BANKING
        The banking system significantly contributes for the development of any country. Due to the importance in the financial stability of a country, banks are highly regulated in most                    countries. A bank is generally understood as an institution which provides fundamental financial services such as accepting deposits and lending loans. Banking sector acts as the              backbone of modern business world. The Ricks Banks of Sweden, which had sprung from a private bank established in 1656 is the oldest central bank in  the world. The Reserve              Bank of India (1935)
History of Indian BANKS
         The Banking system in India was controlled and dominated by the Presidency Banks.
         The first bank of India was Bank of Hindustan (1770) Under British Rule There were
         three Presidency Banks:
           1. Bank of Bengal (1809)
           2. Bank of Bombay (1840)
           3. Bank of Madras (1843).
        All the banks merged in 1921 in the name of Imperial Bank of India later changed in to
       SBI in 1955.
MONEY AND FINANCE
        Money is anything that is generally accepted as payment for goods and services and repayment of debts and that serves as a medium of exchange. A medium of exchange is
        anything that is widely accepted as a means of payments.
Evolution of Money
Barter System
        The introduction of money as a medium of exchange was one of the greatest inventions of mankind. Before money was invented, exchange took place by Barter, that is,                              commodities and services were directly exchanged for other commodities and services.
        Under the barter system, buyers and sellers of commodities had to face a number of difficulties. Surplus goods were exchanged for money which in turn was exchanged for
        other needed goods. Such exchange of goods for goods was known as “Barter
       Exchange” or “Barter System”.

Metallic Standard
        After the barter system and commodity money system, modern money systems evolved. Among these, metallic standard is the premier one. Under metallic standard, some kind of           metal either gold or silver is used to determine the standard value of the money and currency. Standard coins made out of the metal are the principal coins used under the metallic             standard. These standard coins are full bodied or full weighted legal tender. Their face value is equal to their intrinsic metal value.

Gold Standard
       Gold Standard is a system in which the value of the monetary unit or the standard currency is directly linked with gold. The monetary unit is defined in terms of a certain
      weight of gold. The purchasing power of a unit of money is maintained equal to the value of a fixed weight of gold.

Silver Standard
      The silver standard is a monetary system in which the standard economic unit of account is a fixed weight of silver. The silver standard is a monetary arrangement in which a                      country’s  Government allows conversion of its currency into fixed amount of silver.

Paper Currency Standard
       The paper currency standard refers to the monetary system in which the paper currency notes issued by the Treasury or the Central Bank or both circulate as unlimited legal tender.          Paper currency is not convertible into any metal. Its value is determined independent of the value of gold or any other commodity. The paper standard is also known as managed                currency standard. The quantity of money in circulation is controlled by the monetary authority to maintain price stability.

Plastic Money
     The latest type of money is plastic money. Plastic money is one of the most evolved forms of financial products. Plastic money is an alternative to the cash or the standard “money”.            Plastic money is a term that is used predominantly in reference to the hard-plastic cards used every day in place of actual bank notes. Plastic money can come in
     many different forms such as Cash cards, Credit cards, Debit cards, Pre-paid Cash cards, Store cards, Forex cards and Smart cards. They aim at removing the need for
     carrying cash to make transactions.

Functions of Money
The main functions of money can be classified into four categories:
1. Money as a medium of exchange:
This is considered as the basic function of money. Money has the quality of
general acceptability, and all exchanges take place in terms of money. On account
of the use of money, the transaction has now come to be divided into two parts.
First, money is obtained through sale of goods or services. This is known as sale.
Later, money is obtained to buy goods and services. This is known as purchase.
Thus, in the modern exchange system money acts as the intermediary in sales and
purchases.
2. Money as a measure of value:
The second important function of money is that it measures the value of goods
and services. In other words, the prices of all goods and services are expressed in
terms of money. Money is thus looked upon as a collective measure of value. Since
all the values are expressed in terms of money, it is easier to determine the rate of
exchange between various types of goods in the community.
2. Secondary Functions
1. Money as a Store of value:
Savings done in terms of commodities were not permanent. But, with the
invention of money, this difficulty has now disappeared and savings are now done
in terms of money. Money also serves as an excellent store of wealth, as it can be
easily converted into other marketable assets, such as, land, machinery, plant etc.

2. Money as a Standard of Deferred Payments:
Borrowing and lending were difficult problems under the barter system. In the
absence of money, the borrowed amount could be returned only in terms of goods
and services. But the modern money-economy has greatly facilitated the
borrowing and lending processes. In other words, money now acts as the standard
of deferred payments.
3. Money as a Means of Transferring Purchasing Power:
The field of exchange also went on extending with growing economic
development. The exchange of goods is now extended to distant lands. It is
therefore, felt necessary to transfer purchasing power from one place to another.
3. Contingent Functions
1. Basis of the Credit System:
Money is the basis of the Credit System. Business transactions are either in cash
or on credit. For example, a depositor can make use of cheques only when there
are sufficient funds in his account. The commercial banks create credit on the
basis of adequate cash reserves. But money is at the back of all credit.
2. Money facilitates distribution of National Income:
The task of distribution of national income was exceedingly complex under the
barter system. But the invention of money has now facilitated the distribution of
income as rent, wage, interest and profit.

3. Money helps to Equalize Marginal Utilities and Marginal Productivities:
Consumer can obtain maximum utility only if he incurs expenditure on various
commodities in such a manner as to equalize marginal utilities accruing from
them. Now in equalizing these marginal utilities, money plays an important role,
because the prices of all commodities are expressed in money. Money also helps to
equalize marginal productivities of various factors of production.
4.Money Increases Productivity of Capital:
Money is the most liquid form of capital. In other words, capital in the form of
money can be put to any use. It is on account of this liquidity of money that capital
can be transferred from the less productive to the more productive uses.

4. Other Functions
1. Money helps to maintain Repayment Capacity:
Money possesses the quality of general acceptability. To maintain its repayment
capacity, every firm has to keep assets in the form of liquid cash. The firm ensures
its repayment capacity with money. Likewise, banks, insurance companies and
even governments have to keep some liquid money (i.e., cash) to maintain their
repayment capacity.
2. Money represents Generalized Purchasing Power:
Purchasing power kept in terms of money can be put to any use. It is not
necessary that money should be used only for the purpose for which it has been
served.
3. Money gives liquidity to Capital:
Money is the most liquid form of capital. It can be put to any use.
Supply of Money
Money supply means the total amount of money in an economy. It refers to the amount
of money which is in circulation in an economy at any given time. Money supply plays a
crucial role in the determination of price level and interest rates. Money supply viewed
at a given point of time is a stock and over a period of time it is a flow.
Meaning of Money Supply
In India, currency notes are issued by the Reserve Bank of India (RBI) and coins are
issued by the Ministry of Finance, Government of India (GOI). Besides these, the
balance is savings, or current account deposits, held by the public in commercial banks
is also considered money. The currency notes are also called fiat money and legal
tenders.
Money supply is a stock variable. RBI publishes information for four alternative
measures of Money supply, namely M1, M2, M3 and M4.
M1 = Currency, coins and demand deposits
M2 = M1 + Savings deposits with post office savings banks
M3 = M2 + Time deposits of all commercial and cooperative banks
M4 = M3 + Total deposits with Post offices.
M1 and M2 are known as narrow money
M3 and M4 are known as broad money

The gradations are in decreasing order of liquidity.
Determinants of Money Supply
1. Currency Deposit Ratio (CDR); It is the ratio of money held by the public in
currency to that they hold in bank deposits.
2. Reserve deposit Ratio (RDR); Reserve Money consists of two things (a) vault cash
in banks and (b) deposits of commercial banks with RBI.
3. Cash Reserve Ratio (CRR); It is the fraction of the deposits the banks must keep
with RBI.
4. Statutory Liquidity Ratio (SLR); It is the fraction of the total demand and time
deposits of the commercial banks in the form of specified liquid assets.
CENTRAL BANK AND RBI AUTONOMY
A central bank, reserve bank, or monetary authority is an institution that manages a
state’s currency, money supply, and interest rates. Central banks also usually oversee
the commercial banking system of their respective countries. The Reserve Bank of
India started its operations on 1st April 1935. It was permanently moved to Mumbai
from the year 1937. RBI was nationalised in 1949.
Functions of Central Bank or Reserve Bank of India
The Reserve Bank of India (RBI) is India’s central banking institution, which controls
the monetary policy of the Indian rupee. It commenced its operations on 1 April 1935 in
accordance with the Reserve Bank of India Act, 1934. The original share capital was
divided into shares of 100 each fully paid, which were initially owned entirely by
private shareholders. Following India’s independence on 15 August 1947, the RBI was
nationalised on 1 January 1949.
FUCTIONS OF RBI
1.Monetary Authority: It controls the supply of money in the economy to stabilize
exchange rate, maintain healthy balance of payment, attain financial stability, control
inflation, strengthen banking system.
2. The issues of currency: The objective is to maintain the currency and credit
system of the country. It is the sole authority to issue currency. It also takes action to
control the circulation of fake currency.

3. The issuer of Banking License: As per Sec 22 of Banking Regulation Act, every
bank has to obtain a banking license from RBI to conduct banking business in India.
The process of issuing paper currency was started in the 18th century. Private Banks
such as the bank of Bengal the bank of Bombay and the Bank of Madras – first printed
paper money. The first rupee was introduced by Sher Shah Suri based on a ratio of 40
copper pieces (paisa) per rupee. The name was derived from the Sanskrit word Rupya,
meaning silver. Each banknote has its amount written in 17 languages (English and
Hindi on the front and 15 others on the back) illustrating the diversity of the country.
4. Banker to the Government: It acts as banker both to the central and the state
governments. It provides short-term credit. It manages all new issues of government
loans, servicing the government debt outstanding and nurturing the market for
government securities. It advises the government on banking and financial subjects.
5. Banker’s Bank: RBI is the bank of all banks in India as it provides loan to banks,
accept the deposit of banks, and rediscount the bills of banks.
6. Lender of last resort: The banks can borrow from the RBI by keeping eligible
securities as collateral at the time of need or crisis, when there is no other source.
7. Act as clearing house: For settlement of banking transactions, RBI manages 14
clearing houses. It facilitates the exchange of instruments and processing of payment
instructions.
8. Custodian of foreign exchange reserves: It acts as a custodian of FOREX. It
administers and enforces the provision of Foreign Exchange Management Act (FEMA),
1999. RBI buys and sells foreign currency to maintain the exchange rate of Indian
rupee v/s foreign currencies.
9. Regulator of Economy: It controls the money supply in the system, monitors
different key indicators like GDP, Inflation, etc.
10. Managing Government securities: RBI administers investments in
institutions when they invest specified minimum proportions of their total
assets/liabilities in government securities.
11. Regulator and Supervisor of Payment and Settlement Systems: The
Payment and Settlement Systems Act of 2007 (PSS Act) gives RBI oversight authority

for the payment and settlement systems in the country. RBI focuses on the
development and functioning of safe, secure and efficient payment and settlement
mechanisms.
12. Developmental Role: This role includes the development of the quality banking
system in India and ensuring that credit is available to the productive sectors of the
economy. It provides a wide range of promotional functions to support national
objectives. It also includes establishing institutions designed to build the country’s
financial infrastructure. It also helps in expanding access to affordable financial
services and promoting financial education and literacy.
13. Publisher of monetary data and other data: RBI maintains and provides all
essential banking and other economic data, formulating and critically evaluating the
economic policies in India. RBI collects, collates and publishes data regularly.
14. Exchange manager and controller: RBI represents India as a member of the
International Monetary Fund [IMF]. Most of the commercial banks are authorized
dealers of RBI.
15. Banking Ombudsman Scheme: RBI introduced the Banking Ombudsman
Scheme in 1995. Under this scheme, the complainants can file their complaints in any
form, including online and can also appeal to the Ombudsman against the awards and
the other decisions of the Banks.
16. Banking Codes and Standards Board of India: To measure the performance
of banks against Codes and standards based on established global practices, the RBI
has set up the Banking Codes and Standards Board of India (BCSBI).
Credit Control Measures
Credit control is the primary mechanism available to the Central banks to realize the
objectives of monetary management. The RBI is much better placed than many of
credit control. The statutory basis for the control of the credit system by the Reserve
Bank is embodied in the Reserve Bank of India Act, 1934 and the Banking Regulation
Act, 1949.

Methods of Credit Control
1. Quantitative or General Methods:
1. Bank Rate Policy: The bank rate is the rate at which the Central Bank of a
country is prepared to re-discount the first-class securities. It means the bank is
prepared to advance loans on approved securities to its member banks. As the
Central Bank is only the lender of the last resort the bank rate is normally higher
than the market rate. For example: If the Central Bank wants to control credit, it will
raise the bank rate. As a result, the deposit rate and other lending rates in the
money-market will go up. Borrowing will be discouraged, and will lead to
contraction of credit and vice versa.
2. Open Market Operations: In narrow sense, the Central Bank starts the
purchase and sale of Government securities in the money market. In Broad Sense,
the Central Bank purchases and sells not only Government securities but also other
proper eligible securities like bills and securities of private concerns. When the
banks and the private individuals purchase these securities, they have to make
payments for these securities to the Central Bank.
3. Variable Reserve Ratio:
1. Cash Reserves Ratio: Under this system the Central Bank controls credit by
changing the Cash Reserves Ratio. For example, if the Commercial Banks have
excessive cash reserves on the basis of which they are creating too much of
credit, this will be harmful for the larger interest of the economy. So, it will
raise the cash reserve ratio which the Commercial Banks are required to
maintain with the Central Bank. Similarly, when the Central Bank desires that
the Commercial Banks should increase the volume of credit in order to bring
about an economic revival in the economy. The central Bank will lower down
the Cash Reserve Ratio with a view to expand the lending capacity of the
Commercial Banks.
2. Statutory Liquidity Ratio: Statutory Liquidity Ratio (SLR) is the amount
which a bank has to maintain in the form of cash, gold or approved securities.
The quantum is specified as some percentage of the total demand and time
liabilities (i.e., the liabilities of the bank which are payable on demand anytime,
and those liabilities which are accruing in one month’s time due to maturity) of
a bank.

4. Liquidity adjustment facility
Short term credit control measure absorbs excess liquidity. It has two instruments
namely Repo rate and Reverse repo rate
1. Repo rate
The rate at which the RBI is willing to lend to commercial banks is called Repo
Rate. Whenever banks have any shortage of funds they can borrow from the
RBI, against securities. If the RBI increases the Repo Rate, it makes borrowing
expensive for banks and vice versa. As a tool to control inflation, RBI increases
the Repo Rate, making it more expensive for the banks to borrow from the RBI.
Similarly, the RBI will do the exact opposite in a deflationary environment.
2. Reverse Repo Rate:
The rate at which the RBI is willing to borrow from the commercial banks is
called reverse repo rate. If the RBI increases the reverse repo rate, it means that
the RBI is willing to offer lucrative interest rate to banks to park their money
with the RBI. This results in a decrease in the amount of money available for
banks customers as banks prefer to park their money with the RBI as it involves
higher safety. This naturally leads to a higher rate of interest which the banks
will demand from their customers for lending money to them.
5. Marginal standing facility
It is overnight loan facility given by RBI to Banks available from May 9 2011.The
loan is given against the mortgage against eligible government securities like
government dated securities, treasury bills and state development loans. The loan
size maximum one crore. The interest rate for MSF is repo rate plus 1% and Repo
rate act as an anchor rate. The MSF stands above repo rate.
6. Market Stabilisation Scheme
The Market Stabilization Scheme (MSS) was launched in April 2004. Market
Stabilization Scheme (MSS) is a monetary policy tool used by the RBI to manage
money supply in the economy. If there is an excess money supply in the economy,
RBI intervenes by selling Government securities like Treasury Bills, Cash
Management Bills & Dated securities. This helps to withdraw the excess liquidity
from the system. MSS is only selling of Government securities to withdraw excess
liquidity. The money raised through the selling of securities is kept in a separate
account known as MSS account, the amount kept in the MSS account is only used for

redemption of securities issued under the MSS. This money is not used by the
Government to meet its expenditure requirement. It is not a part of Government
borrowing; However, interest is paid on the securities issued under MSS. Hence,
there is only a marginal impact on fiscal deficit due to interest payments. The cost of
interest payment is shown separately in the budget.
2. Qualitative or Selective Method of Credit Control:
The qualitative or the selective methods are directed towards the diversion of credit
into particular uses or channels in the economy. Their objective is mainly to control
and regulate the flow of credit into particular industries or businesses. The following
are the frequent methods of credit control under selective method:
1. Rationing of Credit
2. Direct Action
3. Moral Persuasion
4. Method of Publicity
5. Regulation of Consumer’s Credit
6. Regulating the Marginal Requirements on Security Loans
1. Rationing of Credit
This is the oldest method of credit control. Rationing of credit as an instrument of
credit control was first used by the Bank of England by the end of the 18th Century. It
aims to control and regulate the purposes for which credit is granted by commercial
banks. It is generally of two types.
1. The variable portfolio ceiling: It refers to the system by which the central
bank fixes ceiling or maximum amount of loans and advances for every
commercial bank.
2. The variable capital asset ratio: It refers to the system by which the central
bank fixes the ratio which the capital of the commercial bank should have to the
total assets of the bank.
2. Direct Action
Direct action against the erring banks can take the following forms.
1. The central bank may refuse to altogether grant discounting facilities to such
banks.

2. The central bank may refuse to sanction further financial accommodation to a
bank whose existing borrowing are found to be in excess of its capital and
reserves.
3. The central bank may start charging penal rate of interest on money borrowed
by a bank beyond the prescribed limit.
3. Moral Suasion
This method is frequently adopted by the Central Bank to exercise control over the
Commercial Banks. Under this method Central Bank gives advice, then requests and
persuades the Commercial Banks to co-operate with the Central Bank in
implementing its credit policies.
4. Publicity
Central Bank in order to make their policies successful, take the course of the
medium of publicity. A policy can be effectively successful only when an effective
public opinion is created in its favour.
5. Regulation of Consumer’s Credit:
The down payment is raised and the number of installments reduced for the credit
sale.
6. Changes in the Marginal Requirements on Security Loans:
1. This system is mostly followed in U.S.A. Under this system, the Board of
Governors of the Federal Reserve System has been given the power to prescribe
margin requirements for the purpose of preventing an excessive use of credit
for stock exchange speculation.
2. This system is specially intended to help the Central Bank in controlling the
volume of credit used for speculation in securities under the Securities
Exchange Act, 1934.
COMMERCIAL BANKS
Commercial bank refers to a bank, or a division of a large bank, which more specifically
deals with deposit and loan services provided to corporations or large/middle-sized
business – as opposed to individual members of the public/small business. They do not
provide, long-term credit, as liquidity of assets is to be maintained. 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.
Classification of commercial banks
1. Scheduled Banks: Banks which have been included in the Second Schedule of
RBI Act 1934. They are categorized as follows:
2. Public Sector Banks: These are those banks in which majority of stake is held
by the government. E.g. SBI, PNB, Syndicate Bank, Union Bank of India etc.
3. Private Sector Banks: These are those banks in which majority of stake is
held by private individuals. i.e. ICICI Bank, IDBI Bank, HDFC Bank, AXIS Bank
etc.
4. Foreign Banks: These are the banks with Head office outside the country in
which they are located. E.g. Citi Bank, Standard Chartered Bank, Bank of Tokyo
Ltd. etc.
5. Non scheduled commercial Banks: Those banks which are not added in the
Second Schedule of RBI Act 1934.
List of Commercial Banks in India
SBI & Associates:
1. State Bank of India
Nationalized Banks:
1. Allahabad Bank
2. Andhra Bank
3. Bank of Baroda
4. Bank of India
5. Bank of Maharashtra
6. Canara Bank
7. Central Bank of India
8. Corporation Bank
9. Dena Bank
10.Indian Bank
11. Indian Overseas Bank

12. Oriental Bank of Commerce
13. Punjab & Sind Bank
14. Punjab National Bank
15. Syndicate Bank
16. UCO Bank
17. Union Bank of India
18.United Bank of India
19. Vijaya Bank
Functions of Commercial Banks:
Commercial banks are institutions that conduct business with profit motive by
accepting public deposits and lending loans for various investment purposes.
I. Primary Functions:
1. Accepting Deposits: It implies that commercial banks are mainly dependent
on public deposits. There are two types of deposits, which are discussed as
follows
a. Demand Deposits It refers to deposits that can be withdrawn by individuals
without any prior notice to the bank. In other words, the owners of these
deposits are allowed to withdraw money anytime by writing a withdrawal slip
or a cheque at the bank counter or from ATM centres using debit card.
b. Time Deposits It refers to deposits that are made for certain committed period
of time. Banks pay higher interest on time deposits. These deposits can be
withdrawn only after a specific time period by providing a written notice to
the bank.
2. Advancing Loans: It refers to granting loans to individuals and businesses.
Commercial banks grant loans in the form of overdraft, cash credit, and discounting
bills of exchange.
II. Secondary Functions The secondary functions can be classified under three
heads, namely, agency functions, general utility functions, and other functions.
1. Agency Functions: It implies that commercial banks act as agents of customers
by performing various functions

a. Collecting Cheques Banks collect cheques and bills of exchange on the
behalf of their customers through clearing house facilities provided by the
central bank.
b. Collecting Income Commercial banks collect dividends, pension, salaries,
rents, and interests on investments on behalf of their customers. A credit
voucher is sent to customers for information when any income is collected by
the bank.
c. Paying Expenses Commercial banks make the payments of various
obligations of customers, such as telephone bills, insurance premium, school
fees, and rents. Similar to credit voucher, a debit voucher is sent to
customers for information when expenses are paid by the bank.
2. General Utility Functions: It implies that commercial banks provide some
utility services to customers by performing various functions.
a. Providing Locker Facilities: Commercial banks provide locker facilities
to its customers for safe custody of jewellery, shares, debentures, and other
valuable items. This minimizes the risk of loss due to theft at homes. Banks
are not responsible for the items in the lockers.
b. Issuing Traveler’s Cheques: Banks issue traveler’s cheques to individuals
for traveling outside the country. Traveler’s cheques are the safe and easy
way to protect money while traveling.
c. Dealing in Foreign Exchange: Commercial banks help in providing
foreign exchange to businessmen dealing in exports and imports. However,
commercial banks need to take the permission of the Central Bank for
dealing in foreign exchange.
3. Transferring Funds
It refers to transferring of funds from one bank to another. Funds are transferred by
means of draft, telephonic transfer, and electronic transfer.
4. Letter of Credit
Commercial banks issue letters of credit to their customers to certify their credit
worthiness.

a. Underwriting Securities: Commercial banks also undertake the task of
underwriting securities. As public has full faith in the creditworthiness of
banks, public do not hesitate in buying the securities underwritten by banks.
b. Electronic Banking: It includes services, such as debit cards, credit cards,
and Internet banking.
III. Other Functions:
1.Money Supply
It refers to one of the important functions of commercial banks that help in
increasing money supply. For instance, a bank lends ₹5 lakh to an individual and
opens a demand deposit in the name of that individual. Bank makes a credit entry of
₹5 lakh in that account. This leads to creation of demand deposits in that account.
The point to be noted here is that there is no payment in cash. Thus, without
printing additional money, the supply of money is increased.
2. Credit Creation
Credit Creation means the multiplication of loans and advances. Commercial banks
receive deposits from the public and use these deposits to give loans. However, loans
offered are many times more than the deposits received by banks. This function of
banks is known as ‘Credit Creation’.
3. Collection of Statistics:
Banks collect and publish statistics relating to trade, commerce and industry. Hence,
they advise customers and the public authorities on financial matters.
Mechanism / Technique of Credit Creation by Commercial Banks
Bank credit refers to bank loans and advances. Money is said to be created when the
banks, through their lending activities, make a net addition to the total supply of
money in the economy. Likewise, money is said to be destroyed when the loans are
repaid by the borrowers to the banks and consequently the credit already created by the
banks is wiped out in the process. Banks have the power to expand or contract demand
deposits and they exercise this power through granting more or less loans and
advances and acquiring other assets. This power of commercial bank to create deposits
through expanding their loans and advances is known as credit creation.

Primary / Passive Deposit and Derived / Active Deposit
The modern banks create deposits in two ways.
Primary deposit:
When a customer gives cash to the bank and the bank creates a book debt in his name
called a deposit, it is known as a “primary deposit’.
Derived deposit
When such a deposit is created, without there being any prior payment of equivalent
cash to the bank, it is called a ‘derived deposit’. Credit Creation literally means the
multiplication of loans and advances. Every loan creates its own deposits. Central Bank
insists the banks to maintain a ratio between the total deposits they create and the cash
in their possession. For the purpose of understanding, it is assumed that all banks are
obliged to keep the ratio between cash and its deposits at a minimum of 20 percent.
1. The banks do not keep any excess reserves, in other words, it would exhaust
possible avenues of income earning activities like giving loans etc. up to the
maximum extent after attaining the minimum cash reserves.
2. There are no drains in the supply of money i.e., the public do not suddenly want to
hold more ideal currency or withdraw from the time deposits.
Role of Commercial Banks in Economic Development of a Country
1. Capital Formation
Banks play an important role in capital formation, which is essential for the economic
development of a country. They mobilize the small savings of the people scattered over
a wide area through their network of branches all over the country and make it
available for productive purposes. Now-a-days, banks offer very attractive schemes to
induce the people to save their money with them and bring the savings mobilized to the
organized money market. If the banks do not perform this function, savings either
remains idle or used in creating other assets, (e.g. gold) which are low in scale of plan
priorities.
2. Creation of Credit
Banks create credit for the purpose of providing more funds for development projects.
Credit creation leads to increased production, employment, sales and prices and
thereby they bring about faster economic development.

3. Channelizing the Funds towards Productive Investment
Banks invest the savings mobilized by them for productive purposes. Capital formation
is not the only function of commercial banks. Pooled savings should be allocated to
various sectors of the economy with a view to increase the productivity. Then only it
can be said to have performed an important role in the economic development.
4. Encouraging Right Type of Industries
Many banks help in the development of the right type of industries by extending loan to
right type of persons. In this way, they help not only for industrialization of the country
but also for the economic development of the country. They grant loans and advances
to manufacturers whose products are in great demand. The manufacturers in turn
increase their products by introducing new methods of production and assist in raising
the national income of the country. Sometimes, sub-prime lending is also clone. That is
how there was an economic crisis in the year 2007-08 in the US.
5. Banks Monetize Debt
Commercial banks transform the loan to be repaid after a certain period into cash,
which can be immediately used for business activities. Manufacturers and wholesale
traders cannot increase their sales without selling goods on credit basis. But credit
sales may lead to locking up of capital. As a result, production may also be reduced. As
banks are lending money by discounting bills of exchange, business concerns are able
to carry out the economic activities without any interruption.
6. Finance to Government
Government is acting as the promoter of industries in underdeveloped countries for
which finance is needed for it. Banks provide long-term credit to Government by
investing their funds in Government securities and short-term finance by purchasing
Treasury Bills. RBI has given `68,000 crores to the government of India in the year
2018-19, this is 99% the RBI’s surplus.
7. Employment Generation
After the nationalization of big banks, banking industry has grown to a great extent.
Bank’s branches are opened frequently, which leads to the creation of new employment
opportunities.

8. Banks Promote Entrepreneurship
In recent days, banks have assumed the role of developing entrepreneurship
particularly in developing countries like India by inducing new entrepreneurs to take
up the well-formulated projects and provision of counseling services like technical and
managerial guidance. Banks provide 100% credit for worthwhile projects, which is also
technically feasible and economically viable. Thus, commercial banks help for the
development of entrepreneurship in the country.
NON-BANKING FINANCIAL INSTITUTION (NBFI)
1. 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 the central bank but it is a company registered under the
Companies Act, 1956. The NBFIs do not carry on pure banking business, but they
will carry on other financial transactions. They receive deposits and give loans.
They mobilize people’s savings and use the funds to finance expenditure on
investment activities. In short, they are institutions which undertake borrowing
and lending. They operate in both the money and the capital markets.
2. NBFCs are fast emerging as an important segment of Indian financial system. It is
a heterogeneous group of institutions (other than commercial and co-operative
banks) performing financial intermediation in a variety of ways, like accepting
deposits, making loans and advances, leasing, hire purchase, etc. They cannot
have certain activities as their principal business—agricultural, industrial and
sale-purchase or construction of immovable property.
3. They raise funds from the public, directly or indirectly, and lend them to ultimate
spenders. They advance loans to the various wholesale and retail traders, smallscale industries and self-employed persons. Thus, they have broadened and
diversified the range of products and services
NBFIs can be broadly classified into two categories
1. Financial institutions Under this category comes Finance Companies, Finance
Corporations, Chit Funds, Building Societies, Issue Houses, Investment Trusts
and Unit Trusts and Insurance Companies. And;
2. Stock Exchange or Stock market

1. Financial companies:
1. Asset Finance Company (AFC): An AFC is a company which is a financial
institution focussing on financing of physical assets supporting
productive/economic activity, such as automobiles, tractors, generator sets etc.
2. Investment Company (IC): IC means any company which is a financial
institution carrying on as its principal business the acquisition of securities.
3. Loan Company (LC): LC means any company which is a financial institution
carrying on as its principal business the providing of finance whether by making
loans or advances or otherwise for any activity other than its own but does not
include an Asset Finance Company.
NBFCs categorized as Asset Finance Companies (AFC), Loan Companies (LCs) and
Investment Companies (ICs), will be merged into a new category called NBFC –
Investment and Credit Company (NBFC-ICC).
2. Chit Funds:
1. Chit funds are included in the definition of Non-Banking Financial Companies
(NBFCs) (LINK) by RBI under the sub-head Miscellaneous Non-Banking
Company (MNBC).
2. RBI however has not laid out any separate regulatory framework for them. At
present chit funds are governed by Chit Funds Act of 1962, RBI Act of 1934, and
SEBI Act of 1992 etc. Under the Chit Fund Act of 1962, businesses can be
registered and regulated only by the respective State Governments. Regulator of
chit funds is the Registrar of Chits appointed by respective state governments
under Section 61 of Chit Funds Act.
3. Chit funds are a popular type of savings institutions in India. It is one of the main
parts of the unorganized money market industry.
4. It refers to an agreement arrived at by a group of individuals to invest a certain
amount through periodic instalments over a specified period of time.
5. The chit fund provides access to savings and borrowings for people with limited
access to banking facilities.
6. Chit funds in India are managed, conducted, and regulated according to Chit
Funds Act of 1982.
7. They are governed through central legislation while state governments are
responsible for their administration.

8. Chit funds are the Indian versions of Rotating Savings and Credit
Associations found across the globe.
Types of Chit Funds
There are three types of chit funds:
1. Chit funds run by state governments
1. These funds are managed and regulated by state governments.
2. Funds run by PSUs (public sector undertakings) also belong to this class.
3. These are safe and chances of loss are limited. Business processes are
transparent and clean.
2. Private registered chit funds
1. These chit funds are registered as per Chit Funds Act of 1982.
2. These are normally floated by prominent financial institutes or business
houses.
3. Participating in these funds is not as safe as in state governments or public
sector undertakings.
4. However, as they are under the management of leading private sector
companies or institutes the risk is calculated and bearable.
3. Unregistered chit funds
1. Unregistered chit funds are not legal and participation in these is up to the risk
of members.
2. Such types of chit funds are common throughout India and are usually formed
by a close group of associates.
3. Participation in these funds should be avoided as disputes are subject to
members’ integrity and honesty.
2. STOCK MARKET
A stock exchange is an organization which provides a platform for trading shareseither physical or virtual, a stock exchange, investors through stock brokers buy and
sell shares in a wide range of listed companies. A given company may list in one or
more exchanges by meeting and maintaining the listing requirements of the stock
exchange.

Importance of Stock Exchanges
1. For efficient working of the economy and for the smooth functioning of the
corporate form of organization, the stock exchange is an essential institution.
2. An efficient medium for raising long term resources for business
3. Help raise savings from the general public by the way of issue of equity debt
capital
4. Attract foreign currency
5. Exercise discipline on companies and make them profitable
6. Investment in backward regions for job generation
7. Another vehicle for investors savings
Primary market
The primary market is that part of the capital markets that deals with the issuance of
new securities directly by the company to the investors by an initial public offering.
Companies, governments or public sector institutions can obtain funding through the
sale of a new stock or bond issue.
Secondary market
The secondary market is the financial market for trading of securities that have already
been issued in an initial public offering. Once a newly issued stock is listed on a stock
exchange, investors and speculators can trade on the exchange as there are buyers and
sellers.
Stock exchanges in India
The first company that issued shares was the VOC or Dutch East India Company in. the
early 17th century (1602). Since then we have come a long way. The Indian capital
market is significant in terms of the degree of development, volume of trading and its
tremendous growth potential.
There are 5 stock exchanges in the country
1.Bombay stock exchange
Vision of BSE: “Emerge as the premier Indian stock exchange with a best-in-class
global practice in technology, products innovation and customer service.”

It is Asia’s first and the fastest stock exchange in the world with the speed of 6
microseconds. It was established as ‘The Native Share and Stock Brokers Association’
in 1875. BSE provides the market for trading in equity, currencies, derivatives, mutual
funds, and debt instruments. BSE SME is India’s largest SME platform with more than
250 listed companies. BSE STAR MF is the largest online mutual fund platform that
processes more than 27 lacs transactions per month. BSE has launched India INX,
India’s first international exchange located at the GIFT CITY IFSC in Ahmedabad,
Gujarat. The Corporate Social Responsibility of BSE focuses on education, health and
environment. It has been supporting the rehabilitation and restoration efforts in the
earthquake hit communities of Gujarat. It has been awarded the Golden Peacock
Global CSR award for its initiatives and corporate social responsibility. BSE popular
equity index S&P BSE SENSEX formerly sensex.
National Stock Exchange of India
The National Stock Exchange of India (NSE), is one of the largest and most advanced
stock exchanges in India. In the year 1991 Pherwani Committee recommended to
establish National Stock Exchange (NSE) in India. In 1992 the Government of India
authorized IDBI for establishing this exchange. The National Stock Exchange of India
was promoted by leading Financial Institutions and was incorporated 1992. In 1993, it
was recognized as a stock exchange. NSE commenced operations in 1994. It is located
in Mumbai, the financial capital of India.
Following financial institutions were the promoters of National Stock
Exchange
1. Industrial Development Bank of India (IDBI).
2. Industrial Finance Corporation of India (IFCI).
3. Industrial credit and Investment Corporation of India (ICICI).
4. Life Insurance Corporation of India (LIC).
5. General Insurance Corporation of India (GIC).
6. SBI Capital Markets Limited.
7. Stock Holding Corporation of India Limited
8. Infrastructure Leasing and Financial services Limited.

The Standard & Poor’s CRISIL NSE Index 50 or S&P CNX Nifty – Nifty 50 or simply
Nifty is the leading index for large companies on the National Stock Exchange of India.
The Nifty is a well diversified 50 stock index accounting for 21 sectors of the economy.
The CNX Nifty Junior is an index for companies on the National Stock Exchange of
India. It consists of 50 companies on the National Stock Exchange of India. It has the
second tier of stocks in terms of market capitalisation.
SEBI
Established in 1988 as a body for promoting orderly and healthy growth of securities
market and for investor protection. It was given a statutory status in 1992 through act
of parliament SEBI act 1992.
Reasons for establishment of SEBI:
1. The expanding investor population and the market capitalization led to
malpractices by the companies, traders, brokers, consultants.
2. These malpractices included self-styled merchant bankers, price rigging,
unofficial private placements, insider trading, non-adherence to provisions of
companies act, violation of rules and regulations of stock exchange, delay in
delivery of shares.
3. The investor confidence was eroded and investor grievance was multiplied. To
counter this government set up a regulatory body.
Objectives of the SEBI:
1. Regulate stock exchange and securities industry to promote their orderly
functioning.
2. Protect rights and interests of investors.
3. Prevent malpractices and promote balance between self-regulation by the
industry and statutory regulations.
4. To make the intermediaries more professional and competitive by making a code
of conduct and fair practices.
Functions of SEBI:
1. Registration of brokers, sub broker.
2. Registration of investment schemes and mutual funds.
3. Prohibiting unfair and prohibitor practices.

4. Enforcing the act and penalizing defaulters.
5. Levying charges and fees for enforcing the act.
6. Exercising functions as delegated to it by the central government under the
securities contracts act.
7. Investor education, training of intermediaries, conducting research and
promoting code of conduct.
Capital Market Reforms
Since 1991 when the Government launched economic reforms, the following measures
were taken.
1. SEBI given statutory status- that is Act of Parliament.
2. Electronic trade.
3. Rolling settlement to reduce speculation.
4. FIIs are permitted since 1992.
5. Setting up of clearing houses.
6. Settlement guarantee funds at all stock exchanges.
7. Compulsory dematerialization of share certificates so as to remove problems
associated with paper trading; and speed up the transfer.
8. Clause 49 of the listing agreement for corporate governance.
9. Restrictions on PNs.
10.Platform for MSME.
11. Law in 2014 strengthens SEBI.
12. Merger of FMC with SEBI.
Types of shares:
There are essentially two types of shares: common stock and preferred stock. Preferred
stock is generally issued to banks and others by the companies though retail investors
are also eligible for them. They are preferred for the following reasons:
1. In terms of dividend payment, generally, they are given dividends even if the
common stock holders are not.
2. When the company is to be closed, preference stock holders are given money
first from the proceeds of the sale of the assets of the companies.
3. They may have enhanced voting rights such as the ability to veto mergers or
acquisitions or the right of first refusal when new shares are issued (i.e. the

holder of the preferred stock can buy as much as they want before the stock is
offered to others).
Derivatives
Derivative is a financial instrument. It derives from an underlying asset- securities,
debt instruments, commodities etc. The price of the derivative is directly dependent
upon the value of the underlying asset in the present and the projected future trends.
Futures and options are the two classes of derivates.
Futures:
Futures are financial instrument based on physical underlying asset like commodities,
equities etc. future contract is an agreement between two parties to buy or sell an asset
at a certain time in the future for a certain price.
Options:
Options are class of futures where the buyer or seller has option whether or buy or not.
Anchor Investor
Anchor investors or cornerstone investors (as they are called globally) are institutional
investors like sovereign wealth funds, mutual funds and pension funds that are invited
to subscribe for shares ahead of the IPO to boost the popularity of the issue and provide
confidence to potential IPO investors. The benefit for institutional investors applying in
anchor quota is that they get guaranteed allotment. Allotment to investors applying in
an IPO depends on the number of times the issue gets subscribed. Anchor investors,
however, cannot sell their shares for a period of 30 days from the date of allotment as
against IPO investors who are allowed to sell on listing day.
Global Depository Receipts (GDR)
Indian companies are allowed to raise equity capital in the international market
through the issue of Global Depository Receipt (GDRs) GDRs are designated in Foreign
currency like dollar and euro. The proceeds of the GDRS can be used for financing
capital goods imports, capital expenditure including domestic purchase/ installation of
plant, equipment and building and investment in software development, prepayment
or scheduled repayment of earlier external borrowings, and equity investment in JVs in
India. GDRs are listed on London SE or Luxembourg or elsewhere. They are also called
euro issues in a general sense.

American depository receipts (ADRs)
ADRs are like shares. They are issued to US retail and institutional investors. They are
entitled like the shares to bonus, stock split and dividend. They are listed either on
Nasdaq or New York stock exchange. Like GDRS, they help raise equity capital in forex
for various benefits like expansion, acquisition etc. ADR route is taken as non-USA
companies are not allowed to list on the US stock exchanges by issuing shares.
Similarly, with Indian Depository Receipts (IDRS) as and when they are allowed.
Participatory Notes
Participatory notes are instruments used for making investments in the stock markets.
In India, foreign institutional investors (FIIs) use these instruments for facilitating the
participation of overseas funds like hedge funds and others who are not registered with
the SEBI and thus are not directly eligible for investing in Indian stocks. Any entity
investing in participatory notes is not required to register with SEBI whereas all FIIs
have to compulsorily get registered. Participatory notes are popular because they
provide a high degree of anonymity, which enables large hedge funds to carry out their
operations without disclosing their identity and the source of funds. KYC (know your
customer norms are not applied here).
Clearing House
An organisation which registers, monitors, matches and guarantees the trades of its
members and carries out the final settlement of all futures transactions. when the buy
order of exchanges matches with sell order a trade is generated. The National Securities
Clearing Corporation ltd, Indian clearing corporation ltd. and MCX-SX clearing
corporation ltd are examples. clearing corporation are designated as market
infrastructure institutions for oversight considering its systemic instruments in the
securities market regulated by SEBI. They are also subject to rules and regulations that
are based on the international securities commission principles.
Hedge Fund
A hedge fund is an investment fund open to only a limited range of investors. They are
mostly unregulated. The term-hedge funds, is used to distinguish them from regulated
investment funds such as mutual funds and pension funds, and insurance companies.

Hedge funds are not allowed into India as they do not disclose data required by the
SEBI.
Commodity Exchanges
Commodity exchanges are institutions which provide a platform for trading in
‘commodity futures’ just as how stock markets provide space-for trading in equities and
their derivatives. They thus play a critical role in price discovery where several buyers
and sellers interact and determine the most efficient price for the product. Indian
commodity exchanges offer trading in ‘commodity futures’ in a number of
commodities. Presently, the regulator, Forward Markets Commission allows futures
trading m over 120 commodities. There are two types of commodity exchanges in the
country: national level and regional.
There are five national exchanges:
1. National Commodity & Derivatives Exchange Limited (NCDEX).
2. Multi Commodity Exchange of India Limited (MCX).
3. National Multi-Commodity Exchange of India Limited (NMCEIL).
4. ACE Derivatives and Commodity Exchange.
5. Indian Commodity Exchange (ICEX) .
The unique features of national level commodity exchanges are:
1. They are demutualized.
2. They provide- online platforms or screen-based trading.
3. They allow trading in a number of commodities and are hence multicommodity exchanges.
4. They are national level exchanges which facilitate trading from anywhere in the
country.
FMC -Forward Market Commission
Forward Markets Commission (FMC) headquartered at Mumbai is a regulatory
authority, which is overseen by the Ministry of Consumer Affairs and Public
Distribution, Govt. of India. It is a statutory body set up m 1953 under the Forward
Contracts Regulation Act, 1952.It was merged with the SEBI in 2015.It monitors and
disciplines the working of the exchanges. It recognizes an exchange or can withdraw
such recognition. It collects and whenever the Commission thinks it necessary
publishes information regarding the trading conditions in respect of goods. It makes
inspection of the accounts and other documents of any recognized association or

registered association or any member of such association whenever it considerers it
necessary.
Mutual Fund
Mutual fund a financial intermediary that collects money, from a group of investors, to
invest in capital market so as to generate returns for the investors. Mutual fund does it
for a fee,
There are two types of MFs.
1. Open-ended or open mutual funds issue shares (units) to the investors directly
at any time. The price of share is based on the fund’s net asset value. Open funds
have no time duration, and can be purchased or redeemed at any time on
demand, but not on the stock market.
2. Close ended fund is a collective investment scheme issued by a fund. Only a fixed
number of shares are issued in an initial public offering which may be called
New Fund offering (NFO). They trade on an exchange/ Share prices are
determined not by the total net asset-Value (NAV), but by investor demand.
Once the offering closes, new shares are rarely issued. They can be traded only
on the secondary market (stock exchanges).
Foreign Institutional investors (FIIs)
Foreign institutional investors are organizations which invest huge sums of money in
financial assets – debt and shares- of companies and in other countries- a country
different from the one where they are incorporated. They include banks, insurance
companies retirement or pension funds hedge funds and mutual funds. Foreign
individuals are not allowed to participate on their own but go through FIIs.
FIIs are allowed to invest in the primary and secondary capital markets in India
through the portfolio investment scheme (PIS). The ceiling for overall investment for
this varies from company to company. SEBI prescribes norms to register FIIs and also
to regulate FIT investments.
Reasons for FIIs having India as a favorite destination
1. Growing economy
2. 2 corporate profits are high
3. Government policies are encouraging

4. Compared to other countries, India has brighter prospects
FII investment is referred to as hot, money for the reason that it can leave the country
at the same speed at which it comes in.
Equity
Common stock and preferred stock that is, shares issued by the company. Also, funds
provided to a business by the sale of stock.
Share
Share is a certificate representing ownership of the company that issued it. Shares can
yield dividends and entitle the holder to vote at general meetings. The company may be
listed on a stock exchange. Shares are also known as stock or equity.
Bond
A debt instrument issued for a period of more than one year with the purpose of raising
capital by borrowing.
Debenture
Debt not secured by a specific asset of the corporation, but issued against the issuer’s
general credit- that is, it is unsecured debt. Investment earns an interest for the
debenture holder, the following are various types of debentures
1. Convertible debentures can be converted into equity at a future date.
2. Non-convertible debentures will not be converted.
3. Partly convertible debentures will have some part converted into shares.
Bear market
Bear is an investor who believes that market will go down. A sustained period of falling
stock prices usually preceding or accompanied by a period of poor economic
performance known as a recession.
Bull market
Bull is an investor who believes that the market will go up- optimistic. A stock market
that is characterized by rising prices over a long period of time. The time span is not
precise, but it represents a period of investor optimism, lower interest rates and
economic growth. The opposite of a bear market.

Gilt
Gilt is a bond issued by the government. It is issued by the Central Bank of a country
on behalf of the government. In India, Reserve Bank of India issues the treasury bills or
guts. Gilt Edged Market is the market for government securities.
Blue Chip Share
Blue chip shares are the shares of the companies that are the most valuable. Companies
that are profit making; usually dividend paying and are liquid in the market- that is
there is almost always in demand on the market.
Midcap Company
Generally, companies with a market capitalization that is very high are called large caps
and the next one below is mid cap and the bottom one is small cap companies. Limits
are not statutorily laid down and vary from institution to institution.
Small Investor/retail investor
Market regulator SEBI set the investment limit for retail investors in an initial share
sale offer to ₹2 lakh. This will cut the numerous applications investors sometimes make
in the name of relatives to get more shares.
Primary Dealers
The Reserve Bank of India introduced a system of Primary Dealers (PDs) in
government securities market in 1995 with the objective to strengthen the
infrastructure in the government securities market in order to make it vibrant, liquid
and broad-based.
Market Depth
It is a dimension of market liquidity and it refers to the ability of a market to handle
large trade volumes without a significant impact on prices. Liquidity is the ease to find
a trading partner for a given order. Trading volumes means the number of shares
traded.
Negotiated Dealing System
Negotiated Dealing System (NDS) is an electronic platform for facilitating dealing in
Government Securities and Money Market Instruments.

Short Selling
The sale of a security made by an investor who does not own the security; The short
sale is made in expectation of a decline in the price of a security, which would allow the
investor to then purchase the shares at a lower price in order to deliver the securities
earlier sold short.
Market Capitalization
Price per share multiplied by the total number of shares outstanding also, the markets
total valuation of a public company.
Insider Trading
trading occurs when anyone with information related to strategic and priceinfluencing information purchases or sells stocks so as to make speculative profits.
Depository
A depository holds securities (like shares, debentures, bonds, Government Securities,
units etc.) of investors m electronic form. Besides holding securities, a depository also
provides services related to transactions securities. Benefits of a depository are
reduction in paperwork involved transfer of securities; reduction in transaction cost.
National Securities Depository Limited (NSDL)
In the depository system, securities are held in depository accounts, which is more or
less similar to holding funds in bank accounts. Transfer of ownership of securities is
done through simple account transfers. The enactment of Depositories Act in 1996
paved the way for establishment of NDL, the first – depository in India. NSDL offers
facilities like dematerialization i.e., converting physical share certificates to electronic
form, dematerialization i.e., conversion of securities in demat form into physical
certificates etc.
Ponzi scheme of Pyramid Scheme
A Ponzi scheme is a fraudulent investment operation that pays high returns to
investors and promises higher returns to those who join the scheme later. The
payments are done from investors own money or money paid by subsequent investors
rather than from any actual profit earned because it is not possible to earn such high

returns on any investment. The system is destined to collapse because the earnings, if
any, are less than the payments.
Decoupling
It means that a nation’s economy may have an autonomous logic and need not be
entirely dependent on the global economy. For example, if the world goes into a
recession, all counties need not. India, for example grew at 6.7% (2008-09) while the
USA and the west were contracting. Reflecting the economic realities, equity markets
also perform autonomously after a point, it is called decoupling- that is, isolation from
the rest. China is more integrated with the world as its economy is driven by exports.
However, even China is decoupled as it has a lot of domestic consumption driving its
growth.
Clause 49
Clause 49 of the Listing Agreement to the Indian stock exchange came into effect in
2005. It has been formulated for the improvement of corporate governance in all listed
companies as it mandates that there should be certain independent directors on the
Board of a Company.
IDR
Indian Depository Receipts are issued by a non-Indian company to Indian investors for
its listing on Indian stock exchanges. It is like ADR.
FINANCIAL REFORMS
Financial sector refers to the part of the economy which consists of firms and
institutions that have the responsibility to provide financial services to the customers of
the commercial and retail segment. The financial sector can include commercial
banks, non banking financial companies, investment funds, money market, insurance
and pension companies, and real estate etc. The financial sector is considered as the
base of the economy which is essential for the mobilization and distribution of financial
resources.
Reasons for financial sector reforms in India
1. After independence, due to colonial legacy India was lagging behind in social as
well as economic affairs. To attain the goal of rapid economic development,

India adopted the system of planned economy based on the Mahalanobis model.
This model had started showing its limitations in the mid-80s and early nineties.
2. The government adopted the strategy of fiscal activism for economic growth and
large doses of public expenditure were financed by heavy borrowings at
concessional rates. Due to the policy of Fiscal activism, the fiscal deficit
increased year after year. The policy of automatic monetization of Fiscal deficit
had inflationary tendencies and other negative impacts on the economy.
3. The nationalisation of Banks had given complete control over these banks to the
government, which resulted in the limited role of market forces in the financial
sector.
4. The growth rate was hovering around 3.5 % per annum before 1980, and it
reached around 5% in the mid-1980s. This growth rate was proving insufficient
to solve the economic and financial problems of the country.
5. Lack of transparency and professionalism in the banking sector and issues of
red-tapism had been responsible for the increase of non-performing assets.
6. There were issues of inadequate level of proper Regulation in the financial
sector. The technologies used in the financial system and their institutional
structures were outdated.
The strategy adopted by India for Financial Sector Reforms
1. India adopted the path of gradual reforms instead of Shock Therapy. This was
necessary to ensure continuity and stability of the financial sector in India.
2. India incorporated International best practices at the same time adjusted it as
per the local requirements.
3. The first-generation reforms aimed to create an efficient and profitable financial
sector by ensuring flexibility to operate with functional autonomy.
4. The second-generation reforms were incorporated to strengthen the financial
system through structural improvements.
5. India adopted the policy of consensus driven approach for liberalisation as this
was necessary for a democracy.

Banking sector reforms
Changes in CRR and SLR:
One of the most important reforms includes the reduction in cash reserve ratio (CRR)
and statutory liquidity ratio (SLR). The SLR has been reduced from 39% to the current
value of 19.5%. The cash reserve ratio has been reduced from 15 % to 4%. This
reduction in the SLR and CRR has given banks more financial resources for lending to
the agriculture, industry and other sectors of the economy.
Changes in administered interest rates:
The system of administered interest rate structure was prevalent in which RBI decided
the interest rate charged by the banks. The main purpose was to provide credit to the
government and certain priority sectors at concessional rates of interest. The system
has been done away and RBI no longer decides interest rates on deposits paid by the
banks. However, RBI regulates interest on smaller loans up to ₹2 lakhs on which the
interest rate should not be more than the prime lending rates.
Capital Adequacy Ratio:
The capital adequacy ratio is the ratio of paid-up capital and the reserves to the
deposits of banks. The capital adequacy ratio of Indian banks had not been as per the
international standards. The capital adequacy of 8% on the risk-weighted asset ratio
system was introduced in India. The Indian banks had to achieve this target by March
31, 1994, while the foreign Bank had to achieve this norm by 31st March 1993. Now,
Basel 3 norms are introduced in India.
Allowing private sector banks:
After the financial reforms, private banks we are given life and HDFC Bank, ICICI
Bank, IDBI Bank, Corporation Bank etc. were established in India. This has
brought much needed competition in the Indian money market which was essential for
the improvement of its efficiency. Foreign banks have also been allowed to open
branches in India and banks like Bank of America, Citibank, American Express opened
many new branches in India.

Foreign banks were allowed to operate in India using the following three
channels:
1. As foreign bank branches.
2. As a subsidiary of a foreign bank which is wholly owned by the foreign Bank.
3. A subsidiary of a foreign bank within maximum foreign investment of 74%
Reforms related to non-performing assets (NPA):
Nonperforming assets are those loans on which the loan installments have not been
paid up for 90 days. RBI introduced the recognition income recognition norm.
According to this norm, if the income on the assets of the bank is not received in two
quarters after the last date, the income is not recognised. Recovery of bad debt was
ensured through Lok adalats, civil courts, Tribunals etc. The Securitisation And
Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI)
Act was brought to handle the problem of bad debts.
Elimination of direct or selective credit controls:
Earlier, under the system of selective or direct credit control, RBI controlled the credit
supply using the system of changes in the margin for providing a loan to traders against
the stocks of sensitive commodities and to the stockbrokers against the shares. This
system of direct credit control was abolished and now the banks have greater freedom
in providing credit to their customers.
Promotion of microfinance for financial inclusion:
For the promotion of financial inclusion, microfinance scheme was introduced by the
government, and RBI the gave guidelines for it. The most important model for
microfinance has been the Self-Help Group Bank linkage programme. It is being
implemented by the regional rural banks, cooperative banks, and Scheduled
commercial banks.
Reforms in the government debt market
1. The policy of automatic monetization of the fiscal deficit of government was
phased out in 1997 through an agreement between the government and RBI.
Now the government borrows money from the market through the auction of
government securities.

2. The government borrows the money at market determined interest rates which
have made the government cautious about its fiscal deficits.
3. The government introduced treasury bills for 91 days for ensuring liquidity and
meeting short-term financial needs and for benchmarking.
4. Foreign institutional investors were now allowed to invest their funds in the
government securities.
5. The government introduced the system of delivery versus payment settlement
for ensuring transparency in the system.
6. The system of repo was introduced for dealing with short term liquidity
adjustments.
Role of regulators
1. Importance of the role of the regulator was recognised and RBI became more
independent to take decisions. More operational autonomy was granted to RBI
to fulfil its duties.
2. The Securities and Exchange Board of India (SEBI) became an important
institution in managing the securities market of India.
3. The insurance regulatory and Development Authority was an important
institution for initiating reforms in the Insurance sector. Its responsibilities
include the Regulation and supervision of the Insurance sector in India.
Reforms in the foreign exchange market
Since 1950s, India had a highly controlled foreign exchange market and foreign
exchange was made available to the Reserve Bank of India in a very complex manner.
The steps taken for the reform of the foreign exchange market were:
1. In 1993, India moved towards market-based exchange rates, and the current
account convertibility was now allowed. The commercial banks were allowed to
undertake operations in foreign exchange.
2. The Rupee foreign currency swap market has been developed. New players are
now allowed to enter this market and undertake currency swap transactions
subject to certain limitations.

3. The authorised dealers of foreign exchange were now given the permission for
activities such as initiating trading positions, borrowing and investing in foreign
markets etc. subject to certain limitations and regulations.
4. The foreign exchange Regulation Act, 1973 was replaced by the foreign exchange
management Act, 1999 for providing greater freedom to the exchange markets.
5. The foreign institutional investors and non-resident Indians were allowed to
trade in the exchange-traded derivatives contracts subject to certain regulations
and limitations.
Other important financial sector reforms
1. Some important steps were taken for the non-banking financial companies for
the improvement of their productivity, efficiency, and competitiveness and also
have been brought under the regulation of Reserve Bank of India. Many of the
other intermediaries were brought under the supervision of the Board of
Financial Supervision.
2. In 1992, the Monopoly of UTI was ended and mutual funds were opened for the
private sector. The mutual fund industry is now controlled by the SEBI Mutual
Funds regulations, 1996 and its amendments.
3. In 1992, the Indian capital market was opened for the foreign institutional
investors in all the securities.
4. Electronic trading was introduced in the National Stock Exchange (NSE)
established in 1994, and later on in the Bombay Stock Exchange (BSE) in 1995.
Assessment of financial sector reforms
1. After the financial sector reforms, the resilience and stability of Indian economy
have increased. The growth rate up the economy has increased from around 3.5
% to more than 6% per annum.
2. The country has been able to deal with the Asian economic crisis of 1977-98 and
the recent Global subprime crisis which affected the banking system of the world
but did not have much impact on the economy of India.
3. The banking sector and Insurance sector have grown considerably. The entry of
private sector banks and foreign banks brought much-needed competition in the
banking sector which has improved its efficiency and capability.

4. The Insurance sector has also transformed over the period of time. All these have
benefited the customer with diversified options.
5. The stock exchanges of the country have seen growth and stability, and it has
adopted the international best practices.
6. RBI has effectively regulated and managed the growth and operations of the
non-banking financial companies of India.
7. The budget management, fiscal deficit, and public debt condition have improved
after the financial sector reforms. The country is moving with more such future
reforms in different sectors of the economy.
8. However, all the issues of Indian economy have not been resolved. The social
sector indicators such as the provision of health facilities, quality of education,
empowerment of women etc have not been at par with the economic growth.
9. Further, the new issues like the recent rise in non-performing assets of banks,
slow growth of investments in the economy, the issues of jobless growth, high
poverty rate, a much lower growth rate in the agriculture sector etc need to be
resolved with more concrete efforts.
FINANCIAL STABILITY
1. Financial stability means financial institutions individually and collectively are
being able to deliver their functions properly, withstanding external shocks and
avoiding internal weaknesses.
2. The Reserve Bank of India defines financial stability: “From a macro prudential
perspective, financial stability could be defined as a situation in which the
financial sector provides critical services to the real economy without any
discontinuity.”
3. During the time of the global financial crisis, RBI has made many
unconventional measures to protect the banking system. Liquidity support was
provided abundantly so that no banks should face stress. The RBI since 2010 is
publishing India Financial Stability Report to assess financial stability scenario
in the country. Financial stability is now one of the three important objectives of
monetary policy besides price stability and credit support. In its monetary policy

statement in May 2008, the RBI mentioned that sometimes, the objective of
financial stability becomes more important than the objective of price stability.
Financial Stability and Development Council (FSDC)
The Financial Stability and Development Council (FSDC) was constituted in December,
2010. The FSDC was set up to strengthen and institutionalise the mechanism for
maintaining financial stability, enhancing inter-regulatory coordination and promoting
financial sector development. An apex-level FSDC is not a statutory body. It was
chaired by finance minister.
Composition:
1. The Council is chaired by the Union Finance Minister and its members are
Governor, Reserve Bank of India; Finance Secretary and/or Secretary,
Department of Economic Affairs; Secretary, Department of Financial Services;
Chief Economic Adviser, Ministry of Finance; Chairman, Securities and
Exchange Board of India; Chairman, Insurance Regulatory and Development
Authority and Chairman, Pension Fund Regulatory and Development Authority.
It also includes the chairman of the Insolvency and Bankruptcy Board (IBBI).
2. Recently, the government through a gazette notification, had included ministry
of electronics and information technology (MeitY) secretary in the FSDC in view
of the increased focus of the government on digital economy.
What it does?
The Council deals, inter-alia, with issues relating to financial stability, financial sector
development, inter–regulatory coordination, financial literacy, financial inclusion and
macro prudential supervision of the economy including the functioning of large
financial conglomerates. No funds are separately allocated to the Council for
undertaking its activities.
MONETARY POLICY
Monetary Policy
For spending money, knowing cost of money is important and the central bank is
mandated to decide the cost of money, which is more commonly known as the “interest
rate” in the economy. Monetary policy is the macroeconomic policy laid down by the
central bank. It is a set of economic policies that manages the size and growth rate of

the money supply in an economy and regulates macroeconomic variables such as
inflation and unemployment. Monetary policies are implemented through different
tools, including the adjustment of the interest rates, purchase or sale of government
securities, and changing the amount of cash circulating in the economy. In India,
monetary policy of the Reserve Bank of India is aimed at managing the quantity of
money in order to meet the requirements of different sectors of the economy and to
increase the pace of economic growth.
Monetary Policy Committee in India
On the recommendation of Urjit Patel Committee, Monetary Policy Committee was
created in 2016.
Objectives:
1. To bring transparency and accountability in fixing India’s Monetary Policy also
the main aim was economic growth as well as price and exchange rate stability.
2. The Monetary Policy Committee of India is responsible for fixing the benchmark
interest rate in India, which was earlier decided by the Governor of Reserve
Bank of India alone prior to the establishment of the committee.
3. Composition:
1. Three officials of the Reserve Bank of India (Governor of RBI: chairperson
ex officio)
2. Three external members nominated by the Government of India
4. Decision: On the basis of majority with Governor having the casting vote in
case of a tie.
5. Meeting: At least 4 times a year and it publishes its decisions after each such
meeting.
6. The current mandate of the committee is to maintain 4% annual inflation until
March 31, 2021 with an upper tolerance of 6% and a lower tolerance of 2%, while
supporting growth.
7. The committee is answerable to the Government of India if the inflation exceeds
the range prescribed for three consecutive months

Questions:
1. Explain the Role of Commercial Bank in Economic development.
2. Write about the Functions and credit control measures of central bank.
3. What is stock market? Gives detail notes of SEBI and Explain role of SEBI in
investor Protection.
4. Explain Monetary policy and Monetary policy committee.