REGULATORY FRAMEWORK FOR

FINANCIAL SERVICES IN INDIA

Kailash & Vidya

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

1. The ministry of finance (MOF)

2. The Reserve Bank of India (RBI)

3. SEBI

4. 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

Investors regulation They ensure protection for investorsEg:- 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

1. Regulatory function of RBI

2. Developmental/Promotional Functions of RBI

3. Supervisory Functions of RBI

4. Regulatory Functions of RBI

Regulatory function of RBI1. Monetary control2. Banker to the govt.3. Issuer of note4. Banker’s Bank5. Controller of credit6. Custodian of foreign reserves7. Regulators of banking services

Developmental/Promotional Functions of RBI

1. Developmental of the financial system2. Developmental of agriculture3. Provision of industrial finance4. Provision of training5. Collection of data6. Publication of reports7. Promotion of banking habits8. Housing needs9. Promotion of export through refinance

Supervisory Functions of RBI

1. Granting licences to banks

2. Bank inspection

3. Control over NBFIs

4. NPA norms of commercial banks

RBI’s credit control tools1. Bank Rate2. Repo Rate3. Difference between Bank Rate & Repo Rate4. Reverse repo Rate5. How does an Increase in Repo Rate

Contain Inflation6. Deregulation of Interest Rate7. Cash Reserve Ratio8. 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 rateCollateral 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

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

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

Repo rate MSF