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International Financial System vs Indian Financial System

Primary function of the financial system is the mobilisation of savings, their distribution for industrial investment and stimulating capital formation to accelerate the process of economic growth International Financial System- It consists of institutions and regulators that act on the international level Features of international finance areForeign Exchange Risk The risk of an investment's value changing due to changes in currency exchange rates The risk that an investor will have to close out a long or short position in a foreign currency at a loss due to an adverse movement in exchange rates. This risk usually affects businesses that export and/or import, but it can also affect investors making international investments. For example, if money must be converted to another currency to make a certain investment, then any changes in the currency exchange rate will cause that investment's value to either decrease or increase when the investment is sold and converted back into the original currency

International Financial System vs Indian Financial System

Political Risk The risk of loss when investing in a given country caused by changes in a country's political structure or policies, such as tax laws, tariffs etc The outcome of a political risk could drag down investment returns or even go so far as to remove the ability to withdraw capital from an investment The extreme form of political risk is when the sovereign country changes the rules of the game and the affected parties have no alternatives open to them. Eg- In 1992, Enron Development Corporation signed a contract to build Indias longest power plant. Unfortunately, the project got cancelled in 1995 by the politicians in Maharashtra who argued that India did not require the power plant. The company had spent nearly $300 mn on the project The Enron episode highlights the problems involved in enforcing contracts in foreign countries Political risk associated with international operations is generally greater than that associated with domestic operations and is generally more complicated Expanded opportunity sets When firms go global they tend to benefit from expanded opportunities They can raise funds in capital markets where cost of capital is the lowest

International Financial System vs Indian Financial System

Market Imperfections A situation in which the market does not allocate resources efficiently Market failure can occur When one party has power that can prevent efficient transactions from occurring.eg- monopoly Finally, market failure can occur because of the nature of certain goods or services Some analysts believe that market failure is usually the result of insufficient government protection of property rights. Market failure has been cited as a reason for government intervention in the economy International Monetary System It consists of elements such as laws, rules, agreements, institutions, mechanisms and procedures which affect foreign exchange rates, balance of payments adjustments, international trade and capital flows It plays a crucial role in the financial management of a multinational business and economic and financial policies of each country

International Financial System vs Indian Financial System

Evolution of the International Monetary System can be analysed in four stages Gold standards The government of each country defines its national monetary unit in terms of gold Free import/export of gold Two-way convertibility between gold and national currencies at a stable ratio Inter-war Years War interrupted trade flows and disturbed the stability of exchange rates for currencies of major countries Widespread fluctuation in currencies in terms of gold Half-hearted attempts and failure to restore the gold standard Economic and political instabilities Bank failures and financial crisis

International Financial System vs Indian Financial System

Bretton Woods System Revival of the system was necessary and the reconstruction of the post-war financial system began with the Bretton Woods Agreement that emerged from the International Monetary and Financial Conference in July 1944 at Bretton Woods There was a general agreement that restoring the gold standard was out of question Governments needed access to credits in convertible currencies if they were to stabilise exchange rates Governments should make major adjustments in exchange rates only after consultation with other countries A monetary system was needed that would recognise that exchange rates were both a national and an international concern The agreement established a dollar based International Monetary System and created two new institutions International Monetary Fund(IMF)- To help countries with balance of payments and exchange rate problems International Bank for Reconstruction and Development(World Bank)- To help countries with post-war reconstruction and general economic development

International Financial System vs Indian Financial System

Flexible Exchange Rate Regime Crawling Peg A system of exchange rate adjustment in which a currency is allowed to fluctuate within a band of rates The disadvantage of this system is that it requires countries to have ample reserves for the prolonged process of adjustment. Also, the minor adjustments may not correct the currencys overvaluation or undervaluation Wide Band The purpose of the wide band is to compensate for the rigidity of the fixed rate systems Similar to and yet different from the adjustable peg system, the wide band allows the currency value to fluctuate by say 5% on each side of the par Flexible(Floating)System The market force based on demand and supply, determines a currencys value In the absence of government intervention the float is said to be clean. It becomes dirty when there is a central bank intervention to influence exchange rates

International Financial System vs Indian Financial System

International Financial Institutions World Bank It helps provide long term capital for the reconstruction and development of member countries It provides much of the planning and financing for economic development projects The World Bank has a stated goal of reducing poverty All of its decisions must be guided by a commitment to promote foreign investment, international trade and facilitate capital investment International Bank for Reconstruction and Development(IBRD) It provides funds to borrowers by borrowing funds in the world capital markets, from the proceeds of loan repayments as well as retained earnings The funds for this lending come primarily from the issuing of World Bank bonds on the global capital markets

International Financial System vs Indian Financial System

Because of the IBRD's credit rating, it is able to borrow at relatively low interest rates. As most developing countries have considerably lower credit ratings, the IBRD can lend to countries at interest rates that are usually quite attractive to them, even after adding a small margin (about 1%) to cover administrative overheads The banks major objective is to serve as an international financing facility to function in reconstruction and development International Development Association(IDA) It is responsible for providing long-term, interest-free loans to the world's poorest countries Credit terms are usually extended to 40 to 50 years with no interest Repayment begins after a ten-year grace period and can be paid in the local currency as long as it is convertible While the IBRD raises most of its funds on the world's financial markets, IDA is funded largely by contributions from the governments of the richer member countries IDA loans address primary education, basic health services, clean water supply and sanitation, environmental safeguards, business-climate improvements, infrastructure and institutional reforms. These projects are intended to pave the way toward economic growth, job creation, higher incomes and better living condition

International Financial System vs Indian Financial System

International Finance Corporation(IFC) It shares the primary objective of improving the quality of the lives of people in its developing member countries IFC is the largest multilateral source of loan and equity financing for private sector projects in the developing world. It promotes sustainable private sector development primarily by: Financing private sector projects and companies located in the developing world Helping private companies in the developing world mobilize financing in international financial markets Providing advice and technical assistance to businesses and governments Loans are made to private firms ususlly for a period of seven to twelve years Multilateral Investment Guarantee Agency(MIGA)1 MIGA promotes foreign direct investment into developing countries by insuring investors against political risk, advising governments on attracting investment, sharing information through on-line investment information services, and mediating disputes between investors and governments

International Financial System vs Indian Financial System

International Monetary Fund(IMF) It works to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world The IMF's fundamental mission is to help ensure stability in the international system. It does so in three ways: keeping track of the global economy and the economies of member countries; lending to countries with balance of payments difficulties, and giving practical help to members The IMF provides loans to countries that have trouble meeting their international payments and cannot otherwise find sufficient financing on affordable terms The IMF also provides concessional loans to low-income countries to help them develop their economies and reduce poverty

International Financial System vs Indian Financial System

Asian Development Bank(ADB) It is a regional development bank to facilitate economic development of countries in Asia, reduce poverty and improve the quality of life of their people ADB will follow three complementary strategic agendas: inclusive growth(implies an equitable allocation of resources with benefits accruing to every section of society, which is a utopian concept ), environmentally sustainable growth and regional integration In pursuing its vision, ADBs main instruments comprise loans, technical assistance, grants, advice and knowledge Indian Financial System Organised sector It consists of Banking system Cooperative system

International Financial System vs Indian Financial System

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Development banking system Public sector Private sector Money markets Financial companies/institutions Unorganised sector It consists of moneylenders, indigenous bankers, lending pawn brokers, landlords, traders etc This part of the financial system is not directly amenable to control by the RBI

International Financial System vs Indian Financial System

Role/ Functions of Financial System It serves as a link between savers and investors. It helps in utilizing the mobilized savings of scattered savers in more efficient and effective manner It assists in the selection of the projects to be financed and also reviews the performance of such projects periodically It provides payment mechanism for exchange of goods and services It provides a mechanism for the transfer of resources across geographic boundaries It provides a mechanism for managing and controlling the risk involved in mobilizing savings and allocating credit. It promotes the process of capital formation by bringing together the supply of saving and the demand for investible funds. It helps in lowering the cost of transaction and increase returns. Reduce cost motives people to save more. It provides you detailed information to the operators/ players in the market such as individuals, business houses, Governments etc.

International Financial System vs Indian Financial System

Components/ Constituents of Indian Financial system Financial Market The main functions of financial markets are: To facilitate creation and allocation of credit and liquidity To serve as intermediaries for mobilization of savings To assist process of balanced economic growth To provide financial convenience Components areMoney Market It is a wholesale debt market for low risk, highly liquid, short term instrument Funds are available in this market from a single day up to a year This market is dominated mostly by government, banks and financial institutions Capital Market It is designed to finance the long term investments for periods over a year

International Financial System vs Indian Financial System

Forex Market It deals with the multicurrency requirements, which are met by the exchange of currencies Depending on the exchange rate the transfer of funds takes palce in the market Credit Market It is a place where banks, FIs and NBFCs purvey short, medium and long term loans to corporate and individuals Financial Intermediaries- To ensure transfer of funds from the lender to the borrower Financial Instruments Money market is regulated by RBI and SEBI regulates capital market Capital market consists of primary(IPO) and secondary market Money Market Instruments Call/Notice Money Treasury Bills Term Money Certificate of Deposit Commercial Papers

International Financial System vs Indian Financial System

Capital Market Instruments In the equity segment Equity shares, preference shares etc In the debt segment zero coupon bonds, deep discount bonds etc Hybrid Instruments Hybrid instruments have both the features of equity and debenture. Egconvertible debentures, warrants etc Financial Institutions They are the intermediaries who facilitates smooth functioning of the financial system by making investors and borrowers meet They mobilize savings of the surplus units and allocate them in productive activities promising a better rate of return Financial institutions also provide services to entities seeking advises on various issues ranging from restructuring to diversification plans They provide whole range of services to the entities who want to raise funds from the markets elsewhere Financial institutions act as financial intermediaries because they act as middlemen between savers and borrowers

Financial Institutions

Role of Financial Institutions Reasons for the existence of financial institutions are Economic development Financial stability The FI plays an important role in complementing the facilities offered by the banks in an economy They are the key players in the development of the capital market in any economy FI were established to ensure that industry got sufficient long term funds in the desired sectors and in accordance with the priorities determined Types of FI Central Bank- RBI Commercial Banks- SBI, SBH They provide the deposits and lending services to its customers They facilitate the flow of goods and services from producers to consumers and helps in financial activities of governments They provide a large portion of our medium of exchange and they are the media through which monetary policy is affected

Financial Institutions

Credit Rating Agencies- CRISIL, CARE It estimates the credit worthiness of an individual, corporation or even a country It is an evaluation made by credit bureaus of a borrowers overall credit history Financial Authorities- RBI, SEBI, CBDT Insurance Companies- LIC, GIC They are in the business of assuming risk on behalf of their customers in exchange for a fee , called a premium Merchant Banks It is a financial institution primarily engaged in offering financial services and advice to corporations and to wealthy individuals Merchant bank invests its own capital in client companies They provide fee-based corporate advisory services, including those in mergers and acquisitions

Financial Institutions

Mutual Funds It is a trust that pools the savings of a number of invetsors who share a common financial goal The money collected is invested in capital market instruments such as shares, debentures etc 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 Mutual fund is the most suitable investment for the common man as it offers an opportunity to invets in a diversified, professionally managed absket of securities at a relatively low cost Specialised FI- EXIM Bank of India, SIDBI They are government undertakings established with a view to offer financial as well as technical assistance to the Indian industries Venture Capitalists Venture capital is a type of private equity capital typically provided to earlystage, high potential and growth companies in the interest of generating a return through an eventual realization event such as an IPO or trade sale of the company

Financial Institutions

Regulatory Theory of Financial Institutions RBI It is fully owned by the GOI and acts as the central regulatory authority with regard to the functioning of the various commercial banks and other financial institutions in India To act as the note-issuing authority of all denominations and keep the reserves with a view to secure monetary stability in India It operates the currency and credit system of the country through qualitative and quantitative controls It controls the banking system through the system of licensing and establishments, branch expansion, liquidity of assets, management and methods of working etc It acts as the lender of the last resort by providing rediscount facilities to scheduled banks It is required to maintain price stability and ensure adequate flow of credit to productive sectors Bankers Bank, Banker to the government and to promote the growth of the economy

Financial Institutions

To eliminate moneylenders from the villages the RBI has set up the Agricultural Refinance and Development Corporation to provide long term finance to farmers It is the controller of foreign exchanges and worked as the watchdog of the entire financial system, Besides maintaining the rate of exchange of rupee, the RBI has to act as the custodian of Indias reserves of international currencies The RBI as the central bank of the country is the centre of the Indian Financial and Monetary system It performs a wide range of promotional functions to support national objectives and generate goodwill among the citizens of the country RBI performs the four basic functions of management- planning, organising, directing and controlling in laying a strong foundation for the functioning of commercial bank

Financial Institutions

SEBI It was set up to protect the interests of investors in securities It aims to promote development and regulation of the securities market It prevents trading malpractices Registering and regulating the working of intermediaries associated with securities market in any manner Registering and regulating the working of venture capital funds and collective investment schemes, including mutual funds Promoting investors education and training of intermediaries of securities markets Prohibiting insider trading in securities Regulating substantial acquisition of shares and takeover of companies Levying fees or other charges for carrying out the purposes Calling for information from, undertaking inspection, conducting inquiries and audits of the stock exchanges, mutula funds, other persons associated with the securities market, intermediaries etc

Financial Institutions

IRDA To enable the insurance companies to act as independent companies with economic motives To protect the interests of the policyholders, to regulate, promote and ensure orderly growth of the insurance industry Specifies requisite qualifications, code of conduct and practical training for agents Promoting efficiency in the conduct of insurance business Levying fees and other charges for carrying out the purposes Calling for information from, undertaking inspection of, conducting inquiries and investigations including audit of the insurers, intermediaries and other organisations associated with the insurance business Control and regulation of rates, advantages, terms and conditions that may be offered by insurers Specifying the form and manner in which books of account shall be maintained and statement of accounts shall be rendered by insurers

Financial Institutions

Regulating investment of funds by insurance companies Specifying the percentage of premium income of the insurer to finance schemes for promoting and regulating professional organisations Specifying the percenatge of life insurance business and general insurance business to be undertaken by the insurer in the rural or social sector Forward Markets Commission(FMC) To advise the Central government in respect of the recognition or the withdrawal of recognition from any association To keep forward markets under observation Collecting and publishing information like supply, demand and prices regarding the trading conditions of goods and to submit to the Central government periodical reports on the wotking of forward markets To undertake the inspection of the accounts and other documents of any recognised association

Financial Institutions

Guidelines for Industrial Policy in India Industrial Licensing Policy Industrial licensing will be abolished for all projects except for a short list of industries related to security and strategic concerns, social reasons, hazardous chemicals etc. Areas where security and strategic concerns predominate will continue to be reserved for the public sector Zoning and Land Use Regulation and Environmental Legislation will continue to regulate industrial locations Appropriate incentives are used to promote the dispersal of industry particularly to rural and backward areas and to reduce congestion in cities Existing units will be provided a new broad banding facility to enable them to produce any article without additional investment The exemption from licensing will apply to all substantial expansions of existing units Entrepreneurs will henceforth only be required to file an information memorandum on new projects and substantial expansions

Financial Institutions

Foreign Investment Approval will be given for FDI upto 51%foreign equity in high priority industries The payment of dividends would be monitored through the RBI so as to ensure that outflows on account of dividend payments are balanced by export earnings over a period of time A special Empowered Board would be constituted to negotiate with a number of large international firms and approve direct foreign investment in select areas. This would be a special program to attract substantial investment that would provide access to high technology and world markets Foreign Technology Agreements Automatic permission will be given for foreign technology agreements in high priority industries No permission will be necessary for hiring of foreign technicians, foreign testing of indigenously developed technologies. Payment may be made from free foreign exchange according to RBI guidelines

Financial Institutions

Public Sector Portfolio of public sector investments will be reviewed with a view to focus the public sector on strategic, high tech and essential infrastructure A social security mechanism is created to protect the interests of workers likely to be affected by rehabilitation packages given to chronically sick public sector units In order to raise resources and encourage wider public participation, a part of the governments shareholding in the public sector would be offered to mutual funds, financial institutions, general public and workers Boards of public sector companies would be made more professional and given greater powers Greater thrust on performance improvement through the MOU systems through which managements would be granted greater autonomy and will be held accountable Technical expertise on the part of the Government would be upgraded to make the MOU negotiations and implementation more effective

Financial Institutions

MRTP Act The MRTP Act will be amended to remove the threshold limits of assets in respect of MRTP companies and dominant undertakings. This eliminates the requirement of prior approval of Central Government for establishment of new undertakings, expansion of undertakings, merger, amalgamation and takeover and appointment of Directors under certain circumstances Emphasis will be placed on controlling and regulating monopolistic, restrictive and unfair trade practices

Banking and Non-banking Financial Companies

Banking Institutions in India Central Bank- RBI It is entrusted with the functions of guiding and regulating the banking system of a country It does not deal with general public It acts essentially as Governments banker, maintain deposit accounts of all other banks and advances money to other banks when needed It acts as Bankers Bank and provides guidance to other banks whenever needed It maintains record of government revenue and expenditure under various heads It also advises the government on monetary and credit policies and decides on the interest rates for bank deposits and bank loans Foreign exchange rates are determined Issuance of currency notes, regulating their circulation in the country by different methods

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Commercial Banks They are banking institutions that accept deposits and grant short term loans and advances to their customers They also give medium and long term loans to business enterprises Housing loan provided on a long-term basis to individuals Types of Commercial banks are Public Sector Banks- SBI, Corporation Bank Majority stake is held by the GOI or RBI Private Sectors Banks- DCB, Vysya Bank Majority of share capital of the bank is held by private individuals These banks are registered as companies with limited liability Foreign Banks- HSBC, Citibank These banks are registered and have their headquarters in a foreign country but operate their branches in our country Development Banks- IFCI, SFC Financial assistance is provided for purchase of machinery and equipment, latest technology, expansion and modernisation of business

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Co-operative Banks When a co-operative society engages itself in banking business it is called a Cooperative bank People who come together to jointly serve their common interest, form a cooperative society Types of Co-operative banks are Primary Credit Societies These are formed at the village or town level with borrower and non-borrower members residing in one locality Members know each other and are able to watch over the activities of all members to prevent frauds Central Co-operative Banks These banks operate at the district level These banks provide loans to their members (primary credit societies) and function as a link between the primary credit societies and state co-operative banks

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State Co-operative Banks These are the highest level co-operative banks in allt eh states of the country They mobilise funds and help in its proper channelisation among various sectors The money reaches the individual borrowers from the State Co-operative Banks throught he Central Co-operative Banks and the primary credit societies Specialised Banks- EXIM Bank, NABARD, SIDBI They cater to the requirements and provide overall support for setting up business in specific areas of activity EXIM Bank The bank grants loans to exporters and importers and also provides information about the international market It gives guidance about the opportunities fro export or import, the riske involved and competition to be faced etc SIDBI The aim and focus is to promote, finance and develop SSI It also finances modernisation of SSI, use of new technology and market activities

NABARD It is a central institution for financing agricultural and rural sectors Non-Banking Financial Companies(NBFCs) NBFCs can be classified into Those accepting public deposits Those not accepting public deposits but engaged in financial business Core investment companies with 90 percent of their total assets as investments in the securities oft heir group/holding/subsidiary companies Types of Services Hire purchase services- Bajaj Auto Finance Company It is a conditional sale contract with an intention to finance consumers towards vehicles, white goods etc The contract allows the buyer to hire goods for a monthly rent and if the buyer defaults in paying the installmenst, the owner can repossess the goods

Leasing services- Sundaram Finance It is a contract that transfers the right to possess specific property Housing Finance services- ICICI Home Finance It means financial services related to development and construction of residential and commercial properties Asset Management services- Mutual Funds It manages and invests the pooled funds of retail investors in securities in line with the stated investment objectives and provides more diversification, liquidity and professional management service to the individual investors Venture Capital services Mutual Benefit Finance companies

Risk Management in FI

Basel Committee It is a group of eleven nations who decided to form a cooperative council to harmonise banking standards and regulations within and between all member states The goal is to extend regulatory coverage, promote adequate banking supervision and ensure that no foreign banking establishment can escape supervision At each meeting the authorities of each country discuss the status of the international banking system and propose common standards that can assist the committee in achieving its goals Basel committee cannot enact legally binding banking standards, it is up to the member states to implement and enforce the recommendations of the Basel committee

Risk Management in FI

Basel I Pillars The Constituents of Capital It defines what types of capital are counted as a banks reserves and how much of each type of reserve capital a bank can hold Accord divides capital reserves into two tiers. Banks must hold the same quantity of Tier I and Tier II capital Tier I Capital- disclosed cash reserves and other capital paid for by the sale of bank equity Tier II Capital- reserves created to cover potential loan losses, hybrid debt/equity instrument holdings, potential gains from the sale of assets purchased throught he sale of bank stock Risk Weighting It creates a comprehensive system to risk weight a banks assets Assets at 0%- Riskless- Cash held by Bank, sovereign debt held Assets at 20%- Low risk- Bank debt created by banks incorporated in the OECD, non-OECD bank debt with a maturity of less than one year Assets at 50%- Moderate risk- Residential mortgages Assets at 100%- High risk- Banks claim on the private sector

Risk Management in FI

A Target Standard Ratio It sets a universal standard whereby 8% of a banks risk weighted assets must be covered by TierI and TierII capital reserves This ratio is seen as minimally adequate to protect against credit risk For example, if a bank has risk-weighted assets of $100 million, it is required to maintain capital of at least $8 million Transitional and Implementing Agreements It sets the stage fort he implementation of the Basel Accords

Risk Management in FI

Basel II The purpose of Basel II, is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face Pillar I- Minimum Capital Requirements The first pillar deals with maintenance of regulatory capital calculated for three major components of risk that a bank faces: credit risk, operational risk, and market risk Pillar II- Supervisory Review The second pillar deals with the regulatory response to the first pillar, giving regulators much improved 'tools' over those available to them under Basel I It provides a framework for dealing with all the other risks a bank may face, such as systemic risk, reputational risk, liquidity risk and legal risk, which the accord combines under the title of residual risk. It gives banks a power to review their risk management system It is intended to bridge the gap between regulatory and economic capital requirements and gives supervisors discretion to increase regulatory capital requirements if weaknesses are found in a lender's internal capital assessment process

Risk Management in FI

Pillar III- Market Discipline This pillar aims to promote greater stability in the financial system

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