INDIAN FINANCIAL SYSTEM (SOLVED QUESTIONS) 2017 (MAY) – Sem 6

Dibrugarh University

1. Fill in the blanks: 1*4=4

a) Financial institutions are also termed as financial lender

b) Commercial Banks Scheme, 1970 Provides that are based on directors of nationalized banks will be composed of ………………….. Members including chairman.

c) The Treasury bill is governed …Central Government for a short period usually of 91 days duration.

d) Primary market refers to the long –term flow of funds from the surplus sector to the government and private sector through primary issues of equality and debts.

2. State whether the following are True or False: 1×4=4

a) Commercial Bills are one of the instruments of the money market. True

b) Bull, Bear, Stag and Lame Duck are the speculators who are active on the stock exchange of India. True

c) Merchant bankers undertake the function of purchase and sale of securities of the investors and portfolio management. True

d) Capital market deals with buying and selling of short -items investible funds. False

3.Write short notes on (any four): 4×4=16

Marketable Securities

Marketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. The issuing company creates these instruments for the express purpose of raising funds to further finance business activities and expansion. Governments also issue debt securities of this type in the form of T-bills, used for funding of public projects and expenditures.

Marketable securities are characterized by:

A maturity period of 1 year or less

The ability to be bought or sold on a public stock exchange or public bond exchange

Having a strong secondary market that makes for liquid buy and sell transactions, as well as render an accurate price valuation for investors

Have higher liquidity, effectively lowering risk

Non- cash or cash equivalents (money market securities due within 3 months)

Naturally, the suitability of investments in marketable securities will depend on the investment strategy of the investor or the firm. Marketable securities will often have lower returns compared to longer-period or open-ended investments such as stocks. Since the marketable security is only held for a year or less, there is a lower maturity risk and liquidity risk built into the product.

Management of RBI

RBI started functioning from 1 April 1935 on terms of RBI Act ,1934.But till Jan 1949 it was a private shareholder institution and after it it became a state-owned institution under RBI Act 1948.

The bank is managed by Central Board Of Directors ,four Local Board of Directors , committee of Central board of Directors. The function of Local Board Of Directors is to the Central Board on matters referred to them.

The Final control of Bank vests in the Central board which consist of Governor ,4 deputy governors , and 15 Directors nominated by the central government. The committee of Central board consist of Governor, deputy Governor and such other Director as may be present at a given meeting.RBI has four regional representation like north in New Delhi , south in Chennai ,east in Kolkata, west in Mumbai .For each region Local Board of directors are there ,each consisting 5 members appointed by Central Government. Directors are appointed for 4 years.

The internal Organization set-up of the Bank has been modified and expanded from time to time but the underlying principal is functional specialization with adequate coordination. Bank has been divided into a large number of Departments .Apart from banking and Issue departments, there are 20 more departments and 3 training establishments at the central office of the Bank.

Role of NABARD in Rural Development

National Bank for Agriculture and Rural Development (NABARD) was established on July 12, 1982 . It is an apex institution in rural credit structure for providing credit for promotion of agriculture, small scale industries, cottage and village industries, handicrafts etc.

1. It is an apex institution which has power to deal with all matters concerning policy, planning as well as operations in giving credit for agriculture and other economic activities in the rural areas.

2. It is a refinancing agency for those institutions that provide investment and production credit for promoting the several developmental programs for rural development.

3. It is improving the absorptive capacity of the credit delivery system in India, including monitoring, formulation of rehabilitation schemes, restructuring of credit institutions, and training of personnel.

4. It co-ordinates the rural credit financing activities of all sorts of institutions engaged in developmental work at the field level while maintaining liaison with Government of India, and State Governments, and also RBI and other national level institutions that are concerned with policy formulation.

5. It prepares rural credit plans, annually, for all districts in the country.

6. It also promotes research in rural banking, and the field of agriculture and rural development.

d) Need of Central Bank in India

1. Regulator of Currency:

The central bank is the bank of issue. It has the monopoly of note issue. Notes issued by it circulate as legal tender money. It has its issue department which issues notes and coins to commercial banks. Coins are manufactured in the government mint but they are put into circulation through the central bank.

2. Banker, Fiscal Agent and Adviser to the Government:

Central banks everywhere act as bankers, fiscal agents and advisers to their respective governments. As banker to the government, the central bank keeps the deposits of the central and state governments and makes payments on behalf of governments. But it does not pay interest on governments deposits. It buys and sells foreign currencies on behalf of the government.

3. Custodian of Cash Reserves of Commercial Banks:

Commercial banks are required by law to keep reserves equal to a certain percentage of both time and demand deposits liabilities with the central banks. It is on the basis of these reserves that the central bank transfers funds from one bank to another to facilitate the clearing of cheques. Thus the central bank acts as the custodian of the cash reserves of commercial banks and helps in facilitating their transactions.

4. Custody and Management of Foreign Exchange Reserves:

The central bank keeps and manages the foreign exchange reserves of the country. It is an official reservoir of gold and foreign currencies. It sells gold at fixed prices to the monetary authorities of other countries. It also buys and sells foreign currencies at international prices. Further, it fixes the exchange rates of the domestic currency in terms of foreign currencies.

e)Primary Market V/S. Secondary Market:

f) Commercial paper:

Commercial paper is an unsecured and discounted promissory note issued to finance the short-term credit needs of large institutional buyers. Banks, corporations and foreign governments commonly use this type of funding.

Merits of Commercial Paper

Technically, it provides more funds compared to other sources. The cost of commercial paper to the issuing firm is lower than the cost of commercial bank loans.

It is in freely transferable nature, therefore it has high liquidity and also a wide range of maturity provides more flexibility.

A commercial paper is highly secure and does not contain any restrictive conditions.

Companies can save their extra funds on commercial paper and also earn some good return on the same.

Commercial papers produce a continuing source of funds. This is because their maturity can be tailored to suit the needs of issuing firm. Again, commercial paper that matures can be repaid by selling the new commercial paper.

Limitations of Commercial Paper

Only financially secure and highly rated organizations can raise money through commercial papers. New and moderately rated organizations are not in a position to raise funds by this method.

The amount of money that we can raise through commercial paper is limited to the deductible liquidity available with the suppliers of funds at a particular time.

Commercial paper is an odd method of financing. As such if a firm is not in a position to redeem its paper due to financial difficulties, extending the duration of commercial paper is not possible.

4.What is financial system? Discuss the major components of Indian Financial System

4+10=14

Same as 3(a) 2016.

OR

Discuss about the regulatory reforms in the Indian banking system?

Ans: In the context of economic liberalization and growing trend towards globalization (external liberation), various banking sector reforms have been introduced in India to improve the operation efficiency and upgrade the health and financial soundness of banks so that Indian banks can meet internationally accepted standards of performance.

Reforms in banking sector were introduced on the basis of the recommendation different committees:

The first Narasimhan committee(1991)

The Verma committee(1996)

The second Narasimhan committee(1998).

The First Phase of Performs:

The banking sector reforms are directed towards improving the policy framework, financial health and the institutional framework:

Change in Policy of Reforms:

Improvement in policy framework has been undertaken by reducing the Cash Reserve Ratio (CRR) to the initial standard and phasing out Statutory Liquidity Ratio (SLR) degradation of interest rates, widening the scope of lending rates to the size of advances.

Improving Financial Health:

Attempts to improve the financial soundness of the banking sector have been made by prescribing prudential norms. Moreover, steps have been taken to re-duct the proportion of Non-Performing Assets (NPAs).

Improvement on institutional framework:

Such improvements have been achieved in three ways:

Recapitalization

Creating a competitive environment, and

Strengthening the supervisor system.

5.Mention the causes of interest rate reform in respect of Indian commercial banks since 1991. Discuss about the pattern of interest rate reform in the post-liberalized era. 9+5=14

Ans:-The weakness of the banking system was extensively analyzed by the community (1991) on financial sector reforms, headed by Narasimham. The community found that the banking system was both over regulated and under regulated. Prior to 1991 the system of multiple regulated interest rates prevailed.

Beside, a large proportion of bank funds was preempted by the government through high Statutory Liquidity Ratio (SLR) and a high Cash Reserve Ratio (CRR). As a result, there was a decrease in resources of the bank to provide the loans to the private sector for investment.

The lack of transparency in the accounting practice of the banks and non-application of international norms by the banks meant that their balance sheets did not reflect their underlying financial position.

This was prominently revealed by 1992 scarcity scam triggered by Hashed Mehta. In this situation the quality of investment portfolio of the banks deteriorated and a culture of “non-recovery” developed in the public sector banks which led to a severe problem of non-performing assets (NPA) and low profitability of banks.

Financial sector reforms aim at removing all these weaknesses of the financial system.

Under these reforms, attempts have been made to make the Indian financial system more viable, operationally efficient, more responsive and improve their allocative efficiency.

Financial reforms have been undertaken in all the three segments of the financial system, namely banking, capital market and government securities market.

Types of financial sector reforms:

We explain below various reforms in these segments in financial sector initiated since 1991:

Reduction in Statutory Liquidity Ratio(SLR) and Cash Reserve Ratio (CRR):

An important financial reform has been the reduction in Saturated Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) so that more bank credit is made available to the industry, trade and agriculture. The statutory liquidity ratio (SLR)which was as high as 39 per cent of deposits with the banks has been reduced in a phased manner to 25 per cent.

On the other hand, reduction in statutory liquidity ratio (SLR) has been possible because efforts have been made by the government to reduce fiscal deficit and therefore its borrowing requirements. Besides, reduction in SLR has become possible because of a shift to payment of market-related rates of interest on government securities.

The reduction in CRR and SLR has made available more lendable resources for industry, trade and agriculture. Reductions in CRR and SLR also made it possible for the reserve bank of India to use open market operations and changes in bank rate as tools of monetary policy to achieve the objectives of economic growth, price stability and exchange rate stability.

Thus, Dr. C. Rangarajan, the former governor of reserve bank of India, says, “as we move away from automatic monetization of deficits, monetary policy will come into its own. The regulation of money and credit will be determined by the overall perception of central monetary authority on what appropriate level of expansion of money and credit should be depending on how the real factors in the economy are evolving.

End of Administered Interest Rate Regime:

A basic weakness of the Indian financial system was that interest rates were administered by the Reserve Bank / Government. In the case of commercial bank, both deposits rates and lending rate were regulated by Reserve Bank of

cross subsidization; concessional rates charged from primary sectors were compensated by higher rates charged from other non-concessional borrowers.

The structure of administered rates has been almost totally done away with in a phase manner. RBI no longer prescribed Indian. Before 1993, rate of interest on Government Securities could be maintained at low levels through the means of high Statutory Liquidity Ratio (SLR).

Under SLR regulation commercial banks and certain other financial institutions were required by law to invest a large portion of their liabilities in Government securities. The purpose behind the administered interest-rates structure was to enable certain priority sectors to fund at concessional rates of interest. Thus the system of administered interest rates involved interest rates on fixed or time deposits paid by their banks to their depositors. Banks have also been freed from any prescribed conditions of premature withdrawal by depositors. Individual banks are free to determine their conditions for premature withdrawal. Currently , their prescribed rate of 3.5 per cent for Saving Bank Accounts.

OR

“Regional rural banks are important financial institutions of the rural credit structure of India. “comment. 14

Ans: The RRBs are a type of scheduled C Banks. These are public sector banks and operate like other commercial banks.

The main objective of setting up of RRRs was to fill the gap of institutional credit. The RRBs are aimed at playing an important role in development of Agriculture, Trade, Industries and other productive Activities, in the Rural Sectors.

Special Features of RRBs:

The following are the special features of RRBs .

1. The RRBs main objective is to bring about progress with Social Justice to the rural poor, in time with national objectives.

2.These banks are set-up mainly in under- bank and unbanked regions of the country.

3. These banks would function as a low cost Institutions with the staff drawn from the district or the state in which the banks are located.

4. Their approach to rural credit is sectorial. They are to operate in compact areas of not more than 2 or 3 districts.

5.RRBs are expected to operate at low speeds or margins because they are to lend to weaker sections at lower rates of interest.

6.They enjoy some concession in regard to cash reserve, liquidity and interest rate of deposits.

7. They grant district loans and advances only to small and marginal farmers, rural artisans and others of small means for productive purpose.

Area of operations:

RRBs are a kind of local banks working like others C. Banks . Each RRBs operate within local limits set out in the notification by the C. Government. As its name suggests, it has to serve mainly rural populations; its area of operation may extend to a few districts. It may establish branches or agencies at any place as many be notified by the Government of India.

6. What do you mean by financial markets? Who are the participants in financial markets? Why do they participate in financial markets? Explain. 4+3+7=14

Ans: Financial market is an integral part of the financial system. It facilitates transfer of funds from surplus sector to deficit sector i.e. it facilitates movement of funds from savers on lenders to investors or borrowers.

A Financial market does not refer to a physical location. But it consists of investors or buyers, sellers or savers, dealers and brokers. It is the arrangement which facilitates buying and selling of Financial Assets and services including foreign exchange.

Types of financial Markets :-

Financial market are divided into 2 groups:

1)Primary and Secondary Market :-

The Primary Market. deals in new issue of share, debenture, bond and other securities. So it is known as New Issue Market. or Direct Market. These are new financial claims of fresh issue.

The secondary market deals in issues of financial claims. That is these are securities already issued and held by investors. The Primary Market mobilize fresh savings. Thus, it supplies fresh capital or additional capital for economic activities. Secondary Market or also called stock exchanges don’t contribute additional capital. Secondary Market. provides liquidity to securities issued in primary markets.

2) Money and Capital Market:-

Money Market is a centre where short term monitory instruments are brought and sold.

Capital Market is a centre for dealing in long-term financial assets. Equity Shares, bonds and other long term Financial Instruments are bought and sold here. Thus, Capital Market activities relate to long term lending and borrowing of funds.

Function of Financial Markets;

The important functions of Financial Markets are:-

To facilities creations and allocation of credit and liquidity.

To serve as an intermediary in the process of mobilization of savings in the economy.

To provide financial facilities to people.

To assist in the process of economic development through a balanced regional and sartorial distribution of investible funds.

OR

What do you mean by the new issue market (NIM)? Mention the characteristics of NIM. Explain the role of the new issue market in Indian financial system. 3+4+7=14

Ans: New Issue Market(meaning):

The new issue market represents the primary market where new securities, i.e shares or bonds that have never been previously issued, are offered.

The new issue directs the flow of savings into long-term investors, it is of paramount importance for the economic growth and industrial development of a country. The availability of financial resources for corporate enterprise, to a great extent, depends upon the status of the new issue market of the country.

New issue market deals with the new securities which were not previously available to the investing public, i.e., the securities that are offered to the investing public for the first time. The market, therefore, makes available a new block of securities for public subscription.

Characteristics of new issue market(NMI)

(1)It is the market for the new long term capital.

(2)Here the securities are issued by the company for the first time directly to the investors.

(3)On receiving the money firm the new issues, the company will issue the security certificates to the investors.

(4)The amount obtained by the company after the new issues are utilized for expansion of the present business or for setting up new ventures.

(5)External finance for longer term loans from financial institutions is not included in the new issue market. There is an option called ‘going public’ in which the borrowers in the new issue market raise capital for converting private capital into public capital.

(6) The financial assets sold can only be redeemed by the original holder of security.

Roles of New Issue Market:-

1.Organization:-

It refers to the work of investigation, analysis and processing of new project proposals. It starts before an issue is actually floated in the market. This function is done by merchant bankers, all Indian financial institutions or private firms. At present, financial institutions and private firms also perform this service. Though this service is highly important, the success of the issue depends, to a large extent on the efficiency of the market.

2.Underwriting:-

It is an argument whereby the underwriter promises to subscribe to a specified number of shares and debentures or a specified number of stock in the event of the public not subscribing to the issue. If the issue is fully subscribed, then there is no liability for the underwriter. If a part of shares remains unsold, the underwriter will buy the shares.

3.Distribution:-

It is the function of sale of securities to ultimate investors. This service is performed by specialized agencies like brokers and agents who maintain a regular and direct contact with the ultimate investors.

7. Discusses the role of mutual funds in the financial market of India. Mention the problems of mutual funds in the country. 8+6=14

Ans: Role of mutual funds in financial market of India:

When mutual funds use money from investors to invest in newly issued debt or equity securities, they finance new investment by firms. Conversely, when they invest in equity securities already held by investors, they are transferring ownership of the securities among investors.

By pooling individual investors’ small investments, mutual funds enable them to hold diversified portfolios(combinations) of debt securities.

They are also beneficial to individuals who prefer to let mutual funds make their investment decision for them.

The returns of investors who invest in mutual funds are tied to the return earned by the mutual funds on their investments.

Money market mutual funds and bond mutual funds determine which debt securities to purchase after conducting a credit analysis of the firms that have issued or will be issuing debt securities. Stocks that satisfy their specific investment objective (such as growth in value or high dividend income) and have potential for a high return, given the stock’s level of risk.

Because mutual funds typically have billions of dollars to invest in securities, they use substantial resources to make their investment decisions. In particular, each mutual fund is managed by one or more portfolio managers, who purchased and sold securities in the fund’s portfolio. These managers are armed with information about the firms that issue the securities in which they can invest.

Problems of mutual funds in a country

Cost to manage the mutual fund:

The salary of the market analysts and fund manager basically comes from the investors. Total fund management charge in one of the main parameters to consider when choosing a mutual fund. Greater management fees do not grantee better funds performance.

Lock-in periods:

Many mutual fund have long-term periods, ranging from 5 to 8 years. Existing such funds before maturity can be an expensive affair. A certain portion of the fund is always kept in cash to pay out an investors who wants to exit the fund. This portion in cash cannot earn interest for investors.

Dilution:

While diversification averages your risks of loss, it can also dilute your profits. Hence, you should not invest in more than 7-9 mutual funds at a time.

No control over cost:

The AMC who manages the operational aspect of the mutual funds and the costs are incurred by them. The investors do not control the costs in spite of the fact that they are the one who bear such costs, including the distribution costs of mutual funds scheme.

No Tailor-Made Portfolios:

In mutual funds scheme, an investor’s money is invested by AMC. The AMC decides the products and securities in which the investor’s money will be invested. AMC will build the portfolio, which will be common for the investors of a scheme. The investor can build a portfolio of his choice in direct investing which is not possible in a mutual fund.

Choice overloaded:

Over 800 mutual funds schemes offered by 38 mutual funds and multiple options within those schemes make difficult for investors to choose from them . greater dissemination of industry information through various media and availability of professional advisors in the market should help investors to handle this overload.

Inefficiency in mutual fund management:

Sponsorship of mutual funds has a bearing on the integrity and efficiency of fund management which are the key to establishing investor’s confidence. So far, only public sector sponsorship or ownership of mutual funds organization had taken care of this need. Sometimes sponsors of the AMC forget the scheme objectives for their profits that the investors got losses. So investors do not believe in mutual funds companies and avoid investing in mutual funds.

OR

Mention any two function of SEBI. Explain the powers and function of SEBI regarding protection of the interest of the investors.

Ans: SEBI was set up in 1988 to regulate the function of the securities market with a view to promote orderly and healthy development in stock market. SEBI was not able to work as a watch-dog and could not control capital market effectively.

Purpose of SEBI:

To protect the interest of investors in securities.

To promote the development of the securities market.

To promote the securities market.

Organizational structure of SEBI:

SEBI is a corporate body.

It is administered by a Board having a chairman and 8 members.

It has head office in Mumbai and branch offices in Kolkata, Chennai and New Delhi.

It has two advisory comities, one for primary market and other for secondary market.

It has divided its activities in five department and each department is headed by executive director.

Objectives of SEBI:

Protest interests of investors:

SEBI was mainly set up to protect the interest of investors.

Promoting and Development of Securities Market.

SEBI aims to promote healthy securities market in Indian.

Regulating Securities Market:

SEBI was established to regulate the working of security market, stock exchanges, brokers and other intermediaries.

4) Mobilization and Allocation of Resources:

It helps mobilization and allocation of resources through securities market. It promotes healthy competition in the market and also guides for the meaningful use of funds.

Function of SEBI:

Protecting Function:

Control on Price Rigging:-

Price Rigging is serious practice which harms the interests of investors. Price rigging is the artificial inflation of prices and attracting more and more investors. This type of rigging is done either to purchase or sell the shares by speculator and the common investors loss their money.

Control on Inside Trading:-

When a person is associated with a company and knows about the sensitive information about its performance or decisions and then try to gain out of it by indulging in buying or selling of shares for his benefit, it is called inside trading.

Safeguarding Investors:-

SEBI issues press notes in the papers and bring out booklets for educating investors about various practices bring followed in the stock exchanges and wants about the malpractice also.

Regulatory Function:

Monitoring Stock Exchanges:

SEBI regulates the working stock exchanges including NSE and OTCEI by notifying rules and regulations.

Regulating Intermediaries:

In order to regulate the working of intermediaries like brokers, underwriters, merchant bankers etc. SEBI has devised rules and regulations and have also prepared a code of conduct for them.

Regulating Mutual Funds:

All mutual funds are registered with SEBI. They are required to furnishing information about their business and working as required by SEBI.

Development Function:

Registration :

SEBI has made compulsory the registration of members of stock exchanges, intermediaries, merchant bankers, transfer agents, lead managers etc.

Monitoring issues:

With a view to reduce cost of issues SEBI has devised various measures. Under-writing has been made optional.

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