Regulatory Framework for Financial Services in India

Financial services “Financial services refers to various functions and services which are provided to individuals and business firms by financial institutions in a system” Financial services provided by organisations like banks, credit card companies, insurance company, stock brokerage & mutual fund

Regulatory Framework for Financial Services Regulation refers to the control of commercial & corporate activities through system of rules & norms Direct involvement of government is not necessary Basic function of a regulator is to protect the interests of different categories of stakeholders with a class of financial institutions or services

Need for strong financial regulatory system To ensure financial market & financial services function properly Supervise & regulate the different financial institution in various financial market

Regulators in the Indian financial system The ministry of finance (MOF) The Reserve Bank of India (RBI) SEBI Insurance Regulatory Development Authority (IRDA)

Regulatory framework of financial service Institutional regulation Prudential regulations Investor’s regulations Legislative regulations

Institutional regulation It is also known as structural regulations Each institution’s activities are regulated by one regulator These regulation call for a clear demarcation of activities of financial institution Apex agencies are SEBI & RBI SEBI- regulates the functioning of mutual funds, stock exchanges & stock brokering companies RBI -regulates the activities of commercial banks & non- banking finance companies

Prudential regulations Regulations associated with the internal management of the financial institution & financial services Regulation relates capital adequacy, liquidity & solvency Aim of regulation is to prevent the entry of firms without adequate resources into the market & ensure the proper functioning of firms within the market Eg: SEBI fixes the minimum net worth requirement for various financial services, while RBI’s regulations relate to the non-banking finance companies

Legislative regulations Investors regulation They ensure protection for investors Eg:- SEBI issues guidelines to protect the interest of investors from time to time. Legislative regulations Govt enacted such regulation for overall development of financial service industry Banking regulation act, security contract act

Regulation of Capital Market The SEBI Act, 1992, which established the SEBI, has four objectives: protecting the interests of investors in securities market: the securities market & other incidental matters connected there with. The companies act 2012, deals with the issue, allotment & transfer securities, disclosures to be made in public issue, underwriting, borrowing powers, payment of dividend & winding up of companies The securities contract regulation act,1956, provides for the regulation of securities trading and the management of stock exchanges The Depository act, 1996, provides for the establishment of depositories for the electronic maintenance of Demit securities & transfer ownership

Reserve bank of India RBI is apex/central bank of the country It is entrusted with the control, supervision, promotion & development & planning of financial system The RBI’s main functions is to control the monetary base & through this route influence the supply of money depending on the conditions of the nation Its objectives are to maintain price stability & ensure an adequate flow of credit to the productive sectors It derives power from two different Act. RBI Act,1934 & Banking Regulations Act

Traditional Functions of RBI Regulatory function of RBI Developmental/Promotional Functions of RBI Supervisory Functions of RBI Regulatory Functions of RBI

Regulatory function of RBI Monetary control Banker to the govt. Issuer of note Banker’s Bank Controller of credit Custodian of foreign reserves Regulators of banking services

Developmental/Promotional Functions of RBI Developmental of the financial system Developmental of agriculture Provision of industrial finance Provision of training Collection of data Publication of reports Promotion of banking habits Housing needs Promotion of export through refinance

Supervisory Functions of RBI Granting licences to banks Bank inspection Control over NBFIs NPA norms of commercial banks

RBI’s credit control tools Bank Rate Repo Rate Difference between Bank Rate & Repo Rate Reverse repo Rate How does an Increase in Repo Rate Contain Inflation Deregulation of Interest Rate Cash Reserve Ratio Open Market Operations

Bank rate-Rate at which RBI lends money to other banks without any securities Repo rate- Rate at which commercial bank have to sell securities to RBI with an agreement to repurchase them in future date at a predetermined price When bank experience a gap between the demand from borrower & supply of funds they borrow from RBI at the repo rate If RBI wants to make the funds more expensive for the banks to borrow, it increases the repo rate, if it wants to make it cheaper to borrow they decrease the repo rate When the demand for loan is higher & banks do not have adequate funds to lend, banks borrow from RBI & lend customer at higher rate to maintain earlier profit level Current Repo rate 7.75%

Difference between Bank Rate & Repo Rate Both rates are the rate at which RBI makes funds available to the commercial banks Reverse Repo Rate- The rate at which RBI borrows money from bank. RBI use this tool when it feels there is too much money in the banking system If reverse repo is high, banks get higher intrest rate on the funds they have given the RBI.As a result, banks prefer to keep their money with RBI, which absolutly risk-free Bank rate Repo rate Collateral Not collateralized. Commercial banks have to lend money at fixed rate Commercial banks have to sell the securities to the RBI with an agreement to a Repurchase Impact Long-term Short-term

RESULTS :- REDUCED DEMAND If RBI increases repo rate, the commercial banks have to pay a high cost for borrowing money. The commercial banks then pass on this increase in their own customer in the form of higher interest loan higher interest rates makes more expensive to borrow money RESULTS :- REDUCED DEMAND Reduction of demand lead to reduce production & increase unemployment

Investment decreases. This is the impact in commercial point of veiw Impact of Repo rate As interest rate increase, market rates for securities fall Banks prefer to invest funds with RBI at as the reverse Repo rate also increases There is little money available for lending. Firms & households have problems getting loans Companies that are unable to pay higher interest rates postpone their investments. Investment decreases. This is the impact in commercial point of veiw

Cash Reserve Ratio Amount of money that scheduled by commercial banks must maintain with the RBI CRR does not earn any interest for banks. RBI uses this tool to control the liquidity in the system by increasing or decreasing CRR

Marginal standing facility RBI has introduced a new mechanism MSF Under this mechanism banks are permitted to borrow short term funds (overnight) up to 2% of their respective demand& time liabilities outstanding at the end of the second preceding fortnight Banks can borrow for an overnight period from RBI through this emergency funding window under exceptional circumstances when all other avenues are exhausted

Banks can access MSF only when all avenues(like repo and CBLO) are exhausted for overnight money. That is why it is meant for exceptional MSF allows banks to borrow money from central bank at a higher rate This instrument is likely to reduce volatility in overnight rates & improve monetary transmission The purpose of MSF is to is to provide an additional window to bridge gaps in overnight liquidity, always above the repo rate

Regulatory Functions of RBI On- site inspection Off- site surveillance Corporate governance Appointment of statutory auditors Core principle RBI,s role in the capital market

Difference between MSF & Repo rate Banks can borrow money from the RBI by pledging govt. securities over and above the statutory liquidity requirement Banks can borrow money from the RBI within the statutory liquidity ratio. They do not need to pledge securities under MSF MSF can be used only when all other avenues are exhausted, at an extra cost of 3% above repo rate