Name- Vaibhav Tiwari

Roll No.- 2016bbxx1089

Course-BBA Section-B
Subject- Banking and Insurance

Q.1 Explain indian banking system in detail?

The financial system of a country is an important tool for economic
development of the country as it helps in the creation of wealth by linking
savings with investments. It facilitates the flow of funds from the households
(savers) to business firms (investors) to aid in wealth creation and development
of both the parties. The institutional arrangements include all condition and
mechanism governing the production, distribution, exchange and holding of
financial assets or instruments of all kinds. There are four main constituents of
the financial system as follows:
1. Financial Services
2. Financial Assets/Instruments
3. Financial Markets
4. Financial Intermediaries
Financial Services
Financial Services is concerned with the design and delivery of financial
instruments, advisory services to individuals and businesses within the area of
banking and related institutions, personal financial planning, leasing,
investment, assets, insurance etc. These services include

◦Banking Services: Includes all the operations provided by the banks

including to the simple deposit and withdrawal of money to the issue of
loans, credit cards etc.
◦Foreign Exchange services: Includes the currency exchange, foreign
exchange banking or the wire transfer.
◦Investment Services: It generally includes the asset management, hedge
fund management and the custody services.
 ◦Insurance Services: It deals with the selling of insurance policies,
brokerages, insurance underwriting or the reinsurance.
◦Some of the other services include advisory services, venture capital,
angel investment etc.

Financial Instruments/Assets
Financial Instruments can be defined as a market for short-term money and
financial assets that is a substitute for money. The term short-term means
generally a period of one year substitutes for money is used to denote any
financial asset which can be quickly converted into money. Some of the
important instruments are as follows:

◦Call /Notice-Money: Call/Notice money is the money borrowed on

demand for a very short period. When money is lent for a day it is known
as Call Money. Intervening holidays and Sunday are excluded for this
purpose. Thus money borrowed on a day and repaid on the next working
day is Call Money. When the money is borrowed or lent for more than a
day up to 14 days it is called Notice Money. No collateral security is
required to cover these transactions.
◦Term Money: Deposits with maturity period beyond 14 days is referred to
as the term money. The entry restrictions are the same as that of
Call/Notice Money, the specified entities not allowed to lend beyond 14
days.
◦Treasury Bills: Treasury Bills are short-term (up to one year) borrowing
instruments of the union government. It’s a promise by the Government to
pay the stated sum after the expiry of the stated period from the date of
issue (less than one year). They are issued at a discount off the face value
and on maturity, the face value is paid to the holder.
◦Certificate of Deposits: Certificates of Deposits is a money market
instrument issued in dematerialised form or as a Promissory Note for funds
deposited at a bank, other eligible financial institution for a specified
period.
◦Commercial Paper: CP is a note in evidence of the debt obligation of the
issuer. On issuing commercial paper the debt is transformed into an
instrument. CP is an unsecured promissory note privately placed with
investors at a discount rate of face value determined by market forces.
Financial Markets
The financial markets are classified into two groups:

Capital Market:
A capital market is an organised market which provides long-term finance for
business. Capital Market also refers to the facilities and institutional
arrangements for borrowing and lending long-term funds. Capital Market is
divided into three groups:

◦Corporate Securities Market: Corporate securities are equity and

preference shares, debentures and bonds of companies. The corporate
security market is a very sensitive and active market. It can be divided into
two groups: primary and secondary.
◦Government Securities Market: In this market government securities are
bought and sold. The securities are issued in the form of bonds and credit
notes. The buyers of such securities are Banks, Insurance Companies,
Provident funds, RBI and Individuals.
◦Long-Term Loans Market: Banks and Financial institutions that provide
long-term loans to firms for modernization, expansion and diversification
of business. Long-Term Loan Market can be divided into Term Loans
Market, Mortgages Market and Financial Guarantees Market.
Money Market
Money Market is the market for short-term funds. The money market is divided
into two types: Unorganised and Organised Money Market.

◦Unorganized Market: It consists of Moneylenders, Indigenous Bankers,

Chit Funds, etc.
◦Organized Money Market: It consists of Treasury Bills, Commercial
Paper, Certificate Of Deposit, Call Money Market and Commercial Bill
Market. Organised Markets work as per the rules and regulations of RBI.
RBI controls the Organized Financial Market in India.
Financial Intermediaries
A financial intermediary is an institution which connects the deficit and surplus
money. The best example of an intermediary is a bank which transforms the
bank deposits to bank loans. The role of the financial intermediary is to
distribute funds from people who have an extra inflow of money to those who
don’t have enough money to fulfil the needs. Functions of Financial
Intermediary are as follows:

◦Maturity transformation: Deals with the conversion of short-term

liabilities to long-term assets.
◦Risk transformation: Conversion of risky investments into relatively risk-
free ones.
◦Convenience denomination: It is a way of matching small deposits with
large loans and large deposits with small loans.
Financial Intermediaries are divided into two types:
Depository institutions: These are banks and credit unions that collect money
from the public and use that money to advance loans to financial customers.
Non-Depository institutions: These are brokerage firms, insurance and mutual
funds companies that cannot collect money deposits but can sell financial
products to financial customers.

Q,2 What is RBI? Explain roles of RBI in indian economy?

Ans- Establishment;
The Reserve Bank of India was established in 1935 under the provisions of the
Reserve Bank of India Act, 1934 in Calcutta, eventually moved permanently to
Mumbai. Though originally privately owned, was nationalized in 1949.

Organisation and Management:

The Reserve Bank”s affairs are governed by a central board of directors. The
board is appointed by the Government of India for a period of four years, under
the Reserve Bank of India Act.

• Full-time officials : Governor and not more than four Deputy

Governors. The current Governor of RBI is Mr. Urjit Pattel.
There are 3 Deputy Governors presently – B P Kanungo, N S
Vishwanathan and Viral V Acharya.
• Nominated by Government: ten Directors from various fields and two
government Officials
 • Others: four Directors – one each from four local boards
Main Role and Functions of RBI
• Monetary Authority: Formulates, implements and monitors the
monetary policy for A) maintaining price stability, keeping inflation in
check ; B) ensuring adequate flow of credit to productive sectors.
• Regulator and supervisor of the financial system: lays out parameters
of banking operations within which the country”s banking and financial
system functions for- A) maintaining public confidence in the system, B)
protecting depositors’ interest ; C) providing cost-effective banking
services to the general public.
• Regulator and supervisor of the payment systems: A) Authorises
setting up of payment systems; B) Lays down standards for working of the
payment system; C)lays down policies for encouraging the movement
from paper-based payment systems to electronic modes of payments. D)
Setting up of the regulatory framework of newer payment methods. E)
Enhancement of customer convenience in payment systems. F) Improving
security and efficiency in modes of payment.
• Manager of Foreign Exchange: RBI manages forex under the FEMA-
Foreign Exchange Management Act, 1999. in order to A) facilitate
external trade and payment B) promote the development of foreign
exchange market in India.
• Issuer of currency: RBI issues and exchanges currency as well as
destroys currency & coins not fit for circulation to ensure that the public
has an adequate quantity of supplies of currency notes and in good quality.
• Developmental role : RBI performs a wide range of promotional
functions to support national objectives. Under this it setup institutions like
NABARD, IDBI, SIDBI, NHB, etc.
• Banker to the Government: performs merchant banking function for
the central and the state governments; also acts as their banker.
• Banker to banks: An important role and function of RBI is to maintain
the banking accounts of all scheduled banks and acts as the banker of last
resort.
• An agent of Government of India in the IMF.
Q.3 Explain Monetary Policy?
Ans- Monetary policy is how central banks manage liquidity to create economic
growth. Liquidity is how much there is in the money supply. That includes
credit, cash, checks, and money market mutual funds.

Objectives of Monetary Policy

The primary objective of central banks is to manage inflation. The second is to
reduce unemployment, but only after they have controlled inflation.

The U.S. Federal Reserve, like many other central banks, has specific targets for
these objectives. It seeks an unemployment rate below 6.5 percent. The Fed
says the natural rate of unemployment is between 4.7 percent and 5.8percent. It
wants the core inflation rate to be between 2 percent and 2.5 percent. It seeks
healthy economic growth. That's a 2 to 3 percent annual increase in the nation's
gross domestic product.

Types of Monetary Policy

Central banks use contractionary monetary policy to reduce inflation. They have
many tools to do this. The most common are raising interest rates and selling
securities through open market operations.
They use expansionary monetary policy to lower unemployment and avoid
recession. They lower interest rates, buy securities from member banks, and use
other tools to increase liquidity.
Monetary Policy Versus Fiscal Policy
Ideally, monetary policy should work hand-in-glove with the national
government's fiscal policy. It rarely works this way. Government leaders get re-
elected for reducing taxes or increasing spending. To put it bluntly, it’s about
rewarding voters and campaign contributors. As a result, fiscal policy isusually
expansionary. To avoid inflation in this situation, monetary policy must be
restrictive.
Ironically, during the Great Recession, politicians became concerned about the
U.S. debt. It exceeded the benchmark debt-to-GDP ratio of 100 percent. As a
result, fiscal policy became contractionary just when it needed to be
expansionary. To compensate, the Fed injected massive amounts of money into
the economy with quantitative easing.
Six Tools of Monetary Policy
All central banks have three tools of monetary policy in common. Most have
many more. They all work together in an economy by managing bank reserves.
The Fed has six major tools. First, it sets a reserve requirement, which tells
banks how much of their money they must have on reserve each night. If it
weren't for the reserve requirement, banks would lend 100 percent of the money
you've deposited. Not everyone needs all their money each day, so it is safe for
the banks to lend most of it out.
The Fed requires that banks keep 10 percent of deposits on reserve. That way,
they have enough cash on hand to meet most demands for redemption. When
the Fed wants to restrict liquidity, it raises the reserve requirement. The Fed
only does this as a last resort because it requires a lot of paperwork.
It's much easier to manage banks' reserves using the fed funds rate. This is the
interest rate that banks charge each other to store their excess cash overnight.
The target for this rate is set at the eight annual Federal Open MarketCommittee
meetings. The Fed funds rate impacts all other interest rates, including bank
loan rates and mortgage rates.
The Fed's third tool is its discount rate. That's how it charges banks to borrow
funds from the Fed's fourth tool, the discount window. The FOMC sets the
discount rate a half-point higher than the Fed funds rate. The Fed prefers banks
to borrow from each other.
Fifth, the Fed uses open market operations to buy and sell Treasurys and other
securities from its member banks. This changes the reserve amount that banks
have on hand without changing the reserve requirement.
Sixth, many central banks including the Fed use inflation targeting. It clearly
sets expectations that they want some inflation. The Fed’s inflation goal is 2
percent for the core inflation rate. People are more likely to buy if they know
prices are rising.
In addition, the Federal Reserve created many new tools to deal with the 2008
financial crisis. These included the Commercial Paper Funding Facility and the
Term Auction Lending Facility.

Q.4 Explain Credit policy?

Ans-Credit policy is an important part of the overall strategy of a firm to market
its products. It refers to those decision variables that influence the amount of
trade credit i.e investment in receivables. Credit policy can be lenient or
stringent.
There are two types of credit policies. Let us know about them in brief.

a) Lenient/Loose/expansive Credit Policy:

Under this policy, firms sell on credit to customers very liberally even to those
customers whose creditworthiness is not known or doubtful. Because of liberal
policy, sales increases and as a result, profit also increases but bad debts also
increase and hence the firm face the problem of liquidity.

b) Stringent /Tight /Restrictive Credit Policy:

Here, the firm is very selective in extending credit. credit sales are made only to
those customers who have proven worthiness. Because of tight credit standards,
chances of bad debts and other credit costs are minimized but at the same time
sales and profits, margins are restricted.

Therefore, the objectives of credit management should be the achievement of a

balance that maximizes the overall return of the firm. The firms normally follow
a credit policy which is in between lenient and stringent credit policie

Aspects of Credit Policy:

The important dimensions of a firm’s credit policy are credit terms, credit
standards and collection policies.

1. Credit Terms:
Credit terms are the stipulations under which the firm sells on credit to its
customers. These are with regard to the repayment of the credit sales amount.

1.1 Credit period:

It is time duration for which credit is extended to the customers. it is generally
stated in terms or a net date. For example, ‘net 30’ refers to the payment to be
made within 30 days from the date of the credit sale.

1.2 Cash discount:

In order to induce the customers/debtors to pay their bills early, the cash
discount is allowed. It indicates the rate of discount and the period for which the
discount is offered. The customer is expected to make the payment by the net
date if he does not avail himself of this discount offer.

Credit terms reflect a combination of both credit period and cash discount.

For example, if credit is extended as ‘3/10 net 30’. It implies a cash discount of
3% is offered to a customer who pays within 10 days from the sale date. If the
offer is not availed, then, payment has to be made by the 30th day. If not paid
then, he would be deemed to have defaulted.

2. Credit Standards:
Credit should be allowed to only those customers who contribute good credit
risk. Credit standards are the basic criteria for extension of credit to customers.
they are influenced by three C’s of credit viz..

1. Character: The willingness of the customer to pay.

2. Capacity: The ability of the customer to pay.
3. Condition: The prevailing economic condition.
Liberal credit standards push up sales by attracting more customers. But, this
increases the incidence of bad debts loss, investment in receivables and cost of
collection. Stiff credit standards tend to depress sales but at the same time, also
reduce the incidence of bad debt loss, investment in receivables and collection
costs.

3. Collection policy:
It should aim at accelerating collection from slow payers and be reducing bad
debts losses. The collection program should consist of the following:

• Monitoring the state of receivables.

• Dispatch of letters to the customers whose due date is nearing.
 • Telegraphic and telephonic advice to the customers around the due date.
• The threat of legal action to overdue accounts.
If the firm is strict in its collection policy with the permanent customers who are
temporarily slow payers, they get offended and shift to the competitors and thus,
the firm loses its permanent business.

If the firm is lenient in collection policy, receivables increase and thus

profitability reduces.

Hence, the optimum collection policy is a trade-off between costs and benefits
which maximizes profitability and the value of the firm.