer message to RBI so as to hit • the first settlement at 12 noon, the receiving bank’s account is credited by RBI at the destination centre and beneficiary gets the credit on Day 1 itself.If the same is included in subsequent settlements i.e., for 2 pm and 4 pm, the • beneficiary gets credit on Day 2. As the scheme is retail in nature the maximum amount permitted per transfer • is Rs. 100,000.

The system operates in the following manner:

Step-1The remitter fills in the EFT Application form giving the particulars of the beneficiary (city, bank, branch, beneficiary’s name, account type and account number) and authorizes the branch to remit a specified amount to the beneficiary by raising a debit to the remitter’s account.

Step-2The remitting branch prepares a schedule and sends the duplicate of the EFT application form to its Service branch for EFT data preparation. If the branch is equipped with a computer system, data preparation can be done at the branch level in the specified format.

Step-3The Service branch prepares the EFT data file by using a software package supplied by RBI and transmits the same to the local RBI (National Clearing Cell) to be included for the settlement of 12 noon, 2 pm and 4 pm.

Step-4The RBI at the remitting centre consolidates the files received from all banks, sorts the transactions city-wise and prepares vouchers for debiting the remitting banks on Day-1 itself. City-wise files are transmitted to the RBI offices at the respective destination centres.

Step-5RBI at the destination centre receives the files from the originating centres, consolidates them and sorts them bank-wise. Thereafter, bank-wise remittance data files are transmitted to banks on Day 1 itself. Bank-wise vouchers are prepared for crediting the receiving banks’ accounts the same day or next day.

Step-6On Day 1/2 morning the receiving banks at the destination centres process the remittance files transmitted by RBI and forward credit reports to the destination branches for crediting the beneficiaries’ accounts.

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EFT is an improvement over the other facilities for several reasons. • The primary modes of funds transfer at present are demand draft, mail transfer • and telegraphic transfer. The demand draft facility is paper based. • The remitter, after purchasing demand draft from a bank branch, dispatches • the same by post/courier to the beneficiary. The beneficiary, in turn, lodges the draft to his/her bank for collection and • clearing. The time taken for completing the process is about 10 days. In the case of • telegraphic transfer, fund reaches the beneficiary either on the same day or the next; but both the remitter and the beneficiary would have to be account holders of the same bank. If they are customers of different banks, a good deal of paper processing is • required. On the other hand, RBI EFT system is an inter-bank oriented system. • RBI acts as an intermediary between the remitting bank and the receiving • bank and effects inter-bank funds transfer. The customers of banks can request their respective branches to remit funds to • the designated customers irrespective of bank affiliation of the beneficiary.

LimitThere is no value limit for individual transactions.

Acknowledgment for transferThe receiving branch acknowledges every transaction it receives after crediting • the beneficiary’s account. The acknowledgment particulars reach the remitting branch as an inward • message on Day 3 of the EFT processing cycle. The remitting branch will, therefore, have precise information as to when the • beneficiary’s account was credited.It is not necessary for all branches to have computer systems. • Branches can send the remittance details to their service branch in paper • format (the copies of the EFT Application Forms submitted by the remitting customers accompanied by a Remittance Scroll). The Service branch will make data entry and transmit the funds transfer • information electronically to local NCC. But, if a branch has computer facility, it can transmit funds transfer information electronically to its service branch either on a floppy or through a network. This would minimize the data entry work at the service branch.

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Additional organizational structure Each participating bank has to identify a branch at the respective centre to • act as the link point for transmitting all outward messages and receiving all inward messages.The Service Branches/Main Branches of banks who have been coordinating • the cheque-clearing work are in the best position to discharge this role. So no additional organisational infrastructure is required to be created.

Processing charges/Service chargesWhile RBI has waived processing charges till March 31, 2006, levy of service charges by banks is left to the discretion of respective banks. Benefits the banks?

Banks can now provide inter-bank TT service.• Reconciliation is automatic.• Banks can make use of the EFT infrastructure for introducing new payment/• cash management products to their customers.

The number of outstation cheques issued by customers and consequent service load on banks may decline over a period of time

5.8 Resident Foreign Currency AccountsThe Reserve Bank of India has now made it easier to access foreign currency • by permitting a foreign currency account (domestic) for resident Indians. In line with RBI guidelines, many banks have come up with a scheme that helps to get rid of all forex worries.One can park the foreign currency in banks under RFC account. These accounts • can be opened by a person of Indian nationality or origin, who has returned to India for permanent settlement or persons inheriting assets abroad from persons who acquired such assets while being a non- resident. The account can be opened in any foreign currency other than the currency • of Nepal or Bhutan.Persons who have been resident outside India for a continuous period of not • less than one year (exclusive of short visits for personal reasons) who return to India for permanent settlement should change the status of their NRO/NRE Account from non-resident to resident and inform the bank of the change in status. Such persons have to close NRE and FCNR (B) deposit accounts on • maturity.The proceeds can be transferred either partly or wholly to an RFC account. • An RFC account can be a current, savings or fixed deposit account. The term of the fixed deposit can be from 30 days to 6 months. •

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Cheque facility is not available for current accounts. Balance held in a RFC • account (both interest and principal) is repairable without prior permission of RBI for a bona fide purpose. A RFC account is free from all restrictions regarding utilization including any restrictions on investments outside India. Interest earned on the balance in this account is tax-free for 2 years from the • date of return to India. The account can be held jointly or singly. Nomination facility is available. If the account holder dies and the nominee • is abroad, the balance in the account can be repatriated to him/ her. Loans may be granted against the balances lying in the account subject to • commercial judgment.

5.9 Foreign Currency AccountsThe different types of Foreign Currency accounts a non-resident may have are:

Foreign Currency (Non-resident) Deposit Accounts (FCNR (B)).• Temporary Foreign Currency Accounts.•

5.9.1 Foreign Currency (Non-resident) Deposit Accounts (FCNR (B))

Non-resident Indians, persons of Indian origin/ nationality, residing outside • India are eligible to open FCNR (B) accounts.Overseas corporate bodies are no longer permitted to open these accounts. If • there is an FCNR (B) account in the name of an Overseas Corporate Body (OCB) it can be continued till maturity and on maturity the proceeds must be repatriated.These fixed deposits are denominated in certain foreign currencies.• The currencies that these deposits may be maintained are the US dollar, the • British pound sterling, the Euro, the Japanese yen, the Australian dollar and the Canadian dollar.Interest earned on these accounts is also in foreign currency and tax-free.• FCNR (B) deposit accounts are term deposits and are held by banks for • maturities between one year and five years.Repatriation of funds in foreign currencies is permitted.• Recurring deposits are not accepted under the FCNR (B) scheme.• A FCNR (B) deposit account may be opened by non-residents:•

In foreign currency or �By an inward remittance in convertible foreign currency through normal �banking channels (The remittances should normally be received in the designated currency in which the account is to be opened) orBy tendering traveller’s cheque while on a visit to India �By funds received in rupees to the account a non-resident bank maintains �in India with the bank (vostro account) or

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By funds that are of a repairable nature (per RBI regulations) orBy transfer �from an existing NRE/FCNR (B) account.

Only Authorised Dealers/Authorised Banks are permitted to accept • deposits.However, all others may continue to hold and renew existing deposits held in • their books in the name of NRIs on repatriatiable or non-repatriatiable basis, as the case may be.The interest earned on such deposits can be repatriated as it is considered • current income.These funds can also be credited to non-resident external (NRE) savings • accounts.The RBI will not provide any exchange rate guarantee to banks for deposits • of any maturity.The maturity proceeds will be payable in the same currency. There will, thus, • be no foreign exchange fluctuations risk. The main reason for opening these accounts are to protect savings from depreciation in the value of the rupee. The funds can be repatriated abroad freely.Non-resident accounts cannot be opened by the non-resident’s power of • attorney (POA) holder in India.The account opener must, at the time of opening the account, undertake to • inform the bank on relocating permanently to India.A non-resident can also open the account during his visit to India with travellers • cheques.The bank has the responsibility to satisfy itself that the account is in order • and the account opener is indeed a non-resident. This is normally by checking the individual’s passport and examining the visa or stay permit in the country where the person resides.Nomination facility is available for these accounts• The account can be held jointly with another non-resident of Indian origin.• The account may also be held jointly with minors provided the minors are • also non-residents.A joint deposit account with a person resident is not permissible.• A loan against the deposits held in this account is also permissible subject to • certain constraints as to its utilization. This includes a stipulation that the loan cannot be used for the purpose of investment in India or for re-lending or for investment in arm houses/ real estate.The main reason for maintaining FCNR (B) deposit accounts is to protect the • account from depreciation in the value of the rupee.The funds in this account are freely remittal abroad• Transfer of funds from an existing NRE account to FCNR (B) account and • vice versa of the same account holder is permitted without RBI approval.

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InterestThe board or a body approved by the board has to approve the interest rates • offered on deposits of various maturities.The rate of interest earned on these deposits would vary according to the • currency.Interest is paid in the same currency in which the deposits are held.• Interest is credited either half yearly or annually (at the option of the deposit • holder).Penalty for premature withdrawals is chargeable on premature termination of • the deposits. If these deposits are withdrawn prematurely within the period of I year no interest is payable. The penal interest on deposits held for more than one year prematurely withdrawn is 1%. This is chargeable at the discretion of the bank.The interest on the deposit is paid on the basis of 360 days in a year.• Banks should pay interest at the originally contracted rate on the deposit • amount\ for the holiday/ weekend intervening between the date of expiry and the date of payment.The interest should be calculated and paid in the following manner•

For deposits up to one year, at the rate applicable without any compounding �effect.For deposits more than one year, at intervals of 180 days each and there �after for the remaining number of days.The depositor will have the option to receive the interest on maturity with �the compounding effect.

Interest shall be paid within the ceiling rate of LIBOR/ SWAP rates for the • respective currency/ corresponding maturities minus 25 basis points. On floating rate deposits interest shall be paid within the ceiling of SWAP rates for the respective currency/ maturity minus 25 basis points, For floating rate deposits the interest reset period will be 6 months. In respect of yen deposits bank can set FCNR (B) deposit rates which may be equal to or less than LIBOR.The LIBOR/ SWAP rates as on the last working day of the preceding month • would form the base for fixing ceiling rates for the interest rates that would be offered effective from the following month.Banks have the option to choose the current SWAP rates quoted on any online • screen based information system while offering FCNR (B) deposits.Member or retired member of the bank’s staff, either singly or jointly or • the spouse of a deceased member or a deceased retired member, can at the discretion of the bank, be allowed additional interest at a rate not exceeding 1%. This is provided the depositors are non-residents/ of Indian nationality or origin and the depositor has given a declaration that the money is his/hers.

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Premature WithdrawalPremature withdrawals are permitted.• Bank’s can, at their discretion, levy penalties for premature withdrawals.• Banks can also levy penalties to recover swap costs.• If the premature withdrawal takes place before completion of stipulated • period and no interest is payable, banks can (at their discretion) levy penalty to cover swap costs.The components of penalty must be brought to the notice of the depositor. If • this is not done, the bank will have to bear the exchange loss arising out of the premature withdrawal.Conversion of FCNR (B) to NRE deposits and vice versa before maturity will • be considered a premature withdrawal and attract the penal provisions.

Interest on overdue depositsInterest payable on the renewal of an overdue deposit (if the overdue period • from the date of maturity to the date of renewal (both days inclusive) does not exceed 14 days) is at the discretion of the bank. The rate of interest should be the appropriate rate of interest for the period of renewal as prevailing on the date of maturity or on the date of renewal (whichever is lower).Where overdue period exceeds 14 days and if the depositor places the entire • amount of overdue deposit or a portion as a fresh FCNR (B) deposit, banks may fix their own rate for the overdue period on the amount placed as a fresh term deposit.The rate on the deposit renewed must be the rate prevailing at the date of • maturity.Banks can recover the interest paid for the overdue period if the deposit is • withdrawn before completion of the minimum stipulated period under the scheme, after renewal.

LoansForeign currency /rupee loans to deposit holders against their own deposits • (not against third party) can be availed ofThe bank is free to charge a rate of interest without reference to its own • benchmark prime lending rate (BPLR). These include deposits in the name of:

Borrower either singly or jointly. �One of the partners of a partnership firm and advance is made to that �firm.Proprietor of a proprietary concern and the advance is made to such a �concern.A ward whose guardian is competent to borrow on behalf of the ward and �where advance is made to the guardian in such a capacity.

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The documents should be executed by the deposit holders themselves and not • by their power of attorney holders.The maturity of the loans should not exceed the maturity of the deposit under • any circumstances.The loan can be sanctioned for purposes other than re-lending or carrying on • agricultural/plantation activities or for investment in real estate business.The repayment must be effected in India by fresh remittances in foreign • exchange or by adjustment of the deposit.Loans up to $250,000 or its equivalent can be given to close relatives who • are resident from an FCNR (B) account.The rate of interest charged can be without reference to Prime lending Rate • (PLR).Banks can also charge a rate less than that prescribed for advances upto Rs. • 3 lakhs when granted to a staff member or retired staff member/spouse or spouse of deceased staff member or retired member.When a loan is granted against a third party FCNR (B) deposit, the bank can • charge interest without reference to PLR on a loan up to Rs. 2 lakhs.If it is above Rs. 2 lakhs then it must be at the rate prescribed by the RBI.• If the deposit against which the loan had been given is withdrawn before the • stipulated period, the advance should not be treated as an advance against a term deposit and interest should be charged as prescribed by the RBI.A bank is permitted to determine the margin that will be kept against the • loan.

Interest on the death of a depositorInterest should be paid at the contracted rate.• If the deposit is being claimed before maturity, the bank must pay interest at • the applicable rate prevailing on the date of placement of the deposit, without charging any penalty.If the death is before the maturity of the deposit and the claim is after the date • of maturity, the bank should pay interest at the contracted rate till the date of maturity.From the date of maturity the bank should pay simple interest at the applicable • rate operative on the date of maturity to the date of payment.If the depositor dies after the date of maturity, the interest paid should be at the • savings deposit rate of deposits under the Resident Foreign Currency Account Scheme till the date of payment.

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The bank can agree to split the deposit to two or more receipts in the name of • claimants separately. This will not be considered premature withdrawal.If the claimants are residents, the proceeds should be converted into rupees • at the time of payment.

Addition/ deletion of name of joint account holdersAt the request of all the joint holders names may be deleted/ added.• The amount or duration of the original deposit should not undergo a change • in any manner and all the joint holders must be non-residents of Indian nationality or origin.While doing so the bank should ascertain reason from applicants for requiring • the change. On opening accounts in the name of Pakistanis and Bangladeshis though of Indian origin prior RBI approval is required.

5.9.2 Temporary Foreign Currency AccountsOrganizers of international seminars, conferences, conventions etc. are permitted to open temporary foreign exchange account. These accounts are operated for the receipt of the delegate fee and payment towards expenses including payment to special invitees abroad. Authorized dealers can open such an account subject to the organizers obtaining the prior approval from the concerned Administrative Ministry of Government of India.

Credits to these accountsAll inward remittances in foreign currency towards registration fees payable by overseas delegates, grant, sponsorship fees and donations, received from abroad, in connection with the conference, convention, etc.

Debits to these accountsPayment to foreign/special invitees attending the conference, etc., on the • specific invitation of the organizers, towards travel, hotel charges, etc., and honorarium to foreign guest speakers;Remittance towards refund of registration fees to foreign delegates and • unutilized sponsorship/grant amount, if any;Bank charges, if any;• Conversion of funds into rupees.•

All other credits/debits would require the prior approval of the Reserve �Bank of India.The Account should be closed immediately, after the conference/event �is over.

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5.10 NRI’s return to IndiaDeposits held by an NRI on his return to India for permanent residence can • continue till maturity at the contracted rate.For reserve requirements this will be considered as a resident deposit from • the date of return of the depositor.Premature withdrawal will be subject to the penal provisions of the scheme.• On maturity these should be converted to Resident Rupee Deposits or RFC • (if eligible) at the account holder’s option.NRI policy holders who are beneficiaries of insurance claims/ maturity settled • in respect of policies issued by insurance company in India may credit proceeds to RFC account opened by them on becoming residents.Penal provision on premature conversion can be waived if the balance held • is placed in an RFC account.With regard to interest, it should be paid at the time of conversion of FCNR • (B) to RFC even if it has not run for a minimum maturity period.The rate must not exceed the rate payable on savings bank deposits held under • the RFC scheme.For all other purposes these deposits will be treated as resident deposits from • the date of return.An account holder also has an option of converting these deposits into an RFC • account on maturity on satisfying certain conditions.If the deposits are withdrawn before maturity, all directions of the RBI • including charging of penal interest will apply.Cardholders can settle charges for the use of International Credit Cards out • of funds held in the Card Holder’s FCNR (B) Account.Balances in the EEFC and RFC (D) accounts may be allowed to be credited • to NRE/FCNR (B) Account, at the option/request of the account holders consequent upon change in the residential status from resident to non-resident.Facilitation of better hedging opportunities to holders of FCNR (B) deposits, • deposit holders can book cross currency (not involving the rupee) forward contracts to convert the balances in one currency to another foreign currency in which FCNR (B) deposits are permitted to be maintained at the option of the account holder.Such contracts once cancelled cannot be rebooked.•

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ProhibitionsNo bank should:

Accept or renew deposits over five years.• Discriminate in the matter of interest paid on the deposits between one deposit • and another accepted on the same date and for the same maturity.Permission to offer varying rates is based on the size of deposits subject to•

Conditions such as:Banks must determine currency wise minimum quantum on which differential • rates of interest can be offered.The differential rate must be within overall ceiling• The rates should not be subject to negotiation.• No brokerage or commission should be paid on these.• No person/ agency should be employed to collect these deposits on payment • of commission or fees.

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Summary Wide competition has made banking sector more service oriented towards • customers. Many banks have employed customer friendly knowledgeable staff to cater to all financial requirements of the customer with speed and efficiency. This also implies that in modern times, more and more banks are trying to attract more and more customers towards them.For many people, electronic banking means 24-hour access to their banking • accounts through an automated teller machine (ATM) or Internet. But electronic banking now involves many different types of transactions.Shared payment network arrangements allow participating banks to issue • universal cards that can be used on the electronic banking services shared by the different banks.Bank Teller Machines are installed at fully automated bank premises. Unlike • ATMs they require the presence of an employee of the bank to operate.Automated Teller Machines or 24-hour Tellers are electronic terminals that • allow a person to bank almost any time. Stand-alone ATMs made their appearance in India, in the early 1990s. These • were mostly installed by foreign banks in their branch premises, as per the then existing policy. Internet Banking permits an account holder to access his account by a computer • from home or other remote location and issue instructions. The account is accessed by the account holder stating a unique identification customer number and a password.Telephone banking is a facility offered to customers whereby they can, by • dialling a number, issue instructions or seek information.The Reserve Bank of India has now made it easier to access foreign currency • by permitting a foreign currency account (domestic) for resident Indians. In line with RBI guidelines, many banks have come up with a scheme that helps to get rid of all forex worries.The different types of Foreign Currency accounts a non-resident may have • are:Foreign Currency (Non-resident) Deposit Accounts (FCNR (B)) and Temporary • Foreign Currency AccountsNon-resident Indians, persons of Indian origin/ nationality, residing outside • India are eligible to open FCNR (B) accounts.Overseas corporate bodies are no longer permitted to open these accounts. If • there is an FCNR (B) account in the name of an Overseas Corporate Body (OCB) it can be continued till maturity and on maturity the proceeds must be repatriated.These fixed deposits are denominated in certain foreign currencies.•

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The currencies that these deposits may be maintained are the US dollar, the • British pound sterling, the Euro, the Japanese yen, the Australian dollar and the Canadian dollar.The board or a body approved by the board has to approve the interest rates • offered on deposits of various maturities.The rate of interest earned on these deposits would vary according to the • currency.Interest is paid in the same currency in which the deposits are held.• Interest shall be paid within the ceiling rate of LIBOR/ SWAP rates for the • respective currency/ corresponding maturities minus 25 basis points. On floating rate deposits interest shall be paid within the ceiling of SWAP rates for the respective currency maturity minus 25 basis points, For floating rate deposits the interest reset period will be 6 months. In respect of yen deposits bank can set FCNR (B) deposit rates which may be equal to or less than LIBOR.Interest payable on the renewal of an overdue deposit (if the overdue period • from the date of maturity to the date of renewal (both days inclusive) does not exceed 14 days) is at the discretion of the bank. The rate of interest should be the appropriate rate of interest for the period of renewal as prevailing on the date of maturity or on the date of renewal (whichever is lower).

References

Lehwald, E., Hanley, C., 1990. • Personal Banking. Longmeadow Pr. p. 90 Baxter, J., 2000. • Personalbanking:2000marketreport.Key Note publications. pp. 56-90About.com inventors ,Automatic Teller Machines• –ATM [Online] Available at: <http://inventors.about.com/od/astartinventions/a/atm.htm> [Accessed 22 July 2011]MortgageChoice,Whichhomeloantypeswouldsuityoumost?• Available at: <http://www.mortgagechoice.com.au/buying-next-home/loan-types.aspx> [Accessed 22 July 2011]PersonalLoans,CreditCards&DebtConsolidationAll TypesOfLoans•GuaranteedApproval Visit, 2009, [Video Online] Available at:

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<http://www.youtube.com/watch?v=f43hcoHmqfc > [Accessed 22 July • 2011]eHow, 2009,• CreditCards&PersonalLoans :DifferentTypesof SavingsAccounts [Video Online] Available at: <http://www.youtube.com/watch?v=C1Yc49PIgBY> [Accessed 22 July 2011]

Recommended Reading

Welch, B., 1999. • Electronic banking and treasury security. Wood head publishing. Kerem, K., 2003. • Internet banking in Estonia. PRAXIS. Dalal, K. A., Bharat’s policies&proceduresfornon-residentIndians.Bharat Pub. House.

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Self assessment__________ banking means 24-hour access to their banking accounts through 1. an automated teller machine (ATM) or Internet.

Telly a. Electronicb. Physical c. Automatic d.

Electronic banking, also known as electronic fund transfer (EFT), uses 2. computer and electronic technology as a substitute for checks and other __________transactions.

papera. money b. fundsc. accounts d.

EFT’s are initiated through which of the following devices? 3. pens- drive a. CDb. Cardsc. Chain d.

Bank Teller Machines are installed at fully automated __________ 4. premises.

office a. residential b. industrial c. bankd.

___________ require the presence of an employee of the bank to operate.5. Bank Teller machinesa. Internet b. Telephone c. Mobile d.

Stand-alone ___________ made their appearance in India, in the early 6. 1990s

ATMsa. teller machinesb. cardsc. smart cardsd.

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The member banks which participate in the network issue cards to their 7. customers for transacting on ______________ network.

SHURAKSHA a. SUVIDHA b. SAMAN c. SWADHANd.

The ATMs of member banks are connected to a Central Switch through 8. ________ leased lines.

MTNLa. BSNL b. AirTel c. Idea d.

The Central Switch which is the heart of the SWADHAN network is located 9. in____________

Bandra a. Dadarb. Andheri c. Chembur d.

Internet Banking permits an account holder to access his account by a 10. ________ from home or other remote location and issue instructions.

ATMa. computerb. mobile c. card d.

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Chapter VI

Loan Products and Dematerialization of Shares

Aim

The aim of this unit is to:

highlight the concept of retail loan •

explain personal loans in detail •

discuss concept of consumer durable loans •

Objectives

The objectives of this unit are to:

discuss loans to professionals and self employed persons•

describe vehicle loans •

explain the educational loan •

Learning outcome

At the end of this unit, you will be able to:

recognise concept of loans against shares and debentures •

discuss housing finance •

understand dematerialization of shares •

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6.1 Retail LoansRetail loans are those that are given to individuals to meet their needs as opposed to corporate to meet business or commercial imperatives. These may be unsecured or secured.

Fig 6.1 Types of retail loans

Unsecured loans include:Personal loans;• Some loans to professionals and self employed persons;• Some Educational Loans.•

Secured Loans includeSome educational loans;• Some loans to professionals and self employed persons;• Loans against shares and debentures;• Vehicle Loans; • Housing Loans.•

The Reserve Bank has not stipulated (apart from housing, loans against shares, and educational loans on aspects of these loans. The general features of these loans are detailed in the next few chapters. These may, of course vary from bank to bank in some degree and is intended only to give the reader an understanding of how the loans are structured.

6.2 Personal LoansPersonal loans are loans advanced to individuals for a need. These could be to meet marriage expenses, hospitalization/ medical costs, costs for a holiday or

Retail Loans

Insecured Loans Secured Loans

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for some other need.EligibilityThese loans are advances to persons over the age of 18/ 21 who have sufficient disposable income to repay the loan in monthly instalments. Usually these loans are not advanced to individuals who are likely to retire with one to two years. A certain minimum annual income is also expected – the quantum varies from bank to bank.

Quantum of loanThe amount that is advanced is usually based on the nature of the loan, the take home and disposable income of the person seeking the loan. These loans are between Rs.50, 000 to Rs.200, 000. The amount does vary from bank to bank.

Period of the loanThe loan is usually repayable between twelve to twenty four months.

Rate of Interest The rate of interest would vary from bank to bank.

Security These loans are usually unsecured.6.3 Consumer Durable LoansConsumer durable loans are for the purchase of consumer durables such as washing machines, dish washers, mobile phones, refrigerators, cooking ranges, music systems, televisions and the like.

EligibilityThese loans are normally extended to persons over the age of 18 who have sufficient disposable income to repay the loan in monthly instalments,

Quantum of LoanThese loans are not large and are usually below Rs. 100,000.• They may be for an amount as low in some cases as Rs. 5,000.• As the amounts are usually not large, normally 90% of the value (and in cases • 100%) is advanced.

Period of the loanThe loan is usually repayable in a period between 12 months to 36 months.InterestThe rate of interest varies from bank to bank.

SecurityThese are usually unsecured though at times certain equipment such as computers may be hypothecated.

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6.4 Loans to Professionals and Self Employed PersonsNature and EligibilityLoans to professional and self-employed persons include:

Loans for the purpose of purchasing equipment, repairing or renovating • existing equipment and/or acquiring and repairing business premises or for purchasing tools and/or for working capital requirements to medical practitioners including Dentists, Chartered Accountants, Cost Accountants, Practicing Company Secretary, Lawyers or Solicitors, Engineers, Architects, Surveyors, Construction contractors or Management Consultants or to a person trained in any other art or craft who holds either a degree or diploma from any institutions established, aided, or recognized by Government or to a person who is considered by the bank as technically qualified or skilled in the field in which he is employed.Advances to accredited Journalists and Cameramen who are freelancers, i.e. • not employed by a particular newspaper/magazine for acquisition of equipment by such borrowers for their professional use.Credits for the purpose of purchasing equipment, acquisition of premises • (strictly for business) and tools to practicing company secretaries who are not in the regular employment of any employer.Financial assistance for running Health Centre by an individual who is not • a doctor, but has received some formal training about the use of various instruments of physical exercises.Advances for setting up beauty parlours where the borrower holds qualification • in the particular profession and undertakes the activity as the sole means of living/earning his/her livelihood.Preference may be given by banks to financing professionals like doctors, etc., • who are carrying on their profession in rural or semi-urban areas. The term also includes firms and joint ventures of such professional and self-employed persons. This category will include all advances granted by the bank under special schemes, if any, introduced for the purpose.Only such professional and self-employed persons whose borrowings (limits) • do not exceed Rs. 10 lakhs of which not more than Rs. 2 lakh should be for working capital requirements, should be covered under this category. However, in the case of professionally qualified medical practitioners, setting up of practice in semi-urban and rural areas, the borrowing limits should not exceed Rs. 15 lakhs with a sub ceiling of Rs. 3 lakhs for working capital requirements.

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Advances granted for purchase of one motor vehicle to professional and self-employed persons other than qualified medical practitioners will not be included under the priority sector.Advances granted by banks to professional and self-employed persons for • acquiring personal computers for their professional use, may be classified in this category, provided the ceiling of total borrowings of Rs. 10 lakhs of which working capital should not be more than Rs. 2 lakh per borrower, is complied with in each case for the entire credit inclusive of credit provided for purchase of personal computer. However, home computers should not be treated on par with personal computers and excluded from priority sector lending.

QuantumThe amount advanced will depend on the amount required, the nature of the expense and the earnings of the professional. To qualify within this category it should not exceed Rs. 10 lakhs of which working capital finance should not exceed Rs. 2 lakhs.

Period of the loanThe period is usually between 36 months and 60 months.

Rate of InterestThe rate will vary from bank to bank.SecurityThese loans are secured by the asset purchased with these loans.

6.5 Vehicle LoanVehicle loans are advanced to enable individuals:Purchase new two-wheeler / motorcar of any make for private use or professional or business use. Purchase second hand / used two-wheeler / motorcar of not more than 5 years old.

EligibilityMost banks expect the applicant to be at least 21 years of age and not more • than 60 years old.As a safety criteria to satisfy themselves that the person has the ability to • repay other aspects may be looked at such as for how long the person has been employed, other assets and the like.In addition the net take home pay/ disposable income will be checked to • determine whether the applicant can repay the loan.With regard to professionals & Self Employed Persons such as Doctors, • Engineers, Architects, Chartered Accountants, Lawyers, Consultants, Agriculturists, Businessmen etc. their income should be adequate to pay the monthly instalments.

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Quantum of LoanWhile this may vary, usually the loan is up to 80% (in case of both new and old vehicles; but not older than 5 years) of the cost / invoice value of the vehicle including accessories and registration expenses in the case of new vehicles.

Rate of InterestThe rate of interest will vary from bank to bank.RepaymentEntire loan with interest is required to be paid in 36 to 60 equated monthly instalments.Security

Hypothecation of vehicles purchased out of bank finance.• Hire purchase is to be got noted in the registration book issued by the Regional • Transportation Officer.

InsuranceThe vehicle purchased must be comprehensively insured to its full value with a clause stating that if it is damaged beyond repair, the insurance money be paid to the bank. .

GuarantorAs an additional security, at times a guarantor acceptable to the Bank is taken as Guarantor.

6.6 Educational LoanThe Indian Bank’ Association has suggested a model scheme and the Reserve Bank has suggested that banks adhere to it as much as possible while developing their own scheme.

The Reserve Bank suggests that the main emphasis should be to ensure that every meritorious student though poor is provided with an opportunity to pursue education with the financial support from the banking system with affordable terms and conditions and that no deserving student be denied an opportunity to pursue higher education for want of financial support.

Eligibility CriteriaThe course that is eligible in India and abroad for a loan and those who are eligible are:

Studies in India:School education including plus 2 stage.• Graduation courses: BA, B.Com. B.Sc., etc.•

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Post Graduation courses: Masters & PhD.• Professional courses: Engineering, Medical, Agriculture, Veterinary, Law, • Dental, Management, Computer etc.Computer certificate courses of reputed institutes accredited to Dept. Of • Electronics or institutes affiliated to university.Courses like ICWA, CA, CFA etc.• Courses conducted by IIM, IIT, IISc, XLRI. NIFT etc.• Courses offered in India by reputed foreign universities.• Evening courses of approved institutes.• Other courses leading to diploma/ degree etc. conducted by colleges/ • universities approved by UGC/ Govt./ AICTE/ AIBMS/ ICMR etc.Courses offered by National Institutes and other reputed private institutions.• Banks may have the system of appraising other institution courses depending • on future prospects/ recognition by user institutions.

Studies abroad:Graduation: For job oriented professional/ technical courses offered by reputed • universities.Post graduation: MCA, MBA, MS, etc.• Courses conducted by CIMA- London, CPA in USA etc.•

Student eligibility:Should be an Indian National.• Secured admission to professional/ technical courses through Entrance Test/ • Selection process.Secured admission to foreign university/ Institutions.• There is no need to have secured a minimum qualifying mark.•

Expenses considered for loan:Fee payable to college/ school/ hostel.• Examination/ Library/ Laboratory fee.• Purchase of books/ equipments/ instruments/ uniforms.• Caution deposit/ building fund/ refundable deposit supported by Institution • bills/ receipts.Travel expenses/ passage money for studies abroad.• Purchase of computers - essential for completion of the course.• Any other expense required to complete the course - like study tours, project • work, thesis, etc.

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The amount of loan:Need based finance subject to repaying capacity of the parents/ students with margin and the following ceilings.

Studies in India - Maximum Rs.7.50 lakhs.• Studies abroad - Maximum Rs.15 lakhs.•

MarginLoan upto Rs.4 Lakhs - no margin need be insisted upon.• Loan above Rs. 4 lakhs, the margin should be 5% for studies in India and • 15% for studies abroad.Scholarship/ assistantship to be included in margin.• Margin may be brought in on year-to-year basis as and when disbursements • are made on a pro-rata basis.

SecurityNo security needs to be insisted upon for loans up to Rs. 4 lakhs.• For loans above Rs. 4 lakhs collateral security of suitable value or co-obligation • of parent/ guardians/ third party along with the assignment of future income of the student for payments of instalments should be obtained.

DocumentationBoth the student and the parent/guardian should execute the document. The security can be in the form of land/ building/ Govt. securities/ Public Sector Bonds/ Units of UTI, NSC, KVP, LIC policy, gold, shares/ debentures, bank deposit in the name of student/ parent/ guardian or any other third party with suitable margin. Wherever the land/ building is already mortgaged, the unencumbered portion can be taken as security on II charge basis provided it covers the required loan amount. In case the loan is given for purchase of computer the same to be hypothecated to the Bank.

Banks who wish to support highly meritorious/ deserving students without security may delegate such powers to a fairly higher level authority.

Rate of InterestLoans up to Rs.4 lakhs – interest rate should not exceed prime lending rate • (PLR).Loans above Rs.4 lakhs - PLR + 1%• The interest to be debited quarterly/ half yearly on simple basis during the • Repayment holiday/ Moratorium period.Penal interest @ 2% is charged for above Rs.4 lakhs for the overdue amount • and overdue period.

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SanctionThe loan to be sanctioned as per delegation of powers preferably by the Branch • nearest to the place of domicile.The Reserve Bank states that no application for educational loan received • should be rejected without the concurrence of the next higher authority.The loan to be disbursed in stages as per the requirement/ demand directly • to the Institutions/ Vendors of books/ equipments/ instruments to the extent possible.

RepaymentRepayment holiday/moratorium: Course period + 1 year or 6 months after • getting job, whichever is earlier.The loan to be repaid in 5-7 years after commencement of repayment. If the • student is not able to complete the course within the scheduled time extension of time for completion of course may be permitted for a maximum period of 2 years. If the student is not able to complete the course for reasons beyond his control, sanctioning authority may at his discretion consider such extensions as may be deemed necessary to complete the course.The accrued interest during the repayment holiday period to be added to the • principal and repayment in Equated Monthly Instalments (EMI) fixed.1-2% interest concession may be provided for loanees if the interest is serviced • during the study period when repayment holiday is specified for interest/ repayment under the scheme.

Follow UpBanks to contact college/ university authorities to send the progress report at regular intervals in respect of students who have availed loans.

Processing ChargeNo processing/ upfront charges should be collected on educational loans.

Capability CertificateBanks can also issue the capability certificate for students going abroad for • higher studies. For this financial and other supporting documents may be obtained from applicant, if required.Some foreign universities require the students to submit a certificate from • their bankers about the sponsors’ solvency/ financial capability. This is to afford them comfort that the sponsors of the students going abroad for higher studies are capable of meeting the expenses of the students till they complete their studies.

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Other conditionsDue certificate need not be insisted upon as a pre-condition for considering • an educational loan. However, banks may obtain a declaration/ an affidavit confirming that no loans are availed from other banks.Loan applications have to be disposed of within a period of 15 days to 1 month, • but not exceeding the time norms stipulated for disposing of loan applications under priority sector lending.In order to bring flexibility in terms like eligibility, margin, security norms, • banks may consider relaxation in the norms on a case to case basis delegating the powers to a fairly higher level authority.

Priority Sector AdvanceEducational loans up to the limits stipulated will be considered priority sector advances

Loans against Shares and DebenturesAdvances against security of shares/debentures/bonds may be given to indi-viduals, share and stock- brokers and market makers.Advances to individuals

Banks may grant advances against the security of shares, debentures or bonds • to individuals subject to the following conditions:Loans against shares, debentures and bonds of public sector undertakings • (PSUs) may be granted to individuals to meet contingencies and personal needs or for subscribing to rights or new issues of shares/debentures/bonds or for purchase in the secondary market, against the security of shares/debentures/bonds held by the individual.Loans against the security of shares, debentures and PSU bonds if held in • physical form should not exceed the limit of Rs. 10 lakhs per borrower if the shares are in physical form and Rs. 20 lakhs per borrower if the shares are in dematerialized form.Banks can grant advances to employees for purchasing shares of their own • companies under Employee Stock Option Plans to the extent of 90% of the purchase price or Rs. 20 lakhs whichever is lower.Banks should maintain a minimum margin of 50 percent of the market value • of equity shares/convertible debentures held in physical and dematerialized form. These are minimum margin stipulations and banks may stipulate higher margins for shares whether held in physical form or dematerialized form. The margin requirements for advances against preference shares/non-convertible debentures and bonds may be determined by the banks themselves. Each bank should formulate with the approval of the Board a Lending Policy • for grant of advances to individuals against shares/debentures/bonds keeping in view the general guidelines given by the Reserve Bank. Banks should obtain a declaration from the borrower indicating the extent of loans availed of by him from other banks as input for credit evaluation. It would also be

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necessary to ensure that such accommodation from different banks is not obtained against shares of a single company or a group of companies. As a prudential measure, each bank may also consider laying down an aggregate limit of such advances.

Advances against Units of Mutual FundsWhile granting advances against units of mutual funds, banks should follow the guidelines given below.

The units should be listed in the stock exchanges or repurchase facility for the • units of mutual fund should be available at the time of lending.The units should have completed the minimum lock-in-period stipulated in • the relevant scheme.The amount of advances should be linked to the Net Asset Value (NAV) /• repurchase price or the market value, whichever is less and not to the face value.The advance would attract the quantum and margin requirements as applicable • to advance against shares and debentures wherever stipulated. The margin should be calculated on the NAV/repurchase price or market value, whichever is less.The advances should be purpose-oriented, taking into account the credit • requirement of the investor. Advances should not be granted for subscribing to or boosting up the sales of another scheme of the mutual funds or for the purchase of shares/debentures/bonds.

General guidelinesStatutory provisions regarding the grant of advances against shares contained • inSections 19 (2) and (3) and 20 (1) (a) of the Banking Regulation Act 1949 • should be strictly observed.Banks should be concerned with what the advances are for, rather than what • the advances are against. While considering grant of advances against shares/debentures banks must follow the normal procedures for the sanction, appraisal and post sanction follow-up.Advances against the primary security of shares/debentures/bonds should be • kept distinct and separate and not combined with any other advance.Banks should satisfy themselves about the marketability of the shares/• debentures and the net worth and working of the company whose shares/debentures/bonds are offered as security.Shares/debentures/bonds should be valued at prevailing market prices when • they are lodged as security for advances.Banks should exercise particular care when advances are sought against large • blocks of shares by a borrower or a group of borrowers. It should be ensured that advances against shares are not used to enable the borrower to acquire

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or retain a controlling interest in the company/companies or to facilitate or retain inter-corporate investments.No advance against partly paid shares should be granted. Whenever the limit/• limits of advances granted to a borrower exceed Rs. 10 lakhs, it should be ensured that the said shares/debentures/bonds are transferred in the bank’s name and that the bank has exclusive and unconditional voting rights in respect of such shares. For this purpose the aggregate of limits against shares/debentures/bonds granted by a bank at all its offices to a single borrower should be taken into account. Where securities are held in dematerialized form, the requirement relating to transfer of shares in bank’s name will not apply and banks may take their own decision in this regard. Banks should however avail of the facility provided in the depository system for pledging securities held in dematerialized form under which the securities pledged by the borrower get blocked in favor of the lending bank. In case of default by the borrower and on the bank exercising the option of invocation of pledge, the shares and debentures get transferred in the bank’s name immediately. Banks may take their own decision in regard to exercise of voting rights and • may prescribe procedures for this purpose.Banks should ensure that the scrip’s lodged with them as security are not • stolen/duplicate/fake/benami. Any irregularities coming to their notice should be immediately reported to RBI.The Boards of Directors may decide the appropriate level of authority for • sanction of advances against shares/debentures. They may also frame internal guidelines and safeguards for grant of such advances. Banks operating in India should not be a party to transactions such as making • advances or issuing back-up guarantees favouring other banks for extending credit to clients of Indian nationality/origin by some of their overseas branches, to enable the borrowers to make investments in shares and debentures/bonds of Indian companies.

InterestBanks are free to determine the rate of interest without reference to the BPLR(Benchmark Prime Lending Rate)ProhibitionsBanks cannot sanction loans to trusts and endowments against the security of shares and debentures. Banks cannot sanction loans against the equity shares of the banking company to its directors. Banks cannot advance loans to their employees through employee trusts set up by them under ESOP/ IPO or from the secondary market.

CeilingA bank’s total exposure including both fund based and non fund based to the capital market in all forms (including advances to individuals) must not exceed 5% of its total advances as on March 31 of the previous year. Within this ceiling the bank’s direct investment should not exceed 20% of its net worth.

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6.7 Housing FinanceHousing Loans are advanced for:

The purchase of as house/ flat or the purchase of a plot of land for the • construction of a house.The renovation/ repair of an existing house/ flat.• Extending an existing house.• Short term bridge finance while purchasing another hose/ flat.•

EligibilityThose eligible are all individuals above the age of 18 years with adequate income to repay the loan in equated monthly instalments. Housing loans are not normally extended to individuals who are above 58 years of age as they would retire in a short while.

QuantumThe quantum will vary from bank to bank. Banks would normally stipulate a minimum of Rs. 100,000. The maximum would depend on the bank and could vary from Rs. 10 lakhs to Rs. 2 crores or more. The loan amount for repairs would normally be less around Rs. 10 lakhs. The amount advanced will be based on the individual’s gross pay or take home pay or net disposable income – the criteria differs from one bank to another.

MarginThe entire amount is rarely advanced. The loan is usually between 80% and 85% of the cost of the house/ flat is the amount disbursed.

Term of the loanThe term is dependant on the age of the buyer – the intent being that it should be repaid before the person retires. Most loans are for 15 to 25 years. Loans to selfemployed people are sometimes for a shorter duration.

Rate of InterestInterest may be fixed or floating.SecurityThe property purchased is usually the security and a mortgage is taken on the property. As an additional security guarantees may be taken

6.8 Dematerialisation of SharesDematerialization (“Demat” in short form) is the method by which a person • can get his physical share certificates converted into electronic form, for the same number of holding which is credited to his demat account with a Depository Participant (DP). It is a process by which the physical share certificates of an investor are taken •

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back by the Company and an equivalent number of securities are credited in electronic form at the request of the investor. For this an investor will have to first open an account with a Depository Participant and then request for the dematerialization of his share certificates through the Depository Participant. The dematerialized holdings are credited into the account he has with the DP. This is quite similar to opening a Bank Account. Dematerialization of shares is optional and an investor can still hold shares in • physical form. However, to sell the shares through the stock exchanges one has to dematerialize it before he sells it and similarly, if an investor purchases shares, the delivery of the shares will be in the demat form.

6.9 Meaning of a DepositoryA Depository (NSDL (National Stock Depository Limited) & CSDL (Central Stock Depository Limited) ) is an organization like a Central Bank where at the request of a shareholder his securities are held in the electronic form through the medium of a Depository Participant.

The Depository is different from a traditional custodial service because a transfer of beneficial ownership can be done directly by a depository whereas a custodian cannot do this. The main objective of a Depository is to minimize the paper work involved with the ownership, trading and transfer of securities.

6.10 Operations of a Depository SystemThe Depository System operates in the lines of a banking system. A bank holds funds in its accounts and transfers funds between accounts whereas a Deposi-tory holds securities in accounts and transfers securities between accounts. In both systems, the transfer of funds or securities happens without the actual handling of funds or securities. Banks and the Depository are accountable for the safe keeping of funds and securities respectively.

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Summary

Retail loans are those that are given to individuals to meet their needs as • opposed to corporate to meet business or commercial imperatives. These may be unsecured or secured. The Reserve Bank has not stipulated (apart from housing, loans against • shares, and educational loans on aspects of these loans. The general features of these loans are detailed in the next few chapters. These may, of course vary from bank to bank in some degree and is intended only to give the reader an understanding of how the loans are structured.Personal loans are loans advanced to individuals for a need. These could be • to meet marriage expenses, hospitalization/ medical costs, costs for a holiday or for some other need.Consumer durable loans are for the purchase of consumer durables such as • washing machines, dish washers, mobile phones, and refrigerators, cooking ranges, music systems, televisions and the like. Loans for the purpose of purchasing equipment, repairing or renovating • existing equipment and/or acquiring and repairing business premises or for purchasing tools and/or for working capital requirements to medical practitioners including Dentists, Chartered Accountants, Cost Accountants, Practicing Company Secretary, Lawyers or Solicitors, Engineers, Architects, Surveyors, Construction contractors or Management Consultants or to a person trained in any other art or craft who holds either a degree or diploma from any institutions established, aided, or recognized by Government or to a person who is considered by the bank as technically qualified or skilled in the field in which he is employed.Purchase new two-wheeler / motorcar of any make for private use or • professional or business use. Purchase second hand / used two-wheeler / motorcar of not more than 5 years old.The Indian Bank’ Association has suggested a model scheme and the Reserve • Bank has suggested that banks adhere to it as much as possible while developing their own scheme.The Reserve Bank suggests that the main emphasis should be to ensure that • every meritorious student though poor is provided with an opportunity to pursue education with the financial support from the banking system with affordable terms and conditions and that no deserving student be denied an opportunity to pursue higher education for want of financial support.Both the student and the parent/guardian should execute the document. The • security can be in the form of land/ building/ Govt. securities/ Public Sector

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Bonds/ Units of UTI, NSC, KVP, LIC policy, gold, shares/ debentures, bank deposit in the name of student/ parent/ guardian or any other third party with suitable margin. Wherever the land/ building are already mortgaged, the unencumbered portion can be taken as security on II charge basis provided it covers the required loan amount. In case the loan is given for purchase of computer the same to be hypothecated to the Bank.Advances against security of shares/debentures/bonds may be given to • individuals, share and stock- brokers and market makers.Dematerialization (“Demat” in short form) is the method by which a person • can get his physical share certificates converted into electronic form, for the same number of holding which is credited to his demat account with a Depository Participant (DP).The Depository System operates in the lines of a banking system. A bank • holds funds in its accounts and transfers funds between accounts whereas a Depository holds securities in accounts and transfers securities between accounts.

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ReferencesFabozzi, F. J., 1998. • Bankloans:secondarymarketandportfoliomanagement.John Wiley and Sons. pp. 40-89. Fisher, E. D., 1920. • Loans:Astudyforbankerandborrower.Bank of Detroit. p.19Indian Bank ‘s Association ,Revised Model Educational Loan Scheme For •Pursuing Higher Studies In India And Abroad [Online] Available at: < http://www.iba.org.in/educational_loan.asp> [Accessed 22 July 2011]Reserve Bank of India, Master Circulars • [Online] Available at: <http://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=5129> [Accessed 22 July 2011]Loans Personal And Business Loans ,• 2010 [Video Online] Available at: <http://www.youtube.com/watch?v=CX35gKtVQ6g> [ Accessed 22 July 2011]Loan How To Choose The Right Loan,2010• ,[Video Online] Available at: <http://www.youtube.com/watch?v=zXz2-1rrMDE> [ Accessed 22 July 2011]

Recommended Reading

Haney, H. L., Logan, L.S., and Gavens, H. S., 1975. • Brokers’ loans. Ayer Publishing. Wood, P.R., 2007. • International Loans, Bonds, Guarantees and Legal Opinions. Sweet & Maxwell. Advani, A., 2009. • BusinessLoansfromFamily&Friends:HowtoAsk,MakeIt Legal & Make It Work. Nolo.

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Self Assessment

__________ loans are those that are given to individuals to meet their needs 1. as opposed to corporate to meet business or commercial imperatives.

Homea. Retailb. Personal c. Educational d.

Which are the loans advanced to individuals for a need?2. Homea. Retailb. Personal c. Educational d.

_____________loans are for the purchase of consumer durables such as 3. washing machines, dish washers, mobile phones, refrigerators, cooking ranges, music systems, televisions and the like.

Consumer durablea. Home b. Health c. Retail d.

Most banks expect the applicant to be at least ___________ years of age and 4. not more than _________years old.

21, 60 a. 18, 70 b. 22, 90 c. 1, 90 d.

Advances against _____________ of shares/debentures/bonds may be given 5. to individuals, share and stock- brokers and market makers.

protectiona. Securityb. defencec. safetyd.

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Banks should exercise particular care when advances are sought against large 6. blocks of shares by a ____________or a group of borrowers.

borrowera. helperb. brokerc. lender d.

Banks may take their own decision in regard to exercise of ______________ 7. rights.

borrowing a. lending b. votingc. speaking d.

The _________may decide the appropriate level of authority for sanction of 8. advances against shares/debentures.

President a. Head of department b. Prime minister c. Boards of Directorsd.

_Which of the following cannot sanction loans to trusts and endowments 9. against the security of shares and debentures?

Borrower a. Bank b. President c. Nation d.

Those eligible are all individuals above the age of _________ years with 10. adequate income to repay the loan in equated monthly instalments.

18a. 60b. 90c. 22d.

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Case Study -State Bank of India

BackgroundThe State Bank of India is the oldest and largest bank in India, with more than $250 billion (USD) in assets. It is the second-largest bank in the world in number of branches; it opened its 10,000th branch in 2008. The bank has 84 international branches located in 32 countries and approximately 8,500 ATMs. Additionally, SBI has controlling or complete interest in a number of affiliate banks, resulting in the availability of banking services at more than 14,600 branches and nearly 10,000 ATMs.SBI traces its heritage to the 1806 formation of the Bank of Calcutta. The bank was renamed the Bank of Bengal in 1809 and operated as one of the three premier “presidency” banks (the presidency banks had the exclusive rights to manage and circulate currency and were provided capital to establish branch networks). In 1921, the government consolidated the three presidency banks into the Imperial Bank of India. The Imperial Bank of India continued until 1955, when India’s central bank, the Reserve Bank of India, acquired the majority interest in the bank and changed its name to the State Bank of India (SBI).In 1959, the Indian government passed the State Bank of India Act, resulting in the acquisition (majority shareholding) of eight state-affiliated banks and the creation of the State Bank of India Group (SBI Group). The SBI itself is now majority owned by the Indian government, which purchased the shares held by the Reserve Bank of India. The State Bank of India and its affiliate banks are profiled in Exhibit 1.

Profile of the State Bank of India and Associate Banks (May 2008)Bank Name Headquarters Branches ATMsState Bank of India Mumbai ,

Maharashtra 10000 8500

State Bank of Bikaner and Jaipur

Jaipur ,Rajasthan 833 336

State Bank Of Hyderabad

Hyderabad, Andhra Pradesh

965 450

State Bank of Indore Indore Madhya Pradesh 965 450State Bank of Mysore Bangalore

Karnataka 654 247

State Bank of Patiala Patiala Punjab 766 353State Bank of Saurashtra

Bhavnagar, Gujarat 452 190

State Bank of Travan-core

Trivandrum, Kerala 706 331

Source: State Bank of India group

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Note: The State Bank of Saurashtra has been consolidated into the State Bank of India

Unlike private-sector banks, SBI has a dual role of earning a profit and expanding banking services to the population throughout India. Therefore, the bank built an extensive branch network in India that included many branches in low-income rural areas that were unprofitable to the bank. Nonetheless, the branches in these rural areas bought banking services to tens of millions of Indians who otherwise would have lacked access to financial services. This tradition of “banking inclusion” recently led India’s Finance Minister P. Chidambaram to comment, “The State Bank of India is owned by the people of India.” A lack of reliable communications and power (particularly in rural areas) hin-dered theimplementation of computerization at Indian banks throughout the 1970s and 1980s. During this period, account information was typically maintained at the local branches with either semi automated or manual ledger card processing. During the 1990s, the Indian economy began a period of rapid growth as the country’s low labour costs, intellectual capital, and improving telecommunications technology allowed India to offer its commercial services on a global basis

This growth was also aided by the government’s decision to allow the creation of private-sector banks (they had been nationalized in the 1960s). The private-sector banks, such as ICICI Bank and HDFC Bank, altered the banking landscape in India. They implemented modern centralized core banking systems and electronic delivery channels that allowed them to introduce new products and provide greater convenience to customers. As a result, the private-sector banks attracted middle and upper-class customers at the expense of the public-sector banks. Additionally, foreign banks such as Standard Chartered Bank and Citigroup used their advanced automation capabilities to gain market share in the corporate and high-net-worth markets.

State Bank of India Core Systems Modernisation Drivers for a New Core System SBI had undertaken a massive computerisation effort in the 1990s to automate all of its branches, implementing a highly customised version of Kindle Banking Systems’ Bankmaster core banking system (now owned by Misys). However, because of the bank’s historic use of local processing and the lack of reliable telecommunications in some areas, it deployed a distributed system with operations located at each branch. Although the computerisation improved the efficiency and accuracy of the branches, the local implementation restricted customers’ use to their local branches and inhibited the introduction of new banking products and centralisation of operations functions. The local implementation prevented the bank from easily gaining a single view of corporate accounts, and management lacked readily available information needed for decision making and strategic planning. The advantages in products and efficiency of the private-sector banks became increasing evident in the late 1990s as SBI (and India’s other public-

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sector banks) lost existing customers and could not attract the rapidly growing middle market in India. In fact, this technology-savvy market segment viewed the public-sector banks as technology laggards that could not meet their banking needs. As a result, the Indian government sought to have the public-sector banks modernise their core banking systems. In response to the competitive threats and entreaties from the government, SBI engaged KPMG Peat Marwick (KPMG) in 2000 to develop a technology strategy and a modernisation road map for the bank. In 2002, bank management approved the KPMG-recommended strategy for a new IT environment that included the implementation of a new centralized core banking system. This effort would encompass the largest 3,300 branches of the bank that were located in city and suburban areas.The State Bank of India’s objectives for its project to modernise core systems included:

The delivery of new product capabilities to all customers, including those in • rural areasThe unification of processes across the bank to realize operational efficiencies • and improve customer serviceProvision of a single customer view of all accounts • The ability to merge the affiliate banks into SBI• Support for all SBI existing products• Reduced customer wait times in branches• Reversal of the customer attrition trend •

Challenges for the BankThe bank faced several extraordinary challenges in implementing a centralised core processing system. These challenges included finding a new core system that could process approximately 75million accounts daily — a number greater than any bank in the world was processing on a centralised basis. Moreover, the bank lacked experience in implementing centralised systems, and its large employee base took great pride in executing complex transactions on local in-branch

Explain the background of State Bank of India (SBI) in brief?1.

Answer: The State Bank of India is the oldest and largest bank in India. It now has more than $250 billion (USD) in assets .State Bank of India traces its heritage to the 1806 formation of the Bank of Calcutta. The bank was renamed the Bank of Bengal in 1809 and operated as one of the three premier “presidency” banks (the presidency banks had the exclusive rights to manage and circulate currency and were provided capital to establish branch networks). In 1921, the government consolidated the three presidency banks into the Imperial Bank of India. The Imperial Bank of India continued until 1955, when India’s central bank, the Reserve Bank of India, acquired the majority interest in the bank and changed its name to the State Bank of India (SBI).In 1959, the Indian government passed the State Bank of India Act, resulting in the acquisition (majority shareholding) of eight state-affiliated banks and the creation of the State Bank of India Group (SBI Group).

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State the State Bank of India’s objectives for its project to modernise core 2. systems?

Answer: The State Bank of India’s objectives for its project to modernise core systems included:

The delivery of new product capabilities to all customers, including those in • rural areasThe unification of processes across the bank to realise operational efficiencies • and improve customer serviceProvision of a single customer view of all accounts • The ability to merge the affiliate banks into SBI• Support for all SBI existing products• Reduced customer wait times in branches• Reversal of the customer attrition trend •

What are the challenges faced by State Bank of India in processing centralised 3. core?

Answer: The bank faced several extraordinary challenges in implementing a centralised core processing system. These challenges included finding a new core system that could process approximately 75million accounts daily — a number greater than any bank in the world was processing on a centralised basis. Moreover, the bank lacked experience in implementing centralised systems, and its large employee base took great pride in executing complex transactions on local in-branch.

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The Internet Banking BoomIn 2001, a Reserve Bank of India survey revealed that of 46 major banks operating in India, around 50% were either offering Internet banking services at various levels or planned to in the near future. According to a research report, while in 2001, India’s Internet user base was an estimated 9 Lakh; it was expected to reach 90 Lakh by 2003. Also, while only 1% of these Internet users utilised the Internet Banking services in 1998, the Internet banking user base increased to 16.7% by mid- 2000.

Many of the major banks like ICICI, HDFC, IndusInd, IDBI, Citibank, Global Trust Bank (GTB), Bank of Punjab and UTI were offering Internet banking services. Based on the above statistics and the analysts’ comments that India had a high growth potential for Internet banking, the players focused on increasing and improving their Internet banking services.

As a part of this, the banks began to collaborate with various utility companies to enable the customers to perform various functions online. ICICI’s ‘Infinity,’ which was already a leader in the Indian Internet banking arena, began to allow its customers to pay their online real time shopping bills. HDFC, through its ‘payment gateway’ feature, allowed its Internet banking customers to make online and real time payments for their purchases.

HDFC also entered into tie-ups with various portals to provide these business-to-customer (B2C) e-commerce transactions. Centurion bank acquired an equity stake in the teauction.com portal to bring together buyers, sellers, suppliers, registered brokers and associations in the tea market and eliminate the need for their physical presence at various auctions. As more banks entered Internet banking arena, the competition between the banks also increased. This compelled the banks to focus on capturing new markets and customers and adopting advanced technology on the Internet. In the light of these developments, industry watchers remarked that Internet banking had arrived in a big way. Though it had a long way to go compared to the global standards, it was beginning to be seen as a replacement for the traditional banking set up in the future.

About Internet BankingGlobally, the banking business has always been in the forefront of harnessing technology to improve its services and efficiency. Banks have been quick to adopt rapidly evolving electronic and telecommunication technologies to deliver an extensive line of value added products and services to their customers. By the early 1990s, direct dial-up connections, personal computers, telebanking and automated teller machines (ATMs) became common in most developed nations. Internet banking evolved in the mid-1990s when Internet and the World Wide Web began to catch on. Soon, many major banks in the US and Europe began to use the Internet to provide banking services.

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Internet banking is a web-based service that enables the bank’s authorised customers to access their account information. It allows the customers to log on to the bank’s website with the help of a bank-issued identification and a personal identification number (PIN).

The banking system verifies the user and provides access to the requested services. The range of products and services offered by each bank on the Internet differs widely in their content. Most banks offer Internet banking as a value-added service. Internet banking has also led to the emergence of new banks, which operate only through the Internet and do not exist physically. Such banks are called ‘Virtual’ banks or ‘Internet only’ banks.

The products and services offered by the banks on the Internet can be divided into three types:

Information Kiosks: • It includes providing information regarding various products and services offered by the bank to its customers and others in general. The bank’s site receives and answers queries of customers through e-mails.Basic Internet Banking:• It includes enabling customers to open new accounts, check account balance and pay utility bills.E-commerce Banking: Banks function as electronic market places • (e-market place) enabling customers to use their accounts for money transfers, bills payment, purchase and sale of securities and online real time purchases and payments.

QuestionsExplain Internet Banking in brief.1. What are the products and services offered by the Banks on the internet?2. Explain the Internet Banking boom?3.

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State Bank of India, Resurgent India Bond Issued For Non-Resident Indians.

The ClientThe State Bank of India, one of the largest commercial banks in India provides personal and corporate banking services worldwide through its network of more than 14,000 Branches across the world. The Bank has accepted the NRI Deposits through its exclusive branch called “NRI Branch - Mumbai” under the guidelines of Reserve Bank of India.

The ChallengeThe NRI branch came out with a Resurgent India Bond Issue focusing on Non - Resident Indians only. At the time of issue, the applications were received from the NRI Investors along with their cheques. These investments came in three currencies. The Bank had to pay interest on half yearly basis to the Investors and finally on maturity, the entire investment was redeemed. They needed a thoroughly tested system, which could take care of all the above activities and the various reports required by the statutory bodies like Reserve Bank of India.

The SolutionComputronics was the back office service provider to SBI - NRI Branch for this issue. The RIB Bond Issue lasted for 30 days, which collected $4.3 billion from approximately 150,000 investors across the globe. To expedite the work the bank had designated 125 centres for collecting the applications. These were received by Computronics via post or fax. The applications were verified and then entered to into a database. As part of the processing, the application were also scanned and indexed according the SBI-NRI Branches requirements. The physical documents were also bar coded and stored. After processing the forms, individual certificates were issued and posted to the investors within 30 days of receiving the applications. Various MIS reports were also generated for the bank as per their requirements.

The Benefits:Computronics provided prompt and a customized solution to SBI-NRI Bond Issue to enable them to submit requirement information to the regulatory and statutory bodies in a given format and time.

Questions What facilities were introduced by the State Bank of India for NRIs?1. What challenges did SBI face when they issued Resurgent India Bond for 2. NRIs?What was the solutions and benefits provided by SBI?3.

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ReferencesAbout.com inventors, • Automatic Teller Machines –ATM [Online] Available at: <http://inventors.about.com/od/astartinventions/a/atm.htm> [Accessed 22 July 2011]Akhan, J., 2010. • Non-banking Financial Companies (Nbfcs) in India:Functioning and Reforms, New Century Publications.Amendments to NBFC Regulations,[Online] Available at: <http://rbidocs.rbi.• org.in/rdocs/notification/PDFs/14935.pdf> [Accessed 20 July 2011]Baxter, J., 2000. • Personalbanking:2000marketreport.Key Note publications. pp. 56-90Bhattacharya, H., 1999, Banking Strategy, Credit Appraisal and Lending • Decisions: A Risk-Return Framework, Oxford University Press, USA.Black, K., Skipper, H, D., 1987. • Life insurance. Prentice Hall. Pp10-29. Business maps of India, Financial Institutions in India, [Online] • Available at <http://business.mapsofindia.com/finance-commission/institutions//>[Accessed 19 July 2011]eHow, 2009,• CreditCards&PersonalLoans :DifferentTypesof SavingsAccounts[Video Online] Available at: <http://www.youtube.com/watch?v=C1Yc49PIgBY> [Accessed 22 July 2011]eHow,2008, • InsuranceInformation:HowtoSellInsurance [Video Online]Available at: <http://www.youtube.com/watch?v=mglc11qx1Gc&feature=fvsr> [Accessed 22 July 2011]Fabozzi, F, J., 1998. • Bankloans:secondarymarketandportfoliomanagement.John Wiley and Sons. pp.40-89. Financial Grant from NABARD on Tailoring Trade• , [Video Online] Available at: <http://www.youtube.com/watch?v=XCPnVMHWEY8&feature=relate>[Accessed 19 July 2011]Fisher, E, D., 1920. • Loans:Astudyforbankerandborrower.Bank of Detroit. P. 19ICRA Online Mutual Funds India.com Mutual• , Funds Basics [Online] Available at: <http://www.mutualfundsindia.com/mfbasic.asp> [Accessed 20 July 2011]Indian Bank ‘s Association, • Revised Model Educational Loan Scheme For Pursuing Higher Studies In India And Abroad[Online] Available at: <http://www.iba.org.in/educational_loan.asp> [Accessed 22 July 2011]Insurancewebsales,2007, • Selling Insurance on the Internet -by Gary Savelli [Video Online]Available at: <http://www.youtube.com/watch?v=b4OjNxkFRN0&feature=related> [Accessed 22 July 2011]Investopedia, • Health Insurance [Online] Available at: <http://www.investopedia.com/terms/h/healthinsurance.asp> [Accessed 22 July 2011]

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Investorwords.com, • Health Insurance [Online] Available at: <http://www.investorwords.com/2289/health_insurance.html> [Accessed 22 July 2011]Lehwald, E., Hanley, C., 1990. • Personal Banking. Longmeadow Pr. p. 90 Loans Personal And Business Loans, Loan How To Choose The Right Loan, • 2010,[Video Online]Available at: <http://www.youtube.com/watch?v=zXz2-1rrMDE> [ Accessed 22 July 2011]Machiraju, H. R., 2010, • Indian Financial System. 4th ed., Vikas Publishing House Pvt. Ltd.Maps of the world finance, Financial Institutions in India, [Online] Available • at: <http://finance.mapsofworld.com/financial-institutions/india/> [Accessed 19 July 2011]MarketVisionVideo, 2011, • OpenandClosedEndedMutualFunds [Video Online] Available at: <http://www.youtube.com/watch?v=FedXFIf2oJY&feature=related> [Accessed 20 July 2010]MarketVisionVideo, 2011. • Introduction to Mutual Funds in India, [Video Online] Available at: <http://www.youtube.com/watch?v=mInPCUXo0lw> [Accessed 20 July 2010]Mind map, 2010, • Overview of the Banking System of India, [Video Online] Available at: <http://www.youtube.com/watch?v=PcysuzxkqJo> [Accessed 20 July 2011]Mortgage Choice, • Whichhomeloantypeswouldsuityoumost? Available at: <http://www.mortgagechoice.com.au/buying-next-home/loan-types.aspx> [Accessed 22 July 2011]Ndtvprofit• ,Indiamustmovefasteronfinancialsectorreform:Virmani, [Video Online] Available at: <http://www.youtube.com/watch?v=wQH55v1HyUY> [Accessed 19 July 2011]Ndtvprofit,2008,• Bank status likely for NBFCs, [Video Online] Available at: <http://www.youtube.com/watch?v=AdMNjVQlkXA> [Accessed on 20 July 2011]Norton, B, C., .• Life insurance: its nature, origin and progress; a plainexpositionoftheprinciplesoflifeinsurance.Business and economics. pp. 87. Parker, P.M., 2006, • The 2007-2012 Outlook for Mutual Funds in India, ICON Group International, Inc.PersonalLoans,CreditCards&DebtConsolidationAllTypesOfLoansGuaranteed•ApprovalVisit, 2009, [Video Online] Available at: <http://www.youtube.com/watch?v=f43hcoHmqfc> [Accessed 22 July 2011]Reserve Bank of India [Online]Available at: <http://www.rbi.org.in/• commonman/English/scripts/nbfcs.aspx> [Accessed 20 July 2011]Reserve Bank of India, Master Circulars [Online] Available at: <http://www.• rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=5129> [Accessed 22 July 2011]

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Sadhak, H., 2003, • MutualFundsinIndia(ResponseBooks), 2nd ed., Sage Publications Pvt. Ltd.UTI Mutual Fund, • Our Fund, Available at: <http://www.utimf.com/product_services/funds/fund_display.aspx> [Accessed 20 July 2011]Venugopal and Murthy, 2006. • Indian Financial Systems, I K International Publishing House

Recommended ReadingAdvani, A., 2009. Business Loans from Family & Friends: How to Ask, Make • It Legal & Make It Work. Nolo. Belth, M, J., 1985.Life• insurance: a consumer’s handbook.Business and Economic. Bhasin, N., 2004, • IndianFinancialSystem:Reforms,PoliciesandProspects, New Century Publications.Cummins, D, J., 1999. • Changes in the life insurance industry: efficiency,technology, and risk management. Business and Economic. P 369.Dalal, K, A., • Bharat’spolicies&proceduresfornon-residentIndians. Bharat Pub. House.Dr. Mishra, D. C., and Metilda M. J., 2010. • The Retail Investor and The MutualFundIndustryinIndia:ChallengesandProspects, LAP LAMBERT Academic Publishing.Gupta, S• ., 2011,MutualFundIndustry-GrowthandFutureProspects:(ACase Study of Indian Mutual Fund Industry), LAP LAMBERT Academic PublishingHaney, H. L., Logan, L. S., and Gavens, H. S., 1975. • Brokers’ loans. Ayer Publishing. Kerem, K., 2003. • Internet banking in Estonia. PRAXIS. Sekhar, G.V.S., 2011, • PerformanceAppraisalofMutualFundsInIndia:ACaseStudyOfPublicVsPrivateSectorMutualFunds,VDM Verlag.Steuer, A., 2007.• QuestionsandAnswersonLifeInsurance:TheLifeInsuranceToolbook. Iuniverse Inc. Tarapore, S.S., 2011, Financial• PoliciesandEverydayLife:TheIndianContext,Academic Foundation.Thomas S., Shah, A., and Gorham, M., 2008. • India’sFinancialMarkets:AnInsider’s Guide to How the Markets Work (Elsevier and IIT Stuart Center for Financial Markets Press), Elsevier Science.Welch, B., 1999. • Electronic banking and treasury security. Wood head Publishing. Wood, P. R., 2007. International Loans, Bonds, Guarantees and Legal • Opinions. Sweet & Maxwell.

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Self Assessment Answers

Chapter Id1. a2. a3. a4. d5. c6. b7. c8. a9. b10.

Chapter IIb1. a2. d3. d4. c5. b6. d7. c8. c9. a10.

Chapter IIIb1. a2. a3. c4. a5. d6. a7. c8. a9. a10.

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Chapter IVa1. c2. c3. a4. b5. a6. a7. b8. d9. b10.

Chapter Vb1. a2. c3. d4. a5. a6. d7. a8. b9. b10.

Chapter VIb1. c2. a3. a4. b5. a6. c7. d8. b9. a10.

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