An introduction to FINANCIAL SERVICES

The Financial System is a complex, well - integrated set of sub- systems of - financial institutions - financial markets - financial instruments and - financial services

which facilitates the transfer and allocation of funds, efficiently and effectively

Financial Dualism Financial dualism - coexistence of formal financial sector and informal financial sector Formal financial sector organized, institutional and regulated system Informal financial sector unorganized, noninstitutional and non- regulated system

Constituents

A financial system comprises of Financial institutions Financial markets Financial instruments Financial services.

Features of a Financial System

1. Provides an ideal linkage between depositors and investors. 2. Facilitates expansion of financial markets. 3. Promotes efficient allocation of financial resources. 4. Influences both the quality and the pace of economic development.

Financial Institutions Financial institutions provide credit and credit related services.

Chief characteristics of financial institutions: 1. Savings mobilizers 2. Participants 3. Dealers 4. Generators 5. Regulation

Classification of financial institutions:

Banking and non- banking financial institutions

Term finance institutions

Specialized finance institutions

Sectoral financial institutions

Investment institutions

State- level financial institutions

Financial institutions are regulated by Securities and Exchange Board of India (SEBI) Reserve Bank of India Department of Banking and Insurance Government of India

Financial Markets facilitate buying and selling of financial claims, assets, services and securities. Classified into organized & unorganized markets. Types of financial markets

- Money market - Capital market

Segments of financial markets - Primary market - Secondary market

Two components of secondary market - Over-the-counter market - Exchange traded market ( Derivatives market)

Financial Instruments Financial claims such as financial assets and securities dealt in a financial market

Financial assets claims of periodical payments of certain sum of money by way of payment of principal, interest or dividend. Type of financial securities primary and secondary

Financial services those that help with borrowing and funding lending and investing buying and selling securities making and enabling payments and settlements managing risk exposures in financial markets.

Major categories of financial services are - funds intermediation - payments mechanism - provision of liquidity - risk management - financial engineering

FUNCTIONS OF A FINANCIAL SYSTEM Mobilise and allocate savings Monitor corporate performance Provide payment and settlement systems Optimum allocation of risk- bearing and reduction Disseminate price- related information Offer portfolio adjustment facility Lower the cost of transactions Promote the process of financial deepening and broadening

Key elements of a well functioning financial system A strong legal and regulatory environment Stable money Sound public finances and public debt management A central bank Sound banking system Information system Well- functioning securities market

Importance of the financial system

Facilitates economic activity and growth

Helps accumulate the volume and rate of savings

Lower financial intermediation costs

Makes innovation least costly

Helps in evaluating assets

Helps the Central bank to conduct monetary policy

Monitors the management of companies

FINANCIAL MARKETS

Money market Market for financial assets that are close substitutes for money. Market for overnight to short- term funds and instruments having a maturity period of one or less than one year. Not a physical location, but an activity conducted over the telephone.

Characteristics of money market Not a single market collection of markets for several instruments Wholesale market of short- term debt instruments Principal feature honour where the creditworthiness of the participants is important Need- based market

Main players are: - Reserve Bank of India - Discount and Finance House of India - Mutual funds - Banks - Corporate investors - Non- banking finance companies - State governments - Provident funds - Primary dealers - Securities Trading Corporation of India - Public sector undertakings - Non- resident Indians

Functions

Broad functions:

Provide a balancing mechanism Provide a focal point for Central bank Provide reasonable access to suppliers and users of shortterm Facilitates development of market for long- term securities

Benefits of an efficient money market Provides a stable source of funds to banks Encourage development of non- bank intermediaries Facilitates government market borrowing Makes effective monetary policy actions Helps in pricing different floating interest products

Money market instruments Treasury bills - On- tap Bills - Ad hoc Bills - Auctioned T- Bills Call / Notice money market Commercial Papers Certificates of Deposits Commercial bills Collateralised Borrowing and Lending Obligation

CAPITAL MARKET Market for long term debt Market for funds raised within and outside the country Capital market includes

- Stock market - Bond market

Functions of a capital market

Mobilise long- term savings Provide risk capital Encourage broader ownership of productive assets Provide liquidity Lower the costs of transactions and information Improve the efficiency of capital allocation

 Disseminate information efficiently Enable quick valuation of financial instruments Provide insurance against market risk or price risk (derivative trading) and default risk ( investment protection fund) Enable wider participation by enhancing the width of the market Direct the flow of funds into efficient channels

 Provide operational efficiency through - simplified transaction procedures - lowering settlement timings - lowering transaction costs

Develop integration among - real and financial sectors - equity and debt instruments - long- term and short- term funds - long term and short term interest costs - private and government sectors - domestic and external funds

PRIMARY CAPITAL MARKET Market for new issue of shares, debentures and bonds Investors apply directly to the issuer for allotment. Transactions in the primary market result in new capital formation

Issue mechanism / Methods of issuing securities/Methods of raising funds from primary market

1.
2. Public Issue (Initial Public Offering & Follow - on Public Offering) - Public issue through prospectus - Book building / Tender method

2. Offer for sale

3.
4. Placement Method - Private Placement - Preferential Issue - Qualified Institutions Placement

4.

Rights Issue

IPO Process
The various stages in the life cycle of an Initial Public Offering are as follows : 1. Initialization 2. Pre issue activities 3. Submit prospectus to Stock Exchange 4. Distribution of red herring prospectus 5. Public issue bids and price fixation 6. Filing of final prospectus with the Registrar of Companies 7. Opening placement portion for subscription 8. Opening public issue portion for subscription 9. Processing of applications 10.Listing in the stock exchange 11.

SEBI & Primary Market

Measures undertaken by SEBI Entry norms Promoters contribution Disclosure Book building Allocation of shares Market intermediaries

Secondary Market Market in which existing securities are resold or traded Also known as stock market India secondary market consists of recognised stock exchanges operating under rules, by- laws and regulations duly approved by the government Sec. 2(3) Securities Contracts (Regulation) Act, 1956 stock exchange is defined as any body of individuals whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities.

Functions of secondary market Facilitate liquidity and marketability of the outstanding equity and debt instruments Contribute to economic growth through the allocation of funds through the process of disinvestment to reinvestment Provide instant valuation of securities this facilitates measurement of cost of capital and rate of return Ensure a measure of safety and fair dealing to protect investors interests Induce companies to improve performance

SEBI & Secondary Market

Reforms in the secondary market Governing board Infrastructure Settlement & clearing Debt market Price stabilization Delisting Brokers Insider Trading

Stock Market in India Origin Growth Post reforms stock market scenario ( 1991) three- tier form - Regional Stock exchanges - The National Stock Exchange (1994) - The Over The Counter Exchange of India (1992)

Organisational forms of various recognised stock exchanges in India

Stock exchange Bombay, Ahmedabad, Patna, Indore Kolkata, Delhi, Bangalore, Cochin, Kanpur, Guwahati, Ludhiana, Mangalore, Chennai Hyderabad, Pune, Rajkot, Magadh The National Stock Exchange Form of organisation Voluntary non- profit making association Public Limited Company

Company Limited by Guarantee A tax- paying company incorporated under the Companies Act and promoted by leading financial institutions and banks A company under section 25 of the Companies Act 1956

The Over The Counter Exchange of India

Demutualisation of Stock Exchanges process by which any member - owned organisation can become a shareholder- owned company. Such a company could either be listed on a Stock Exchange or be closely held by its shareholders In India- stock exchanges are either Sec. 25 companies under the Companies Act or an Association of persons and are exempt from all taxes. Through demutualisation, a stock exchange becomes a corporate entity, changing from a non- profit making company to a profit making and tax paying company

Listing of securities Permits trading Unlocks the value of the company Creates wealth effect Can list in more than one stock exchange but compulsory to list on the regional stock exchange nearest to its registered office. A security listed on one stock exchange is permitted for trading on the other Listing agreement between the company and the concerned stock exchange ensures liquidity and investor protection

A company can seek listing:

At least 10% of the securities, subject to a minimum of 20 lakh securities, have been offered to the public for subscription In addition, the size of the net offer to the public is not less than Rs. 100 crore and the issue is made only through book building method with 60% of the issue size allocated to the Qualified Institutional Buyers Alternatively, a company has to offer at least 25% of the securities to the general public

 Stock exchanges levy annual listing fees from the listed companies constitutes their major source of income Issuing company -make continuous disclosures relating to - financial results, - material information and - information in the form of a statement on the actual

utilisation of funds and actual profitability as against the projected utilisation of funds and projected profitability on a quarterly basis.

Mandatory provide half- yearly results on the basis of a limited review by its auditors or CAs

Trading arrangements
Open outcry system is replaced by online screen- based electronic trading system

Trades are executed through a computer terminal

Ensures transparency

Increases information efficiency

Increases operational efficiency

Improves depth and liquidity of the market

Provides a single trading platform

Trading systems

Two types of trading systems:

1. Order driven trading system ( NSE & BSE) orders from all over the country are entered into an electronic system and matched directly and continuously without the involvement of a jobber or a market maker. 1. 3. Quote driven trading system (BSE) market makers continuously offer two- way quotes (buy and sell quotes) and are willing to buy and sell any quantity

Dematerialisation of securities Electronic book entry form of holding and transferring securities Introduced to eliminate theft, fake/ forged transfers, transfer delays and the paperwork associated with physical certificates All IPOs will be issued in dematerialised form Two depositories offer trading facility in dematerialised form National Securities Depository Limited (NSDL) and Central Depository Service Limited (CDSL)

Internet trading Introduced in India in April 2000 Investors can buy and sell shares online through the internet. has driven down the transaction costs substantially Increased liquidity options - to enter or exit from the stock at his own wish Wide range of information enabled the investor to take calculated risks Online trading represents about 10% of the total traded volumes on the NSE and BSE

Reasons for such low online trading volumes Erratic bandwidth and erratic net connectivity coupled with low personal computer penetration Low security and inadequate cyber laws Lack of automation in the banking sector especially among public sector banks Lack of funding for internet-based business incremental and ongoing investment in technology and brand building are required

 Stipulation from the SEBI Know Your Customer (KYC) Time lag of 10-15 minutes between the placing of an order and its execution fluctuations in prices High cost of transactions (brokerage 0.200.25 % for non- delivery based transaction and between 0.500.75 % for delivery based transaction) Online investor pays more margin for trading than the off- line investor and his funds are also tied up for more trading days.

 Absence of streaming data on the investors computer broker gets streaming data on his computer while the client does not clients get a browser based web application which works on a request reply model, most suited for document presentation High development, acquisition, maintenance and service costs

There is a great potential for the growth of internet trading in India Stock markets have moved from T+5 to the T+2 settlement cycle velocity of funds is expected to increase

Requirements: A regulatory authority to control this market Availability of high bandwidth An online infrastructure Investor interest in internet trading requires innovations and new products

Stock Market Index

Major indices in India: BSE Sensex NSE Nifty

Global Stock Market Indices: the Dow Jones Industrial Average the Nasdaq composite index the Nasdaq 100 index the S&P 500 index the FTSE 100 the MSCI Indices

Depository Receipts

A Depository Receipts (DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity, that is issued by a foreign publicly listed company.

The DR, which is a physical certificate, allows investors to hold shares in equity of other countries.

E.g.. American Depository receipt (ADR), Global Depository Receipts (GDR).

Indian Depository Receipts

An IDR is an instrument in the form of a Depository Receipt created by the Indian Depository in India against the underlying equity shares of the issuing company in order to enable foreign companies to raise funds from the Indian markets.

Reasons
Diversify Holding across regions Risk of portfolio getting concentrated in the home market. Exchange rate risks are reduced Acquire shares of global companies Allow global companies to access funds at cheaper costs. Enables foreign companies to raise capital in India Enable Indian investors to diversify risk Enable globalization of Indian stock exchanges

How it will work?

Draft Prospectus is filed with SEBI Issue fee is paid Issuing Company will obtain necessary permission and exemption from the country of its incorporation and appoint an overseas custodian bank for issue Deliver the underlying shares to overseas bank Trading & settlement will be similar to those of Indian shares

Who can invest in IDR?

Indian Companies Qualified Institutional Buyers NRIs and FIIs with permission of the Reserve Bank of India

Global markets

Indian companies have raised resources from international capital markets through Global Depository Receipts American Depository Receipts Foreign Currency Convertible Bonds External Commercial Borrowings

American Depository Receipts

introduced in the American market in 1927. ADRs are issued to offer investment routes that avoid the expensive and cumbersome laws that apply sometimes to non-citizens buying shares on local exchanges ADR is a security issued by a company outside the U.S. which physically remains in the country of issue, usually in the custody of a bank, but is traded on U.S. stock exchanges.

 ADR is a stock that trades in the United States but represents a specified number of shares in a foreign corporation ADRs are issued to offer investment routes that avoid the expensive and cumbersome laws that apply sometimes to non-citizens buying shares on local exchanges ADR access to US institutional markets and retail markets

ADR Issue HDFC Bank Ltd. ICICI Bank Ltd Infosys Technologies ltd

Symbol HDB IBN INFY

Industry Banks Banks

DR. Reddys Laboratories Ltd. RDY

Exchan Pharmaceutical ge NYSE NYSE NYSE NASD AQ NYSE NASD AQ NYSE NASD AQ NYSE NYSE

Mahanagar Telephone Nigam MTE Ltd Rediff. Com India Ltd REDF Satyam Computer Services ltd SAY SIFY Ltd Videsh Sanchar Nigam Ltd Wipro Ltd SIFY VSL WIT

Technology services Fixed line comm Technology services Technology services Technology services Fixed line comm Technology services

Global Depository Receipts

are equity instruments issued abroad by authorised overseas corporate bodies against the shares / bonds of Indian companies held with nominated domestic custodian banks. Issue of GDR creates equity shares of the issuing company which are kept with a designated bank Are freely transferable outside India and dividend in respect of the shares represented by the GDR is paid in Indian rupees only

 similar to the ADR but are usually listed on exchanges outside the U.S. Dividends are usually paid in U.S. dollars. The first GDR was issued in 1990.

GDR - access only to US institutional markets