Financial Market Institutions And Reserve Bank Of India (RBI)

Financial Market Institutions

Both the primary and secondary markets in India have demonstrated phenomenal growth in both number of corporate entities that are listed, as well as market capitalization, market value of listed companies to the Gross National Product (GNP), number of shareholders (especially participation by the retail public, which is still set to increase further) and various other parameters. The success of the capital market structure is due to the policy making institutions, regulatory institutions, self regulatory institutions (SRO), independent watchdogs, depositories / custodians, and other intermediaries.

The key to efficient and effective performance of global financial markets is regulation based on sound policy framework. The recent credit crisis (2007-08) was due to the lack of effective governance of the over-the-counter markets. The US government has instituted widespread reforms in the regulatory structure of financial and securities markets. Many banks have collapsed in US during the recent economic crisis.

The Government of India through the regulatory, Securities Exchange Board Of India (SEBI) ensures broad uniformity in the structure and functioning of the equity markets. As of today, there are 24 recognized stock exchanges in India – some of them have permanent recognition and other exchanges need to renew their license every year.

The largest stock in India is the National Stock Exchange (NSE). Even though Bombay Stock Exchange (BSE) is the oldest stock exchange in Asia, NSE substantially overtaken the volumes traded in the Indian equity markets – both in the cash segment and derivatives segment.

With the advent of currency futures trading, the latest stock exchange to be established is the MCX Stock Exchange (MCX-SX), a subsidiary of Multi Commodity Exchange of India Limited, (MCX). MCX-SX was established for trading in currency futures. It is expected to be allowed to trade in equity and interest rate futures also, shortly, subject to regulatory approval.

While stock exchanges play a very important role in enabling the development of the secondary market, the primary markets allow companies to raise capital by issue of shares – Initial Public Offering, Follow-On Public Offering, Rights Issue, Debentures, and other instruments. Intermediaries in the primary markets include, Merchant Banker, Registrars (to the issue) and Bankers to the issue.

Banks, Financial Institutions, Insurance companies, Mutual Funds (Asset Management Companies) are major participants in the Indian capital markets.

The term financial intermediary usually refers to an institution, firm or individual who perform 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 to economic agents that would like to utilize those funds. Such intermediaries are broadly classified into two types.

1. 1. Bank Financial Intermediaries, consisting of Central Bank, Commercial Banks.
   2. Non-Bank Financial Intermediaries, such as insurance companies, mutual funds (asset management companies), investment companies, pensions funds and discount houses.

The regulatory structure in Indian Financial Markets has to a large extent, not impacted the performance of financial markets in India. Not a single banking institution in India has been affected due to the credit crisis the originated in the developed markets. The regulation in Indian Financial Markets is governed by a multi-layered structure of Government and its regulatory bodies, as well as self-regulatory organization.

In India, the first level of regulatory structure is the Government of India. The regulatory bodies effectively report to the Government of India and are accountable for the efficient and effective performance of the Indian Financial System.

The banking institutions are regulated by the central bank, Reserve Bank Of India (RBI). RBI regulates all commercial banks, scheduled and non-scheduled banks, urban cooperative banks, state and central district cooperative banks, All-India Financial Institutions such as the Industrial Finance Corporation of India (IFCI), Industrial Investment Bank of India (IIBI), Export-Import (Exim) Bank, TFCL, State Industrial Development Bank of India (SIDBI), National Bank for Agriculture and Rural Development (NABARD), National Housing Board (NHB), Non-banking Financial Companies (NBHC) and the debt market and money market participants including primary dealers, and foreign exchange markets participants – authorized forex dealers.

The Securities Exchange Board of India (SEBI) is the regulator for all Capital Market Institutions, intermediaries, mutual funds (the Association of Mutual Funds in India or AMFI is also a self-regulatory organization overseeing the functioning of mutual fund activities), venture capital, foreign institutional investors and the corporate bond market.

The currency future market is regulated by both SEBI and RBI. SEBI oversees the functioning of the stock exchanges that permit trading in equity products and currency futures. It may be noted that while the Government Securities markets and money markets are governed by RBI, the Corporate Bond markets is regulated by SEBI. The Insurance Regulatory and Development Authority has complete jurisdiction over the functioning of the insurance companies – both life insurance companies and non-life insurance companies.

The RBI, State Government and State Industrial Development Bank of India (SIDBI) jointly regulate the functioning of the Urban Cooperative Banks, State and District level Cooperative Banks, State Financial Corporation (SFC) and the State Industrial Development Corporation (SIDC). NABARD, which has been formed with specific focus on rural development and agricultural financing, oversees the functioning of Rural Cooperative Banks and Regional Rural Banks (RRB).

The Indian Securities Market is also regulated by Government agencies such as Department of Economic Affairs (DEA) and Department of Company Affairs (DCA). The activities of these entities are coordinated with the functioning of SEBI and RBI, by a high level committee on capital and financial markets.

All stock exchanges are managed by a governing body that consist of elected broker-directors (except National Stock Exchange and Over-the-Counter-Exchange-of-India), public representatives and Government / SEBI nominees. The number of stock broker members has now been reduced to 40%. For regulation and control of transactions, each stock exchange has its own bye-laws and regulations which are almost uniform across all exchanges.

Until end of 1980s, stock exchanges were working as self-regulatory organizations supervised by the Minister of Finance under SCRA. This was until SEBI was established, which became the regulatory of all stock exchanges in India.

Stock exchange regulations focus on several important activities, including;

• 1. Market Operations: Risk Management, Trading and Surveillance, Clearing and Settlement (through exchange clearing departments of clearing corporations).
  2. Enrolment of members – brokers and their authorizes assistants.
  3. Enlistment of securities of companies.
  4. Imposition of margins, limits is also the function of the stock exchange. Client registrations and exposures are also tracked. To prevent any disruption in trading activity, circuit breakers – with floor and ceiling prices – are put in place by the exchange, as part of risk management.
  5. Disciplining in case of malpractices – constitutes measures such as giving warning, reprimand, censure, fine, or withdrawal of all or any membership rights. In the case of errant listed companies, the stock exchanges are empowered to suspend dealings in securities and delist securities.

Some of the major committees that have recommended reforms in the organization of stock exchanges in India are G S Patel Committee (1985), L C Gupta Committee (1991), Pherwani Committee (1991), G S Patel Committee (1995) and Varma Committee (1997).

Stock exchanges create a wealth effect for the economy. As companies continue to generate profit, reserves and surplus of the company increases. This in turn increases the confidence of the shareholders and results in increase in the share price, due to expected future earnings. This in turn increases the market capitalization of the firm.

 

Reserve Bank Of India (RBI)

The Reserve Bank of India (RBI) was established enacting the Reserve Bank of India Act in 1934. RBI commenced functioning on 1st April 1935 and is headquartered in Mumbai. Upon inception, RBI was a private entity. Subsequently, Government of India nationalized in 1949.

The major objectives of RBI are as follows:

• • Secure and monetary stability of India.
  • Operate currency and credit system to the advantage of India.

Thus, price stability, ensuring adequate availability of credit to finance economic activities for the benefit of the country are the major objectives of RBI.

Structure of RBI

RBI is managed by a central board of directors and four local board of directors. The central board is appointed/nominated by the central government for a period of four years. It consists of official directors and non-official directors.

The RBI Governor and not more than four Deputy Governors can be full time official directors. Non-official directors are 15 in number. Ten directors are come various fields and one government official are nominated by the Government of India. Four directors from from local local boards are nominated as non-official directors.

The functions of the central board is to advise the central board on local matters, to represent territorial and economic interns of local cooperative and indigenous bank’s interests and to perform such other functions as delegated by the Central Board, periodically.

RBI has 22 regional offices in major state capitals. RBI also has six facilities for providing training to bank employees.

Legal Framework

RBI functions under the framework of the following legislations:

• • The Reserve Bank of India Act, 1934 – this governs the functions of RBI.
  • The Banking Regulation Act, 1949 – this governs the financial sector.

Both are prior mentioned Acts provide wide-ranging powers to RBI. The following acts govern specific functions of RBI:

• • Public Debt Act of 1944 and is replaced by the Government Securities Act, 2006.
  • Securities Contract regulation Act, 1956.
  • Indian Coinage Act, 1906.
  • FERA, 1973 is replaced by FEMA, 1999.

The act that govern banking operations are as follows:

• • Companies Act, 1956.
  • Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980, is associated with nationalization of banks.
  • Banker’s Book Evidence Act.
  • Banking Secrecy Act.
  • Negotiable Instruments Act, 1881.

The acts governing individual institutions are as follows:

• • State Bank of India Act, 1954.
  • The Industrial development Bank of India Act.
  • Industrial Finance Cooperation of India Act.
  • National Bank for Agricultural and Rural Development Act.
  • National Housing Bank Act.
  • Deposit Insurance and Credit Guarantee Corporation Act.

Functions of RBI

RBI was originally constituted to regulate the issue of bank notes and to keep reserves to secure monetary stability and operate currency and credit system of the country. The major functions of RBI are as follows:

• • To maintain monetary stability, facilitating growth and development of Indian economy.
  • Maintain financial stability.
  • Regulate financial institutions.
  • Build confidence among the public, in the Indian economic strength.
  • Promote development of financial infrastructure.
  • Ensure credit allocation by the financial system broadly reflects the national economic priorities and societal concerns.
  • To regulate the overall volume of money and credit in the economy.

Role of RBI

RBI is the lender of last report. Following are the roles and responsibilities of RBI:

• • RBI is the note issuing authority and the only authorized issuer of currency notes. One-Rupee coins and other coins of smaller denominations are issued by the central Government. But RBI has the responsibility of circulating the coins, apart from issuing currency notes.
  • RBI is also the Government’s banker – both for central and state government. RBI is not eligible to receive any interest for the activities conducted on behalf of the Government. RBI performs all banking activities on behalf of the Government – including acceptance of deposits, withdrawal of funds by cheques, making/receiving payment, transfer of funds, management of public debt, etc. RBI also provides safe custody facilities, manages special funds such as the Calamity Relief Funds, Consolidated Sinking Funds, etc. RBI also issues and manages RBI relief bonds. It also administers disbursal of pension for Government employee. The management of public debt is facilitated by special mechanism such as Ways and Means Advances (WAMA).
  • RBI also functions as a Banker’s Bank, by stipulating the Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) which banks need to maintain.
  • RBI also has powers to regulate the functioning of the Non-Banking Financial Companies (NBFC).
  • RBI also oversees the functioning of the currency markets is the Exchange Control Authority. This is done under the FEMA.
  • RBI has the important function of regulating the money supply in the country and credit availability. This is done through a series of techniques / tools / instruments of monetary controls, as follows:

Open Market Operations (OMC): Sale and Purchase of Central and State Government Securities, Treasury Bills, etc.

Bank Rate (B/R): This is the standard rate at which RBI buys / rediscounts bills of exchange or other eligible securities, such as commercial papers.

Refinance: This facility is executed through the “export credit refinance” and “general refinance”. It facilitates directional flow of credit for selective sectors, as well as relieve temporary liquidity shortage faced by banks.

Cash Reserve Ratio (CRR): Cash which banks have to maintain with RBI, as a percentage of their demand and time liabilities. This is a primary reserve requirement specified by RBI to banks.

Statutory Liquidity Ratio (SLR): This is the secondary and supplementary reserve requirements on the banking system. SLR aims at restricting expansion of bank credit, encourage bank’s investment in Government Securities and ensure solvency of banks.

Liquidity Adjustment Facility (LAF): In order to transform RBI’s intervention from direct method (such as sector specific refinance facilities and collateralized lending facilities) to more indirect methods of general refinancing, RBI commenced using repo and reserve repo rate effectively, to implement monetary control. This was based on recommendations if the Narasimha Committee II (1998).

It may be noted that the LAF operations combined with OMO and B/R changes have become the manor technique (operating procedure) for controlling the monetary policy in India, by RBI.

 

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