Chapter ‒ 1

INDIAN FINANCIAL SYSTEM

Content:
Concept and Components – Meaning, Functions, and Structure of Financial
System – Financial Markets (Money Market, Capital Market, Forex Market) – Financial
Institutions (Banks, NBFCs, Asset Management Company (AMC)) – Financial
Instruments (T-Bills, Commercial Papers, Derivatives, Delivery and Non-Delivery
contracts in capital market) – Regulatory Bodies (RBI, SEBI, IRDAI, PFRDA) –.
Impact of Digital Rupee (e ₹) on Traditional Banking ‒ Rise of Fintech and Shadow
Banking ‒Case Study: Paytm Payments Bank Transition.

1.1 Introduction to Indian Financial System

The Indian Financial System plays a very important role in the Indian Economy
and it shows the economic growth of our economy. It helps in the flow of funds to
people and the people use this money economically for their betterment.
The economic development of a nation is reflected by the progress of the various
economic units, broadly classified into corporate sector, government and household
sector. While performing their activities, these units are placed in a surplus or deficit
budgetary situations.
There are areas or people with surplus funds and there are those with a deficit. A
financial system or financial sector functions as an intermediary and facilitates the flow
of funds from the areas of surplus to the areas of deficit. A Financial System is a
composition of various institutions, markets, regulations and laws, practices, money
manager, analysts, transactions and claims and liabilities.
The financial system of a country is an important tool for economic development
of the country as it helps in the creation of wealth by linking savings with investments.
It facilitates the flow of funds from the households (savers) to business firms
(investors) to aid in wealth creation and development of both the parties. The
institutional arrangements include all conditions and mechanism governing the
production, distribution, exchange and holding of financial assets or instruments of all
kinds.
2 Indian Financial System

The word “system”, in the term “financial system”, implies a set of complex and
closely connected or interlined institutions, agents, practices, markets, transactions,
claims, and liabilities in the economy. The financial system is concerned about money,
credit and finance - the three terms are intimately related yet are somewhat different
from each other.
In simple words, finance is a term equivalent to money. However, this is only
partially correct. Finance refers to the source which provides funds for any particular
activity.
Therefore, Financial System is a mixed composition of institutions, markets,
regulations, laws, practices, money managers, analysts, transactions, claims, and
liabilities that exist within the economy.
The diagram below will give a clear idea of what the Indian Financial System
refers to:

Incomes and Financial Claims

Seekers of Funds Suppliers of Funds
(Business, Firms (Mainly
and Governments) Flow of Financial Services
Households)
Flow of Funds (Saving)

1.2 Meaning of Financial System

The economic expansion of any country depends upon the existence of a well-
ordered financial system. It helps in the creation of wealth by linking savings with
investment. The financial system is an organized and regulated structure where an
exchange of funds takes place between the lender and the borrower. It supplies the
necessary financial inputs for the production of goods and services, and in turn,
promotes the well-being and standard of living of people in the country.

1.3 Definition of the Financial System

According to Prasanna Chandra, the financial system consistsing of a variety of
institution, markets, and the instruments which are related in a systematic manner and
provide the principal means by which savings are transformed into instruments.
In the worlds of Van Horne, “financial system allocates savings efficiently in an
economy to ultimate users either for investment in real assets or for consumption .”.
Christy has opined that the objective of the financial system is to “supply funds to
various sectors and activities of the economy in ways that promote the fullest possible
utilization of resources without the destabilizing consequence of price level changes or
unnecessary interference with individual desires.”
Indian Financial System 3

According to Robinson, the primary function of the system is “to provide a link
between savings and investment for the creation of new wealth and to permit portfolio
adjustment in the composition of the existing wealth.”

1.4 Features of Financial System

The Indian financial system is a complex and interconnected network of
institutions, markets, and instruments that facilitate the flow of funds between savers
and borrowers. It plays a vital role in the economic development of the country by
mobilizing savings and allocating them to productive investments.
The Indian financial system is characterized by the following features:
 Dual Structure System: IFS is consistsing of a formal sector and an informal
sector.
 Intermediation: It means that financial institutions play a key role in
mobilizing savings and allocating them to borrowers.
 Market Based: IFS is increasingly market-based.
 Regulation: It is regulated by the government through a number of regulatory
bodies.
 Financial Inclusion: It promotes financial inclusion, through the Pradhan
Mantri Jan Dhan Yojana and the Pradhan Mantri Mudra Yojana, etc.
 Economic Growth: It pPromotes for economic growth. It provides funds for
businesses. It also helps improve living standards.

1.5 Significance of the Financial System

The significance of financial system is studied as givenunder:
1. To attain economic development, financial systems are important since they
induce people to save by offering attractive interest rates. These savings are
then channelized by lending to various business concerns which are involved in
production and distribution.
2. It helps in monitoring corporate performance.
3. It links savers and investors. This process is known as capital formation.
4. It helps in lowering the transaction cost and increase returns which will
motivate people to save more.
5. It helps the government in deciding monetary policy.
4 Indian Financial System

1.6 Objectives of Financial System

The broad objectives of the Financial System are:
 To Stimulate Capital Formation: The objective of supporting the industries
doesis not ended with the sanctioning of funds to them. Further, it makes them
to formulate the capital out of their earnings for the further capital requirements
& industrial investment.
 To Accelerate the Process of Economic Growth: The ultimate goal of the
financial institutions is to support the process of economic growth of a nation.
Directing the saving fund to the industrial capital need, motivating them for the
capital formation supports the acceleration of the process of economic growth.
 To Mobilize the Financial Resources: The first and the foremost function
which financial system performs is the channelization of the individual’s
savings & making it available for borrowers. The borrowers are usually the
companies which take loans in order to increase the overall growth of the
economy. It collects the funds through offering different schemes which attract
the investors to fund their savings in different institutions, services, securities
etc.
 ToIt Ensures Effective Allocation of Resources: It also creates an
environment for one to invest their funds which involves good returns on
investment. It provides various opportunities to secure the investment against
risks involved in the market like risk arising from accidents, health related
issues, etc. through various life insurance options. It helps in liquidating one’s
own savings whenever required.

1.7 Functions of Indian Financial System

The financial system of a country performs certain valuable functions for the
economic growth of that country. The main functions of a financial system may be
briefly discussed as below:
1. Saving Function: An important function of a financial system is to mobilize
savings and channelize them into productive activities. It is through financial
system that the savings are transformed into investments.
2. Liquidity Function: The most important function of a financial system is to
provide money and monetary assets for the production of goods and services.
Monetary assets are those assets which can be converted into cash or money
easily without loss of value. All activities in a financial system are related to
liquidity - either provision of liquidity or trading in liquidity.
3. Payment Function: The financial system offers a very convenient mode of
payment for goods and services. The cheque system and credit card system are
Indian Financial System 5

the easiest methods of payment in the economy. The cost and time of
transactions are considerably reduced.
4. Risk Function: The financial markets provide protection against life, health
and income risks. These guarantees are accomplished through the sale of life,
health insurance and property insurance policies.
5. Information Function: A financial system makes available price-related
information. This is a valuable help to those who need to take economic and
financial decisions. Financial markets disseminate information for enabling
participants to develop an informed opinion about investment, disinvestment,
reinvestment or holding a particular asset.
6. Transfer Function: A financial system provides a mechanism for the transfer
of the resources across geographic boundaries.
7. Reformatory Functions: A financial system undertaking the functions of
developing, introducing innovative financial assets/instruments services and
practices and restructuring the existing assets, services etc. to cater the
emerging needs of borrowers and investors (financial engineering and re-
engineering).
8. Other Functions: It assists in the selection of projects to be financed and also
reviews performance of such projects periodically. It also promotes the process
of capital formation by bringing together the supply of savings and the demand
for investible funds.

1.8 Components of Financial System

Like any other country, the Financial System of India comprises of financial
institutions, financial assets, financial services, and financial markets and financial
instruments.
There are fiveour main constituents of the Indian Financial System. This includes:
1. Financial Institutions
2. Financial Assets
3. Financial Services
4. Financial Markets
5. Financial Instruments
The detailed discussion on each component is as follows :

1. Financial Institutions
Meaning: Financial Institutions are business organizations serving as a link between
savers and investors and so help in the credit allocation process. In simple terms,
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Financial Institutions are the institutions which offer financial services for its clients or
members. The most probable service is financial intermediation. The institutions
include banks, trust, companies, insurance companies and investment dealers.
Definition: Financial institution is defined as “an establishment that focuses on dealing
with financial transactions, such as investment, loans and deposits.” In other words, the
financial institution is an organization which may be either profit or non-profit, that
takes money from clients and places it in any of a variety of investment vehicles for the
benefit of both the client and the organization.

Classification of Financial Institutions

The financial institutions are classified into term lending institutions, refinance
institutions, investment institutions and state level institutions. These are also to be
classified into Banking, Non-Banking Financial Companies (NBFCs) institutions and
Asset Management Companies (AMC)

I. Banking Institutions
These are the type of financial institutions which involve in accepting public
deposits and lending the same to the needy customers. These are fundamentally
established to earn profit, and secondarily to safeguard the interest of the members. The
banking institutions ensure that deposits accumulated from people are productively
utilized.
The following are the types of banking institutions which are running their
business in India.
A. Commercial banks: These are also called as Business Banks.
The following are the types of commercial banks.
(i) Public sector.
(ii) Private sector.
(iii) Regional Rural Banks (RRB’s).
(iv) Foreign banks.
B. Cooperative Banks: These are established to safeguard the interest of its
members. These are organized on a co-operative basis, they accept deposits and
lend money to the required members.

II. Non-banking Institutions

These are the financial institutions that provide banking services without meeting
the legal definition of a bank. The non-banking financial institutions also mobilize
financial resources directly or indirectly from the people. They lend the financial
resources mobilized. ???
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The non-banking institutions are classified into organized and unorganized

financial institutions. The following are examples of non-banking institutions:
(i) Provident and pension fund.
(ii) Small Saving organization.
(iii) Life Insurance Corporation (LIC).
(iv) General Insurance Corporation (GIC).
(v) Unit Trust of India (UTI).
(vi) Mutual funds.
(vii) Investment Trust, etc.
Non-banking financial institutions can also be categorized as investment
companies housing companies, leasing companies, hire purchase companies,
specialized financial institutions (EXIM Bank), Investment Institutions, State level
institutions etc.

1.9 Asset Management Company (AMC)

Meaning of AMC: An Asset Management Company (AMC) is a financial institution
that’s primarily engaged in investing and managing mutual funds on behalf of
individuals and institutions. These companies pool resources from clients like retail
investors, high-net-worth individuals, corporations and institutional investors. They
then allocate these collective funds into various assets such as stocks, bonds, real estate,
and other securities.
Asset Management Company (AMC) is defined as an enterprise that manages
customers' funds by accumulating and investing them in various provisions such as
stocks, real estate, bonds, and other investments. AMCs not only manage portfolios of
high-net-worth individuals (HNWI) but also look after hedge funds, pension funds,
mutual funds, index funds, and Exchange Traded Funds (ETFs) using funds from small
investors and combining them into a single consolidated portfolio.
The role of AMCs is crucial in the financial landscape because they provide access
to diversified investment portfolios. They also offer the benefit of professional fund
management and strategic allocation of assets based on market research and economic
trends. These companies employ experienced fund managers and analysts who
continuously monitor market conditions, conduct research and make informed
investment decisions to maximise returns while attempting to mitigate risks.
AMCs also play a significant role in financial markets by facilitating liquidity and
enabling price discovery. Since they purchase and redeem units on a large scale, their
activities can influence market trends and asset prices. Additionally, by choosing to
purchase your mutual fund units directly from AMCs, you can benefit from the
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economies of scale in transaction costs and gain access to a wider range of investment
opportunities.

Different Types of Asset Management Companies

Based on their investment focus, client base and strategies, you can find different
types of asset management companies in India. Each type of asset management
company has its unique characteristics, risk profiles and investment strategies.
Together, they cater to the diverse needs and preferences of investors. The choice of
AMC for your investment strategy depends on your financial goals, risk tolerance and
the type of assets you are interested in.
Here are some of the different types of asset management companies you can
choose from.

 Mutual Fund Companies

Also known as mutual fund houses, these AMCs create and manage mutual funds
by pooling money from individual investors to invest in a diversified portfolio of
stocks, bonds or other securities. Each investor owns shares of the fund called units.

 Hedge Funds
When compared to mutual fund houses, hedge fund AMCs often employ more
aggressive strategies like leveraging and derivative trading. They typically aim for
higher returns and cater to high-net-worth individuals and institutional investors.

 Private Equity Firms

These firms invest in private companies in various stages of growth, from startups
to mature companies. PE firms are also often involved in the management and
restructuring of these companies to increase the value of their shares.

 Real Estate Asset Managers

These AMCs specialise in investing in real estate properties ‒ which may include
residential, commercial and industrial properties. They manage these properties to
generate rental income and capital appreciation over time.

 Exchange-Traded Fund (ETF) Providers

ETFs are similar to mutual funds but are traded on stock exchanges. ETF AMCs
offer a variety of exchange-traded funds that track different indices or sectors,
providing investors with flexibility and ease of trading.

 Pension Funds Managers

These AMCs, which manage the assets of pension funds, typically focus on long-
term and low-risk investment strategies. Their key responsibility is to ensure that there
are sufficient funds to meet the future obligations of pension payments.
Indian Financial System 9

 Insurance Asset Managers

These AMCs, which are a part of insurance companies, are responsible for
investing and managing the premiums collected from policyholders. Their goal is to
generate returns for the insurance companies while ensuring there is enough liquidity to
pay out claims.

 Wealth Management Firms

Wealth management firms cater to the investment needs of high-net-worth
individuals. They offer personalised investment solutions through a range of expert
services including estate planning, tax planning and retirement planning.

2. Financial Assets
The products which are traded in the Financial Markets are called Financial
Assets. Based on the different requirements and needs of the credit seeker, the
securities in the market also differ from each other.
Some important Financial Assets have been discussed briefly below:
 Call Money: When a loan is granted for one day and is repaid on the second
day, it is called call money. No collateral securities are required for this kind of
transaction.
 Notice Money: When a loan is granted for more than a day and for less than 14
days, it is called notice money. No collateral securities are required for this kind
of transaction.
 Term Money: When the maturity period of a deposit is beyond 14 days, it is
called term money.
 Treasury Bills: It is also known as T-Bills, these are Government bonds or
debt securities with maturity of less than a year. Buying a T-Bill means lending
money to the Government.

Meaning of Treasury Bills: Treasury bills (T-bills) are short-term, government-issued

money market instruments used to raise funds, offering investors a low-risk investment
option. T-Bills are pPurchased at a discount and redeemed at full face value at maturity,
they provide predictable returns over terms typically ranging from 14 to 364 days. They
are backed by the government’s credit, T-bills are highly secure and liquid, making
them ideal for short-term financial planning.
Hence, the Treasury Bills are short-term financial instruments issued by RBI on
the Government of India’s behalf (GOI) in the form of a promissory note. The primary
objective of a treasury bill is to meet the short-term financial requirements of the
central government. For investors, they present one of the safest investments with the
highest liquidity among government securities.
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 Certificate of Deposits: It is a dematerializsed form (eElectronically

generated) for funds deposited in the bank for a specific period of time.
A Certificate of Deposit or CD is a fixed-income financial tool that is governed
by the Reserve Bank of India and is issued in a dematerialized form. It is a type
of agreement made between the depositors and the banks, wherein the bank
pays an interest on your investment. Certificate of Deposit is a short-term
investment that comes with fixed investment amounts and maturity tenure
ranging between 1-3 years.
 Commercial Paper: Commercial paper is an unsecured, short-term debt
instrument issued by corporations to meet their immediate financial
requirements. Commonly, it is issued at a discount and redeemed at face value
upon maturity. The primary purpose of commercial paper is to provide
companies with a cost-effective means of financing short-term liabilities such
as payroll, inventory, and accounts payable.
In the commercial paper market, this instrument is highly favoured due to its
lower interest rates compared to traditional bank loans. The maturity period of
commercial papers is usually of less than 1 year.

3. Financial Services
Services provided by Asset Management and Liability Management Companies.
They help to get the required funds and also make sure that they are efficiently
invested.
The financial services in India include:
 Banking Services: Any small or big service provided by banks like granting a
loan, depositing money, issuing debit/credit cards, opening accounts, etc.
 Insurance Services: Services like issuing of insurance, selling policies,
insurance undertaking and brokerages, etc. are all a part of the Insurance
services
 Investment Services: It mostly includes asset management
 Foreign Exchange Services: Exchange of currency, foreign exchange, etc. are
a part of the Foreign exchange services.

The main aim of the financial services is to assist a person with selling, borrowing
or purchasing securities, allowing payments and settlements and lending and investing.

4. Financial Markets
The marketplace where buyers and sellers interact with each other and participate
in the trading of money, bonds, shares and other assets is called a financial market.
The financial market can be further divided into four types:
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(i) Capital Market: It is designed to finance the long-term investment, the Capital
market deals with transactions which are taking place in the market for over a
year. The capital market can further be divided into three types:
(a) Corporate Securities Market
(b) Government Securities Market
(c) Long Term Loan Market
(ii) Money Market: Mostly dominated by Government, Banks and other Large
Institutions, the type of market is authorised for small-term investments only. It
is a wholesale debt market which works on low-risk and highly liquid
instruments. It is characterized by two sectors:
1. Organized Sector: This sector comes within the direct purview of RBI. It
includes banking and sub-markets.
(a) Banking sector: Commercial banks [under Banking regulation act
1949 and consist of both private and public], RRBs, Cooperative
Banks.
(b) Sub Markets: Meet the need of govt and industries. It includes call
money, Bill market [Commercial bill, T-Bill], Certificate of Deposit
[CD] and Commercial Paper [CP].
2. Unorganized Sector: consists of indigenous bankers, money lenders, non-
banking financial institutions, etc.
(iii) Foreign Exchange Market (Forex Markets): One of the most developed
markets across the world, the Foreign exchange market, deals with the
requirements related to multi-currency. The transfer of funds in this market
takes place based on the foreign currency rate.
(iv) Credit Market: A market where short-term and long-term loans are granted to
individuals or Organizations by various banks and Financial and Non-Financial
Institutions is called Credit Market.

5. Financial Instruments
Financial instruments refer to that type of contract which creates a financial asset
in favour of one party and a financial liability or equity instrument in favour of another.
It is a mutual understanding between two parties wherein one party enjoys some
monetary reward, and the other party acquires some form of ownership or duty. Such
instruments are significant in several financial deals, such as investments, loans or any
other form of money transaction.
In other words, financial instruments are tools utilised to help businesses and
persons manage money, transfer of ownership, and risk management involved in
financial undertakings.
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Financial instruments are legal contracts between the parties involved in

transactions revolving around monetary assets. These assets can be bought, created,
transformed, or traded. For example, if we want to purchase a company bond or equity
in cash, the company or the other party would need to provide a financial instrument to
complete the transaction in full. It is an asset in the form of financial investment in
return for money. Some fundamental financial instruments in India are securities,
bonds, and cheques.

Types of Financial Instruments

The types of financial instruments include equity-based instruments like stocks,
debt-based instruments such as bonds, derivatives like futures and options, and foreign
exchange instruments. Additionally, there are money market instruments for short-term
funding and hybrid instruments combining debt and equity features.
 Equity-Based Instruments: These include stocks or shares, representing
ownership in a company. Investors gain from dividends and capital
appreciation.
 Debt-Based Instruments: Such as bonds, debentures, and treasury bills,
where investors lend money to an entity in exchange for periodic interest
payments and the return of principal at maturity.
 Derivatives: Instruments like futures, options, and swaps, which derive their
value from underlying assets like stocks, commodities, or indices. They are
used for hedging or speculation.
 Foreign Exchange Instruments: Involve the trading of currencies and
include spot contracts, forwards, swaps, and options in the foreign exchange
market.
 Money Market Instruments: Short-term debt instruments like certificates
of deposit, commercial paper, and repurchase agreements, typically used for
short-term borrowing and lending.
 Hybrid Instruments: Combine features of both debt and equity, examples
include convertible bonds and preference shares, offering versatility in
investment and financing.

1.10 Delivery and Non-Delivery Contracts in Capital Market

1. Delivery Trading in Stock Market
Delivery Trading is a trading method in the stock market. The shares are bought
and held by the trader for more than a day for the purpose of making profit over a
period of time. In delivery based trading, the stock will be delivered to the trader’s
demat (dematerialization) account. This strategy is generally used by long term
investors and traders.
Indian Financial System 13

In delivery trading, the trader need not square off the position on the same day.
The trader can hold on to their shares for more than one day. Usually, the trades are
settled according to the T+2 (Trade + 2 days) settlement cycle.

Delivery Trading Rules

Delivery trading in the stock market follows certain rules and regulations set by
the regulatory bodies and exchanges. Some key rules related to delivery trading are:
Settlement: In delivery trading, the settlement of trades happens on a T+2 (trade date
plus two days) basis in India. This means if you buy shares on Monday, the settlement
will take place on Wednesday, and you will receive the shares in your demat account on
Wednesday.
Demat Account: To engage in delivery trading, you need to have a demat account.
This account holds your shares in electronic form.
Delivery Instruction Slip (DIS): When you buy shares for delivery, you need to
submit a Delivery Instruction Slip (DIS) to your broker. This instructs the broker to
transfer the shares from the broker’s pool account to your demat account.
Physical Share Certificates: In the past, shares were issued in the form of physical
certificates. However, with the implementation of dematerialization, physical share
certificates are no longer issued, and all trading is done in electronic form.
Delivery vs. Payment (DVP): In delivery trading, the concept of Delivery vs. Payment
(DVP) ensures that securities are delivered only when payment is received. This helps
in reducing the risk of non-payment or default.
Stamp Duty: Stamp duty is applicable on the transfer of shares in delivery trading. The
rate of stamp duty varies from state to state in India.
Settlement Guarantee: Stock exchanges provide settlement guarantee for trades
executed on their platform. This ensures that even if one party defaults, the other party
will receive the securities or funds.

Types of Delivery Trading

There are two types of delivery trading that investors can choose from. The most
common type of delivery trading is:
(a) Spot Delivery: Spot Delivery, which is used to buy or sell assets such as
currencies, commodities, or company shares. Spot delivery trades are typically
settled within two days, making them ideal for investors who want to buy or sell
an asset quickly.
(b) Forward Delivery: Another type of delivery trading is forward delivery.
Forward trades are similar to spot trades but involve an agreement to buy or sell
an asset at a future date. This type of trade is often used by investors who want
to hedge against potential price movements in an asset. For example, if an
investor thinks that the price of a currency will fall in the future, they might
14 Indian Financial System

enter into a forward contract to sell that currency at a set price on a specific
date.

2. Non-Delivery Contracts
In the Indian capital market, non-delivery contracts primarily refer to derivatives,
specifically futures and options contracts, which do not involve the actual delivery of
the underlying asset at the time of settlement. These contracts are based on the future
price movements of assets like stocks, indices, or commodities.

Meaning of Future Contracts and Options Contracts

a. Futures Contracts
 These contracts obligate the buyer to purchase or the seller to sell an asset at a
predetermined price on a future date.
 The underlying asset is not delivered during the contract period.
 Settlement usually involves cash payments based on the price difference
between the contract price and the market price at expiry.

b. Options Contracts
 Options give the buyer the right, but not the obligation, to buy or sell an
underlying asset at a specific price (strike price) on or before a certain date.
 Like futures, options contracts are settled based on price differences, not
physical delivery of the asset.
 There are two main types: call options (right to buy) and put options (right to
sell).

Characteristics of Non-Delivery Contracts

The main Characteristics of Non-Delivery Contracts are:

 No Physical Delivery
The main feature is that the underlying asset is not physically delivered at
settlement.

 Cash Settlement
Settlement is typically done through cash payments based on price differences.

 Leverage
Derivatives offer leverage, allowing traders to control a large position with a
smaller investment.
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 Hedging and Speculation

Derivatives are used for both hedging (reducing risk) and speculation (betting on
price movements).

Hence, non-delivery contracts in the Indian capital market are primarily

derivatives, including futures and options, which are settled based on price differences
rather than physical delivery of the underlying asset.

1.11 Structure of the Indian Financial System

The Indian Financial System is made up of various components that work together
to facilitate the flow of funds between savers and investors. The structure of the Indian
financial system can be broadly divided into two parts: the organized sector and the
unorganized sector.

a. Organized Sector
The organized sector includes formal financial institutions such as banks,
insurance companies, NBFCs, mutual funds, stock exchanges, and pension funds. These
institutions are regulated by the Reserve Bank of India (RBI) and other regulatory
bodies such as the Securities and Exchange Board of India (SEBI), the Insurance
Regulatory and Development Authority of India (IRDAI), and the Pension Fund
Regulatory and Development Authority of India (PFRDAI).

b. Unorganized Sector
The unorganized sector, on the other hand, includes informal financial
intermediaries such as moneylenders, chit funds, and other unregulated entities that
cater to the financial needs of the unbanked and underserved sections of society.

1.12 Role of Financial System

A financial system performs the following functions:
 It serves as a link between savers and investors. It helps in utilizing the
mobilized savings of scattered savers in a more efficient and effective manner.
It channelizes the flow of saving into productive investment .
 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.
16 Indian Financial System

 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. Reduced costs
motivates people to save more.
 It provides detailed information to the operators/players in the market such as
individuals, business houses, gGovernments, etc.

1.13 Financial Regulators in India

In India, the financial system is regulated by independent regulators incorporated
with the field of insurance, banking, commodity market, pension funds, and capital
market.
The Indian government is also accountable for playing a significant role in
handling the field of financial safety as well as influencing the roles of such mentioned
regulators. The most commonly known and significant of all the financial regulators in
India is the Reserve Bank of India (RBI).
An independent regulatory agency is one that is not dependent on the other
branches or arms of the central government. Regulatory authorities are set up to enforce
standards and security.

Meaning of Financial Regulator

Financial Regulators are ‘government entities or agencies responsible for
controlling and regulating financial markets and institutions.’. The main goal of
financial regulators is to protect consumers, maintain financial stability, and promote
fair and transparent financial practices.
Financial regulators may have a variety of responsibilities, including:
 Supervising financial institutions such as banks and insurance companies to
ensure that they comply with laws and regulations.
 Enforcing laws and regulations related to financial products and services, such
as consumer protection laws and anti-money laundering regulations.
 Monitoring financial markets to detect and address potential risks or threats to
financial stability.
 Conducting investigations and imposing penalties on financial institutions or
individuals that violate laws or regulations.

Examples of financial regulators include Reserve Bank of India (RBI), the

Securities & Exchange Board of India (SEBI) etc.
Following are the different financial regulatory bodies in India:
Indian Financial System 17

Regulatory Body Sector

Reserve Bank of India (RBI) Banking & Finance, Monetary Policy
Securities & Exchange Board of India Securities (Stock) & Capital Market
(SEBI)
Insurance Regulatory & Development Insurance
Authority of India (IRDAI)
Pension Fund Regulatory & Development Pension
Authority of India (PFRDAI)
The Ministry of Corporate Affairs (MCA) Corporate Affairs
Insolvency and Bankruptcy Board of Bankruptcy and Insolvency cases
India (IBBI)
Association of Mutual Funds of India Mutual Funds
(AMFI)

The brief information on the above authorities has been stated below:

1. Reserve Bank of India

Introduction and Meaning of RBI
The regulators are required to carefully safeguard the sanctity of payment systems,
generally from systematic risks, the risk of fraud, etc. The responsibility of a central
bank of any given country is to ensure and carry on the development of payment
systems at the national level. In India, this responsibility is vested with the Reserve
Bank of India (RBI).
RBI, as the central bank of the country, occupies a significant place in the Indian
Banking and Financial System. As an apex institution, it acts as a guide, regulator,
controller and promoter of the financial system. RBI was established in 1935, under
RBI Act, 1934. Till 1949, it was a private shareholders’ institution and became a state-
owned institution after its nationalization. It is banker to the banks and controller of
activities of banking, non-banking and financial institutions in the country.
Reserve Bank of India is the central bank of India. The Reserve Bank of India was
established on 1 st April 1935, in accordance with the provisions of the Reserve Bank of
India Act, 1934. The Central Office of the Reserve Bank was initially established in
Kolkata but was permanently moved to Mumbai in 1937. The Central Office is where
the Governor sits and where policies are formulated.
The Reserve Bank of India is the backbone of the Financial System of the country.
It has been entrusted by the people and the Government to control, supervise and
promote the flow of money in the market. It also takes part in planning and
18 Indian Financial System

development to maintain economic stability of the country and take the country towards
growth.
Reserve Bank of India was established in 1935 and since then it has regulated the
flow of Indian rupee in the country. The Reserve Bank is also responsible for managing
other commercial banks through its various policies and directions.
Every bank is entitled to keep an amount of money with the RBI which serves as
the limit to the amount of money that that bank can lend to the public. There are various
other policies and rules through which RBI keeps a check on the economy of the
country.

Objectives of RBI
Being the backbone of the financial state of the country, RBI has various
objectives as mentioned in the RBI preamble. Some of them are listed below:

Primary Objectives
The primary objectives of RBI include:
 Addressing the issue of Banknotes.
 Maintaining monetary stability in the country.
 To operate the credit system and currency in the country to its own advantage.
 Remain independent of the political influence: In order to maintain financial
stability and promote economic growth, RBI should be free from any political
pressure and refrain from corrupted activities.

Fundamental Objectives
RBI should serve as a central authority and serve as:
– Bank of all the other Commercial banks
– Only authority who has note issuing power
– Bank to the Government of India
Promote Economic Growth: RBI, along with maintaining price stability, should also
design policies which promote economic growth within the framework

Functions of RBI
According to the RBI Aact, 1934, RBI has various functions to serve. Some of
them include:
1. Monetary Authority: It plans and supervises the monetary policies designed
for the country. The objective behind this is that every policy should be
designed keeping in mind the idea of growth and at the same time should also
maintain price stability.
Indian Financial System 19

2. Financial System Supervisor: It designs the parameters under which all the
banks of the country should work. The main aim here is to maintain the trust of
the general public in the financial system of the country and provide them with
services thatwhich are cost-friendly.
3. Foreign Exchange: All the foreign exchange that happens between the
countries is maintained and looked after by RBI. This is done so that easy and
smooth foreign trade can happen and also foreign market remains maintained.
4. Issuer of Currency: RBI is the authority thatwho issues notes, destroys the old
notes and decides which currency is fit for circulation among the people.
Demonetisation was done after taking advice from RBI and the new notes of
2000 came into circulation.
5. Development: Vvarious national projects are funded by RBI. It undertakes
development of the country as its objective and invests at various places in
national interest.

Supervisory Functions of RBI

RBI also has certain supervisory functions to fulfil. They include:
1. Granting licence to commercial banks
2. Inspection of the other banks
3. Implementing Deposit Insurance scheme
4. Controlling Non-Banking financial institutions
The Reserve Bank of India is entrusted with the statutory powers of supervising
the banks and promoting efficient and healthy banking systems in the country. The RBI
is given wide powers of monetary policy making, supervising, and controlling the
commercial, cooperative, and regional banks in India.
 Every new bank and/ or branch being established in India must have a valid
license from the RBI to do so.
 The nationalized and rural banks come directly under the control and
supervision of the RBI.
 RBI ensures monetary, price, and financial stability in the country.
 It ensures the regulation of currency and credit in the economy.
 The RBI also ensures the development of efficient financial structure of India.

2. Securities & Exchange Board of India (SEBI)

SEBI stands for Securities and Exchange Board of India. It is a statutory regulatory
body that was established by the Government of India in 1992 for protecting the
interests of investors investing in securities along with regulating the securities market.
SEBI also regulates how the stock market and mutual funds function.
20 Indian Financial System

Objectives of SEBI
Following are some of the objectives of the SEBI:
1. Investor Protection: This is one of the most important objectives of setting up
SEBI. It involves protecting the interests of investors by providing guidance and
ensuring that the investment done is safe.
2. Preventing the fraudulent practices and malpractices which are related to
trading and regulation of the activities of the stock exchange.
3. To develop a code of conduct for the financial intermediaries such as
underwriters, brokers, etc.
4. To maintain a balance between statutory regulations and self regulation.

Functions of SEBI
SEBI has the following functions
1. Protective Function
2. Regulatory Function
3. Development Function
The givenfollowing functions will be discussed in detail as follows:

1. Protective Function
The protective function implies the role that SEBI plays in protecting the investor
interest and also that of other financial participants. The protective function includes
the following activities:
(a) Prohibits Insider Trading: Insider trading is the act of buying or selling of the
securities by the insiders of a company, which includes the directors, employees
and promoters. To prevent such trading SEBI has barred the companies to
purchase their own shares from the secondary market.
(b) Check Price Rigging: Price rigging is the act of causing unnatural fluctuations
in the price of securities by either increasing or decreasing the market price of
the stocks that leads to unexpected losses for the investors. SEBI maintains
strict watch in order to prevent such malpractices.
(c) Promoting Fair Practices: SEBI promotes fair trade practice and works
towards prohibiting fraudulent activities related to trading of securities.
(d) Financial Education Provider: SEBI educates the investors by conducting
online and offline sessions that provide information related to market insights
and also on money management.
Indian Financial System 21

2. Regulatory Function
Regulatory functions involve establishment of rules and regulations for the
financial intermediaries along with corporates that helps in efficient management of the
market.
The following are some of the regulatory functions.
(a) SEBI has defined the rules and regulations and formed guidelines and code of
conduct that should be followed by the corporates as well as the financial
intermediaries.
(b) Regulating the process of taking over of a company.
(c) Conducting inquiries and audit of stock exchanges.
(d) Regulatinges the working of stock brokers, merchant brokers.

3. Developmental Function
Developmental function refers to the steps taken by SEBI in order to provide the
investors with knowledge of the trading and market function. The following activities
are included as part of developmental function:.
(a) Training of intermediaries who are a part of the security market.
(b) Introduction of trading through electronic means or through the internet by the
help of registered stock brokers.
(c) By making the underwriting an optional system in order to reduce cost of issue.

Purpose of SEBI
The purpose for which SEBI was setup was to provide an environment that paves
the way for mobilisation and allocation of resources. It provides practices, framework
and infrastructure to meet the growing demand.
It meets the needs of the following groups:
(a) Issuer: For issuers, SEBI provides a marketplace that can utilised for raising
funds.
(b) Investors: It provides protection and supply of accurate information that is
maintained on a regular basis.
(c) Intermediaries: It provides a competitive market for the intermediaries by
arranging for proper infrastructure.
The SEBI is responsible for:
 Formulating guidelines and the code of conduct for the proper functioning of
the financial intermediaries and businesses.
 Regulating businesses in the stock exchange and other securities market.
22 Indian Financial System

 Conducting audit and enquiries of the exchanges.

 Registering and protecting the interest of the securities market participants.
These include trustees of the trust deeds, brokers, sub-brokers, investment
advisors, merchant bankers, intermediaries, etc.
 Levying fees.
 Formulating, implementing, and monitoring exercising powers.
 Registering and regulating credit rating agencies and self-regulating
organizations.
 Identifying and prohibiting insider trading and unfair trade practices.

3. Insurance Regulatory and Development Authority of India (IRDAI)

The IRDA is another important financial regulatory body that regulates the
insurance industry in India. It was established as per the provisions of the Insurance
Regulatory and Development Authority Act of 1999. Its headquarters are situated in
Hyderabad, Telangana State.

Establishment of IRDA
The Government of India was the regulator for the insurance industry until 2000.
However, to institute a stand-alone apex body, the IRDA was established in 2000
following the recommendation of the Malhotra Committee report in 1999. In August
2000, the IRDA began accepting applications for registrations through invites and
allowed companies from other countries to invest up to 26% in the market.
The IRDA has outlined several rules and regulations under Section 114A of the
Insurance Act, 1938. Regulations range from registration of insurance companies for
operating in the country to protecting policyholder’s interests. As of September 2020,
there are 31 General Insurance companies and 24 Life Insurance companies thatwho are
registered with the IRDA.

Objective of IRDAI
The main objective of the Insurance Regulatory and Development Authority of
India is to enforce the provisions under the Insurance Act. The mission statement of the
IRDA is:
 To protect the interest and fair treatment of the policyholder.
 To regulate the insurance industry in fairness and ensure the financial
soundness of the industry.
 To regularly frame regulations to ensure the industry operates without any
ambiguity.
Indian Financial System 23

Role of IRDA in India

The insurance industry in India dates back to the early 1800s and has grown over
the years with better transparency and focus on protecting the interest of the
policyholder. The IRDA plays an integral role in emphasizing the importance of
policyholders and their interest while framing rules and regulations. The important
roles of the IRDA are:
 To protect the policyholder’s interests.
 To help speed up the growth of the insurance industry in an orderly fashion, for
the benefit of the common man.
 To provide long-term funds to speed up the nation’s economy.
 To promote, set, enforce and monitor high standards of integrity, fair dealing,
financial soundness and competence of the insurance providers.
 To ensure genuine claims are settled faster and efficiently.
 To prevent malpractices and fraud, the IRDA has set up a grievance redress
forum to ensure the policyholder is protected.
 To promote transparency, fairness and systematic conduct of insurance in the
financial markets.
 To build a dependable management system to make sure high standards of
financial stability are followed by insurers.
 To take adequate action where such high standards are not maintained.
 To ensure the optimum amount of self-regulation of the industry.

Functions of IRDA
The important functions of the IRDAI in the insurance industry in India are:
 Grant, renew, modify, suspend, cancel or withdraw registration certificates of
the insurance company.
 Protecting the interests of the policyholder in matters concerning the grant of
policies, settlement of claims, nomination by policyholders, insurable interest,
surrender value of the policy and other terms and conditions of the policy.
 Specify code of conduct, qualifications and training for intermediary or
insurance agents.
 Specify code of conduct for loss assessors and surveyors.
 Levying fees and charges for carrying out the provisions of the Act.
 Undertaking inspection, calling for information, and investigations including an
audit of insurance companies, intermediaries, and other organizations
associated with the insurance business.
 Regulate and control insurance rates, terms and conditions, advantages that may
be offered by the insurance providers.
24 Indian Financial System

Apart from the above-mentioned core functions of the IRDA, there are several
functions that the regulator performs keeping the policyholder’s interest as its priority.
The IRDAI is responsible for the following:
 Registering, issuing, renewing, and cancellation of licenses.
 Specifying qualifications, the code of conduct, and providing to training to the
agents and other intermediaries.
 Protecting the rights of the insurance policyholders, providing registration
certificates to the life insurance companies. Besides, the IRDAI is also
concerned with renewing, modifying, cancelling and/ or suspending the
registration certificates as and when it deems fit.
 Promoting efficiency in the conduct of the insurance business, and promoting
and regulating professional organizations that are directly or indirectly
connected with insurance and reinsurance businesses.
 Regulating investment of funds by insurance companies, adjudicating between
insurers and insurance intermediaries.

4. Pension Fund Regulatory and Development Authority of India

(PFRDAI)
PFRDA, full form beingis Pension Fund Regulatory and Development Authority,
and was created in 2003 with the goal of promoting, regulating, and expanding India’s
pension industry. PFRDA was initially designed for government employees
exclusively, but its services were subsequently expanded to include all Indian nationals
and NRIs, including self-employed persons.

PFRDA Act 2013

IPRDA (Interim Pension Fund Regulatory & Development Authority) was passed
by Parliament in 2003 in order to have a system in place till the final and fool-proof
system is prepared, re-approved, and implemented with the acceptance of all political
parties including the opposition parties. PFRDA, Pension Fund Regulatory and
Development Authority was established with the President’s assent on 19 th September,
2013 and was made a permanent Act. The President was the guardian of PFRDA till
Financial Year 2014-15 and it has become fully autonomous and functions
independently from Financial Year 2014-15.

Functions of PFRDA
The PFRDA’s preamble declares that the authority’s goals are to “promote old age
income security by creating, growing, and regulating pension funds, to safeguard the
interests of subscribers to pension fund schemes, and for issues associated with or
incidental thereto.”
Indian Financial System 25

PFRDA is headquartered in New Delhi, with regional offices located around the
country. The main functions of PFRDA are stated below:
1. Undertaking steps for educating subscribers and the general public on issues
relating to pension, retirement savings and related issues and training of
intermediaries.
2. Providing pension schemes not regulated by any other enactment.;
3. Protecting the interests of subscribers of NPS (National Pension Scheme) and
such other schemes as approved by the authority from time to time.
4. Approving the schemes, and laying down norms of investment guidelines under
such schemes.;
5. Registering and regulating intermediaries- NPS Trust, Points of Presence,
Central Record keeping Agency, Trustee Bank, Pension Funds, Custodian for
time bound service to subscribers.
6. Ensuring that the intermediation and other operational costs are economical and
reasonable.;
7. Making existing grievance redressal process robust and time bound.
8. Adjudication of disputes between intermediaries and between intermediaries
and subscribers.

5. The Ministry of Corporate Affairs (MCA)

The Ministry of Corporate Affairs (MCA) is a ministry of the Indian government.
It is mainly responsible for regulation of Industrial and Service sector enterprises. The
Institute of Chartered Accountants of India (ICAI), Institute of Company Secretaries of
India (ICSI) and Institute of Cost Accountants of India (ICAI) are also supervised by it.
It also has the responsibility to carry out the functions related to the administration of
the Companies Act 2013, the Companies Act 1956, the Limited Liability Partnership
Act, 2008 and Societies Registration Act, 1980.

1.14 Impact of Digital Rupee (e₹) on Traditional Banking

Meaning of Digital Rupee
The Digital Rupee is a Central Bank Digital Currency (CBDC) issued by the
Reserve Bank of India (RBI). The Digital Rupee is a government-backed, digital form
of the Indian rupee, serving as legal tender for transactions.
The Reserve Bank of India is spearheading the digital rupee initiative, with a focus
on enhancing the efficiency and security of financial transactions.
26 Indian Financial System

Unlike physical currency, the digital rupee is issued, controlled, and used
digitally, offering advantages like reduced costs, increased transparency, and
enhanced security.
The digital rupee represents the Indian rupee in a digital format, issued by the
Reserve Bank of India (RBI). It is a legal tender, designed to function just like physical
money.
e₹ ias a legal tender issued by a central bank in a digital form. The conversion rate
is 1 e₹ = 1 Rupee. e₹ shall be accepted as a medium of payment, legal tender and a
safe store of value.

Benefits of Digital Rupee

Digital Rupee has several added benefits like:
 Increased Financial Inclusion: By making financial services more accessible,
the digital rupee can help reduce poverty and boost economic growth.
 Reduced Transaction Costs: By eliminating intermediaries, such as banks, it
lowers transaction costs and enhances payment efficiency.
 Improved Security: The digital rupee can mitigate risks related to counterfeit
currency and fraud.
 Enhanced Cross-Border Payments: It allows for faster and more efficient
international transactions, lowering costs and fostering trade.

Impact of Digital Rupee on Traditional Banking

The adoption of the digital rupee has made several changes in traditional banking,
which includes:
 Banking Transactions: The digital rupee has the potential to streamline and
secure banking transactions.
 Payment Systems: It has transformed payment methods, enabling instant and
seamless transactions.
 Cost Reduction: Banks may experience reduced operational costs, particularly
in areas like cash handling, distribution, and security.
 Customer Experience: Faster, more efficient services could significantly
improve customer experience.
 Increased Competition: Traditional banks face greater competition from non-
bank financial institutions and fintech startups offering digital payment
services.
 Reduced Demand for Physical Cash: As digital currency use grows, the
demand for cash may decrease, prompting changes in banking operations.
Indian Financial System 27

 New Revenue Opportunities: Banks can capitalize on new revenue streams by

developing digital payment services and financial products tied to the digital
rupee.

1.15 The Rise of FinTech in India

The advent of digitalisation marked the rise of FinTech. It represents an innovative
shift in how financial services are accessed and delivered. This evolution has been
primarily driven by technological advancements, changing consumer expectations, and
a dynamic regulatory landscape. It has led to an influx of startups and new solutions
redefining the industry. The blend of FinTech finance and traditional banking is
creating a new paradigm in the financial world.
This change from traditional banking to FinTech has profoundly impacted the
financial landscape. It has democratised access to financial services, making them
available to a broader population segment, including those previously marginalised by
conventional banking systems. Consumers now enjoy a more diversified array of
services, from mobile banking and digital payments to sophisticated investment
platforms, all tailored to their unique needs and available at their fingertips.
Meanwhile, traditional banks, spurred by the competition and innovation from
FinTech startups, are digitizing their operations and collaborating with these new
entrants to enhance their offerings and retain their customer base. This is reshaping the
way financial services are provided and consumed and paving the way for a more
inclusive and efficient financial ecosystem.

Impact of Rise of Fin Tech

FinTech has indeed revolutionised various sectors within the financial world. The
Fin Tech is not just changing the game but also shaping the future of finance which are
as follows:

 Digital Payments
India has witnessed exponential growth in digital payments. This surge is largely
attributed to initiatives like "Digital India," which promotes online infrastructure and
internet connectivity. For example, UPI (Unified Payments Interface) opened up a
revolutionary chapter in India's payments history. It allows instant money transfers and
merchant payments with a single mobile application. Due to its unique model that
drastically simplifies instant transactions, UPI became widely accepted across the
country.

 Personal Finance Management

Individuals now have access to advanced budgeting, investing, and wealth
management tools. Budgeting and savings apps also help users track their spending, set
28 Indian Financial System

budgets, and save money. They often link directly to users’ bank accounts and provide
insights into spending patterns.

 Lending
Advanced credit risk analysis technologies are streamlining access to loans for
both individuals and businesses. P2P (Peer-to-Peer) platforms in India are growing,
allowing individuals to lend and borrow directly from each other. This bypasses
traditional banking channels and can often offer more competitive rates and terms for
both parties.

 Insurtech (Insurance Technology)

The insurance industry has seen innovation in policy customisation, claims
processing efficiency, and precise risk evaluation. Microinsurance is particularly
influential in India. Insurtech firms are offering low-cost, flexible insurance products to
cater to the low-income segment of the population.

Key Technologies Pioneering the FinTech Revolution

The FinTech revolution is being propelled forward by a wave of technological
advancements that are reshaping the financial industry at an unprecedented pace.
The following are the eight key technologies pioneering this revolution and how
they are contributing to the evolving financial services landscape.

1. Artificial Intelligence (AI)

 AI has become integral to financial services, simulating human decision-
making processes.
 AI enhances customer interaction by utilising chatbots and virtual assistants.
 It secures transactions by detecting fraud and anomalies.
 AI provides personalised financial advice, tailoring recommendations to
individual needs.

2. Big Data Analytics

 Big data analytics involves the analysis of large and complex datasets.
 This technology uncovers hidden patterns, market trends, and customer
preferences.
 Financial institutions use these insights to make data-driven decisions,
customise their offerings, and identify new market opportunities.

3. Machine Learning (ML)

 ML algorithms continually improve their accuracy by learning from new data.
Indian Financial System 29

 They excel in financial forecasting, credit scoring, and developing investment

strategies.
 ML can identify patterns and predictions human analysts might miss.

4. Robotic Process Automation (RPA)

 This technology automates routine and repetitive tasks.
 It increases operational efficiency by reducing the need for human intervention.
 It helps cut costs and reduce errors in data entry, report generation, etc.

5. Cloud Computing
 It offers financial institutions scalable, flexible, and cost-effective
infrastructure.
 It supports vast data storage, advanced analytics capabilities, and uninterrupted
service delivery.
 This facilitates growth and innovation without the need for heavy upfront
investments.

6. Blockchain
 It provides a decentralised and secure way to record and verify various types of
transactions, potentially reducing fraud, expediting the settlement process, and
increasing transparency in activities ranging from currency transfers to
maintaining shareholder records.

7. Internet of Things (IoT)

 IoT links everyday devices to the internet, enabling valuable data collection.
 The data can be used to offer more personalised services, manage risks, etc.

8. Open-Source SaaS (Software as a Service)

 It provides customisable and flexible software solutions for financial
institutions.
 It reduces costs while offering scalability, allowing organisations to quickly
adapt and scale their services in response to market changes and regulatory
requirements.

In India, FinTech's growth is driven by technological innovation, strategic

regulation, and a focus on financial inclusion. As the sector expands, it offers advanced
tools, collaborates with traditional banks, and contributes to global financial discourse.
This integration of technology and finance is transforming India's economy and
enhancing financial accessibility for a broader population.
30 Indian Financial System

1.16 Shadow Banking

Shadow Banking is a term used to describe bank-like activities (mainly
lending) that take place outside the traditional banking sector. It is also referred as non-
bank financial intermediation or market-based finance. Generally, it is not regulated in
the same way as traditional bank lending.
The term ‘shadow bank’ was coined by Paul McCulley in 2007. Examples of
shadow lenders include Special Purpose Entities, Non-Banking Financial Companies
(NBFCs), Hedge Funds, etc. These institutions function as intermediaries between the
investors and the borrowers, providing credit, thus, leading to financial inclusion and
hence generate liquidity in the system.
A shadow banking system can be broadly defined as ‘the system of credit
intermediation that involves entities and activities outside the regular banking
system’. Non-bank financing provides a valuable alternative to bank funding and helps
support real economic activity. It is also a welcome source of diversification of credit
supply from the banking system, and provides healthy competition for banks.
The shadow banking system describes ‘financial intermediaries that participate in
creating credit but are not subject to regulatory oversight’.
Shadow Banking is a system of financial intermediaries, activities, and institutions
that operate outside the regular banking system and regulatory oversight. Shadow
banking entities engage in credit creation and lending but are not subject to the same
regulations as traditional banks.
Shadow banking involves financial activities carried out by non-bank entities such
as hedge funds, private equity firms, and Nnon-Bbanking Ffinancial Ccompanies
(NBFCs). These institutions provide similar services to banks, such as lending and
investment opportunities, but are not subject to the same stringent regulations.
Banks play a key role in the economy, underpinning the credit system by taking
money from depositors and creating new credit to make loans. Banks usually have to
operate with plenty of scrutiny from financial regulators in their home countries and
around the world. Shadow banks, often known as Nnon-Bbank Ffinancial Ccompanies
(NBFCs), can usually operate with little to no oversight from regulators.
Examples of shadow banks or financial intermediaries not subject to regulation
include hedge funds, private equity funds, mortgage lenders, and even large investment
banks. The shadow banking system can also refer to unregulated activities by regulated
institutions, which include financial instruments like credit default swaps.
In India, NBFCs play a significant role in the shadow banking system. While they
offer flexibility and credit to sectors underserved by traditional banks, they also pose
risks to financial stability due to their lack of regulation. The 2008 subprime crisis
Indian Financial System 31

highlighted the dangers of shadow banking, where high-risk lending and lack of
oversight contributed to the collapse of the financial system.

Shadow Banks in India

The examples for Shadow Banks in India are:
1. Non-Banking Financial Companies (NBFCs): NBFCs are a prominent
example of shadow banking entities in India. They provide various financial
services such as loans, credit, and investment activities similar to traditional
banks, but they are not regulated as strictly.
2. Housing Finance Companies (HFCs): HFCs specialize in providing loans for
housing and real estate projects. They play a crucial role in facilitating home
ownership but can also contribute to systemic risks if not regulated effectively.
3. Microfinance Institutions (MFIs): MFIs provide small loans to low-income
individuals and microenterprises. While they contribute to financial inclusion,
their rapid growth and lack of proper regulation have raised concerns about
over-indebtedness among borrowers.
4. Peer-to-Peer (P2P) Lending Platforms: P2P lending platforms connect
borrowers directly with lenders, bypassing traditional banks. They offer an
alternative source of credit but are relatively new and require regulatory
oversight to ensure consumer protection.
5. Asset Management Companies (AMCs): Some AMCs offer products like
Fixed Maturity Plans (FMPs) that resemble bank fixed deposits. These products
can carry risks if they invest heavily in illiquid assets without proper disclosure.
6. Non-Banking Financial Services (NBFS): These include a range of financial
service providers, such as insurance brokers, financial advisors, and credit
rating agencies, that operate outside the traditional banking system.
7. Gold Loan Companies: Certain companies offer loans against gold as
collateral. While they serve a specific credit need, rapid growth without proper
risk assessment can lead to potential instability.
8. Alternative Investment Funds (AIFs): AIFs pool funds from various investors
and invest in different asset classes. While they offer diversification
opportunities, their operations need to be transparent and well-regulated to
prevent potential risks.
32 Indian Financial System

1.17 Paytm Case Study: The dramatic downfall of a Fintech

Pioneer
Paytm was launched in 2010 by Vijay Shekhar Sharma as a mobile-first digital
payment platform. Initially, it aimed to facilitate prepaid mobile and DTH (direct-to-
home) recharges.
The acronym for the business is “Pay Through Mobile.” Making cash payments
easier to use and more accessible for people all over India was the aim. Over time,
Paytm expanded its services significantly.
By 2013, Paytm introduced debit card and postpaid mobile payments. A significant
breakthrough came in 2014 when the company launched its wallet system. This move
attracted major services like Indian Railways and Uber to accept Paytm payments.
The user base grew rapidly. By 2015, this number had skyrocketed to 100 million.
The launch of the Paytm wallet was a game-changer, making digital payments widely
accessible.
In 2016, India’s demonetization of ₹ 500 and ₹ 1,000 notes provided an
unexpected boost. With cash suddenly scarce, people turned to digital payments. Paytm
quickly became a household name, capitalising on this shift.
Paytm’s reach extended to small merchants who adopted its QR code system. This
allowed easy digital payments, linking directly to their bank accounts. The simplicity
and convenience made it popular among businesses of all sizes.
With over 100 million app downloads by 2017, Paytm became the first payment
app to accomplish this feat. The company continued to expand its offerings, including
movie and flight tickets, gold purchases, insurance, and remittances.
Investors were enthusiastic. Alibaba’s Ant Group, Masayoshi Son’s Softbank, and
Warren Buffett’s Berkshire Hathaway invested, pushing Paytm’s valuation to over $16
billion by 2019. These investments supported further growth and diversification of
services.
Paytm Payments Bank (PPBL) was introduced by Paytm in 2017. This added
another layer to its services, combining banking with digital payments. The bank aimed
to reach unbanked populations and provide a seamless banking experience.

Key Factors for Downfall

 Regulatory Non-compliance Issues
Paytm faced significant regulatory challenges starting in 2018. The Reserve Bank
of India (RBI) flagged the company for multiple violations, including non-compliance
with KYC (Know Your Customer) norms.
Indian Financial System 33

In June 2018, the RBI halted the opening of new accounts due to compliance
issues. By 2021, the bank was fined ₹ 1 crore for submitting false information. Despite
an external audit, further lapses were found in technology and cybersecurity. In October
2023, another fine of ₹ 5.39 crore was imposed.

These persistent operational shortcomings resulted in repeated regulatory

interventions, including bans on onboarding new customers and other banking
activities. This constant pressure hindered Paytm’s ability to function smoothly and
grow.
The RBI’s final crackdown on PPBL was severe. On January 31, 2024, the bank
was instructed to cease accepting deposits, top-ups, and offering certain banking
services by February 29, 2024.
The directive to halt new deposits and top-ups in PPBL disrupted its core
operations. This forced the company to shift its banking activities to other financial
institutions, significantly impacting its business model and revenue streams.

 Strategic mMissteps
Paytm’s strategy to diversify into various financial services, such as credit,
insurance, wealth management, and FASTag, did not yield the expected results. The
Indian stock market and public shareholders found it challenging to understand and
value this business model, further complicating Paytm’s post-IPO journey.

 Market Competition
The company was up against fierce competition from other online payment
services like PhonePe and Google Pay. These competitors offered similar services,
often with fewer regulatory hurdles and more straightforward business models. This
increased competition further eroded Paytm’s market share and profitability.

 Technological and Operational Lapses

PPBL also struggled with technological and operational issues. The RBI identified
lapses in cybersecurity and IT infrastructure, which posed significant risks to customer
data and transaction security. These deficiencies undermined user trust and added to the
company’s operational challenges.

 Political and Economic Climate

The broader political and economic environment also played a role. Regulatory
crackdowns on financial institutions, particularly those with ties to Chinese investors,
created additional pressure. Antfin, an Alibaba affiliate, held a significant stake in
One97 Communications, raising concerns amid strained India-China relations.
34 Indian Financial System

The cumulative effect of regulatory fines, bans, and operational challenges led to a
significant loss of trust among users and partners. This erosion of trust, coupled with
negative media coverage and ongoing regulatory scrutiny, weakened Paytm’s market
position.
The company’s future course will be decided by how well it handles these
problems and regains the trust of its stakeholders.

Review Questions
Conceptual type questions for 2 marks.
1. State the meaning of Financial System
2. What do you mean by Financial Services?
3. What are Treasury Bills?
4. What is the meaning Commercial Paper?
5. What do you mean by financial markets.
6. Give the meaning of Financial Assets.
7. Expand SEBI & IRDAI
8. What is What is Shadow Banking?
9. What is the meaning Financial Regulator?
10. Give the meaning of Digital Rupee.
11. What is Shadow Banking?
12. What do you mean by Traditional Banking?
13. Give the meaning of NBFC.

Analytical type questions for 5 marks.

1. Explain briefly the functions of Financial System.
2. Explain the Constituents of Financial System.
3. Mention the Regulators of Financial System.
4. Write a note on key elements for well-functioning financial system.
5. Briefly explain the structure of financial system.
6. Write the differences between money market and capital market.
7. Write a note on SEBI.
8. Write a note on Delivery and Non-Delivery Contracts.
Indian Financial System 35

Essay type questions for 15 marks.

1. Explain in details about the Regulators of Financial System.
2. Write a note on a) Financial Assets, b) Financial Markets and c) Financial
Instruments
3. Write in detail the various Regulatory Authorities of Financial System.
4. Discuss case study on Paytm Payments Bank Transition.

CHAPTER ‒ 2
MONEY MARKET AND
CAPITAL MARKET
Contents:
Money Market – Meaning, Instruments (Call Money, T-Bills, CPs, CDs),
Participants – Capital Market – Primary vs Secondary Market – Stock Exchanges (NSE,
BSE) – SEBI Regulations – Recent Reforms (T+1 Settlement, ASBA) --. Adani ‒
Hindenburg Case: Market Volatility and SEBI’s Role ‒ IPO Boom in India (2021-
2023).

2.1 Introduction to Financial Market

When we talk about markets, we think about a place to sell and buy goods and
services. However, in reality, the term has a much wider scope. A market is basically a
sum total of demand and supply of any particular commodity or service.
So, a Financial Market is a market, or an arrangement or an institution that
facilitates the exchange of financial instruments and securities. These instruments
include shares, stocks, bonds, debentures, commercial papers, bills, cheques etc. The
price of these instruments is determined by the laws of demand and supply in the
market.

2.2 Meaning of Financial Market

A Financial Market is a location where buyers and sellers meet to exchange
goods and services at prices determined by the forces of supply and demand.
Financial Market refers to a ‘marketplace, where creation and trading of financial
assets, such as shares, debentures, bonds, derivatives, currencies, etc. take place’. It
plays a crucial role in allocating limited resources, in the country’s economy. It acts as
an intermediary between the savers and investors by mobilizing funds between them.
The financial market provides a platform to the buyers and sellers, to meet, for
trading assets at a price determined by the demand and supply forces.
Money Market and Capital Market 37

A Financial Market may be a physical location or a virtual one over a network (for
example, the Internet). People who have a specific good or service they want to sell (the
supply) trade with people who wish to buy it (the demand).
Prices in a Financial Market are determined by changes in supply and demand. If
market demand is steady, an increase in market supply results in a decline in market
prices and vice versa. If market supply is steady, a rise in demand results in a rise in
market prices and vice versa.
Financial markets are affected by many variables including consumer preferences
and perceptions, the availability of materials and external sociopolitical events. Eg:
wars, government spending and unemployment.
Financial markets include a broad range of assets being traded between buyers and
sellers.
 The stock market is where traders buy and sell shares of ownership in publicly-
traded companies.
 The bond market involves buying and selling bonds (corporate or government
debt).
 The real estate market trades homes, commercial property or land.
 The futures market offers buyers a place to purchase futures contracts, which
gives the buyer an obligation to purchase an asset (including stocks, bonds,
commodities, grain, precious metals, or any other asset) at a set price at a future
point in time.

2.3 Functions of Financial Market

Following are the important functions of financial market

1. Mobilizing Funds
In a successful economy, money should never sit idle. Investors that have savings
must be linked with industries that require investment. So financial markets will enable
this transaction, where investors can invest their savings according to their choices and
risk assessment. This will utilize idle funds and the economy will boom.

2. Price Determination
The financial commodities traded in a financial market get their prices from the
rules of demand and supply. The investors or the household are the suppliers of the
funds, and the industries are the ones demanding them. The interaction between the two
and other market factors will help determine the prices.
38 Indian Financial System

3. Liquidity
The instruments sold in the financial market tend to have high liquidity. This
means at any given time the investors can sell their financial commodities and convert
them to cash in a very short period. This is an important factor for investors who do not
want to invest long term.

4. Easy Access
Both investors and industries need each other. The financial market provides a
platform where both the buyers and sellers can find each other easily without spending
too much time, money or effort.
The financial market may or may not have a physical location, i.e. the exchange
of asset between the parties can also take place over the internet or phone also.

2.4 Structure or Types of Financial Market in India

The financial market in India can be broadly divided into two main components.
They are, the Money Market and the Capital Market. Wherein, the Capital Market is
further divided into Primary and Secondary Markets. Let us understand more about the
structure of the financial market in India.

 Money Market
The money market acts as a marketplace for short-term borrowing and lending.
OnAt the wholesale level, it involves large-volume transactions between traders and
institutions. At the retail level, the money market involves mutual funds bought by
individual investors and accounts opened by bank customers.
The assets traded in the money market are risk-free and highly liquid. As the
maturity period is less, the risk of volatility is low and the returns are low as well.
Common examples of instruments traded in the money market are treasury bills,
commercial papers, certificates of deposits, bankers’ acceptance, etc.

 Capital Market
As opposed to the money market, capital markets deal in long-term securities. The
securities that have a maturity period of more than a year are traded in the capital
market. Subsequently, the market trades in both debt as well as equity-oriented
securities.
Participants of the capital market include Foreign Institutional Investors (FIIs),
financial institutions, NRIs, individuals, and so on. The capital market is further divided
into Primary Market and Secondary Market.
The detailed discussion on the above two markets are gives as follows:
Money Market and Capital Market 39

2.5 Money Market

Meaning: Money Markets refer to the segment of the financial market where short-
term borrowing and lending of funds take place. It primarily deals with highly liquid
and low-risk instruments that have maturities typically ranging from overnight to one
year. Money markets play a vital role in facilitating the efficient allocation of funds and
meeting the short-term funding requirements of various participants in the economy.
Money Market can be understood as the market for short term funds, wherein
lending and borrowing of funds varies from overnight to a year. It is an important part
of the financial system that helps in fulfilling the short term and very short term
requirements of the companies, banks, financial institution, government agencies and so
forth.
Money market basically refers to a section of the financial market where financial
instruments with high liquidity and short-term maturities are traded. Money market has
become a component of the financial market for buying and selling of securities of
short-term maturities, of one year or less, such as treasury bills and commercial papers.
Over-the-Counter (OTC): Over-the-Counter trading is done in the money market and
it is a wholesale process. It is used by the participants as a way of borrowing and
lending for the short term. Money market consists of negotiable instruments such as
treasury bills, commercial papers and certificates of deposit. It is used by many
participants, including companies, to raise funds by selling commercial papers in the
market. Money market is considered a safe place to invest due to the high liquidity of
securities.
It has certain risks which investors should be aware of, one of them being default
on securities such as commercial papers. Money market consists of various financial
institutions and dealers, who seek to borrow or loan securities. It is the best source to
invest in liquid assets.
The money market is an unregulated and informal market and not structured like
the capital markets, where things are organized in a formal way. Money market gives
lesser return to investors who invest in it but provides a variety of products.
Withdrawing money from the money market is easier. Money markets are different
from capital markets as they are for a shorter period of time while capital markets are
used for longer time periods.
Meanwhile, a mortgage lender can create protection against a fallout risk by
entering an agreement with an agency or private conduit for operational, rather than
mandatory, delivery of the mortgage. In such an agreement, the mortgage originator
effectively buys an option, which gives the lender the right, but not the obligation, to
deliver the mortgage. Against that, the private conduit charges a fee for allowing
optional delivery.
40 Indian Financial System

2.6 Features of Money Market

The following are some of the important features of a developed money market:
(a) Short-term Maturity: Money market instruments have short durations,
providing quick access to funds and flexibility in cash management.
(b) High Liquidity: Money market instruments can be easily bought or sold
without significant price impact, meeting immediate cash needs and serving as a
benchmark for short-term interest rates.
(c) Low Risk: Money market instruments are considered low-risk due to their short
maturities and high credit quality, often comprising government securities and
high-quality corporate instruments.
(d) Diverse Participants: Money markets attract banks, financial institutions,
corporations, mutual funds, insurance companies, and individual investors, each
with unique objectives like managing liquidity, short-term funding, or investing
idle cash.
(e) Market Regulation: Money markets are regulated by central banks or financial
authorities, ensuring stability, transparency, and fair practices.

2.7 Objectives of Money Market

The objectives of the Money Market can be summarized as follows:
1. Short-term Financing: Facilitating borrowing and lending for immediate
funding needs.
2. Liquidity Management: Providing a platform for efficient management of
cash positions.
3. Low-risk Investments: Offering secure investment options with stable returns.
4. Benchmark Interest Rates: Establishing reference rates for pricing other
financial instruments.
5. Monetary Policy Implementation: Supporting central banks in managing
liquidity and interest rates.
6. Market Stability and Transparency: Ensuring a stable and transparent
marketplace through regulations and oversight.

2.8 Functions of Money Market

A money market plays an important role in the allocation of resources in the
economy by performing the following important functions.
Money Market and Capital Market 41

 Provides Funds
The money market provides short term funds for borrowing at a lower rate of
interest. The private and the public institutions can borrow money from the money
market to finance capital requirements and fund business growth through the system of
finance bills and commercial paper. The government can also borrow funds from the
money market by issuing treasury bills.
Therefore, money market issues money market instruments like commercial
papers, treasury bills and so on and helps in the development of trade, industry and
commerce within and outside India. The money market plays an important role in
financing domestic and international trade.

 Uses of Surplus Funds

The money market provides a platform where the banks and other lending
institutions can lend excess money for a short period of time and earn profits. This
fulfils the main objectives of the commercial banks i.e. to earn income from reserves as
well as maintain liquidity to meet the cash required for daily transactions. The
institutions that can lend funds in money market not only include commercial banks
and other financial institutions, but also comprises of non-financial business
corporations, central, state and local governments.

 ExcludesNo Need to Borrow from Banks

A developed money market helps commercial banks become self-sufficient. The
existence of an established money market increases the options of borrowing money at
lower interest rates and helps commercial banks and the central bank.
However, if there is a shortage of cash in the commercial banks and central banks,
they can call in some of their loans from the money market. Most of the commercial
banks like SBI, Union Bank, BOI and others prefer to recall their loans.

 Helps Government
The money market instruments help the government raise money for financing
government projects for public welfare and infrastructure development. The
government can borrow short term funds by issuing treasury bills at low interest rates.
On the other hand, if the government were to issue paper money or borrow from the
central bank, it would lead to inflation in the economy.

 Helps in Monetary Policy

A properly functioning money market helps the central bank successfully
implement monetary policies. Though the central bank can function and influence the
banking system in the absence of a money market, the existence of a developed money
market helps in the efficient functioning and increases the effectiveness of the central
banks. The money market helps the central banks in the following ways:
42 Indian Financial System

(a) Short-run interest rates serve as an indicator of the monetary and banking
conditions in the country and, in this way, guide the central bank to adopt an
appropriate banking policy.
(b) Sensitive and integrated money markets help the central bank secure quick and
widespread influence on the sub-markets, thus facilitating effective policy
implementation.

 Helps in Financial Mobility

The money market helps in financial mobility by enabling easy transfer of funds
from one sector to the other. Financial mobility is essential for the development of
industry and commerce in the economy.

 Promotes Liquidity and Safety

This is one of the most important functions of money market, as it provides safety
and liquidity of funds. It also encourages savings and investments. These investment
instruments have shorter maturity which means they can readily be converted to cash.
The money market instruments are issued by entities with good credit score which
makes them safe investment options.

 Equilibrium between Demand and Supply of Funds

The money market creates a balance between the demand and supply of loanable
funds. The money market helps in allocating savings into investment channels. A
money market helps in mobilizing savings and makes better use, by allowing them to
be invested through the money market. It helps savers channelize funds, thus leading to
productive use of money in the economy.

 Economy in Use of Cash

As the money market deals in near-money assets and not proper money, it helps in
economizing the use of cash. It provides a convenient and safe way of transferring
funds from one place to another, thereby immensely helping commerce and industry in
India.

2.9 Importance of the Money Market

The money market is most suitable for short term transactions which helps ensure
liquidity in the market. The importance of money market is studies as follows:
 It helps to strengthen the balance between the demand and supply of short-term
monetary transactions in the market.
 It helps businesses grow, which can positively affect economic development.
 It assists with the evaluation of certain monetary policies.
Money Market and Capital Market 43

 Money market instruments can help the development of trade and industry in a
country.
 The money market provides finances for working capital requirements.
 Short term interest rates in the money market can have a positive effect on the
long-term interest rates of the capital market and can mobilise resources for the
capital market.
 The money market can serve as a guide to enacting new policies as it concerns
short-term money supply.
 The money market helps the modern financial economy run smoothly.
 It helps those in need of short-term loans receive money from savers and puts
capital towards a more profitable use.
 It helps with the active functioning of a central bank and the implementation of
its policies.
 It can help governments raise short-term funds to help fund projects and solve
other major concerns.
 It prevents the government from taking out loans that can cause inflation.
 It helps in the smooth functioning of commercial banks.

2.10 Participants of Money Market

Various participants utilize the money market, including governments,
corporations, financial institutions, and individual investors. Let us look at each of
these groups and their involvement in the money market:
 Governments: Governments often play a significant role in the money market.
They issue money market instruments, such as Treasury bills, to finance their
short-term funding requirements. These instruments are considered highly
secure, backed by the government’s creditworthiness.
 Corporations: Large and tiny corporations utilize the money market to meet
short-term funding needs. They issue commercial paper, which represents
unsecured promissory notes, to raise funds for operational expenses, inventory
management, or capital investments.
 Financial Institutions: Banks and other financial institutions actively
participate in the money market. They use money market instruments to
manage their liquidity and meet regulatory requirements. Financial institutions
also invest in money market instruments as a source of income to ensure the
stability of their cash positions.
 Individual Investors: Individual investors, including retail investors, also
engage with the money market. They can invest in money market instruments
such as Treasury bills, certificates of deposit, or money market funds offered by
banks or investment firms. These investments provide individuals with a safe
and short-term avenue to park their surplus funds or earn modest returns.
 Money Market Funds: These are investments that pool funds from individual
and institutional investors. Professional investment managers oversee managing
these funds, and they distribute the pooled funds among various money market
44 Indian Financial System

instruments. Money market funds provide investors with a convenient way to

access the money market and benefit from diversification.
 Central Banks: They play a crucial role in the money market by conducting
monetary policy operations. They use tools such as open market operations to
buy or sell money market instruments to manage the money supply, influence
interest rates, and stabilize financial markets.

2.11 Classification or Organization of Money Market

Figure 2.1: Organization of Money Market

The Money Market in India is not an integrated unit and has two segments:
1. Unorganized Money Market
2. Organized Money Market
Now, let us understand about these two segments in more detail as below:

1. Unorganized Money Market

The unregulated non-banking financial intermediaries’ function in the form of Chit
Funds, Nidhis, and loan companies.
Indigenous bankers receive deposits and lend money to the extent of an individual
or private firm. There are four such bankers in the country presently functioning as non-
homogenous groups such as Gujarati Shroffs, Multani or Shikarpuri Shroffs, Chettiars,
and Marwari Kayas.
There are two forms of money lenders as:
(a) The professional money lenders who lend their own money as a profession in
order to derive income through interest.
(b) The non-professional money lenders who might be businessmen and lend their
money to derive interest income as a secondary business.

2. Organized Money Market

Following are the types of organized money markets in India:
 Treasury bill
Money Market and Capital Market 45

 Cash management bills (CMBs)

 Certificates of Deposits (CDs)
 Commercial Papers (CPs)
 Commercial bills
 Money market mutual funds (SEBI)
 Repo/Reverse Repo Market
 Discount and Finance House of India (DFHI)
The money market instruments are mostly regulated by the RBI, except for mutual
funds. The mutual funds are regulated by the Securities and Exchange Board of India
(SEBI).

Differences Between Organized Money Market and Unorganized Money Market

Basis for
Organized Money Market Unorganized Money Market
Comparison
Structure There is a structure of operation There is no structure of
in this market, which is well laid operation in this market, so
out by our regulator, the RBI. that it is governed by local
custom, convention and
economic forces.
Regulator The Central Bank, that is the RBI There is no regulator.
is the regulator.
Rules and There is a strict set of rules as There is virtually no
regulations operational guidelines, applicable regulation; only non-formal or
for the entire economy. verbal agreement on a one-to-
one basis, the terms and
conditions of which vary from
place to place.
Players RBI is at the same time a Transactions are carried out in
regulator, a player and a individual capacity without
developer, while mainly FIs, institutional involvement.
commercial banks, insurance
companies, NBFCs, etc. enter the
market as players.
Interest Interest rates are lower and Interest rates are much higher
integrated. and not integrated.

Based on Tenure
Depending upon the tenure, within a year, the money market is classified into:
(a) Overnight or call market: Transaction tenure of one working day.
(b) Notice money market: Transaction tenure from 2 days to 14 days.
46 Indian Financial System

(c) Term money market: Transaction tenure from 15 days to one year.

Difference Between Call Money, Notice Money and Term Money

Call money is a short-term loan from one bank to another, usually for a day or a
few days. The borrower must repay it immediately when the lender asks. It helps banks
manage their daily cash needs, and the lender earns interest called the call rate on the
loan amount.
The call money market is similar to a financial playground for the banks and
institutions, where they lend or borrow money for the short term, usually one day. For
example, if Bank A has surplus money, and Bank B needs funds urgently to honour its
obligations. Bank A may lend money to Bank B at a specific rate and only for one day.
The overnight setting thus enables the day to manage the daily cash flow for the banks
effectively. It ensures they are meeting the regulatory requirement without holding an
excess reserve.
The money market primarily facilitates lending and borrowing of funds between
banks and entities like Primary Dealers (PDs). Banks and PDs borrow and lend
overnight or for the short period to meet their short-term mismatches in fund positions.
This borrowing and lending is on unsecured basis. ‘Call Money’ is the borrowing or
lending of funds for 1 day. Where money is borrowed or lend for period between 2 days
and 14 days it is known as ‘Notice Money’. ‘Term Money’ refers to borrowing/lending
of funds for period exceeding 14 days.

2.12 Money Market Instruments

Common Money Market Instruments include:

(a) Bill of Exchange/Commercial Bills

A Bill of Exchange is a written unconditional order by one party to another, to pay
a specified amount of money either immediately or on a fixed date. A bill of exchange
is a document used in international trade to pay for goods and services. It is signed by
the person promising to pay and given to the person receiving the payment. A bill of
exchange can be compared to a promissory note.

(b) Treasury Bills

Treasury bills are short term borrowing instruments issued by the Government of
India. These are the oldest money market instruments that are still in use. The treasury
bills do not pay any interest, but are available at a discount to face value at the time of
the issue. Treasury bills can be classified in two ways i.e. based on maturity and based
on type. These are the safest instruments as they are backed by a government guarantee.
Money Market and Capital Market 47

The rate of return, also known as risk-free rate, is low for Treasury bills like T-364,
T-182 and so on, as compared to all other instruments.

(c) Commercial Papers

Commercial Paper is an unsecured money market instrument, issued in the form of
a promissory note. It was introduced in India in 1990 with the objective of enabling
corporate borrowers diversify their sources of short-term borrowings and to provide an
additional investment instrument to investors. Commercial paper is a money-market
security issued (sold) by large corporations to obtain funds to meet short-term debt
obligations (for example, payroll), and is backed only by an issuing bank or company’s
promise to pay the face value on the maturity date specified on the note.

(d) Certificate of Deposit

A certificate of deposit is a savings instrument that is similar to a fixed deposit.
Unlike fixed deposit, certificate of deposit cannot be withdrawn before maturity. These
deposits have a fixed maturity date and a specified rate of interest.
The certificate of deposit was introduced in the Indian market in the year 1989 to
increase the options among money market instruments. Certificates of deposit are
issued by scheduled commercial banks and some select financial institutions in India
and are monitored by the RBI. The RBI issues guidelines for certificate of deposit from
time to time.

(e) Banker’s Acceptance

A banker’s acceptance is a document that promises future payment that is
guaranteed by the commercial bank. It is considered to be a very safe investment option
and is widely used in foreign trade. Banker’s acceptance is time drafts which are
accepted and guaranteed by the bank and drawn on a deposit at the bank. The maturity
period of banker’s acceptance can range from 30 to 180 days.

(f) Repurchase Agreements

These are known as Repo or reverse Repo. They are loans of short duration which
are agreed by buyers and sellers for the purpose of trading. However, the transactions
are carried out between institutions approved by the Reserve Bank of India.

Key Features of the Indian Money Market

Following are some key features of the Indian money market:

 Short-term Funds
The money market deals with financial assets that mature within one year.

 Financial Instruments
48 Indian Financial System

The money market provides a market for credit instruments like promissory notes,
bills of exchange, commercial paper, and treasury bills.

 Central Bank Intervention

The Reserve Bank of India (RBI) regulates the money market, and uses it to
influence interest rates and liquidity.

 Sub-markets
The money market is made up of several sub-markets, each dealing with a specific
type of short-term credit.

 Transactions
Most money market transactions are conducted by phone, fax, or the internet.

 Turnover
The average daily turnover of the Indian money market is over Rs. 40,000 crores.
Some of the participants in the Indian money market include:
 Commercial banks
 Co-operative banks
 Non-Banking Financial Companies (NBFCs)
 Financial institutions like LIC, GIC, and UTI
Inspite of the above, some challenges faced by the Indian money market include:
 An unorganized money market
 Lack of integration between the organized and unorganized sectors
 Interest rate differences across the country

2.13 Capital Market

Introduction
Capital Market is one of the significant aspects of every financial market. Hence it
is necessary to study its correct meaning. Broadly speaking the capital market is a
market for financial assets which have a long or indefinite maturity. Unlike money
market instruments the capital market instruments become mature for the period above
one year. It is an institutional arrangement to borrow and lend money for a longer
period of time. It consists of financial institutions like IDBI, ICICI, UTI, LIC, etc.
These institutions play the role of lenders in the capital market. Business units and
corporate are the borrowers in the capital market. Capital market involves various
instruments which can be used for financial transactions. Capital market provides long
term debt and equity finance for the government and the corporate sector. Capital
market can be classified into primary and secondary markets. The primary market is a
market for new shares, where as in the secondary market the existing securities are
Money Market and Capital Market 49

traded. Capital market institutions provide rupee loans, foreign exchange loans,
consultancy services and underwriting.

2.14 Meaning of Capital Market

The Capital Market is a marketplace that acts as the meeting point for the suppliers
and the interested parties in savings and investments. Suppliers referred to here are the
parties that are willing to invest their capital or lend it to parties in need of such loans.
These suppliers include banks and investors. In this market, companies, governments,
and the general public are looking for funds. In technical terms, it is a place where
buyers and sellers of financial securities meet to engage in trading these securities. Both
individuals and institutions participate in the trading procedure.
Definition: Capital Market is used to mean the market for long term investments that
have explicit or implicit claims to capital. Long term investments refer to those
investments whose lock-in period is greater than one year.
Capital market is a market where buyers and sellers engage in trade of financial
securities like bonds, stocks, etc. The buying or selling is undertaken by participants
such as individuals and institutions.
In the capital market, both equity and debt instruments, such as equity shares,
preference shares, debentures, zero-coupon bonds, secured premium notes and the like
are bought and sold, as well as it covers all forms of lending and borrowing.
Capital Market is composed of those institutions and mechanisms with the help of
which medium and long-term funds are combined and made available to individuals,
businesses and government. Both private placement sources and organized market like
securities exchange are included in it.
Capital markets help channelize surplus funds from savers to institutions which
then invest them into productive use. Generally, this market trades mostly in long-term
securities.
Capital market consists of primary markets and secondary markets. Primary
markets deal with trade of new issues of stocks and other securities, whereas secondary
market deals with the exchange of existing or previously-issued securities. Another
important division in the capital market is made on the basis of the nature of security
traded, i.e. stock market and bond market.

Capital Market Examples:

In everyday life, we can see many examples of these types of markets:
1. Stock Exchanges: Purchase and sale of stocks of publicly traded companies.
2. Bond Markets: Companies and governments issue bonds to raise capital, and
investors buy and trade these bonds.
50 Indian Financial System

3. Commodity Markets: Investors buy and sell raw materials such as gold, oil,
and agricultural products.
4. Real Estate Markets: Buying and selling residential and commercial
properties.
5. Foreign Exchange Markets: Exchange of different currencies by investors and
businesses for international trade and investment purposes.
6. Cryptocurrency Markets: Purchase and sale of digital currencies such as
Bitcoin and Ethereum.

2.15 Features of Capital Market

The capital market encompasses various features that make it a crucial component
of the financial system. They are:
 Link Between Savers and Investors: The capital market acts as an important
link between savers and investors. The savers are lenders of funds while
investors are borrowers of funds. The savers who do not spend all their income
are called “Surplus units” and the investors/borrowers are known as “Ddeficit
units”. The capital market is the transmission mechanism between surplus units
and deficit units. It is a conduit through which surplus units lend their surplus
funds to deficit units.
 Diverse Investment Opportunities: The capital market offers various
investment options, including stocks, bonds, derivatives, and commodities. This
allows investors to diversify their portfolios and allocate funds based on risk
tolerance and investment goals.
 Capital Formation: One of its key functions is facilitating capital formation
for businesses and governments. Through Iinitial Ppublic Oofferings (IPOs) and
secondary offerings, companies can raise funds by selling shares to investors.
This capital infusion enables businesses to expand operations, invest in research
and development, and create new job opportunities.
 Market Efficiency: It aims to achieve efficiency by ensuring that the prices of
financial instruments reflect all available information. This efficiency is driven
by transparency, liquidity, and competition. Investors can make informed
decisions based on the latest market data, reducing information asymmetry and
promoting fair and efficient trading.
 Risk Management: It provides tools and mechanisms for investors to manage
and mitigate risks. For example, investors can hedge against price fluctuations
through derivatives and protect their investments.
 Long-term Investment Opportunities: The capital market offers opportunities
for long-term investment and wealth creation. Investors can participate in IPOs,
invest in growth-oriented stocks, or purchase bonds with longer maturities.
Money Market and Capital Market 51

These options allow individuals and institutions to plan for their future financial
goals, such as retirement or education expenses.

2.16 Functions of Capital Market

Like the money market capital market is also very important. It plays a significant
role in the national economy. A developed, dynamic and vibrant capital market can
immensely contribute for speedy economic growth and development.
Let us get acquainted with the important functions and role of the capital market.
1. Mobilization of Savings: Capital market is an important source for mobilizing
idle savings from the economy. It mobilizes funds from people for further
investments in the productive channels of an economy. In that sense it activates
the ideal monetary resources and puts them in proper investments.
2. Capital Formation: Capital market helps in capital formation. Capital
formation is net addition to the existing stock of capital in the economy.
Through mobilization of ideal resources it generates savings; the mobilized
savings are made available to various segments such as agriculture, industry,
etc. This helps in increasing capital formation.
3. Provision of Investment Avenue: Capital market raises resources for longer
periods of time. Thus, it provides an investment avenue for people who wish to
invest resources for a long period of time. It provides suitable interest rate
returns also to investors. Instruments such as bonds, equities, units of mutual
funds, insurance policies, etc. definitely provides diverse investment avenue for
the public.
4. Speed up Economic Growth and Development: Capital market enhances
production and productivity in the national economy. As it makes funds
available for long period of time, the financial requirements of business houses
are met by the capital market. It helps in research and development. This helps
in, increasing production and productivity in economy by generation of
employment and development of infrastructure.
5. Proper Regulation of Funds: Capital markets not only helps in fund
mobilization, but it also helps in proper allocation of these resources. It can
have regulation over the resources so that it can direct funds in a qualitative
manner.
6. Service Provision: As an important financial set up capital market provides
various types of services. It includes long term and medium-term loans to
industry, underwriting services, consultancy services, export finance, etc. These
services help the manufacturing sector in a large spectrum.
7. Continuous Availability of Funds: Capital market is place where the
investment avenue is continuously available for long term investment. This is a
52 Indian Financial System

liquid market as it makes fund available on continues basis. Both buyers and
seller can easily buy and sell securities as they are continuously available.
Basically, capital market transactions are related to the stock exchanges. Thus,
marketability in the capital market becomes easy.

2.17 Importance of Capital Markets

The capital market is a vital component of the financial system. It complements the
intermediated credit channel and enhances competition by granting alternative
financing mechanisms for firms; projects and attractive investment options that can
help adjust to the risk and return levels for investors.
These markets are important for several reasons:
1. Facilitate Capital Formation: Capital markets provide a platform for
companies and governments to raise capital by issuing securities.
2. Resource Allocation: Capital markets help to allocate capital to its most
productive uses by providing investors with a wide range of investment
opportunities.
3. Price Discovery: These markets play a crucial role in price discovery,
determining the fair value of securities.
4. Debt Management: Capital markets allow the issuance of debt, which is a
more efficient and less restrictive form of borrowing for corporations. These
markets equalize borrowers and investors regarding debt, acting as buffers
during economic stress or market turmoil.
5. Liquidity: Capital markets provide liquidity to investors by allowing them to
buy and sell securities quickly and easily, thus freeing up capital for other
investments.
6. Risk Management: Capital markets offer a range of risk management tools,
such as derivatives, which allow investors to manage their exposure to various
types of risks.
7. Building Wealth: These markets help people build wealth and invest in their
future. Investors can invest in many types of securities, including stocks, ETFs,
mutual funds, corporate bonds, etc. Individuals can use invested principal and
any corresponding appreciation to invest in their pension, buy their own home,
or save for higher education.
8. Innovation: A capital market fuel companies or entrepreneurs to turn an idea or
industrial innovation into a real business or expansion for an existing company.
This, in turn, creates jobs and stimulates economic growth.

2.18 Organization of Capital Market

Capital Market Organization refers to the institutions that facilitate the smooth
operation of the market. These institutions play a crucial role in connecting various
Money Market and Capital Market 53

participants and ensuring their regulated interactions for trading through instruments
available in the market.
Major types of institutions forming part of the capital market are as follows:
(a) Stock Exchanges: Stock exchanges are essentially marketplaces for buying and
selling financial instruments. They act as a central platform where investors and
companies connect.
(b) Regulatory Bodies: These organizations ensure fair and transparent practices
within the market. Major regulators involved in regulation of Capital Market in
India are:
 Securities and Exchange Board of India (SEBI),
 Reserve Bank of India (RBI),
 Union Ministry of Corporate Affairs, and
 Department of Economic Affairs, Union Ministry of Finance.
(c) Financial Intermediaries: These institutions connect investors with those
seeking capital like bBrokers, investment banks, and underwriters are some
examples.

2.19 Types or Classification of Capital Market

Capital market deals in financial instruments and commodities that are long-term
securities. They have a maturity of at least more than one year.
Capital markets perform the same functions as the money market. It provides a
link between the savings/investors and the wealth creators. The funds will be used for
productive purposes and create wealth in the economy in the long term.
One of the important functions of the capital markets is to provide ease of
transactions for both the investors and the companies. Both parties should be able to
find each other with ease and the legal aspect of things should go smoothly. Now let us
take a look at the two major types of capital markets.
The capital market is bifurcated in two segments, primary market and secondary
market:
54 Indian Financial System

A. Primary Market
Primary Market is also called as New Issues Market., Iit is the market for the
trading of new securities, for the first time. It embraces both initial public offering and
further public offering. In the primary market, the mobilization of funds takes place
through prospectus, right issue and private placement of securities.
The Primary Market, also known as a New Issue Market, is where new
securities are issued. It is part of the capital market. Corporations, national and local
governments, and other public sector institutions can get financing through the sale of
new stock or bond issues through the primary market. Put simply, the primary market
creates new securities and offers them for sale to the public.
All companies require capital for their operations. This capital (money) can be in
the form of equity or debt. Equity is the stock capital (share capital) of a company. Debt
consists of all the loans taken by the business.
Primary market is the part of capital market where issue of new securities takes
place. Public sector institutions, companies and governments obtain funds for further
growth of the company after the sale of their securities or bonds in primary market. The
selling process of new issues in primary market is called as Underwriting and this
process is done by a group of people called underwriters or security dealers. From a
retail investor’s point of view, investing in the primary market is the first step towards
trading in stocks and shares.

B. Secondary Market
Secondary Market can be described as the market for old securities, in the sense
that securities which are previously issued in the primary market are traded here. The
trading takes place between investors that follows the original issue in the primary
market. It covers both stock exchange and over-the counter market.
A secondary market is a marketplace where already issued securities both shares
and debt can be bought and sold by the investors. So, it is a market where investors buy
securities from other investors, and not from the issuing company.
When a company issues its securities for the first time, it does it in the primary
market. After the IPO (Initial Public Offering), those securities get available for trade in
the secondary market. Stock markets such as the BSE (Bombay Stock Exchange) and
NSE (National Stock Exchange) are the example for the Secondary Market. This is the
market wherein the trading of securities is done. Secondary market consists of both
equity as well as debt markets.
Securities issued by a company for the first time are offered to the public in the
primary market. Once the IPO is done and the stock is listed, they are traded in the
Money Market and Capital Market 55

secondary market. The main difference between the two is that in the primary market,
an investor gets securities directly from the company through IPOs, while in the
secondary market, one purchase securities from other investors willing to sell the same.
Equity shares, bonds, preference shares, treasury bills, debentures, etc. are some of
the key products available in a secondary market for which SEBI (Securities Exchange
Board of India) is the regulator.

2.20 Capital Market Instruments

In the capital market, five types of instruments are traded. They are explained
below.

A. Equities
Equities refer to the money invested in an organization by purchasing shares in the
stock market.
(a) Equity Shares: Equity shares are part ownership where the shareholders are
fractional owners and initiate the maximum entrepreneurial liability related to a
trading concern. Equity shareholders reserve the right to vote. However, holders
of this instrument rank bottom on the scale of preference in the event of
company liquidation because they are considered owners of the enterprise.
(b) Preference Shares: Preference shares are issued by corporate bodies, and on
the scale of preference, the investors rank second when the company goes
under. These shares are often treated as debt instruments as they do not confer
voting rights to the holders. They also have a dividend payment structured like a
coupon or interest paid for bond issues.

B. Debt Securities
Debt securities are financial assets entitling the owners to a stream of interest
payments. Borrowers must repay the principal borrowed and are classified into bonds
and debentures.
(a) Bonds: Bonds are fixed-income instruments primarily issued by the state and
center governments, municipalities, and organisations for financing
infrastructural development and other projects. It is referred to as a loaning
capital market instrument, and the bond issuer is the borrower. Typically, bonds
carry a fixed lock-in period, and on the maturity date, bond issuers must repay
the principal amount to the bondholders.
(b) Debentures: Debentures are unsecured investment options and not backed by
any collateral. The lending is based on mutual trust. Investors act as potential
creditors of the issuing company or institution.
56 Indian Financial System

C. Derivatives
Derivatives are capital market financial instruments. Their values are determined
by underlying assets like stocks, currency, stock indexes and bonds. The most common
types of derivative instruments are:
 Forward: It is a contract between two parties in which the exchange occurs at
the end of the contract at a specific price.
 Future: It is a derivative transaction involving the exchange of derivatives on a
determined future date at a predetermined price.
 Options: It is an agreement between two parties. Here, the buyer has to right to
buy or sell a specific number of derivatives at an exact price for a particular
period.
 Interest Rate Swap: An agreement between two parties involving swapping
interest rates. Both parties must agree to pay each other interest rates on their
loans in different options, currencies, and swaps.

D. Exchange-Traded Funds
Exchange-traded funds are a pool of financial resources from many investors.
These are utilized to purchase different capital market instruments like debt securities
(derivatives and bonds), shares, etc. Most of the ETFs are registered with the SEBI
(Securities and Exchange Board of India). Therefore, it is an appealing option for
investors with limited knowledge of the stock market.
In the stock market, ETFs with features of mutual funds and shares are traded as
shares produced through blocks. They are listed on stock exchanges, and investors can
purchase and sell them according to their requirements during the equity trading.

E. Foreign Exchange Instruments

Foreign exchange instruments are represented on the foreign market. It primarily
consists of derivatives and currency agreements.
They can be broken into three categories. They are outright forwards, spot, and
currency swaps.
(a) Outright Forward: An outright forward is a financial transaction that involves
buying or selling foreign currency for delivery at a future date, typically beyond
two working days. This enables individuals or businesses to lock in a currency
exchange rate for a future transaction. Outright forwards are commonly used to
hedge against potential currency fluctuations, providing a sense of stability and
security in the ever-changing world of finance.
(b) Spot Market: A spot market is a public financial market where financial
instruments or commodities are traded for immediate delivery. In contrast to
Money Market and Capital Market 57

futures markets, which involve trading contracts for future delivery, these
markets enable transactions to occur in real time.
(c) Currency Swap: A currency swap is an agreement in which two parties
exchange the principal amount of a loan and the interest in one currency for the
principal and interest in another currency.

2.21 Differences between Money Market and Capital Market

A market where fresh securities are offered to the public for subscription is known
as Primary Market. Whereas, a market where already issued securities are traded among
investors is known as Secondary Market
The important difference between Primary Market and Secondary Market are:

Money Market Capital Market

Money Market is the place where lending Capital Market is the place where lending
and borrowing of short-term funds takes and borrowing of medium-term and long-
place. term funds take place.
Deals With
Money Market deals with promissory Capital Market deals with Equity shares,
notes, bills of exchange, commercial debentures, bonds, and preference shares
paper, treasury bills, call money, etc. ,etc.
Contains
The Money Market contains banks, The Capital Market contains stockbrokers,
financial institutions, financial mutual funds, underwriters and individual
companies, chit funds, etc. investors, etc.
Maturity Period
The instruments which are traded in The instruments which are traded in
money market normally have a maximum capital market have a longer time frame or
time frame of 1 year or less. no maturity period.
Risk Factor
The risk factor in trading with money The risk factor in trading with capital
market instruments is very low because of market instruments is high because of
shorter duration and can be easily longer duration and cannot be easily
converted into cash. converted into cash.
Divided Into
The Money Market is divided into two The capital Market is divided into two
segments called Organized and Un- segments called Primary Market and
Organized sector. Secondary Market.
Activities
58 Indian Financial System

Money Market Capital Market

The activities carried on in Money The activities carried on in Capital Market
Market are regulated by Reserve Bank of are regulated by Securities Exchange
India (RBI). Board of India (SEBI).
Returns
The expected return from Money Market The returns expected are very high
instruments is less. because of higher durations.

2.22 Players in Capital Markets

The important players in capital market are:

(a) Stock Exchange

A stock exchange is an organized marketplace or facility that brings buyers and
sellers together and facilitates the sale and purchase of stocks. It makes sure that trading
transactions are done in an efficient, orderly, fair, and transparent manner. It enforces
rules and regulations that its publicly listed companies and trading participants must
strictly abide by. In this way, the National Stock Exchange, for instance, fulfills its
function as the “guardian” of the Indian stock market.

(b) Investors
Investors, also referred to as stockholders or shareholders, are those who own
shares of stock of a publicly listed company. They are accorded certain privileges like
the right to fair and equal treatment, the right to vote and exercise related rights, and the
right to receive dividends and other benefits due to stockholders. They are classified as
either retail or institutional, and local or foreign.

(c) Stockbrokers
A stockbroker or trading participant is licensed by the Securities and Exchange
Commission (SEC) and is entitled to trade at the Exchange. They act as an agent
between a buyer and seller of stocks in the market. For their services as stockbrokers,
they receive from their clients either a buying or a selling commission.
The representatives (licensed salesmen) of these accredited stockbrokers convene
daily, at certain specified hours, on the “trading floor” of the exchange, where they sell
and buy shares of stocks for the account of their clients. They execute orders in the
market to the greatest possible advantage of their customers, by buying at the lowest
possible price or by selling at the highest possible price.
There are two types of stockbrokers
Money Market and Capital Market 59

 Traditional – those who assign a licensed salesman to handle your account and
to take your orders via a written instruction or a phone call
 Online – those whose main interface is the internet where clients execute their
orders and access market information online

(d) Listed Companies

Listed companies, also called “issuers”, are those whose shares of stock are traded
on the Exchange. These companies qualified with the stringent listing and reportorial
requirements of the stock exchange, and have gone through Iinitial Ppublic Ooffering
(IPO) or listing by way of introduction.

(e) Clearing House

A clearing house is a wholly owned subsidiary of the Exchange. It was established
to ensure the orderly settlement of equity trades executed at the Exchange. The clearing
house is responsible for:
 Eestablishing the cash and securities liabilities and entitlements of its clearing
members, synchronizing the settlement of funds and the transfer of securities
based on the delivery-versus-payment model or multilateral net settlement;
 Gguaranteeing the settlement of trades in the event of a trading participant’s
trade default in order to ensure the finality and irrevocability of all Exchange
trades through its fails management procedures;
 Iimplementing appropriate risk management measures in order to mitigate risks
inherent in the clearing and settlement of Exchange trades and the maintenance
and administration.

(f) Depository
The depository acts as securities depository or “custodian” of listed shares of stock
that are traded at the exchange. It was organized to establish a central depository in
India and to implement scripless trading.
The depository performs book-entry transfer of securities:
 From sellers to buyer’s accounts during settlement of Exchange trades;
 From one PDTC participant to another per client instruction, and;
 From lenders to borrower’s account for loan transactions.

(g) Settlement Banks

The settlement banks accept deposits of funds for payment of securities bought,
confirm payments of due clearing obligations to SCCP, debit buyer’s cash account and
credit seller’s cash account during settlement, and receive and/or return cash collateral
put up by clearing members to cover their daily trade negative exposures.
60 Indian Financial System

(h) Transfer Agents

The stock transfer agent is considered the “official keeper” of the corporate
shareholder records. The stock transfer agents provide the issuer or the listed company
with a list of holders of its securities. They effect transfer of beneficial ownership and
process corporate actions like stock or cash dividends, stock rights, stock splits, and
collation of proxy forms.

2.23 Secondary Market

Secondary Market is the form of market and refers to the financial markets where
securities, such as shares and bonds, are bought and sold after they have been already
issued in the primary market. Secondary market examples include stock exchanges
(Bombay Stock Exchange, National Stock Exchange and Over-the-Counter (OTC))
markets. The secondary market is the market for the sale and purchase of previously
issued or second-hand securities.
In secondary market securities are not directly issued by the company to investors.
The securities are sold by existing investors to other investors. Sometimes the investor
is in need of cash and another investor wants to buy the shares of the company as he
could not get directly from company. Then both the investors can meet in secondary
market and exchange securities for cash through intermediary called broker.
Secondary market functions allow investors to buy and sell securities among
themselves without the involvement of the issuing company. Intermediaries such as
brokers and dealer market play a key role in matching buyers and sellers, and
facilitating the transaction process. Trading mechanisms in secondary markets can take
the form of auctions, where buyers and sellers compete to match their orders, or
continuous trading, where trades are executed based on a set of predetermined rules.

Example of Secondary Market:

An investor buys a bond issued by a company, such as Microsoft or Coca-Cola,
from another investor in the stock market. The bond was previously issued by the
company to raise funds and is now being traded on the secondary market.

2.24 Types of Secondary Market

The types of secondary market are:
(a) Stock Exchanges: These markets facilitate the trading of stocks issued by
public companies. One will not find direct contact between the seller and the
buyer of the security dealers. To make trading safe and secure, heavy
regulations are in place. Counterparty risk, in this case, is almost zero as the
exchange is a guarantor. In Exchanges, there is a comparatively high transaction
Money Market and Capital Market 61

cost because of the exchange fees and commission. For example: New York
Stock Exchange (NYSE) and BSE.
(b) Over-the-Counter (OTC) Markets: These markets are a decentralized space
where investors trade amongst themselves. In such markets, there is a very
fierce competition to get higher volumes, which leads to a difference in prices
from one seller to another. Compared with exchanges, the risk is higher as the
seller and buyer deal on a one-to-one basis. The foreign exchange market is an
example of OTC markets.

2.25 Stock Market in Stock Trading

The words, both “Stock Market” and “Stock Exchange” are often used
interchangeably, but they are not the same. Traders in the stock market buy or sell
shares on one or more stock exchanges, which are only part of the overall stock
market.
Meaning of Stock Market: The Stock Market, which is also known as the stock
exchange or equity market, is the platform where publicly traded companies sell their
stock to attract investors.
A stock exchange is an important factor in the capital market. It is a secure place
where trading is done in a systematic way. In stock market, the securities are bought
and sold as per well-structured rules and regulations. Securities mentioned here
includes debenture and share issued by a public company that is correctly listed at the
stock exchange, debenture and bonds issued by the government bodies, municipal and
public bodies.
The main aim of the stock market is to facilitate the buying and selling of shares
between buyers or traders and investors. This can be done virtually or from a trading
floor. Without the stock market, it would be difficult to trade stocks. Whenever stocks
are sold on the stock market buyers and traders are attracted for different reasons; while
traders will try to bid higher or lower prices for a share depending on how they feel
about the future potential of a company, buyers seek lower prices to guarantee higher
return on their investments when they decide to sell.
An investor can invest in stocks and earn profits in two ways: long term and short
term. Long term investments are called equity investments, and short-term investments
are called debt investments.
The share market in India is quite popular among retail investors as well as
institutional investors. The Indian stock market is quite popular among international
investors due to its high returns, especially in the primary markets. The share market is
an organised, regulated and centralised forum that brings together investors and
62 Indian Financial System

companies. Its primary purpose is to raise finances for business expansion through the
sale of shares.
The Indian Stock Market is a financial market wherein many securities, including
equities, bonds, ETFs and derivatives, trade on exchanges at prices determined by
demand and supply. SEBI in India regulates the stock exchanges. There are two major
stock markets in India- NSE, (the National Stock Exchange of India) and BSE, (the
Bombay Stock Exchange.)

2.26 National Stock Exchange

The stock exchange in India has gone through a transition state. The trading
functions can be performed electronically with equal opportunities to find the best
option for investing stocks. It provides an electronic trading platform for the exchange
of stocks, shares, bonds, etc. It enables the issue and redemption of securities and
capital events commonly known as ‘continuous auction’ markets with buyers and
sellers performing different transactions.

Meaning of NSE
National Stock Exchange of India, is a key player in the country’s financial scene.
Established in 1992, it has modernized the Indian capital market with its automated
electronic trading system. Headquartered in Mumbai, it is a leading financial exchange,
serving as a crucial indicator of India’s financial well-being. It stands as the fourth-
largest exchange globally in terms of trading volume
The National Stock Exchange of India Limited (NSE) is the largest financial
exchange in the Indian market. It was established in 1992 on the recommendation of the
High-Powered Study Group, which was founded by the Indian government to provide
solutions to simplify participation in the stock market and make it more accessible to all
interested parties. In 1994, the NSE introduced electronic trading in the Indian stock
exchange market.
National Stock Exchange is an electronic platform where the investors can carry
out trading, buy and sell equities, stock, debts and shares from the different stock
markets or financial markets. This electronic facility provided the clients even in
remote areas to access the stock price information with ease, previously only a few
people were able to access that information.
The National Stock Exchange of India Limited offers a platform to companies for
raising capital. Investors can access equities, currencies, debt, and mutual fund units on
E-platform. In India, foreign companies can raise capital using the NSE platform
through initial public offerings (IPOs), Indian Depository Receipts (IDRs), and debt
issuances. The NSE also offers clearing and settlement services.
Money Market and Capital Market 63

As an institution of national importance and international stature, NSE is a trusted

market infrastructure entity with high corporate governance standards. Recognized as
one of the world’s largest exchanges, NSE catalyses India’s economic growth. It was
the pioneer in implementing electronic trading in 1994, showcasing its commitment to
innovation and technology investment.
NSE’s cutting-edge technology platform ensures reliability, performance, and
transparency across all asset classes, catering to diverse investor categories. It focused
on investor protection, NSE plays a crucial role in the disciplined development of the
Indian capital market landscape.

NSE Functions
The important functions of NSE are:
 Marketplace: NSE facilitates trading of various securities like equities, bonds,
and derivatives.
 Price Discovery: Through its electronic trading system, NSE ensures fair and
transparent price discovery for accurate market values.
 Liquidity Provider: With numerous listed companies and high trading
volumes, NSE offers ample liquidity, making entering or exiting positions easy.
 Clearing and Settlement: NSE’s clearing house ensures efficient and timely
settlement, reducing the risk of default.
 Indices Management: NSE is known for market indices like NIFTY 50,
serving as benchmarks for the Indian economy and investment products.
 Risk Management: NSE minimizes market risk through regulations and real-
time monitoring, ensuring a level playing field for all investors.
 Investor Education: NSE conducts programs to improve financial literacy
among investors.
 Data Services: NSE provides crucial market data and analytics for informed
decision-making.
 Regulatory Functions: Operated under SEBI, NSE plays a key role in ensuring
adherence to market laws.
 Technology Upgradation: NSE employs cutting-edge technology for efficient,
secure, and accessible trading.

Features of NSE
The important features of NSE are given below:
(a) Market Operation: NSE operates an order-driven market using the National
Exchange for Automated Trading (NEAT), an automated screen-based trading
system. Each order is assigned a unique number. Orders are matched based on
price-time priority, with the best value and older orders taking precedence.
64 Indian Financial System

(b) Order Matching System: Large trading volumes and liquidity on the NSE
facilitate efficient price discovery and trade execution, reducing market
volatility.
(c) Advanced Technology: NSE is known for its cutting-edge technology,
providing high-speed and reliable trading platforms for various financial
instruments.
(d) Transparency: NSE emphasizes transparency, ensuring readily available
market data, price information, and trading activities for investors.
(e) Diverse Product Offerings: NSE offers a wide range of financial products,
including equities, derivatives, currencies, and debt securities, meeting diverse
investor needs
(f) Market Indices: Prominent indices like Nifty 50 and Nifty Bank reflect top
companies’ performance, serving as benchmarks for investors and fund
managers.
(g) Regulatory Oversight: It operates under SEBI’s regulatory oversight, ensuring
compliance with market regulations and safeguarding investor interests.
(h) Liquidity and Efficiency: Large trading volumes and liquidity on NSE
facilitate efficient price discovery and trade execution, reducing market
volatility.

Market segments of NSE

The National Stock Exchange (NSE) operates in two main market segments:
(a) Whole Sale Debt Market: Which Deals with various fixed-income instruments
and includes Certificates of Deposit, Bonds, Commercial Paper, Treasury Bills,
and Central Government Securities.
(b) Capital Market: Iit facilitates trading of securities like debentures, equity
shares, exchange-traded funds, preference shares, and retail government
securities.

Trading Process of NSE

The National Stock Exchange of India Limited trading takes place through market
orders, which are matched through trading computers. The market makers or specialists
are not involved in the trading process. Whenever an investor places a market order, it
is given a unique number, and the trading computer immediately matches it with a limit
order, while keeping the sellers and buyers anonymous.
In case a match is not found, the order is added to a list of orders to be matched in
a sequence, which is determined based on the price-time precedence. The best price
order is given higher priority, and for the orders with the same price, the older order is
given precedence.
Money Market and Capital Market 65

The order-driven exchange market displays every sell and buy order in the system;
thus, it provides transparency to the investors. Customers can be provided the online
trading facility by brokers, who place the orders in the trading system. Except for the
holidays declared by the NSE, the exchange market is available five days a week, from
Monday to Friday.
NSE market trading in the equities segment is carried on throughout the week,
except on Saturdays, Sundays and other holidays declared by the stock exchange. The
timing is as follows –

 Pre-opening Session
Order entry opens at 9.00 hours
Order entry closes at 9.08 hours

 Regular Session
The market opens at 9.15 hours
The market closes at 15.30 hours

Benchmark Index of NSE

In 1996, the NSE introduced the S&P CNX Nifty (Nifty 50) as its benchmark
index. The top 50 most traded stocks on the NSE forms Nifty 50. CNX Nifty signifies
the weighted average of stocks of 50 companies from 17 different sectors.

2.27 Bombay Stock Exchange

Stock exchange is the marketplace where buyers and sellers trade securities like
bonds, stocks, and other instruments. Companies use a stock exchange in India to sell
their securities to raise capital, and investors buy them to earn a profit. Among India's
two primary stock exchanges, NSE and BSE, BSE, or Bombay Stock Exchange, is the
oldest in Asia, located in Mumbai. With over 5,000 listed companies on the BSE, it is
one of the top stock exchanges worldwide with the maximum number of listed
companies.
Thus, it is crucial to the country’s economic growth by helping companies raise
capital and letting investors earn profit. Let’s dive deeper into BSE and it’s working.

Introduction to Bombay Stock Exchange

The Bombay Stock Exchange is Asia's largest and oldest stock exchange, serving
as a platform for trading various financial instruments like stocks, currencies, and
derivatives. Comprising some of the most actively traded and liquid stocks, BSE
Sensex is the benchmark index in the country. Significantly impacting the Indian
economy, it is a barometer of India’s financial performance.
66 Indian Financial System

Over the years, the Bombay Stock Exchange has introduced several new products
and services, including currency trading, debt, equity, mutual funds, investment
banking, etc. BSE has been a crucial player in the country's economic development
because of its efficient trading systems, solid technology infrastructure, and high
accountability and transparency.

History of the Bombay Stock Exchange

The formulation of BSE started in the mid-19 th century when stockbrokers
informally traded stocks under banyan trees on Bombay's Dalal Street. Over the years,
the requirement for a regulated and organised trading platform became prominent. As a
result, BSE was formally established in Bombay in 1875 and lists over 6000
companies. It is the oldest stock exchange in India as well as Asia. Bombay Stock
Exchange was established by Mr. Premchand Roychand in 1875. The Bombay Stock
Exchange (BSE) is one of India’s oldest and most prestigious stock exchanges. It was
founded in 1875 in Mumbai, Maharashtra, as the “Native Share & Stock Brokers’
Association.” BSE Limited is now its official name.
BSE is India's financial centre, and many large investment firms, banks, and
financial services companies are operational on Dalal Street. Considering the
requirement for a digital platform, the BSE received technological support from CMC
Ltd. in 1995 to go digital. Like Wall Street in the US, many Indian investors cite
investment activities in Dalal Street to represent the Indian financial sector.

Features of Bombay Stock Exchange (BSE)

The Bombay Stock Exchange (BSE) provides a variety of features and services to
investors, traders, and listed firms in the Indian market. The following are a few
prominent characteristics of the Bombay Stock Exchange (BSE):
1. Stock Trading: The Bombay Stock Exchange (BSE) serves as a key
marketplace for the exchange of equities, namely stocks and shares, belonging
to publicly listed corporations inside India. Investors have the ability to engage
in the purchase and sale of these securities within the specified trading hours.
2. Listing Services: Through initial public offerings (IPOs) and follow-on public
offerings (FPOs), the BSE helps companies get listed in the stock market.
Companies can get money by selling shares to the public and getting listed on
an exchange.
3. Commodities Trading: BSE also has a place where buyers can buy and sell
derivatives of commodities like gold, silver, and agricultural goods.
4. Regulatory Compliance: The BSE makes sure that listed companies follow the
rules set by the Securities and Exchange Board of India (SEBI) and other
important bodies about disclosure and other rules.
Money Market and Capital Market 67

5. Corporate Governance: The exchange encourages good corporate governance

and openness among businesses that are listed, which is important for
maintaining investor trust.

Functions of Bombay Stock Exchange (BSE)

The key functions of the Bombay Stock Exchange are as follows:
1. Price Determination: On the secondary market, the prices of securities are
determined by demand and supply. Therefore, the BSE assists in this process by
continuously evaluating all listed securities. Moreover, investors can readily
monitor the prices of these securities using the SENSEX index.
2. Contributes to the Economy: BSE provides a trading platform for various
companies’ securities. Continuous reinvestment and disinvestment are integral
to the trading procedure. This presents an opportunity for capital formation,
funds flow, and economic growth.
3. Facilitates Liquidity: The most essential function of the BSE is to facilitate the
sale and purchase of securities. This enables investors to convert existing
securities into cash at any time. Therefore, investors can purchase and sell at
any time, providing them with high liquidity.
4. Transactional Safety: After verifying the company’s position, BSE ensures
that the securities are listed. In addition, all listed companies are required to
abide by the Securities and Exchange Board of India (SEBI) rules and
regulations.

Trading on BSE
BSE has laid out certain conditions for listing a company on the exchange through
new listing (IPO or FPO) and direct listing. IPO allows a company to offer its shares to
investors for the first time. FPO allows an already-listed company to issue new shares
to new investors or existing shareholders. An already-listed company can approach the
exchange to list its shares through a direct listing.
To get listed, a company must obtain permission from the BSE to use the
exchange's name on its prospectus. They must submit an application letter to the stock
exchange and complete securities allotment within a month of subscription list closure.
After completing all the formalities, the company must deposit a percentage of the issue
amount with the BSE. Major market segments and categories include equity
instruments, IPOs, government securities, and debt instruments.

BSE Indices
The BSE has multiple indices to get a snapshot of the stock market’s performance.
The major ones include the following:
68 Indian Financial System

 BSE Sensex: It is a flagship BSE index comprising thirty of the most actively
traded stocks on the stock exchange in India. Analysts, media, and investors
widely track it to gauge the Indian economy.
 BSE 500: The index comprises 500 BSE-listed companies from various sectors,
indicating the Indian stock market. Investors can use it to monitor the Indian
stock market’s overall performance.
 BSE Midcap: It comprises companies from multiple sectors with a market cap
between ₹ 5,000 crore and ₹ 20,000 crore. Investors use it to gain exposure to
mid-sized companies.
 BSE Smallcap: The index comprises companies below a market capitalisation
of ₹ 5,000 crore or less. Investors use it for exposure to small-sized companies.
 BSE Bankex: Comprising companies in financial and banking services, it helps
investors measure the banking sector’s performance.
 BSE Healthcare: The index comprises healthcare and pharmaceutical
companies listed on the Bombay Stock Exchange. For investors, it is a useful
indicator of the healthcare sector’s performance.
These indices provide investors with an easy and quick way to track different
sectors’ performance and the overall stock market in India. Investors use them to make
informed investment decisions, analyse market trends, and monitor portfolio
performance.

Transactions in BSE
Financial transactions in BSE are done online through an electronic trading
system. Market orders can be directly placed in BSE online without the requirement of
external specialists through direct market access. Due to the absence of such limit
orders, the focus is shifted from buyers/sellers to the total value of transactions in a day.
Trading in the BSE share market has to be done through a brokerage agency
against a stipulated charge. However, direct investment access is given to certain
preferential investors making large transactions in the BSE stock market. BOLT-
Bombay Online trading platform is used by this stock exchange for efficient trading.
Transactions made in BSE online are done through a T+2 (Trading + 2 days)
rolling settlement, wherein all transactions are processed within two days. Securities
and Exchange Board of India (SEBI) is responsible for the regulation of this stock
exchange, continuously updating rules for its smooth operation.

Importance of Bombay Stock Exchange (BSE)

The Bombay Stock Exchange (BSE) is similar to a large marketplace where people
purchase and sell “stocks” or “shares” of businesses. It is essential because it allows
businesses to develop by raising funds from the public. It also enables ordinary people
Money Market and Capital Market 69

to invest in these enterprises and potentially profit from ownership. The success of the
nation’s enterprises is a positive indicator for everyone. In addition, it serves as a large
scoreboard for the economy, indicating how things are moving forward. Therefore, it is
not just a platform to trade stocks; it is an integral element of the financial system of the
country which are as follows:
1. Liquidity and Investment Opportunities: The BSE facilitates the purchase
and sale of equities and other financial instruments, providing a liquid market
for investors to exchange their investments. This liquidity facilitates the
purchase and sale of assets by investors.
2. Economic Indicator: The performance of the BSE is frequently viewed as a
barometer of the Indian economy as a whole. When the stock market performs
well, it may indicate economic growth and stability.
3. Financial Inclusion: The BSE has introduced a number of initiatives aimed at
encouraging financial inclusion, making it possible for a broader segment of the
population to invest in the stock market and thus participate in wealth creation
and economic development.
4. Market Benchmark: BSE’s primary index, the S&P BSE Sensex, is widely
regarded as an indicator of the Indian stock market’s performance. Investors,
analysts, and fund managers use it to evaluate market trends and performance.
5. Corporate Governance and Transparency: Listed companies on the BSE are
subject to stringent regulatory and reporting requirements that encourage
transparency and corporate governance. This is essential for establishing
investor confidence.

2.28 Securities and Exchange Board of India (SEBI)

SEBI stands for Securities and Exchange Board of India. It is a statutory regulatory
body that was established by the Government of India in 1992 for protecting the
interests of investors investing in securities along with regulating the securities market.
SEBI also regulates how the stock market and mutual funds function.

Objectives of SEBI
Following are some of the objectives of the SEBI:
1. Investor Protection: This is one of the most important objectives of setting up
SEBI. It involves protecting the interests of investors by providing guidance and
ensuring that the investment done is safe.
2. Preventing the fraudulent practices and malpractices which are related to
trading and regulation of the activities of the stock exchange.
70 Indian Financial System

3. To develop a code of conduct for the financial intermediaries such as

underwriters, brokers, etc.
4. To maintain a balance between statutory regulations and self-regulation.

Functions of SEBI
SEBI has the following functions
1. Protective Function
2. Regulatory Function
3. Development Function
The following functions will be discussed in detail

A. Protective Function
The protective function implies the role that SEBI plays in protecting the investor
interest and also that of other financial participants. The protective function includes
the following activities.
(a) Prohibits Insider Trading: Insider trading is the act of buying or selling of the
securities by the insiders of a company, which includes the directors, employees
and promoters. To prevent such trading SEBI has barred the companies to
purchase their own shares from the secondary market.
(b) Check Price Rigging: Price rigging is the act of causing unnatural fluctuations
in the price of securities by either increasing or decreasing the market price of
the stocks that leads to unexpected losses for the investors. SEBI maintains
strict watch in order to prevent such malpractices.
(c) Promoting Fair Practices: SEBI promotes fair trade practice and works
towards prohibiting fraudulent activities related to trading of securities.
(d) Financial Education Provider: SEBI educates the investors by conducting
online and offline sessions that provide information related to market insights
and also on money management.

B. Regulatory Function
Regulatory functions involve establishment of rules and regulations for the
financial intermediaries along with corporates that helps in efficient management of the
market.
The following are some of the regulatory functions.
(a) SEBI has defined the rules and regulations and formed guidelines and code of
conduct that should be followed by the corporates as well as the financial
intermediaries.
(b) Regulating the process of taking over of a company.
Money Market and Capital Market 71

(c) Conducting inquiries and audit of stock exchanges.

(d) Regulates the working of stock brokers, merchant brokers.

C. Developmental Function
Developmental function refers to the steps taken by SEBI in order to provide the
investors with knowledge of the trading and market function. The following activities
are included as part of developmental function.
(a) Training of intermediaries who are a part of the security market.
(b) Introduction of trading through electronic means or through the internet by the
help of registered stock brokers.
(c) By making the underwriting an optional system in order to reduce cost of issue.

Purpose of SEBI
The purpose for which SEBI was setup was to provide an environment that paves
the way for mobilisation and allocation of resources. It provides practices, framework
and infrastructure to meet the growing demand.
It meets the needs of the following groups:
(a) Issuer: For issuers, SEBI provides a marketplace that can utilised for raising
funds.
(b) Investors: It provides protection and supply of accurate information that is
maintained on a regular basis.
(c) Intermediaries: It provides a competitive market for the intermediaries by
arranging for proper infrastructure.
The SEBI is responsible for:
 Formulating guidelines and the code of conduct for the proper functioning of
the financial intermediaries and businesses.
 Regulating businesses in the stock exchange and other securities market.
 Conducting audit and enquiries of the exchanges.
 Registering and protecting the interest of the securities market participants.
These include trustees of the trust deeds, brokers, sub-brokers, investment
advisors, merchant bankers, intermediaries, etc.
 Levying fees.
 Formulating, implementing, and monitoring exercising powers.
 Registering and regulating credit rating agencies and self-regulating
organizations.
 Identifying and prohibiting insider trading and unfair trade practices.
72 Indian Financial System

2.29 SEBI Regulations

The main regulatory body in charge of monitoring India's securities markets is the
Securities and Exchange Board of India (SEBI). Since it was founded in 1992, SEBI's
main goal has been to protect investors' interests, keep the securities markets honest,
and encourage their orderly growth. It reaches these objectives by putting in place a
strong set of rules and regulations that apply to all market participants, such as
investors, listed companies, stock exchanges, and listed companies.
The Indian securities market is supported by a number of significant regulations
that SEBI has introduced. Some of the most important regulations are listed below:

1. SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015

(LODR)
Listed companies are required by the LODR regulations to follow corporate
governance guidelines and provide the public with important information. In order for
investors to make wise decisions, these regulations ensure transparency and
accountability. These regulations were updated by SEBI in 2025 to increase the
threshold for materiality for SMEs listed on exchanges and to tighten disclosure
requirements particularly with regard to related party transactions.

2. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR)

The ICDR regulations control the issuance of securities by companies, such as
public offerings, rights issues, and first-choice distributions. Companies must abide by
these regulations in order to give investors all the information they need to make an
informed decision. By removing the need for lead managers in some situations SEBI
changed these regulations in 2025 to make the rights issue process easier for companies
to raise money and cut down on the amount of paperwork that was required.

3. SEBI (Prohibition of Insider Trading) Regulations, 2015

These regulations prohibit trading based on unpublished price-sensitive
information (UPSI). Insider trading occurs when someone uses non-public information
to trade stocks. SEBI ensures that people with access to such information do not misuse
it. It also requires companies to disclose any material information that could affect
stock prices. In 2025 SEBI amended these regulations to expand the definition of UPSI
to include information about the award or termination of orders or contracts not in the
ordinary course of business.

4. SEBI (Mutual Funds) Regulations, 1996

Mutual funds operating in India are subject to these regulations. They make rules
about how mutual funds can be set up and run. They also make sure that mutual funds
handle investor money in an honest way. In order to protect investors' interests and
Money Market and Capital Market 73

guarantee the openness of mutual fund operations SEBI amended these regulations in
2025.

5. SEBI (Alternative Investment Funds) Regulations, 2012

Alternative investment funds (AIFs) must follow these regulations in order to
operate. Private equity funds, hedge funds and venture capital funds are all types of
AIFs. SEBI makes sure that these funds follow the rules and are open to everyone. To
further simplify the regulatory framework for these funds and encourage their growth
and development, SEBI amended these regulations in 2025.

6. SEBI (Research Analysts) Regulations, 2014

Research analysts, who give the public stock recommendations and financial
advice, are governed by these regulations in their work. They set standards for how
analysts should behave and make sure that their reports are clear, impartial, and free of
any conflicts of interest. In order to ensure a higher standard of integrity and investor
protection SEBI amended these regulations in 2025 to strengthen the independence of
research reports and impose stricter compliance requirements on research analysts and
firms.

7. SEBI (Investment Advisers) Regulations, 2013

The goal of the Investment Advisers Regulations is to set rules for people and
businesses that give investment advice to clients. They make advisers register with
SEBI and follow a strict code of conduct to make sure the advice they give is good for
their clients. Disclosure of any conflicts of interest is also a requirement of the
regulations. In 2025, SEBI introduced amendments to enhance the transparency of
advisory services, strengthening the regulations to improve investor protection and
ensure a more ethical advisory environment.

Recent Amendments to SEBI Regulations (2025)

To keep up with the changing needs of the financial market and improve investor
protection, SEBI made several significant amendments to its regulations in 2025. The
following are some of the most significant amendments:
 Expansion of Same-Day Settlement (T+0) for Top 500 Stocks: Starting from
January 31, 2025, SEBI introduced an optional same-day settlement cycle for
the top 500 stocks by market capitalization. This initiative aims to enhance
liquidity and improve market efficiency.
 Strengthening Insider Trading Regulations: SEBI added new types of
information to the definition of unpublished price-sensitive information (UPSI),
such as changes to business contracts and orders. This extension makes sure
that investors are safer.
74 Indian Financial System

 Easing the Process for Rights Issues: Companies raising money through
rights issues can now do so more quickly and easily thanks to SEBI. The new
rules make it easier for companies to raise money by getting rid of the need for
lead managers in some situations and cutting down on the paperwork that needs
to be done.
 Review of ESG (Environmental, Social, and Governance) Disclosure
Requirements: SEBI began reviewing environmental, social, and governance
(ESG) disclosure requirements in April 2025. This review seeks to ensure that
companies provide meaningful and accurate ESG information, which is
becoming increasingly important for investors.

2.30 T+1 Settlement System of SEBI

Securities and Exchange Board of India allowed stock exchanges to start the T+1
system as an option in place of T+2 for completion of share transactions. It has been
introduced on an optional basis in a move to enhance liquidity.
In the securities industry, the ‘Trade Settlement Period’ refers to the time between
the trade date that an order is executed in the market and the settlement date when a
trade is considered final. On the last day of the settlement period, the buyer becomes
the holder of record of the security.
If the stock exchange opts for the T+1 settlement cycle for a scrip, it will have
to mandatorily continue with it for a minimum 6 months. A scrip is a substitute or
alternative to legal tender that entitles the bearer to receive something in return.
Thereafter, if it intends to switch back to T+2, it will do so by giving one month’s
advance notice to the market. Any subsequent switch (from T+1 to T+2 or vice versa)
will be subject to a minimum period.

Difference Between T+1 vs T+2 Settlement

 In T+2, if an investor sells shares, the settlement of the trade takes place in two
working days (T+2) and the broker who handles the trade will get the money on
the third day, but will credit the amount in the investor’s account only by the
fourth day. In effect, the investor will get the money only after three days.
 In T+1, settlement of the trade takes place in one working day and the investor
will get the money on the following day. The move to T+1 will not require
large operational or technical changes by market participants, nor will it cause
fragmentation and risk to the core clearance and settlement ecosystem.

 Benefits of T+1 Settlement

 Reduced Settlement Time: A shortened cycle not only reduces settlement time
but also reduces and frees up the capital required to collateralise that risk.
Money Market and Capital Market 75

 Reduction in Unsettled Trade: It also reduces the number of outstanding

unsettled trades at any instant, and thus decreases the unsettled exposure to
Clearing Corporation by 50%. The narrower the settlement cycle, the narrower
the time window for a counterparty insolvency/bankruptcy to impact the
settlement of a trade.
 Reduction in Blocked Capital: Further, the capital blocked in the system to
cover the risk of trades will get proportionately reduced with the number of
outstanding unsettled trades at any point of time.
 Reduction in Systemic Risks: A shortened settlement cycle will help in
reducing systemic risk.

2.31 ASBA (Application Supported by Blocked Amount)

Application Supported by Blocked Amount, or ASBA, is a SEBI-developed IPO
(Initial Public Offering) application process. It is a process providing authorization to
block money in a bank account to subscribe to an IPO issue. Applying through ASBA
as an investor enables the money to be deducted from the bank account only if the
application is chosen for allotment.
SEBI designed the Applications Supported by Blocked Amount (ASBA) technique
to block funds for applications such as Initial Public Offerings (IPOs), Follow-on
Public Offerings (FPOs), Rights Issues, etc. The bank account of an IPO applicant is
not debited until they get the allotment of shares, according to ASBA. Investors can
submit their ASBA applications to the Self Certified Syndicate Banks or SCSBs.

Features of ASBA
Application Supported by Blocked Amount offers an alternate payment method in
which the application money remains in the investor’s account until the basis of
allotment in the public offering is finalised.
SEBI, the stock market regulator, ensures that the entire investment activity for an
investor is pleasant. Furthermore, it supports any opportunity for the investor to
subscribe to more IPOs. The entire process requires minimal manual intervention, with
complete transparency being maintained.
The prime features of ASBA are:
 Only authorised SCSBs (Self-Certified Syndicate Banks) who can perform
ASBA can accept investor applications for IPO subscriptions.
 SCSBs will verify the account’s relevant background once they receive the
form.
 Post application approval, the amount is blocked from the applicant’s account
and set aside for the IPO.
76 Indian Financial System

 The shares are assigned through the NSE’s bidding mechanism, and the details
are uploaded to the bidding system.
 Shares are credited to the investor’s Demat account in the event of a successful
subscription. In a failed allotment, the blocked amount is restored to the
investor’s original account.
 SEBI has notified that all IPO subscriptions will be made through ASBA from
10th November 2015 onwards.

2.32 Adani Hindenburg Issue

The net worth of one of the richest persons in India fell after a report was released
by an institute named Hindenburg. Adani Enterprises shares and other Adani group
stocks have nosedived after the New York-based investor research firm Hindenburg
Research accused the conglomerate of stock manipulation and accounting fraud scheme
over decades.
Hindenburg is an institute specialising in “forensic financial research”. In other
words, it looks for corruption or fraud in the business world, such as accounting
irregularities and bad actors in management. Hindenburg, a US-based investment
research firm, specialises in activist short-selling.
The Securities and Exchange Board of India defines ‘Short Selling’ as the sale of a
security or share that the seller does not own. In short selling, an investor sells
borrowed shares in the market in the hope of buying them back at a cheaper price. In
other words, short selling is exactly the opposite of usual stock market investments,
where an investor has bought a stock, hoping that its price will rise in future. In short
selling, an investor holds a short position after anticipating a decrease in the value of a
stock. In short selling, an investor does not need to own a particular company’s shares
to sell them. Instead, they can borrow shares/assets of the company from any broker or
dealer.

Hindenbuerg’s Allegation Against the Adani Group

Hindenburg Research has alleged that the Adani Group was “engaged in a stock
manipulation and accounting fraud”. The Adani Group has interests in varied sectors
such as ports and logistics, power generation, agribusiness, real estate, defence, solar
energy, financial services, natural resources and media.
 The research firm alleges that the Adani group has engaged in ₹ 17.8 trillion
(US$ 218 billion) brazen stock manipulation and accounting fraud schemes
over the course of decades.
 The Hindenburg’s report says that the Adani family controlled offshore shell
entities in tax havens spanning the Caribbean and Mauritius to the United Arab
Money Market and Capital Market 77

Emirates, which it claims were used to facilitate corruption, money laundering

and taxpayer theft, while syphoning off money from the group’s listed
companies.

Looming Concern with the Report

 Adani group has taken a lot of debt from Indian banks. So, there is a looming
threat around whether the business tycoon would be able to return the debt on
time or not.
 There is risk involved in banks’ lending huge sums of money against shares
since when a company is unable to fulfil its debt obligations its share price also
often drops.
 LIC has also invested its money in the Adani group business. The investment
fell sharply due to the report and there is a fear among the investors regarding
the loss of money.
This would potentially lead to a rise of non-performing assets of the bank in the
coming time which would adversely affect its lending capacity.

Adani’s Response
 The Adani Group vehemently denied all allegations, calling the report a
“maliciously motivated” attack on their reputation.
 They responded with a detailed 413-page rebuttal and launched “Operation
Zeppelin” to counter the negative narrative.
 The company also took legal action and engaged in public relations efforts to
restore investor confidence.

Regulatory Action and Investigations

 The Supreme Court of India directed the Securities and Exchange Board of
India (SEBI) to investigate the matter.
 SEBI conducted multiple investigations into the allegations, including those
related to stock manipulation, related party transactions, and insider trading.
 The Supreme Court also reviewed the regulatory framework surrounding the
allegations and endorsed reforms proposed by an expert committee.
 The Supreme Court ultimately upheld SEBI’s autonomy in conducting the
investigation, though it acknowledged the need for regulatory improvements.
 The investigations into the Adani Group’s dealings are ongoing, with SEBI
completing most of its probes.
 Hindenburg Research, the firm behind the initial report, has since shut down
operations.

2.33 Market Volatility and SEBI’s Role

Supreme Court has asked the SEBI and the Government about the existing
regulatory framework in place to protect Indian middle-class investors. This comes
78 Indian Financial System

after the Adani Group was accused of stock manipulation and accounting fraud by
the American firm Hindenburg Research. Earlier, a number of small investors lost lakhs
of crores due to rapid market volatility following a collapse in the value of the shares of
the Adani Group.

Meaning of Market Volatility

The stock markets sometimes experience sharp and unpredictable price
movements, either down or up. These movements are often referred to as a “volatile
market” and can occur over a period of days, weeks, or months.

Causes for Market Volatility

The main causes are:
 Surprising economic news that differs from the expectations of investors.
 A sudden change in monetary policy, such as the Federal Reserve announcing
plans to.
 Political developments including unexpected election results, an event such as a
government shutdown or passage of key legislation designed to give the
economy a boost.
 Geopolitical events such as an outbreak of a military conflict or flaring
tensions between powerful nations that could have economic ramifications.
 Events specific to markets, such as stocks becoming overvalued.

Measures to Control Market Volatility

Market Volatility can be dealt with the following measures:

 Monetary Policy
The Reserve Bank of India (RBI) can adjust interest rates to influence the supply
of money and credit in the economy, which can have an impact on market sentiment
and stability. The stock market and the interest rates have an inverse relationship. For
example, a rate cut can help calm investor concerns and boost market confidence.

 Fiscal Policy
Governments can use fiscal measures such as tax cuts, spending increases, and
targeted subsidies to boost economic activity and provide support to affected industries
and individuals.

 Regulatory Measures
Governments and regulatory authorities can introduce measures to increase
transparency and stability in financial markets. This may include increased disclosure
Money Market and Capital Market 79

requirements for companies, stricter standards for financial institutions, and greater
oversight of hedge funds and other speculative investors.

 International Cooperation
In a globalized financial system, sudden market volatility can spread quickly
across borders. Coordination among central banks and regulatory authorities can help
mitigate the impact of market volatility and prevent financial contagion.

 Financial Education and Literacy

Encouraging financial education and literacy among the public can help reduce the
risk of market speculation and improve overall financial stability.

 Diversification
By spreading investments across different assets and markets, investors can reduce
the impact of market volatility on their portfolios.

2.34 IPO Boom in India (2021-2023)

Capital markets of a country are reflection of its economic health and trend of
investor confidence in that countries policy and framework. They act as a platform for
new companies to raise capital and fund their projects or idea. One of the methods for
raising funds through capital markets is an Initial public offer (IPO). IPO is the process
through which a private company list itself in the capital market by selling its share to
the investors. In recent years, IPO market in India has witnessed a robust growth with
243 new companies doing so in 2023.

IPO trends in India 2021-23

Capital markets across the globe witnessed subdued demand and selling pressure
in 2020 as investors moved to safe heavens due to uncertainty around the outcome of
the pandemic. As the pandemic situation eased in 2021, investors returned to the capital
markets. The race to recovery after the easing of the pandemic resulted in several
stimulus packages from government across the worlds, boosting business environment,
and investor confidence. As a result, 2021 witnessed a record number of IPOs, both
globally and in the Indian domestic market.
80 Indian Financial System

Factors Driving the IPO Boom

The recent rise in IPO activity in India can be driven by two primary factors:
Growing retail investor participation and favourable regulatory reforms.

(a) Retail Investor Participation

India has experienced a large number of retail investors participating from last few
years. In monetary value, they bought shares amounting to a US$ 17.87 billion ( ₹ 1.49
lakh crore). This is twice the amount of total IPO funds raised in 2022.

Few examples of IPO with huge retail participations are:

 Tata Technologies with 52.11 lakh applications

 DOMS Industries with 41.30 lakh applications
 INOX India with 37.34 lakh applications

(b) Favourable Regulatory Reforms

SEBI initiatives to streamline processes for investors and companies:

SEBI’s strategic decision to shorten IPO listing timelines from T+6 to T+3 days
represents a major move towards optimising the IPO process, rendering it more
appealing to both issuers and investors. This acceleration in the listing process enables
issuers to expedite access to capital, enhance market sentiment, reduce pricing
uncertainties, and streamline administrative procedures. For investors, it translates to
earlier share access, lower holding period risks, improved liquidity, and more
confidence in Indian capital markets.
Money Market and Capital Market 81

Other Key Reforms of SEBI

 Introduction of pre-filing for draft offer documents and disclosure of key
performance indicators.
 Modification to the responsibilities of regulatory oversight bodies to enhance
transparency and efficiency.
 Implementation of an electronic initial public offering (e-IPO) system
facilitating online application for shares.
 Elimination of the need for physical applications, enhancing accessibility and
efficiency, for retail investors.
 Introduction of a fast-track approval process for companies with strong
corporate governance and financial performance.
 Reduction of the number of days for qualifying companies to receive approval
for their DRHP (Draft Red Herring Prospectus) to 21 days from the standard
60-90 days.

Impact of IPO on Capital Markets

The IPO has made the strong impact as follows:
 Increased Market Capitalisation: As more companies go public, the total
market value of listed companies rises, indicating overall growth and expansion
of the stock market.
 Enhanced Liquidity: As companies launch their IPOs, additional shares enter
the market for purchase and sale. This boost in liquidity simplifies the process
for investors to trade shares and contributes to a more efficient operation of the
market.
 Financial Inclusion: IPOs give common people the chance to invest in
companies that are growing. This allows individuals to join in on creating
wealth and potentially benefit from the company's success, which helps more
people become financially included.
The rise in new listings is changing how people invest by offering more options
and promoting competition, therefore, forcing companies to think out of the box and
come up with new ideas to distinguish themselves. This drives advancements across
various sectors. Such a dynamic setting provides investors with a wider range of
options and fosters economic growth by promoting competition and innovation.
As of June 2023, 3% of India's population is involved in the Capital market. And
moving forward, this percentage is expected to grow as more people join because of the
rising disposable income. This rise in investors can positively influence the Indian
stock market, creating opportunities for both businesses and investors.
82 Indian Financial System

Review Questions
Conceptual type questions for 2 marks.
1. State the meaning of Financial Market.
2. What are the types of Financial Markets?
3. What is Money Market?
4. Give the meaning of secondary market.
5. What are Derivatives?
6. What do you mean by Exchange Traded Funds?.
7. What is Spot Market?
8. Give the meaning of Bill of Exchange.
9. Give the meaning of Primary Market.
10. What is secondary market?.
11. Expand IPO and ASBA.
12. What do you mean by T-Bills?
13. What is a Cash Market?
14. What do you mean by Private Placement?
15. Give the meaning of T + 1 Settlement.

Analytical type questions for 6 marks.

1. Explain briefly the functions of Financial Market.
2. Explain the components of Financial Market.
3. Briefly explain the features of Money Market.
4. What are the objectives of money market?
5. Write a note structure of money market.
6. Write on instruments traded in money market.
7. Explain the functions of money market.
8. Briefly explain the features of Capital Market.
9. Explain the functions of Capital market.
10. Briefly explain the types of secondary market.
11. Write a note on Organization of Money Market.
12. Briefly explain the participants of Primary Market.
Money Market and Capital Market 83

Essay type questions for 14 marks.

1. Explain in detail the structure of capital Market and Instruments in Capital
Market.
2. What is Capital Market? Explain the Players of Capital Market.
3. State the meaning of Primary Market and Secondary Market. Explain the
differences between primary market and secondary market.
4. Elaborate the role of IPO Boom in India (2021-2023)
5. Write in detail about National Stock Exchange and Bombay Stock Exchange
6. Discuss the case study on Adani-Hindenburg.

Chapter ‒ 3
BANKING AND NON-BANKING
FINANCIAL INSTITUTIONS
Content:
Banking System – Structure (Commercial Banks, RRBs, Payment Banks) – RBI’s
Monetary Policy Tools (Repo Rate, Reverse Repo Rate, CRR, SLR) ‒ Income
Recognition and Asset Classification (Standard ‒ Sub-Standard-Doubtful and Loss
Assets) – Punjab and Maharashtra Cooperative Bank (PMC) Crisis-NBFCs – Types,
Regulations, Role in Financial Inclusion ‒ Neo-Banks vs Traditional Banks (Fi vs SBI).

3.1 Introduction to Banking

Today banks have become a part and parcel of our life. Earlier the facilities of
banks were enjoyed by dwellers of city alone. Now it offers access to a common man
which was untouched hitherto. Apart from traditional functions, banks now have to
fulfill national responsibilities. Banks cater to the needs of agriculturists, industrialists,
traders and all sections of the society and thus help in accelerations of economic growth
of the country.
Not long ago, an account holder had to wait for hours at the bank counters for
getting a draft or for withdrawing his own money. Today, he has a choice. Those days
have gone when the most efficient bank transferred money from one branch to other in
two days. Now it is simple as instant messaging or dial a pizza. Money has become the
order of the day.

3.2 Definition of Banking

As per Section 5(b) of the Banking Regulation Act, 1949, “Banking” means the
accepting, for the purpose of lending or investment, of deposits of money from the
public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or
otherwise. Hence, the term Banking has ‘the business activity of accepting and
safeguarding money owned by other individuals and entities, and then lending out this
money in order to earn a profit.’ However, with the passage of time, the activities
Banking and Non-Banking Financial Institutions 85

covered by banking business have widened and now various other services are also
offered by banks. The banking services these days include issuance of debit and credit
cards, providing safe custody of valuable items, lockers, ATM services and online
transfer of funds across the country / world.

3.3 Meaning of Bank

Finance is the life blood of trade, commerce and industry. Now-a-days, banking
sector acts as the backbone of modern business. Development of any country mainly
depends upon the banking system.
The term bank is either derived from Old Italian word banca or from a French
word banque both mean a Bench or money exchange table. In olden days, European
money lenders or money changers used to display (show) coins of different countries in
big heaps (quantity) on benches or tables for the purpose of lending or exchanging.
A Bank’ is a ‘financial institution which deals with deposits and advances and
other related services.’. It receives money from those who want to save in the form of
deposits and it lends money to those who need it.

Definition of a Bank
Oxford Dictionary defines a bank as “an establishment for custody of money,
which it pays out on customer’s order.”

3.4 Characteristics or Features of a Bank

The following are the important features of a bank:.

1. Dealing in Money
Bank is a financial institution which deals with other people’s money i.e. money
given by depositors.

2. Individual/Firm/Company
A bank may be a person, firm or a company. A banking company means a
company which is in the business of banking.

3. Acceptance of Deposit
A bank accepts money from the people in the form of deposits which are usually
repayable on demand or after the expiry of a fixed period. It gives safety to the deposits
of its customers. It also acts as a custodian of funds of its customers.
86 Indian Financial System

4. Giving Advances
A bank lends out money in the form of loans to those who require it for different
purposes.

5. Payment and Withdrawal

A bank provides easy payment and withdrawal facility to its customers in the form
of cheques and drafts. It also brings bank money in circulation. This money is in the
form of cheques, drafts, etc.

6. Agency and Utility Services

A bank provides various banking facilities to its customers. They include general
utility services and agency services.

7. Profit and Service Orientation

A bank is a profit seeking institution having service oriented approach.

8. Ever increasing fFunctions

Banking is an evolutionary concept. There is continuous expansion and
diversification as regards the functions, services and activities of a bank.

9. Connecting Link
A bank acts as a connecting link between borrowers and lenders of money. Banks
collect money from those who have surplus money and give the same to those who are
in need of money.

10. Banking Business

A bank’s main activity should be to do business of banking which should not be
subsidiary to any other business.

11. Name Identity

A bank should always add the word “bank” to its name to enable people to know
that it is a bank and that it is dealing in money.

3.5 Origin of Banking

The word ‘Bank’ has derived from French word ‘Banco’ or ‘Bancus’ which means
a ‘Bench’. In olden days, Jews transacted their banking business by sitting on benches.
When their business failed, these benches were broken and hence the word ‘bankrupt’
came in vogue. Another view is that the word ‘bank’ might be originated from German
word ‘Back’ which means a joint stock fund. Hence banks essentially deal with the
funds.
Banking and Non-Banking Financial Institutions 87

A brief History of Indian Banking

From the ancient times in India, an indigenous banking system has prevailed. The
businessmen called Shroffs, Seths, Sahukars, Mahajans, Chettis, etc. had been carrying
on the business of banking since ancient times. These indigenous bankers included very
small money lenders to shroffs with huge businesses, who carried on the large and
specialized business even greater than the business of banks. The origin of western type
commercial Banking in India dates back to the 18th century.
The story of banking starts from Bank of Hindusthan established in 1770 and it
was first bank at Calcutta under European Management. In 1786 General Bank of India
was set up. Since Calcutta was the most active trading port in India, mainly due to the
trade of the British Empire, it became a banking center.

3.6 Banking Company

A Banking Company is a financial institution that offers banking services to its
customers, such as accepting deposits, lending money, and providing various financial
services. These institutions may also offer services such as investment management,
trading, and insurance.
A banking company can be a commercial bank, a savings bank, or a cooperative
bank. Commercial banks are generally larger banks that offer a wide range of services
to individuals, businesses, and governments. Savings banks, on the other hand, are
typically smaller and focus on personal savings and loans. Cooperative banks are
owned and controlled by their members, who are typically customers of the bank. The
activities of a banking company are regulated by various government agencies to ensure
the safety and soundness of the financial system. These agencies may also provide
deposit insurance, which guarantees that customers’ deposits will be reimbursed up to a
certain amount in the event of the bank’s failure.

3.7 Functions of a Banking Company

A banking company typically offers a variety of financial services and products to
individuals and businesses. Some of the key functions of a banking company are:
 Accepting Deposits: Banking companies accept deposits from individuals and
businesses, which can be used to lend to other customers or invest in various
financial instruments.
 Providing Loans: Banking companies provide loans to individuals and
businesses for various purposes such as home loans, car loans, business loans,
personal loans, etc. These loans are typically paid back with interest over a
specified period.
88 Indian Financial System

 Facilitating Payments: Banking companies offer payment services such as

credit/debit cards, online banking, mobile banking, and wire transfers to
facilitate the transfer of funds between individuals and businesses.
 Offering Investment Services: Banking companies may offer investment
services such as mutual funds, stocks, bonds, and other financial instruments to
help customers grow their wealth.
 Providing Insurance: Some banking companies also provide insurance
products such as life insurance, health insurance, and general insurance to
protect individuals and businesses against unforeseen events.
 Providing Advisory Services: Banking companies may offer financial
advisory services to help customers make informed investment decisions and
manage their finances better.
 Providing Foreign Exchange Services: Banking companies also offer foreign
exchange services to facilitate the exchange of one currency for another for
individuals and businesses engaged in international trade.

3.8 Structure of Banking System in India

The banking system plays an important role in promoting economic growth not
only by channeling savings into investments but also by improving allocative efficiency
of resources. The recent empirical evidence, in fact, suggests that banking system
contributes to economic growth more by improving the allocative efficiency of
resources than by channeling of resources from savers to investors. An efficient
banking system is now regarded as a necessary precondition for growth.
A bank is a financial institution that provides banking and other financial services
to their customers. A bank is generally understood as an institution which provides
fundamental banking services such as accepting deposits and providing loans. There are
also nonbanking institutions that provide certain banking services without meeting the
legal definition of a bank. Banks are a subset of the financial services industry.
Indian banking industry has been divided into two parts, organized and
unorganized sectors. The organized sector consists of Reserve Bank of India,
Commercial Banks and Cooperative Banks, and Specialized Financial Institutions
(IDBI, ICICI, IFC etc.).
1. Reserve banks of India.
2. Indian Scheduled Commercial Banks.
(a) State Bank of India and its associate banks.
(b) Twenty nationalized banks.
(c) Regional rural banks.
(d) Other scheduled commercial banks.
Banking and Non-Banking Financial Institutions 89

3. Foreign Banks.
4. Non-scheduled banks.
5. Co-operative banks.
The banking system of India consists of the RBI, commercial banks, cooperative
banks and development banks (development finance institutions). These institutions,
which provide a meeting ground for the savers and the investors, form the core of
India’s financial sector. Through mobilization of resources and their better allocation,
banks play an important role in the development process of underdeveloped countries.
Banks that are included in the second schedule of the Reserve Bank of India Act,
1934 are considered to be Scheduled Banks. All scheduled banks enjoy the following
facilities:
 Such a bank becomes eligible for debts/loans on bank rate from the RBI.
 Such a bank automatically acquires the membership of a clearing house.

All banks which are not included in the second section of the Reserve Bank of
India Act, 1934 are Non-Scheduled Banks. They are not eligible to borrow from the
RBI for normal banking purposes except for emergencies. Scheduled banks are further
divided into commercial and cooperative banks.

Meaning of Scheduled Banks

Scheduled banks are those banks that are listed in the 2nd schedule of the Reserve
Bank of India Act, 1934. The Scheduled banks have a capital requirement of a
minimum of Rupees five lakhs. The major advantage that these banks have is that they
can raise funds from the Reserve Bank at low-interest rates and also automatically
become members of clearinghouses.
However, these banks need to keep a minimum balance with the Reserve Bank
daily. This balance is referred to as the Cash Reserve Ratio or CRR. All the commercial
banks, national and international banks, cooperative, and regional rural banks are
Scheduled banks in India.
Scheduled banks in India can be broadly classified into the following –
commercial public sector banks, State Bank of India and its associate banks,
commercial private banks, and finally the scheduled foreign banks running in India.

Meaning of Non-Scheduled Banks

Non-scheduled banks are those that are not listed in the 2nd Schedule of the
Reserve Bank of India Act 1934. These banks essentially do not comply with the
requirements that are set out by the central bank of the country. As they are not listed in
the schedule, they are thought to be not capable of protecting and promoting depositors’
interests.
90 Indian Financial System

However, it is important to point out that non-scheduled banks also need to keep
the cash reserve ratio, not with the central bank but with themselves. Their influence is
narrow. These banks are generally very small. They are immensely risky to do business
with. Their paid-up capital is less than Rupees five lakhs.

There are eleven State cooperative banks that are classified as non-scheduled
banks. There are more than 1000 urban cooperative banks that are classified as non-
scheduled banks. Usually, the non-scheduled banks are not allowed to take loans from
the Reserve Bank of India. These banks are also not eligible to be members of
clearinghouses. This means that they cannot allow inter-bank transactions for their
customers.

3.9 Comparing Scheduled and Non-Scheduled Banks

The difference between scheduled banks and unscheduled banks is studied as
under:

Factor Scheduled Banks Non-scheduled banks

Presence in the They are listed in the second They are not listed in the
second schedule of the Reserve Bank of second schedule of the Reserve
schedule India Act 1934. Bank of India Act 1934.
Meaning A scheduled bank is a duly There is no such express
registered company with a paid- requirement for non-scheduled
up capital of more than Rupees banks.
five lakhs.
Cash Reserve CRR is kept with the Reserve CRR is kept within the non-
Ratio (CRR) Bank of India. scheduled bank itself.
Borrowing The scheduled banks are Non-scheduled banks are not
allowed to borrow from the allowed to borrow from the
Reserve Bank of India. Reserve Bank unless in an
emergency.
Risk Scheduled banks are considered Non-scheduled banks are
to be less risky and it is not considered risky.
usual for the scheduled banks to
hurt the depositor interests.
Reports to the Scheduled banks have to Non-scheduled banks are not
Reserve Bank mandatorily send periodic expected to file any reports to
reports to the Reserve Bank. the Reserve Bank.
Clearinghouses Scheduled banks automatically Non-scheduled banks do not
become the members of have a membership to the
clearinghouses. clearinghouses.
Banking and Non-Banking Financial Institutions 91

Figure 3.1: Structure of Banking System in India

3.10 Commercial Banks

Meaning of Commercial Bank
Commercial banks in India are governed by the Banking Regulation Act of 1949.
It is common knowledge that the Indian banking system is regulated by the Reserve
Bank of India (RBI). A commercial bank is a type of financial institution that offers
loans, CDs, savings accounts, overdraft protection, and other services to its clients.
These organizations profit from the loans they make to people and the interest they
charge.
A Commercial Bank is a kind of financial institution that carries all the operations
related to deposit and withdrawal of money for the general public, providing loans for
investment, and other such activities. These banks are profit-making institutions and do
business only to make a profit.
The institutions that accept deposits from the general public and advance loans
with the purpose of earning profits are known as Commercial Banks.
Commercial banks form a prominent part of the country’s Financial Institution
System. Commercial Banks are those profit-making institutions which accept deposits
from general public and gives money (loan) to individuals like household,
entrepreneurs, businessmen etc. The prime objective of these banks is to earn profit in
the form of interest, commission etc. The operations of all these commercial banks are
regulated by the Reserve Bank of India, which is the central bank and supreme financial
authority in India.
92 Indian Financial System

The main source of income of a commercial bank is the difference between these
two rates which they charge to borrowers and pay to depositors. Some commercial
banks in India are ICICI Bank, State Bank of India, Axis Bank, and HDFC Bank,
Punjab national bank, Central bank of India.

3.11 Functions of Commercial Banks

The two most distinctive features of a commercial bank are borrowing and lending,
i.e., acceptance of deposits and lending of money to projects to earn Interest (profit). In
short, banks borrow to lend. The rate of interest offered by the banks to depositors is
called the borrowing rate while the rate at which banks lend out is called lending rate.
The difference between the rates is called ‘spread’ which is appropriated by the banks.
Mind, all financial institutions are not commercial banks because only those which
perform dual functions of (i) accepting deposits and (ii) giving loans are termed as
commercial banks. For example, post offices are not bank because they do not give
loans. Functions of commercial banks are classified in to two main categories:
A. Primary functions and
B. Secondary functions.
The above two functions are studied as under:

A. Primary Functions: It includes:

1. It Accepts Deposits: A commercial bank accepts deposits in the form of
current, savings and fixed deposits. It collects the surplus balances of the
Individuals, firms and finances the temporary needs of commercial transactions.
The first task is, therefore, the collection of the savings of the public. The bank
does this by accepting deposits from its customers. Deposits are the lifeline of
banks. Deposits are of three types as under:
(i) Current Account Deposits: Such deposits are payable on demand and are,
therefore, called demand deposits. These can be withdrawn by the
depositors any number of times depending upon the balance in the account.
The bank does not pay any Interest on these deposits but provides cheque
facilities. These accounts are generally maintained by businessmen and
Industrialists who receive and make business payments of large amounts
through cheques.
(ii) Fixed Deposits (Time deposits): Fixed deposits have a fixed period of
maturity and are referred to as time deposits. These are deposits for a fixed
term, i.e., period of time ranging from a few days to a few years. These are
neither payable on demand nor they enjoy cheque facilities. They can be
withdrawn only after the maturity of the specified fixed period. They carry
higher rate of interest. They are not treated as a part of money supply
Recurring deposit in which a regular deposit of an agreed sum is made is
also a variant of fixed deposits.
Banking and Non-Banking Financial Institutions 93

(iii) Savings Account Deposits: These are deposits whose main objective is to
save. Savings account is most suitable for individual households. They
combine the features of both current account and fixed deposits. They are
payable on demand and also withdraw able by cheque. But bank gives this
facility with some restrictions, e.g., a bank may allow four or five cheques
in a month. Interest paid on savings account deposits in lesser than that of
fixed deposit.
2. It gives Loans and Advances: The second major function of a commercial
bank is to give loans and advances particularly to businessmen and
entrepreneurs and thereby earn interest. This is, in fact, the main source of
income of the bank. A bank keeps a certain portion of the deposits with itself as
reserve and gives (lends) the balance to the borrowers as loans and advances in
the form of cash credit, demand loans, short-run loans, overdraft as explained
under.
(i) Cash Credit: An eligible borrower is first sanctioned a credit limit and
within that limit he is allowed to withdraw a certain amount on a given
security. The withdrawing power depends upon the borrower’s current
assets, the stock statement of which is submitted by him to the bank as the
basis of security. Interest is charged by the bank on the drawn or utilised
portion of credit (loan).
(ii) Demand Loans: A loan which can be recalled on demand is called
demand loan. There is no stated maturity. The entire loan amount is paid in
lump sum by crediting it to the loan account of the borrower. Those like
security brokers whose credit needs fluctuate generally, take such loans on
personal security and financial assets.
(iii) Short-term Loans: Short-term loans are given against some security as
personal loans to finance working capital or as priority sector advances.
The entire amount is repaid either in one instalment or in a number of
instalments over the period of loan.

B. Secondary Functions
Apart from the above-mentioned two primary (major) functions, commercial banks
perform the following secondary functions also.
1. Discounting Bills of Exchange or Bundles: A bill of exchange represents a
promise to pay a fixed amount of money at a specific point of time in future. It
can also be encashed earlier through discounting process of a commercial bank.
Alternatively, a bill of exchange is a document acknowledging an amount of
money owed in consideration of goods received. It is a paper asset signed by the
debtor and the creditor for a fixed amount payable on a fixed date. It works like
this.
94 Indian Financial System

Suppose, A buys goods from B, he may not pay B immediately but instead give
B a bill of exchange stating the amount of money owed and the time when A
will settle the debt. Suppose, B wants the money immediately, he will present
the bill of exchange (Hundi) to the bank for discounting. The bank will deduct
the commission and pay to B the present value of the bill. When the bill matures
after specified period, the bank will get payment from A.
2. Overdraft Facility: An overdraft is an advance given by allowing a customer
keeping current account to overdraw his current account up to an agreed limit. It
is a facility to a depositor for overdrawing the amount than the balance amount
in his account. In other words, depositors of current account make arrangement
with the banks that in case a cheque has been drawn by them which are not
covered by the deposit, then the bank should grant overdraft and honour the
cheque. The security for overdraft is generally financial assets like shares,
debentures, life insurance policies of the account holder, etc.
3. Agency Functions of the Bank: The bank acts as an agent of its customers and
gets commission for performing agency functions as under:
(i) Transfer of Funds: It provides facility for cheap and easy remittance of
funds from place-to-place through demand drafts, mail transfers,
telegraphic transfers, etc.
(ii) Collection of Funds: It collects funds through cheques, bills, bundles and
demand drafts on behalf of its customers.
(iii) Payments of Various Items: It makes payment of taxes. Insurance
premium, bills, etc. as per the directions of its customers.
(iv) Purchase and Sale of Shares and Securities: It buys sells and keeps in
safe custody securities and shares on behalf of its customers.
(v) Collection of Dividends: interest on shares and debentures is made on
behalf of its customers.
(iv) Acts as Trustee and Executor of property of its customers on advice of its
customers.
(vii) Letters of References: It gives information about economic position of its
customers to traders and provides similar information about other traders to
its customers.
4. Performing General Utility Services: The banks provide many general utility
services, some of which are as under:
(i) Traveller’s Cheques: The banks issue traveller’s cheques and gift
cheques.
(ii) Locker Facility: The customers can keep their ornaments and important
documents in lockers for safe custody.
Banking and Non-Banking Financial Institutions 95

(iii) Underwriting securities issued by government, public or private bodies.

(iv) Purchase and sale of foreign exchange (currency).

3.12 Structure or Types of Commercial Banks in India

Commercial banks can be broadly divided into public sector, private sector,
foreign banks and RRBs.

3.13 Public Sector Banks

Public Sector Banks refers to a type of commercial banks that are nationalized by
the government of a country. In public sector banks, the major stake is held by the
government. In India, public sector banks operate under the guidelines of Reserve Bank
of India (RBI), which is the central bank. Some of the Indian public sector banks are
State Bank of India (SBI), Corporation Bank, Bank of Baroda, Dena Bank, and Punjab
National Bank.

3.14 Private Sector Banks

Private Sector Banks refers to a kind of commercial banks in which major part of
share capital is held by private businesses and individuals. These banks are registered
as companies with limited liability. Some of the Indian private sector banks are Vysya
Bank, Industrial Credit and Investment Corporation of India (ICICI) Bank, and Housing
Development Finance Corporation (HDFC) Bank.
In India, the banking sector plays an important role in the economic development
of India. Banks are like hubs where people save, borrow, and manage their money.
They help individuals, businesses, and the government by providing financial services
such as loans, Deposit accounts, and investment options. There are mainly two types of
banks in India - public sector banks and private sector banks.

Public and Private Sector Banks Examples in India

The following are some examples of public sector banks in India:
1. State Bank of India
2. Central Bank of India
3. Union Bank of India
4. Indian Bank
5. UCO Bank
6. Bank of Maharashtra
7. Canara Bank
96 Indian Financial System

8. Bank of Baroda
9. Punjab National Bank
10. Punjab & Sind Bank
The following are some examples of private sector banks in India:
1. Axis Bank
2. HDFC Bank
3. IndusInd Bank
4. ICICI Bank
5. Kotak Mahindra Bank
6. Bandhan Bank
7. IDFC First Bank
8. IDBI Bank
9. Karur Vysya Bank
10. City Union Bank

3.15 Differences between Public Sector Banks and Private Sector

Banks
The following table provides a comparison between Public Sector Banks and
Private Sector Banks in India
Parameters Public Sector Banks Private Sector Banks
Objective Prioritizses social objectives Aims to maximizse profits.
and public welfare.
Controlling Governed by the government. Controlled by private
Authority companies or individuals.
Governing Formed by legislation in Registered under the Indian
Act/Law parliament. Companies Act.
Customer Base Generally, has a larger customer Usually has a smaller customer
base. base.
Share in Industry It holds almost 59% of the total It holds only 34% of the total
market share in India, in terms market share in India, in terms
of deposit. of deposit.
Foreign Direct It allows up to 20% FDI. It allows up to 74% FDI with
Investment (FDI) restrictions on control and
ownership.
Number of Banks There are 12 public sector banks There are 21 private sector
Banking and Non-Banking Financial Institutions 97

in India. banks in India.

Pension They provide pensions to No pension scheme for
employees. employees.

3.16 Foreign Banks

A Foreign Bank is a bank that has its headquarters outside the country but runs its
offices as a private entity at any other location outside the country. Such banks are
under an obligation to operate under the regulations provided by the central bank of the
country as well as the rule prescribed by the parent organization located outside India.
Some of the foreign banks operating in India are Hong Kong and Shanghai
Banking Corporation (HSBC), Citibank, American Express Bank, Standard &
Chartered Bank, and Grindlay’s Bank. In India, since financial reforms of 1991, there is
a rapid increase in the number of foreign banks. Commercial banks mark significant
importance in the economic development of a country as well as serving the financial
requirements of the general public.
Foreign Banks are those banks which are registered or incorporated outside India.
They have an office or branch in India. These banks had their presence from the British
Period. With the changes in the banking policy in post 1993 period, the number of
foreign banks have been increased. The globalization of Indian economy has increased
the presence of more foreign banks.
Besides performing banking functions, foreign banks play an important role in
shaping the attitudes and polices of government, companies and their clients towards
India. There as 39 foreign banks with 182 branches operating in India. They contribute
about 8% of total commercial banks’ assets in India. Their profitability is higher than
Indian Banks.

Additional functions of Foreign Banks

 Providing finance for power generation, telecommunication, mining projects.
 Enter into joint ventures and collaborations.
 Managing euro-issues of debt-equity of Indian companies.
 Managing data and information system with latest technology.
 Bringing together FIIs and Indian Companies.

3.17 Regional Rural Banks

Regional Rural Banks were established under the Regional Rural Banks
Ordinance, 1975 with the aim of ensuring sufficient institutional credit for agriculture
and other rural sectors. The area of operation of RRBs is limited to the area notified by
the Government. RRBs are owned jointly by the Government of India, the State
98 Indian Financial System

Government and Sponsor Banks. An example of RRB in India is Arunachal Pradesh

Rural Bank.
Regional Rural Banks (RRBs) in India are the scheduled commercial banks that
conduct banking activities for the rural areas at the state level. As the name suggests,
the Regional Rural Banks cater to the needs of the rural and underprivileged people at
the regional level across different states in the country.

Ownership of RRB
The equity of the Regional Rural Banks is held by the stakeholders in a fixed
proportion. This proportion is 50:35:15, distributed as:
1. Central Government – 50%
2. Sponsor Bank – 35%
3. State Government – 15%
The Regional Rural Banks, or RRBs, are the third layer of commercial banking
organization, after commercial and cooperative banks. The RRBs were established as
per the recommendations of the Narasimham Committee to cater to the rural credit
needs of the farming and other rural communities. The main aim of the RRBs is to
provide credit and other banking facilities to the small and marginal farmers,
agricultural labourers, and small artisans who form an evident part of the development
of the rural economy. The RRBs are a new form of commercial banks, backed by
commercially strong banks to serve within a limited local area. The RRBs were set up
under the Regional Rural Bank Act of 1976. The Prathama Grameen Bank was the first
bank to be established on 2 nd October 1975. The Syndicate Bank became the first
commercial bank to sponsor the Prathama Grameen Bank RRB.

Features of RRB
Following are the characteristic features of the Regional Rural Banks in India:
1. The RRBs possess complete knowledge of the problems faced by the people in
the rural regions as they operate in a familiar environment.
2. They show professionalism in mobilizing the finances just like that of a
commercial bank.
3. RRBs provide banking as well as credit facilities to the marginal farmers, small
entrepreneurs, artisans, labourers, etc. in rural areas.
4. They fulfill the priority sector lending norms as applicable on the commercial
banks.
5. They are required to work within their prescribed local limits only.
Banking and Non-Banking Financial Institutions 99

Objectives of RRB
The Regional Rural Banks in India are entrusted with the following functions and/
or objectives as described below:
1. Opening branches of banks in the rural areas.
2. Providing loans for the development of the agricultural sector to small farmers,
agricultural labourers, small entrepreneurs, etc.
3. Generating employment opportunities.
4. Encouraging savings among the rural people, accepting deposits, and using the
funds for productive purposes.
5. Protecting common people from money lenders’ exploitation.
6. Reducing the cost of providing loans in rural areas.

3.18 Payment Banks

Payment Banks are a new type of financial institution in India that was introduced
in 2014. They provide basic banking services to people who are currently unbanked or
underbanked. Payment Banks cannot offer loans or credit cards. They can only offer
savings accounts, current accounts, and mobile banking services. The introduction of
payment banks is a significant development in the Indian financial sector.
A Payment Bank is created by the Reserve Bank of India. Payments Bank seeks to
o provide financial and payment services to small businesses, low-income households,
and migratory workers in a safe, technology-driven environment. They function as
regular banks but cannot provide credit or loan facilities.
The history of payment banks in India can be traced back to 2013. The RBI set up
a committee to look into the feasibility of introducing a new type of bank. This bank
would focus on providing basic banking services to people who are currently unbanked.
The committee, which was headed by Nachiket Mor, submitted its report in January
2014. The report recommended the introduction of payment banks. The RBI issued the
final guidelines for payment banks in November 2014.
The first payment bank in India, Airtel Payments Bank, was set up in January
2017. Since then, a total of 11 payment banks has been set up in India. Example: Airtel
Payments Bank, Paytm Payments Bank, India Post Payments Bank, Jio Payments Bank ,
etc.

Objectives of Payment Banks

 A payment bank primarily aims to provide secure, technology-driven payment
and financial services to small enterprises, low-income consumers, and the
migratory labour workforce.
100 Indian Financial System

 The RBI’s payments banks programme aims to improve financial service

distribution in the country’s outlying areas.

Features of Payment Banks

 A Payment Bank is a special sort of bank that solely performs the limited
banking tasks that the Banking Regulation Act of 1949 allows.
 Some activities include deposit acceptance, payments and remittance services,
internet banking, and acting as a business correspondent for other banks.
 They can take deposits of up to ₹ 1 lakh per person at first.
 They can assist with money transfers and insurance, and mutual fund sales.
 They can also only issue ATM/debit cards and not credit cards.
 They are prohibited from forming subsidiaries to provide non-banking financial
services.
 They are not permitted to engage in any lending activity.
 Payment Banks are not allowed to issue Loans and cannot accept NRI Deposits.
 A person with a payment bank account might deposit and take money from any
ATM or other service provider.
 Licensing would be granted to mobile companies, grocery chains, and others to
cater to individuals and small enterprises.
 They are only allowed to invest money from customers’ deposits into
government securities.
 The minimum capital for payment bank is of ₹ 100,00,00,000.

3.19 Reserve Bank of India

Introduction to Reserve Bank of India
The overall economic efficiency and the stability of a nation are dependent on the
payment and settlement system prevailing in that country. As a result, the various
regulators in India, including the central bank, have been regularly and consistently
revising their operating models and policies to ensure and carry on the development of
payment systems at the national level. These regulators are required to carefully
safeguard the sanctity of payment systems, generally from systematic risks, the risk of
fraud, etc. The responsibility of a central bank of any given country is to ensure
and carry on the development of payment systems at the national level. In India, this
responsibility is vested with the Reserve Bank of India (RBI).
RBI, beingas the central bank of the country, occupies a significant place in the
Indian Banking and Financial System. As an apex institution, it acts as a guide,
regulator, controller and promoter of the financial system. RBI was established in 1935,
under RBI Act, 1934. Till 1949, it was a private shareholders’ institution and became a
state-owned institution after its nationalization. It is banker to the banks and controller
of activities of banking, non-banking and financial institutions in the country.
Banking and Non-Banking Financial Institutions 101

Meaning of Reserve Bank of India (RBI)

The Reserve Bank of India (RBI) is the central bank of India whose primary
function is to manage and govern the financial system of the country. It is a statutory
body established in the year 1935 under the Reserve Bank of India Act, 1934. The
central bank regulates the issue and supply of the Indian rupee. It also looks after the
central government’s money. The central bank plays the role of the bankers’ bank and
regulates the banking sector. It also plays an important role in India’s development
story by supporting the government in its developmental projects and policies.
The head office of the RBI, in Kolkata when the bank was established, was shifted
to Mumbai in 1937. Originally, the bank was privately owned. However, after
Independence, it was nationalised in 1949 and is now fully owned by the Government
of India.

Constitution of RBI
RBI has been constituted as a corporate body having perpetual succession and a
common seal. It was established with an authorized capital of ₹ 5 crores divided in
shares of ₹ 100 each. When bank was nationalized in 1949, the shareholders were paid
in Securities of Govt. of India, shareholders were paid ₹ 118 each as compensation for
every share of ₹ 100.

Management of RBI
The management of the RBI is under the control of ‘Central Board of Directors’
consisting of 20 members:
(a) The Executive Head of the Bank is called Governor who is assisted by 04
Deputy Governors. They are appointed by the Government of India for a period
of five years. The head office of the Reserve Bank is at Bombay.
(b) There are 15 directors from various fields and one government official from the
Ministry of Finance.
(c) There are 04 ‘Local Boards’ at Delhi, Kolkata, Chennai and Mumbai
representing four regional areas, i.e., northern, eastern, southern and western
respectively. These local boards are advisory in nature and the Government of
India nominates one member each from these boards to the Central Board.
102 Indian Financial System

Management of RBI

Objectives of RBI
The Preamble to the Reserve Bank of India Act, 1934 spells out the objectives of
the Reserve Bank as:
“Tto regulate the issue of Bank notes and the keeping of reserves with a view to
securing monetary stability in India and generally to operate the currency and credit
system of the country to its advantage.”.
Being the backbone of the financial state of the country, RBI has various
objectives as mentioned in the RBI preamble. Some of them are listed below:
 Primary Objectives: The primary objectives of RBI includes:
Addressing the issue of Banknotes
Maintaining monetary stability in the country
To operate the credit system and currency in the country to its own advantage
 Remain Independent of the Political Influence: In order to maintain financial
stability and promote economic growth, RBI should be free from any political
pressure and refrain from corrupted activities.
 Fundamental objectives: RBI should serve as a central authority and serve as:

– Bank of all the other Commercial banks

Banking and Non-Banking Financial Institutions 103

– Only authority who has note issuing power

– Bank to the Government of India
 Promote Economic Growth: RBI, along with maintaining price stability,
should also design policies which promote economic growth within the
framework.

Role and Importance of RBI

It is in charge of deciding on the country’s monetary policy. The Reserve Bank of
India’s (RBI) primary responsibility is to preserve financial stability and appropriate
liquidity in the economy.
Some of the significant functions of the Reserve Bank of India are mentioned and
explained below:
1. Monetary Management: The formulation and seamless execution of monetary
policy are one of the Reserve Bank of India’s main responsibilities. Various
policy instruments are used by monetary policy to impact the cost and
availability of money in the economy. The goal remains to encourage economic
growth while maintaining price stability. It assures a steady supply of credit to
the economy’s productive sectors.
2. The issuer of Currency: Currency management and issuance are critical
central banking functions. The Reserve Bank of India (RBI) is in charge of the
country’s currency design, manufacture, distribution, and overall management.
It aims to ensure that the state has a sufficient supply of clean and legitimate
notes. Its goal is to lower the risk of counterfeiting. Counterfeit notes are
frequently used for terrorist financing, which has a variety of negative
consequences.
3. Banker and debt manager of the Government: The Reserve Bank of India
(RBI) is in charge of the government’s banking transactions. The Reserve Bank
of India also holds the cash holdings of the Indian government. It can also serve
as a lender to state governments. It appoints other banks to act as its agents in
carrying out the government’s transactions. On behalf of the federal and state
governments, it also manages public debt and offers new loans.
4. Banker to Banks: The RBI is also responsible for the settlement of interbank
transactions. This is normally accomplished through the employment of a
“clearing house,” which allows banks to present cheques and other similar
instruments for clearing. The central bank serves as a common banker for all of
the banks.
5. Financial Regulation and Supervision: The regulatory and supervisory
powers of the RBI are extensive. Through a variety of policy initiatives, it aims
104 Indian Financial System

to ensure general financial stability. Its goal is to ensure the orderly

development and conduct of banking activities, as well as bank liquidity and
solvency.
6. Developmental Role: The Reserve Bank of India (RBI) actively supports and
enhances development efforts in the country. It guarantees that the productive
sectors of the economy have access to sufficient credit and establishes
organisations to support the development of financial infrastructure. It also tries
to ensure that everyone has access to banking services.
7. Oversees Market Operations: The Central Bank implements its monetary
policy through government securities, foreign exchange, and money market
operations. It also regulates and develops market instruments such as the term
money market, repo market, and others.
8. Foreign Exchange Management: The foreign exchange market is regulated by
the Reserve Bank of India (RBI). It has also opened practically all areas to
international investment.

Functions of RBI
As a central bank, the Reserve Bank has significant powers and duties to perform.
For smooth and speedy progress of the Indian Financial System, it has to perform some
important tasks which include:
 Mmaintaining monetary and financial stability,
 Tto develop and maintain stable payment system,
 Tto promote and develop financial infrastructure and
 T to regulate or control the financial institutions.

For simplification, the functions of RBI are classified into:

 The Traditional Functions,
 The Development Functions, and
 Supervisory Functions.

I. Traditional Functions of RBI

Traditional functions are those functions which every central bank of each nation
performs all over the world. Basically, these functions are in line with the objectives
with which the bank is set up. It includes fundamental functions of the Central Bank.
They comprise the following tasks.
1. Issue of Currency Notes: The RBI has the sole right or authority or monopoly
of issuing currency notes except one rupee and two rupees coins of smaller
denomination. These currency notes are legal tender issued by the RBI.
Currently it is in denominations of ₹ 5, 10, 20, 50, 100, 500, and 2,000. It issues
Banking and Non-Banking Financial Institutions 105

these notes against the security of gold bullion, foreign securities, rupee coins,
exchange bills and promissory notes and government of India bonds.
2. Banker to Other Banks (Lender of the last Resort): The RBI being an apex
monitory institution has obligatory powers to guide, help and direct other
commercial banks in the country. The RBI can control the volumes of banks
reserves and allow other banks to create credit in that proportion. Every
commercial bank has to maintain a part of their reserves with its parent's viz.
the RBI. Similarly in need or in urgency these banks approach the RBI for fund.
Thus, it is called as the ‘Lender of the Last Resort’.
3. Banker to the Government: The RBI being the apex monitory body has to
work as an agent of the central and state governments. It performs various
banking function such as to accept deposits, taxes and make payments on behalf
of the government. It works as a representative of the government even at the
international level. It maintains government accounts, provides financial advice
to the government. It manages government public debts and maintains foreign
exchange reserves on behalf of the government. It provides overdraft facility to
the government when it faces financial crunch.
4. Exchange Rate Management: It is an essential function of the RBI. In order to
maintain stability in the external value of rupee, it has to prepare domestic
policies in that direction. Also, it needs to prepare and implement the foreign
exchange rate policy which will help in attaining the exchange rate stability. In
order to maintain the exchange rate stability, it has to bring demand and supply
of the foreign currency (U.S Dollar) close to each other.
5. Credit Control Function: Commercial bank in the country creates credit
according to the demand in the economy. But if this credit creation is
unchecked or unregulated then it leads the economy into inflationary cycles. On
the other credit creation is below the required limit then it harms the growth of
the economy. As a central bank of the nation the RBI has to look for growth
with price stability. Thus, it regulates the credit creation capacity of commercial
banks by using various credit control tools.
6. Supervisory Function: The RBI has been endowed with vast powers for
supervising the banking system in the country. It has powers to issue license for
setting up new banks, to open new branches, to decide minimum reserves, to
inspect functioning of commercial banks in India and abroad, and to guide and
direct the commercial banks in India. It can have periodical inspections an audit
of the commercial banks in India.

II. Developmental/Promotional Functions of RBI

Along with the routine traditional functions, central banks especially in the
developing country like India have to perform numerous functions. These functions are
country specific functions and can change according to the requirements of that
country. The RBI has been performing ‘as a promoter of the financial system’ since its
inception. Some of the major development functions of the RBI are maintained below.
106 Indian Financial System

1. Development of the Financial System: The financial system comprises the

financial institutions, financial markets and financial instruments. The sound
and efficient financial system is a precondition of the rapid economic
development of the nation. The RBI has encouraged establishment of main
banking and non-banking institutions to cater to the credit requirements of
diverse sectors of the economy.
2. Development of Agriculture: In an agrarian economy like ours, the RBI has to
provide special attention for the credit need of agriculture and allied activities. It
has successfully rendered service in this direction by increasing the flow of
credit to this sector. It has earlier the Agriculture Refinance and Development
Corporation (ARDC) to look after the credit, National Bank for Agriculture and
Rural Development (NABARD) and Regional Rural Banks (RRBs).
3. Provision of Industrial Finance: Rapid industrial growth is the key to faster
economic development. In this regard, the adequate and timely availability of
credit to small, medium and large industry is very significant. In this regard the
RBI has always been instrumental in setting up special financial institutions
such as ICICI Ltd. IDBI, SIDBI and EXIM BANK etc.
4. Provisions of Training: The RBI has always tried to provide essential training
to the staff of the banking industry. The RBI has set up the bankers’ training
colleges at several places. National Institute of Bank Management i.e., NIBM,
Bankers Staff College i.e. BSC and College of Agriculture banking i.e., CAB
are few to mention.
5. Collection of Data: Being the apex monetary authority of the country, the RBI
collects process and disseminates statistical data on several topics. It includes
interest rate, inflation, savings and investments etc. This data proves to be quite
useful for researchers and policy makers.
6. Publication of the Reports: The Reserve Bank has its separate publication
division. This division collects and publishes data on several sectors of the
economy. The reports and bulletins are regularly published by the RBI. It
includes RBI weekly reports, RBI Annual Report, Report on Trend and
Progress of Commercial Banks India., etc. This information is made available to
the public also at cheaper rates.
7. Promotion of Banking Habits: As an apex organization, the RBI always tries
to promote the banking habits in the country. It institutionalizes savings and
takes measures for an expansion of the banking network. It has set up many
institutions such as the Deposit Insurance Corporation-1962, UTI-1964, IDBI-
1964, NABARD-1982, NHB-1988, etc. These organizations develop and
promote banking habits among the people. During economic reforms it has
taken many initiatives for encouraging and promoting banking in India.
8. Promotion of Export through Refinance: The RBI always tries to encourage
the facilities for providing finance for foreign trade especially exports from
Banking and Non-Banking Financial Institutions 107

India. The Export-Import Bank of India (EXIM Bank India) and the Export
Credit Guarantee Corporation of India (ECGC) are supported by refinancing
their lending for export purpose.

III. Supervisory Functions of RBI

The reserve bank also performs many supervisory functions. It has authority to
regulate and administer the entire banking and financial system. Some of its
supervisory functions are given below.
1. Granting License to Banks: The RBI grants license to banks for carrying its
business. License is also given for opening extension counters, new branches,
even to close down existing branches.
2. Bank Inspection: The RBI grants license to banks working as per the directives
and in a prudent manner without undue risk. In addition to this it can ask for
periodical information from banks on various components of assets and
liabilities.
3. Control over NBFIs: The Non-Bank Financial Institutions are not influenced
by the working of a monitory policy. However, RBI has a right to issue
directives to the NBFIs from time to time regarding their functioning. Through
periodic inspection, it can control the NBFIs.
4. Implementation of the Deposit Insurance Scheme: The RBI has set up the
Deposit Insurance Guarantee Corporation in order to protect the deposits of
small depositors. All bank deposits below ₹ One lakh are insured with this
corporation. The RBI work to implement the Deposit Insurance Scheme in case
of a bank failure.

3.20 Monetary and Credit Policy of RBI

Meaning: Monetary policy refers to the use of official instruments under the control of
the central bank to regulate availability, cost and use of money and credit with the aim
of achieving:
 Ooptimum levels of output and employment,
 Pprice stability,
 Eequilibrium in balance of payments or
 Any other goals set by the state.

In other words, monetary policy is the process by which monetary authority of a

country, generally a central bank controls the supply of money in the economy by its
control over interest rates in order to maintain price stability and achieve high
economic growth. In India, the central monetary authority is the Reserve Bank of India
is so designed as to maintain the price stability in the economy.
108 Indian Financial System

Credit Control Measures of RBI

Credit Control Policy
RBI uses a Credit control monetary policy strategy to ensure that the country’s
economic development is accompanied by stability. It means that banks will not only
contain inflationary trends in the economy but will also stimulate economic growth,
resulting in increased real national income stability in the long run. Because of its
functions, including issuing notes and keeping track of cash reserves, the RBI does not
regulate credit because it would cause social and economic instability in the country.

Meaning of Credit Control

Credit control is a monetary policy tool used by the Reserve Bank of India to
control the demand and supply of money, or liquidity, in the economy. The Reserve
Bank of India (RBI) supervises the credit granted by commercial banks.
Credit control is defined as ‘the lending strategy that banks and financial
institutions employ to lend money to customers.’. The strategy emphasizses on lending
money to customers who have a good credit score or credit record.
Example: An example of credit control is imposing credit card limits. Financial
institutions set a maximum limit on cardholders’ spending, which helps control the
amount of credit extended and manage the risk of excessive debt accumulation.

Monetary Policy Tools in India

Various instruments used by the RBI to control the money supply can be
categorized into two categories:
 Quantitative Tools: Quantitative tools of monetary policy are aimed at
controlling the cost and quantity of credit.
 Qualitative Tools: Qualitative tools of monetary policy are aimed at
controlling the use and direction of credit.

Quantitative Method or Traditional Method: Tools are designed to regulate the

volume of credit created by the banking system. Qualitative measures or selective
methods are designed to regulate the flow of credit in specific uses. RBI employs bank
rate, CRR, SLR and open market operations, variable reserve ratio etc.
Banking and Non-Banking Financial Institutions 109

Figure 3.2: Credit Control measures of RBI

Qualitative Methods or Selective Methods of credit control include regulation of

Margin Requirement, Credit Rationing, Regulation of consumer credit and direct
action.

I. Quantitative Method
A. Bank Rate
The Bank Rate, also known as the Discount Rate, is the rate payable by
commercial banks on the loans from or rediscounts of the Central Bank. A change in
bank rate affects other market rates of interest.
An increase in bank rate leads to an increase in other rates of interest and on the
other hand, a decrease in bank rate results in a fall in other rates of interest. A deliberate
manipulation of the bank rate by the Central Bank to influence the flow of credit
created by the commercial banks is known as Bank Rate Policy. It does so by affecting
the demand for credit, the cost of the credit and the availability of the credit.
 Contraction of Credit: An increase in bank rate results in an increase in the
cost of credit; this is expected to lead to a contraction in demand for credit. A
contraction in demand for credit consequently increases in the cost of credit &
restricts the total availability of money in the economy, and hence may prove an
anti-inflationary measure of control.
 Expansion of Credit: A fall in the bank rate causes other rates of interest to
come down. The cost of credit falls and hence credit becomes cheaper. Cheap
credit may induce a higher demand both for investment and consumption
purposes. More money, through increased flow of credit, comes into circulation
and hence may prove an inflationary measure.

A fall in bank rate may, thus, prove an anti-deflationary instrument of control.

110 Indian Financial System

Bank Rate Comprises Two Instruments

(i) Cash Reserve Ratio (CRR)

Cash Reserve Ratio (CRR) is the minimum percentage of a bank’s total Demand
and Time Liabilities (DTL) that a Scheduled Commercial Bank is obligated to deposit
with the RBI in the form of cash.
RBI does not pay any interest on CRR deposits. RBI Act does not prescribe any
range (ceiling or floor) for fixing CRR. Thus, RBI has the freedom to fix the CRR at
any rate depending on the macroeconomic conditions.
If CRR is Increased: If the RBI increases the CRR, the commercial banks have to
deposit more money with the RBI and are left with less money to lend to customers.
Thus, the effect is reduced money supply in the economy.
If CRR is Decreased: If the RBI decreases the CRR, the commercial banks have to
deposit less money with the RBI and are left with more money to lend to customers.
Thus, the effect is increased money supply in the economy.

(ii) Statutory Liquidity Ratio (SLR)

Statutory Liquidity Ratio (SLR) is the percentage of Net Demand and Time
Liabilities (NDTL) that a Scheduled Commercial Bank (SCB) has to keep with itself, in
the form of:
 Cash, or
 Gold, or
 SLR Securities (such as government bonds, treasury bills, and any other
instrument notified by the RBI), or
 Any combination of the above three.

Unlike the CRR, SLR need not be deposited with RBI. The range of
SLR prescribed by the RBI is from 0 percent to 40 percent.
 If SLR is increased: If the RBI increases the SLR, the commercial banks are left
with less money to lend to customers. Thus, the effect is reduced money supply
in the economy.
 If CRR is decreased: If the RBI decreases the SLR, the commercial banks are
left with more money to lend to customers. Thus, the effect is increased money
supply in the economy.

If the bank fails to maintain the required SLR, then it is liable to pay penal interest
at (Bank Rate + 3%) per annum above the bank rate, on the shortfall amount.
 If the shortfall continues for the next succeeding day, penal interest is to be paid
at (Bank Rate + 5%).
Banking and Non-Banking Financial Institutions 111

B. Open Market Operations

Open market operations refer to the purchase and sale of securities by the Central
bank to the commercial banks. A sale of securities by the Central Bank, i.e., the
purchase of securities by the commercial banks, results in a fall in the total cash
reserves of the banks.
 Expansion of Credit Creation: In order to increase money supply in the
market, RBI starts purchasing securities in the open market. Borrowings in
money market become cheaper due to increasing supply of money. People are
encouraged to borrow more and more money is deposited in the banks by
people. This raises the CRR of commercial banks.
 Contraction of Credit Creation: In order to contract the credit supply in the
market, RBI starts selling securities in the open market. People wanting to buy
the securities utilize either the cash holdings or withdraw the cash from
commercial, which leads to depletion of cash reserves with commercial banks.
It reduces the credit creation power of the banks.

Liquidity Adjustment Facility (LAF)

Liquidity Adjustment Facility (LAF) allows banks to borrow money from the
RBI through repurchase agreements (repos) or to make loans to RBI through reverse
repo agreements.
 It is aimed to aid banks in adjusting the day-to-day mismatches in liquidity.
 It comprises the following 2 sub-instruments:

(a) Repo Rate (Re-purchase Option Rate)

Repo Rate is the rate of interest at which the RBI provides short-term loans to
SCBs (Scheduled Commercial Banks) against approved securities.

(b) Reverse Repo Rate

Reverse Repo Rate is the rate of interest at which the RBI borrows funds from the
SCBs. In other words, it is the rate at which SCBs park their excess funds with the RBI
for a short period of time.
The RBI has frequently resorted to the sale of government securities to which the
commercial banks have been generously contributing. Thus, open market operations in
India have served, on the one hand as an instrument to make available more budgetary
resources and on the other as an instrument to take out the excess liquidity in the
system.

(c) Marginal Standing Facility or MSF

MSF is one of the important provisions put forth by the Reserve Bank of India
through which certain commercial banks can achieve liquidity overnight. This proves to
112 Indian Financial System

be very beneficial at the time when all liquidities are dried up. MSF is used as an
emergency tool by the banks to obtain liquidity at the Marginal Standing Facility or
MSF rate.
By using the Marginal Standing Facility or MSF, the concerned banks borrow
money from the central bank which is done by pledging the government securities at a
rate higher than the repo rate. This will help the banks to obtain quick money in the
period of 24 hours.
The Reserve Bank of India (RBI) introduced the marginal Standing Facility (MSF)
in the year 2011-2012 to help banks in emergency situations and also helps the RBI to
maintain the money flow in the economy. There are a number of benefits of
the marginal standing facility including less volatility in the overnight lending rates,
avoiding short term liquidity shortfalls, it gives RBI more control over the money flow
in the economy and helps banks in emergency situations.
The current Marginal Standing Facility rate or MSF rate in India is 4.25%. This is
the rate at which the banks can pledge government securities for gaining liquidity in
situations when the liquidity is dried up.

II. Qualitative Method or Selective and Direct Credit Control

The regulation of credit for specific purposes or branches of economic activity is
termed as Selective or Qualitative Credit Control.

Measures of Qualitative Credit Control

(i) Credit Rationing
Rationing of credit is a method by which the Central Bank seeks to limit the
maximum amount of loans and advances and, also in certain cases, fix ceiling for
specific categories of loans and advances.

(ii) Regulation of Consumer Credit

Regulation of consumer credit is designed to check the flow of credit for consumer
durable goods. This can be done by regulating the total volume of credit that may be
extended for purchasing specific durable goods and regulating the number of
installments through which such loan can be spread. Central Bank uses this method to
restrict or liberalize loan conditions accordingly to stabilize the economy.

(iii) Margin Requirements

Changes in Margin Requirements are designed to influence the flow of credit
against specific commodities. The commercial banks generally advance loans to their
customers against some security offered by the borrower and acceptable to banks.
Banking and Non-Banking Financial Institutions 113

More generally, the commercial banks do not lend up to the full amount of the
security but lend an amount less than its value. The margin requirements against
specific securities are determined by the Central Bank. A change in margin
requirements will influence the flow of credit. A rise in the margin requirement results
in a contraction in the borrowing value of the security and similarly, a fall in the margin
requirement results in expansion in the borrowing value of the security.

(iv) Moral Suasion

Moral suasion and credit monitoring arrangement are other methods of credit
control. The policy of moral suasion will succeed only if the Central Bank is strong
enough to influence the commercial banks.
In India, from 1949 onwards, the Reserve Bank has been successful in using the
method of moral suasion to bring the commercial banks to fall in line with its policies
regarding credit. Publicity is another method, whereby the Reserve Bank marks direct
appeal to the public and publishes data which will have sobering effect on other banks
and the commercial circles.

(v) Direct Action

In this method, if the lending institutions do not follow the policy laid by RBI. It
only has a recourse to the direct action. This method is usually used to supplement
other credit control methods.

Brief Meaning of the Terms

(a) Cash Reserve Ratio (CRR)
Cash Reserve Ratio is a ‘specified minimum fraction’ of the total deposits of
customers, which commercial banks have to hold as reserves with the central bank.
Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of
customers, which commercial banks have to hold as reserves either in cash or as
deposits with the central bank. CRR is set according to the guidelines of the central
bank of a country.

(b) Statutory Liquidity Ratio (SLR)

Statutory liquidity ratio (SLR) is the ‘Indian government term’ for reserve
requirement that the commercial banks in India require to maintain in the form of gold,
cash or government approved securities before providing credit to the customers.
The SLR is commonly used to control inflation and fuel growth, by increasing or
decreasing it respectively. This counter acts by decreasing or increasing the money
supply in the system respectively. Indian banks’ holdings of government securities are
now close to the statutory minimum that banks are required to hold to comply with
existing regulation.
114 Indian Financial System

(c) Bank Rate

Bank Rate is the rate at which central bank of the country (in India it is RBI)
allows finance to commercial banks. Bank Rate is a tool, which central bank uses for
short-term purposes. Any upward revision in Bank Rate by central bank is an indication
that banks should also increase deposit rates as well as Base Rate/Benchmark Prime
Lending Rate.
Thus, any revision in the Bank rate indicates that it is likely that interest rates on
deposits are likely to either go up or go down, and it can also indicate an increase or
decrease in EMI.

(d) Repo (Repurchase) Rate

Repo (Repurchase) rate is the rate at which the RBI lends shot-term money to the
banks against securities. When the repo rate increases borrowing from RBI becomes
more expensive. Therefore, we can say that in case, RBI wants to make it more
expensive for the banks to borrow money, it increases the repo rate; similarly, if it
wants to make it cheaper for banks to borrow money, it reduces the repo rate.

(e) Reverse Repo Rate

Reverse Repo rate is the rate at which banks park their short-term excess liquidity
with the RBI. The banks use this tool when they feel that they are stuck with excess
funds and are not able to invest anywhere for reasonable returns. An increase in the
reverse repo rate means that the RBI is ready to borrow money from the banks at a
higher rate of interest. As a result, banks would prefer to keep more and more surplus
funds with RBI.
Thus, we can conclude that Repo Rate signifies the rate at which liquidity is
injected in the banking system by RBI, whereas Reverse repo rate signifies the rate at
which the central bank absorbs liquidity from the banks.

3.21 Punjab and Maharashtra Cooperative Bank Crisis

Punjab and Maharashtra Cooperative Bank (PMC Bank) has been facing
regulatory actions and investigation over alleged irregularities in certain loan accounts.
Loans given to financially stressed real estate player Housing Development &
Infrastructure (HDIL) are at the centre of the investigation.
The crisis at PMC Bank first came to light on 24 th September 2019, the day the
Reserve Bank of India (RBI) placed curbs on the activities of the Mumbai-based bank
for six months. The central bank also limited the amount a customer could withdraw
from their account during the next six months to ₹Rs 1,000 at first, and later to ₹
25,000.
The Enforcement Directorate (ED) has filed a money laundering case in the PMC
Bank scam.
Banking and Non-Banking Financial Institutions 115

About PMC Bank

PMC was Founded in 1984, and PMC Bank has 137 branches across seven states,
81 of these in Mumbai, Navi Mumbai, Thane and Palghar regions, 10 in Pune and 12 in
the rest of Maharashtra. Its customers include small businesses, housing societies and
institutions.

Case against PMC Bank

According to an FIR filed in the case, HDIL promoters allegedly colluded with the
bank management to draw loans from the bank’s Bhandup branch. The bank officials
did not classify these loans as non-performing advances, despite non-payment.
Reports estimate the bank’s overall exposure to the HDIL group at around ₹ 6,500
crore, or over 73 per cent of all of the bank’s advances and all of this is not being
serviced.
The bank also allegedly created fictitious accounts of companies which borrowed
small sums of money, and created fake reports to hide from regulatory supervision.
In 2018-19, the bank had reported a net profit of ₹ 99.69 crore in its annual report.
The bank showed 3.76 per cent (or ₹ 315 crore) of advances ( ₹ 8,383 crore) as gross
non-performing assets (NPAs), which was good performance as compared to
public-sector banks.
However, it is now clear that the bank presented false financial reports to hide the
bad loan mess and the alleged collusion with HDIL and other companies.

Investigation Update
A special investigation team of the Mumbai Police is probing the case. The
police's Economic Offences Wing registered a case against the former bank
management and promoters of HDIL on 30 th September 2019. The case for forgery,
cheating and criminal conspiracy was filed on the basis of a complaint by RBI-
appointed administrator.
The bank’s former chairman Waryam Singh, managing director Joy Thomas and
other senior officials, along with HDIL’s executive chairman Rakesh Kumar
Wadhawan and his son Sarang, have been named in the FIR.
Most people named in the FIR have been arrested. The bank’s former MD Joy
Thomas and HDIL’s Wadhawans were arrested before him.
116 Indian Financial System

3.22 Non-Banking Financial Companies (NBFCs)

Introduction
A Non-Banking Financial Company (NBFC) is a company registered under the
Companies Act, 1956 engaged in the business of loans and advances, acquisition of
shares/stocks/bonds/debentures/securities issued by Government or local authority or
other marketable securities of a like nature, leasing, hire-purchase, insurance business,
chit business but does not include any institution whose principal business is that of
agriculture activity, industrial activity, purchase or sale of any goods (other than
securities) or providing any services and sale/purchase/construction of immovable
property. A non-banking institution which is a company and has principal business of
receiving deposits under any scheme or arrangement in one lump sum or in installments
by way of contributions or in any other manner, is also a non-banking financial
company.
A Non-Banking Financial Institution (NBFI) or Non-Bank Financial Company
(NBFC) is a financial institution that does not have a full banking license or is not
supervised by a national or international banking regulatory agency. NBFI facilitate
bank-related financial services, such as investment, risk pooling, contractual savings,
and market brokering. Hence, the term non-bank financial institution refers to
companies that offer financial services, but do not hold banking licenses and cannot
accept deposits. Insurance companies, brokerage firms, and companies offering
microloans are examples of non-bank financial institutions.
Non-banking financial companies are responsible for providing financial services
but are not regulated by a national or international governing body and do not hold a
full-fledged license for conducting operations.
The financial services offered by NBFCs include disbursement of loans and
advances, acquisition of stocks, shares or bonds etc. They do not accept demand drafts
and are not a part of payment/settlement system unlike banks. NBFCs are more
commonly known in the forms of microloan organizsations, insurance companies,
investment houses and more.
According to Alan Greenspan, non-banking financial institutions contribute in
empowering the economy as they deliver multiple alternatives to transform an
economy’s savings into capital investment act as backup facilities should the primary
form of intermediation fail.

Objectives of NBFCs
NBFCs serve the financial needs of individual customers as well as business
organizations. The various other objectives of the non-banking financial companies are
as follows:
Banking and Non-Banking Financial Institutions 117

 Provides Long-Term Credits: NBFCs facilitate lengthy credit periods to suit

the long-term financial needs of the commerce, trade, infrastructure and
construction companies for accomplishing huge projects.
 Growth of National Income: They provide capital to various private
companies, accelerating the growth of industries and thus improving the Gross
Domestic Product (GDP) of the country.
 Generate Employment Opportunities: By promoting and supporting small
and medium enterprises (SMEs), NBFCs indirectly develops job opportunities
in the country.
 Movement of Funds: NBFCs are always good for the economy since it
mobilizes the funds by transforming the savings into investments and utilizing
these funds to provide loans to the companies.
 Better Living Standard: With the growth of industrialization and loans
provided by the NBFCs increases the purchasing power of the individuals,
ultimately enhancing the standard of living.
 Strengthening the Financial Market: The NBFCs are the soul of the financial
market. Most of the startups and SMEs solely rely upon the NBFCs to acquire
loans for meeting the capital requirement.

3.23 Role of NBFCs for Economic Development

The role of NBFC for economic development of nation is as follows:

1. Greater Employment Opportunities and Standard of Living

NBFCs help attain the objective of macroeconomic policies of creating more jobs
in the country by promoting SMEs and private industries through lending them loans.
This increase in new businesses consequently raises the demand for manpower and
creates employment. Furthermore, the Purchasing Power Parity (PPP) of people rises
and so does their standard of living.

2. Strengthening of Financial Market

The financial market relies heavily on non-banking financial institutions for
raising capital. The start-ups and small-sized businesses are dependent on funds offered
by NBFCs and also in order to maintain liquidity. For an effective functioning and
balance in the financial market, NBFCs play a significant role.

3. Supplying Long-term Credits

Unlike the regular banks, NBFCs extend long-term credits to infrastructure,
commerce and trade companies. The traditional banks expect timely, schedules and
short-term repayment of loans that may not always suit the requirements of these
industries. NBFCs on the other hand, fund large projects and so promote economic
growth. They also allow industries to participate in equity.
118 Indian Financial System

4. Mobilization of Funds
Non-banking financial companies help in rotation of resources, asset distribution
and regulation of income to shape the economic development. They enable converting
saving into investments and thus help in the mobilization of funds/resources in the
economy.

5. Growth of National Income

As NBFCs aim to build capital for several industries – private and otherwise – they
aid in accumulating a capital stock for the country. This directly adds on to the national
income and results in the progression of Gross Domestic Product (GDP).

3.24 Types of NBFCs

There are different types of NBFCs fulfilling multiple objectives of the investors
and the borrowers. These are as follows:
(a) Non-Banking Financial Company-Factors: NBFC-Factors is that form of
NBFCs which functions as a factoring business where at least 50% of the total
assets, is the financial assets and the business income should constitute at least
50% of the gross income.
(b) Investment Companies: The principal function of an investment company is
dealing in securities.
(c) Mutual Benefit Finance Company: These companies invest the money
collected by multiple investors or customers having similar investment
objective, and pool the clubbed amount into the particular securities or bonds.
(d) Asset Finance Company (AFC): An asset finance company usually provides
loan for the purchase of physical assets which are used for business or
production purpose such as automobiles, machinery, equipment, etc. The
income generated by an AFC should not be less than 60% of its total assets or
income.
(e) Equipment Leasing Company: The companies which either give out
equipment on lease or carry out the financing of such lease contracts are known
as equipment leasing company.
(f) Hire-Purchase Company: These companies provide the facility of buying
goods on instalment where the hirer, i.e. the buyer needs to pay the amount
(principal + interest) regularly in parts till the total payment is made to the hire.
(g) Housing Finance Company: The housing finance companies are engaged in
providing loans to the clients for constructing or acquiring houses along with
the development of the land available.
Banking and Non-Banking Financial Institutions 119

(h) Loan Company: Except for the AFC, any company sanctioning loans or
advances to the public for any activity is called a loan company.
(i) Residuary Non-Banking Company: The RNBCs are engaged in accepting
deposits as per certain schemes or arrangements or through other means except
the Loan Company, investment or asset financing.
(j) Infrastructure Finance Company (IFC): These NBFCs grant loans (project
loans and term loans) to the companies belonging to the infrastructure sector
including social and commercial infrastructure, transport, communication,
water, energy and sanitation.
(k) Non-banking Financial Company: Micro Finance Institution (NBFC-MFI): A
NBFC-MFI is that NBFC which has at least 85% of assets as qualifying assets,
i.e., microfinance or the funds given out as loans without any collateral and the
repayment is in the form of regular installments.
(l) Infrastructure Debt Fund: Non-Banking Finance Company (IDF-NBFC):
With the aim of generating fixed income on the investment value, these NBFCs
engage the client’s funds into the infrastructure sector for the long term.
(m) Systematically Important Core Investment Company (CIC-ND-SI): The
companies which own a net asset of at least Rs. One hundred crores out of
which 90% of the value is invested in the shares and debts while 60% of it must
be out into equity shares or other instruments which can be easily converted
into cash.
(n) Chit Fund Company: A chit fund company runs, manages and controls
various chit schemes by making the subscribers or investors subscribe for such
plan by paying the sum in regular installments up to a certain period. Every
subscriber is then liable to receive a prize amount as per the lot, tender or
auction.

Advantages of NBFCs
NBFCs work parallelly with the banking organizations and function to facilitate
loans and advances along with accepting deposits. The various benefits of an NBFC are
as follows:
 Borrower’s Evaluation: NBFCs usually verify the credibility of the customer
by going through the credit scores and business history of the companies. Thus,
making the loans more reliable.
 Unsecured Loans: These financial companies also provide unsecured loans
which let the borrower to avail loans without mortgaging any asset or property.
 Lenient Credit Condition: NBFCs offer loans to customers at easy terms
and fewer formalities, making it suitable for small business enterprises.
120 Indian Financial System

 Facilitates Small Loans: Usually, banks provide high-value business loans,

but NBFCs also entertain the smallest of the credit to meet the customer’s
needs.

Drawbacks of NBFCs
There are certain limitations which differentiate an NBFC from a bank. These
drawbacks are discussed below:
 Cannot Accept Demand Deposits: Since NBFCs lies within the dimension of
commercial banks and therefore they are not liable to accept demand deposits.
 No Deposit Insurance Facility: The depositor cannot avail any insurance
facility on the sum deposited with the NBFCs because such financial
organizations are not covered under the regulations of Deposit Insurance and
Credit Guarantee Corporation.
 Cannot Issue Cheques Drawn on Itself: The country’s payment and
settlement system does not cover NBFCs and thus not letting them issues the
cheques drawn on itself.

RBI Restrictions on NBFC

There are some apparent restrictions to NBFC issued by RBI mainly as given
below:
1. NBFC Company should keep away from accepting demand deposits from any
sources.
2. NBFC Company can’t issue cheques drawn on itself.
3. NBFC Company can’t form part of the payment and settlement system.
4. Depositors of a NBFC company cannot have facilities like deposit insurance.
scheme.

3.25 Differences Between Banks and NBFCs

The distinctions between banking and non-banking financial companies are stated
below:

Parameters Banks NBFCs

1. Licensing and The Reserve Bank of India Although they have authorized
Regulation Act of 1934 and the Banking financial institutions, NBFCs
Regulation Act of 1949 both are not authorized. They are
control banks as licensced governed by the Reserve Bank
financial entities. of India Act of 1934 and are
established in accordance with
the Companies Act.
Banking and Non-Banking Financial Institutions 121

Parameters Banks NBFCs

2. Types of Banks offer services like Services offered by NBFCs
Services loan advances, credit card include mutual funds, stocks,
facilities, guarantees, money insurance, savings and
transfers, and check investment programmes, and
payment. more.
3. Deposit The primary function of NBFCs deal in deposits for the
Function banks’ business is accepting process of securitizsation.
deposits and offering loans.
4. Acceptance of Banks takes money deposits NBFCs are not allowed to take
Demand repayable as per the need. demand deposits.
Deposits
5. Extend Foreign Banks are meant for foreign NBFCs are allowed for
Investment investments up to 74%. foreign investments up to
a maximum of 100%.
6. Payment and Banks are part of the NBFCs do not form part of
Settlement Cycle payment and settlement any such payment and
cycle. settlement cycle.
7. Maintenance of Banks are obliged to CRR and SLR are not allowed
CRR and SLR maintain ratios like Cash in the case of NBFCs.
Reserve Ratios (CRR) and
Statutory Liquidity Ratios
(SLR).
8. Facility of Banks come with deposit NBFCs don't have this facility.
DICGC insurance facility of Deposit
Insurance and Credit
Guarantee Corporation
(DICGC).
9. Creation of Banks get engaged in Credit creation is not feasible
Credit creating credits. for NBFCs.
10. Option of Banks generally offer NBFCs do not provide such
Transactional transactional services like types of transactional services.
Services deposits, cash withdrawals,
checks, debit card payments,
or even online payments.

3.26 Regulations for NBFCs

A Non-Banking Financial Company (NBFC) refers to a financial institution. It is a
type of company engaged in the business of receiving loans and advances, acquisition
122 Indian Financial System

of stocks or shares, leasing, hire-purchase, insurance business, and chit business under
the Companies Act 2013.
In India, The Reserve Bank of India regulates the registration of NBFC. NBFC
regulations provide a variety of banking and non-banking services to the concerned
people. They do not hold banking license but they have to follow the rules and
regulations laid down by RBI.
NBFCs functions are regulated and supervised by RBI according to the provisions
mentioned in Chapter III B of the RBI Act 1934. NBFC registration must be done
according to rules & regulations given in Section 45-IA of the RBI Act 1934. It must be
duly registered as per Companies Act 2013.
The main business activity of the NBFCs is to raise capital funds from public
depositors and investors and then lend to borrowers as per the rules and regulations
prescribed by the Reserve Bank of India. NBFCs are becoming an alternative to the
banking and financial sector. In NBFC, there is a requirement of a minimum net owned
fund of ₹ 10 Crore (Previously, it was ₹ 2 Crore). While NBFCs with no public funds
and no customer interface, the NOF (Net Owned Fund) shall continue to be ₹INR 2
crore.
NBFCs can commence their operations only after obtaining a “Certificate of
Registration” from the RBI.

NBFC Registration Requirements

 The company must be registered as a public limited company or private limited
company in India.
 The company must have a minimum net-owned fund of ₹ Rs.10 Crore.
 (Provided that net owned funds should be calculated according to the last
audited balance sheet of the company.)
 For a minimum period of 12 months and a maximum period of 60 months,
NBFCs are allowed to accept/renew public deposits.
 NBFCs cannot accept deposits repayable on demand.
 NBFCs can offer interest rates not higher than the ceiling rate prescribed by
RBI from time to time.
 Offering gifts/incentives or any other additional benefit to the depositors is not
allowed.
 There is a requirement for a minimum investment-grade credit rating.
 RBI does not guarantee the repayment of deposits by NBFCs.
 Furnishing hard copies of the list of documents with the regional office of the
RBI.
Banking and Non-Banking Financial Institutions 123

Role of Non-Banking Financial Companies in Financial Inclusion

To serve our nation’s unbanked and underserved people, Non-Banking Financial
Companies have, throughout the years, developed a solid ecosystem. Non-Banking
Financial Companies have been instrumental in resolving some of the major obstacles
to financial inclusion. The following are the main factors that have supported financial
inclusion in India:

(a) Facilitating through Digital Technology

 By providing services to diverse and underserved people across the nation,
technology-led NBFCs have generated opportunities. Aadhaar is the main pillar
of the digital banking system.
 As a result, digital finance is replacing or complementing traditional finance to
increase financial inclusion. Consider a small-scale business that can now
instantaneously apply for a working capital loan through a mobile device.
 Digital financial services have been shown to be more rapid, effective and
economical. Covid-19 has accelerated digital financial inclusion as contactless
transactions and cashless payments were preferred over traditional modes.

(b) Simple and Easy Financial Solutions Access

 India has a sizable and diversified population. Maintaining a simple product
design and customising it to match the complicated demands of a low-income
individual or family are the best ways to promote financial inclusion.
 The lending structure is intended to be simple, quick, and hassle-free. Insurance
is another important area, and it is now also easily accessible.
 For instance, NBFCs collaborate with neighbourhood panchayats to offer
specialised health insurance plans, such as those that exclusively cover dengue
or shield farmers from crop or livestock losses.
 In order to provide easy access to credit in the most isolated regions of the
nation, NBFCs have, over the years, invested in creative distribution networks
and products.

(c) Expertise and Innovative Solutions

 The expertise that NBFC offers is in risk underwriting, with the ability to finely
evaluate income and repayment capacity over the loan.
 Digital partner options that enable innovative solutions further aid in their
development. As the total number of companies or people that qualify for credit
grows, this strategy enables widespread credit availability and raises financial
penetration.
 With the expertise and innovative solutions, NBFCs have reached out to rural,
metro areas, and semi-urban areas where access to formal credit is often
124 Indian Financial System

limited. It has increased the depth and width of the availability to a great
extent.

(d) Increase in Credit Facility

 Due to the Government’s emphasis on financial inclusion and the rising
demand for credit from various societal segments, NBFCs have played a larger
role in financial inclusion over the past several years.
 They offer all types of credit, including personal loans, consumer loans,
mortgage loans, auto loans, gold loans, etc. The new credit customer represents
one of the major potentials for NBFCs.
 There are individuals who have never before borrowed money. Banks are
worried about these consumers’ creditworthiness. Due to their difficulties with
financial literacy, this group turns to the unorganised informal sector for their
borrowing requirements.
 The informal sector typically fills the time gap for this section more quickly.
The NBFCs are closing this gap by using sophisticated underwriting algorithms
and digital technologies.

(e) Collaborating with Fintech Companies

 Non-Banking Financial Companies are having trouble reaching the unbanked.
Nearly 25% of the assets in the banking sector are currently held by Non-
Banking Financial Companies.
 However, as financial inclusion is a team effort, Non-Banking Financial
Companies collaborate with new fintech firms to increase efficiencies and
develop products and services that are more intelligent.
 Non-Banking Financial Companies market penetration will expand, and their
bottom line will rise as a result of their collaboration with the fintech. It is seen
from the rising desire among participants in both segments to provide simple
and affordable financing options.

Hence, Non-Banking Financial Companies have a huge potential to help people

who need financial solutions the most. Non-Banking Financial Companies involvement
will contribute to greater financial inclusion across the country. Their expertise in
reaching out to remote areas and larger community reach is undoubtedly crucial in
resolving challenges with rural families lack of working capital. Although the business
model may have changed from earlier times, Non-Banking Financial Companies will
still play a significant role in the financial sector.
Banking and Non-Banking Financial Institutions 125

3.27 Neo-Banks vs Traditional Banks

The word Neo comes from a Greek word that basically translates to “new.” So,
Neobanks is a clever way of saying that this is the new age of banking. Digital banking
or Neo-Banking is the next natural step that the financial industry will take, at least
according to some industry experts. Traditional banks offer savings accounts, current
accounts, loans, money transfers, credit cards, and more.

NEO Banks
Meaning: Neo banks are the banks of the technological era. Their primary mode of
offering banking services is online. Neo banks do not have any offline branches; all
banking services offered can be accessed via a website or an app. Customers choose
Neo banks over traditional ones because of the flexibility and agility they offer.
The Neo-banks are changing the face of fin-tech by bridging the gap between the
services that traditional banks offer and the evolving expectations of customers in the
digital age.
Common Neo bank services include:
 Bank accounts
 Credit cards
 Loans and investments
 Money transfer services

Benefits of Neo Banks

 Lower fees or minimal fees for transactions, account maintenance, and other
financial services.
 Neo banks offer higher interest rates compared to traditional banks.
 More convenient and accessible because of their online mode of operation.
 Fast and streamlined account opening.
 Ideal for tech-savvy users who want financial services at their fingertips.

Drawbacks of Neo Banks

 No physical branches, so there’s a lack of in-person guidance.
 Neo Banks offer limited financial services compared to traditional banks.
 Not suitable for non-tech-savvy users; moreover, technical issues can cause a
complete stoppage of services.
 As Neo banks are primarily digital, there may be concerns regarding the
security of financial and personal information.
126 Indian Financial System

Key Features of Neo Banks

(a) Digital-First Approach
Neobanks offer better flexibility and accessibility to financial services for users of
all kinds because of their digital-first nature. Customers can access financial services
through mobile apps and web platforms, making it easy to access financial services.

(b) User-Friendly Interfaces

As they are digital-first, Neo banks often offer user-centric design that makes
accessing financial services easy.

(c) Personalized Services

Neobanks offer more personalized banking services and experiences to customers
as they rely on AI & data analytics. Common personalized services include:
 Tailored saving plans
 Budgeting strategies
 Customized financial tools

(d) Lower Cost

As Neo banks do not have physical branches, overhead costs, Neo banks offer
more affordable banking services compared to traditional banks. This can make them
an attractive option for users who want to save money.

3.28 Traditional Banks

Traditional banks are the brick-and-mortar institutions that offer physical banking
and non-banking services. Most traditional banks have decades of experience under
their belt and have multiple branches in towns and cities.

Traditional Banks Offer these Services

 Bank account opening and closing
 Locker facilities
 Money transfer services
 Loans and investments
 Credit cards
 Cash withdrawal through ATMs

Benefits of Traditional Banks

 Comprehensive banking services
 In-person customer services offer better guidance
 Established reputation and trust
Banking and Non-Banking Financial Institutions 127

 Wide network of ATMs for cash disbursal

Drawbacks of Traditional Banks

 Legacy systems don’t offer the flexibility tech-savvy customers want.
 Higher fees for various services & account maintenance.
 Service processing times are slower than those of Neo banks.
 Customers have to visit physical branches to get things done.

Key Features of Traditional Banks

(a) Physical Presence
Traditional banks have several branches across multiple cities. Customers can
access financial services from their bank at any of the branches. Customers who want
in-person assistance, traditional banks are the best option.

(b) Wide Range of Financial Services

Traditional banks, unlike Neo banks, offer a wide range of financial services.
Banks provide a range of services, such as loans, credit cards, investment services,
foreign exchange, locker services, and more.

(c) Regulatory Oversight

Traditional banks have to operate under rules and regulations set by their
governing bodies. This ensures that banks offer financial stability and work towards
protecting depositors and financial information.

(d) Customer Service and Relationships

Traditional banks offer in-person customer service at all their branches. This
makes customers feel safe. In-person experience also offers cultivate long-term
relationships with their customers, offering personalized service and financial advice.

Comparison between Traditional Banks and Neobanks

Comparison
Traditional banks Neo Banks
Factors
Popularity Traditional banks are more Neo banks do not have this
popular on account of better advantage as they are relatively new
accessibility, awareness, and to the Indian market and do not have
connectivity. any physical presence.
Non- Traditional banks have Neo banks do not offer such non-
banking established businesses and offer banking services and hence, they are
services many non-banking services not preferred by customers who
locker facilities, personal require a complete banking
banking, relationship managers,
128 Indian Financial System

Comparison
Traditional banks Neo Banks
Factors
factoring services, Demat experience.
accounts, ATMs, etc.
Banking Traditional banks have a clear Neo banks do not have this benefit
license banking license and enjoy the as they are not directly regulated by
trust of the customers on the RBI or come under the purview
account of their physical of the Banking Regulations Act.
presence and better regulations
imposed on these banks by the
RBI and the parliamentary act,
Banking Regulations Act.
Popularity Traditional banks are more The technology-driven format of the
among the popular with the older neo banks makes it popular among
younger generation. the younger generation but the older
generation generation may not find it
convenient.
Technology- Traditional banks have digital The app-based functions backed by
driven banking facilities but the the latest technology make neo
format technology may not be as sound banking a smoother and better
as neo banks, especially in the banking experience as compared to
case of public sector banks. traditional banks that may not be
technologically as efficient and face
many glitches giving the ultimate
customer a bad banking experience.

Review Questions
Conceptual type questions for 2 marks.
1. Define the term Banking.
2. What do you mean by the term ‘Bank’?
3. Give the meaning of Banking Company.
4. What do you mean by Commercial Banks?
5. Give the meaning of Public Sector Bank.
6. What is Private Sector Bank?
7. What do you mean by Foreign Bank?
8. What do you mean by Regional Rural Bank?
9. What are Repo and Reverse Repo Rate?
10. Expand CLR and SLR.
Banking and Non-Banking Financial Institutions 129

11. Give the meaning of Scheduled Banks.

12. What do you mean Unscheduled Banks?
13. What is NBFCs?
14. What is Traditional Banking?

Analytical type questions for 8 marks.

1. What are the important features of Bank?.
2. Explain briefly the functions of Banking Company.
3. Mention the various types of Commercial Banks in India.
4. Distinguish between Public Sector Bank and Private Secor Bank.
5. Write a note of Neo Banks.
6. What are NBFCs? State the types of NBFCs.
7. Differentiate between Scheduled and Unscheduled Banks in India.
8. Distinguish between Banks and NBFCs.
9. Distinguish Neo Banks and Traditional Banks.

Essay type questions for 14 marks.

1. Explain the structure of Banking in India.
2. What is RBI? Explain the functions of RBI.
3. What are Commercial Banks? Explain the functions of commercial Banks.
4. Discuss the case study of Punjab and Maharashtra Cooperative Bank (PMC)
Crisis.

Chapter ‒ 4
FINANCIAL REGULATORS
AND INSURANCE
Content:
Regulators – RBI, SEBI, IRDAI, PFRD– Functions and Recent Interventions –
Insurance Sector – Life and General Insurance – ULIPs – Micro insurance – Deposit
Insurance Reforms – Deposit Insurance and Credit Guarantee Corporation (DICGC) ‒
Pension System – NPS, Atal Pension Yojana. LIC IPO and Disinvestment Policy ‒
IRDAI’s “Bima Sugam”.

4.1 Introduction to Financial Regulators in India

In India, the financial system is regulated by independent regulators incorporated
with the field of insurance, banking, commodity market, pension funds, and capital
market.
The Indian government is also accountable for playing a significant role in
handling the field of financial safety as well as influencing the roles of such mentioned
regulators. The most commonly known and significant of all the financial regulators in
India is the Reserve Bank of India (RBI).
An independent regulatory agency is one that is not dependent on the other
branches or arms of the central government. Regulatory authorities are set up to enforce
standards and security.

4.2 Meaning of Financial Regulator

Financial Regulators are ‘government entities or agencies responsible for
controlling and regulating financial markets and institutions.’ The main goal of
financial regulators is to protect consumers, maintain financial stability, and promote
fair and transparent financial practices.
Financial regulators may have a variety of responsibilities, including:
Financial Regulators and Insurance 131

 Supervising financial institutions such as banks and insurance companies to

ensure that they comply with laws and regulations.
 Enforcing laws and regulations related to financial products and services, such
as consumer protection laws and anti-money laundering regulations.
 Monitoring financial markets to detect and address potential risks or threats to
financial stability.
 Conducting investigations and imposing penalties on financial institutions or
individuals that violate laws or regulations.

Examples of financial regulators include Reserve Bank of India (RBI), the

Securities and Exchange Board of India (SEBI) etc.

4.3 Important Financial Regulatory Bodies in India

Following shows the different Financial Regulatory Bodies in India:

Regulatory Body Sector

Reserve Bank of India (RBI) Banking and Finance, Monetary Policy

Securities and Exchange Board of India Securities (Stock) and Capital Market
(SEBI)
Insurance Regulatory and Development Insurance
Authority of India (IRDAI)
Pension Fund Regulatory and Development Pension
Authority of India (PFRDAI)

The brief information on the above authorities has been stated below:

4.3.1 Reserve Bank of India

Introduction to Reserve Bank of India
The overall economic efficiency and the stability of a nation are dependent on the
payment and settlement system prevailing in that country. As a result, the various
regulators in India, including the central bank, have been regularly and consistently
revising their operating models and policies to ensure and carry on the development of
payment systems at the national level. These regulators are required to carefully
safeguard the sanctity of payment systems, generally from systematic risks, the risk of
fraud, etc. The responsibility of a central bank of any given country is to ensure
and carry on the development of payment systems at the national level. In India, this
responsibility is vested with the Reserve Bank of India (RBI).
132 Indian Financial System

RBI, as the central bank of the country occupies a significant place in the Indian
Banking and Financial System. As an apex institution, it acts as a guide, regulator,
controller and promoter of the financial system. RBI was established in 1935, under
RBI Act, 1934. Till 1949, it was a private shareholders’ institution and became a state-
owned institution after its nationalization. It is banker to the banks and controller of
activities of banking, non-banking and financial institutions in the country.

Meaning of Reserve Bank of India (RBI)

The Reserve Bank of India (RBI) is the central bank of India whose primary
function is to manage and govern the financial system of the country. It is a statutory
body established in the year 1935 under the Reserve Bank of India Act, 1934. The
central bank regulates the issue and supply of the Indian rupee. It also looks after the
central government’s money. The central bank plays the role of the bankers’ bank and
regulates the banking sector. It also plays an important role in India’s development
story by supporting the government in its developmental projects and policies.
The head office of the RBI, in Kolkata when the bank was established, was shifted
to Mumbai in 1937. Originally, the bank was privately owned. However, after
Independence, it was nationalised in 1949 and is now fully owned by the Government
of India.

Constitution of RBI
RBI has been constituted as a corporate body having perpetual succession and a
common seal. It was established with an authorized capital of ₹ 5 crores divided in
shares of Rs. 100 each. When bank was nationalized in 1949, the shareholders were
paid in Securities of Govt. of India, shareholders were paid ₹ 118 each as compensation
for every share of ₹ 100 .

Objectives of RBI
The Preamble to the Reserve Bank of India Act, 1934 spells out the objectives of
the Reserve Bank as:
“Tto regulate the issue of Bank notes and the keeping of reserves with a view to
securing monetary stability in India and generally to operate the currency and credit
system of the country to its advantage”.
Being the backbone of the financial state of the country, RBI has various
objectives as mentioned in the RBI preamble. Some of them are listed below:
 Primary Objectives: The primary objectives of RBI includes:
Addressing the issue of Banknotes.
Maintaining monetary stability in the country.
To operate the credit system and currency in the country to its own advantage.
Financial Regulators and Insurance 133

 Remain Independent of the Political Influence: In order to maintain financial

stability and promote economic growth, RBI should be free from any political
pressure and refrain from corrupted activities.
 Fundamental Objectives: RBI should serve as a central authority and serve as:

– Bank of all the other Commercial banks.

– Only authority who has note issuing power.
– Bank to the Government of India.
 Promote Economic Growth: RBI, along with maintaining price stability,
should also design policies which promote economic growth within the
framework.

Role or Functions of RBI

As a Central Bank, the Reserve Bank has significant powers and duties to perform.
For smooth and speedy progress of the Indian Financial System, it has to perform some
important tasks which include:
 Mmaintaining monetary and financial stability,
 Tto develop and maintain stable payment system,
 Tto promote and develop financial infrastructure and
 Tto regulate or control the financial institutions.

For simplification, the functions of RBI are classified into:

 The Traditional Functions,
 The Development Functions, and
 Supervisory Functions.

I. Traditional Functions of RBI

Traditional functions are those functions which every central bank of each nation
performs all over the world. Basically, these functions are in line with the objectives
with which the bank is set up. It includes fundamental functions of the Central Bank.
They comprise the following tasks.
1. Issue of Currency Notes: The RBI has the sole right or authority or monopoly
of issuing currency notes except one rupee and two rupees coins of smaller
denomination. These currency notes are legal tender issued by the RBI.
Currently it is in denominations of ₹ 5, 10, 20, 50, 100, 500, and 2,000. It issues
these notes against the security of gold bullion, foreign securities, rupee coins,
exchange bills and promissory notes and government of India bonds.
134 Indian Financial System

2. Banker to Other Banks (Lender of the Last Resort): The RBI being an apex
monitory institution has obligatory powers to guide, help and direct other
commercial banks in the country. The RBI can control the volumes of banks
reserves and allow other banks to create credit in that proportion. Every
commercial bank has to maintain a part of their reserves with its parent's viz.
the RBI. Similarly in need or in urgency these banks approach the RBI for fund.
Thus, it is called as the ‘Lender of the Last Resort’.
3. Banker to the Government: The RBI being the apex monitory body has to
work as an agent of the central and state governments. It performs various
banking function such as to accept deposits, taxes and make payments on behalf
of the government. It works as a representative of the government even at the
international level. It maintains government accounts, provides financial advice
to the government. It manages government public debts and maintains foreign
exchange reserves on behalf of the government. It provides overdraft facility to
the government when it faces financial crunch.
4. Exchange Rate Management: It is an essential function of the RBI. In order to
maintain stability in the external value of rupee, it has to prepare domestic
policies in that direction. Also, it needs to prepare and implement the foreign
exchange rate policy which will help in attaining the exchange rate stability. In
order to maintain the exchange rate stability, it has to bring demand and supply
of the foreign currency (U.S Dollar) close to each other.
5. Credit Control Function: Commercial bank in the country creates credit
according to the demand in the economy. But if this credit creation is
unchecked or unregulated then it leads the economy into inflationary cycles. On
the other credit creation is below the required limit then it harms the growth of
the economy. As a central bank of the nation the RBI has to look for growth
with price stability. Thus, it regulates the credit creation capacity of commercial
banks by using various credit control tools.
6. Supervisory Function: The RBI has been endowed with vast powers for
supervising the banking system in the country. It has powers to issue license for
setting up new banks, to open new branches, to decide minimum reserves, to
inspect functioning of commercial banks in India and abroad, and to guide and
direct the commercial banks in India. It can have periodical inspections an audit
of the commercial banks in India.

II. Developmental/Promotional Functions of RBI

Along with the routine traditional functions, central banks especially in the
developing country like India have to perform numerous functions. These functions are
country specific functions and can change according to the requirements of that
country. The RBI has been performing ‘as a promoter of the financial system’ since its
inception. Some of the major development functions of the RBI are maintained below:
Financial Regulators and Insurance 135

1. Development of the Financial System: The financial system comprises the

financial institutions, financial markets and financial instruments. The sound
and efficient financial system is a precondition of the rapid economic
development of the nation. The RBI has encouraged establishment of main
banking and non-banking institutions to cater to the credit requirements of
diverse sectors of the economy.
2. Development of Agriculture: In an agrarian economy like ours, the RBI has to
provide special attention for the credit need of agriculture and allied activities. It
has successfully rendered service in this direction by increasing the flow of
credit to this sector. It has earlier the Agriculture Refinance and Development
Corporation (ARDC) to look after the credit, National Bank for Agriculture and
Rural Development (NABARD) and Regional Rural Banks (RRBs).
3. Provision of Industrial Finance: Rapid industrial growth is the key to faster
economic development. In this regard, the adequate and timely availability of
credit to small, medium and large industry is very significant. In this regard the
RBI has always been instrumental in setting up special financial institutions
such as ICICI Ltd. IDBI, SIDBI and EXIM BANK etc.
4. Provisions of Training: The RBI has always tried to provide essential training
to the staff of the banking industry. The RBI has set up the bankers’ training
colleges at several places. National Institute of Bank Management i.e., NIBM,
Bankers Staff College i.e., BSC and College of Agriculture banking i.e., CAB
are few to mention.
5. Collection of Data: Being the apex monetary authority of the country, the RBI
collects process and disseminates statistical data on several topics. It includes
interest rate, inflation, savings and investments etc. This data proves to be quite
useful for researchers and policy makers.
6. Publication of the Reports: The Reserve Bank has its separate publication
division. This division collects and publishes data on several sectors of the
economy. The reports and bulletins are regularly published by the RBI. It
includes RBI weekly reports, RBI Annual Report, Report on Trend and
Progress of Commercial Banks India., etc. This information is made available to
the public also at cheaper rates.
7. Promotion of Banking Habits: As an apex organization, the RBI always tries
to promote the banking habits in the country. It institutionalizes savings and
takes measures for an expansion of the banking network. It has set up many
institutions such as the Deposit Insurance Corporation-1962, UTI-1964, IDBI-
1964, NABARD-1982, NHB-1988, etc. These organizations develop and
promote banking habits among the people. During economic reforms it has
taken many initiatives for encouraging and promoting banking in India.
136 Indian Financial System

8. Promotion of Export through Refinance: The RBI always tries to encourage

the facilities for providing finance for foreign trade especially exports from
India. The Export-Import Bank of India (EXIM Bank India) and the Export
Credit Guarantee Corporation of India (ECGC) are supported by refinancing
their lending for export purpose.

III. Supervisory Functions of RBI

The reserve bank also performs many supervisory functions. It has authority to
regulate and administer the entire banking and financial system. Some of its
supervisory functions are given below:
1. Granting License to Banks: The RBI grants license to banks for carrying its
business. License is also given for opening extension counters, new branches,
even to close down existing branches.
2. Bank Inspection: The RBI grants license to banks working as per the directives
and in a prudent manner without undue risk. In addition to this it can ask for
periodical information from banks on various components of assets and
liabilities.
3. Control over NBFIs: The Non-Bank Financial Institutions are not influenced
by the working of a monitory policy. However, RBI has a right to issue
directives to the NBFIs from time to time regarding their functioning. Through
periodic inspection, it can control the NBFIs.
4. Implementation of the Deposit Insurance Scheme: The RBI has set up the
Deposit Insurance Guarantee Corporation in order to protect the deposits of
small depositors. All bank deposits below ₹ One lakh are insured with this
corporation. The RBI work to implement the Deposit Insurance Scheme in case
of a bank failure.

4.3.2 Securities and Exchange Board of India (SEBI)

SEBI stands for Securities and Exchange Board of India. It is a statutory regulatory
body that was established by the Government of India in 1992 for protecting the
interests of investors investing in securities along with regulating the securities market.
SEBI also regulates how the stock market and mutual fund’s function.

Objectives of SEBI
Following are some of the objectives of the SEBI:
1. Investor Protection: This is one of the most important objectives of setting up
SEBI. It involves protecting the interests of investors by providing guidance and
ensuring that the investment done is safe.
2. Preventing the fraudulent practices and malpractices which are related to
trading and regulation of the activities of the stock exchange
Financial Regulators and Insurance 137

3. To develop a code of conduct for the financial intermediaries such as

underwriters, brokers, etc.
4. To maintain a balance between statutory regulations and self-regulation.

Functions of SEBI
SEBI has the following functions:
1. Protective Function
2. Regulatory Function
3. Development Function
The following functions will be discussed in detail.
A. Protective Function: The protective function implies the role that SEBI plays
in protecting the investor interest and also that of other financial participants.
The protective function includes the following activities.
(a) Prohibits Insider Trading: Insider trading is the act of buying or selling
of the securities by the insiders of a company, which includes the directors,
employees and promoters. To prevent such trading SEBI has barred the
companies to purchase their own shares from the secondary market.
(b) Check Price Rigging: Price rigging is the act of causing unnatural
fluctuations in the price of securities by either increasing or decreasing the
market price of the stocks that leads to unexpected losses for the investors.
SEBI maintains strict watch in order to prevent such malpractices.
(c) Promoting Fair Practices: SEBI promotes fair trade practice and works
towards prohibiting fraudulent activities related to trading of securities.
(d) Financial Education Provider: SEBI educates the investors by
conducting online and offline sessions that provide information related to
market insights and also on money management.
B. Regulatory Function: Regulatory functions involve establishment of rules and
regulations for the financial intermediaries along with corporates that helps in
efficient management of the market.
The following are some of the regulatory functions.
(a) SEBI has defined the rules and regulations and formed guidelines and code
of conduct that should be followed by the corporates as well as the
financial intermediaries.
(b) Regulating the process of taking over of a company.
(c) Conducting inquiries and audit of stock exchanges.
(d) Regulates the working of stock brokers, merchant brokers.
138 Indian Financial System

C. Developmental Function: Developmental function refers to the steps taken by

SEBI in order to provide the investors with a knowledge of the trading and
market function. The following activities are included as part of developmental
function.
(a) Training of intermediaries who are a part of the security market.
(b) Introduction of trading through electronic means or through the internet by
the help of registered stock brokers.
(c) By making the underwriting an optional system in order to reduce cost of
issue.

Purpose of SEBI
The purpose for which SEBI was setup was to provide an environment that paves
the way for mobilisation and allocation of resources. It provides practices, framework
and infrastructure to meet the growing demand.
It meets the needs of the following groups:
(a) Issuer: For issuers, SEBI provides a marketplace that can utilised for raising
funds.
(b) Investors: It provides protection and supply of accurate information that is
maintained on a regular basis.
(c) Intermediaries: It provides a competitive market for the intermediaries by
arranging for proper infrastructure.

Responsibilities of SEBI
The SEBI is responsible for:
 Formulating guidelines and the code of conduct for the proper functioning of
the financial intermediaries and businesses.
 Regulating businesses in the stock exchange and other securities market.
 Conducting audit and enquiries of the exchanges.
 Registering and protecting the interest of the securities market participants.
These include trustees of the trust deeds, brokers, sub-brokers, investment
advisors, merchant bankers, intermediaries, etc.
 Levying fees.
 Formulating, implementing, and monitoring exercising powers.
 Registering and regulating credit rating agencies and self-regulating
organizations.
 Identifying and prohibiting insider trading and unfair trade practices.
Financial Regulators and Insurance 139

4.3.3 Insurance Regulatory and Development Authority of India (IRDAI)

The IRDA is another important financial regulatory body that regulates the
insurance industry in India. It was established as per the provisions of the Insurance
Regulatory and Development Authority Act of 1999. Its headquarters are situated in
Hyderabad, Telangana State.

Establishment of IRDA
The Government of India was the regulator for the insurance industry until 2000.
However, to institute a stand-alone apex body, the IRDA was established in 2000
following the recommendation of the Malhotra Committee report in 1999. In August
2000, the IRDA began accepting applications for registrations through invites and
allowed companies from other countries to invest up to 26% in the market.
The IRDA has outlined several rules and regulations under Section 114A of the
Insurance Act, 1938. Regulations range from registration of insurance companies for
operating in the country to protecting policyholder’s interests. As of September 2020,
there are 31 General Insurance companies and 24 Life Insurance companies who are
registered with the IRDA.

Objective of IRDA
The main objective of the Insurance Regulatory and Development Authority of
India is to enforce the provisions under the Insurance Act. The mission statement of the
IRDA is:
 To protect the interest and fair treatment of the policyholder.
 To regulate the insurance industry in fairness and ensure the financial
soundness of the industry.
 To regularly frame regulations to ensure the industry operates without any
ambiguity.

Role of IRDA in India

The insurance industry in India dates back to the early 1800s and has grown over
the years with better transparency and focus on protecting the interest of the
policyholder. The IRDA plays an integral role in emphasizing the importance of
policyholders and their interest while framing rules and regulations. The important
roles of the IRDA are:
 To protect the policyholder’s interests.
 To help speed up the growth of the insurance industry in an orderly fashion, for
the benefit of the common man.
 To provide long-term funds to speed up the nation’s economy.
 To promote, set, enforce and monitor high standards of integrity, fair dealing,
financial soundness and competence of the insurance providers.
140 Indian Financial System

 To ensure genuine claims are settled faster and efficiently.

 To prevent malpractices and fraud, the IRDA has set up a grievance redress
forum to ensure the policyholder is protected.
 To promote transparency, fairness and systematic conduct of insurance in the
financial markets.
 To build a dependable management system to make sure high standards of
financial stability are followed by insurers.
 To take adequate action where such high standards are not maintained.
 To ensure the optimum amount of self-regulation of the industry.

Functions of IRDA
The important functions of the IRDAI in the insurance industry in India are:
 Grant, renew, modify, suspend, cancel or withdraw registration certificates of
the insurance company.
 Protecting the interests of the policyholder in matters concerning the grant of
policies, settlement of claims, nomination by policyholders, insurable interest,
surrender value of the policy and other terms and conditions of the policy.
 Specify code of conduct, qualifications and training for intermediary or
insurance agents.
 Specify code of conduct for loss assessors and surveyors.
 Levying fees and charges for carrying out the provisions of the Act.
 Undertaking inspection, calling for information, and investigations including an
audit of insurance companies, intermediaries, and other organizations
associated with the insurance business.
 Regulate and control insurance rates, terms and conditions, advantages that may
be offered by the insurance providers.

Apart from the above-mentioned core functions of the IRDA, there are several
functions that the regulator performs keeping the policyholder’s interest as its priority.
The IRDAI is responsible for the following:
 Registering, issuing, renewing, and cancellation of license.
 Specifying qualifications, the code of conduct, and providing to training to the
agents and other intermediaries.
 Protecting the rights of the insurance policyholders, providing registration
certificates to the life insurance companies. Besides, the IRDAI is also
concerned with renewing, modifying, cancelling and/or suspending the
registration certificates as and when it deems fit.
 Promoting efficiency in the conduct of the insurance business, and promoting
and regulating professional organizations that are directly or indirectly
connected with insurance and reinsurance business.
Financial Regulators and Insurance 141

 Regulating investment of funds by insurance companies, adjudicating between

insurers and insurance intermediaries.

4.3.4 Pension Fund Regulatory and Development Authority of India

(PFRDAI)
PFRDA full form is Pension Fund Regulatory and Development Authority and was
created in 2003 with the goal of promoting, regulating, and expanding India’s pension
industry. PFRDA was initially designed for government employees exclusively, but its
services were subsequently expanded to include all Indian nationals and NRIs,
including self-employed persons.

PFRDA Act 2013

IPRDA (Interim Pension Fund Regulatory & Development Authority) was passed
by Parliament in 2003 in order to have a system in place till the final and fool-proof
system is prepared, re-approved, and implemented with the acceptance of all political
parties including the opposition parties. PFRDA, Pension Fund Regulatory and
Development Authority was established with the President’s assent on 19 September
2013 and was made a permanent Act. The President was the guardian of PFRDA till
Financial Year 2014-15 and it has become fully autonomous and functions
independently from Financial Year 2014-15.

Functions of PFRDA
The PFRDA’s preamble declares that the authority’s goals are to “promote old age
income security by creating, growing, and regulating pension funds, to safeguard the
interests of subscribers to pension fund schemes, and for issues associated with or
incidental thereto.”
PFRDA is headquartered in New Delhi, with regional offices located around the
country. The main functions of PFRDA are stated below:
1. Undertaking steps for educating subscribers and the general public on issues
relating to pension, retirement savings and related issues and training of
intermediaries.
2. Providing pension schemes not regulated by any other enactment.
3. Protecting the interests of subscribers of NPS (National Pension Scheme) and
such other schemes as approved by the authority from time to time.
4. Approving the schemes, and laying down norms of investment guidelines under
such schemes.
5. Registering and regulating intermediaries- NPS Trust, Points of Presence,
Central Record keeping Agency, Trustee Bank, Pension Funds, Custodian for
time bound service to subscribers.
142 Indian Financial System

6. Ensuring that the intermediation and other operational costs are economical and
reasonable.
7. Making existing grievance redressal process robust and time bound.
8. Adjudication of disputes between intermediaries and between intermediaries
and subscribers.

4.4 Insurance Sector

The insurance industry is critical for any country’s economic development. A
well-developed insurance sector boosts risk-taking in the economy, as it provides some
security in the event of an unforeseen, loss-causing incident. It also provides
much-needed support to family members in the case of loss of life or health. Since the
assets under management of insurance companies represent long-term capital, they also
act as a pool in which to invest in long-term projects such as infrastructure
development.
The insurance industry in India has also grown along with the country’s
economy. Several insurance companies in the country are expanding their operations,
across both the public and private sector.

History of Insurance Sector

The history of India’s insurance industry reflects the history of India’s economy.
Insurance companies in India were nationalised during pre-liberalisation. This was done
to protect the interests of policyholders. Two state-owned insurance companies were
thus created: the Life Insurance Corporation in 1956, and the General Insurance
Corporation in 1972 for the non-life insurance business.
Post liberalization, the industry was opened up. The Insurance Regulatory and
Development Authority of India (IRDAI) was created in 1999 to regulate the insurance
industry in India. Thus, the insurance sector was opened to private players. This
allowed foreign players to collaborate with Indian entities to enter the sector.
The number of insurance companies in India has increased quickly and
continuously, and this has led to a vibrant insurance sector- with more variety and
affordability for the consumer.
There are currently 57 insurance companies in India, of which 46 are from the
private sector. There are 24 life insurance and 33 non-life insurance companies in India.
The major names in the sector are:

Life Insurance
 Life Insurance Corporation (LIC)
 HDFC Standard Life
Financial Regulators and Insurance 143

 SBI Life Insurance

 ICICI Prudential Life Insurance

Non-life Insurance
 New India Assurance
 United India Assurance
 National Insurance Company
 ICICI Lombard
 Oriental Insurance Company
 Bajaj Allianz

4.5 Life Insurance and General Insurance

Life insurance is a contract between an individual and a company, the latter being
famous for insurance services. The former receives the amount of money after being
paid a series of instalments against regular premiums that are paid against the policy to
the insurance companies. The amount paid here is famously known as the “death
benefit” since it is provided after the death of the owner of the policy. More
importantly, life insurance provides the client's family with a way to sustain at least a
very basic lifestyle so that dependents left behind do not sink to a worse position.

Key Features of Life Insurance

Features of Life Insurance include:
 Long-term Financial Security: It is usually a long-term contract, sometimes
until the end of the policyholder's life or for a term of years (10, 20, or 30
years).
 Death Benefit: It is the most obvious and primary feature of a life insurance
policy. The sum will be paid to the named beneficiaries after the insured has
died.
 Diverse Policies: There are diverse policies of life insurance such as term life
insurance, whole life insurance, and universal life insurance, all of which carry
different benefits and features.

Types of Life Insurance

The Types of Life Insurance consist of:
 Term Insurance: This is a type of insurance that covers the life of an
individual for a specified number of years, say 10, 20, or 30 years. In case death
occurs during the term, the death benefit will be paid to the named
beneficiaries. Term life insurance is relatively cheaper than permanent life
insurance but does not acquire any cash value.
144 Indian Financial System

 Whole Life Insurance: Whole life insurance offers lifetime insurance and
contains a cash value factor that increases with time. It is more costly than term,
providing both a death benefit and a savings component.
 Universal Life Insurance: It is much like whole life insurance except that it
provides flexibility concerning the payment of premiums and death benefits.
The cash value also grows, but its growth varies with performance of
underlying investments.

Benefits of Life Insurance

The important benefits are:
 Protection for Loved Ones: First and foremost, life insurance protects your
family or dependents in case you are no longer there.
 Tax Benefits: Life insurance pays tax-free, so the death benefit paid to the
beneficiary is free of income taxes.
 Savings and Investment: Some forms of life insurance, including whole life
and universal life insurance, contain a savings or investment element that
accumulates value over time and can be available during the lifetime of the
policyholder.

4.6 General Insurance

General Insurance, often known as non-life insurance, offers protection against a
range of risks and provides specific event cover, including accidents, theft, natural
disasters, and medical expenses. As compared to life insurance, general insurance
policies are rather short-term and need renewal after a certain period; mostly, they are
annual renewals.

Features of General Insurance

The important features of General Insurance are:
 Short-term Coverage: General insurance of almost all types is provided for
covering risks for a short-term period, which is around one year. It then has to
be renewed.
 No Death Benefit: General insurance does not provide any death benefit like
life insurance. This kind of insurance pays financial losses that occur due to
specific events or incidents.
 Very Wide Area of Coverage: General insurance contains some very
wide-ranging policies: health insurance, motor insurance, property insurance,
travel insurance, etc.

Types of General Insurance

General Insurance Types includes:
Financial Regulators and Insurance 145

 Health Insurance: Health insurance covers costs related to medical treatment

when an illness or injury arises. Health insurance can range from covering
hospitalisation, surgical operations, doctor visits, and medicines to many others.
 Motor Insurance: Motor insurance offers protection against various forms of
accidents, theft, and natural disasters which damage or destroy vehicles. It is a
legal necessity in most countries for every vehicle owner to have motor
insurance.
 Home Insurance: Covers damage or loss to one's home due to fire, theft, or
any other covered perils.
 Travel Insurance: Covers all kinds of risks that can occur while travelling,
including cancellations of trips, loss of luggage, medical emergencies, and
many more.

Benefits of General Insurance

The important benefits of General Insurance are:
 Safety from Unexpected Events: General insurance provides safety from all
kinds of unexpected events which may cause financial loss such as accidents,
theft, or illness.
 Peace of Mind: This is because owning insurance provides them with the peace
of mind that they will not bear the financial haemorrhage in case an emergency
occurs.
 Customised Coverage: General insurance policies can be customised
according to the needs of a particular individual, such as health care, vehicle
protection, or protecting homes.

4.7 Key Differences Between Life Insurance and General

Insurance
The important differences Between Life Insurance and General Insurance are
stated below:

Basis of
Life Insurance General Insurance
Difference
Purpose Provides financial support to Covers financial losses due to
dependents upon death. specific events.
Payout Paid out to beneficiaries after the Paid out when a covered event
policyholder’s death. (e.g., accident or theft) occurs.
Duration Long-term or permanent. Short-term, typically one year.
Types of Term life, whole life, universal Health, motor, home, travel, and
Policies life. more.
146 Indian Financial System

Basis of
Life Insurance General Insurance
Difference
Tax Benefits Death benefits are generally tax- Some policies (e.g., health
free. insurance) offer tax benefits for
premiums paid.

4.8 ULIP
ULIP meaning refers to Unit Linked Insurance Plans (ULIPs), which are a type of
life insurance plan that combine the benefits of life cover and market linked
investments. A portion of the premium paid for a ULIP is invested in a variety of
market-linked funds, while the remaining portion is used to provide life insurance
coverage. It is a single insurance plan that offers the dual benefit of life insurance and
investment. The premium paid in ULIP has two parts: one covers the life insurance and
the other is invested in the market funds.
A ULIP offers investors the dual advantage of life insurance protection and
market-linked investment through a single plan. A part of the premium is invested in
equities, debt or a combination of both funds, depending on the preferences. The part of
the premium that is invested in the funds buys the “units” of the funds that has chosen.
How many units are required to get depends on the fund’s daily price which is called
the NAV or Net Asset Value.
On maturity, the insurance company pays out the fund value, which is an aggregate
of all the chosen funds and is equivalent to the NAV on the maturity date. However, in
the case of an unexpected event, the beneficiaries receive the higher of these amounts:
 The Death Benefit (Sum Assured).
 The fund value accumulated during the time of demise.
 105% of the total premiums paid up to that date.

Benefits of Buying the ULIP Policy

Here are the 6 benefits you will enjoy from ULIP investment:

1. Dual Benefit of Life Insurance and Investment

When we purchase the ULIP policy, the beneficiaries get the life insurance benefit
in case of a unfortunate event. It takes care of our loved ones and ensures that they do
not suffer from financial instability in our absence.

2. Flexibility to Switch Funds During the Tenure Period

One of the biggest advantages of the ULIP policy is the flexibility to switch funds.
This flexibility enables us to yield the best financial returns on our investment. There
are very less financial instruments that provide with this leverage. Based on the market
performance, we can switch from equity to debt and vice-versa. ULIPs provide the
Financial Regulators and Insurance 147

additional benefit of choosing the premium payment option that fits our financial
situation. We can pay the premium either annually, semi-annually, quarterly, or
monthly.

3. Liquidity Option of Partial Withdraw

In case of emergency, we can avail of a partial withdrawal facility under this
investment scheme.

4. Top-Up Option to Maximize Return

With time, new needs arise and lifestyle changes. ULIP financial instrument comes
with a top-up option, implying that we can invest more money into the existing ULIP
plan during the policy tenure. The top-up feature not only maximizes the return but also
takes away the stress of buying a new policy for new needs.

5. Long-Term Financial Goal Planning

ULIP acts as a long-term investment instrument option, thus it enables to achieve
your long-term financial goals like financing for child’s higher education or buying a
home post-retirement.

6. Tax Benefits Under Income Tax Act, 1961

If we are looking for a financial instrument for tax-saving purposes, then the ULIP
policy is right for us. It offers incredible tax benefits under the Income Tax Act, 1961
under section 80C.

4.9 Micro Insurance

Micro Insurance is defined as a category of life insurance plans designed to benefit
low-income families. Unlike a comprehensive insurance plan, it offers financial
security for only the basics. This reduces the policy cost considerably, which is why the
insured has to pay smaller premiums.
For example, a person can purchase a micro insurance policy to insure him/her
against a particular illness or insure a valuable item by paying an affordable premium.
In this regard, it is essential to note that the coverage offered for micro insurance can
only be up to ₹ 50,000.
The Insurance Regulatory and Development Authority of India (IRDAI)
introduced micro insurance in India. This association also governs the micro insurance
market in India as per the IRDAI Micro Insurance Regulations, 2005.
Micro Insurance plans are ideal for people who earn a low annual income and have
minimal savings. These policies provide financial aid to policyholders to tackle
emergencies like medical expenses etc., against a minimal premium paid on a recurring
basis.
148 Indian Financial System

 The micro insurance plan covers only certain risks relevant to the insured, like
chronic diseases, accident risks, etc.
 The maximum cover amount for micro insurance in India is ₹ 50,000. People
who cannot afford expensive comprehensive plans can benefit from micro
insurance schemes. The policyholders enjoy financial security without spending
much.
 Micro insurances are often distributed through organisations like NGOs to
reach the target group and benefit the low-income category.

Types of Micro Insurance

Micro insurances are of two primary types:

1. Life Micro Insurance

Life micro insurances are term plans or lifelong plans that offer low cover values.
These micro insurances have long-term maturity and offer dependable coverage at low
premiums.

2. General Micro Insurance

General micro insurances include health insurance, property insurance, accident
insurances, etc., which offer safety against all necessary risks against an affordable
premium. Policyholders can insure themselves against a particular disease or insure
their automobile by purchasing micro insurance.

Benefits of Micro Insurance

Following are the benefits of micro insurance policies:

1. Life Micro Insurance Benefits

 Micro Life insurance policies provide a financially secured retirement life for
the lower income group who cannot afford retirement planning.
 In case of the unfortunate demise of the policyholder, these plans provide death
benefit cover to the family, which can otherwise be a costly affair.

2. General Micro Insurance Benefits

 This provides financial aid during health emergencies to people belonging to
the economically weaker section. Hazardous accidents like fire, etc., can be
financially shattering for lower economic class people. A micro insurance
policy can be of tremendous help during such circumstances.
 Micro Insurance protects assets and personal property for people who cannot
afford damages.
 Micro Insurance policy insures unfortunate incidents like theft and damage to
assets, providing a sense of safety to the policyholder.
Financial Regulators and Insurance 149

Advantages of Microinsurance Policies

The biggest advantage concerning Microinsurance is that it offers the opportunity
for the economically vulnerable section of the population to buy insurance at a low
cost. Because of buying Microinsurance Policies, they can receive financial assistance
during challenging times. This will result in the safeguarding of their savings, which
are usually on the lower side. Following are some top advantages of specific
Microinsurance Covers.

1. Endowment/Pension Microinsurance
It offers survival as well as death benefits as per the terms and conditions.

2. Term Microinsurance
Covers life risk with accidental benefits and some insurers offer permanent
disability benefits.

3. Health Microinsurance
It covers pre-and post-hospitalisation expenses and it covers medical bills for
diagnosis, medical bills, etc.

4. Property Microinsurance
It offers coverage due to damage/losses of properties due to natural calamities.

Importance of Micro Insurance

Microinsurance Policies are important as under:
 They are an accessible risk-management tool to reduce financial vulnerability in
times of adversity.
 The affordable premium of such plans is an incentive for better reach in an
organized manner.
 Microinsurance covers the policyholder’s financial liability as per the chosen
plan.
 Microinsurance helps the poor to save money.
 Can bring about a positive change in poor people’s perception of insurance.

4.10 Deposit Insurance

Most Indian investors opt for bank deposits as they expect safety and guaranteed
returns from these. Bank deposits can include fixed deposits, recurring deposits, and
savings or current accounts. While these investment formats are comparatively safer
than others available in the market.
150 Indian Financial System

Deposit Insurance is a measure of protection to depositors, particularly small

depositors, from the risk of loss of their savings arising from bank failures. The purpose
was to avoid panic and to promote greater stability and growth of the banking system.
Deposit Insurance or Bank deposit insurance is a protection cover meant for bank
deposit holders. It can be used in case a bank fails and does not have sufficient money
to repay its depositors.
Deposit insurance is a measure to protect bank depositors, in full or in part, from
losses caused by a bank's inability to pay its debts when due. The Centre has set up
Deposit Insurance and Credit Guarantee Corporation under RBI to protect depositors if
a bank fails. The deposit insurance scheme is mandatory for all banks and no bank can
voluntarily withdraw from it.

Features of Deposit Insurance

Following are some of the features of this insurance facility:
1. This insurance is covered by Deposit Insurance and Credit Guarantee
Corporation (DICGC) which is a wholly owned subsidiary of the RBI.
2. DICGC provides insurance for all bank deposits, including savings, fixed,
current and recurring deposits. The maximum limit is ₹ 5 lakhs per bank
account.
3. If the net deposit amount held by an individual in one bank exceeds ₹ 5 lakhs,
then he/she can avail only ₹ 5 lakhs, including principal and interest amount.
This is, in case the bank goes bankrupt.
4. DICGC provides deposit insurance to all depositors of commercial banks and
foreign banks that operate in India. It covers state, central and urban co-
operative banks, local area banks and regional rural banks. The bank must have
bought the cover from DICGC for the insurance to be applicable to its
depositors.
5. In case a bank fails or does not allow withdrawal of deposits, customers can
claim the insurance cover of up to ₹ 5 lakhs and withdraw within this limit
depending on the amount they have deposited with a bank.

Kind of Deposits are Covered under Deposit Insurance

Following are the categories of deposits that are covered under the bank deposit
insurance scheme:
DICGC covers all kinds of bank deposits such as savings, fixed, current, recurring,
and so on except for the following deposits:
1. Deposits of foreign governments;.
2. Deposits of Central/State Governments;.
Financial Regulators and Insurance 151

3. Inter-bank deposits;.
4. Deposits of the State Land Development Banks with the State co-operative
bank;.
5. Any amount due on account of and deposit received outside India.;
6. Any amount that is specifically exempted by the corporation with the previous
approval of Reserve Bank of India.

4.11 Deposit Insurance and Credit Guarantee Corporation

(DICGC)
Introduction
The Deposit Insurance and Credit Guarantee Corporation or also called DICGC is
referred to as a fully owned subsidiary of RBI or the Reserve Bank of India. It
offers deposit insurance, which acts as a safeguard for bank customers in the event that
the institution goes bankrupt or fails to return the invested money to its depositors.
The agency covers various types of bank deposit accounts, including current,
savings, fixed, as well as recurring deposits, up to a ceiling of 5 lakh rupees per account
owner per institution. If a person deposits more than 5 lakh rupees in a commercial
institution, DICGC will pay just 5 lakh, comprising interest and principal, in case the
bank goes bankrupt.

Working of DICGC
The working and framework of DICGC include:
 Depositors’ money is protected by DICGC throughout all commercial as well
as international banks operating in India; federal, urban co-operative, as well as
state banks and regional rural banks, presuming the bank has elected for
DICGC coverage.
 DICGC is now a completely owned subsidiary of the RBI. The organization’s
principal goal is to ensure cash deposits as well as deliver assurance on bank
lending facilities to a limited section of people. Every bank presently operating
in India is required to participate in the deposit insurance system.
 The Deposit Insurance and Credit Guarantee Corporation manage three kinds of
funds: the ‘Credit Guarantee,’ the ‘General’, and the ‘Deposit Insurance’.
 The bank deposit insurance program is supported by insurance premiums
collected from banks, whereas the credit guarantee scheme or fund is supported
by guarantee fees collected at the period of credit issue.
 The above-mentioned funds are utilised to pay disputes that arise in their
respective sectors.
 The general assets or funds are used to keep the organisation running and to
cover other administrative costs.
152 Indian Financial System

 Any surplus money from either of these 3 types of funds is reinvested in

government securities solely as authorised by the Deposit Insurance and Credit
Guarantee Corporation Act of 1961.
 Furthermore, any profit from these kinds of holdings is contributed to these
reserves. The company has the authority to move money from one type of fund
to the other.

Banks Covered under DICGC

Banks that come under DICGC for bank deposit insurance facilities are as follows:
 Co-operative Banks: Most co-operative banks operating in various union
territories and states have made relevant amendments to their regional
Co-operative Societies Act, granting the RBI the authority to issue certain
orders that are covered under the deposit insurance and credit guarantee
corporation schemes.
 Commercial Banks: Currently, the DICGC plan insures the entire commercial
banking system in our country. Commercial banks in our nation include
divisions of international banks and also nationalized/local banks and regional
rural banks.

List of Deposits Insured by DICGC

With the exception of the deposits expressly stated below, most deposits, including
fixed, savings, recurring, current and so on, are typically guaranteed by the DICGC.
 All deposits undertaken by foreign governments.
 Deposits made by the Union Government or any other State Governments.
 Deposits done with any cooperative bank by a State Land Development Bank.
 On any sum owed as a result of a deposit collected outside of the country,
regardless of its size.
 Interbank deposits of many types.
 With prior clearance from the RBI, the corporation may expressly exclude any
deposit.

4.12 Pension System

Retirement planning is necessary to ensure that a person enjoys his post-retirement
life just as he has imagined. With the rising medical costs and inflation, the sooner to
start planning retirement, the more secure to sunset years can be.
Pension plans are long-term financial products designed to help individuals secure
their financial well-being during their golden years. These plans are typically offered by
employers or financial institutions and are voluntary in nature, although some
employers may make them mandatory for their employees.
The fundamental principle behind a pension plan is to build a retirement corpus by
contributing regular payments or premiums over the years, often with the added benefit
Financial Regulators and Insurance 153

of potential tax advantages. Upon reaching retirement age, the plan holder can begin to
receive regular pension payments or withdraw a lump sum amount from the
accumulated corpus, depending on the type of pension plan chosen.
In India, the Pension System, primarily the National Pension System (NPS), is a
government-backed scheme designed to provide financial security during retirement. It
is a defined contribution plan where individuals save regularly during their working
years, accumulating a corpus for post-retirement income. NPS offers flexibility in
investment choices and allows for partial withdrawals and annuity purchases upon
retirement.

4.13 National Pension System (NPS)

The NPS, widely known as the National Pension System, is a voluntary savings
system in India designed for long-term pension benefits. NPS is regulated by the
PFRDA, this program allows employed individuals to diligently contribute to their
retirement funds. These funds can be withdrawn upon retirement or when a certain age
is reached, and the remaining amount is utilized for post-retirement pensions or
consistent annuities.
The NPS offers two distinct levels for individuals to choose from:
 Tier-I, a mandatory pension account with withdrawal limitations, and
 Tier II, an optional bank account with more flexibility.

This allows individuals to customize their investments from a diverse range of

assets, giving them an advantage over traditional pension plans. Additionally, the NPS
provides tax benefits, making it a compelling choice for individuals looking to establish
a stable financial footing in their retirement years.

Types of NPS Accounts

There are two types of NPS accounts: Tier I and Tier II.

1. Tier I Account
It is a mandatory pension account. As you opt for the National Pension Plan, you
basically open a Tier 1 NPS Account. This account has a lock-in period until the age of
60. Only partial withdrawals up to 25% of contributions are permitted in specific cases
such as critical illnesses or higher education, and that too after 3 years of opening the
NPS account. Tax benefits are available for contributions made towards this account
under Section 80 CCD(1) and Sec 80CCE of the Income Tax Act.

2. Tier II Account
It is an optional NPS account that offers more liquidity than the Tier I account.
The Tier II account does not have a lock-in period, and subscribers can withdraw
154 Indian Financial System

money from the account as and when required. However, there are no tax benefits
available for contributions made towards this account.

Features of the NPS

The National Pension System (NPS) is a dependable retirement savings system
that boasts a variety of attractive features, making it a sought-after option for those who
desire financial stability during their golden years.

1. Dual Tiers
 Tier-I Account: The primary pension account with withdrawal restrictions to
promote long-term savings. Its purpose is to provide a steady stream of income
during retirement.
 Tier-II Account: An additional flexible savings account that permits
individuals to withdraw funds as needed. However, eligibility for a Tier-II
account is only granted to those who maintain an active Tier-I account.

2. Lower Eligibility Criteria

Investing in NPS is made easier with its relaxed eligibility criteria compared to oth
er investment systems. As long as you are an Indian citizen between the ages of 18 and
60, you are eligible to invest.

3. Investment Option Selection

Users of NPS can choose from a wide range of asset classes to invest in. These
include Equities (E), Corporate Bonds (C), Government Securities (G), Alternative
Investment Funds (A), and Tier II investments. This allows individuals to tailor their
investments to align with their personal risk preferences and financial objectives.

4. Auto Selection
NPS offers an “Auto Choice” option to those who may not be well-versed in
financial market operations. This cutting-edge technology automatically allocates assets
across various classes according to the subscriber’s age, gradually transitioning towards
more secure investments as retirement approaches.

5. Tax Advantages
NPS offers tax advantages underneath diverse elements of the Income Tax Act.
Contributions to the Tier-I account are deductible under Section 80CCD (1), with
employers receiving an extra advantage underneath Section 80CCD (2). Furthermore,
the plan permits tax-free partial withdrawals and lump-sum payouts upon retirement.

6. Portability
The NPS is a portable plan, which means that it isn’t tied to work. Subscribers can
keep contributing to their NPS even though their jobs or addresses alternate.
Financial Regulators and Insurance 155

7. Annuity Choices
When subscribers reach the age of 60, they should use at least 40% of their
amassed corpus to buy an annuity that gives an everyday pension. NPS gives a lot of
annuity alternatives, permitting individuals to adapt their pension profits to their
particular needs.

8. Online Management and Access

Managing NPS is an entirely online process, making it a smooth experience for
members to sign up, check their balances, and make contributions. The user-friendly
interface also enhances transparency and simplifies management.

9. Partial Withdrawals
The NPS offers a unique benefit of partial withdrawals before reaching retirement
age, in specific situations. This enables individuals to have financial flexibility and the
ability to meet unexpected monetary needs.

10. The Pension Fund Regulatory and Development Authority (PFRDA) Regulates
the NPS
The PFRDA administers the NPS, ensures transparency, and accountability, and
protects clients’ interests. This regulatory power contributes greatly to the credibility
and reliability of the system.

Objectives of the National Pension System

Following are some of its key objectives:
 Ensure financial security in retirement.
 Regulated by a government-appointed authority.
 National Pension System (NPS) Trust oversees asset and fund management.
 Custodians safeguard underlying securities.
 Points of Presence (POPs) like Banks facilitate accessibility.
 Professional Fund Managers optimize investments.
 Offers tax benefits and cost-effective equity-linked investments.
 Provides diverse investment choices.
 Allows portability and employer contributions.
 Subject to government regulation for secure savings.

Benefits of the National Pension System

The following are the important benefits of NPS

 Returns and Interest

A portion of your contributions is allocated to equities, offering returns that
surpass traditional tax-saving investments like the PPF. Over the past decade, the NPS
156 Indian Financial System

has consistently delivered annualised returns ranging from 9% to 12%. Moreover, you
can switch fund managers if dissatisfied with your fund's performance.

 Risk Management
NPS places a cap on equity exposure, maximum upto 75%. For government
employees, this cap is set at 50%. With the Auto choice also known as lifecycle fund,
the system will rebalance the portfolio every year on the dDate of bBirth of the
sSubscriber, reducing the equity exposure and allocating the same between stable assets
corporate bond and Government securities. This safeguard stabilises the risk-return
balance, protecting your corpus from the equity market's volatility.

 Regulation and Transparency

The PFRDA closely monitors NPS, ensuring adherence to transparent investment
norms and conducting regular performance evaluations of fund managers through NPS
Trust. This regulatory oversight enhances the scheme's reliability.

 Flexibility
NPS allows subscribers to contribute anytime during the financial year, adjust
contribution amounts, and select their preferred investment options. A person can
manage his account online from anywhere, even when changing cities or jobs.

4.14 Atal Pension Yojana (APY)

Atal Pension Yojana is a pension scheme introduced by the Government of India
in 2015–16. It was implemented with an objective to provide pension benefits to
individuals in the unorganized sector. This scheme is regulated and controlled by the
Pension Funds Regulatory Authority of India (PFRDA).
It is an extension of the recognized National Pension Scheme and replaces the
previously institutionalised ‘Swavalamban Pension Yojana’ of Government of India.
Atal Pension Yojana is a Social Security Scheme initiated by the Government of
India and is aimed at providing a steady stream of income after the age of 60 to all
citizens of India. In other words, it is a pension scheme focused mainly on the people
employed in the unorganized sector such as maids, delivery boys, gardeners, etc.
The primary goal of the scheme is to make sure that no Indian citizen has to worry
about sudden illness, accidents or chronic diseases in their old age, giving a sense of
security. Not only confined to only unorganized sector, private sector employees or
those who are working with an organization that does not provide them pension
benefits can also apply for the scheme.
Financial Regulators and Insurance 157

Objectives of Atal Pension Yojana

The main objective of the Atal Pension Yojana are as follows:
 Provision of security and protection of citizens against illness, accidents,
diseases, and so on.
 This scheme is mainly aimed at the unorganized sector in the country.
 Under the APY, will receive monthly payments from their accrued corpus. If a
beneficiary passes away, the pension payments will be made to their spouse. In
the event of both the beneficiary and their spouse’s death, a lump sum payment
will be made to the nominee.

Features of APY Scheme

The features of the APY scheme are discussed below:

 Automatic debit
One of the primary conveniences of the Atal Pension Yojana is the facility of
automatic debit. The bank account of a beneficiary is linked with his/her pension
accounts and the monthly contributions are directly debited. On that account,
individuals who have subscribed to this scheme shall ensure that their account has
sufficient finances to entertain such automatic debit, failing which shall attract a
penalty.

 Facility to Increase Contributions

As mentioned earlier, the pension amount one is eligible to receive upon reaching
the age of 60 is determined by their contributions. There are different contributions
which tantamount to different pension amounts. It might be so that individuals decide
to make larger contributions to their pension account backed by an increased financial
capacity to secure a higher pension amount later in the course of the scheme. To
facilitate this requirement, the government provides an opportunity to increase and even
decrease one’s contributions once a year to change the corpus amount.

 Guaranteed Pension
Beneficiaries of the scheme can choose to receive a periodic pension of ₹ 1000,
₹ 2000, ₹ 3000, ₹ 4000 or ₹ 5000, depending on their monthly contributions.

 Age Restrictions
Individuals who are above 18 years and below 40 years of age can decide to invest
in the Atal Pension Yojana. Therefore, college students can also invest in this scheme
to create a corpus for their old age. 40 years has been set as the maximum bar for entry
into the programme, as contributions to this scheme shall be made for at least 20 years.
158 Indian Financial System

 Withdrawal Policies
If a beneficiary has attained the age of 60, he/she shall be eligible to annuiti zse the
entire corpus amount, i.e. receive monthly pensions after closing the scheme with the
respective bank. One can only exit this scheme before reaching the age of 60 under
circumstances like terminal illness or death.

 Terms of Penalty
If beneficiary delays in the payment of contributions, the following penalty
charges are applicable:
 ₹ 1 for monthly contributions of up to ₹ 100.
 ₹ 2 for monthly contributions within ₹ 101 and ₹ 500.
 ₹ 5 for monthly contributions within ₹ 501 and ₹ 1000.
 ₹ 10 for monthly contributions of ₹ 1001 and above.

 Tax exemptions
Tax exemption is available on contributions made by individuals towards Atal
Pension Yojana under Section 80CCD of the Income Tax Act, 1961. Under Section
80CCD (1), the maximum exemption allowed is 10% of the concerned individual’s
gross total income up to a limit of ₹ 1,50,000. An additional exemption of ₹ 50,000
under NPS.

Benefits of Atal Pension Yojana

The benefits of Atal Pension Yojana are as follows:
 Provides financial security against illness, accidents, and other risks for
unorganised sector workers.
 Backed by the Government of India, ensuring low investment risk.
 Accessible to Indian residents, including self-employed and salaried
individuals.
 Offers guaranteed monthly pensions of ₹ 1000 to ₹ 5000, based on
contributions.
 Monthly pension continues to spouse upon beneficiary’s death; a lump sum is
paid to the nominee if both beneficiary and spouse pass away.
 Tax benefits on contributions under Section 80CCD of the Income Tax Act,
1961.
 Flexible contribution options: monthly, quarterly, or half-yearly.
 Subscription available for workers in both organised and unorganised sectors.
 Allows adjustment of pension amount (upgrade or downgrade) as per subscriber
choice.
 Eligible for individuals with other private or government pension schemes.
Financial Regulators and Insurance 159

4.15 LIC IPO (Life Insurance Corporation, Initial Public Offer)

The union budget presented by finance minister Nirmala Sitharaman on the 1st of
February 2020 has proposed an unanticipated decision to go for an Initial Public Offer
(IPO) with the public sector insurance behemoth LIC of India. The decision to divest
the most trusted insurer and the all-time financial savior of the Government of India has
naturally raised the eyebrows of the populace.
Initial Public Offer (IPO) is the process by which a business entity going public by
the first sale of its stocks (shares) to the general public. Public share issuance allows
a company to raise capital from public investors. After IPO the company’s shares are
traded in an open market.

Objects of listing of LIC

The objects of LIC IPO are:
 Profit-making for Govt: The government is trying to make the most of the
brand value of LIC, given that it is one of the few remaining profit-making
entities owned by the state.
 Better Returns: Listing will boost LIC’s efficiency and thereby policy returns.
 Reforming the Insurance Sector: LIC will also become more competitive.
This will put pressure on its peers to innovate, benefitting policyholders in
terms of pricing, product features, and services.
 Better Financial Position: Less govt interference will be a positive for LIC’s
financial health.
 Risk-free: As long as a sovereign guarantee over the maturity proceeds and the
sum assured to continue, policyholders won’t perceive any risk.

Advantages of LIC IPO

The advantages of going public through IPO include:
 Increased public image
 Facilitate mergers and acquisitions
 Higher responsibility to the public
 More transparency in corporate administration
 Sharing strategic information through periodic reporting
 Maintaining shareholder value through corrective measures
 Sharing financial gain to the public

LIC has filed its DRHP (Draft Red Herring Prospectus) with SEBI on 13th
February 2022. According to the DRHP, the government which owns 100% of the stake
in LIC is providing a 5% stake through the IPO. This stake represents 31.6 crore shares
out of the total outstanding shares of the company. The shares are estimated to be
priced at Rs. 2000-2100 per share approximately. The IPO is in the form of an Offer for
160 Indian Financial System

Sale and the government aims to raise approximately ₹ 1,00,000 crores towards the
disinvestment target .

Meaning of Draft Red Herring Prospectus

A Draft Red Herring Prospectus (DRHP) is a document that is prepared to
introduce a new business or product to a potential investor. Preparing a Draft Red
Herring Prospectus (DRHP) is a crucial step for any company aiming to go public and
raise funds through an Initial Public Offering (IPO) and to be submitted to SEBI.

Eligibility for LIC IPO

The IPO is available for retail investors as well as Qualified Institutional Buyers
(QIB) to the tune of 35% and 50% respectively. Apart from these investors, the IPO
also reserves 10% of the IPO for existing policyholders and 5% for the employees of
LIC.
The DRHP for LIC IPO has set some specific qualifications for the especially
policyholders and the employees to meet in order to be eligible for applying for this
IPO. These conditions are mentioned hereunder.
1. The policyholder should have a valid PAN card attached to their policy and
updated on the LIC portal. The last date to link the PAN card to their policy for
this purpose was 28th February 2022.
2. The policyholders need to have a valid Demat account.
3. The policy needs to be issued on or before filing the DRHP with SEBI i.e.,
before 13th February 2022.
4. The policy needs to stay on record on the LIC portal and not removed on
account of withdrawal of the policy, surrender, maturity, or settlement of death
claim as on the offer opening date.
5. The proposer of a policy in the name of a minor child can subscribe to the IPO.
6. The ‘Karta’ of the HUF having a HUF policy is also eligible to subscribe to the
IPO.
7. The eligible policyholders will not be bound by any lock-in period to hold the
shares subscribed through the IPO.

Key Features of LIC-IPO

 LIC IPO should not be seen as privatisation.
 IPO will not impact employees or customers in any way.
 Sovereign Guarantee will be retained even after LIC IPO/listing.
 Even though it is not mandated to publish quarterly results, LIC already doing it
to ensure transparency.
Financial Regulators and Insurance 161

 With the listing, LIC will remain to be transparent as far as investments are
concerned.
 Even a decade after the privatisation of the Insurance sector, the market share in
terms of first premium income and number of policies stood at 80% and 77.6%
which shows the confidence of the public in LIC of India.

Life Insurance Corporation is going through an excellent phase as far as business

growth is concerned. It was in this year that its new business premium crossed ₹ 1.5
lakh crore in a financial year for the first time, with two more months remaining in the
financial year. Further, the market share stands high at 80% in terms of premium. All
these can be attributed to the trust and confidence the public has kept with the insurer.
The listing of the company may neither bring a positive nor a negative difference
to the policyholders overnight. The reason is that LIC is likely to abide by the time
tested and proven strategies as far as corporate governance is concerned. But the
positive note is, even though LIC is transparent to a great extent, the listing can bring in
more transparency as there is a chance for the shareholders to monitor the day - to- day
activities from inside, which in turn can add the stability of the corporation in the long
run.
LIC IPO is being targeted as the biggest IPO in the country and is expected to raise
a huge amount to meet the disinvestment target of the government. This IPO can be
subscribed by existing policyholders as well as employees of LIC along with other
eligible investors like Qualified Institutional Buyers (QIB), NII (Non-Institutional
Investor), etc. This IPO is an excellent opportunity for the employees to subscribe to
the shares of LIC and include them in their short-term or long-term portfolios.

4.16 Disinvestment in LIC

Disinvestment means the sale or liquidation of assets of the government. Mainly
public sector firms and other fixed assets of the Central and State Governments sold by
the government under the disinvestment plan. Generally, the objective of disinvestment
is to reduce the fiscal deficit. In the year 1991, the policy of economic liberalization
was implemented in the country. Under this policy, the disinvestment of its stake in
public companies was started by the government. Initially, the objective of
disinvestment was not privatization of public institutions but to improve the
performance of these institutions and reduce the budget deficit.
The name of the Department of Disinvestment was changed to the Department of
Investment and Public Asset Management (DIPAM) on 14th April 2016 by the
Government of India. At present this department works under the Ministry of Finance.
The function of DIPAM is to implement the disinvestment programs as per the annual
targets set by the Ministry of Finance. Every year, disinvestment targets are set by the
government in its annual budget and on the basis of set targets the disinvestment plan is
162 Indian Financial System

implemented. As per the disinvestment program of the Government of India, Finance

Minister Mrs. Nirmala Sitharaman had proposed to sell part of its stake in LIC through
an IPO in her Financial Year 202-22 Budget speech. The country’s Chief Economic
Advisor Mr. K.V. Subramanian has indicated that the government could mobilize
₹ 90,000 crores by selling the 6 to 7% stake in LIC. LIC’s IPO will not only help the
government to reduce its budget deficit but will provide an opportunity for small
investors to participate in LIC’s wealth creation.
There are two types of disinvestments. First, minority disinvestment and second,
majority disinvestment. Under minority disinvestment, majority shares are kept by the
government, that is, 51% or more shares are owned by the government; So that the
control and management of the business remains with the government. Disinvestment
in LIC was a kind of minority disinvestment. Whereas in majority disinvestment, 51 per
cent or more stake is sold by the government and the government keeps ownership of
less than 50 per cent of shares. If the disinvestment is more than 50% then it is called
privatization as in such cases the management and control are also transferred.
Disinvestment does not mean privatization but privatization means disinvestment,
whether a disinvestment is privatization or not depends on what percentage of stake is
sold under disinvestment. If the government sells its 100% stake, it will be called
complete disinvestment or privatization. Disinvestment by the government can be done
in many ways. One of the main methods of disinvestment is IPO. In the case of LIC, the
government has adopted this (IPO) method of disinvestment.

4.17 IRDAI’s Bima Sugam

Almost every aspect of our lives is moving to digital platforms in today’s fast-
paced, convenience-obsessed world. Our everyday routines, like ordering food or
clothes, have been made simpler, faster and more efficient by the internet. The
insurance business, on the other hand, has been relatively new to this digital
revolution.
Bima Sugam is an innovative project that is being designed to provide a one-stop
shop for all the insurance requirements, be it managing the coverage, servicing an
existing policy, or buying a new one.
Bima Sugam-insurance electronic market is a robust digital public infrastructure
with open standards and an interoperable platform. It shall be a one-stop solution for all
Insurance stakeholders: customers, insurers, intermediaries, or insurance intermediaries.
The Insurance Regulatory and Development Authority of India (IRDAI) has
approved the setting up of Bima Sugam, an online insurance marketplace (like an
e-commerce platform) for buying, selling, and servicing insurance policies as well as
settling claims.
Financial Regulators and Insurance 163

 It will onboard all the companies that offer life and non-life insurance products
under one roof.
 Bima Sugam will serve as a unified platform, integrating with government
databases, insurers, intermediaries, and insurance repositories.
 It will fetch customer details, provide product information, and facilitate the
purchase and servicing of insurance policies.
 Acting as a single interface, it will cater to customers, intermediaries, and
agents, enabling them to connect and transact across various insurers (life,
health,
non-life).

With the Insurance Regulatory and Development Authority of India (IRDAI)

keeping a strict eye on everything, Bima Sugam wants to make the whole insurance
process more efficient. This system is designed to benefit everyone involved, from
consumers who purchase and manage their insurance policies to intermediaries (like
agents or brokers) and insurers who handle the distribution, renewals, and processing of
claims. This technology is poised to transform the insurance industry by improving
efficiency and transparency.
This portal is like a thriving online marketplace where one can easily browse and
buy a range of insurance products offered by various providers. It will use state-of-the-
art technology to digitise and automate procedures for everyone involved. This, in turn,
will make insurance easier to get and more affordable than it has ever been.
Bima Sugam is another part of the IRDAI’s ambitious Bima Trinity, which also
includes Bima Vahak and Bima Vistaar. On 19 th March 2024, the IRDAI officially
launched Bima Sugam. The program's initial phase is scheduled to begin in April 2025.
This program helps to reach a greater goal of “Insurance for all by 2047.” The platform,
which is getting ready for launch, is intended to change how people interact with
insurance services in India.
Similar to how the Unified Payments Interface (UPI) revolutionised digital
transactions, Bima Sugam has the potential to make insurance products more accessible
to everybody. Its ultimate goal is to increase the penetration of insurance across the
nation by cultivating consumer trust.

Key Features Bima Sugam

Following are the important features of Bima Sugam:

 One-stop Shop
Bima Sugam will act as a unified platform for all insurance stakeholders, including
individuals, insurers, intermediaries, and agents.

 Digital Platform
164 Indian Financial System

It will be a digital public infrastructure, leveraging technology to streamline

insurance processes.

 Transparency and Convenience

The platform will provide clear information on policy terms, coverage, and costs,
making it easier for individuals to understand and compare options.

 End-to-end Digital Journey

It will facilitate the entire insurance lifecycle, from purchase to claim settlement,
in a digital format.

 Increased Insurance Penetration

By making insurance more accessible and affordable, Bima Sugam aims to
increase the overall insurance penetration in India.
 “Insurance for all by 2047”
This is a long-term vision that Bima Sugam is designed to support.

Benefits of Bima Sugam for Customers

Following are some of the benefits of this platform:

 A Simplified Experience with Insurance

Purchasing insurance through conventional channels, such as brokers and agents,
can involve a lot of paperwork. However, it all changes with Bima Sugam.
This platform gives the access to the policy in an easy-to-read electronic format.
When one purchases an insurance policy with Bima Sugam, he can get soft copies that
are kept in in electronic insurance account, so can say goodbye to piles of paper.

 Effortless Policy Management

It can be difficult to keep track of all the insurance policies, especially in many
policies such as health, life, vehicle, and fire insurance. In Bima Sugam, Policyholders
will take pleasure in having their own E-Bima accounts, where all of their insurance
details are arranged conveniently in one location. This implies that one can just click a
few times to view and manage the policies whenever need arises.

 Increased Protection and Better Management

One of the Bima Sugam portal's most notable features is the shift from paper
policies to safe electronic formats. This change actually lowers the risk of loss and theft
connected with traditional paper while also streamlining the experience. Modern
technology, strict privacy regulations, and strong security measures all work together to
guarantee open and equitable access to Bima Sugam while protecting the private data.
Financial Regulators and Insurance 165

 A Tool for Transparency and Countering Fraud

This unique platform will also aid the IRDAI in tackling fraud and unethical
behaviour inside the insurance sector. Bima Sugam will enhance the capacity to
identify suspicious activity by employing cutting-edge data integration techniques,
fostering a more open environment for every stakeholder involved.

 Simplified Claim Settlement

The online features of Bima Sugam will enable faster and more effective
underwriting and claim settlement procedures. With the help of data integration,
interactions would be more seamless and enable quicker claim settlement. So, when it
is time to make a claim and can expect a straightforward and speedy experience.

 Potential for Lower Premiums

In a fascinating turn of events, using technology may also result in lower
distributor margins, which might eventually mean lower premiums for customers. The
commissions normally paid to intermediaries are expected to drop as insurance
companies start selling plans directly through Bima Sugam, opening the door for more
reasonably priced options. Additionally, the IRDAI may even offer discounts on
policies purchased through this platform.

 No Charges for Customers

There will be no fees for customers to use Bima Sugam’s services. This implies
that one can take advantage of all of these benefits without incurring any further
expenses, benefiting everyone worldwide.

Regulatory framework for Bima Sugam

 Bima Sugam will be formed under Section 8 of the Companies Act, 2013 as
a not-for-profit company.
 Shareholding of the company will be widely held amongst life, general, and
health insurers, with no single entity having a controlling stake.
 Consent-based architecture for the services.
 Consumers will not be charged for availing services of Bima Sugam.
 IRDAI would nominate two members to the Board of the Company.

Significance of Bima Sugam

Bima Sugam is important on the following grounds:
 Bima Sugam will enable insurance companies to easily access validated and
authentic data from multiple touchpoints in real time.
 Bima Sugam will help to increase insurance penetration and density by
enhancing the 3A’s: “Availability, Accessibility, and Affordability” of
insurance products and services.
166 Indian Financial System

 Insurance penetration is measured as the percentage of insurance premiums to

GDP (Gross Domestic Product), and insurance density is calculated as the ratio
of premiums to population (per capita premium).
 Bima Sugam Promote transparency, efficiency, and collaboration across the
entire insurance value chain.

Review Questions
Conceptual type questions for 2 marks.
1. Give the meaning of RBI.
2. What do you understand by Monetary Policy.
3. What do you mean by Credit Control?
4. What is CRR?
5. What do you mean by Credit Rationing?
6. Give the meaning of Bank Rate and Repo Rate.
7. What is Reverse Repo Rate?
8. Give the meaning of Statutory Liquidity Ratio.
9. Give the meaning SEBI
10. Mention Financial Regulators in India.
11. Expand ULIP and DICGC.
12. Give the meaning of Deposit Insurance.
13. What do you mean by Micro Insurance.

Analytical type questions for 8 marks.

1. Explain briefly the objectives of RBI.
2. Briefly explain the objectives of monetary policy.
3. Give the management structure of RBI
4. Write a note on IRDAI Bima Sugam.
5. What do you understand by the term NPS? What the benefits of NPS.
6. Differentiate between Life and General Insurance.

Essay type questions for 14 marks.

1. What is RBI? Explain the functions of RBI.
2. What is Monetary Policy? Explain the Monetary Policy of RBI.
3. What is SEBI? Explain in detail the functions of SEBI.
4. Explain the role of Atal Pension Yojana.
Financial Regulators and Insurance 167

5. What is LIC IPO? Explain features of LIC IPO and Disinvestment Policy.

Chapter ‒ 5
CONTEMPORARY CHALLENGES
Content:
Emerging Trends – Green Finance (Sustainable Bonds) – AI in Fraud Detection –
CBDCs – Challenges – NPAs, Cyber security Risks, Crypto Regulation.

5.1 Introduction to Contemporary Challenges

Contemporary challenges are the significant, current issues facing society today,
spanning social, economic, political, and environmental domains. Understanding these
challenges is crucial for individuals and societies to adapt, innovate, and create a better
future. Contemporary challenges are problems or situations that are relevant to the
present time and require attention and solutions. They are not abstract or historical
issues but rather events, trends, and problems that directly impact people’s lives and the
world around them in the here and now. These challenges can be diverse, affecting
individuals, communities, nations, and the global community.
Contemporary Challenges or Issues refer to the current events and problems that
are facing the society today. These issues are diverse and can range from social,
economic, political, and environmental issues.
Contemporary issues have been a part of human society since the beginning of
civilization. However, the nature of these issues has changed over time, with new
challenges emerging as societies evolve. The modern era has been characterized by
rapid technological advancements, globalization, and increasing awareness of
environmental and social issues.

5.2 Types of Contemporary Issues

Contemporary issues can be broadly categorized into the following types:
 Social Issues: This refers to issues related to social inequality, discrimination,
and access to basic needs such as healthcare, education, and housing.
 Economic Issues: This refers to issues related to economic growth, income
inequality, and unemployment.
Contemporary Challanges 169

 Political Issues: This refers to issues related to government policies, political

corruption, and civil rights.
 Environmental Issues: This refers to issues related to climate change,
pollution, and the depletion of natural resources.

Examples of Contemporary Issues

 Social Issues: The #MeToo movement, which has brought attention to sexual
harassment and assault in the workplace, as well as the Black Lives Matter
movement, which seeks to address systemic racism and police brutality.
 Economic Issues: The increasing income inequality in many countries, with
the wealthiest individuals and corporations amassing more wealth while many
others struggle to make ends meet.
 Political Issues: The ongoing debate over immigration policies, with many
countries grappling with how to balance the needs of immigrants with the
concerns of their citizens.
 Environmental Issues: The growing concern over climate change, with
increasing evidence of its impacts on ecosystems and human societies, as well
as the depletion of natural resources such as fresh water and fossil fuels.

5.3 Introduction to Emerging Trends

The concept of emerging trends signifies new patterns or changes occurring within
society and specific fields such as Finance, Marketing, Banking, Technology and the
likes.
The strength of any modern economy is based on the soundness of its financial
system. We have all seen the impact of a collapsing financial system in our neighboring
countries. The financial system of a country comprises of a few main elements namely,
financial institutions, financial markets, financial instruments, and financial
intermediaries. Following are recent trends in the Indian financial market.

5.4 Recent Trends in Financial Market

The Indian financial markets have witnessed many changes in recent years and are
faced with everchanging trends that ultimately shape the financial markets. Some of the
recent trends in the Indian financial markets are highlighted below.

 Growth of Digital Finance

There has been an exponential increase in digital finance in India over recent
years. This is further backed by various measures under the ‘Digital India’ vision of the
government. This includes digital payment methods such as UPI, mobile banking, and
e-wallets. This growth is also the result of the increase in internet and smartphone
penetration which has taken digital finance to even the rural parts of the country.
170 Indian Financial System

 Focus on Financial Inclusion

Financial inclusion has been the focus of the Indian government and regulators for
many years now. Many measures for financial inclusion include increasing access to
financial services for under-served populations such as farmers and small businesses.

 Rise of Mutual Funds

Mutual funds have become increasingly popular and a staple among retail
investors as a way to invest in the stock market. The introduction of direct plans has
also made them more accessible and cost-effective for the average investor.

 Increased Focus on ESG Investing

Social consciousness has been increasing greatly among the public at large over
the years. This has therefore resulted in an increase in Environmental, Social, and
Governance (ESG) investing which is gaining prominence as investors increasingly
seek to align their investments with their values.

 Emergence of Robo-Advisors
Financial markets have also seen a rise in Robo-advisors. These are algorithms that
provide investment advice based on AI (Artificial Intelligence). Such platforms are
becoming quite popular by offering low-cost and personalized investment solutions to
businesses and investors.
These trends are shaping the future of the Indian financial market and are likely to
continue to drive growth and innovation in the years to come.
The other areas of emerging trends have been discussed below:

5.5 Green Finance (Sustainable Bonds)

Climate change has emerged as the defining political and economic problem of
this century and it is likely to stay so for the foreseeable future. Governments,
investors, businesses, and private individuals worldwide are beginning to take action in
response to the climate issue, especially on decarbonization techniques. Moving to a
low-carbon or green economy would need extraordinary levels of fresh capital
investment, notably in the form of green financing, to support activities that cut GHG
(Green House Gas) emissions and assist firms in adapting to the effects of climate
change. That makes it important to understand what is green finance and how it
matters.

Meaning of Green Finance

Green finance is a loan or investment that promotes environmentally-positive
activities, such as the purchase of ecologically-friendly goods and services or the
construction of green infrastructure. As the hazards connected to ecologically
Contemporary Challanges 171

destructive products and services rise, green finance is becoming a mainstream

phenomenon.
Green Finance delivers economic and environmental advantages to everybody. It
broadens access to environmentally-friendly goods and services for individuals and
enterprises, equalizing the transition to a low-carbon society, and resulting in more
socially inclusive growth. This results in a ‘great green multiplier’ effect in which both
the economy and the environment gain, making it a win-win situation for everyone.
Green financing differs from traditional financing methods in several ways, such
as:
 It emphasizes the environmental and social outcomes of projects or activities,
going beyond mere financial returns.
 It mandates greater transparency and disclosure from issuers and investors
regarding the environmental and social performance of their investments.
 Involvement in green financing may carry higher risks and lower returns
compared to traditional methods due to less available information about the
environmental and social impacts of certain projects or activities.

5.6 Types of Green Financing

The different types of Green Finance are:

 Green Mortgages
They allow lenders to provide better terms to home purchasers of properties with a
high environmental sustainability rating or if the buyer agrees to invest in enhancing
the environmental performance of a property.

 Green Loans
These are loans used to support environmental initiatives such as household solar
panels, electric automobiles, energy efficiency projects, and more.

 Green Credit Cards

Green credit cards such as Aspirations’ Zero card plant a tree every time a
customer makes a purchase. They enable customers to direct their expenditure toward
green finance in order to have a lasting impact on the environment.

 Green Banks
Green banks operate similarly to traditional banks, but they employ public funds to
spur private investment in renewable energy and other environmentally friendly
initiatives.

 Green Bonds
172 Indian Financial System

Green bonds account for the vast bulk of green funding. They include bond
investments, the earnings from which are used to support a variety of green initiatives
such as renewable energy, clean transportation, and conservation, among others.

Benefits of Green Finance

The important benefits of Green Finance are:

 Encourages Spread of Technologies and Development of Environmentally

Friendly Infrastructure
Governments of developing countries are constructing infrastructure that will
improve long-term resource management, increase a country’s competitiveness and
channel private sector money into local green markets.

 Produces a Comparative Advantage

In response to mounting challenges from climate change and other environmental
and economic issues, a low-carbon green development may unavoidably shift from a
voluntary to an obligatory strategy. Expanding green financing will give you a
competitive advantage when environmental regulations tighten.

 It Adds Business Value

Businesses can enhance the value of their portfolio by increasing (and advertising)
their participation in green financing. It offers their company a green edge, attracting
more environmentally concerned investors and customers.

 Enhances Economic Prospects

Governments that promote green financing assist in protecting their societies from
scarcity of resources. They do this by building and encouraging local market s for
renewable energy, as well as entering new markets with high employment potential.

Green Finance Examples

The examples of Green Finance include:

 Green Bonds
These are bonds issued by governments, companies, or organizations to fund
environmentally-friendly projects such as renewable energy, energy efficiency, and
sustainable land use. Investors receive a financial return while also supporting projects
that have a positive environmental impact.

 Sustainable Investment Funds

These are mutual funds or exchange-traded funds that invest in companies or
projects that have a positive environmental impact. By investing in sustainable
Contemporary Challanges 173

investment funds, individuals or organizations can support environmentally-friendly

initiatives while also potentially earning a financial return on their investment.

5.7 Sustainable Bond

Meaning of Sustainable Bond
Sustainable Bonds are any type of bond instrument where the proceeds or an
equivalent amount will be exclusively applied to finance or re-finance a combination of
both Green and Social Projects.
Sustainable Bond or a Green Bond is a type of debt instrument designed to raise
capital for projects that deliver positive environmental outcomes. These projects can
span various domains, including renewable energy infrastructure, energy efficiency
improvements, sustainable agriculture, and clean transportation. The distinguishing
feature of green bonds lies in their purpose: they exist solely to finance or refinance
“green” initiatives.

Features of Sustainable Bonds or Green Bonds

The following are the important key highlights of Green Bonds:
(a) Purpose: The primary objective of green bonds is to mobilise funds for
environmentally beneficial projects. By channelling investments toward green
initiatives, these bonds contribute to a more sustainable future.
(b) Categories of Projects: Green bonds are versatile and can be utilised across a
wide spectrum of projects. Some common categories include:
 Renewable Energy Infrastructure: Funding solar, wind, hydroelectric,
and other renewable energy projects.
 Energy Efficiency Improvements: Supporting initiatives that enhance
energy efficiency in buildings, factories, and transportation.
 Sustainable Agriculture: Financing practices that promote soil health,
biodiversity, and responsible land use.
 Clean Transportation: Investing in electric vehicles, public transport
systems, and infrastructure.
(c) Transparency and Accountability: Regulatory bodies, such as the Securities
and Exchange Board of India (SEBI), have established stringent disclosure
requirements for issuing and listing green debt securities. These guidelines
ensure transparency in the use of proceeds from green bonds, fostering investor
confidence.
(d) Investor Interest: Investors who prioritise environmental impact actively seek
out green bonds. By aligning their investments with sustainability goals, they
contribute to positive change while earning financial returns.
174 Indian Financial System

Green Bonds in India

In India, green bonds have gained prominence as a sustainable financing
instrument. Several notable instances of green bonds are listed on Indian stock
exchanges, they are:
 Sovereign Green Bonds: These bonds are backed by the government, offer a
higher level of safety compared to corporate green bonds. Investors benefit
from the sovereign guarantee, making them a reliable investment option.
 Corporate Green Bonds: These are issued by corporations, these bonds vary
in credit safety based on their credit ratings. They serve as a means for
companies to raise capital for green projects while appealing to environmentally
conscious investors.
As the world increasingly focuses on sustainability, green bonds emerge as a
powerful tool for financing positive change. By directing capital toward projects that
benefit both the environment and society, we pave the way for a greener, more resilient
future.

5.8 AI (Artificial Intelligence) Fraud Detection do from

Meaning of Artificial Intelligence
Artificial intelligence (AI) is technology that enables computers and machines to
simulate human learning, comprehension, problem solving, decision making, creativity
and autonomy.
The term “AI” describes a wide range of technologies that power many of the
services and goods we use every day, from apps that recommend TV shows to chatbots
that provide customer support in real time.
An Artificial Intelligence (AI), is the ability of a digital computer or computer-
controlled robot to perform tasks commonly associated with intelligent beings. The
term is frequently applied to the project of developing systems endowed with
the intellectual processes characteristic of humans, such as the ability to reason,
discover meaning, generalize, or learn from past experience.

5.9 AI Fraud Detection

AI Fraud Detection refers to the use of Artificial Intelligence (AI) to identify,
prevent, and mitigate fraudulent activities across digital platforms. Security solutions
use advanced algorithms, machine learning models, and behavioral analysis to
Contemporary Challanges 175

distinguish in real-time between genuine users of a digital platform and those who
intend to commit fraud through it.
AI Fraud Detection uses AI and ML algorithms to identify suspicious patterns,
anomalies, and behaviours that indicate fraudulent activities. Unlike traditional rule-
based systems like a web application firewall (WAF), AI fraud detection continuously
learns from new data, improving its accuracy over time while adapting to changing
fraud tactics.
AI Fraud Detection Systems analyse vast amounts of data in real-time. They
examine everything from transaction patterns and user behaviour to device fingerprints
and network signals. By identifying subtle patterns and correlations that human analysts
might miss, these systems can detect fraud attempts with higher accuracy and speed
than conventional methods.
The technology has become crucial as fraudsters use increasingly sophisticated
techniques, including AI-powered attacks. As digital transactions continue to grow in
volume, manual review processes simply cannot keep pace with the scale and
sophistication of modern fraud attempts.

Evolution of AI in Fraud Prevention

AI has become increasingly important in fraud prevention. Its evolution happened
in three phases:

Phase 1: Rule-based Systems and Manual Reviews

Traditional fraud prevention relied heavily on static rules and human analysis.
These systems flagged transactions based on predefined criteria, such as transaction
size or geographical location. While effective against simple fraud attempts, they
struggled with sophisticated attacks and generated high rates of false positives.

Phase 2: Machine Learning and Behavioural Analysis

The introduction of machine learning helped fraud detection systems identify
patterns in large datasets, so they could adapt to new fraud tactics. These systems
focused on behavioural analysis and examined how users interacted with digital
platforms to identify suspicious activities. This approach improved detection accuracy
while reducing false positives.

Phase 3: Advanced AI and Real-time Prevention

Today’s cutting-edge fraud prevention systems use advanced AI technologies,
including deep learning and neural networks, to detect and prevent fraud in real-time.
These systems analyse hundreds of variables, identifying complex patterns and subtle
anomalies that indicate fraudulent behaviour. By providing immediate feedback and
continuously learning from new data, they stay ahead of evolving fraud tactics.
176 Indian Financial System

Benefits of AI Fraud Detection

AI fraud detection offers numerous advantages for businesses across all industries:

(a) Real-time Detection and Prevention

Unlike traditional systems that may flag suspicious activities for later review,
AI-powered solutions can identify and respond to fraud attempts in milliseconds. This
real-time capability is crucial for preventing financial losses and protecting customers
before they suffer from any kind of fraud.
The speed of detection also helps businesses stop fraudulent activities before they
escalate or spread to multiple accounts. It’s a proactive approach that significantly
reduces the potential damage from coordinated fraud attacks.

(b) Scalability
As transaction volumes grow, AI fraud detection systems can easily scale to
handle the increased load without proportional increases in cost or resources. This
scalability is essential for businesses experiencing rapid growth or seasonal fluctuations
in activity.
Modern AI systems can analyse billions of transactions daily, adapting
automatically to changes in traffic patterns. This allows businesses to maintain effective
fraud protection regardless of their size or growth trajectory.

(c) Cost Reduction

AI fraud detection delivers significant cost savings through several mechanisms:
 Reduced Fraud Losses: By preventing fraudulent transactions, businesses
avoid direct financial losses that can amount to millions of dollars annually.
 Lower Operational Costs: Automating fraud detection reduces the need for
large teams of manual reviewers, decreasing operational expenses.
 Decreased Chargeback Fees: Preventing fraud means fewer credit card
chargebacks, saving businesses from associated fees and penalties.
 Protected Reputation: Avoiding public fraud incidents prevents the substantial
costs associated with reputational damage and customer loss.

(d) Increased Accuracy

AI systems significantly outperform traditional rule-based approaches in both
detecting actual fraud and reducing false positives. Machine learning algorithms can
identify subtle patterns and anomalies that might escape rule-based systems, leading to
more accurate fraud detection.
Contemporary Challanges 177

This improved accuracy ensures that legitimate customers aren’t incorrectly

flagged as fraudulent, improving the user experience while still providing robust
protection against actual threats.

(e) Customer Trust and Satisfaction

By preventing fraud without creating unnecessary friction, AI fraud detection
helps businesses build and maintain customer trust. Customers appreciate both the
security and the seamless experience, leading to higher satisfaction rates and higher
loyalty.

Process of AI Fraud Detection

Many organizations have a dedicated fraud prevention team. Before implementing
a fraud detection system, this team often performs a risk management assessment. This
assessment helps determine which functional areas of the business might be the targets
for different types of fraud.
The fraud prevention team assigns risk scores to each fraud risk to determine
which pose the greatest threats and should be prioritized. Risk scores typically measure
how likely a threat is to occur and how much damage it might do.
The team then evaluates the fraud prevention measures and fraud detection
solutions that it can use to address fraud threats based on their type and severity.
The most common fraud detection techniques include transaction monitoring,
statistical data analysis and artificial intelligence. The briefly information on these
techniques have been given below:

 Transaction Monitoring
For many businesses, the most obvious place to search for potential fraud is among
financial transactions. Transaction monitoring tools automate the process of fraud
detection by monitoring and analysing transaction data workflows in real time. These
tools can perform identity verification and account authentication to interrupt
fraudulent transactions as they happen.
Transaction monitoring tools might also use anomaly detection to uncover unusual
patterns or behaviours that require further investigation. Variables such as purchase
frequencies, number of transactions, geographic locations of users and the monetary
value of transactions help distinguish normal activity from potentially fraudulent
behaviour.

 Statistical Data Analysis

Fraud detection doesn’t always take place in real time. Statistical data analysis can
uncover fraud long after it has taken place through the auditing of historical data.
178 Indian Financial System

Fraud investigators use techniques such as data mining, regression analysis and
data analytics to identify and isolate fraud patterns in large datasets. Probability
distributions and data matching can help investigators determine where and when fraud
has already happened or will likely take place in the future. By adding fraud metrics
and data points to charts, graphs and other visualizations, investigators can help even
nontechnical users understand fraud threats across their organizations.

 Artificial Intelligence
Many organizations now use artificial intelligence and machine learning to
accelerate and improve their fraud detection capabilities. A neural network, which is a
type of machine learning model, can monitor transactions, analyse data and detect (or
predict) fraudulent behaviour faster and more efficiently than traditional fraud detection
techniques.

5.10 Common Types of Fraud in AI

The common types of frauds in AI Fraud detection are:
(a) Credit Card Fraud: One of the most common use cases for fraud detection.
Credit card fraud occurs when an unauthorized user obtains someone else’s
credit card information and uses it to purchase goods or services or withdraw
funds. Often, the authorized card user discovers the theft and is issued a
chargeback. The merchant loses both the product or service and the purchase
cost, and the issuing bank might levy a chargeback fee.
(b) Account Takeovers: This type of fraud can be the result of identity
theft, hacking or a successful phishing email. A criminal obtains the login
credentials of a user account and uses that account to make fraudulent
transactions. Targets include bank accounts, online merchants, payment
vendors, government services and online gambling sites.
(c) Payment Fraud: An umbrella term for fraudulent transactions that were
conducted by using stolen or counterfeit payment information. Fraudsters might
use fake checks, hijacked electronic fund transfers, stolen credit card
information or fake user accounts to commit payment fraud.
(d) Money Laundering: Money laundering is the process of “washing” illegally
obtained funds so they can be used for legitimate purposes, with no way to trace
the funds back to their criminal source. Fraudsters often use money laundering
to conceal the money they have stolen from fraudulent transactions.
(e) Insider Fraud: Anyone within an organization that is familiar with its IT
systems, processes, data and security protocols could be an insider threat.
Employees, contractors, business partners and vendors might commit insider
fraud for monetary gain or intellectual property theft.
Contemporary Challanges 179

The Role of Artificial Intelligence in Fraud Detection

The role of Artificial Intelligence (AI) in fraud detection is crucial due to the
rapidly increasing volume of digital transactions and the rising sophistication of
fraudulent activities. AI technology enables fraud detection systems to analyse vast
amounts of data in real time and identify unusual patterns of behaviour that are
indicative of fraudulent activity. The following are some key ways in which AI is used
in fraud detection:
(a) Automated Anomaly Detection: AI algorithms in automated fraud
detection can be trained in transactional fraud monitoring systems to recognise
patterns in data that suggest fraudulent activity. These patterns can
include unusual transaction amounts, multiple transactions from the same
device, or purchases made from different locations in a short time frame. Once
the AI detects an anomaly, it can flag the transaction for further investigation.
(b) Behavioural Analysis: AI technology can analyse customer behaviour patterns
over time to identify unusual activity. For example, if a customer suddenly
begins to make large purchases outside their usual spending habits, the AI
system can flag these transactions as suspicious.
(c) Natural Language Processing (NLP): AI algorithms can use NLP to analyse
customer communications, such as emails or chat transcripts, to identify
indications of fraud. For example, if a customer suddenly changes their account
information and then sends an email requesting a password reset, the AI system
can identify this as a potential fraud attempt.
(d) Continuous Learning: AI algorithms can be trained with new data to improve
their accuracy and effectiveness over time. This continuous learning helps to
ensure that fraud detection systems stay up to date with the latest fraud trends
and tactics.
Overall, the role of AI in fraud detection is to identify suspicious behaviour and
fraudulent transactions in real-time, reducing the risk of financial losses for
businesses and protecting customer data.

Future of Artificial Intelligence in Financial Fraud Detection

Artificial intelligence (AI) has been a game changer for the financial industry
when it comes to fraud detection. The use of machine learning models and other
AI-powered fraud prevention technologies has enabled financial institutions to better
protect themselves against fraudulent activities. With advancements in technology, the
future of AI in financial fraud detection is set to become even more sophisticated and
effective.

 Machine Learning Algorithms

One of the key areas where AI is likely to make significant inroads in the future is
in the detection of fraudulent activities that are increasingly difficult to detect using
traditional rule-based systems. Machine learning algorithms, which can analyse vast
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amounts of data and identify patterns and anomalies that are indicative of fraud, will
become even more adept at identifying fraudulent activity in real time.

 Natural Language Processing (NLP)

Another area where AI is expected to have a significant impact in the future is in
the use of natural language processing (NLP) to analyse unstructured data sources such
as emails, chat logs, and social media posts. By analysing this data, AI-powered
systems can identify potential fraudsters and other suspicious activities.

 Blockchain Technology
One of the most exciting developments in the future of AI in financial fraud
detection is the integration of blockchain technology. Blockchain provides a secure and
transparent ledger that can be used to store transaction data, while AI can be used to
analyse the data and detect fraudulent activity. This combination of technologies will
enable financial institutions to better track and detect fraudulent activities, even in
complex networks.
Hence, the future of AI in financial fraud detection is set to be a game changer for
the industry. With continued advancements in machine learning, natural language
processing, and the integration of blockchain technology, financial institutions will be
better equipped to detect and prevent fraudulent activities, ultimately protecting their
customers and their businesses.

5.11 CBDC (Central Bank Digital Currency)

Introduction to CBDC
A Central Bank Digital Currency (CBDC) is the legal tender issued by a central
bank in a digital form. It is the same as a fiat currency and is exchangeable one-to-one
with the fiat currency. Only its form is different. It is basically the virtual form of a fiat
currency created and regulated by the nation’s monetary authority or central bank
(Reserve Bank of India).
CBDC is a digital token or electronic record of a country’s official money. It is
sovereign currency in an electronic form and it would appear as liability (currency in
circulation) on a central bank’s balance sheet. The underlying technology, form and
use of a CBDC can be moulded for specific requirements. CBDCs should be
exchangeable at par with cash.
The Digital currency backed by the central bank of a country. Just like currency
notes issued by the Central Bank, the CDBC is a legal tender and accepted for the
payment of various transactions within a country.
Contemporary Challanges 181

CBDC is similar to sovereign paper currency but takes a different form,

exchangeable at par with the existing currency and shall be accepted as a medium of
payment, legal tender and a safe store of value.
CBDCs is substantially not different from banknotes, but being digital it is likely
to be easier, faster and cheaper. It also has all the transactional benefits of other forms
of digital money. CBDC, being a sovereign currency, holds unique advantages of
central bank money viz. trust, safety, liquidity, settlement finality and integrity.

Features of CBDC
The main features of CBDC are:
 CBDC is sovereign currency issued by Central Banks in alignment with
their monetary policy.
 It appears as a liability on the central bank’s balance sheet.
 Must be accepted as a medium of payment, legal tender, and a safe store of
value by all citizens, enterprises, and government agencies.
 Freely convertible against commercial bank money and cash.
 Fungible legal tender for which holders need not have a bank account.
 Expected to lower the cost of issuance of money and transactions.

Types of CBDC
There are two types of CBDC: namely,
 Retail CBDC: CBDC that can be used for people for day-to-day transactions.
 Wholesale CBDC: CBDC that can be used only by financial institutions such
as Banks, NBFCs etc.

Legal Framework for Issuance of CBDC

The Finance Act of Government of India 2022 has amended the RBI Act, enabling
it to introduce Central Bank Digital Currency. The definition of bank note was amended
wherein RBI was allowed to issue both physical and digital currency by amending
Section 2 of RBI Act, 1934.

Significance of Central Bank Digital Currency

The Significance of Central Bank Digital Currency is studied as under:
 It would reduce the cost of currency management while enabling real-time
payments without any inter-bank settlement.
 India’s fairly high currency-to-GDP ratio holds out another benefit of CBDC to
the extent large cash usage can be replaced by (CBDC), the cost of printing,
transporting and storing paper currency can be substantially reduced.
 It will also minimize the damage to the public from the usage of private virtual
currencies.
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 It will enable the user to conduct both domestic and cross border transactions
which do not require a third party or a bank.
 It has the potential to provide significant benefits, such as reduced dependency
on cash, higher seigniorage due to lower transaction costs, and reduced
settlement risk.
 It would also possibly lead to a more robust, efficient, trusted, regulated and
legal tender-based payments option.

Advantages of Central Bank Digital Currency

The main advantages of Central Bank Digital Currency are:
 Promote cashless economy by reducing Cash-to-GDP ratio.
 Increase in Financial Inclusion.
 Stability and Resilience of payment system since CBDC would promote
competition in the payment system and ensures that no single company
dominates the payment ecosystem.
 Counter the Stable coins such as Diem which could be used for making
payments.
 Increase in effectiveness of Monetary Policy.
 Push to development of Fintech sector.
 Provide a real time picture of economic activity and hence better GDP estimates
and efficient monetary policy formulation.
 Traceability of transactions would crack down on corruption and money
laundering.
 As it being a sovereign currency, ensures settlement finality and thus reduces
settlement risk in the financial system.
 CBDCs could also potentially enable a more real-time, cost-effective seamless
integration of cross border payment systems.
 The e₹ system will bolster India’s digital economy, cashless economy, enhance
financial inclusion, and make the monetary and payment systems more
efficient.
 Could ease current frictions in cross-border payments.
 Counter the monopoly of private sector issued cryptocurrencies.

Disadvantages of Central Bank Digital Currency

The main drawbacks of Central Bank Digital Currency are:
 CBDC does not decentralize the economy as the central bank controls data of
transactions between the banks and their consumers.
 The privacy of users was compromised to some extent.
 Legal and regulatory issues act like limitations.
Contemporary Challanges 183

Challenges and Concerns of CBDC

The challenges before CBDC are:
 Potential Disintermediation of Banks as People may Shift from Depositing
Money in the Bank to CBDC: This will lower the deposits with the banks
which will force them to increase their deposit rates to attract customers. It may
lead to an increase in the rate of interest on loans in the economy.
 Accelerate Bank Runs: By providing depositors a safe and liquid alternative to
bank deposits, CBDCs may accelerate bank runs during a period of financial
stress.
 Security Risks and Financial System Abuses: CBDC may be susceptible to
cyber-attacks and other security breaches. Such attacks or breaches may be
committed to misuse the CBDC for illicit activities.
 Competition to Private Payment Service Providers: Introduction of CBDC
could lead to direct competition with private payment providers (such as Paytm,
Google pay etc). This may reduce their incentives to invest in innovation.
 Higher Burden on the RBI: If the RBI adopts “Direct Model”, it will have to
directly engage with the public for opening accounts and hence overall burden
on the RBI could increase. This may in turn lead to neglect of its core activities.
 Reputation Risk: Security breaches on the CBDC may dent public confidence
in the RBI.
 Data Privacy Issues: Traceability feature of CBDC would have impact on
Right to Privacy of the Individuals. Hence, the need for strong data regulation
law in India.

5.12 Important Challenges in Financial System

A challenge can be defined as a situation that tests someone’s abilities, skills, or
resources. Challenges can be perceived as obstacles that hinder progress or as
opportunities for growth and development. The perception of a challenge often depends
on an individual’s mindset, resilience, and coping strategies.
Hence, a challenge is a situation one faces that needs great mental or physical
effort in order to be done successfully and therefore tests a person’s ability.
The following are the challenges of Financial System:

5.12.1 Non-Performing Assets (NPA)

Non-Performing Assets (NPA) have been a significant concern for banks and
financial institutions globally. The term ‘Non-Performing Asset’ (NPA) might sound
complex, but it is key to understanding the health of financial institutions. When loans
like Personal Loans or advances stop bringing in interest or other returns, they are
known as NPAs.
184 Indian Financial System

Meaning of Non- Performing Asset

A NPA refers to loans or advances that have stopped generating income for the
bank. This situation occurs when borrowers fail to make scheduled interest payments or
principal repayments for a continuous period of 90 days. When this limit is crossed, the
loan is classified as an NPA. This classification is important because it signals that the
loan might be at risk of default, meaning the bank might not get its money back.
The NPA full form in banking is ‘Non-Performing Asset.’ NPAs are important
signs of financial health for banks, as they directly impact a bank’s profitability and
stability. When a loan becomes an NPA, it stops affecting the bank’s income, leading to
a loss of revenue. Moreover, it requires banks to keep aside additional funds as
provisions to cover potential losses from these assets, affecting their overall financial
condition. Essentially, NPAs reflect the credit risks and management effectiveness of a
bank, shaping how it is viewed by investors and regulators.
Examples of Non-Performing Assets include loans where the borrower has
defaulted on payments for an extended period, leading to the loan being classified as
non-performing. Other examples of NPAs can be overdue credit card payments,
unpaid mortgages, or loans where the borrower has declared bankruptcy and is unable
to repay the borrowed amount.
Non-performing assets (NPAs) significantly impact a bank’s operations and
financial health. When a loan or advance is classified as an NPA, it signals that the
borrower has not made interest payments or principal repayments for at least 90 days.
This situation leads to several direct consequences for the bank. First, there’s the
immediate risk of loss. Since the loan payments are not being made, the bank faces the
possibility that the borrowed money might never be repaid. This can lead to the
financial institution having to write off the loan as a loss, which directly affects its
profit margins.
Now, the presence of NPAs on a bank’s books relates to additional capital
allocation for covering these potential losses. This process, known as provisioning,
involves setting aside a certain amount of money to cushion the bank against the
financial impact of these non-performing loans. This provisioning reduces the amount
of money available for other lending opportunities, limiting the bank’s ability to
generate income from new loans. It also affects the bank’s profitability, as funds that
could have been used to earn interest are instead held as a protective measure. Overall,
managing NPAs is very important for maintaining a bank’s financial health and
operational efficiency.

Types of Non-Performing Asset

In the banking sector, as we have established already, non-performing assets
(NPAs) are loans that have stopped generating income. Now, these are categorised into
three main types based on the duration of non-payment and the likelihood of recovery:
 Substandard Assets: These are loans where payments are overdue between 90
days and up to 12 months. At this stage, the loans are considered risky because
Contemporary Challanges 185

the borrower has started to miss payments, but there is still a possibility that
they might resume payment. Banks keep a close watch on these loans to
manage the risk effectively.
 Doubtful Assets: If a substandard asset continues to be non-performing beyond
12 months, it transitions into a doubtful asset. Here, the chances of recovery
begin to go down significantly. The uncertainty of recovering the money
increases, and banks may have to consider provisions for potential losses,
which can impact their financial statements.
 Loss Assets: These are loans where, after thorough evaluation, the bank or an
external auditor concludes that recovery is unlikely. The bank has exhausted all
practical avenues of recovery, and continuing to consider this asset recoverable
becomes unreasonable. Loss assets require banks to write off the debt,
acknowledging that the funds lent are unlikely to be recovered.

Advantages of NPA Classification

NPA Classification benefits are:
 Transparency: NPA classification shows up in banks’ financial statements the
loan portfolio and associated risk.
 Corrective Actions: The bank can take actions like restructuring loans or
recovering assets through recognition of NPAs.
 Strict Regulation and Compliance: Reporting on NPAs is a way to exercise
regulatory powers and ensure that banking policies and standards are followed
in the industry.
 Informed Decision Making: Helps investors, regulators and stakeholders to
analyze the financial health and risk exposure of a bank or institution.

Reasons for Non-Performing Assets

The important reasons for NPA are:
 Defective Lending Process: Improper selection and lack of periodic review of
the credit profile of borrowers ensuring their repayment capabilities can create
NPAs in PSBs.
o Due to a lack of cooperation with financial institutions, borrowers
default in more than one bank.

 Willful Defaults: Rising cases of borrower who have access to funds to repay
their loans but still choose not to, and default on the repayment of the loan.
 Industrial Sickness: Ineffective management, lack of adequate resources and
technological changes, and changing government policies produce industrial
sickness. Therefore, banks financing these industries ultimately end up with
a low recovery rate of loans reducing their profit and liquidity.
186 Indian Financial System

 Regulatory: Flouting of RBI guidelines and non-compliance with regulatory

directions regarding banking operations by Public Sector Banks (PSBs), can
lead to frauds and rise in NPAs.
 Frauds by Banker and Borrower: The size of frauds in the public sector
banking system has been increasing, though still small relative to the overall
volume of NPAs.

Impact of Non-Performing Assets

The impact of Non-Performing Assets (NPAs) goes deep into various aspects of a
bank's operations, influencing financial health, strategic decisions, and customer
relations. The following factors indicate the NPAs affect a bank's operations:

 Reduced Profitability
NPAs directly affect a bank’s income since the principal and interest are not being
paid. This reduction in income impacts the bank’s profitability and ability to lend.

 Increased Provisioning
Banks must set aside funds to cover potential losses from NPAs, which affects
their liquidity and capital adequacy.

 Higher Borrowing Costs

To compensate for the risk of NPAs, banks may increase interest rates, making
borrowing more expensive for other customers.

 Strained Banking Relationships

High levels of NPAs can strain the relationship between banks and their clients,
leading to a more cautious lending environment.

 Economic Impact
A high level of NPAs in the banking sector can lead to reduced credit availability,
slowing down economic growth.

Measures of RBI to Control Non-Performing Assets (NPA)

As the Non-Performing Assets is not a new phenomenon, there have been many
efforts on the part of the Government of India and RBI to sort out the problem. The
following Steps have taken to reduce NPA:
 Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002 (SARFAESI Act): It allows secured creditors to
take possession of collateral, against which a loan had been provided, upon a
default in repayment.
Contemporary Challanges 187

 Debt Recovery Tribunals: Established under the Recovery of Debts and

Bankruptcy Act, 1993 provide for the establishment of Tribunals for
expeditious adjudication and recovery of debts.
 Insolvency and Bankruptcy Code (IBC), 2016: For reorganisation and
insolvency resolution of corporate persons, partnership firms and individuals in
a time-bound manner i.e. within 180 days or the extended period of 90 days.
 National Asset Reconstruction Company (NARCL): It aims to reduce NPAs
of banks, improving financial system stability and efficiency.
 Indradhanush plan for revamping PSBs, envisaging infusion of capital in
PSBs.
 It is incorporated under the Companies Act 2013 with PSBs holding a majority
stake.

Challenges Associated with NPAs

The important challenges are:
 Profitability: Increase in NPAs increases provisioning and reduces the bank’s
net income.
 Liquidity: NPAs block funds and restrict the bank from lending to other
customers.
 Credit Availability: High NPAs may force institutions to reduce lending and
hence credit flow to borrowers.

5.12.2 Cyber Security Risks

Introduction
As we transition to a digital economy, the importance of cybersecurity in banking
is becoming a serious concern. Utilizing methods and procedures created to safeguard
the data is essential for a successful digital revolution. The rise of cyber security threats
in banking sector has made proactive defence strategies more important than ever. The
effectiveness of cybersecurity in banks influences the safety of our Personally
Identifiable Information (PII), whether it be an unintentional breach or a well-planned
cyberattack.
The stakes are high in the banking and financial industry since substantial financial
sums are at risk and the potential for significant economic upheaval if banks and other
financial systems are compromised.
In the digital age, online banking has revolutionized financial management,
offering convenience and efficiency. However, the rapid expansion of digital banking
also brings an increased risk of cyber threats. Cybersecurity has become a cornerstone
in safeguarding sensitive financial data, ensuring the trust and safety of both banks and
their customers.
188 Indian Financial System

Meaning of Cybersecurity
The arrangement of technologies, protocols, and methods referred to as
“Cybersecurity” and it is meant to safeguard against attacks, damage, malware, viruses,
hacking, data theft, and unauthorized access to networks, devices, programs, and data.
Protecting the user’s assets is the primary goal of cyber security in banking. As
more people become cashless, additional acts or transactions go online. People conduct
transactions using digital payment methods like debit and credit cards, which must be
protected by cyber security in banking sector frameworks and standards.

5.13 Cybersecurity Risk

Meaning: Cybersecurity risk is the probability of exposure or loss resulting from
a cyber-attack or data breach on your organization. A better, more encompassing
definition is the potential loss or harm related to technical infrastructure, use of
technology or reputation of an organization.
Organizations are becoming more vulnerable to cyber threats due to the increasing
reliance on computers, networks, programs, social media and data globally. Data
breaches, a common cyber-attack, have massive negative business impact and often
arise from insufficiently protected data.
Cybersecurity is relevant to all systems that support an organization's business
operations and objectives, as well as compliance with regulations and laws. An
organization will typically design and implement cybersecurity controls across the
entity to protect the integrity, confidentiality and availability of information assets.
Cyberattacks are committed for a variety of reasons including financial fraud,
information theft, activist causes, to deny service, disrupt critical infrastructure and
vital services of government or an organization.

Types of Cyber Security Risks

The six common types of cyber security risks:
 Nation States: cybersecurity, a “nation-state” actor refers to a government or
state-sponsored group that engages in cyberattacks for strategic and political
objectives, often targeting other nations, organizations, or critical
infrastructure. These actors are distinct from cybercriminals or hacktivists due
to their motivations, resources, and the scale of their operations.
The Nation State Actor has a ‘Licence to Hack’. They work for a government to
disrupt or compromise target governments, organisations or individuals to gain
access to valuable data or intelligence, and can create incidents that have
international significance. They might be part of a semi-hidden ‘cyber army’ or
Contemporary Challanges 189

‘hackers for hire’ for companies that are aligned to the aims of a government or
dictatorship.
 Cyber Criminals: Cybercriminals are individuals or groups who use
computers and the internet to commit illegal activities, often with the goal of
financial gain, disruption, or unauthorized access to data. They exploit
vulnerabilities in systems and networks to carry out various crimes, including
hacking, identity theft, online fraud, and malware attacks. Cybercrime is a
serious issue with significant financial and social consequences, impacting
individuals, businesses, and even national security
 Hacktivists: Hacktivists are individuals or groups who use their technical skills
to promote a political or social agenda through computer-based activism. They
leverage hacking techniques to achieve their goals, often targeting organizations
or governments they disagree with. Hacktivism is a form of civil disobedience,
distinct from cybercrime, as it's driven by ideology rather than financial gain.
Hacktivism is derived from combining the words ‘Hack’ and ‘Activism’,
hacktivism is the act of hacking, or breaking into a computer system, for
politically or socially motivated purposes. The individual who performs an act
of hacktivism is said to be a hacktivist. The hacktivist who does such acts, such
as defacing an organization’s website or leaking that organization’s
information, aims to send a message through their activities and gain visibility
for a cause they are promoting.
 Insiders and Service Providers: An insider is any person who has or had
authorized access to or knowledge of an organization’s resources, including
personnel, facilities, information, equipment, networks, and systems. Insider
threat is the potential for an insider to use their authorized access or
understanding of an organization to harm that organization.
This harm can include malicious, complacent, or unintentional acts that
negatively affect the integrity, confidentiality, and availability of the
organization, its data, personnel, or facilities.
 Developers of Substandard Products and Services: Sub-standard
cybersecurity products can expose organizations to significant risks, including
data breaches, financial losses, and reputational damage. These products might
lack essential security features, fail to meet industry standards, or have
vulnerabilities that can be exploited by attackers. sub-standard cybersecurity
products include: Lack of essential security features, Vulnerabilities, Non-
compliance with standards, Weak vendor support, Weak vendor support, Lack
of transparency etc
 Poor Configuration of Cloud Services: Poor configuration of cloud services
is a major cyber security risk, often cited as the leading cause of cloud
breaches. Misconfigurations can expose sensitive data, grant unauthorized
190 Indian Financial System

access, and lead to various security incidents like data breaches, financial
losses, and legal issues. Cloud misconfigurations occur when security settings
in cloud environments are not properly configured, leaving systems vulnerable
to attack. This can include issues like overly permissive access controls,
incorrect firewall settings, weak identity and access management, or neglecting
software updates.

Significance of Cybersecurity
The significance of cybersecurity in banking cannot be overstated. The
significance is studied as under:

(a) Protecting Sensitive Data

Financial institutions handle vast amounts of sensitive customer data, such as
personal details, account information, and transaction records. Cybersecurity measures
ensure this information remains secure and inaccessible to unauthorized entities.

(b) Preventing Financial Loss

Cyberattacks, such as unauthorized transactions and data breaches, can result in
significant financial losses for both banks and customers. A robust cybersecurity
infrastructure mitigates these risks effectively.

(c) Maintaining Customer Trust

In the digital landscape, customer trust hinges on the bank’s ability to secure their
financial data. Strong cybersecurity fosters confidence, enhancing customer loyalty and
satisfaction.

(d) Ensuring Regulatory Compliance

Financial institutions must comply with strict data protection regulations, such as
GDPR or RBI guidelines. Effective cybersecurity systems ensure adherence to these
legal requirements, avoiding penalties and reputational damage.

(e) Preventing Operational Disruptions

Cyberattacks can disrupt banking operations, leading to customer inconvenience
and reputational harm. A resilient cybersecurity strategy ensures seamless service
delivery.

Types of Cybersecurity
There are seven types of cyber security, each explained below in detail with uses
and functions:
Contemporary Challanges 191

(a) Network Security (Protecting Networks from Unauthorized Access)

It focuses on securing computer networks from unauthorized access, data breaches,
and other network-based threats. This involves implementing technologies such
as Firewalls, Intrusion detection systems (IDS), Virtual private networks (VPNs),
and Network segmentation as well as deploying antivirus software.
 Using public Wi-Fi in locations like cafes and malls poses significant security
risks. Malicious actors on the same network can potentially intercept your
online activity, including sensitive information. If you use payment gateways
on these unsecured networks, your financial data could be compromised
because these open networks don’t have proper security layers, which means
anyone even hackers can watch what you’re doing online.
 So, use a secure private network or VPN to protect your internal network from
outside threats.

(b) Application Security (Ensuring Secure Software and Apps)

Concerned with securing software applications and preventing vulnerabilities that
could be exploited by attackers. It involves secure coding practices, regular software
updates and patches, and application-level firewalls.
 Most of the Apps that we use on our cell phones are Secured and work under
the rules and regulations of the Google Play Store.
 There are 3.553 million applications in Google Play, Apple App Store has
1.642 million, and Amazon App Store has 483 million available for users to
download. With so many choices, it’s easy to assume all apps are safe but that’s
not true.
 Some apps pretend to be secure, but once installed, they collect personal data
and secretly share it with third-party companies.
 The app must be installed from a trustworthy platform, not from some 3rd party
website in the form of an APK (Android Application Package).

(c) Information or Data Security (Safeguarding Sensitive Data)

Focuses on protecting sensitive information from unauthorized access, disclosure,
alteration, or destruction. It includes Encryption, Access controls, Data classification,
and Data loss prevention (DLP) measures.
 Incident response refers to the process of detecting, analysing, and responding
to security incidents promptly.
 Promoting security awareness among users is essential for maintaining
information security. It involves educating individuals about common security
risks, best practices for handling sensitive information, and how to identify and
respond to potential threats like phishing attacks or social engineering attempts.
192 Indian Financial System

 Encryption is the process of converting information into an unreadable format

(ciphertext) to protect it from unauthorized access.

(d) Cloud Security (Defending Cloud Storage and Applications)

It involves securing data, applications, and infrastructure hosted on cloud
platforms, and ensuring appropriate access controls, data protection, and compliance. It
uses various cloud service providers such as Azure, Google Cloud, etc., to ensure
security against multiple threats.
 Cloud-based data storage has become a popular option over the last decade. It
enhances privacy if configured and managed correctly and saves data on the
cloud, making it accessible from any device with proper authentication.
 These platforms offer free tiers for limited usage, and users must pay for
additional storage or services
 It is a cloud service provider that offers a wide range of services, including
storage, computing, and security tools.

(e) Endpoint Security (Protecting Devices like Laptops and Phones)

It refers to securing individual devices such as computers, laptops, smartphones,
and IoT devices. It includes antivirus software, intrusion prevention systems (IPS),
device encryption, and regular software updates.
 Antivirus and Anti-malware software that scans and detects malicious software,
such as Viruses, Worms, Trojans, and Ransomware. These tools identify and
eliminate or quarantine malicious files, protecting the endpoint and the network
from potential harm.
 Firewalls are essential components of endpoint security. They monitor and
control incoming and outgoing network traffic, filtering out potentially
malicious data packets.
 Keeping software and operating systems up to date with the latest security
patches and updates is crucial for endpoint security.

(f) Operational Security (Managing Internal Security Protocols)

Operational Security refers to the processes and policies organizations implement
to protect sensitive data from internal threats and human errors. It involves access
controls, risk management, employee training, and monitoring activities to prevent data
leaks and security breaches.
 Access Controls ensure that only authorized personnel can access critical
systems and sensitive information. This includes role-based access, multi-factor
authentication (MFA), and least privilege principles.
 Risk Management involves identifying, analysing, and mitigating security risks
within an organization. It includes regular security assessments, vulnerability
testing, and compliance audits.
 Employee Training is crucial for preventing insider threats and social
engineering attacks. Organizations conduct cybersecurity awareness programs
Contemporary Challanges 193

to educate employees on phishing scams, password security, and data handling

best practices.
 Monitoring and Incident Response includes tracking user activity, detecting
suspicious behaviour, and responding to security incidents in real time. Security
Information and Event Management (SIEM) tools help organizations analyse
and mitigate threats effectively.

(g) Internet of Things (IoT) Security

IoT refers to protecting internet-connected devices such as smart home gadgets,
industrial sensors, medical equipment, and wearable technology from cyber threats. IoT
security ensures that these devices do not become entry points for hackers to exploit
networks and steal sensitive data.
 Device Authentication and Encryption ensures that only authorized devices can
connect to networks. Encryption protects data transmitted between IoT devices
and servers from interception.
 Firmware and Software Updates are crucial to patch security vulnerabilities.
Regular updates help prevent exploitation by cybercriminals who target
outdated IoT firmware.
 Network Segmentation isolates IoT devices from critical systems, reducing the
risk of widespread attacks if one device is compromised. This approach limits
unauthorized access and lateral movement within a network.
 IoT Security Standards and Compliance include implementing industry security
frameworks like Zero Trust Architecture (ZTA) and following best practices
such as strong password policies, secure APIs, and endpoint protection to
enhance IoT device security.

5.14 Cybersecurity Challenges in India

The important Cyber security challenges are:

 Overview of Cyber Threats

Cybersecurity in India faces numerous challenges. Cyber threats are increasing in
frequency and sophistication. These threats can come from various sources, including
hackers, organized crime, and even state-sponsored attacks. The rise of digital
technology has made it easier for these threats to spread.

 Impact on National Security

The impact of cyber threats on national security is significant. Cyber attacks can
disrupt critical services, steal sensitive information, and undermine public trust. For
instance, attacks on government websites or infrastructure can lead to chaos and
confusion. Protecting national security from these threats is a top priority for the
government.
194 Indian Financial System

 Economic Implications
The economic implications of cyber threats are also serious. Businesses can suffer
huge financial losses due to data breaches or ransomware attacks. According to a study,
the cost of cybercrime in India is expected to reach billions of dollars in the coming
years. This can affect job creation and economic growth.

5.15 Types of Cybersecurity Threats in India

A threat in cyber security is a malicious activity by an individual or organization to
corrupt or steal data, gain access to a network, or disrupts digital life in general. The
cyber community defines the following threats available today:

 Malware
Malware means malicious software, which is the most common cyber attacking
tool. It is used by the cybercriminal or hacker to disrupt or damage a legitimate user's
system. The following are the important types of malware created by the hacker:
‒ Virus: It is a malicious piece of code that spreads from one device to another. It
can clean files and spreads throughout a computer system, infecting files, stoles
information, or damage device.
‒ Spyware: It is a software that secretly records information about user activities
on their system. For example, spyware could capture credit card details that can
be used by the cybercriminals for unauthorized shopping, money withdrawing,
etc.
‒ Trojans: It is a type of malware or code that appears as legitimate software or
file to fool us into downloading and running. Its primary purpose is to corrupt
or steal data from our device or do other harmful activities on our network.
‒ Ransomware: It is a piece of software that encrypts a user's files and data on a
device, rendering them unusable or erasing. Then, a monetary ransom is
demanded by malicious actors for decryption.
‒ Worms: It is a piece of software that spreads copies of itself from device to
device without human interaction. It does not require them to attach themselves
to any program to steal or damage the data.
‒ Adware: It is an advertising software used to spread malware and displays
advertisements on our device. It is an unwanted program that is installed
without the user's permission. The main objective of this program is to generate
revenue for its developer by showing the ads on their browser.
‒ Botnets: It is a collection of internet-connected malware-infected devices that
allow cybercriminals to control them. It enables cybercriminals to get
credentials leaks, unauthorized access, and data theft without the user's
permission.

 Phishing
Contemporary Challanges 195

Phishing is a type of cybercrime in which a sender seems to come from a genuine

organization like PayPal, eBay, financial institutions, or friends and co-workers. They
contact a target or targets via email, phone, or text message with a link to persuade
them to click on that links. This link will redirect them to fraudulent websites to
provide sensitive data such as personal information, banking and credit card
information, social security numbers, usernames, and passwords. Clicking on the link
will also install malware on the target devices that allow hackers to control devices
remotely.

 Man-in-the-middle (MITM) Attack

A man-in-the-middle attack is a type of cyber threat (a form of eavesdropping
attack) in which a cybercriminal intercepts a conversation or data transfer between two
individuals. Once the cybercriminal places themselves in the middle of a two-party
communication, they seem like genuine participants and can get sensitive information
and return different responses. The main objective of this type of attack is to gain
access to our business or customer data. For example, a cybercriminal could intercept
data passing between the target device and the network on an unprotected Wi-Fi
network.

 Distributed Denial of Service (DDoS)

It is a type of cyber threat or malicious attempt where cybercriminals disrupt
targeted servers, services, or network’s regular traffic by fulfilling legitimate requests
to the target or its surrounding infrastructure with Internet traffic. Here the requests
come from several IP addresses that can make the system unusable, overload their
servers, slowing down significantly or temporarily taking them offline, or preventing an
organization from carrying out its vital functions.

 Brute Force
A brute force attack is a cryptographic hack that uses a trial-and-error method to
guess all possible combinations until the correct information is discovered.
Cybercriminals usually use this attack to obtain personal information about targeted
passwords, login info, encryption keys, and Personal Identification Numbers (PINS).

 SQL Injection (SQLI)

SQL injection is a common attack that occurs when cybercriminals use malicious
SQL scripts for backend database manipulation to access sensitive information. Once
the attack is successful, the malicious actor can view, change, or delete sensitive
company data, user lists, or private customer details stored in the SQL database.

 Domain Name System (DNS) Attack

A DNS attack is a type of cyberattack in which cyber criminals take advantage of
flaws in the Domain Name System to redirect site users to malicious websites (DNS
196 Indian Financial System

hijacking) and steal data from affected computers. It is a severe cybersecurity risk
because the DNS system is an essential element of the internet infrastructure.
Cybersecurity is not just a technology issue; it’s a business issue that requires a
comprehensive strategy. Organizations must remain vigilant and proactive in their
cybersecurity efforts to protect against these evolving threats.

5.16 Cyber Security Challenges

With the increase of the cyber-attacks, every organization needs a security analyst
who makes sure that their system is secured. These security analysts face many
challenges related to cyber security such as securing confidential data of government
organizations, securing the private organization servers, etc. The recent important cyber
security challenges are described below:

(a) Ransomware Evolution

Ransomware is a type of malware in which the data on a victim’s computer is
locked, and payment is demanded before the ransomed data is unlocked. After
successful payment, access rights returned to the victim. Ransomware is the bane of
cybersecurity, data professionals, IT, and executives.
Ransomware attacks are growing day by day in the areas of cybercrime. IT
professionals and business leaders need to have a powerful recovery strategy against
the malware attacks to protect their organization. It involves proper planning to recover
corporate and customers' data and application as well as reporting any breaches against
the Notifiable Data Breaches scheme. Today's DRaaS solutions are the best defence
against the ransomware attacks. With DRaaS solutions method, we can automatically
back up our files, easily identify which backup is clean, and launch a fail-over with the
press of a button when malicious attacks corrupt our data.

(b) Blockchain Revolution

Blockchain technology is the most important invention in computing era. It is the
first time in human history that we have a genuinely native digital medium for peer-to-
peer value exchange. The blockchain is a technology that enables cryptocurrencies like
Bitcoin. The blockchain is a vast global platform that allows two or more parties to do a
transaction or do business without needing a third party for establishing trust.
It is difficult to predict what blockchain systems will offer in regards to
cybersecurity. The professionals in cybersecurity can make some educated guesses
regarding blockchain. As the application and utility of blockchain in a cybersecurity
context emerges, there will be a healthy tension but also complementary integrations
with traditional, proven, cybersecurity approaches.
Contemporary Challanges 197

(c) IoT Threats

IoT stands for Internet of Things. It is a system of interrelated physical devices
which can be accessible through the internet. The connected physical devices have a
unique identifier (UID) and have the ability to transfer data over a network without any
requirements of the human-to-human or human-to-computer interaction. The firmware
and software which is running on IoT devices make consumer and businesses highly
susceptible to cyber-attacks. When IoT things were designed, it is not considered in
mind about the used in cybersecurity and for commercial purposes. So, every
organization needs to work with cybersecurity professionals to ensure the security of
their password policies, session handling, user verification, multifactor authentication,
and security protocols to help in managing the risk.

(d) AI Expansion
AI short form is Artificial intelligence. According to John McCarthy, father of
Artificial Intelligence defined AI: “The science and engineering of making intelligent
machines, especially intelligent computer programs.”
It is an area of computer science which is the creation of intelligent machines that
do work and react like humans. Some of the activities related to artificial intelligence
include speech recognition, Learning, Planning, Problem-solving, etc. The key benefits
with AI into our cybersecurity strategy has the ability to protect and defend an
environment when the malicious attack begins, thus mitigating the impact. AI take
immediate action against the malicious attacks at a moment when a threat impact a
business. IT business leaders and cybersecurity strategy teams consider AI as a future
protective control that will allow our business to stay ahead of the cybersecurity
technology curve.

(e) Serverless Apps

Vulnerability Serverless architecture and apps is an application which depends on
third-party cloud infrastructure or on a back-end service such as google cloud function,
Amazon web services (AWS) lambda, etc. The serverless apps invite the cyber
attackers to spread threats on their system easily because the users access the
application locally or off-server on their device. Therefore, it is the user responsibility
for the security precautions while using serverless application. The serverless apps do
nothing to keep the attackers away from our data.
The serverless application does not help if an attacker gains access to our data
through a vulnerability such as leaked credentials, a compromised insider or by any
other means then serverless.
We can run software with the application which provides best chance to defeat the
cybercriminals. The serverless applications are typically small in size. It helps
developers to launch their applications quickly and easily. They don't need to worry
198 Indian Financial System

about the underlying infrastructure. The web-services and data processing tools are
examples of the most common serverless apps.
Cyber security is a huge issue that is becoming more essential because the world is
becoming extremely interconnected, with networks being used to carry out serious
transactions. All need to be aware of cyber security as well as cybercrimes and its little
seriousness about security regarding online, social and other activities. It causes loss of
data, modifying data removing useful information as personal details, passwords of
mail accounts or bank accounts. Cyber crime continues to diverge down different paths
with each New Year that passes and so does the security of the information. The latest
and disruptive technologies, along with the new cyber tools and threats that come to
light each day, are challenging organizations with not only how they secure their
infrastructure, but how they require new platforms and intelligence to do so. There is no
proper solution for cyber crimes but using recent techniques to minimize the cyber
crime in cyber space.

The Role of Government in Cybersecurity

The Government role in Cybersecurity has been studied as under:

 Policy Framework and Legislation

The government plays a crucial role in shaping the cybersecurity landscape in
India. Strong policies and laws are essential to protect the nation from cyber threats.
Key legislation includes the Information Technology Act, 2000, which provides a legal
framework for electronic governance and cybersecurity. Additionally, the National
Cyber Security Policy, 2013, outlines strategies to enhance the security of cyberspace
in India.

 Government Initiatives and Programs

To combat cyber threats, the Indian government has launched several initiatives:
 Cyber Swachhta Kendra: A project aimed at cleaning up malware and
securing systems.
 CERT-In: The Computer Emergency Response Team provides timely alerts
and guidance on cybersecurity incidents.
 National Cyber Security Strategy: A comprehensive approach to strengthen
the nation’s cybersecurity posture.

 Public-Private Partnerships
Collaboration between the government and private sector is vital for effective
cybersecurity. Public-private partnerships help in sharing information, resources, and
expertise. This collaboration can lead to:
 Enhanced threat intelligence sharing.
 Development of innovative cybersecurity solutions.
Contemporary Challanges 199

 Joint training programs for cybersecurity professionals.

The government’s proactive approach in cybersecurity is essential for safeguarding
national interests and ensuring economic stability.

5.17 CRYPTO Regulation

A Cryptocurrency or Crypto is a virtual currency secured by cryptography. It is
designed to work as a medium of exchange, where individual ownership records are
stored in a computerized database. The defining trait of cryptocurrencies is that they are
not issued by the government agency of any country.
A cryptocurrency is a virtual or digital currency that can be used to buy goods and
services; which implies there’s no physical coin or bill used and all the transactions
take place online. It used an online ledger with strong cryptography to ensure that
online transactions are completely secure.

Definition of Cryptocurrency
In simplistic terms, Cryptocurrency is a digitised asset spread through multiple
computers in a shared network. The decentralised nature of this network shields them
from any control from government regulatory bodies.
The term “cryptocurrency in itself is derived from the encryption techniques used
to secure the network”.
Cryptocurrency is a digital currency. It doesn’t depend on the central banking
system or any third party to verify the transactions. Alternatively, it uses a decentralised
platform to validate transactions on a publicly distributed ledger called ‘Blockchain’.
This blockchain helps in limiting the duplicity of currency. One can buy crypto coins
and trade them on various crypto exchange platforms. However, these coins and the
exchanges are free from the supervision or monitoring of any centralised authority.
As per computer experts, any system that falls under the category of
cryptocurrency must meet the following requirements.:
1. Absence of any centralised authority and is maintained through distributed
networks.
2. The system maintains records of cryptocurrency units and who owns them.
3. The system decides whether new units can be created and in case it does,
decided the origin and the ownership terms.
4. Ownership of cryptocurrency units can be proved exclusively cryptographically.
5. The system allows transactions to be performed in which ownership of the
cryptographic units is changed.
200 Indian Financial System

History of Crypto
The history of cryptocurrency can be traced back to the 2008 Global Financial
Crisis, when financial markets were in deep stress and people were losing faith in them.
During that time, Satoshi Nakamoto, the father of the bitcoin, paved way for the first
ever cryptocurrency using the blockchain technology. In January 2009, the first block
of the bitcoin was mined, popularly known as the ‘Genesis Block’.
In plain English, cryptocurrency is a digital currency, which can be held by an
individual in their digital wallet. It is essentially a digital representation of value that
can be stored and transferred virtually. It is a cash system ‘based on cryptographic
proof instead of trust, allowing any two willing parties to transact directly with each
other without the need for trusted third party’.
The working and functioning of a cryptocurrency is based on the use of a complex
digital algorithm known as ‘blockchain’, which is an online database of
cryptocurrencies storing all the details, including the transactions executed.
Consequently, whenever any transaction/exchange of cryptocurrency is executed, the
process gets lodged in the database (blockchain).
Unlike traditional currencies, cryptocurrencies are not backed by any country or
government and, therefore, not considered legal tender in many jurisdictions. No
affiliated body issues cryptocurrency and it is not backed by any collateral such as
bullion. Also, while traditional currencies can be stored virtually (in online accounts,
wallets, etc), cryptocurrencies cannot be stored physically. Given the differences,
regulating cryptocurrency requires a holistic perspective as compared to traditional
forms of currency.
Despite the above limitations, cryptocurrencies are widely traded internationally
because of their potential high profits, leading to wealth generation for traders. The
transactions involving trade of cryptocurrency works on the pure economic principle of
supply and demand. The greater the demand, the higher the price and vice versa.

Types of Cryptocurrency
The first type of crypto currency was Bitcoin, which to this day remains the most-
used, valuable and popular. Along with Bitcoin, other alternative cryptocurrencies with
varying degrees of functions and specifications have been created. Some are iterations
of bitcoin while others have been created from the ground up.
Bitcoin was launched in 2009 by an individual or group known by the pseudonym
“Satoshi Nakamoto. As of March 2021, there were over 18.6 million bitcoins in
circulation with a total market cap of around $927 billion.
Contemporary Challanges 201

The competing cryptocurrencies that were created as a result of Bitcoin’s success

are known as Altcoins.

Popular Cryptocurrencies
While Bitcoin (BTC) is the most popular and prominent of all the
cryptocurrencies, there are now thousands circulating in the market. Among these all,
there are some coins which have been a tough competitor to BTC.
Following are the ten most popular cryptocurrencies right now:
 Ethereum (ETH)
 Tether (USDT)
 Dogecoin (DOGE)
 Cardano (ADA)
 Binance Coin (BNB)
 USD Coin (USDC)
 Polygon (MATIC)
 Binance USD (BUSD)
 XRP (XRP)
 Polkadot (DOT)
Today, the aggregate value of all the cryptocurrencies in existence is around $1.5
trillion. Bitcoin currently represents more than 60% of the total value.3.

Advantages of Cryptocurrency
Cryptocurrency has the following advantages
 Funds transfer between two parties will be easy without the need of third party
like credit/debit cards or banks
 It is a cheaper alternative compared to other online transactions
 Payments are safe and secured and offer an unprecedented level of anonymity
 Modern cryptocurrency systems come with a user “wallet” or account address
which is accessible only by a public key and pirate key. The private key is only
known to the owner of the wallet
 Funds transfer is completed with minimal processing fees.

Disadvantages of Cryptocurrency
Cryptocurrencies have the following disadvantages.
 The almost hidden nature of cryptocurrency transactions makes them easy to be
the focus of illegal activities such as money laundering, tax-evasion and
possibly even terror-financing
 Payments are not irreversible
 Cryptocurrencies are not accepted everywhere and have limited value
elsewhere
202 Indian Financial System

 There is concern that cryptocurrencies like Bitcoin are not rooted in any
material goods. Some research, however, has identified that the cost of
producing a Bitcoin, which requires an increasingly large amount of energy, is
directly related to its market price.

Reasons for Investment in Crypto

Cryptocurrencies have become a hot topic in the last few years. The reasons for
investment in this investment vehicle are:
 One primary advantage is that crypto transactions are lightning-fast and take
minutes to complete.
 The transaction fees are relatively lower.
 Anyone can use crypto with an internet connection and computer. Opening an
account is also faster and more convenient as there is no requirement of ID or
credit history check.
 Crypto transactions are extremely secure, and no one has access to your funds
without the private key.

5.18 Cryptocurrencies Challenges

Cryptocurrencies are not without issues, challenges and controversies. The
following are important challenges:
(a) Lack of Regulation: The cryptocurrency industry is largely unregulated, which
makes it difficult for governments to monitor and control the market. This
leaves investors at risk of fraud and scams, and can also lead to issues with
money laundering and terrorist financing.
(b) Volatility: The cryptocurrency market is highly volatile, making it a
challenging sector to navigate. This volatility can lead to drastic price
fluctuations in a short period.
(c) Cybersecurity: With increasing hacking incidents targeting cryptocurrency
exchanges and wallets, cybersecurity is a crucial issue facing the cryptocurrency
industry. Security measures must be continuously upgraded to protect against
potential threats.
(d) Government Intervention: There is a possibility of government intervention
that may restrict the use and growth of cryptocurrency, given its potential to be
used for illicit activities.
(e) Energy Consumption: Mining cryptocurrency consumes a large amount of
energy, causing environmental concerns.
(f) Interoperability: The lack of standardization across various blockchain
networks hinders interoperability, which could limit the widespread adoption of
cryptocurrency in different industries.
Contemporary Challanges 203

(g) Adoption Rate: Despite the increasing interest and awareness of

cryptocurrency, the adoption rate among the general public remains low.
(h) Education: There is a lack of understanding of the underlying technology
behind cryptocurrency, which may lead to misinformation and potential fraud.
(i) User Error: Given that cryptocurrency transactions cannot be reversed, errors
made by users can lead to irreversible financial losses.
(j) Use in Criminal Activities: The anonymity offered by cryptocurrency makes it
an attractive option for criminals to conduct illegal activities.
(k) Perception: Cryptocurrency has been associated with criminal activities and
financial instability, leading to a negative public perception.
(l) Taxation: The taxation of cryptocurrency is a controversial issue, with various
countries having different regulations and policies.
(m) Market Manipulation: The unregulated nature of the cryptocurrency market
makes it vulnerable to price fluctuations driven by market manipulation.
(n) Technical Challenges: The technology behind cryptocurrency is complex,
which cause technical challenges in terms of implementation and development.
(o) Lack of Customer Support: Many cryptocurrency exchanges lack customer
support mechanisms, making it challenging for users to receive assistance or
make claims.
(p) Interference from Centralized Entities: The decentralized nature of
cryptocurrency is threatened by the actions of centralized entities, such as
governments or large corporations, which may seek to control or manipulate the
market.

5.19 Regulation of Cryptocurrency in India

The most well-known cryptocurrency is Bitcoin, but there are hundreds of others
including Ethereum, Litecoin, and Ripple. Cryptocurrencies are decentralized, which
means they are not controlled by any government or financial institution. Transactions
are recorded on a public digital ledger, also known as a blockchain, which is
maintained by a network of computers around the world. This makes them largely
immune to government interference, corruption, and manipulation.
In India, cryptocurrencies are currently unregulated. However, historically the
Reserve Bank of India (the RBI) and the Government of India have banned dealing in
cryptocurrency. The RBI had, through its notification dated 6 April 2018, entitled
‘Prohibition on dealing in Virtual Currencies (VCs)’ (the ‘Crypto Ban Notification’),
banned all banks and financial institutions (the ‘Regulated Entities’) from providing
services to transactions related to cryptocurrency. Additionally, the RBI had also issued
repeated warnings with respect to investing in cryptocurrencies. According to the RBI,
cryptocurrencies are ‘stateless digital currencies’, in which encryption techniques are
204 Indian Financial System

used for trading and as these currencies operate independent of a central bank, they
enjoy immunity from state intervention. Consequently, they could be widely used for
carrying out illegal transactions.
Cryptocurrencies are unregulated in India, historically, the RBI has banned dealing
in cryptocurrencies and, therefore, cryptocurrency stakeholders are advocating for
regulating the cryptocurrency realm. However, given that currency is an inalienable
element of any state and as cryptocurrencies invade this space, regulation of
cryptocurrency may be subject to heavy regulations and supervision from various
authorities, such as:
1. The RBI, for regulating cryptocurrencies as a legal tender;
2. The Directorate of Enforcement, for banning of use of cryptocurrency in
economic offences;
3. The Department of Economic Affairs, for interference of cryptocurrencies in
economic policies of state;
4. The Securities and Exchange Board of India (SEBI), for use of cryptocurrencies
in security contracts; and
5. India’s tax authorities, for tax implications on trading in cryptocurrencies.
It may, therefore be a herculean task for India’s legislature to build a robust
framework for regulating every aspect of cryptocurrency trade.
The RBI may rely on the blockchain infrastructure to create a regulatory presence
in the crypto space. It may also consider issuing licences to crypto exchanges which
may only be issued following an appropriate scrutiny of records and after meeting
necessary compliance requirements. Also, a framework inter alia providing for
submission of transaction records to the RBI within a stipulated timeframe may be put
in place which will not only ensure safety of transactions and minimise illicit use, but
also increase customer protection.
The tax authorities may also consider taxing the incomes earned from buying and
selling cryptocurrencies as capital gains. The SEBI may also regulate the trading
aspects of crypto transactions. This will boost the confidence of traders, as they will be
assured that a proper due diligence of crypto transactions is being conducted, therefore
decreasing chances of any embezzlement in such transactions. Furthermore, initial coin
offerings (just like initial public offerings (IPOs)) may also be offered by companies,
through which they may be permitted to raise funds by issuing tokens in exchange for
cryptocurrency. This entire process can be monitored by SEBI and refund mechanism
on delivery failure can be established for consumer and investor protection.
The use of blockchain as a development in technology by India’s banks also gives
them a ray of hope with regard to regulating of cryptocurrencies. One of the country’s
largest public sector banks, along with 28 other commercial banks, is testing blockchain
technology under the name ‘BankChain’, for achieving an integrated corporate e-KYC
(electronic know your customer) platform, a vendor rating system and a blockchain-
Contemporary Challanges 205

powered register, which records hypothecation, lien, mortgages and pledges on

movable, immovable and tangible assets.
Since March 2023, all crypto-related profits must be registered with the Financial
Intelligence Unit India (FIU-IND) under the Prevention of Money Laundering Act
(PMLA). The following rules are fundamental:
 Customer Due Diligence (CDD): Know Your Customer (KYC) and Electronic
Know Your Customer (eKYC) must be used.
 Suspicious Transaction Reporting (STR): Suspicious transactions are
investigated by the Financial Intelligence Unit India (FIU-IND).
 Record Keeping for 5 Years: Customer transactions in crypto must be stored
for at least 5 years.
 AML Audits and Inspections: International anti-money laundering rules must
be consistently applied.
However, the following authorities are regulating the Crypto related transactions
 The Reserve Bank of India (RBI) manages India’s monetary policy and
ensures financial stability. As cryptocurrencies become more popular, the RBI
monitors risk factors such as volatility and fraud.
 Securities and Exchange Board of India (SEBI) checks crypto trading
platforms to ensure legal crypto-token transactions.
 The Ministry of Finance implements rules for cryptocurrency transactions.

Top Traded Cryptocurrencies in India

% of Daily
Rank Cryptocurrency Popularity Reason
Trade Volume
1. Bitcoin (BTC) Long-term store of value, global 37%
credibility
2. Ethereum (ETH) Smart contracts, DeFi support 22%
3. Tether (USDT) Stablecoin used for arbitrage 15%
4. Polygon (MATIC) Made-in-India L2 solution, low fees 12%
5. Solana (SOL) High-speed transactions, growing 7%
Indian NFT use

Review Questions
Conceptual type questions for 2 marks.
1. What do you mean by the term ‘Contemporary Challenges’?
2. Give the meaning of Emerging Trends.
206 Indian Financial System

3. What do you mean by Green Finance?

4. Give the meaning of Public Sector Bank.
5. What is Meaning of Sustainable Bond?
6. What do you mean by Meaning of Artificial Intelligence?
7. What do you mean by Non-Performing Asset?
8. What is Cyber Security?
9. Give the meaning of Cryptocurrency

Analytical type questions for 8 marks.

1. What are the important types of Contemporary Issues
2. Explain briefly the Recent Trends in Financial Market
3. Mention the various types of Green Finance.
4. What are the benefits of Green Finance?
5. What are the features of Sustainable Bonds?
6. What are the common types of frauds in AI Fraud detection?
7. What are the types of Non-Performing Assets?
8. Write a note on regulation of Cryptocurrencies in India.
9. State the various types of Cryptocurrency.
Essay type questions for 14 marks.
1. What is CBDC? What are the advantages and disadvantages. Explain the
Challenges and Concerns of CBDC.
2. What is Cyber Security Risk? Explain the Types of Cyber Security Risks
3. Elaborate the various types of Cybersecurity
4. What are Cryptocurrencies? Elaborate the Cryptocurrencies Challenges in India.
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MODEL QUESTION PAPER
Third Semester B.B.A. Examination
COMMERCE
INDIAN FINANCIAL SYSTEM
(SEP Semester CBCS Scheme 2024-25 Regular)
Time: 3 Hours Max. Marks: 80

Instruction: Answers to be written completely in English only.

SECTION-A
Answer any SEVEN sub-questions. Each question carries 2 marks. (7 × 2 = 14)
1. (a) What is a Financial System?
(b) Give the meaning of Money Market.
(c) What are Treasury Bills?
(d) Define a Foreign Bank
(e) What is NBFC?
(f) What do you mean by Credit Control?
(g) What do you mean by ULIP?
(h) What is Commercial Bank?
(i) What is Cryptocurrency?
(j) Give the meaning of Deposit Insurance.
SECTION-B
Answer any THREE questions. Each question carries 8 marks. (3 × 8 = 24)
2. Write the differences between money market and capital market.
3. Briefly explain the functions of Non-Banking Financial Companies.
4. Explain the components of Financial Market.
5. Write on instruments traded in money market.
6. Write a note on IRDAI Bima Sugam.
SECTION-C
Answer any THREE questions. Each question carries 14 marks. (3 × 14 = 42)
7. State the meaning of Primary Market and Secondary Market. Explain the
differences between primary market and secondary market.
8. What is SEBI? Explain in detail the functions of SEBI
9. Explain in detail the role of Atal Pension Yojana.
10. Explain in details about the Regulators of Financial System.
11. What is CBDC? What are the advantages and disadvantages. Explain the
Challengs and Concerns of CBDC.
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