MCom I Semester Business Environment Finance Study Material Notes

MCom I Semester Business Environment Finance Study Material Notes : Development of Financial System of India Weaknesses of Indian financial system Reforms in financial system Exercise Questions Long Answer Questions Short Answer Questions Objectives Questions ( this Post Is Most Important for MCom Students )

BCom 2nd Year Deduction Collection Income Tax Source Study Material notes in Hindi

Finance

Within the present basis of society, it is impossible to escape from finance in one or another way. To live we must have money. Money may be the root of all evils, but the need for money is certainly the root of all industrial and trading activity. Finance refers to monetary resources needed by individuals, business houses and the government. It is required to keep business going and is needed to expand business. Availability of money and its use whenever required is finance. By industrial finance we mean the finance for industries whether the industry is established by an individual proprietor or as partnership or incorporated as company. There is only one source of money and that source is savings. In a large business enterprise the time lag between production and consumption is very great. Finance is required to keep the industrial unit going.

The financial system of India refers to the system of borrowing and lending of funds or to meet the demand for supply of the funds of all individuals, institutions companies and of the government. India’s financial system includes the savings by the community, the mobilisation of savings and the effective distribution of savings among all those who demand the funds for investment purposes. The Indian financial system is composed of the banking system, the insurance companies, mutual funds, other institutions and the investors. There are a number of financial institutions. in the country) to finance industries, agricultural development etc. The structure of Indian financial system is divided into two parts which are as follows:

1 Indian Capital Market: Capital market is the market for long term funds. It refers to all the facilities and the institutional arrangements for borrowing and lending term funds (medium-term and long term funds). The demand for long term money capital comes predominantly from private sector manufacturing industries, agriculture and from the government largely for the purpose of economic development. As the central and the state government are investing not only on economic overheads such as transport, irrigation and power development but also on basic industries and sometimes even consumer goods industries, they require substantial sums from the capital market. The supply of funds for the capital market comes largely from individual savings, corporate, savings, banks, insurance companies, specialised financial agencies and the government.

The Indian capital market is divided into the gilt-edged market and the industrial security market. The gilt-edged market refers to the market for government and semi-government securities backed by RBI. The industrial security market refers to the market for shares and debentures of old and new companies. The Indian capital market comprises the capital transaction

(i) Non-banking financial instutions,

(ii) Development financial institutions;

(iii) Trading of the shares and debentures of industrial corporation, and

(iv) Sale and purchase of government and semi government securities.

2. Indian Money Market: A money market may be defined as the market for lending and borrowing of short-term funds. It is the place where the shortterm surplus investible funds at the disposal of banks and other financial institutions are bid by borrowers comprising of companies, individuals and the government. The Indian money market consists of two parts-the unorganised and organised sectors. The unorganised sector consists of indigenous bankers who pursue the banking business on traditional lines. The organised money market consists of the Reserve Bank of India, the State Bank of India together with the seven associates, nationalised commercial banks, other scheduled and non-scheduled commercial banks, foreign banks and the regional rural banks, some large joint stock companies and quasi-government bodies also operate in the money market. These are termed as the ‘non-banking companies which are distinguised as the financial and ‘non financial companies. Besides there are financial intermediaries such as called ‘loan-brokers’ general finance and stock brokers and underwriters.

Finance Study Material Notes

DEVELOPMENT OF FINANCIAL SYSTEM OF INDIA

In 1947, the partition of the country put a heavy strain on the banks. The Reserve Bank and the government helped to overcome the crises. The Reserve Bank of India was given wide powers of supervision and control over banks under the Banking Companies Act, 1949-renamed as the Banking Regulation Act March 1966. In July 1969, 14 major Indian scheduled commercial banks were nationalised. After the nationalisation of six more banks on April 1980, the share of public sector banks in total deposits and outstanding credits has increased to 90.8 percent and 90.7 percent respectively. Commercial banking in India is now a strictly regulated sector in the economy. It was intended to achieve the aim of bank nationalisation through a two-pronged approach one, expanding the banking network and second, making bank credit available to all segments of the economy and regions of the country. Till June 1969, commercial banks had opened 8,260 branches. The number of branches of commercial banks has increased to 1,18,450 on 30 June, 2014. During this period, rural sector branches increased to 46,976 from 1,860. The regional disparities in the distribution of bank offices have also declined substantially after 1969. Commercial banks have extended liberal credit facilities to the priority sectors of the economy which include agriculture, small scale industries, and other priority sectors comprising of small borrowers such as road and water transport operators, retail traders, small businessmen, and persons desirous of receiving higher education. Percentage of advances to priority sectors in total bank credit has increased from 14.9 percent in June 1969 to 39 percent in 2013-14. In 1980s Regional Rural Bank was established. The main objective of the setting the RRBs was to Provide credit and other facilities especially to the small and marginal farmers, Agricultural labourers, artisans, small entrepreneurs and persons with small means engaged in productivity activities in rural areas. Advance to agriculture in 2013-14 amounted to 7,02,541 crore and total advances were 41,10,591 crore.

With a view to providing long-term funds to industry, the government set up the Industrial Finance Corporation (IFC) in 1948. This was followed by the setting up of a number of other development banks and financial institutions like the Industrial Credit and Investment Corporation of India (ICICI) in 1955, Industrial Development Bank of India (IDBI) in 1964, Industrial Reconstruction Corporation of India (IRCI) in 1971, various State Financial Corporations (SFCs) at the state level, Unit Trust of India (UTI) in 1964, State Development Corporations, Life Insurance Corporation of India etc. These financial institutions and development banks have contributed significiantly to the widening and strengthening of the capital market in India.

With the rapid expansion of economic activity over the years, some specialised financial institutions have been set up. ICICI Ventures Fund, formerly known as Technology Development and Information Company of India Ltd. (TDICI) was set up in 1988. ICICI Venture Fund is a technology venture finance company that grants projects finance to new technology ventures. It operates through venture capital funds.

IFCI Venture Capital Funds (IVCF)-formerly known as RCTC Ltd. provides both risk capital technology finance under one roof to innovative entrepreneurs and technocrats for their technology oriented ventures. Tourism Finance Corporation of India Ltd. (TFCI) commenced its business from February 1, 1989. TFCI caters the financial assistance to tourism industry, allied activities, facilities and service. Export-Import Bank of India (EXIM Bank) was established for financing, facilitating and promoting foreign trade in India. Another specialised financial institution is the Insfrastructure Development Finance Corporation (IDFC).

Finance Study Material Notes

WEAKNESSES OF INDIAN FINANCIAL SYSTEM

Indian financial system has been under the control of public sector and the government that is why they are utilised largely for the fulfilment of social objective in place of business motives. The government implemented various programmes for employment generation and poverty eradication which remained failed. The government directed to advance loans to these plans. The flow of bank credit to priority sectors has increased. The fact, however, is that a major part of loans for agriculture are given to high class farmers, while small and marginal farmers remain ignored. Similarty, bulk of the amount lent to small scale industries has been pre-empted by rich-managed small and ancillary industries. Thus, really small and poor people are left with no alternative but to suffer deprivations, despite the fact that credit policy is supposed to have shifted in their favour. The performance of the various State Financial Corporations was not very satisfactory. The SFCs have failed to meet the demands of medium and small scale industries adequately. In recent years a disquieting feature of their operations has come to the lime light. The overdues position has deteriorated considerably. Development financing institutions have been facing serious difficulties for the last few years on the one hand, the burden of nonperforming assets have been increasing while on the other hand the cost of raising funds has been rising. However, DFIs are now passing through a difficult time. DFIs have developed a rigid attitude in their working in which they did not help them in new environment in which they found new competitors. Thus, the shortcomings of the Indian financial system are as follows:

1 To provide finance to non-profitable social policies.

2. Lack of integration.

3. Failure in supervision process.

4. Expanding corruption.

5. Misuse of subsidies and concessions.

6. More directed investments.

7. Political interference.

8. Lack of effective control.

Finance Study Material Notes

REFORMS IN FINANCIAL SYSTEM

India had witnessed a phenomenal expansion in the geographical coverage and functional spread of our barking and financial system since bank nationalisation in 1969. Despite impressive quantitative achievements in resource mobilisation and in extending the credit reach, several distortious had over the years, crept into the banking and finance systems. As a result, productivity and efficiency of system had suffered; its portfolio quality had badly deteriorated and profitability had been eroded. Several public sector banks and financial institutions had become financially weak and some public sector banks had been incurring losses year after years. It was under these circumstances that the Government of India set up a high level committee with Mr. M. Narasimham, a former Governor of the Reserve Bank of India as chairman to examine all aspects relating to the structure, organisation, functions and procedure of the financial system. This committee on the financial system submitted its report in November 1991.

1 Reforms in Banking Sector: The Narsimham Committee’s recommendations were based on fundamental assumption that the resources of banks come from the general public and were held by the banks in trust and that they are to be deployed for maximum benefits of the depositors. This assumption automatically implied that even the government had no business to endanger the solvency, health and efficiency of the nationalised banks under the pretext of using bank resources for economic planning, social banking, poverty eradication etc. Besides the government had no right to get hold of the funds of the bank at low rates of interest and use them for financing its consumption expenditure and thus defraud the depositors. The Committee has given following recommendation as regards banks reforms:

(i) Recommendation in respect of directed investment : The Narsimham Committee recommended that the system of directed credit programme should be gradually phased out. For one thing, agriculture, and small industry had already grown to mature stage and they did not require any special support. For another two decades of assistance with interest subsidy were enough and therefore concessional interest rate could be dispensed with.

(ii) Changes in respect of interest rate structure : The Committee recommended that the level and structure of interest rates in the country, should be broadly determined by market forces. All controls and regulations on interest rates on lending and deposit rates of banks and financial institutions of debentures and company deposits etc. should be removed, concessional rates of interest for priority sector, loans of small sizes should be phased out; and subsidies in IRDP loans should be withdrawn.

(iii) Capital receipt from market: The Government of India has amended the Banking Companies (Acquistion and Transfer of Undertaking) Act to enable the nation lised banks to access the market for capital funds through public issues subject to the provision that the holding of the Central Government would not fall below 51 percent of the the paid up capital. SBI was the first to raise through public issue over 1,400 crores as equity and 1,000 crores through bonds. The Oriental Bank of Commerce raised 360 crores during 1994-95 through a public issue. Other nationalised banks also have approached or planned to approach capital market.

(iv) Autonomy in working: Scheduled commercial banks have now been given freedom to open branches and upgrade extension counters, after obtaining capital adequacy norms and prudential accounting standards. They are permitted to close non-viable branches other than in rural areas. Bank lending norms have been liberalised and banks have been given freedom to decide levels of holding of individual items of inventories and receivables.

(v) Permission to private sector: The private sector banks have started functioning. The Government of India has also approved 3 proposals to set up new private sector banks “in principle.” These new private banks are allowed to raise capital contribution from foreign institutional investors upto 20 percent and from non-resident India (NRIs) upto 40 percent. In 1996-97 budget, the Government of India announced the setting up of new private local area banks with jurisdiction over three contiguous districts.

(vi) Recommendations in respect of directed investment: Commercial banks in India were required by the Banking Regulation Act, 1949 (U/s 24) to maintain statutory liquidity ratio (SLR) at 38.5 percent and cash reserve ratio (CRR) up to 15 percent. The Narsimham Committee argued that the high SLR adversely affected profitability of the bank. Besides with higher SLR, the amount of funds left with banks for allocation to the productive economic sectors like agriculture, industry and trade were reduced. The Government followed the committee’s recommendations and SLR has been reduced from 38.5 percent to 25 percent and CRR has been reduced from 15 percent to 10 percent.

(vii) Supervision of Banks : Supervisions of commerical banks is being tightened by RBI, specially after the securities scam of 1992. RBI has set up a Board of Financial Supervision with an Advisory Council under the chairmanship of Governor to strengthen the supervisory and surveillance system of banks and financial institutions.

(viii) Reforms in structural system : To bring about greater efficiency in banking operations, the Narsimham Committee, 1991, proposed a substantial reduction in the number of public sector banks through mergers and acquistions. According to the Committee, the broad pattern should consist of:

(a) 3 or 4 large banks which could be international in character;

(b) 8 to 10 national banks with a network of branches throughout the country engaged in general or universal banking;

(c) Local banks whose operations would be generally confined to a specific region; and

(d) rural banks including RRBs whose operations would be confined to rural areas.

Banks should have the freedom to open branches purely on profitability considerations. The Committee wanted the goverment to make a positive declaration that there would be no more nationalisation of banks. RBI should permit the setting up of new banks in the private sector.

The Government of India appointed Mr. Narsimham as chairman of one more committee : the Committee on Banking Sector Reforms. The Committee submitted its report to the Government in April, 1998. The setting of the Narsimham Committee of Banking Sector Reform was brain wave of the officials of the banking division of the Finance Ministry who have actually no real work to do. The two members of the Narsimham Committee (1991) clearly recommended the closing down of the banking division of the Finance Ministry as redundant and unnecessary and that all matters pertaining to the banking system should be the responsibility of one authority, viz. RBI. This recommendation was not accepted by the Finance Ministry.

2. Reforms in Development of Financial Institutions : The recommendations of the Narsimham Committee, 1991 are based on the Committee’s assumption that the DFIs are relevant in the Indian context, even though their promotional and developmental role would diminish as the Indian economy acquired greater sophistication with greater industrial development. The major recommendations of the Narsimham Committee (1991) or DFIs were as follows:

(i) The ownership pattern of DFIs should be broad-based, like that of ICICI.

(ii) The Government should work out an action plan to be implemented in the next three years which would usher in a measure of autonomy of the DFls in matters of internal administration.

(iii) The chief executives of DFIs should be men of proven professional competence and should be selected on the recommendations of a panel of eminent persons.

(iv) The Board of DFIs should include representatives from industrial sectors.

(v) In the case of state level financial institutions the link with the state governments should be broken and these institutions should be helped to work with improved efficiency and approach the capital market for their funds.

(vi) It should be guided by professional appraisal of the technical and economic aspects of the project evaluation of the promoters, competence and integrity. The DFIs should supervise their own loan implementation.

(vii) The DFIs should raise their funds from the capital market at market related rates. They should also mobilize the savings of household sectors.

(viii) The present system of consortium funding should be given up. The cross representation in each other’s boards would not be necessary with the giving up of consortium funding.

(ix) The role and functions of IDBI should be changed to make it equal to other institutions.

(x) The Committee had proposed that DFIs should adopt internationally adopted norms, restore capital adequacy, inject an element of competition in term-lending finance with a view to providing greater choice to borrow.

3. Reforms in capital market : The Narsimham Committee had made many recommendation for the reforms in the capital market. The securities and UTI seams brought out the serious weaknesses of the financial system. The Narsimham Committee had proposed that financial institutions should adopt internationally adopted norms and inject an element of competition in term lending finance with a view to providing greater efficiency. The Committee had also recommended that banking should be encouraged to extend term finance while the DFIs should start extending loans for short periods for working capital requirements. Instead of considering only inter bank mergers Es recommended repeatedly by the Narsimham Committee (1991 and 1998), the Khan working group has recommended the merger of one or more strong banks with DFIS, purely based on viability and profitability considerations.

The Indian capital market has witnessed a radical transformation within a period of just over one decade. During the early part of 1990, the ranking of Indian capital market with reference to global standards of efficiency, safety, market integrity etc. was low with reference to the risk indices the Indian capital market was regarded as one of the worst as it figured almost at the bottom of the league. However, the scenario has now completely changed. Because of extensive capital market reforms carried out over the period of the last decade and a half the setting up and extension of activities of NSE and steps taken by SEBI, the Indian capital market is now ranked in the top league. In fact it is now considered to be way ahead of many developed countries’ capital market.

The Securities and Exchange Board of India (SEBI) set up in 1988 was given statutory recognition in 1992 on recommendations of the Narsimham Committee. SEBI has introduced a number of measures to reform India’s capital market in recent years. By improving market efficiency, enhancing transparency, preventing unfair trade practices, it has succeded to a considerable extent in bringing up Indian market to international standards.

A significant feature of the primary market activity after abolition of capital controls has been that the corporates attempted to diversify the range of instruments. A wide variety of innovative, hybrid instruments were introduced to suit varied needs of investors and issuers/ borrowers. Some of the instruments which became quite popular were secured premium note (SPN) with detachable warrants, non-convertible debentures with detachable equity warrants, fully convertible cumulative redeemable preference shares etc. However what continues to be a matter of concern is that it is the foreign institutional investors (Flls) that call the shots in the Indian capital market due to the vast amount of resources at their command.

EXERCISE QUESTIONS

Long Answer Questions

1 What is meant by finance? Explain the development of financial system in India.

2. Explain the main reforms of banking sector in India.

3. Explain the weakness of Indian financial system.

4. Throw light on financial system reforms in India.

Finance Study Material Notes

Short Answer Questions

1 What do you understand by capital market?

2. What is money market?

3. What is meant by finance?

4. Write the reforms of financial system in India.

Finance Study Material Notes

Objective Questions

(I) Choose the correct alternative:

1 Finance is related to trade as :

(a) soul

(b) saving

(c) capital

(d) none of these

2. Indian money market is classified in the parts:

(a) two

(b) three

(c) four

(d) five

3. Government and semi-government securities are transacted in:

(a) banking sector

(b) Indian capital market

(c) Indian money market

(d) none of these

4. The Indian money market includes:

(a) construction industry

(b) multinational companies

(c) State Finance Corporations

(d) none of these

5. The market which provides long-term and medium-term financial resources is :

(a) money market

(b) banking sector

(c) Finance market

(d) Indian capital market

(Ans: 1. (a), 2. (a), 3. (b), 4. (c), 5. (d)]

Finance Study Material Notes

(II) Write True or False :

1 The finance system comprises various institutions and processes of organized and unorganized sector. term credit.

2. The Capital Market deals in the lending and borrowing of medium tern and long term credit.

3. The Indian money market is divided into two parts the organized and unorganized.

4. The Indian capital market does not fulfill the need of long-term capital.

[Ans:(1) True, (2) True, (3) True, (4) False]

(III) Fill in the Blanks :

1 There have been serious departures from the sound banking on account of shifts from security oriented credit to …..

2. The capital market got the ……………………. in the first three-four years of the post liberalization phase.

3. To make banking industry more…………………….. banking has been opened for private sector.

4. …. were set up and developed to meet the requirement of industry for term finance.

(Ans. 1. Purpose-oriented credit,  2. tremendous boost, 3. Competitive, 4. The Development Financial Institution)

Finance Study Material Notes