Professional Documents
Culture Documents
Financial Institutions
1
constitute less than one-fifth of the total assets. The 33 foreign banks operating in
India account for about 6-7 per cent of the assets of SCBs. The 196 RRBs play a
critical role in extending credit to the poorer sections of the rural society. The
ownership of RRBs jointly vests with the Central Government, the State
Governments and the sponsor banks. The co-operative banking system, with two
broad segments of urban and rural co-operatives, forms an integral part of the
Indian financial system. While the urban co-operative banking system has a
single tier comprising the Primary Co-operative Banks (commonly known as
ʹurban co-operative banks – UCBs), the rural co-operative credit system is
divided into long-term and short-term co-operative credit institutions which
have a multi-tier structure.
Pre-reforms Phase
Until the early 1990s, the role of the financial system in India was
primarily restricted to the function of channelling resources from the surplus to
deficit sectors. Whereas the financial system performed this role reasonably well,
its operations came to be marked by some serious deficiencies over the years.
The banking sector suffered from lack of competition, low capital base, low
productivity and high intermediation cost. After the nationalisation of large
banks in 1969 and 1980, the Government-owned banks dominated the banking
2
sector. The role of technology was minimal and the quality of service was not
given adequate importance. Banks also did not follow proper risk management
systems and the prudential standards were weak. All these resulted in poor asset
quality and low profitability. Among non-banking financial intermediaries,
development finance institutions (DFIs) operated in an over-protected
environment with most of the funding coming from assured sources at
concessional terms. In the insurance sector, there was little competition. The
mutual fund industry also suffered from lack of competition and was dominated
for long by one institution, viz., the Unit Trust of India. Non-banking financial
companies (NBFCs) grew rapidly, but there was no regulation of their asset side.
Financial markets were characterised by control over pricing of financial assets,
barriers to entry, high transaction costs and restrictions on movement of
funds/participants between the market segments. This apart from inhibiting the
development of the markets also affected their efficiency.
(The major achievements of the financial sector reforms are presented in Slide 4).
3
The reform of the interest regime constitutes an integral part of the
financial sector reform. With the onset of financial sector reforms, the interest
rate regime has been largely deregulated with a view towards better price
discovery and efficient resource allocation. Initially, steps were taken to develop
the domestic money market and freeing of the money market rates. The interest
rates offered on Government securities were progressively raised so that the
Government borrowing could be carried out at market-related rates. In respect of
banks, a major effort was undertaken to simplify the administered structure of
interest rates. Banks now have sufficient flexibility to decide their deposit and
lending rate structures and manage their assets and liabilities accordingly. At
present, apart from savings account and NRE deposit on the deposit side and
export credit and small loans on the lending side, all other interest rates are
deregulated.
Indian banking system operated for a long time with high reserve
requirements both in the form of Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR). This was a consequence of the high fiscal deficit and a
high degree of monetisation of fiscal deficit. The efforts in the recent period have
been to lower both the CRR and SLR. The statutory minimum of 25 per cent for
SLR has already been reached, and while the Reserve Bank continues to pursue
its medium-term objective of reducing the CRR to the statutory minimum level
of 3.0 per cent, the CRR of SCBs is currently placed at 5.0 per cent of NDTL.
4
foreign banks have been allowed more liberal entry. Since 1993, twelve new private
sector banks have been set up. As a major step towards enhancing competition in the
banking sector, foreign direct investment in the private sector banks is now allowed up to
74 per cent, subject to conformity with the guidelines issued from time to time.
5
Over the last few years, the several policy initiatives undertaken in the
form of recapitalisation of the weak RRBs, deregulation of deposits and lending
rates and relaxation to lend to non-target groups, have improved their
operational efficiency, governance and regulation and brought them almost at
par with the rural branches of commercial banks.
6
Housing Bank (NHB), and EXIM Bank. At the State level, the State Financial
Corporations registered under the State Financial Corporations Act, 1951 and the
State Industrial Development Corporations (SIDCs) - purvey credit to
industries/sectors in different States. On balance, the development financial
institution (DFI) model has become increasingly unsustainable and AIFIs are fast
adopting the business model of a bank for long-term commercial viability.
7
Table 1: Select Financial Sector Indicators: 2002-03 vis-a-vis 2003-04
Financial Indicator 2002-03 2003-04
Entity
1 2 3 4
1. Scheduled a) Growth in Major Aggregates (Per cent)
Commercial Aggregate Deposits 13.4 * 17.5
Banks Non-food Credit 18.6 * 18.4
Investment in Government Securities 27.3 25.1
b) Financial Indicators (as percentage of total assets)
Operating Profits 2.4 2.7
Net Profits 1.0 1.1
Spread 2.8 2.9
c) Non-Performing Assets (as percentage of advances)
Gross NPAs 8.8 7.2
Net NPAs 4.4 2.9
d) CRAR 12.7 12.9
2. Scheduled a) Growth in Major Aggregates (Per cent)
Urban Deposits 9.1 8.6
Co-operative Credit 4.5 4.0
Banks b) Financial Indicators (as percentage of total assets)@
Operating Profits 1.4 2.1
Net Profits -1.1 0.9
Spread 2.1 2.7
c) Non-Performing Assets (as percentage of advances)
Gross NPA 21.0 28.9
d) CRAR N.A. N.A.
3. All-India a) Growth in Major Aggregates (per cent)1
Financial Sanctions -31.3 65.2
Institutions Disbursements -30.5 25.9
b) Financial Indicators (as percentage of total assets) 2
Operating Profits 1.4 1.3
Net Profits 0.9 0.9
Spread 0.7 0.2
c) Non-Performing Assets (as percentage of advances) 2
Net NPA 10.6 N.A.
8
d) CRAR
i) IDBI 18.7 18.3
ii) IFCI 0.95 -17.0
iii) SIDBI 44.0 51.6
iv) NABARD 39.1 39.4
v) IDFC 51.3 36.9
4. Non-banking a) Growth in Major Aggregates (per cent)
Financial Public Deposits 6.8 —
Companies b) Financial Indicators (as percentage of total assets)
Net Profits 0.9 —
c) Non-Performing Assets (as percentage of advances)3
Net NPA 2.9 N.A.
CRAR 93.7#
*Adjusted for merger. @ Relates to scheduled urban co-operative banks.
# percentage of NBFCs above 30 per cent CRAR.
1. Comprise IDBI, IFCI, IIBI, IDFC, SIDBI, IVCF, ICICI Venture, TFCI, LIC, UTI, and GIC.
2. Comprise following nine FIs, viz., IDBI, IFCI, IIBI, IDFC, Exim Bank, TFCI, SIDBI, NABARD and NHB.
3. For reporting companies with variations in coverage.
Financial Markets
9
episodes of volatility in the foreign exchange market, these were swiftly controlled by
appropriate policy measures. The capital market also underwent some metamorphic
changes during the 1990s. The development of the financial markets was well supported
by deregulation of balance sheet restrictions in respect of financial institutions, allowing
them to operate across markets. This resulted in increased integration among the various
segments of the financial markets.
The Indian capital market is more than a century old. Its history goes back
to 1875, when 22 brokers formed the Bombay Stock Exchange (BSE). Over the
period, the Indian securities market has evolved continuously to become one of
the most dynamic, modern, and efficient securities markets in Asia. Today,
Indian market confirms to best international practices and standards both in
terms of structure and in terms of operating efficiency.
a) The Companies Act 1956 deals with issue, allotment and transfer of
securities and various aspects relating to company management. It
provides norms for disclosures in the public issues, regulations for
underwriting, and the issues pertaining to use of premium and discount
on various issues.
10
c) The SEBI Act empowers SEBI to protect the interest of investors in the
securities market, to promote the development of securities market and to
regulate the security market.
The major reforms in the Indian capital market since the 1990s are
presented below:
As a first step to reform the capital market, the Securities and Exchange
Board of India (SEBI), which was earlier set up in April 1988 as a non-
statutory body under an administrative arrangement, was given statutory
powers in January 1992 through an enactment of the SEBI Act, 1992 for
regulating the securities markets. Twin objectives mandated in the SEBI
11
Act are investor protection and orderly development of the capital
market.
The most significant development in the primary capital market has been
the introduction of free pricing. The issuers of securities are now allowed
to raise the capital from the market without requiring any consent from
any authority either for making the issue or for pricing it. However, the
issue of capital has been brought under SEBI’s purview in that issuers are
required to meet the SEBI guidelines for Disclosure and Investor
Protection, which, in general, cover the eligibility norms for making issues
of capital (both public and rights) at par and at a premium by various
types of companies, reservation in issues, etc.
The abolition of capital issues control and the freeing of the pricing of
issues led to unprecedented upsurge of activity in the primary capital
market as the corporates mobilised huge resources. It, inter alia, exposed
certain inadequacies of the regulations. Therefore, without seeking to
control the freedom of the issuers to enter the market and freely price
their issues, the SEBI further strengthened the norms for public issues in
April 1996. Alongside, SEBI raised the standards of disclosure in public
issues to enhance their transparency for improving the levels of investor
protection. Issuers of capital are now required to disclose information on
various aspects, such as, track record of profitability, risk factors, etc.
Issuers now also have the option of raising resources through fixed price
floatations or the book building process.
12
The trading and settlement cycles were initially shortened from 14 days to
7 days. Subsequently, to further enhance the efficiency of the secondary
market, rolling settlement was introduced on a T+5 basis. With effect from
April 1, 2002, the settlement cycle was further shortened to T+3 for all
listed securities. The settlement cycle is now T+2.
In India, all listed companies are now required to furnish to the stock
exchanges and also publish unaudited financial results on a quarterly
basis. To enhance the level of continuous disclosure by the listed
companies, the SEBI decided to amend the Listing Agreement to
incorporate the Segment Reporting, Accounting for Taxes on Income,
Consolidated Financial Results, Consolidated Financial Statements,
Related Party Disclosures and Compliance with Accounting Standards.
13
international capital markets through issues of Global Depository Receipts
(GDRs), American Depository Receipts (ADRs), Euro Convertible Bonds
(ECBs), etc.
(The major reforms in Indian capital market are presented in Slide 8-11)
14
Foreign Institutional Investment in India
Each FII (investing on its own) or sub-account cannot hold more than 10
per cent of the paid-up capital of a company. A sub-account under the
15
foreign corporate/individual category cannot hold more than 5 per cent of
the paid up capital of the company.
(The limits on FII investments and trends in FII investments in India are presented in
Slide 12-13)
The Indian equity market has developed tremendously since the 1990s.
The market has grown exponentially in terms of resource mobilisation, number
of listed stocks, market capitalisation, trading volumes, turnover and investors’
base. Along with this growth, the profiles of the investors, issuers and
intermediaries have changed significantly. The market has witnessed a
fundamental institutional change resulting in drastic reduction in transaction
costs and significant improvement in efficiency, transparency and safety. In the
1990s, reform measures initiated by the SEBI such as, market determined
allocation of resources, rolling settlement, sophisticated risk management and
16
derivatives trading have greatly improved the framework and efficiency of
trading and settlement. Almost all equity settlements take place at two
depositories. As a result, the Indian capital market has become qualitatively
comparable to many developed markets.
There are 23 stock exchanges in the country with 9413 listed companies as
at end-December 2004. The market capitalization of BSE has grown over the
period and is estimated at Rs.16,860 billion as at end-December 2004. (Slide 14).
(The comparative picture of Indian capital market with select country groups is
presented in Slide 15)
Indian stock markets are currently trading at all-time high levels. The BSE
Sensex (a BSE index comprising 30 large-cap companies with Base: 1978-79=100)
closed at all-time high level of 7859.53 on August 17, 2005. On a point-to-point
basis, the BSE Sensex has gained 21.05 per cent during the current financial year
so far (up to August 17, 2005). The rally has been supported by strong investment
by the FIIs, satisfactory progress of monsoon, firm trends in the international
markets and satisfactory financial results by the corporates for Q1 2005-06.
The gains in the stock markets in the financial year so far have been
widespread among blue-chips as well as small and mid-cap stocks.
17
The Indian stock markets have outperformed the other markets. On point-
to-point basis, the BSE Sensex witnessed an increase of 21.05 per cent during
current financial year so far (up to August 17, 2005) over end-March 2005, as
compared with Hong Kong (14.3 per cent), Japan (5.2 per cent), UK (8.1 per cent),
US (Dow Jones – 0.4 per cent), South Korea (15.3 per cent), Taiwan (3.9 per cent),
Indonesia (3.1 per cent), and Malaysia (6.3 per cent).
(The latest trends in Indian stock markets are presented in Slide 16)
In recent years, the endeavour of the Reserve Bank has been to improve
the efficiency of the financial system by ensuring safe, secure and effective
payment and settlement system. In the process, the Reserve Bank apart from
performing the regulatory and oversight functions has also played an important
role in promoting its functionality and modernisation on an on-going basis. The
consolidation of the existing payment systems revolves around strengthening
computerised cheque clearing, expanding the reach of Electronic Clearing
Services (ECS) and Electronic Funds Transfer (EFT). The critical elements of the
developmental strategy are opening of new clearing houses, interconnection of
clearing houses through the Indian Financial Network (INFINET); development
of Real Time Gross Settlement (RTGS) System, Centralised Funds Management
System (CFMS), Negotiated Dealing System (NDS) and the Structured Financial
Messaging System (SFMS). Similarly, integration of the various payment
products with the systems of individual banks has been another thrust area. A
Board for Regulation and Supervision of Payment and Settlement Systems
(BPSS) has also been recently constituted to prescribe policies relating to the
regulation and supervision of all types of payment and settlement systems, set
standards for existing and future systems, authorise the payment and settlement
systems and determine criteria for membership to these systems.
18
The Indian Financial Sector: Some Issues
The major challenges facing the banking sector are the judicious
deployment of funds and the management of revenues and costs. Concurrently,
the issues of corporate governance and appropriate disclosures for enhancing
market discipline have received increased attention for ensuring transparency
and greater accountability. Financial sector supervision is increasingly becoming
risk based with the emphasis on quality of risk management and adequacy of
risk containment. Consolidation, competition and risk management are no doubt
critical to the future of Indian banking, but governance and financial inclusion
have also emerged as the key issues for the Indian financial system.
The capital market in India has become efficient and modern over the
years. It has also become much safer. However, some of the issues would need
to be addressed. Corporate governance needs to be strengthened. Retail
investors continue to remain away from the market. The private corporate debt
market continues to lag behind the equity segment.
19