Dibrugarh University B.Com 6th Sem: Indian Financial System Solved Papers (May' 2017)

2017 (May)
1. Fill in the blanks:                                        1x4=4
a)      Financial institutions are also termed as Financial Market.
b)      Commercial Banks Scheme, 1970 provides that the board of directors of nationalized banks will be composed of seven members including chairman.
c)       The Treasury bill is government bond for a short period usually of 91 days duration.
d)      Primary market refers to the long-term flow of funds from the surplus sector to the government and private sector through primary issue of equity and debts.
2. State whether the following statements are True or False:                                     1x4=4

a)      Commercial Bills are one of the instruments of money market.                          True
b)      Bull, Bear, Stag and Lame Duck are the speculators who are active on Stock Exchange of India.           True
c)       Merchant bankers undertake the function of purchase and sale of securities of the investors and provide portfolio management.                                 True
d)      Capital market deals with buying and selling of short-term investible fund.                   False, Long term
3. Write short notes on (any four):                                          4x4=16
a) Marketable securities: Marketable securities are instruments which are liquid and can be easily sold in stock market or bond market. Marketable securities are classified into two categories marketable equity securities and marketable debt securities. Marketable equity securities includes equity shares and preference shares which are quoted and traded in stock exchange. Marketable debt securities includes debentures and bonds which are quoted and traded in bond market.
b) Management of Reserve Bank of India
The Reserve Bank was set up as corporate body. The organizational structure of the Reserve Bank is provided by the Reserve Bank of India Act, 1934. It comprises of the – (a) Central Board and (b) Local Boards.
a) Central Board: The Central Board of Directors is the supreme governing body of the Bank. It consists of 20 members. The members include the following:
1.       A Governor and not more than four Deputy Governors to be appointed by the Central Government.
2.       Four Directors to be nominated by the Central Government, one each from the four local boards.
3.       Ten Directors to be nominated by the Central Government. They are experts from the fields of business, industry, finance and co-operation.
4.       One Government Official (Secretary, Ministry of Finance) to be nominated by the Central Government.
The power of the Board vests with the Governor who is the Chief Executive Officer of the Bank. The Governor has the responsibility of directing the affairs and business of the Bank. The Governor and Deputy Governors hold office for a period of 5years and are eligible for the reappointment. The Governor in his work is assisted by four Deputy Governors and four Executive Directors. The executive directors are not the members of the Central Board but attend Board meetings by invitation. They are subordinate to Deputy Governors.
b) Local Boards: Apart from Central Board of Directors, four Local Boards are constituted representing each area specified in the first schedule to the Act. There is a Local Board in Eastern, Western, Northern and Southern regions of the country with headquarters at Kolkata, Mumbai, New-Delhi and Chennai.
Local Board consists of five members, each appointed by the Central Government. They represent territorial and economic interest in their respective areas. In each Local Board, a Chairman is elected from amongst the members. The members of the Local Board hold office for a period of four years and are eligible for reappointment.
The Local Board carry out the functions of advising the Central Board on such matters of local importance as may be generally or specifically referred to it or perform such functions as may be delegated to it from time to time. Generally a Local Board deals with the management of regional commercial transactions.
c) Role of NABARD in rural development: The National Bank For Agriculture and Rural Development (NABARD), a developing bank, came into existence on July 12, 1982, under an Act of Parliament with an initial capital of Rs. 100 crores. It is an apex institution set up for providing and regulating credit and other facilities for the promotion and development of agriculture, small scale industries, cottage and village industries, handicrafts and other rural crafts and other allied economic activities in rural areas with a view to promoting integrated rural development and securing prosperity of rural areas and for matters connected therewith or incidental thereto.
The NABARD has taken over the functions of ARDC (Agricultural Refinance and Development Corporation) and refinancing functions of RBI in respect of co-operative banks and the RRBs. The subscribed and paid up capital of NABARD was Rs. 100 crores which was enhanced to Rs. 500 crores, contributed by the Government of India and the Reserve Bank of India in equal proportions. The capital is now enhanced to Rs. 200 crores.
Functions of NABARD: The important functions of NABARD are as follows:
a)      It serves as an apex refinancing agency for the institutions providing investment and production credit for promoting the various developmental activities in rural areas.
b)      It provides short term accredit to Regional Rural Banks, State co-operative Banks and other financial institutions approved by the Reserve Bank. Such credit is given by the NABARD for a period upto 18 months.
c)       It provides medium term credit to State Co-operative Banks and other financial institution approved by the Reserve Bank. This credit is provided for a period between 18 months and 7 years.
d)      It provides long term credit to State land Development Banks, Commercial Banks and other financial institutions approved by reserve Bank of India. This credit is given for a period upto a maximum period of 25 years.
e)      It provides facilities for training the research and information in rural banking and development.
f)       NABARD undertakes monitoring and evaluation of projects refinanced by it.
g)      It functions as an apex institution i.e. it takes up all the functions performed by the Reserve Bank of India with regard to rural credit.
h)      NABARD has the responsibility to inspect Regional Rural Banks, Central and State Co-operative Banks.

d) Need and Objectives of RBI
The main objectives of the RBI are contained in the preamble of the RBI Act, 1934. It reads ‘Whereas it is expedient to constitute a Reserve Bank for India to regulate the issue of bank notes and 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. RBI keeps importance because it was constituted for the following needs:
(i) To maintain monetary stability such that the business and economic life of the country can deliver the welfare gains of a mixed economy.
(ii) To maintain financial stability and ensure sound financial institutions so that economic units can conduct their business with confidence, 
(iii) To maintain stable payment systems, so that financial transactions can be safely and efficiently executed, 
(iv) To ensure that credit allocation by the financial system broadly reflects the national economic priorities and social concerns.
(v) To regulate the overall volume of money and credit in the economy to ensure a reasonable degree of price stability, 
(vi) To promote the development of financial markets and systems to enable itself to operate/regulate efficiently.
e) Differences between primary and secondary market
Primary Market
Secondary Market
It deals in new securities which are issue for the first time.
It deals in already issued securities.
For Primary market, no organizational set up required.
But for a secondary market, a proper organizational set up is required.
Life of primary market is limited to point of issue of securities.
But Secondary Market has perpetual life.
It provides funds to the issuers for a particular purpose.
Funds from sell of shares can be utilised in any manner.
Individual issues are managed individually.
Manage and controlled by a central authority.
No fixed place for market.
Located at known fixed places.

f) COMMERCIAL PAPER MARKET (CP): Commercial paper is a short term money market instruments which is issued by companies to raise short term finance for the business. Companies can issue CPs either directly to the investors or through banks / merchant banks (called dealers). These are basically instruments evidencing the liability of the issuer to pay the holder in due course a fixed amount (face value of the instrument) on the specified due date. These are issued for a fixed period of time at a discount to the face value and mature at par.
4. What is financial system? Discuss the major components of Indian financial system.                                4+10=14
Ans: Meaning and definition of financial system:
The financial system is possibly the most important institutional and functional vehicle for economic transformation. Finance is a bridge between the present and the future and whether the mobilization of savings or their efficient, effective and equitable allocation for investment, it the access with which the financial system performs its functions that sets the pace for the achievement of broader national objectives.
According to Christy, 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.”
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.
A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the deficit. It is a composition of various institutions, markets, regulations and laws, practices, money manager analyst, transactions and claims and liabilities.
Elements or Structure of Indian Financial System

The formal financial system comprises financial institutions, financial markets, financial instruments and financial services. These constituents or components of Indian financial system may be briefly discussed as below:
A. Financial Institutions: Financial institutions are the participants in a financial market. They are business organizations dealing in financial resources. They collect resources by accepting deposits from individuals and institutions and lend them to trade, industry and others. They buy and sell financial instruments. They generate financial instruments as well. They deal in financial assets. They accept deposits, grant loans and invest in securities.
On the basis of the nature of activities, financial institutions may be classified as: (a) Regulatory and promotional institutions, (b) Banking institutions, and (c) Non-banking institutions.
1. Regulatory and Promotional Institutions: Financial institutions, financial markets, financial instruments and financial services are all regulated by regulators like Ministry of Finance, the Company Law Board, RBI, SEBI, IRDA, Dept. of Economic Affairs, Department of Company Affairs etc. The two major Regulatory and Promotional Institutions in India are Reserve Bank of India (RBI) and Securities Exchange Board of India (SEBI). Both RBI and SEBI administer, legislate, supervise, monitor, control and discipline the entire financial system.
2. Banking Institutions: Banking institutions mobilise the savings of the people. They provide a mechanism for the smooth exchange of goods and services. They extend credit while lending money. They not only supply credit but also create credit. There are three basic categories of banking institutions. They are commercial banks, co-operative banks and developmental banks.
3. Non-banking Institutions: The non-banking financial institutions also mobilize financial resources directly or indirectly from the people. They lend the financial resources mobilized. They lend funds but do not create credit. Companies like LIC, GIC, UTI, Development Financial Institutions, Organisation of Pension and Provident Funds etc. fall in this category.
B. Financial Markets: Financial markets are another part or component of financial system. Efficient financial markets are essential for speedy economic development. It facilitates the flow of savings into investment. Financial markets bridge one set of financial intermediaries with another set of players. Financial markets are the backbone of the economy. This is because they provide monetary support for the growth of the economy.
Classification of Financial Markets: There are different ways of classifying financial markets. There are mainly five ways of classifying financial markets.
1. Classification on the basis of the type of financial claim: On this basis, financial markets may be classified into debt market and equity market.
Debt market: This is the financial market for fixed claims like debt instruments.
Equity market: This is the financial market for residual claims, i.e., equity instruments.
2. Classification on the basis of maturity of claims: On this basis, financial markets may be classified into money market and capital market.
Money market: A market where short term funds are borrowed and lend is called money market. It deals in short term monetary assets with a maturity period of one year or less. Liquid funds as well as highly liquid securities are traded in the money market. Examples of money market are Treasury bill market, call money market, commercial bill market etc.
Capital market: Capital market is the market for long term funds. This market deals in the long term claims, securities and stocks with a maturity period of more than one year.
3. Classification on the basis of seasoning of claim: On this basis, financial markets are classified into primary market and secondary market.
Primary market: Primary markets are those markets which deal in the new securities. Therefore, they are also known as new issue markets.
Secondary market: Secondary markets are those markets which deal in existing securities. Existing securities are those securities that have already been issued and are already outstanding. Secondary market consists of stock exchanges.
4. Classification on the basis of structure or arrangements: On this basis, financial markets can be classified into organised markets and unorganized markets.
Organised markets: These are financial markets in which financial transactions take place within the well established exchanges or in the systematic and orderly structure.
Unorganised markets: These are financial markets in which financial transactions take place outside the well established exchange or without systematic and orderly structure or arrangements.
5. Classification on the basis of timing of delivery: On this basis, financial markets may be classified into cash/spot market and forward / future market.
Cash / Spot market: This is the market where the buying and selling of commodities happens or stocks are sold for cash and delivered immediately after the purchase or sale of commodities or securities.
Forward/Future market: This is the market where participants buy and sell stocks/commodities, contracts and the delivery of commodities or securities occurs at a pre-determined time in future.
6. Other types of financial market: Apart from the above, there are some other types of financial markets. They are foreign exchange market and derivatives market.
Foreign exchange market: Foreign exchange market is simply defined as a market in which one country’s currency is traded for another country’s currency.
Derivatives market: It is a market for derivatives. The important types of derivatives are forwards, futures, options, swaps, etc.
C. Financial Instruments (Securities): Financial instruments are the financial assets, securities and claims. They may be viewed as financial assets and financial liabilities. Financial assets represent claims for the payment of a sum of money sometime in the future (repayment of principal) and/or a periodic payment in the form of interest or dividend. Financial liabilities are the counterparts of financial assets. They represent promise to pay some portion of prospective income and wealth to others. Financial assets and liabilities arise from the basic process of financing.
D. Financial Services: The development of a sophisticated and matured financial system in the country, especially after the early nineties, led to the emergence of a new sector. This new sector is known as financial services sector. Its objective is to intermediate and facilitate financial transactions of individuals and institutional investors. The financial institutions and financial markets help the financial system through financial instruments. The financial services include all activities connected with the transformation of savings into investment. Important financial services include lease financing, hire purchase, instalment payment systems, merchant banking, factoring, forfaiting etc. 
Discuss about the regulatory reforms in the Indian banking system.                       14
Ans: Economic Reforms in India since 1991
The Indian Government has introduced many Economic Reforms in India since 1991. In 1990-91 India had to face grave economic problem. India was facing serious deficiency in her foreign trade balance and it was increasing. Since 1987-88 till 1990-91 it was increasing in such a rapid scale that by the end of 1990-91 the amount of this deficit balance became 10,644 crores of rupees.
At the same time the foreign exchange stock was also decreasing. In 1990 and 1991 the government of India had to take huge amount of loan from the IMF as compensatory financial facility. Even by mortgaging 46 tons of gold it had taken short term foreign loan from the Bank of England.
At the same time, India was also suffering from inflation, the rate of which was 12% by 1991. The reasons of that inflation were the increase in the procurement price of the agricultural products for distribution, the increase in the amount of monetized deficit in the budget, increase of import cost and decrease in the rate of currency exchange and Administered price like. Thus she was facing trade deficit as well as Fiscal Deficit.
To get relief from such a grave problem the government of India had only two ways before it to take foreign debt and to create favorable conditions within the country for increasing the flow of foreign exchange and also to increase the volume of export. The other was to establish fiscal discipline within the country and to make structural adjustment for the purpose.
Hence the government of India had to introduce a package of reforms which included:
a)      To liberalize the industrial policy of the government and to invite foreign investment by privatization of industries and abolishing the license system as a part of that liberalization.
b)      To make the import-export policy of the country more liberal and so that the export of Indian goods may become more easy and the necessary raw materials and instruments for both industrial development and production of exportable commodities may be imported and also to facilitate free trade by reducing the import duty.
c)       To decrease the value of money in terms of dollar
d)      To take huge amount of foreign debt from the IMF and the world Bank for rejuvenating the economic condition of the country and to introduce the structural adjustment in the economic condition of the country as a pre-condition of that debt,
e)      To reform the banking system and the tax structure of the country and
f)       To establish market economy by withdrawing and restricting government interference on investment.
The main objectives of the new fiscal policy are, however, to establish economic structural adjustment at the first stage and then to establish market economy by removing all controls and restrictions on it. There are two phases in the structural adjustment phase, the stabilization phase where all government expenditures are reduced and the banks are restricted on creating debt. The second phase is the structural adjustment phase where the production of exportable good and the alternative of import goods are increased and at the same time reducing governmental interference in industry, the management skill and productive capacity of the industries are increased through privatization.
Thus the new fiscal policy has introduced three significant things Deregulation, Privatization and Exit Policy. Excepting 15 important industries all other industries have been made free from license system. To encourage foreign investment its highest limit has been increased up to 51%. 38 industries have been made open for foreign investment like the Metal industry, Food Processing industry, Hotel and tourism industry etc. Exit Policy has been introduced in the industries which are running at a loss with surplus staff and the sick industries are scheduled to be closed.
The Economic liberalization have helped India to grow at faster pace. India is now considered one of the major economy of Asia. The Foreign investments in India have increased over the years. Many multinational companies have set-up their offices in India. The per-capita GDP of India have increased, which is a sign of growth and development.
India has emerged as a leading exporter of services, software and information-technology products. Many companies such as Wipro, TCS, HCL Technologies, Tech Mahindra have got worldwide fame. Thus the new economic policy is taking India towards liberal economy or market economy. It has relieved India much of her hardship that she faced in 1990-91.
5. Mention the causes of interest rate reforms in respect of Indian commercial banks since 1991. Discuss about the pattern of interest rate reforms in the post-liberalized era.                                        9+5=14
Since nationalisation of banks in 1969, the banking sector had been dominated by the public sector. There was financial repression, role of technology was limited, no risk management etc. This resulted in low profitability and poor asset quality. The country was caught in deep economic crises. The Government decided to introduce comprehensive economic reforms. Banking sector reforms were part of this package. In august 1991, the Government appointed a committee on financial system under the chairmanship of M. Narasimhan.
FIRST PHASE OF BANKING SECTOR REFORMS / NARASIMHAN COMMITTEE REPORT – 1991: To promote healthy development of financial sector, the Narasimhan committee made recommendations.
1.    Establishment of 4 tier hierarchy for banking structure with 3 to 4 large banks (including SBI) at top and at bottom rural banks engaged in agricultural activities.
2.    The supervisory functions over banks and financial institutions can be assigned to a quasi-autonomous body sponsored by RBI.
3.    Phased reduction in statutory liquidity ratio.
4.    Phased achievement of 8% capital adequacy ratio.
5.    Abolition of branch licensing policy.
6.    Proper classification of assets and full disclosure of accounts of banks and financial institutions.
7.    Deregulation of Interest rates.
8.    Delegation of direct lending activity of IDBI to a separate corporate body.
9.    Competition among financial institutions on participating approach.
10.  Setting up asset Reconstruction fund to take over a portion of loan portfolio of banks whose recovery has become difficult.
II) Banking Reform Measures of Government: On the recommendations of Narasimhan Committee, following measures were undertaken by government since 1991:-
1.    Lowering SLR and CRR: The high SLR and CRR reduced the profits of the banks. The SLR has been reduced from 38.5% in 1991 to 25% in 1997. This has left more funds with banks for allocation to agriculture, industry, trade etc.
The Cash Reserve Ratio (CRR) is the cash ratio of a bank’s total deposits to be maintained with RBI. The CRR has been brought down from 15% in 1991 to 4.1% in June 2003. The purpose is to release the funds locked up with RBI.
2.    Prudential Norms: Prudential norms have been started by RBI in order to impart professionalism in commercial banks. The purpose of prudential norms include proper disclosure of income, classification of assets and provision for Bad debts so as to ensure that the books of commercial banks reflect the accurate and correct picture of financial position.
Prudential norms required banks to make 100% provision for all Non-performing Assets (NPAs). Funding for this purpose was placed at Rs. 10,000 crores phased over 2 years.
3.    Capital Adequacy Norms (CAN): Capital Adequacy ratio is the ratio of minimum capital to risk asset ratio. In April 1992 RBI fixed CAN at 8%. By March 1996, all public sector banks had attained the ratio of 8%. It was also attained by foreign banks.
4.    Deregulation of Interest Rates: The Narasimhan Committee advocated that interest rates should be allowed to be determined by market forces. Since 1992, interest rate has become much simpler and freer.
a)    Scheduled Commercial banks have now the freedom to set interest rates on their deposits subject to minimum floor rates and maximum ceiling rates.
b)    Interest rate on domestic term deposits has been decontrolled.
c)    The prime lending rate of SBI and other banks on general advances of over Rs. 2 lakhs has been reduced.
d)    Rate of Interest on bank loans above Rs. 2 lakhs has been fully decontrolled.
e)    The interest rates on deposits and advances of all Co-operative banks have been deregulated subject to a minimum lending rate of 13%.
5.    Recovery Of Debts : The Government of India passed the “Recovery of debts due to Banks and Financial Institutions Act 1993” in order to facilitate and speed up the recovery of debts due to banks and financial institutions. Six Special Recovery Tribunals have been set up. An Appellate Tribunal has also been set up in Mumbai.
6.    Competition from New Private Sector Banks: Now banking is open to private sector. New private sector banks have already started functioning. These new private sector banks are allowed to raise capital contribution from foreign institutional investors up to 20% and from NRIs up to 40%. This has led to increased competition.
7.    Phasing Out Of Directed Credit: The committee suggested phasing out of the directed credit programme. It suggested that credit target for priority sector should be reduced to 10% from 40%. It would not be easy for government as farmers, small industrialists and transporters have powerful lobbies.
8.    Access to Capital Market: The Banking Companies (Acquisition and Transfer of Undertakings) Act was amended to enable the banks to raise capital through public issues. This is subject to provision that the holding of Central Government would not fall below 51% of paid-up-capital. SBI has already raised substantial amount of funds through equity and bonds.
9.    Freedom of Operation: Scheduled Commercial Banks are given freedom to open new branches and upgrade extension counters, after attaining capital adequacy ratio and prudential accounting norms. The banks are also permitted to close non-viable branches other than in rural areas.
10.  Local Area banks (LABs): In 1996, RBI issued guidelines for setting up of Local Area Banks and it gave its approval for setting up of 7 LABs in private sector. LABs will help in mobilizing rural savings and in channeling them in to investment in local areas.
11.  Supervision of Commercial Banks: The RBI has set up a Board of financial Supervision with an advisory Council to strengthen the supervision of banks and financial institutions. In 1993, RBI established a new department known as Department of Supervision as an independent unit for supervision of commercial banks.
“Regional rural banks are important financial institutions of the rural credit structure of India.” Comment         14
Ans: Regional Rural Banks
Regional Rural Banks were set by the state government and the sponsoring commercial banks with the objective of developing the rural economy. Regional rural banks provide banking services and credit to small farmers, small entrepreneurs in the rural areas. The regional rural banks were set up with a view to provide credit facilities to weaker sections. They constitute an important part of the rural financial architecture in India.
The regional banks where established in 1975 for supplementing the commercial banks and co-operative is supplying rural credit. The main objective of regional rural banks in India is to advance credit and other facilities especially to small and marginal farmers, agricultural labourers artisans and small entrepreneurs in order to develop agriculture, trade, commerce, industry and other productive activities in different rural areas of the country.
                At the initial state, fine regional rural banks were established on October 2, 1975 under the sponsorship of the state Bank of India. The syndicate bank united commercial bank, Punjab National Bank and united Bank of India. The Regional Rural Banks are maintaining its special character as they are area of operation is very much limited to a definite region. They grant direct loan to rural people at a concessional rate subsidy and concessions from the Reserve Bank & Sponsoring bank. Regional Rural banks have made a commendable progress in advancing various types of loan to the weaker and under privileged sections of the rural society. In respect of credit operations, RDBS were successful in identifying the target groups and also in meeting their credit requirements.
There were 196 RRBs at the end of June 2002, as compared to 107 in 1981 and 6 in 1975. Till date in rural banking in India, there are 14,475 rural banks in the country of which 2126 (91%) are located in remote rural areas.
There are several concessions enjoyed by the RRBs by Reserve Bank of India such as lower interest rates and refinancing facilities from NABARD like lower cash ratio, lower statutory liquidity ratio (SLR), lower rates of interest on loans take from sponsoring banks, managerial and staff assistance from the sponsoring bank and reimbursement of the expenses on staff training. The RRBs are under the control of NABARD. NABARD has the responsibility of laying down the policies for the RRBs, to oversee their operations, provide refinance facilities, to monitor their performance and to attend their problems.
Government decided to restructure the RRB’s on the recommendation of Bhandari Committee in 1994 – 95. As a result, the amount of Rs. 360 crores was allocated towards the restructuring programme. The State Bank of India took several measures of managerial and financial restructuring including enhancement of issued capital and placements of officers of proven ability to head the RRBs. The Government of India released Rs. 1867.65 crores between 1994 – 98 for the recapitalization of RRBs, 175 out of total of 196 RRBs were fully recapitalized by 1998 – 99.
NABARD took several policy measures such as quarterly/half yearly review of RRBs by the sponsor banks, framing of Appointment and Promotion Rules (1998) for the staff of RRBs, introduction of Kissan Credit Cards, introduction of self-help groups etc, for improving the overall performance of RRBs. In order to strengthen and consolidate RRBs, the government in 2005 initiated the process of amalgamation of RRBs in a phased manner. Consequently, the total number of RRBs has reduced from 196 to 82 as on March 31, 2010.
Importance of RRBs:
A rural bank is a financial institution that helps rationalize the developing regions or developing country to finance their needs specially the projects regarding agricultural progress. In other words, a rural bank is actually just a normal bank but one that caters to the needs of the rural public in India’s villages. Majority of the population in rural India do not have banking facilities and still don’t have a bank account. These rural banks provide banking services to the rural citizens and help them save money effectively.
Actually the services provided by a commercial bank and a rural bank are the same. They provide bank accounts, accept deposits, and grant loans etc. to its customers. The only difference between the two is the population they serve. Commercial banks serve the general population of the country that lives in cities and towns whereas the rural banks serve the customers from the rural villages of the country.
Rural banking in India started since the establishment of banking sector in India. Rural Banks in those days mainly focused upon the agro sector. Today, commercial banks and Regional Rural Banks in India are penetrating every corner of the country are extending a helping hand in the growth process of the rural sector in the country.
Rural banking institutions are playing a very important role for all round development of rural areas of the country. In order to support the rural banking sector in recent years. Regional Rural Banks have been set up all over the country with the objective of meeting the credit needs of the most under privileged sections of the society. These regional rural banks have been receiving a high degree of importance and attention in the rural credit system.
Functions of Rural Banks
A rural bank may offer or perform any or all of the following services:
1)            Grant loans and make investments in accordance with existing rules and regulations.
2)            Accept deposits (both savings and time)
3)            Sell domestic drafts.
4)            Act as agent for other financial institutions.
5)            Receive in custody funds, documents, and other valuable objects, and rent safety deposit boxes for the safe guarding of such objects.
6)            Act as financial agent, buy and sell, by order of and for the account of its customers, shares, evidences of indebt and all types of securities.
7)            Make collections and payments for the account of others and perform such other services for its customers as are not incompatible with banking business.
6. What do you mean by financial markets? Who are the participants in financial markets? Why do they participate in financial markets? Explain.                                         4+3+7=14
Ans: Meaning of Financial Market
A financial market is an institution that facilitates exchange of financial instruments including deposits, loans, corporate stocks, government bonds, etc.
According to Brigham Eugene F. "The place where people and organizations wanting to borrow money, are brought together, with those having surplus funds is called a financial market". This definition makes it clear that a financial market is a place where those who need money and those who have surplus money are brought together. They may come together directly or indirectly. Financial market in India performs an important function of mobilization of savings and channelizing them into most productive uses.
Major Participants in the Indian Money Market is given below:
a)      The Central Government
b)      Commercial Banks
c)       Financial Institutions
d)      Mutual Funds
e)      Non-banking financing companies
f)       Stock exchange
g)      Brokers
h)      Merchant bankers
i)        underwriters
Role of Various participants
1) The Central Government: The Central Government is an issuer of Government of India Securities (G-Secs) and Treasury Bills (T-bills). These instruments are issued to finance the government as well as for managing the Government’s cash flow. T-bills and G-secs are issued by RBI on behalf of central bank to meet its short-term financial needs. Money market is regulated by RBI.
2) Commercial Banks: Commercial banks are major participants in both capital market and money market. In capital market, banks take active part in bond market. Banks may invest in equity and mutual funds as a part of their fund management. Certificate of deposits are issued by banks in money market. Then invest in government securities to maintain their statutory liquidity ratio. They also participate in call and term markets both as lenders and borrowers.
3) Life Insurance Companies: Life Insurance Companies (LICs) invest their funds in various capital market instruments and G-Sec, Bond or short term money markets. They have certain pre-determined thresholds as to how much they can invest in each category of instruments.
4) Mutual Funds: Mutual funds invest their funds in capital market and money market instruments. The proportion of the funds which they can invest in any one instrument varies according to the approved investment pattern declared in each scheme.
5) Non-banking Finance Companies: Non-banking Finance Companies (NBFCs) invest their funds in debt instruments to fulfill certain regulatory mandates as well as to park their surplus funds. NBFCs are required to invest 15% of their net worth in bonds which fulfill the SLR requirement.
6) Stock exchange: Secondary market also called stock exchange represents a market where existing securities i.e. shares and debentures are traded. Its main function is to create a link between the buyers and sellers of securities so that investments can change hands in the quickest and cheapest manner. They also provide clearing house facilities to its various investors.
7) Brokers: Only brokers approved by Capital Market Regula­tor can operate on stock exchange. Brokers perform the job of intermediating between buyers and seller of securities. They help build up order book, price discovery, and are responsible for a contract being honoured. For their services brokers earn a fee known as brokerage.
8) Merchant Bankers: These are agen­cies/organisations regulated and licensed by SEBI, the Capital Markets Regulator. They arrange raising of funds through equity and debt route and assist companies in completing various for­malities like filing of the prescribed document and other compli­ances with the Regulator and Regulators.
9) Underwriters: An underwriter may be an individual, broker, merchant banker, financial institution or banks. The underwriting is an agreement between the issuing company and the assuring party through an agreement to take up shares or debentures or other securities to a specified extent in case public subscription does not amount to the expected level. Thus, in case any short-fall, it has to be made good by underwriting arrangements by the underwriter as per the agreement. 
What do you mean by New Issue Market (NIM)? Mention the characteristics of NIM. Explain the role of New Issue Market in Indian financial system.                                          3+4+7=14
Ans: Primary Market (New Issue Market):. A primary market refers to any market where new shares of stock are sold. The primary market is the entry market for companies and investors, where a company or institution that requires initial or additional capital sells its shares or financial instrument to the investors. For example, Initial Public Offering (IPO), public offer, rights issue and bond issue are done on the primary market. The primary market is also unique that the initial buyer is the only person who can exchange the securities for funds. When companies are willing to go for publicly listed on the stock exchange and wants to collect funds from general investors, they first sell their financial instrument in the primary market. Primary market is the first place for trading financial instruments including stocks and bonds.
Features of Primary Market
a)      It deals in new securities which are issue for the first time.
b)      For Primary market, no organizational set up required.
c)       Life of primary market is limited to point of issue of securities.
d)      It provides funds to the issuers for a particular purpose.
e)      Individual issues are managed individually.
f)       There is no fixed place for primary market.
Functions of Primary Market
The main function of a primary market can be divided into three service functions. They are: origination, underwriting and distribution.
1. Origination: Origination refers to the work of investigation, analysis and processing of new project proposals. Origination begins before an issue is actually floated in the market. The function of origination is done by merchant bankers who may be commercial banks, all India financial institutions or private firms.
2. Underwriting: When a company issues shares to the public it is not sure that the whole shares will be subscribed by the public. Therefore, in order to ensure the full subscription of shares (or at least 90%) the company may underwrite its shares or debentures. The act of ensuring the sale of shares or debentures of a company even before offering to the public is called underwriting. It is a contract between a company and an underwriter (individual or firm of individuals) by which he agrees to undertake that part of shares or debentures which has not been subscribed by the public. The firms or persons who are engaged in underwriting are called underwriters.
3. Distribution: This is the function of sale of securities to ultimate investors. This service is performed by brokers and agents. They maintain a direct and regular contact with the ultimate investors.

7. Discuss the role of mutual funds in the financial market of India. Mention the problems of mutual funds in the country.                                                 8+6=14
Ans: Meaning of Mutual Fund: A mutual fund is an investment security type that enables investors to pool their money together into one professionally managed investment. Mutual funds can invest in stocks, bonds, cash and/or other assets. 
Advantages of Mutual Funds for Investors
a)      Professional Management: Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. There are several aspects to such professional management viz. investing in line with the investment objective, investing based on adequate research, and ensuring that prudent investment processes are followed.
b)      Affordable Portfolio Diversification: Units of a scheme give investors exposure to a range of securities held in the investment portfolio of the scheme. Thus, even a small investment of Rs 5,000 in a mutual fund scheme can give investors a diversified investment portfolio.
c)       Economies of Scale: The pooling of large sums of money from so many investors makes it possible for the mutual fund to engage professional managers to manage the investment. Individual investors with small amounts to invest cannot, by themselves, afford to engage such professional management.
d)      Liquidity: Investors in a mutual fund scheme can recover the value of the moneys invested, from the mutual fund itself. Depending on the structure of the mutual fund scheme, this would be possible, either at any time, or during specific intervals, or only on closure of the scheme.
e)      Tax Deferral: Mutual funds are not liable to pay tax on the income they earn. If the same income were to be earned by the investor directly, then tax may have to be paid in the same financial year.
f)       Tax benefits: Specific schemes of mutual funds (Equity Linked Savings Schemes) give investors the benefit of deduction of the amount invested, from their income that is liable to tax. This reduces their taxable income, and therefore the tax liability.
g)      Convenient Options: The options offered under a scheme allow investors to structure their investments in line with their liquidity preference and tax position.
h)      Investment Comfort: Once an investment is made with a mutual fund, they make it convenient for the investor to make further purchases with very little documentation. This simplifies subsequent investment activity.
i)        Regulatory Comfort: The regulator, Securities & Exchange Board of India (SEBI) has mandated strict checks and balances in the structure of mutual funds and their activities. These are detailed in the subsequent units. Mutual fund investors benefit from such protection.
j)        Systematic approach to investments: Mutual funds also offer facilities that help investor invest amounts regularly through a Systematic Investment Plan (SIP); or withdraw amounts regularly through a Systematic Withdrawal Plan (SWP); or move moneys between different kinds of schemes through a Systematic Transfer Plan (STP). Such systematic approaches promote an investment discipline, which is useful in long term wealth creation and protection.
Limitations of a Mutual Fund
1.       Lack of portfolio customization: Mutual fund unit-holder is just one of several thousand investors in a scheme. Once a unit-holder has bought into the scheme, investment management is left to the fund manager. Thus, the unit-holder cannot influence what securities or investments the scheme would buy.
2.       Choice overload: Over 800 mutual fund schemes offered by 38 mutual funds – and multiple options within those schemes – make it difficult for investors to choose between them.
3.       No control over costs: All the investor's moneys are pooled together in a scheme. Costs incurred for managing the scheme are shared by all the Unitholders in proportion to their holding of Units in the scheme. Therefore, an individual investor has no control over the costs in a scheme.
Mention any two functions of SEBI. Explain the powers and functions of SEBI regarding protection of the interests of the investors.
Ans: With the growth in the dealings of stock markets, lot of malpractices also started in stock markets such as price rigging, ‘unofficial premium on new issue, and delay in delivery of shares, violation of rules and regulations of stock exchange and listing requirements. Due to these malpractices the customers started losing confidence and faith in the stock exchange. So government of India decided to set up an agency or regulatory body known as Securities Exchange Board of India (SEBI).
Securities Exchange Board of India (SEBI) was set up in 1988 to regulate the functions of securities market. SEBI promotes orderly and healthy development in the stock market but initially SEBI was not able to exercise complete control over the stock market transactions.
It was left as a watch dog to observe the activities but was found ineffective in regulating and controlling them. As a result in May 1992, SEBI was granted legal status. SEBI is a body corporate having a separate legal existence and perpetual succession.
Functions of SEBI: The SEBI performs functions to meet its objectives. To meet three objectives SEBI has three important functions. These are:
i. Protective functions
ii. Developmental functions
iii. Regulatory functions.
Powers and Functions of SEBI
1. Protective Functions: These functions are performed by SEBI to protect the interest of investor and provide safety of investment. As protective functions SEBI performs following functions:
(i) It Checks Price Rigging: Price rigging refers to manipulating the prices of securities with the main objective of inflating or depressing the market price of securities. SEBI prohibits such practice because this can defraud and cheat the investors.
(ii) It Prohibits Insider trading: Insider is any person connected with the company such as directors, promoters etc. These insiders have sensitive information which affects the prices of the securities. This information is not available to people at large but the insiders get this privileged information by working inside the company and if they use this information to make profit, then it is known as insider trading. SEBI keeps a strict check when insiders are buying securities of the company and takes strict action on insider trading.
(iii) SEBI prohibits fraudulent and Unfair Trade Practices: SEBI does not allow the companies to make misleading statements which are likely to induce the sale or purchase of securities by any other person.
(iv) SEBI undertakes steps to educate investors so that they are able to evaluate the securities of various companies and select the most profitable securities.
(v) SEBI promotes fair practices and code of conduct in security market by taking following steps:
(a) SEBI has issued guidelines to protect the interest of debenture-holders wherein companies cannot change terms in midterm.
(b) SEBI is empowered to investigate cases of insider trading and has provisions for stiff fine and imprisonment.
(c) SEBI has stopped the practice of making preferential allotment of shares unrelated to market prices.
2. Developmental Functions: These functions are performed by the SEBI to promote and develop activities in stock exchange and increase the business in stock exchange. Under developmental categories following functions are performed by SEBI:
(i) SEBI promotes training of intermediaries of the securities market.
(ii) SEBI tries to promote activities of stock exchange by adopting flexible and adoptable approach in following way:
(a) SEBI has permitted internet trading through registered stock brokers.
(b) SEBI has made underwriting optional to reduce the cost of issue.
(c) Even initial public offer of primary market is permitted through stock exchange.
3. Regulatory Functions: These functions are performed by SEBI to regulate the business in stock exchange. To regulate the activities of stock exchange following functions are performed:
(i) SEBI has framed rules and regulations and a code of conduct to regulate the intermediaries such as merchant bankers, brokers, underwriters, etc.
(ii) These intermediaries have been brought under the regulatory purview and private placement has been made more restrictive.
(iii) SEBI registers and regulates the working of stock brokers, sub-brokers, share transfer agents, trustees, merchant bankers and all those who are associated with stock exchange in any manner.
(iv) SEBI registers and regulates the working of mutual funds etc.
(v) SEBI regulates takeover of the companies.
(vi) SEBI conducts inquiries and audit of stock exchanges.

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