1 JAIIB/ Principles and Practice of Banking / Module A Indian Financial System-An overview-unit-1 Structure and Functions of Indian Financial System Financial System is a structure through which financial surpluses in the economy are mobilized from surplus sectors and transferred to needy sectors. That means SAVINGS of certain sections of society are transformed in to INVESTMENTS or CONSUMPTION or for PRODUCTIVE purpose. In simple words that there are areas or people with surplus funds and there are those with a deficit. A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. Various FINANCIAL INETRMEDIARIES like Banks/NBFCs/Primary Dealers/Mutual Fund Companies etc undertakes the intermediation between INVESTERS and SPENDERS. So FINANCIAL SYSTEM helps transform SAVINGS in to PRODUCTIVE INVESTMENTS. Indian financial system consists of Financial Markets, Credit market and many Financial Intermediaries. Various long term and short term Financial Instruments are issued and various Financial Services are rendered by important stake holders in the system. FINANCIAL MARKETS A Financial Market can be defined as the market in which Financial assets are created or transferred. Financial Assets or Financial Instruments represents a claim to the payment of a sum of money sometime in the future /or certain periodic payment in the form of interest or dividend. For example shares in a company represent financial wealth of investors holding them as well as capital to the company as a whole. Thus financial markets help investors create wealth as well as raise capital for the companies. A financial Market System mainly comprises of CAPITAL MARKET controlled by SEBI, MONEY MARKET regulated by RBI FOREX MARKET, CREDIT MARKET supervised and regulated by RBI. Capital Market A capital market provides long term finance for business. Capital Market refers to the facilities and institutional arrangements for borrowing and lending long-term funds as well as raising capital by way of issuing shares to interested investors. Capital Market can be divided into following groups: 1. Corporate Debt/ Corporate Bond/Securities/Share Market: It is a market for industrial securities. Corporate securities are equity and preference shares, debentures and bonds of companies. It can be divided into two groups: Primary and Secondary Market Primary Market: It is a market for new issue of securities, which are issued to the public for first time. It is also called as Initial Public Offering (IPO) Secondary Market: In the secondary market, there is a sale of secondary securities. It is also called as Stock/Share Market. It facilitates buying and selling of securities through stock Exchanges. 2. Government Securities Market (G-SECs): In this market, government securities are bought and sold. It is also called as Gilt-Edged Securities Market. The securities are issued in the form of bonds and credit notes. The buyers of such securities are Banks, Insurance Companies, Provident funds, RBI and Individuals. These securities may be of shortterm or long term. Money Market This Market consists of many financial instruments such as Treasury Bills, Commercial Paper (CP), Certificate Of Deposit (CD), Call Money, Commercial Bills etc.
2 JAIIB/ Principles and Practice of Banking / Module A Treasury Bills: To raise short term funds treasury bills are issued by Government. It is purchased by Commercial Banks. At present, Government issues 91 days. 182 days and 364 days treasury bills. Commercial Paper (CP): Commercial paper is issued by high net worth companies (HNC) who are listed on Stock Exchange. CP is issued at discount and repaid at face value. The maturity period ranges from 7 days to one year. CP's are issued in multiple of 5 lakh. The company issuing CP must have tangible net worth of at least 4 crores. Certificate Of Deposit (CD): CD's are used by Commercial Banks and Financial Institutions to raise finance from the market. The maturity period for CD's is between 7 days to 1 year. CD's is issued at a discount and repaid at face value. CD's is issued for a minimum of 25 lakhs. Call Money Market: A loan which is taken or given for a very short period that is for one day is called Call Money Market. It involves lending and borrowing of money on a daily basis. No security is required for these very short-term loans. Commercial Bill Market (CBM): This market deals with Bills of exchange. The drawer of the bill can get the bills discounted with Commercial Banks. The Commercial Banks can get the bills rediscounted with RBI at the rate called Bank Rate which is also called Rediscounting Rate. FOREX Market The Forex market deals with the multicurrency requirements, which are met by the exchange of currencies. Depending on the exchange rate, the transfer of funds takes place in this market. This market is must facilitating International Trade. Credit Market Credit market is a place where Commercial banks and NBFCs provide short, medium and long-term loans to corporate and individuals. Financial intermediaries A Financial intermediary is a financial institution such as bank, insurance company, investment bank or a Pension fund company etc. which offers a service to help an individual/ firm to save or borrow money. The term financial intermediary thus refers to an institution, firm or individual who performs intermediation between two or more parties in a financial context. Typically the first party is a provider of a product or service and the second party is a consumer or customer. Financial intermediaries are banking and non-banking institutions which transfer funds from economic agents with surplus funds (surplus units) to economic agents (deficit units) that would like to utilize those funds. FIs are basically two types: Bank Financial Intermediaries, BFIs (Central banks and Commercial banks) and Non-Bank Financial Intermediaries NBFIs (Insurance companies, Mutual trust funds, Investment companies, Pensions funds, Discount houses and Bureaux de change). Important Regulatory agencies in India Reserve Bank of India (RBI) regulates credit products, savings and remittances; Money market, Forex market The Securities and Exchange Board of India (SEBI) regulates Share market, investment products, Mutual Fund Companies etc The Insurance Regulatory and Development Authority (IRDA) regulates All insurance products such as Life/General/medical/fire/marine, Unit linked Insurance Plans(ULIPS) except Deposit insurance. Deposit insurance is regulated by RBI and insurance on bank deposits are covered by Deposit credit Guarantee Corporation of India (DICGCI). The Pension Fund Regulatory and Development Authority (PFRDA) regulates pension products.
3 JAIIB/ Principles and Practice of Banking / Module A The Forward Markets Commission (FMC) working under the Ministry of Consumer Affairs regulates commodity-based exchange-traded futures and commodity exchanges. Now this commodity market regulator is merged with SEBI recently. Quasi-regulatory agencies: There are other government bodies which perform quasi-regulatory functions, including National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India (SIDBI), and National Housing Bank (NHB) etc. NABARD supervises Regional Rural Banks (RRBs) as well as State and District Rural cooperative Banks. NHB regulates housing finance companies SIDBI regulates the State Finance Corporations (SFCs) Rural Cooperative banks, which, except in terms of their ownership structure, are very much, like other banks. They take deposits and give loans. Still, their management is largely left to the Registrar of cooperatives of the state and statutory supervision to NABARD. Financial Sector Development Council (FSDC), which replaced the High Level Committee on Capital Markets. FSDC, which is convened by Ministry of Finance, does not have statutory authority, and would be expected to resolve inter-agency disputes. Stake Holders in Capital /Equity/Pension Funds/Debt Market Asset Management Company: the Company which handles the day to day operations and investment decisions of a unit trust. Broker: A member of a Stock Exchange who acts as an agent for clients and buys and sells shares on their behalf in the market. Though strictly a stock broker is an agent, yet for the performance of his part of the contract both in the market and with the client, he is deemed as a principal, a peculiar position of dual responsibility. Broker dealer: Any person, other than a bank engaged in the business of buying or selling securities on its own behalf or for others Collective Investment Management Company: A company incorporated under the provisions of the Companies Act, 1956 and registered with SEBI under the SEBI (Collective Investment Schemes) Regulations, 1999, whose object is to organise, operate and manage a Collective Investment Scheme. Debenture Trustee: A trustee of a trust set up for undertaking any issue of debentures of a company on its behalf. Depository: A Depository facilitates holding of securities in the electronic form (DEMAT form) and enables securities transactions to be processed by book entry. Ex: National Securities Depository Limited (NSDL) and Central Depository Services (India) Ltd. (CDSL). Depository Participant (DP): is an agent of the depository. They are the intermediaries between the depository and the investors. The relationship between the DPs and the depository is governed by an agreement made between the two under the Depositories Act. In a strictly legal sense, a DP is an entity who is registered as such with SEBI under the sub section 1A of Section 12 of the SEBI Act. Foreign institutional investor (FII) : An institution established or incorporated outside India which proposes to make investment in India in Share/securities, market or domestic Asset Management Company or domestic portfolio manager who manages funds raised or collected or brought from outside India for investment in India on behalf of a *sub-account, shall be deemed to be a Foreign Institutional Investor. Subaccount: Sub-account includes foreign corporates or foreign individuals and those institutions, established or incorporated outside India and those funds, or portfolios, established outside India, whether incorporated or not, on whose behalf investments are proposed to be made in India by a Foreign Institutional Investor
4 JAIIB/ Principles and Practice of Banking / Module A Mutual Funds /Unit Trusts: Mutual Fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document. A fund established in the form of a trust to raise monies through the sale of units to the public or a section of the public under one or more schemes for investing in securities. Pension Fund Managers(PFMs) or Pension Funds(PFs): Pension fund means an intermediary which has been granted license by Pension Fund Regulatory Authority of India(PFRDAI) for receiving contributions from pension seeking investors, accumulating them and investing them in the manner as may be specified by the PFRDAI and making payments to the subscriber from time to time. Stake Holders in Credit Market The Banking Regulation Act, 1949 and the Reserve Bank of India Act, 1934 authorize the RBI to regulate the banking sector in India. Commercial banks: Commercial banking sector comprises of public sector banks, private banks and foreign banks. Co-operative Banks and Regional Rural Banks too makes up entire banking segment in India. Development banks: In India, there is also Development banks which are special re-financial institutions established for the development specific sectors of economy by providing them refinance and Development credit. These are constituted by Government of India by respective special legislations. These are typically set up for financing and refinancing various sectors for which they are created for. These are not commercial banks since they will not receive deposits from Public. Ex: NABARD/SIDBI/NHB/EXIM banks All India financial institutions (AIFIs):India has a two-tier structure of Development financial institutions with All India financial institutions (AIFIs) at National level and State Financial Institutions (SFCs) at the state level. All India financial institutions comprise term-lending institutions, specialized institutions and investment institutions, including Public sector insurance Institutes. Government holds majority shares in these financial institutions, All India Financial Institutions (AIFIs) are the Development Finance Institutions (DFIs) and Investment Institutions, which play a pivotal role in the financial market. All India Financial Institutions (AIFIs): All-India Financial Institutions (AIFIs) comprise five All-India Development Banks (AIDBs), viz., Industrial Development Bank of India (IDBI), Industrial Finance Corporation of India Ltd. (IFCI), ICICI Bank Ltd., Infrastructure Development Finance Corporation (IDFC), Small Industries Development Bank of India (SIDBI) and Industrial Investment Bank of India (IIBI, erstwhile Industrial Reconstruction Bank of India or IRBI), three Specialised Financial Institutions (SFIs) viz., IVCF (erstwhile Risk Capital and Technology Corporation or RCTC), ICICI Venture (erstwhile TDICI) and Tourism Finance Corporation of India (TFCI) and three investment institutions viz., Life Insurance Corporation of India (LIC), Unit Trust of India (UTI) and General Insurance Corporation (GIC). A set of parallel, financial institutions, known as the State Financial Corporation s (SFCs), were set up at the State level in 1951 to extend the benefits of long-term loans to medium and small sized industrial undertakings in the respective states. State level institutions comprise of State Financial Institutions(SFCs) and State Industrial Development Corporations (SDCs) providing project finance, equipment leasing, corporate loans, short-term loans and bill discounting facilities to corporate. Non-banking Financial Institutions (NBFCs) provides loans and hire-purchase finance, mostly for retail assets and are regulated by RBI under provisions of RBI Act 1934. A primary dealer is a bank or securities broker-dealer that may trade directly with the government securities in open market operations. RBI regulates and licenses primary Dealers and governs all rules pertaining to securities Market. Currently 21 primary dealers are permitted by RBI to work in securities Market.
5 JAIIB/ Principles and Practice of Banking / Module A Banking Regulation-Unit-2 The Reserve Bank of India is the Apex or Central Bank of India endowed with powers to regulate banking system in India. It was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934.The Central Office of the Reserve Bank was initially established in Calcutta but was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated. Though originally privately owned, since nationalization in 1949, the Reserve Bank is fully owned by the Government of India. Legal Framework of RBI Umbrella Acts Reserve Bank of India Act, 1934: governs the Reserve Bank functions Banking Regulation Act, 1949: governs the financial sector Acts governing specific functions Public Debt Act, 1944/Government Securities Act (Proposed): Governs government debt market Securities Contract (Regulation) Act, 1956: Regulates government securities market Indian Coinage Act, 1906:Governs currency and coins Foreign Exchange Regulation Act, 1973/Foreign Exchange Management Act, 1999: Governs trade and foreign exchange market Payment and Settlement Systems Act, 2007: Provides for regulation and supervision of payment systems in India" The major Functions of RBI The Reserve Bank is the central bank or Apex bank for numerous activities, all related to the nation s financial sector, encompassing the following functions. Regulator and supervisor of the financial system RBI is the regulator and supervisor of the financial system. Its objectives are to maintain efficient financial system, protect depositors' interest and provide cost-effective banking services to the public. The RBI controls the monetary supply, monitors economic indicators like the gross domestic product and has to decide the design of the rupee banknotes as well as coins.rbi now covers the regulation of Commercial banks (91), All India Financial Institutions (5), Credit Information Companies (4), Regional Rural Banks (56) and Local Area Banks (4). Supervisory Regulatory functions In addition to its traditional central banking functions, the Reserve bank has certain functions of the nature of supervision of banks and promotion of sound banking in India. The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949 have given the RBI wide powers of supervision and control over scheduled banks, relating to licensing and establishments, branch expansion, liquidity of their assets, management and methods of working, amalgamation, reconstruction, and liquidation. The RBI is authorized to carry out periodical inspections of the banks and to call for returns and necessary information from them. The Reserve Bank regulates and supervises the nation s financial system. Different departments of the Reserve Bank oversee the various entities that comprise India s financial infrastructure. RBI oversees: Commercial banks and All-India Development Financial Institutions: Regulated by the Department of Banking Operations and Development, supervised by the Department of Banking Supervision Urban co-operative banks: Regulated and supervised by the Urban Banks Department Regional Rural Banks (RRB), District Central Cooperative Banks and State Co-operative Bank: Regulated by the Rural Planning and Credit Department Of RBI and co- supervised by NABARD
6 JAIIB/ Principles and Practice of Banking / Module A Non-Banking Financial Companies (NBFC): Regulated and supervised by the Department of Non-Banking Supervision under provisions of RBI act 1934. Bank of Issue or Issuer of Currency Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations. However the distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government. Role of RBI as a Banker to Government The Reserve Bank has well defined obligations and provides several banking services to the governments. As a banker to the Government, the Reserve Bank receives and pays money on behalf of the various Government departments. The Reserve Bank also undertakes to float loans and manage them on behalf of the Governments. It provides Ways and Means Advances (WMA), a short-term interest bearing advance to the Governments, to meet temporary liquidity shortages. Management of Public Debt RBI helps both the central government and state governments to manage their public debt, float new loans by issuing on their behalf Government Bonds/Securities. Such securities are short term (usually called treasury bills, with original maturities of less than one year) or long term (usually called Government bonds or dated securities with original maturity of one year or more). In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs). Banker to Banks: In order to facilitate a smooth inter-bank transfer of funds, or to make payments and to receive funds on their behalf, banks need a common banker like RBI. By providing the facility of opening accounts for banks, the Reserve Bank becomes this common banker, known as Banker to Banks function. Since banks need to settle transactions with each other occurring at various places in India, they are allowed to open accounts with different regional offices of the Reserve Bank. The Reserve Bank also facilitates remittance of funds from a bank s surplus account at one location to its deficit account at another. Such transfers are electronically routed through a computerized system called e-kuber. Monetary Controller or Controller of Credit The Reserve Bank of India is also the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. RBI controls the volume of credit by using different methods or tools called Quantitative Credit Controls and Qualitative Credit Controls (or) Selective credit controls. The Quantitative measures of credit control Tools Direct Instruments 1) Cash Reserve Ratio (CRR): The share of net demand and time liabilities that banks must maintain as cash balance with the Reserve Bank. RBI uses CRR either to drain excess liquidity or to release funds needed for the growth of the economy from time to time. Increase in CRR means that banks have fewer funds available and money is absorbed out of circulation. 2) Statutory Liquidity Ratio (SLR): The share of net demand and time liabilities that banks must be maintaining as safe and liquid assets, such as government securities, cash and gold.
7 JAIIB/ Principles and Practice of Banking / Module A Indirect Instruments Liquidity Adjustment Facility (LAF): Consists of daily infusion or absorption of liquidity on a repurchase basis, through repo (liquidity injection) and reverse repo (liquidity absorption) auction operations, using government securities as collateral. a) Repo Rate: Repo (Repurchase) rate is the rate at which the RBI lends shot-term money to the banks against securities. When the repo rate increases borrowing from RBI becomes more expensive. Therefore, we can say that in case, RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate. b) Reverse Repo rate is the rate at which banks park their short-term excess liquidity with the RBI. The banks use this tool when they feel that they are stuck with excess funds and are not able to invest anywhere for reasonable returns. An increase in the Reverse Repo Rate means that the RBI is ready to borrow money from the banks at a higher rate of interest. As a result, banks would prefer to keep more and more surplus funds with RBI. Thus, we can conclude that Repo Rate signifies the rate at which liquidity is injected in the banking system by RBI, whereas Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks. These tools are used by RBI for short term Liquidity Adjustments c) Open Market Operations (OMO): Outright sales/purchases of government securities, in addition to LAF, as a tool to determine the level of liquidity over the medium term. d) Marginal Standing Facility (MSF): was instituted under which scheduled commercial banks can borrow over night at their discretion up to one per cent of their respective NDTL at 100 basis points(1%) above the Repo Rate to provide a safety valve against unanticipated liquidity drain. e) Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. It also signals the medium-term stance of monetary policy. f) Market Stabilization Scheme (MSS): This instrument for monetary management was introduced in 2004. Liquidity of a more enduring nature arising from large capital flows from abroad is absorbed through sale of short-dated Government securities (G-SECs) and Treasury bills. The mobilized cash is held in a separate government account with the Reserve Bank. Qualitative credit control Tools /Selective Credit Control Tools These are used by the RBI for selective purposes. According to the Banking Regulation Act of 1949, the Reserve Bank of India can also use Selective credit controls or Qualitative Credit Controls by asking any particular bank or the whole banking system not to lend to particular groups or persons on the basis of certain types of securities or put certain restrictions on lending against certain commodities/securities. Since 1956, selective controls of credit are increasingly being used by the Reserve Bank. Selective Credit Controls (SCCs) RBI issues directives, under Sections 21 and 35A of the Banking Regulation Act, stipulating certain restrictions on bank advances against specified sensitive commodities as such as Pulses, other food grains (viz., coarse grains), oilseeds, oils including vanaspati, all imported oil seeds and oils, sugar including imported sugar etc. RBI's objectives in issuing Selective Credit Control (SCC) directives is to prevent speculative holding of essential commodities and the resultant rise in their prices. Some of other selective control tools are 1) Margin requirements: This refers to difference between the securities offered and amount borrowed by the banks. 2) Consumer Credit Regulation: This refers to issuing rules regarding down payments and maximum maturities of installment credit for purchase of goods. 3) RBI Guidelines: RBI issues oral, written statements, appeals, guidelines, and warnings etc. to the banks. 4) Rationing of credit: The RBI controls the Credit granted / allocated by commercial banks.
8 JAIIB/ Principles and Practice of Banking / Module A 5) Moral Suasion: psychological means and informal means of selective credit control. 6) Direct Action: This step is taken by the RBI against banks that don't fulfil conditions and requirements. RBI may refuse to rediscount their papers or may give excess credits or charge a penal rate of interest over and above the Bank rate, for credit demanded beyond a limit. REGULATORY RESTRICTIONS ON LENDING There are certain regulatory restrictions on lending by banks in terms of RBI directives or the Banking Regulation Act, 1949 (BRA) as follows: No advance or loan can be granted against the security of the bank's own shares or partly paid shares of a company, No bank can hold shares in a company: a) As pledgee or mortgagee in excess of the limit of 30 per cent of the Paid-up capital of that company or 30 per cent of the Bank's Paid-up capital and Reserves, whichever is less (Under Sec. 19 (ii) of BRA). b) in the management of which Managing Director or Manager of the Bank is interested (Sec. 19(iii) of BRA). Bank's aggregate investment in shares, Certificate of Deposits (CDs), bonds, etc., should not exceed the limit of 40 per cent of Bank's net owned funds as at the end of the previous year, No bank should grant loans against: a) CDs b) FDs issued by other banks c) Money Market Mutual Funds Bank should adhere to the RBI guidelines relating to the level of credit, margin and interest rate etc. for loans against the security of commodities covered by the Selective Credit Control Directives of RBI. No loan should be granted by banks to: a) The Bank's directors or firms in which a director is interested as a partner/manager/employee/guarantor (certain exemptions allowed). b) Relatives of other bank's directors ('relatives' defined by RBI) - Such loans can be sanctioned by higher authorities or the Bank's Board as per RBI guidelines. Banks should not sanction a new or additional facility to borrowers appearing in RBI's list of "Willful Defaulters" for a period of 5 years from the date of publication of the list by RBI. Custodian of Foreign Exchange Reserves The statutory power for exchange control was provided by the Foreign Exchange Regulation Act (FERA) of 1947, which was subsequently replaced by a more comprehensive Foreign Exchange Regulation Act, 1973. This Act empowered the Reserve Bank, and in certain cases the Central Government, to control and regulate dealings in foreign exchange payments outside India, export and import of currency notes and bullion, transfer of securities between residents and non-residents, acquisition of foreign securities, and acquisition of immovable property in and outside India, among other transactions. After Liberalization and in view the changed environment, the Foreign Exchange Management Act (FEMA) was enacted in 1999 to replace FERA. FEMA became effective from June 1, 2000.
9 JAIIB/ Principles and Practice of Banking / Module A Retail/Whole sale/international Banking Services-Unit-1 Retail Banking and Whole sale Banking Retail banking is the provision of various services by a bank to individual consumers catering to their multiple banking needs. Retail banking refers to that banking which targets individuals and the main focus of such banks is retail customer whereas wholesale banking refers to that banking which targets corporate or big customers and their main focus is providing services to corporate clients. Loans such as car, housing, educational, personal loans are some of the examples of loans given in retail banking whereas loans such as loan for setting industry, machinery advance, export credit are some of the examples of loans given in wholesale banking. Retail banking requires large network of branches in order to cater to large customer base and hence it results in high operational costs while in case of wholesale banking small number of branches is sufficient to cater to corporate clients. The typical products offered in the Indian retail banking segment are: Savings Bank Account Recurring Deposit Recurring Deposit Account Current Deposit Account Term Deposit Account Home Loans to resident Indians for purchase of land and construction of residential house/purchase of ready built house/for repairs and renovation of an existing house. Home Loans to Non-Resident Indians Auto Loans - for purchase of new/used four-wheelers and two-wheelers Consumer Loans - for purchase of white goods and durables Retail Deposit Products Retail Loan Products Zero Balance Account for salaried class people No Frills Account for the common man Senior Citizen Deposit Accounts, etc. Personal loans - for purchase of jewels, for meeting domestic consumption etc. Educational Loans - for pursuing higher education both in India and abroad Trade related advances to individuals - for setting up business, retail trade etc. Crop loans to agricultural farmers Credit Cards etc. Retail Services o Bancassurance Products etc. o Safe Deposit Lockers o Depository Services Whole sale banking Wholesale Banking refers to doing banking business with industrial and business entities - mostly corporates and trading houses, including multinationals, domestic business houses and prime public sector companies. The products offered can be classified into four major groups, such as- Fund Based Services, Non-Fund Based Services, Value-Added Services and Internet Banking Services. Fund-based Services Term Lending short Term Finance Working Capital finance Bank Guarantees Letter of Credit Collection of Bills and Documents Bill Discounting Structured Finance Export Credit Non-fund-based Services
10 JAIIB/ Principles and Practice of Banking / Module A Cash Management Services Vendor Financing Corporate Salary Accounts Forex Desk Derivatives Desk Tax Collection Payment Gateway Services Supply Chain Management Value-added Services Channel Financing Real Time Gross Settlement Syndication Services Money Market Desk Bankers to Right/Public Issue Internet Banking Services Corporate Internet banking INTERNATIONAL BANKING Banks provide certain types of services to their customers who are engaged in international trade and who undertake certain foreign exchange transactions. Such Banking services catering to cross-border transactions are called International Banking. Banks have been traditionally offering various services to the international business people. Services for Exporters Export Packing Credit: Banks provide pre shipment finance in the form of Export Packing Credit (EPC) both in rupees as well as in foreign currencies to assist the exporters for manufacturing or packing the goods for export from India. Export Bill Negotiation: Banks negotiate export bills drawn under Letter of Credit (LC), if the documents are found to be strictly in terms with the LC conditions and payment of the bills to the exporter is made even before the bills are realised from the importers. Export Bill Purchase and Discounting: Even when the exports are not covered under Letter of Credit, banks sanction credit limits and pay the value of the invoice, immediately on shipment to the exporter at a discount. The export documents are presented and the proceeds will be credited to the advance account on realisation. Export Bill Collection Services: The export documents are sent in collection by the exporter through his banker for payment by the overseas buyer on their presentation. Such payments received against the delivery of documents by the buyer's bank are remitted to the collecting bank and proceeds credited to his account after deducting commission and other charges, if any. Bank Guarantees: Banks also issue Guarantees in foreign currency on behalf of exporters for approved purposes as defined under FEMA, subject to availability of credit limits or against 100 per cent cash margin. Rupee Advance against Export Bills: If an exporter expects the currency of his invoicing to appreciate further and does not want to surrender the export value of forex, before the due date, banks offer rupee advance against export bills up to the due date of the receivables, subject to limit availability and RBI rules. Export LC Advising: With a correspondent banking relationship with the leading banks across the world, Letter of Credit is advised through Banks. Export LC Confirmation: When the exporter does not have confidence in the credit standing of an LC opening bank or if the political climate or credit risk of the buyer's country is not satisfactory, banks offer LC confirmation services. Suppliers Credit: This facility enables Indian exporters to extend term credit to importers (overseas) of eligible goods at the post-shipment stage. Services for Importers Import Collection Bill: Services: Documentary Collections are a common and flexible method of payment for goods purchased from abroad. Although relatively simple in principle, they require
11 JAIIB/ Principles and Practice of Banking / Module A careful and accurate attention to bills of exchange, stamping requirements on bill of exchange, bills of lading and other documents. Banks handle the Import collection documents meticulously and help the importers to remit the import value. Direct Import Bills: FEMA allows importers to receive import documents directly from the overseas supplier subject to certain conditions and banks help importers to settle payments against the direct imports. Advance Payment towards Imports: Whenever any advance payment to an overseas supplier is required to be made, banks provide advisory services and also assist in faster remittance to the suppliers. Import Letters of Credit: Banks issue Import Letters of Credit on behalf of importers. Arranging for Buyer's and Supplier's Credit: Banks offer a wide range of offshore financing options to importers and take care of their working capital requirements. Banks also arrange for financing import requirements of importers by way of Suppliers' credit and Buyers' credit. Bank Guarantees: Banks issue Bank Guarantees in foreign currency on behalf of Importers for all approved purposes as defined under FEMA, against 100 percent cash margin or under regular limits. Remittance Services EEFC Account Services: Banks provide facilities to maintain an Exchange Earners Foreign Currency a/c (EEFC a/c) in all permitted currencies. Receipt of Foreign Inward Remittances Services: Banks receive from abroad and credit them to the Indian beneficiaries accounts. Payment Services to Abroad (Outward Remittances): Banks as Authorised Dealers in Foreign Exchange provide remittance facilities in foreign currency to any country for any permitted purpose up to the limits permitted by RBI. Correspondent Banking A bank that provides services on behalf of another is called a correspondent or Agent bank A correspondent bank can conduct business transactions, accept deposits and gather documents on behalf of the other financial institution. Correspondent banks are more likely to be used to conduct business in foreign countries, and act as a domestic bank's agent abroad. Nostro and vostro accounts Nostro Account is a bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts are used to facilitate settlement of foreign exchange and trade transactions. The term is derived from the Latin word for "ours." Conversely, accounts that are held by the domestic bank in its home country for foreign banks are called vostro accounts, derived from the Latin word for "yours." UNIVERSAL BANKING Universal banking means offering all types of financial products like banking, insurance, mutual funds, capital market related products including share broking, commodity broking, investment type products like sale of gold/bullion, government/corporate bonds, providing advisory services and Merchant Banking Activities, etc., - all at one place. Universal banking is common in some European countries, including Switzerland. Depository Services by Banks A Depository Receipt (DR) is a type of negotiable (transferable) financial instrument that is traded on a local stock exchange of a country but represents a security, usually in the form of equity that is issued by a foreign publicly listed company. The Deposit Receipt, which is a physical certificate, allows investors to hold shares in equity of other countries. One of the most common types of Deposit Receipts is the American Depository Receipt (ADR) American depositary receipt (ADR)
12 JAIIB/ Principles and Practice of Banking / Module A An American depositary receipt (ADR) is a stock that trades in the United States but represents a specified number of shares in a foreign corporation. ADRs are bought and sold on American markets just like regular stocks, and are issued/sponsored in the U.S. by a bank or brokerage. A depositary U.S. bank simply purchase a bulk lot of shares from the company, bundle the shares into groups, and reissues them to investors and to be listed on either the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) or the NASDAQ. How ADRs work? If a company in India wants to list its publicly traded shares on the NYSE in the form of an ADR, first a US broker, through an international office or a local brokerage house in India, would purchase the domestic shares of the company from the Indian market and then have them delivered to the local (Indian) custodian bank of the depository bank. The depository bank is the American institution that issues the ADRs in America. Once the Depository bank s local custodian bank in India receives the shares, this custodian bank verifies the delivery of the shares by informing the Depository bank that the shares can now be issued in the United States. The Depository bank then delivers the ADRs to the broker who initially purchased them. Based on a determined ADR ratio, each ADR may be issued as representing one or more of the Indian local shares and the price of each ADR would be stated in US dollars converted from the equivalent Indian price of the shares being held by the depository bank. The ADRs now represent the local Indian shares held by the depository and can now be freely traded equity on the NYSE. After the process whereby the new ADR of the Indian company is issued, the ADR can be traded freely among the investors and transferred from the buyer to the seller on the NYSE, through a procedure known as intra-market trading. Now all ADR transactions of the Indian company will now take place in US dollars and are settled like any other US transaction on the NYSE. The ADR investor also holds privileges like those granted to shareholders of ordinary shares in India, such as voting rights and cash dividends. The rights of the ADR holder are stated on the ADR certificate. Global Depository Receipt (GDR) Unlike ADRs, GDRs are usually listed on stock exchanges outside the US, such as Luxembourg or London. Participatory notes (PNs / P-Notes) PNs are instruments used by, foreign institutional investors (FIIs) that are not registered with the SEBI (Securities & Exchange Board of India) to invest in Indian securities. SEBI permitted FIIs to register and participate in the Indian stock market in 1992. Indian based brokerages buy Indianbased securities and then issue PNs to foreign investors. Participatory notes are instruments used by foreign investors for making investments in the stock markets. They are offered outside India for making investments India. That is why they are also called offshore derivative instruments. In the Indian context, foreign institutional investors (FIIs) and their sub-accounts mostly use these instruments for facilitating the participation of their overseas clients, who are not interested in participating directly in the Indian stock market. For example, Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. Participatory notes which accounted for roughly 50% of FII investment.