Page 1: Introduction to Financial System

Key Components

• Indian Financial System: Framework encompassing financial markets, institutions, and services.

• Financial Markets: Platforms for trading financial securities, commodities, etc.

• Financial Institutions: Entities providing financial services to clients and customers.

• Financial Services: Services that manage money, investments and facilitate transactions.

• Derivative Markets: Markets where financial instruments like derivatives are traded.

• Investors Protection: Measures undertaken to protect investors' rights and interests.

Page 2: Commercial Bank

Definition

• A commercial bank is a financial institution that provides services such as accepting deposits, providing loans, and other financial services.

Page 3: Financial Institution (FI)

Definition and Operations

• A financial institution is a company engaged in financial transactions like deposits, loans, investments, and currency exchange.

• Relation to Banks: All banks are financial institutions, but not all financial institutions are banks.

Page 4: Etymology of the Term 'Bank'

Origin

• The term 'bank' is derived from the Old Italian word "banca" or the French word "banque", referring to a bench or money exchange table.

Page 5: Organised Sector in Banking

Structure of the Indian Banking System

Organised Sector

• Categories:

  • Reserve Bank of India

  • Commercial Banks

  • Scheduled Banks

  • Co-operative Banks

  • Specialized Institutions

  • Public Sector Banks

  • Private Sector Banks

  • Foreign Banks

Unorganised Sector

• Includes indigenous bankers and money lenders.

Page 6: Historical Background of Indian Banks

Early Banks

• Bank of Hindustan: Established in 1770; earliest Indian bank.

• East India Company Banks:

  • Bank of Bengal (1806)

  • Bank of Bombay (1840)

  • Bank of Madras (1843)

• Amalgamation: Presidency banks formed the Imperial Bank of India in 1921.

Page 7: Evolution of Indian Banking

Significant Banks Established

• Allahabad Bank: Founded in 1865 with European management.

• Oudh Commercial Bank: First bank with Indian ownership in 1881.

• Followed by:

  • Ajodhya Bank (1884)

  • Punjab National Bank (1894)

  • Nedungadi Bank (1899)

Page 8: Regulatory Acts

Establishment of RBI

• Reserve Bank of India Act: Passed in 1934, forming RBI as the apex banking body.

• Banking Regulations Act: Established in 1949 under government control providing RBI with extensive supervisory powers.

Page 9: Banking Landscape at Independence

Bank Statistics in 1951

• Commercial Banking System: Development resulted in 566 private banks with 4,151 branches.

• Types of Banks:

  • 12 Public Sector Banks

  • 21 Private Sector Banks

  • 43 Regional Rural Banks

  • 46 Foreign Banks

Page 10: Functions of Commercial Banks

Key Responsibilities

• Accepting Deposits: Safekeeping customer funds.

• Advancing Loans: Lending money to customers.

• Credit Creation: Generating additional funds for lending through deposits.

• Agency Function: Acting on behalf of clients for financial transactions.

Page 11: Working Capital Finance by Banks

Page 12: Understanding Working Capital Finance

Definition

• Working Capital: Metric indicating the liquidity available for daily operations.

Objective

• Ensure business operations continue smoothly by managing funds effectively to meet short-term debts and operational expenses.

Page 13: Sources of Working Capital Finance

Major Sources

1. Trade Credit

2. Bank Borrowing

Page 14: Trade Credit Explained

Characteristics

• Refers to credit granted by suppliers to customers in regular trade.

Importance

• A significant source of short-term financing, especially for small firms in India, accounting for approximately 1/3 of total short-term financing.

Alternative Name

• Known as a Spontaneous Source of Financing.

Page 15: Major Modes of Bank Finance for Working Capital

• Overdraft

• Cash Credit

• Purchase or Discounting of Bills

• Letter of Credit

• Working Capital Loan

Page 16: Overdraft Facility

Description

• Allows borrowers to withdraw more than their current account balance up to a specified limit, within a stipulated time period.

Page 17: Cash Credit

Characteristics

• Short-term Finance: Provides a loan up to a certain limit secured against tangible assets.

• Interest Calculation: Charged only on the utilized amount, not the total limit sanctioned.

Synonym

• Also referred to as bank overdraft.

Page 18: Cash Credit vs. Overdraft

Key Differences

Page 19: Purchase or Discounting of Bills

Process

• Borrowers can obtain credit against their bills; banks purchase or discount these bills within the overall cash credit or overdraft limit.

Page 20: Letter of Credit

Purpose

• Used to assure foreign suppliers that payment will be made by the bank if the buyer defaults.

Functionality

• The bank opens a Letter of Credit (L/C) in favor of the customer to facilitate the purchase of goods.

Page 21: Working Capital Loans

Description

• Offered sometimes when borrowers need excess funds beyond their sanctioned limits for unforeseen circumstances, categorized under demand loan accounts with potentially higher interest rates.

Page 22: Security for Bank Finance

Types of Security

• Hypothecation

• Pledge

• Mortgage

• Lien

Page 23: Hypothecation

Explanation

• Working capital finance secured against movable property without transferring ownership or possession to the bank.

Conditions

• Usually granted to first-class customers with high integrity.

Page 24: Pledge

Definition

• Requires the borrower to physically transfer possession of the property as security for credit (e.g., share certificates, insurance policy documents).

Page 25: Mortgage

Definition

• Legal/equitable interest in immovable property transferred for debt payment.

Lien

• Right of lenders to retain property until debt repayment.

Page 26: Mortgage Details

Purpose

• A mortgage is a loan secured by real estate (home, land).

Payment Structure

• Borrower repays over time through regular payments covering principal and interest.

Collateral

• Property serves as collateral for the loan.

Page 27: Comparing Security Types

Differences Summary

Page 28: Regulations of Bank Finance

Norms and Committees

• Banks adhere to norms influenced by various RBI committee recommendations, notably:

  • Tandon Committee

  • Chore Committee: Strengthened standards and procedures.

Page 29: Tandon Committee Regulations

Key Recommendations

1. Operating Plan: Borrowers must indicate working capital needs based on operating plans.

2. Production-based Financing: Financing restricted to genuine production needs only.

3. Partial Bank Financing: Banks should not finance total requirements but only a reasonable part.

Page 30: Additional Recommendations

4. Current Assets Levels: Borrowers maintain reasonable levels of inventory and receivables without excessive or unprofitable stocks.

5. Maximum Permissible Bank Finance (MPBF): Suggestions for calculating limits based on borrowers' contributions and bank financing.

Page 31: MPBF Methodologies

Contribution Models

1. Borrower contributes 25% of the working capital gap.

2. Borrower contributes 25% of total current assets.

3. Borrower contributes 100% of core assets and 25% of remaining current assets.

Page 32: Commercial Paper in India

Regulation and Requirements

• Issued only under RBI regulations for eligible companies.

Criteria for Issuance

• Net Worth of at least 10 Crores.

• Maximum Permissible Banking Finance (MPBF) not less than 25 Crores.

• Typically, a minimum issue size of One Crore and each CP size should be at least 25 Lacs.