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Indian Financial System, Merchant Banking and its recent developments

Indian Financial System, Merchant Banking and its recent developments. A. Sulthan Assistant Professor, KV Institute of Management, Coimbatore. Financial System. The word ‘system’ implies a set of complex and interrelated factors organized in a particular form.

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Indian Financial System, Merchant Banking and its recent developments

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  1. Indian Financial System, Merchant Banking and its recent developments A. Sulthan Assistant Professor, KV Institute of Management, Coimbatore

  2. Financial System • The word ‘system’ implies a set of complex and interrelated factors organized in a particular form. • These factors are mostly interdependent but not always “mutually exclusive” • Financial system of any country consists of several ingredients. It includes financial institutions, markets, financial instruments, services, transactions, agents, claims and liabilities in the economy 2

  3. Cont.. • ‘Financial system’ is a system to canalize the funds from the surplus units to the deficit units - ‘Deficit units’ is a case where current expenditure exceeds their current income - There are other entities whose current income exceeds current expenditure which is called as ‘Surplus Units’ 3

  4. Financial system - Definition According to Van Horne, financial system is defined as the purpose of financial markets to allocate savings efficiently in an economy to ultimate users - either for investment in real assets or for consumption. 4

  5. Cont.. Thus the financial system mainly stands on three factors 1.‘Money’ is the unit of exchange or medium of payment. It represents the value of financial transactions in qualitative terms. 2.‘Credit’ on the other hand, is a debt or loan which is to be returned normally with interest. 3. ‘Finance’ is monetary wealth of the state, an institution or a person. Comprising these factors in a systematic order forms a financial system. 5

  6. Objectives of Financial system 1. Accelerating the growth of economic development. 2. Encouraging rapid industrialization 3. Acting as an agent to various economic factors such as industry, agricultural sector, government etc. 4. Accelerating rural development 5. Providing necessary financial support to industry 6. Financing housing and small scale industries 7. Development of backward areas, infrastructure and livelihood 8. Imposing price control in need 9. Protecting environment 6

  7. Functions of Financial system • Functions of financial system are distributed from creation of money to efficient management. It is the sum total of the functions of the various intermediaries. • The functions of financial system can be classified into two broad categories: 1. Controlling functions 2. Promotional functions 7

  8. CONTROLLING FUNCTIONS Government imposes certain controls over the financial and business activities of different organizations through the regulatory bodies. E.g. RBI plays an important part in regulatory functions. They are (i) Supervision of financial institutions (ii) Restrictions on interest and bank rates (iii) Selective credit control (iv) Controlling foreign exchange (v) Regulation of stock exchanges (vi) Framing rule for effective portfolio management and distribution, diversification and reduction of risk. (vii)Imposing monetary control (viii)Prevention of unfair trade practices (ix) Formulating policies on licensing, investment or credit (x) Acting as the government’s and other banks’ bankers 8

  9. PROMOTIONAL FUNCTIONS 1. Efficient operation of the payment mechanism. 2. Managing information to make it easily available to all interested parties . 3. Providing training to investors, intermediaries and employees in order to upgrade their skills. 4. Conducting development and research activities in order to update the system. 5. Creation and establishment of need based financial institutions. 6. Promotion of fair practices which are transparent and effective. 6. Creating financial awareness to captivate investors, entrepreneurs and borrowers. 7. Organizing seminar, dialogues, collection of data and publication. 9

  10. Significance Of Financial System • Financial system of a country or an organization is the main motivating factor to run the economy. • It ensures that transactions are effected smoothly and quickly on an ongoing basis. • It enables the financial agents to accelerate financial growth and economic prosperity of the unit. 10

  11. PRE INDEPENDENCE SITUATIONS During the 274 year regime of the East India Company (1600-1874) the financial system of the country was not at all organized. It was monopolized by the mercantile houses who were involved in banking business by providing loans, receiving deposits and issuing currency. They are commonly known as ‘agency houses’ who actually laid the foundation of modern banking. The formal banking business was developed by establishment of three Presidency Banks, namely 1. The Bank of Bengal (1806) 2. Bank of Bombay (1840) 3. The Bank of Madras (1846). 11

  12. POST INDEPENDENCE ERA (1950-1991) The different landmarks during this phase were • Bank nationalization in 1969 • Establishment of various financial institutions which are need based and useful for expansion of financial sector. • Imposing overall control on insurance sector by the Government. • Establishment of large scale industrial units and introduction of long term finance to all industries. • Emphasizing the growth of small scale industries by helping them through subsidized funding and direct investment. • Imposition of regulatory measures and inserting Government intervention in business through amending the companies Act, Securities Contracts (Regulation) Act, 1956, Monopolies and Restrictive Trade practices Act 1970, Foreign Exchange Regulation Act 1973 etc., 12

  13. ERA AFTER LIBERALISATION • The announcement of the New Economic Policy in 1991, the India Financial System has shown quite flexibility in terms of transformation •The reformation process has been started in order to remove the stagnation of growth described before and, till date, the response is positive. • This is the phase of liberalization and globalization of Indian economy following the world trend which is duly supported by deregulation of Government Control. • Market force becomes dominant resulting in privatization of industries, emergence of new generation financial institutions with competitive ability and introduction of computerized business environment where information technology plays a vital role. • The regulatory framework has been duly changed giving space to this reform process and one can say that the Indian financial sector is gradually moving towards attainment of global standards. 13

  14. MERCHANT BANKING-DEFINITION “A merchant banker has been defined as any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering corporate advisory services in relation to such issue management”. -Securities and Exchange Board of India (Merchant Bankers) Rules, 1992 14

  15. Objectives of merchant Bank • Channelizing the financial surplus of the general public into productive investments avenues • Co-coordinating the activities of various intermediaries like the registrar, bankers, advertising agency, printers, underwriters, brokers, etc., to the share issue • Ensuring the compliance with rules and regulations governing the securities market 15

  16. Functions of Merchant Bank • Corporate Counselling • Project Counselling • Capital Structuring • Portfolio Management • Issue Management • Credit Syndication • Working capital • Venture Capital • Lease Finance • Fixed Deposits 16

  17. Classification Of Merchant Bankers By SEBI 1. Issue management 2. Underwriters 3. Consultants to Issue 4. Mobilization of foreign funds for companies

  18. Merchant Bankers in India As of now there are 135 Merchant bankers who are registered with SEBI in India. It includes Public Sector, Private Sector and foreign players some of them are: Public Sector Merchant Bankers • SBI capital markets ltd • Punjab national bank • Bank of Maharashtra • IFCI financial services ltd • Karur Vysya bank ltd • State Bank of Bikaner and Jaipur 18

  19. Cont.. Private Sector Merchant Bankers • ICICI Securities Ltd • Axis Bank Ltd (Formerly UTI Bank Ltd.) • Bajaj Capital Ltd • Tata Capital Markets Ltd • ICICI Bank Ltd • Reliance Securities Limited • Kotak Mahindra Capital Company Ltd • Yes Bank Ltd 19

  20. Cont.. Foreign Players in Merchant Banking • Goldman Sachs (India) Securities Pvt. Ltd. • Morgan Stanley India Company Pvt. Ltd • Barclays Securities (India) Pvt. Ltd • Bank Of America, • Deutsche Bank • Deutsche Equities India Private Limited • Barclays Bank Plc • Citigroup Global Markets India Pvt. Ltd. • DSP Merrill Lynch Ltd • FEDEX Securities Ltd 20

  21. Recent Developments in Merchant Banking and Challenges Ahead The recent developments in Merchant banking are due to certain contributory factors in India. They are 1. The Merchant Banking was at its best during 1985-1992 being when there were many new issues. 2. The foreign investors – both in the form of portfolio investment and through foreign direct investments are venturing in Indian Economy. It is increasing the scope of merchant bankers in many ways. 3. Disinvestment in the government sector in the country gives a big scope to the merchant banks to function as consultants. 4. New financial instruments are introduced in the market time and again. This basically provides more and more opportunity to the merchant banks. 5. The mergers and corporate restructuring along with MOU and MOA are giving immense opportunity to the merchant bankers for consultancy jobs. 21

  22. Challenges faced by merchant bankers in India 1. SEBI guideline has restricted their operations to Issue Management and Portfolio Management to some extent. So, the scope of work is limited. 2. Inefficiency of the clients are often blamed on to the merchant banks, so they are into trouble without any fault of their own. 3. The net worth requirement is very high in categories I and II specially, so many professionally experienced person/ organizations cannot come into the picture. 4. Poor New issues market in India is drying up the business of the merchant bankers. 22

  23. SEBI Guidelines for Merchant Bank Operational Guidelines: SEBI has pronounced the following guidelines for merchant bankers : 1. Submission of offer document 2. Dispatch of issue material 3. Underwriting 4. Compliance obligations a. Association of resource personnel b. Redressal of investor grievances c. Submission of post issue monitoring reports d. Issue of No objection Certificate (NOC) e. Registration of merchant bankers f. Reporting requirements g. Impositions of penalty points

  24. Meaning of stock exchanges • It is the market for exchange of stocks. • ‘Stocks’ refers to the old securities i.e., those which have been already issued and listed on a stock exchange. • These securities are purchased and sold continuously among investors without the involvement of companies. • Stock exchange provides not only free transferability of shares but also makes continuous evaluation of securities traded in the market.

  25. Definition of Stock Exchange According to Hastings, “Stock exchange or securities market comprises all the places where buyers and sellers of stocks and bonds or their representatives undertake transactions involving the sale of securities”

  26. Objectives of Stock Exchanges The Objectives of stock exchanges are 1. Assisting in buying and selling of securities 2. Regulating the business of buying and selling or dealing in securities.

  27. Functions of Stock Exchanges The stock market occupies a pivotal position in the financial system. It performs several economic functions and renders invaluable services to the investors, companies, and to the economy as a whole. They may be summarized as follows: 1. Liquidity and marketability of Securities 2. Safety of Funds 3. Supply of Long term funds 4. Flow of Capital to Profitable Ventures. 5. Motivation for improved performance 6. Promotion of Investment 7. Reflection of Business Cycle 8. Marketing of New Issues 9. Miscellaneous Services

  28. Organization of Stock Exchanges The first organized stock exchange in India was started in Bombay in 1875 with the formation of the ‘Native share and Stock Brokers Association’. Thus the Bombay Stock Exchange is the oldest one in the country. With the growth of Joint stock companies, the stock exchanges also made a steady growth and at present these are 23 recognized stock exchanges with about 6000 stock brokers.

  29. Demutualization of Stock Exchanges •The transition process of an exchange from a “mutually-owned” association to a company “owned by Shareholders” is called demutualization. •Demutualization is transforming the legal structure, of an exchange from a mutual form to a business corporation form. In a mutual exchange, the three functions of ownership, management and trading are intervened into a single group. It means that the broker members of the exchange are owners as well as traders on the exchange and further they themselves manage the exchange. These three functions are segregated from one another after demutualization. The demutualised stock exchanges in India are; 1. The National Stock Exchange (NSE) 2. Over the Counter Exchange of India (OTCEI)

  30. METHODS OF TRADING IN A STOCK EXCHANGE The stock exchange operation at follow level is highly technical in nature. Non-members are not permitted to enter into the stock market. Hence, various stages have to be completed in executing a transaction at a stock exchange. The steps involved in the methods of trading have been given below: (1) Choice of Broker (2) Placement of Order (3)Execution of Orders (4) Preparation of Contract Notes (5) Settlement of Transactions

  31. ONLINE TRADING • It is the trading over the net i.e., E-trading •To overcome the wastage of time consumed and inefficient operations of the traditional method and the limits on trading volumes the NSE has introduced a nation-wide on line fully automated Screen Based Trading System (SBTS). Now, other stock exchanges have been forced to adopt SBTS and today India can boast that almost 100% trading take place through electronic order matching. • Under SBTS, a member can punch into the computers quantities of securities and the prices at which he likes to transact the transaction. It is executed as soon as it finds a matching sale or buy order from a counter party; Thus, technology is used to carry the trading platform from the trading hall of the exchanges to the premises of the brokers. NSE has carried the trading platform further to the PCs at the residence of the investors through the internet and the hand held devices through WAP for the convenience of the mobile investors.

  32. Cont.. • This system also provides complete market information online. The market screens at any point of time provide complete information as to (1) total order depth in a security (2) the best five buys and sells in the market (3) the quantity traded during the day in that security (4) the high and the low price for each security (5) the last traded price for a security etc., • BSE BOLT SYSTEM, BOLT (Bombay on line Trading) has been introduced in the Bombay Stock Exchange. All the scripts are being traded through BOLT.

  33. OTCEI ( Over the Counter Exchange of India ) • It is a Stock Exchange without a proper trading floor • All stock exchanges have a specific place for trading their securities through counters. But, OTCEI is connected through a computer network and the transactions are taking place through computer operations. Thus, the development in information technology has given scope for starting this type of stock exchange. This stock exchange is recognized under the Securities Contract ( Regulation) Act and so all the stocks listed in this exchange enjoy the same benefits as other listed securities enjoy. • OTCEI has been incorporated under Section 25 of the companies Act. As a result of which the word ‘Limited’ need not be used since it is promoted for a common case of promoting the interest of small and medium companies. This privilege has been given to the company by the Central government. • This company was promoted by a group of financial institutions owned by Government of India, consisting of UTI, ICICI, IDBI, SBI Capital Market , IFCI, LIC, GIC and CAN BANK financial Services.

  34. FEATURES OF OTCEI (1) Use of Modern Technology (2) Restrictions for other stocks (3) Minimum issued capital requirements (4) Restrictions for large companies (5) Base Capital requirement for members (6) All India network (7) Satellite facility (8) Computerization of transactions

  35. Objectives of OTCEI 1. Assisting and guiding small companies to raise funds from the capital market in a cost-effective manner 2. Providing a convenient and an efficient avenue of capital market investments for small investors 3. Strengthening investors’ confidence in the financial market by offering them the two-way best prices to them 4. Ensuring transparency, redressing investors’ complaints and unifying the country’s securities market to cover even those places which do not have a stock exchange 5. Acting as a launch pad to an IPO 6. Providing liquidity advantage to the securities traded 7. Promoting organized trading in Unlisted Securities 8. Providing a source of valuation for securities traded

  36. Securities Traded Following are the securities that are traded on the OTCEI : 1. Listed equity (exclusive) 2. Listed debt 3. Gilts 4. Permitted securities 5. Listed mutual funds

  37. FEMA Act, 1999 • The Foreign Exchange Management Act, 1999 (FEMA) is an Act of the Parliament of India "to consolidate and amend the law relating to foreign exchange with the objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India". • It was passed in the winter session of Parliament in 1999, replacing the Foreign Exchange Regulation Act (FERA). 

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