Introduction to the Indian Financial Markets

1The Indian economy and financial markets

India has moved from agriculture towards services and manufacturing, which contribute about three-quarters of GDP. Growth needs a robust financial system: banks provide credit and savings channels; securities markets let businesses raise equity and debt; forex markets affect import costs, enable global investment and help manage currency risk; commodity markets manage price volatility; insurance protects against shocks.

Financial markets channel surplus funds from lenders or investors to borrowers or businesses, through intermediaries such as banks, mutual funds and insurers. They aggregate funds, provide liquidity and disseminate information. Two broad parts:

• money markets: short-term borrowing and lending;
• capital markets: long-term funding through debt and equity.

Transactions occur in primary markets (new issues) or secondary markets (trading among investors). Commodity, forex, insurance and pension markets also matter for stability and risk management.

Remember

• Money market = short term; capital market = long term.

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2Who regulates what

Regulation exists to protect investors and help them make informed decisions.

• RBI: banks (and the monetary system).
• SEBI: securities and commodity markets.
• IRDAI: insurance.
• PFRDA: pensions.

The Central Government has some oversight of all. The Financial Stability and Development Council (FSDC) is a government body that monitors financial stability, financial sector development and financial inclusion.

Remember

• FSDC: stability, development and inclusion.

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3Ministry of Finance, MCA and the ROC

The Ministry of Finance oversees banking, insurance and pensions through the Department of Financial Services, and capital markets through the Department of Economic Affairs; it drives reforms and implementation of law. Its five departments:

• Economic Affairs: nodal agency for macroeconomic policy (monetary and fiscal) and the capital market, including exchanges.
• Expenditure: financial rules, central employees' service conditions, assistance and borrowing by states.
• Revenue: direct and indirect taxes through the CBDT and the Central Board of Excise and Customs (now CBIC).
• Financial Services: public sector banks, term-lending institutions, life and general insurance, pension reform.
• Investment and Public Asset Management (DIPAM): disinvestment of central government equity in CPSUs and use of proceeds.

The Ministry of Corporate Affairs administers the Companies Acts (2013 and 1956), the LLP Act, 2008 and allied laws, and the Competition Act, 2002 (to prevent anti-competitive practices and protect consumers, through the Competition Commission). It supervises ICAI, ICSI and the Institute of Cost Accountants.

The Registrar of Companies (RoC) registers companies and checks their compliance with the Companies Act.

Remember

• Capital markets policy: Department of Economic Affairs.
• Competition Act: administered by the MCA.

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4Reserve Bank of India

The RBI's preamble: to regulate the issue of bank notes and keep reserves for monetary stability, operate the currency and credit system, and have a modern monetary policy framework to maintain price stability while keeping growth in mind. Its roles:

• formulates, implements and monitors monetary policy;
• regulator and supervisor of the financial system;
• manager of foreign exchange;
• issuer of currency;
• regulator and supervisor of payment and settlement systems;
• banker to the government (central and states), including merchant banking functions;
• banker to banks (accounts of all scheduled banks).

Remember

• RBI objective: price stability with an eye on growth.

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5SEBI, IRDAI, PFRDA and SROs

SEBI is a statutory body under the SEBI Act, 1992 and the primary securities regulator, "to protect the interests of investors in securities and to promote the development of, and to regulate the securities market". It regulates exchanges; registers and regulates intermediaries (brokers, authorised persons, transfer agents, bankers to an issue and others); prohibits fraudulent and unfair practices and insider trading; can call for information, inspect, inquire, audit and summon witnesses; and promotes investor education and intermediary training.

IRDAI (IRDA Act, 1999) licenses insurers and sets their capital and net worth; registers insurers and clears products; licenses intermediaries and sets their training and commissions; sets rules on sum assured, surrender value, claims, nomination, assignment and insurable interest; supervises the Tariff Advisory Committee; and sets investment norms for insurers.

PFRDA (PFRDA Act, 2013) regulates the National Pension System (NPS), a defined contribution scheme with a choice of investment options and fund managers, and other pension schemes not covered by other laws. It approves schemes and investment guidelines, registers intermediaries (fund managers, custodians, the central record-keeping agency, trustee bank), protects subscribers (mandate compliance, reasonable costs, grievance redressal) and educates the public on retirement saving.

A self-regulatory organisation (SRO), under the SEBI (SRO) Regulations, 2004, is an organisation of intermediaries representing a market segment and recognised by SEBI, excluding stock exchanges. It must meet norms on board competence, infrastructure and capital, follow SEBI's directions and act in investors' interest; SEBI nominates directors to its board. It can inspect and audit members and must report violations to SEBI.

Remember

• An SRO is recognised by SEBI; stock exchanges are not SROs under these rules.

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6Banks, NBFCs, HFCs and P2P platforms

The banking system is at the core: it collects savings and lends them for productive use. The RBI supervises through the Board for Financial Supervision (BFS), covering scheduled commercial and co-operative banks, all-India financial institutions, local area banks, small finance banks, payments banks, credit information companies, NBFCs and primary dealers.

Banks take deposits, lend after credit evaluation, and run payment systems (cheques, electronic payments). They also distribute third-party products (mutual funds, PMS, insurance). Types:

• scheduled commercial banks: public sector, private sector, foreign and regional rural banks; non-scheduled banks include local area banks;
• co-operative banks: urban co-operative banks and state and district co-operative banks for rural needs;
• payments banks: for financial inclusion; accept current and savings deposits up to a limit (₹1 lakh in the workbook; the RBI has since raised it to ₹2 lakh), issue ATM and debit cards but not credit cards, offer payments and remittances, and cannot lend;
• small finance banks: savings and credit for small businesses, marginal farmers, micro and small industries and the unorganised sector.

NBFCs lend, lease, do hire purchase, insurance or chit business. Unlike banks, they cannot accept demand deposits, cannot issue cheques and have no DICGC deposit insurance; they serve borrowers banks find too risky or hard to reach.

Housing finance companies lend mainly for property purchase; their regulation has moved from the National Housing Bank to the RBI.

P2P lending platforms let individuals lend to individuals, unsecured; they are regulated by the RBI and must do due diligence on participants.

Remember

• Payments banks cannot lend or issue credit cards.
• NBFCs: no demand deposits, no cheques, no deposit insurance.

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7Money, forex, credit information and account aggregators

Money market: instruments under one year: call money (overnight) and notice money (up to 14 days), commercial paper, certificates of deposit, commercial bills and T-bills. Call/notice money and T-bills are the biggest segments; banks, FIs and primary dealers are the main players. It is very liquid, a wholesale market, with heavy RBI intervention to meet policy goals.

Forex market: a currency pair such as USD/INR has a base currency (first) and a quoting currency (second). India has spot and forward markets and exchange-traded currency derivatives. The spot market has an interbank segment (banks make two-way quotes) and a merchant segment (customers are price takers). Financial Benchmarks India Ltd (FBIL) publishes daily reference rates for USD, EUR, GBP and JPY against the rupee on Mumbai business days.

Credit information companies (CICs): TransUnion CIBIL, Experian, Equifax and CRIF High Mark, with banks, FIs, NBFCs, HFCs, state financial corporations and card companies as credit institutions, under the CIC (Regulation) Act, 2005, CIC Rules and Regulations 2006. Credit information reports go to specified users (credit institutions, telecom companies, regulators, insurers, brokers, rating agencies, resolution professionals and others). The RBI requires a Free Full Credit Report, including the score, once every calendar year to individuals.

Account aggregators (AAs): RBI-licensed entities that gather a customer's financial information and share it with third parties only with the customer's express consent, which can be revoked at any time. They make digital lending easier and reduce paperwork.

Remember

• Call money: overnight; notice money: up to 14 days.
• AAs share data only with consent.

8Securities, exchanges, clearing and depositories

Securities are defined in Section 2(h) of the SCRA, 1956: shares, bonds, debentures and similar marketable securities; derivatives; units of collective investment schemes and mutual funds (not ULIPs); security receipts; securitised debt certificates; government securities; instruments the government declares (onshore rupee bonds of ADB and IFC, electronic gold receipts, zero coupon zero principal instruments); and rights or interests in securities. (Derivatives include commodity derivatives, per the Finance Act 2017 amendment.)

The primary market raises capital; the secondary market provides liquidity and price discovery. Exchanges such as NSE and BSE offer anonymous electronic order matching.

• Clearing corporations confirm, settle and deliver trades and run risk management so one party's default does not threaten the system.
• Depositories (NSDL and CDSL) hold securities electronically: equities, warrants, preference shares, MF units, bonds, money market instruments, G-secs, securitised instruments and postal schemes. A security must be dematerialised to trade in the secondary market; issuers admit their securities by agreement and fee.
• Depository participants (DPs) (brokers, banks) open investor demat accounts and act as agents of the depositories.
• Custodians (usually large banks) hold securities and bank accounts for institutional investors, settle trades and collect corporate benefits.
• Stock brokers are trading members through whom all exchange trades must go; many also offer research and screen or phone trading, for a commission.

Remember

• DPs are agents of the depositories.

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9Other market segments and intermediaries

• Bond market: where bonds, debentures and G-secs are listed and traded.
• Derivatives market: futures and options give leveraged exposure; good for hedging but risky for speculation by the unaware.
• Mutual funds: pool money from many investors and invest per the scheme mandate across equity, debt, commodities and international assets.
• Investment advisers: guide clients to goals by building suitable portfolios.
• Alternative investment funds (AIFs): privately pooled funds for sophisticated investors.
• KYC registration agencies: keep central KYC records so investors need not resubmit documents; CKYC Registry for individuals (as the workbook describes) and KRAs (such as CVL, CAMS, NDML) for KYC records.
• Credit rating agencies: rate specific issues in standard terms, especially for default risk in debt; symbols must be read in each agency's context.
• Investment banks: advise on capital raising, expansion, project finance, M&A and valuation, and arrange funding.
• Asset management companies: issue units representing a share of a pooled mutual fund portfolio.
• Portfolio managers: manage individual portfolios for clients but cannot pool money or issue securities. Both AMCs and PMS charge fees and use brokers, registrars and custodians.
• Registrars and transfer agents (RTAs): keep investor records, pay dividends, send e-voting details, process MF transactions and update investor details.

Remember

• AMCs pool money; portfolio managers do not.

10Insurance and pension markets

Insurance (regulated by IRDAI) has life and general segments; life insurance opened to private companies in 2001 (as the workbook states).

• Traditional life products: term insurance (pure protection, no maturity benefit), endowment and whole life (small savings element with maturity benefits).
• Variable and unit-linked products combine cover and investment, with part of the premium invested for market-linked returns.
• Distribution: agents, bancassurance, direct, brokers and corporate agents.
• General insurance: motor, health, travel, fire, personal accident and more.
• Other players: brokers (can sell any insurer's policies, paid brokerage by the insurer); individual agents (licensed by IRDAI; typically one life, one general and one standalone health insurer); corporate agents such as banks; surveyors and loss assessors (general insurance claims); third-party administrators (health claims).

Pensions (regulated by PFRDA): demand is driven by a growing elderly population and a large unorganised workforce outside formal retirement cover. Government pensions moved from defined benefit (same pension by rank, no employee contribution) to defined contribution (employee and employer contribute; pension depends on the corpus). Private sector retirement is mainly via the EPF (run by EPFO), with part of the employer's contribution going to the Employees' Pension Scheme; some firms offer superannuation plans. The NPS is a voluntary, defined contribution scheme for government employees and the public, with several fund managers and investment choices.

Remember

• Term insurance: pure protection, no maturity benefit.
• Government pensions: defined benefit → defined contribution.

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