Indian financial system

Indian Financial System, Institutions & Markets

Ramesh SubramanianM.com., C.A.I.I.B.,F.C.S.,LL.M.,ACMA

September 24 , 2012

Presentation Plan

DefinitionFeaturesFrameworkConstituentsHigh Level Committee of RegulatorsFinancial Sector ReformsFinancial InclusionActs -Overview National Payments Corporation of India

Financial System • System (from Latin systēma, in turn from Greek ''''

systēma) is a set of interacting or interdependent entities forming an integrated whole.

• A system that aims at establishing and providing a regular, smooth, efficient and cost effective linkage between depositors and investors is known as Financial System.

• A set of complex and closely connected instructions/institutions agents, practices, markets, transactions, claims and liabilities relating to financial aspects of an economy may be referred to as a financial system.

• Activities related to finance and organised into a system may be called financial system.

• A well-developed financial system enables transfer of resources from depositors/savers to borrowers/investors/entrepreneurs and plays a crucial role in the functioning of the economy.

Features

• Provides a linkage between depositors and users/investors (encourages savings and investments)

• Expansion of financial markets• Efficient allocation of financial

resources• Enables deployment of funds for

socially desirable and economically productive purposes

• Aids rapid economic development

Framework

• The legal framework for Bank supervision is provided under the Banking Regulation Act, 1949, RBI Act, 1934, FEMA, 1999.

• Institutional framework RBI has the following important departments for the same:– Department of Banking Operations &

Development– Department of Banking Supervision– Department of Non Banking Supervision– Foreign Exchange Department

Constituents

• Financial Institutions• Financial Services• Financial Markets• Financial Instruments

Financial Institutions

• Institutions that provide Financial Asset and Liability products

• Loans & Advances• Savings products• Regulated by RBI, SEBI, IRDA• Banking and Non-Banking (NBFCs)• Specialised Institutions – NABARD,

EXIM Bank, SIDBI,LIC, GIC etc.

Financial Institutions

• Difference between Banks and NBFCs: • Banks can accept Demand deposits but

NBFCs cannot. They can only accept Time deposits.

• An NBFC is not a part of the payment and settlement system and cannot issue cheques drawn on itself.

• Deposit insurance facility of DICGC is not available for NBFC depositors unlike in case of banks

Financial Services• Services that help in borrowing/lending,

investing, buying, selling securities, enabling payment and settlements,

• Comprises services provided by FIs.• Enable raising of funds and efficient

distribution of financial products• Examples- underwriting, stock-broking, Hire

purchase, leasing, factoring, credit rating, depositories, etc.

• Various services provided by banks – collection of bills/cheques, BGs, LCs, locker facilities etc.

Financial Markets

• FM – facilitate buying and selling of financial claims, securities etc

• Enables transfer of funds from surplus to deficit units.

• Consists of merchant bankers, dealers, lenders, borrowers, investors, agents, etc.

• Organised and Unorganised• Unorganised – no adequate regulation, non-

standardised in character, no proper settlement mechanism etc.

• Organised - Act, Rules, Regulations,• Organised - High degree of

institutionalisation & instrumentalisation

Financial Markets

• FMs- significant role in resource management

• Act as a bridge between savers and spenders through various instruments like equity or debt or a combination

• Facilitates price discovery• Provides liquidity

Financial Markets

• Money Market & Capital Market• MM – Short Term claims or financial

assets for a period of ONE DAY to one less than ONE YEAR

• MM – mostly dominated by Banks, Financial Institutions.

• MM – MM is a whole sale debt market for low risk, highly liquid, short-term instruments

Financial Markets• Capital Market – Designed to finance Long

Term investments above one year.• CM – a place where people buy and sell

financial instruments in equity or debt.• CM- a mechanism to facilitate the exchange

of financial assets.• Primary Market – both corporate and

Government raise funds by issuing securities. • Secondary Market – through continuous

trading activities provides liquidity in the system and reflects the changing perception of the investors. Barometer of economy.

Financial Markets

• Forex market – deals with multicurrency requirements which are met by exchange of currencies. Most developed and integrated market.

• Credit Market – Banks, FIs, NBFCs- provide short, medium, and long-term loans to corporate and individuals.

Financial Instruments

• FIs – financial assets and securities dealt with in a financial market.

• Debt – Government bonds, corporate bonds

• Capital – Equity, Preference• Classification – Money Market

Instruments and Capital Market Instruments

• ST in nature – are near substitutes for money.• Call/Notice Money : Call one day, Notice >1 day

< 14 days• No collateral security is required.• Term Money : Inter-bank deposits for maturity

beyond 14 days is referred to as term money.• Treasury Bills – T-Bills are borrowing instruments

of the Central Government – issued for ST. Issued at a discount to Face Value.

• Certificate of Deposits – Is negotiable instrument issued by Banks and FIs. Governed by RBI guidelines.

• Commercial Paper – CP is an unsecured Promissory Note privately placed issued by corporates. It is negotiable.

Money Market Instruments

Elements of Markets

–Investors–Issuers–Intermediaries–Regulators

Financial Regulation

• The formal financial system comes under the purview of the Ministry of Finance.

• Regulation of Banks and Finance Companies - Delegated to Reserve Bank of India. (Banking Regulation Act, and RBI Act)

• Capital Markets are regulated by Securities and Exchange Board of India (SEBI)

• Insurance Sector – regulated by Insurance Regulatory & Development Authority (IRDA)

Overview of the Acts regulating the Financial Sector

• Banking Regulation Act, 1949• Reserve Bank of India Act, 1934• Negotiable Instruments Act,1881 • Securities and Exchange Board of India Act,

1992• Insurance Regulatory and Development Act,

1999• Payment and Settlements System Act,2007• Foreign Exchange Management Act, 1999 • Companies Act, 1956

Banking Regulation Act, 1949

Banking Regulation Act, 1949 - Objective

• The provisions of law relating to banking formed part of the Indian Companies Act, 1913.

• Objective of the Company Law is to safeguard the interests of the stock-holder while that of Banking Regulation would be to protect the interests of the Depositor.

• Branch Expansion and rapid strides in banking.

• Need was felt to have a separate legislation for Banks.

Banking Regulation Act, 1949 - Features

• A comprehensive definition of the word BANKING so as to bring within the scope of the legislation all institutions which receive deposits, repayable on demand or otherwise, for lending or investment.

• Prohibiting non-banking companies from accepting deposits repayable on demand.

• Prohibition of trading with a view to eliminating non-banking risk.

• Prescription of minimum capital standards.

• Limiting the payment of Dividends.• Introduction of a comprehensive system

of licensing of banks and their branches.

Banking Regulation Act, 1949 – Important definitions/provisions

• Section 5 (b) banking means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise.

Banking Regulation Act, 1949 Important definitions/provisions

• Reserve Bank of India is the Regulator• Section 6- Forms of business a bank may undertake

(a) to (n) • Section 7 – use of words Bank, Banker Banking or

Banking Company• Section 8 – Prohibition of TRADING- No banking

company shall directly or indirectly deal in the buying or selling or bartering of goods, except in connection with the realisation of security given.

• Section 9 –No banking company shall hold any immovable property except such as is required for its own use for any period exceeding SEVEN years from the acquisition. RBI has powers to extend the period by a maximum of 5 years in depositors interest

• Section 11 – minimum paid up capital

Banking Regulation Act, Important

Provisions • Section 10-A (2) not less than 51 percent of the

total number of members of the BoD shall consist of persons who shall have special knowledge or practical experience in respect of one or more of – accountancy, agriculture and rural economy, banking, co-operation, economics, finance, law, SSI others sectors which RBI may prescribe.

• Section 10 (2-A) no Director, Other than its Chairman or whole-time Director shall hold office continuously for a period exceeding EIGHT years.

• Voting Rights – Section 12 – No person holding shares in a banking company shall in respect of any shares held by him, exercise voting rights on poll in excess of TEN percent of the total voting rights of all the shareholders of the banking company.

Banking Regulation Act, 1949

• Section 22-licensing of banking companies• Discussion paper on Bank Licensing • Section 24 – Statutory Liquidity Ratio.

Present SLR 23%• Section 35 – Inspection of Banks• 35 A – Power to issue Directions in public

interest to secure proper management of the Bank

• Section 45 – power to apply to CG for suspension of banking business

• Section 45 (2) – CG to order moratorium on the recommendations of the RBI

Discussion Paper on New Bank Licences

• As of March 31, 2009, the Indian banking system comprised – 27 public sector banks,

- 7 new private sector banks, -15 old private sector banks, - 31 foreign banks, -86 Regional Rural Banks (RRBs), -4 Local Area Banks (LABs), -1,721 urban cooperative banks, - 31 state co-operative banks and - 371 district central co-operative banks.

- The average population coverage by a commercial bank branch in urban areas improved from 12,300 as on June 30, 2005 to 9,400 as on June 30, 2010 and -in rural and semi urban areas from 17,200 as on June 30, 2005 to 15,900 as on June 30, 2010.


– Though the Indian financial system has made impressive strides in resource mobilization, geographical and functional reach, financial viability, profitability and competitiveness, vast segments of the population, especially the underprivileged sections of the society, have still no access to formal banking services.

– The Reserve Bank is therefore considering providing licences to a limited number of new banks. A larger number of banks would foster greater competition, and thereby reduce costs, and improve the quality of service. More importantly, it would promote financial inclusion, and ultimately support inclusive economic growth, which is a key focus of public policy.


• The initial minimum paid up capital was prescribed at Rs. 200 crore to be raised to Rs.300 crore within three years of commencement of business.

• Reserve Bank’s experience• 10 new banks were set up in the private sector after

the 1993 guidelines and 2 new banks after the 2001 revised guidelines. Out of these, four were promoted by financial institutions, one each by conversion of co-operative bank and NBFC into commercial banks, and the remaining six by individual banking professionals and an established media house.

Reserve Bank Experience– Out of the four banks promoted by individuals in 1993,

only one has survived with muted growth. One bank has been compulsorily merged with a nationalized bank due to erosion of networth on account of large capital market exposure. The other two banks have voluntarily amalgamated with other private sector banks over a period of 10 to 13 years due to the decisions of the majority shareholders arising out of poor governance and lack of financial strength.

– Out of the remaining six banks that were licensed in 1993, one bank promoted by a media group has voluntarily amalgamated itself with another private sector bank within five years of operations and four banks promoted by financial institutions have either merged with the parent or rebranded and achieved growth over a period of time. The bank that was converted from a Cooperative bank has taken some time in aligning itself to the commercial banking and is endeavoring to stabilize itself.

Reserve Bank Experience• The experience of the Reserve Bank over these 17

years has been that banks promoted by individuals, though banking professionals, either failed or merged with other banks or had muted growth.

• Only those banks that had adequate experience in broad financial sector, financial resources, trustworthy people, strong and competent managerial support could withstand the rigorous demands of promoting and managing a bank.

Reserve Bank of India Act, 1934

Reserve Bank of India Act, 1934• Preamble – Whereas it is expedient to constitute a

Reserve Bank for India to regulate the issue of Bank Notes and the keeping of reserves with a view to securing the monetary stability in India and generally to operate the currency and credit system of the country to its advantage.

RBI Act- Important Provisions

–Business which the Bank may transact section 17-• Accepting money on deposit from CG,

SG.• Export credit refinance• Loans and advances to SCBs, State Coop

Bannks• Loans and advances to Fis like IDBI, IFCI,

NABARD etc• Advances to CG, SG• Management of public debt• Issue of bank notes

RBI Act- Provisions

Section 19 - Business which the Bank may not Transact-

• Engage in trade or have direct interest in any commercial, industrial undertaking.

• Purchase the shares of any banking company• Become owner of immovable property except

as required for its own use and officers and staff

• Make loans or advances• Draw or accept bills otherwise than on

demand• Allow interest on deposits or current amounts

RBI Act, Important Provisions• Section 20 – obligation of the Bank to

transact CG business. (shall)• Section 21 – CG shall entrust to the Bank

its business (shall)• Section 21 A – Bank MAY by agreement

with SG undertake its business.• Section 22 – Right to Issue Bank Notes –

Sole Right-Monopoly.• Section 24 – Denomination of bank notes –

2, 5, 10, 20, 50, 100, 500, 1000, 5000, 10000, and such other denomination not exceeding 10000 as the CG may on the recommendation of the Central Board specify in this behalf.

RBI Act, Provisions– Section 42 Cash Reserve Ratio. Present CRR 4.75%– Section 45 – appointment of agents – SBI, PSBs,

NABARD – Chapter III B 1997.- NBFCs brought under RBI

purview.– Section 45 IA Registration of NBFCs– Section 49 – Publication of Bank Rate- the Bank

shall make public from time to time the standard rate at which it is prepared to buy or re-discount bills of exchange or other commercial paper eligible for purchase under the Act. Present BR 6.00%

– Returns – within two months of closing of annual accounts the Bank shall transmit to the CG a copy of the annual accounts.

RBI Act, Provisions • Section 47 – allocation of surplus profits –

after making necessary provisions, depreciation of assets etc. the balance of profits shall be paid to the CG.

• Scheduled Banks in India constitute those banks which have been included in the Second Schedule of Reserve Bank of India(RBI) Act, 1934. RBI in turn includes only those banks in this schedule which satisfy the criteria laid down vide section 42 (6) (a) of the Act.

RBI Act - Provisions

The banks included in this schedule list should fulfil two conditions -

1. The paid capital and collected funds of bank should not be less than Rs. 5 lac. 2.Any activity of the bank will not adversely affect the interests of depositors.

Every Scheduled bank enjoys the following facilities.

1. Such bank becomes eligible for debts/loans on bank rate from the RBI.2. Such bank automatically acquire the membership of clearing house.

Repo & Reverse Repo• Repo is the mechanism by which RBI adds

liquidity to the banking system. Any bank can park its Government securities with the RBI and meet its liquidity requirement with an agreement to buy the security back from RBI after a specified number of days. (Present Rate -8%)

• Under the reverse repo the banking system parks its excess liquidity with the RBI and in turn purchases the Government security of equivalent amount with an underlying agreement to reverse the transaction at a later date. The mechanism helps in absorption of excess liquidity from the system. (Present Rate –7 %)

Repo & Reverse Repo• Repo rate is the rate at which RBI lends its

short term funds or the process of injecting funds into the system. Reverse repo is the rate at which the RBI borrows short term funds from commercial banks or the process of sucking off of funds from the system.

• The impact of increase in the repo rate will make loans costlier as the reverse repo rate represents the benchmark interest rate. Repo rate also serves as the bench mark rate for the short/medium term, while the Bank Rate is an indicator of the long rate rates.

Inspection of Banks & NBFCs• Section 35 of Banking Regulation Act• Department of Banking Operations &

Development (DBOD) is the Regulatory Deptt.

• Department of Banking Supervision carries out the inspection

• Chapter III B of RBI Act, 1934 deals with NBFC regulation

• Inspection of NBFCs u/s 45N of RBI Act• Section 45 IA of RBI Act requires CoR for

NBFCs

Inspection of Banks• Onsite Inspection –

– CAMELS pattern of Inspection• Capital• Asset Quality• Management• Earnings• Liquidity• Systems & Controls

-Risk Based Supervision

Off site Monitoring and Surveillance System (OSMOS)

Inspection of Banks - INROADS• The Reserve Bank of India (RBI) has

decided to change the way it monitors and supervises banks in order to make the process more forward-looking.

• The move comes against the backdrop of the risks that have emerged after the global financial crisis of 2008, with lenders shifting from offering traditional products to more complex ones.

Inspection of Banks - INROADS• The country’s financial sector would now be

evaluated under a dynamic risk-based mechanism, an aspect the present CAMELS rating system lacked, central banking sources said. RBI proposes to replace CAMELS with INROADS (Indian Risk-Oriented and Dynamic Rating System) from the next round of annual financial inspection, in 2013.

• At present, the central bank uses the CAMELS (Capital adequacy, Asset quality, Management, earnings, Liquidity, and Systems and control) method, to assign ratings to Indian banks. CAMELS, which goes from A+ to D is assigned to a bank while finalising the annual financial inspection (AFI) report.

Inspection of Banks - INROADS• RBI has argued that the present form of rating

captures only a few risk elements and represents a bank’s past-year performance. Besides, RBI is of the view, the present rating does not capture the risks that could cause a bank to fail.

• Some of the broader risks, such as credit risk, operational risk, and strategic and business group risk, increase the probability of a bank’s failure.

• The process of annual financial inspection has been expedited and it is now proposed that banks should address the areas of concern mentioned in AFI during a particular year. In a given year, AFI is undertaken for the previous year, and significant delays were noticed last year.

Inspection of Banks - INROADS• The banking regulator is also entering into

mutual regulatory cooperation agreements with regulators of other countries to extract information about Indian banks operating overseas and vice versa.

• RBI has already signed an agreement with 14-15 countries and is in talks with the US – a country where a majority of Indian banks have presence.

• Since the US had three federal banking supervisors, the process might take some time.

Inspection of Banks - INROADS• The central bank is also planning to

create a single-point contact for each bank in order to plug the regulatory lacuna.

• It is quite often the case that information about a bank with one department of RBI is not known to other departments.

• So, a single-point contact will be created for each banks.

Board for Financial Supervision

• Constituted on November 16, 1994• Chaired by the Governor, RBI• Consist of Four Directors of the Central

Board and DGs of RBI• Department of Banking Supervision is the

Secretariat• Supervises the commercial banks, FIs and

NBFCs• Provides recommendations for effective

supervision and monitoring

High Level Committee on Financial Markets• HLCC consists of top officials of Indian

banking, capital markets, insurance and pension regulators besides representatives from the ministry of finance.

• The government is in favour of creating a formal structure, even enacting a law to enable and strengthen coordination between various financial sector regulators and plug the gaps in the current regulatory framework.

• The Indian banking regulator seems to be not comfortable with the idea. Reserve Bank of India governor D. Subbarao had said the issue had to be debated.

Financial Stability and Development Council• The then Finance Minister Pranab Mukherjee

said that the proposed high-level Financial Stability and Development Council (FSDC) would be established soon but would not dilute the autonomy of individual regulators.

• To strengthen and institutionalize the mechanism for maintaining financial stability.

• All regulatory heads would be members.• Governor RBI would be the VC• Would be Chaired by the Finance Minister.

Financial Stability and Development Council• First meeting held on January 1, 2011.• Mukherjee in his Budget speech had proposed to set up

the FSDC to deal with financial stability, financial sector development, inter-regulatory coordination, financial literacy, financial inclusion and macro-prudential supervision of the economy, including the functioning of large financial conglomerates.

• Council would be in the Department of Economic Affairs, Ministry of Finance.

• It is also expected to coordinate the country's international interface with financial sector bodies such as the Financial Action Task Force (FATF) and Financial Stability Board (FSB).

•

Financial Inclusion

• Financial inclusion is not merely providing reliable access to an efficient payments system.

• Financial inclusion is also not just micro finance

• Financial inclusion represents reliable access to affordable savings, loans, remittances and insurance services.

• Financial inclusion primarily implies access to a bank account backed by deposit insurance, access to affordable credit and the payments system.

Financial Inclusion• First, the lead bank in each district has been asked

to draw a roadmap by the end of March 2010, for ensuring that all villages with a population of over 2,000 will have access to financial services through a banking outlet, not necessarily a bank branch, by March 2012.

• Banks will have to harness technology and innovate low cost business models to accomplish this.

• Second, all domestic public and private sector commercial banks have agreed to come up with their specific, Board approved Financial Inclusion Plans (FIPs) by March 2010 to be rolled out over the next three years. These Plans will have both qualitative indicators and quantitative milestones.

• Third, we have urged all banks to include criteria regarding financial literacy and financial inclusion in the performance evaluation of their field staff.

Financial Inclusion –Regulatory initiatives

• Banking Correspondents• Branch Licensing• No Frills account (since replaced by Basic SB Deposit A/c (vide

DBOD.No. Leg. BC.35/09.07.005/2012-13 dated August 10, 2012)• Priority Sector Lending • KYC - In rural areas, this is addressed by asking for identification by

local officials and requiring a photograph of the account holder. Drives for financial inclusion locally have been achieved through active involvement of government in the identification process.

• In big towns and cities where there are a large number of migrants who do not have any documents, fulfilling KYC norms and opening a bank account continue to be a challenge. As a proportional regulatory dispensation having regard to the degree of risk, RBI has simpler KYC norms for small value accounts where the balances in the account do not exceed about $1000 and where the annual credits in the account do not exceed about $4000.

• There are similar dispensations for walk-in clients for small remittances and payments not exceeding US$1,000.

Financial Inclusion

• Interest rates for loans up to Rs.200000 (about $4200) in the priority sector are capped at the prime lending rates of banks. RBI has taken a decision to free the interest rates, which has come into effect from July 1, 2010

• Non-banking non-financial players are encouraged to be partners and agents of banks rather than principal providers of financial services. (BC Model)

The Negotiable Instruments Act, 1881

The Negotiable Instruments Act, 1881• The Act does not define a negotiable instrument

• Section 13 merely states that a negotiable instrument means a promissory note, bill of exchange or cheque payable either to order or bearer.

• This does not indicate the characteristics of a negotiable instrument but only states that Three instruments are Negotiable.

• These three instruments are, therefore, by statute.

• This section does not prohibit any other instrument which satisfies the essential features of negotiability to be treated as negotiable instrument.

Essential Features of Negotiable Instrument• Justice K.C.Wells ‘one the property in which is

acquired by any one who takes it bona fide and for value notwithstanding any defect of title in the person from whom he took it.’

• Thomas - an instrument is negotiable when it is, by a legally recognised custom of trade or by law, transferable by delivery or by endorsement and delivery, without notice to the party liable, in such a way that a) the holder of it for the time being may sue upon ii in his own name, and b) the property in it passes to a bona fide transferee for value free from any defect in the title of the person from whom he obtained it’.

Essential features

• A negotiable Instrument –

– A transferable document either by application of law or by the custom of the trade concerned

– It confers a privilege on the person who receives it bona fide and for value

– To possess good title thereto,– Even if the transferor had no title or Had

defective title to the instrument

Essential features

Special Features of a Negotiable Instrument

• Transferable from person to person and the ownership of the property in the instrument passes by mere delivery in case of a bearer instrument

• By endorsement and delivery in case of an order instrument• Transferability is an essential feature of a negotiable instrument

BUT all transferable instruments are not Negotiable instruments.• A negotiable instrument confers absolute and good title on the

transferee, who takes it in good faith, for value and without notice of the fact that the transferor had defective title thereto. THIS IS THE MOST IMPORTANT CHARACTERISTIC OF A NI. Such a person is called the HOLDER IN DUE COURSE and his interest in the instrument is well protected by the law.

e.g a person who taken a NI from another person, who had stolen it from somebody will have absolute and undisputable title to the instrument provided he receives the same for VALUE and in GOOD FAITH without knowing that the transferor was not the true owner of the instrument.

Transferability and Negotiability• In the case of any goods or commodity, which is

transferable from one person to another the general rule of law is that the Transferor cannot transfer a title better than what he himself possesses.

E.g X purchases an article or a commodity (BOOK) from Y against payment of its full value. But Y had stolen the book from the house of Z. If Y is caught for his theft or if the stolen book is found in the possession of X the latter will have to return the same to the true owner of the article because the title of X to the property is not deemed to be better than the title possessed by Y. In fact, Y had no title thereto and hence X will also stand on the same footing.

Contd

• A NI is an exception to this general rule of law.

Suppose in the above eg X takes a cheque he will have good title thereto and will not be responsible to the true owner Z. The latter will have a right against Y the thief of the instrument. This privilege of the HOLDER of a NI in due course constitutes the main difference between a transferable instrument or article and a NI.

• A HOLDER IN DUE COUSE can sue upon the NI in his own name. Thus he can recover the amount of the NI from the party liable to pay thereon.

CONTD

• A drawer or holder of a NI may take away the essential characteristic of negotiability and thus instrument ceases to be a NI. E.g if a cheque is payable to a specified person only and NO TO HIS ORDER OR BEARER, it cannot be transferred to any other person and hence it loses its negotiability.

• Another eg.if a cheque is crossed NOT NEGOTIABLE it can be transferred BUT without conferring on the transferee absolute and good title in all cases. The transferee of such a cheque will stand at par with the transferee of any other commodity and shall not possess title better than that that of his transferor.

Section 138

• Till 1989 the Drawer of cheque was subject to civil liability only in respect of money due on a cheque, if it was dishonoured for reasons whatsoever.

• April 1, 1989 NI Act was amended.• Section 138 - Dishonour of cheques

because of insufficiency of funds was deemed as an offence for which the drawer may be punished with imprisonment for a term upto TWO years or fine up to twice the amount of the cheque or with both. Such a punishment will be in addition to a civil suit.

Conditions for punishment– The cheque has been issued in discharge of a debt or

other liability in whole or in part– Cheque given in gift will not attract punishment. – The cheque should be presented to the paying

banker within 6 months or its specific validity period, which ever is earlier.

– The dishonour of the cheque must be on account of insufficiency of funds only.

– The payee or holder in due course should give notice in writing to the drawer demanding payment, within 15 days of his receiving information of dishonour.

– The drawer can make payment within 15 days of the receipt of the notice.

– The complaint is to be made within one month of the cause of action (i.e expiry of 15 days time given to the drawer to make payment)

– No Court lower to that of Metropolitan Magistrate or Judicial Magistrate of 1st Class will try the offence.

Company’s responsibility

• If the dishonoured cheque was drawn on behalf of a company, a firm or association of individuals every person who was incharge of and was responsible to the company or the firm for the conduct of the business, at the time the offence was committed shall be deemed to be guilty of the offence. Section 141

• An offence in terms of section 138 is committed even if the cheque is returned on the ground of closure of account (G.Venkataramanaiah Vs Sillakollu Ventakeswarlu (1997 97 Comp Cas 13.)

• Even if a cheque is dishonoured because of ‘stop payment’ instruction to the bank, section 138 would get attracted (ET & TDC Vs Indian Technologists and Engineers 1996 (2) SCC 739

Payment and Settlement Act, 2007

Payment and Settlement Act, 2007

• The PSS Act, 2007 received the assent of the President on 20th December 2007 and it came into force with effect from 12th August 2008.

• The PSS Act, 2007 provides for the regulation and supervision of payment systems in India and designates the Reserve Bank of India (Reserve Bank) as the authority for that purpose and all related matters. The Reserve Bank is authorized under the Act to constitute a Committee of its Central Board known as the Board for Regulation and Supervision of Payment and Settlement Systems (BPSS), to exercise its powers and perform its functions and discharge its duties under this statute. The Act also provides the legal basis for “netting” and “settlement finality”. This is of great importance, as in India, other than the Real Time Gross Settlement (RTGS) system all other payment systems function on a net settlement basis.

• Under the PSS Act, 2007, two Regulations have been made by the Reserve Bank of India, namely, the Board for Regulation and Supervision of Payment and Settlement Systems Regulation, 2008 and the Payment and Settlement Systems Regulations, 2008. Both these Regulations came into force along with the PSS Act, 2007 on 12th August 2008.

Payment and Settlement Act, 2007• All systems (except stock exchanges and clearing

corporations set up under stock exchanges) carrying out either clearing or settlement or payment operations or all of them are regarded as payment systems. All entities operating such systems will be known as system providers. Also all entities operating money transfer systems or card payment systems or similar systems fall within the definition of a system provider. To decide whether a particular entity operates the payment system, it must perform either the clearing or settlement or payment function or all of them.

• In terms of Section 4 of the PSS Act, 2007 no person other than the Reserve Bank can operate or commence a payment system unless authorized by the Reserve Bank. Any person desirous of commencing or operating a payment system needs to apply for authorization under the PSS Act, 2007(Section 5). Any unauthorized operation of a payment system would be an offence under the PSS Act, 2007 and accordingly liable for penal action under that Act.

Payment and Settlement Act, 2007• Under the PSS Act, 2007, dishonor of an

electronic fund transfer instruction due to insufficiency of funds in the account etc., is an offence punishable with imprisonment or with fine or both, similar to the dishonor of a cheque under the Negotiable Instruments Act 1881. Subject to complying with the procedures laid down under the PSS Act, 2007, criminal prosecution of defaulter can be initiated in such cases. This provision was introduced to discourage dishonour of electronic payment instructions. (Section 25 of the Act)

Electronic Clearing Service • ECS is an electronic mode of payment / receipt

for transactions that are repetitive and periodic in nature.

• ECS is used by institutions for making bulk payment of amounts towards distribution of dividend, interest, salary, pension, etc., or for bulk collection of amounts towards telephone / electricity / water dues, cess / tax collections, loan installment repayments, periodic investments in mutual funds, insurance premium etc.

• Essentially, ECS facilitates bulk transfer of monies from one bank account to many bank accounts or vice versa.

Electronic Clearing Service

• There are two variants of ECS - ECS Credit and ECS Debit.

• ECS Credit is used by an institution for affording credit to a large number of beneficiaries (for instance, employees, investors etc.) having accounts with bank branches at various locations within the jurisdiction of a ECS Centre by raising a single debit to the bank account of the user institution.

• ECS Credit enables payment of amounts towards distribution of dividend, interest, salary, pension, etc., of the user institution.

Electronic Clearing Service • ECS Debit is used by an institution for raising

debits to a large number of accounts (for instance, consumers of utility services, borrowers, investors in mutual funds etc.) maintained with bank branches at various locations within the jurisdiction of a ECS Centre for single credit to the bank account of the user institution.

• ECS Debit is useful for payment of telephone / electricity / water bills, cess / tax collections, loan installment repayments, periodic investments in mutual funds, insurance premium etc., that are periodic or repetitive in nature and payable to the user institution by large number of customers etc.

National Electronic Funds Transfer (NEFT)• National Electronic Funds Transfer (NEFT) is a

nation-wide payment system facilitating one-to-one funds transfer.

• Under this Scheme, individuals, firms and corporates can electronically transfer funds from any bank branch to any individual, firm or corporate having an account with any other bank branch in the country participating in the Scheme.

• Individuals, firms or corporates maintaining accounts with a bank branch can receive funds through the NEFT system.

• It is, therefore, necessary for the beneficiary to have an account with the NEFT enabled destination bank branch in the country.

National Electronic Funds Transfer (NEFT)• The NEFT system takes advantage of the

core banking system in banks. Accordingly, the settlement of funds between originating and receiving banks takes places centrally at Mumbai, whereas the branches participating in NEFT can be located anywhere across the length and breadth of the country.

• Presently, NEFT operates in hourly batches - there are eleven settlements from 9 am to 7 pm on week days (Monday through Friday) and five settlements from 9 am to 1 pm on Saturdays.

National Electronic Funds Transfer (NEFT)• IFSC or Indian Financial System Code is an alpha-

numeric code that uniquely identifies a bank-branch participating in the NEFT system. This is an 11 digit code with the first 4 alpha characters representing the bank, and the last 6 characters representing the branch. The 5th character is 0 (zero).

• IFSC is used by the NEFT system to identify the originating / destination banks / branches and also to route the messages appropriately to the concerned banks / branches.

• NEFT is a credit-push system i.e., transactions can be originated only to transfer / remit funds to a beneficiary.

Real Time Gross Settlement (RTGS)

• Real Time Gross Settlement, which can be defined as the continuous (real-time) settlement of funds transfers individually on an order by order basis (without netting).

• 'Real Time' means the processing of instructions at the time they are received rather than at some later time.

• 'Gross Settlement' means the settlement of funds transfer instructions occurs individually (on an instruction by instruction basis).

• The RTGS system is primarily meant for large value transactions. The minimum amount to be remitted through RTGS is Rs. 2 lakh. There is no upper ceiling for RTGS transactions.

Real Time Gross Settlement (RTGS)

• NEFT is an electronic fund transfer system that operates on a Deferred Net Settlement (DNS) basis which settles transactions in batches.

• In DNS, the settlement takes place with all transactions received till the particular cut-off time.

• These transactions are netted (payable and receivables) in NEFT whereas in RTGS the transactions are settled individually.

• Any transaction initiated after a designated settlement time would have to wait till the next designated settlement time Contrary to this, in the RTGS transactions are processed continuously throughout the RTGS business hours.

Speed Clearing

• Speed Clearing refers to collection of outstation cheques (a cheque drawn on non-local bank branch) through the local clearing.

• It facilitates collection of cheques drawn on outstation core-banking-enabled branches of banks, if they have a net-worked branch locally.

• The collection of outstation cheques, till now, required movement of cheques from the Presentation centre (city where the cheque is presented) to Drawee centre (city where the cheque is payable) which increases the realisation time for cheques. Speed Clearing aims to reduce the time taken for realisation of outstation cheques.

Speed Clearing

• A person who has an outstation cheque with him deposits it with his bank branch.

• This bank branch is called the Presenting branch.

• The cheque is sent for collection to the city where it is payable / drawn called Destination centre or Drawee centre.

• The branch providing the collection service at the Destination centre is called the Collecting branch.

• On receipt of the cheque, the Collecting branch presents it in local clearing to the Drawee branch or the Destination branch.

Speed Clearing

• Once the cheque is paid the Collecting branch remits the proceeds to the Presenting branch.

• On receipt of realisation advice of the cheque from the Collecting branch, the customer’s account is credited. This, in short, is the process of Collection.

• Banks have networked their branches by implementing Core Banking Solutions (CBS). In CBS environment, cheques can be paid at any location obviating the need for their physical movement to the Drawee branch. The concept of Speed Clearing combines the advantages of MICR clearing with that of CBS.

• Cheques drawn on outstation CBS branches of a Drawee bank can be processed in the Local Clearing under the Speed Clearing arrangement if the Drawee bank has a branch presence at the local centre.

Cheque Truncation System

• Truncation is the process of stopping the flow of the physical cheque issued by a drawer at some point with the presenting bank en-route to the drawee bank branch.

• In its place an electronic image of the cheque is transmitted to the drawee branch by the clearing house, along with relevant information like data on the MICR band, date of presentation, presenting bank, etc.

• Cheque truncation thus obviates the need to move the physical instruments across branches, other than in exceptional circumstances for clearing purposes.

• This effectively eliminates the associated cost of movement of the physical cheques, reduces the time required for their collection and brings elegance to the entire activity of cheque processing.

Cheque Truncation System

• The Reserve Bank has implemented CTS in the National Capital Region (NCR), New Delhi and Chennai with effect from February 1, 2008 and September 24, 2011.

• After migration of the entire cheque volume from MICR system to CTS, , the traditional MICR-based cheque processing has been discontinued in these two locations.

• Grid based CTS clearing has since been started in Chennai by including a few banks from Coimbatore and Bengaluru with effect from March 2012.

• It has also been envisaged to bring all the bank branches in the states of Tamilnadu, Kerala, Karnataka, Andhra Pradesh and the Union Territory of Puducherry under Chennai Grid in a phased manner.

National Payments Corporation of India• National Payments Corporation of India (NPCI) was

incorporated in December 2008 and the Certificate of Commencement of Business was issued in April 2009.

• It has been incorporated as a Section 25 company under Companies Act and is aimed to operate for the benefit of all the member banks and their customers.

• The authorized capital has been pegged at Rs. 300 crore and paid up capital is Rs. 60 crore.

• Presently, there are ten core promoter banks ( State Bank of India, Punjab National Bank, Canara Bank, Bank of Baroda, Union bank of India, Bank of India, ICICI Bank, HDFC Bank, Citibank and HSBC).

• The Board constitutes of Shri N. R. Narayana Murthy among others.

National Payments Corporation of India• The Board for Regulation and Supervision of Payment

and Settlement Systems (BPSS) at its meeting held on September 24,2009 has approved in-principle to issue authorisation to NPCI for operating various retail payment systems in the country and granted Certificate of Authorisation for operation of National Financial Switch (NFS) ATM Network with effect from October 15, 2009.

• NPCI has deputed its officials to IDRBT Hyderabad and NPCI has taken over NFS operations from December 14, 2009.

• NPCI would function as a hub in all electronic retail payment systems which is ever growing in terms of varieties of products, delivery channels, number of service providers and diverse Technology solutions.

National Payments Corporation of India• NPCI has a mandate to create a domestic card scheme.

The Brand name finalised for the same is RuPay. • This scheme would be similar to domestic card schemes

one of which is China UnionPay in China. China UnionPay (CUP) was a national agenda for a few years by mandating all domestic transactions to be routed through the national card system.

• Now China UnionPay cards are accepted in 26 countries. The card base is 1.8 billion. Bulk of the payments are made in China by CUP cards.

• Although it may not be possible to mandate such transaction flow in India, a domestic card is not a distant dream if all banks work in a co-operative framework.

• NPCI can reach the scale of China UnionPay by excelling in service quality and by placing the next generation products and services.

National Payments Corporation of India• Vocalink in UK provides another benchmark for

NPCI. Vocalink facilitates money transfer from any bank account to any other bank account in UK on a real time 24 x 7 basis. This implies that the experience of RTGS has been extended to retail payment segment.

• Now that more than 60,000 bank branches in the country are covered under Core Banking Solution, this is very much a feasible proposition in India and would be known as India MoneyLine.

• NPCI would also benchmark against Bankserv in South Africa and KFTC in South Korea in terms of operational efficiency, reach across the country and range of products and service.

Financial Sector Legislative Reforms Commission - FSLRC

• Chairman – Justice (Retd.) B.N.Srikrishna• To rewrite and clean up the financial sector laws to

bring them in tune with current requirements.• Set up in March 2011• To submit recommendations within 24 months• The terms of reference of the commission include

to examine the architecture of the legislative and regulatory system governing the financial sector in India and to look at the most appropriate means of oversight over regulators and their autonomy from the government.

Financial Sector Legislative Reforms Commission - FSLRC

• There are over 60 Acts and numerous rules and regulations dealing with the financial sector and many of them are considered to be archaic.

• Large number of amendments made in in these Acts over time has increased the ambiguity and complexity of the system.

• The 11-member commission is to be headed by Retired Supreme Court Justice BN Srikrishna.

• The then Finance Minister Pranab Mukherjee had in his Budget for 2010-11 announced plans to set up such a committee to rewrite and harmonise financial sector legislations, rules and regulations.

Indian Financial System

Indian Financial System

Formal (organised )Financial System

Informal (unorganised)Financial System

Regulators :MOF, SEBI, RBI, IRDA

Financial Institutions(Intermediaries)

Financial Markets

Financial Institutions(Intermediaries)

Banking Institutions(Scheduled Commercial

Banks And

Scheduled Cooperative Banks)

Non-Banking Institutions(Non Banking Finance

CompaniesAnd

Development FinanceInstitutions)

Mutual Funds (Public Sector

And Private Sector)

Insurance and HousingFinance Companies

Financial Markets

Financial Markets

Capital Market Money Market

Equity Market Debt Market

Primary market

Secondary Market

Derivatives Market

Thank you

IIT Research Park , Chennai

www.trust.ifmr.co.in

Indian financial system

Economy & Finance

Transcript of Indian financial system