EC6CRT13, MONEY & FINANCIAL MARKETS
Module-1 Financial System
Structure of Indian Financial System–Banks and NBFIs –Insurance Companies, Pension funds, Mutual Funds,
Asset Management Companies.
FINANCIAL SYSTEM
A financial system plays a paramount role in the economic growth of a nation. It intermediates between the
flow of funds belonging to those who save a part of their income and those who invest in productive assets. It
mobilizes and usefully allocates scarce resources of a nation. A financial system may be defined as a
complex, well integrated set of sub systems of financial institutions, markets, instruments and services
which facilitates the transfer and allocation of funds efficiently and effectively. One of the striking
characteristic features of the financial systems in many developing nations is the prevalence of financial
dualism. Financial dualism exhibits the co-existence and co-operation between the formal and informal
sectors.
Formal financial system has the following characteristic features.
• Presence of organized, institutional and regulated system
• Catering the financial needs of modern spheres of an economy
Informal financial system has the following characteristic features.
• Presence of unorganized, non-institutional and non-regulated dealings with traditional and rural spheres.
• Flexibility of operations and interface relationship between creditor and debtor.
Informal financial system emerged out of intrinsic dualism of economic and social structures and financial
repression in developing countries.
STRUCTURE OF INDIAN FINANCIAL SYSTEM
Indian financial system is a financial system that allows the exchange of funds between investors, lenders, and
borrowers. Indian Financial systems operate at national and global levels. They consist of complex, closely
related services, markets, and institutions intended to provide an efficient and regular linkage between
investors and depositors. The following are the four major components that comprise the Indian Financial
System:
Financial Institutions, Financial Markets, Financial Instruments/Assets/Securities, Financial Services.
Financial Institutions
Financial institutions are the intermediaries who facilitate the smooth functioning of the financial system by
making investors and borrowers meet. They mobilize savings of the surplus units and allocate them in
productive activities promising a better rate of return. Structure of Indian Financial System also provides
services to entities (individual, business, government) seeking advice on various issues ranging from
restructuring to diversification plans. They provide whole range of services to the entities who want to raise
funds from the markets or elsewhere. The financial Institutions is very important for the function of a
financial system
Types of Financial Institutions : Financial institutions can be classified into three categories
• Monetary or Banking Institutions & Non-Monetary or Non-Banking Financial Institutions
• Speicalised institutions
Monetary institutions include Central bank, Commercial banks and Cooperative banks etc., Non-Monetary
institutions comprise of Saving banks, Development banks, Investment companies etc., Specialized
institutions include industrial development banks, industrial Finance Corporations, Land development banks
etc.,
Financial Markets
Financial market is a broad term describing any market place where buyers and sellers participate in the
trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically defined by
having transparent pricing, basic regulations on trading, costs and fees and market forces determining the
prices of securities that trade. A financial market presents a transmission mechanism between investors
(lenders) and borrowers (users) through which transfer of funds is facilitated. It consists of individual
investors, financial institutions, financial intermediaries etc. who are linked by formal trading rules and
communication network for trading the various financial assets and credit instruments.
Financial markets may be broadly classified as negotiated loan markets and open market. The negotiated loan
market is a market in which the lender and the borrower personally negotiate the terms of the loan agreement,
e.g. a businessman borrowing from a bank or from a small loan company. On the other hand, the open market
is an impersonal market in which standardized securities are treated in large volumes. The stock market is an
example of an open market. The financial markets, in a nutshell, the credit markets catering to the various
credit needs of the individuals, links and institutions. Credit is supplied both on a short as well as a long term
basis.
On the basis of the credit requirement for short-term and long term purposes, financial markets are divided
into two categories
Types of the financial market
Money Market& Capital Market
Functions of financial markets
• Providing facilities for interaction between investors and borrowers
• Giving pricing information
• Providing security to dealings in financial assets
• Ensures liquidity by providing a mechanism for an investor to sell the financial assets
• Ensuring low cost transactions
Financial Instruments/ Assets/ Securities
This is an important component of the financial system. Financial instruments are the documents/securities
that facilitate transactions on financial claims. Financial instruments are monetary contracts between parties.
The products which are traded in a financial market are financial assets, securities or other types of financial
instruments. There is a wide range of securities in the markets since the needs of investors and credit seekers
are different. Financial instruments can be real or virtual documents representing a legal agreement involving
any kind of monetary value. Equity-based financial instruments represent ownership of an asset. Debt-based
financial instruments represent a loan made by an investor to the owner of the asset.
Types of Financial Instruments: Cash Instruments & Derivative Instrument
Financial Services
It consists of services provided by Asset Management and Liability Management Companies. They help to get
the required funds and also make sure that they are efficiently invested. They assist to determine the financing
combination and extend their professional services up to the stage of servicing of lenders.
Types of Financial Services
Banking, Wealth Management, Mutual Funds &Insurance etc.,
The Structure of Indian Financial System is about A financial system is a system that system which allows the
exchange of funds between investors, lenders, and borrowers. Indian Financial systems operate at national and
global levels. They consist of complex, closely related services, markets, and institutions intended to provide
an efficient and regular linkage between investors and depositors.
Functions of Financial System:
The financial system helps production, capital accumulation, and growth by (i) encouraging savings, (ii)
mobilising them, and (iii) allocating them among alternative uses and users. Each of these functions is
important and the efficiency of a given financial system depends on how well it performs each of these
functions.
(i) Encourage Savings:
Financial system promotes savings by providing a wide array of financial assets as stores of value aided by
the services of financial markets and intermediaries of various kinds. For wealth holders, all this offers ample
choice of portfolios with attractive combinations of income, safety and yield.
With financial progress and innovations in financial technology, the scope of portfolio choice has also
improved. Therefore, it is widely held that the savings-income ratio is directly related to both financial assets
and financial institutions. That is, financial progress generally insures larger savings out of the same level of
real income.
As stores of value, financial assets command certain advantages over tangible assets (physical capital,
inventories of goods, etc.) they are convenient to hold, or easily storable, more liquid, that is more easily
encasahable, more easily divisible, and less risky.
A very important property of financial assets is that they do not require regular management of the kind most
tangible assets do. The financial assets have made possible the separation of ultimate ownership and
management of tangible assets. The separation of savings from management has encouraged savings greatly.
Savings are done by households, businesses, and government. Following the official classification adopted by
the Central Statistical Organization (CSO), Government of India, we reclassify savers into— household
sector, domestic private corporate sector, and the public sector.
The household sector is defined to comprise individuals, non-Government, non-corporate entities in
agriculture, trade and industry, and non-profit making organisations like trusts and charitable and religious
institutions.
The public sector comprises Central and state governments, departmental and non departmental undertakings,
the RBI, etc. The domestic private corporate sector comprises non-government public and private limited
companies (whether financial or non-financial) and corrective institutions.
Of these three sectors, the dominant saver is the household sector, followed by the domestic private corporate
sector. The contribution of the public sector to total net domestic savings is relatively small.
(ii) Mobilisation of Savings:
Financial system is a highly efficient mechanism for mobilising savings. In a fully-monetised economy this is
done automatically when, in the first instance, the public holds its savings in the form of money. However,
this is not the only way of instantaneous mobilisation of savings.
Other financial methods used are deductions at source of the contributions to provident fund and other savings
schemes. More generally, mobilisation of savings taken place when savers move into financial assets, whether
currency, bank deposits, post office savings deposits, life insurance policies, bill, bonds, equity shares, etc.
(iii) Allocation of Funds:
Another important function of a financial system is to arrange smooth, efficient, and socially equitable
allocation of credit. With modem financial development and new financial assets, institutions and markets
have come to be organised, which are replaying an increasingly important role in the provision of credit.
In the allocative functions of financial institutions lies their main source of power. By granting easy and cheap
credit to particular firms, they can shift outward the resource constraint of these firms and make them grow
faster.
On the other hand, by denying adequate credit on reasonable terms to other firms, financial institutions can
restrict the growth or even normal working of these other firms substantially. Thus, the power of credit can be
used highly discriminately to favour some and to hinder others.
Banking Financial Institution
A bank is an institution which deals with money and credit. It accepts deposits from the public, makes the
funds available to those who need them, and helps the remittance of money from one place to another. Banks
are the back bone of any financial system. They play an important role in the mobilization of deposits and
disbursement of credit to various sectors of the economy. Commercial banks are the single most important
source of institutional credit in India.
Indian banking industry is subject to the control of the Central Bank (i.e. Reserve Bank of India). The RBI as
the apex institution organises, runs, supervises, regulates and develops the monetary system and the financial
system of the country. The main legislation governing commercial banks in India is the Banking Regulation
Act, 1949.
The Indian banking institutions can be broadly classified into two categories:
1. Organised Sector 2. Unorganised Sector
1. Organised Sector
The organised banking sector consists of commercial banks, cooperative banks and the regional rural banks
(A) Commercial Banks
The commercial banks may be scheduled banks or non-scheduled banks. Commercial banking system in India
consisted of 297 scheduled banks (including foreign banks) and one non-scheduled bank at end of December
2000. Traditionally, commercial banks accepted deposits and met the short and medium term funding needs of
the industry. But now. since 1990's, banks are also funding the long term needs of the industry particularly the
infrastructure sector. The liberalisation measures initiated in the Indian economy, led to the entry of large
private sector banks in 1993. This has increased competition among public and private sector banks and quality
of services has improved. A major development in the Indian banking industry was the entry of major banks in
merchant banking. The merchant bankers are financial intermediaries providing a range of financial services to
the corporates and investors. Some of the merchant banker's activities include issue management and
underwriting, project counselling and finance, mergers and acquisition advice, portfolio management services
etc.
(B) Co-Operative Banks
An important segment of the organised sector of Indian banking is the co-operative banking, The segment is
represented by a group of societies registered under the Acts of the States relating to co-operative societies. In
fact, co-operative societies may be credit societies or non-credit societies.
Different types of co-operative credit societies are operating in the Indian economy. These institutions can be
classified into two broad categories (a) Rural credit societies which are primarily agricultural ; (b) Urban credit
societies which are primarily non-agricultural. For the purpose of agricultural credit there are different co-
operative credit institutions to meet different kinds of needs. For example, short and medium term credit is
provided through three tier federal structure. At top is the apex body i.e., state co-operative bank ; in the middle
there are district co-operative banks or central co-operative banks, at the grass root level i.e., village level there
are primary agricultural credit societies. For medium to long term loans to agriculture, specialised co-
operatives societies have been formed. These are called 'Land Development Banks'. The land Development
Banks movement started in 1929. In the beginning they were named 'Central Land Mortgage Banks'. Land
development banking is a two-tier structure. At the state level there are state or central land development
banks. At local level there are branches of these banks and primary land development banks. These land
development banks deal with agriculturists directly and also through primary land development banks. At the
national level they have formed All India Land Development Banks' Union.
(C) Regional Rural Banks (RRBs)
Regional Rural Banks were set by the state government and the sponsoring commercial banks with the
objective of developing the rural economy. Regional rural banks provide banking services and credit to small
farmers, small enterpreneurs in the rural areas. The regional rural banks were set up with a view to provide
credit facilities to weaker sections. They constitute an important part of the rural financial architecture in India.
Government decided to restructure the RRBs on the recommendation of Bhandari Committee in 1994-95. As a
result, an amount of Rs.360 crores was allocated towards the restructuring programme The State Bank of India
took several measures of managerial and financial restructuring including enhancement of issued capital and
placements of officers of proven ability to head RRBS. The Government of India released Rs. 1867.65 crores
between 1994-98 for the recapitalization of RRBS. 175 out of total of 196 RRBS were fully recapitalised by
1998-99.
NABARD took several policy measures such as quarterly/half yearly review of RRBS by sponsor banks,
framing of Appointment and Promotion Rules (1998) for the staff of RRBs introduction of Kissan Credit
Cards, introduction of self-help groups etc for improving the overall performance of RRBS.
(D) Foreign Banks
Foreign Banks have been in India from British days. Foreign banks have their offices in India but they are
incorporated outside India and their head office in foreign country. Since 2002 foreign banks have been
allowed to set up their subsidiaries in India. They have to operate according to the banking regulations in India.
The foreign banks are allowed to operate in India only if they are financially sound.
ANZ Grindlays Bank has its to presence in number of places with 56 branches. The Standard and Chartered
Bank has 24 branches and Hongkong Bank 21. All other foreign banks have branches less than 10. Obviously,
these banks have concentrated on corporate clients and have been specialising in areas relating to international
banking. With the deregulation of banking in 1993, a number of foreign banks are entering India or have got
the licenses.
2. Unorganised Sector
In the unorganised banking sector are the indigenous bankers, money lenders, seths carrying out the function of
banking.
(A) Indigenous Bankers, Indigenous bankers are the forefathers of modern banks. These are the individuals or
partnership firms performing the banking functions. They also act as financial intermediaries. As the term
indigenous indicates, they are the local bankers. The geographical area covered by the indigenous bankers is
much larger than the area covered by commercial banks. They can be found in all parts of the country
although their names,styles of functioning and the functions performed by them may differ.
(b) Money Lenders. Money lenders depend entirely on their own funds for the working capital. Money
lenders may be rural or urban, professional or non-professional. They include large farmers merchants, traders,
goldsmiths, village shopkeepers, sardars of labourers, etc. The methods and areas of operation differ from
money lender to money lender. The main characteristics of money lenders are the following
1. The funds are their own funds.
2. Their clients are mainly the weaker sections of society
3. Their loans are highly exploitative. They charge very high rates of interest.
4. Their operations are entirely unregulated
5. The credit is prompt and flexible
They are able to exploit the weaker sections because of their dependence on them. They enjoy monopoly in
their areas of operation
B. Non-Banking Institutions
The non-banking institutions may be categorised broadly into two groups.
(a) Organised Financial Institutions (b) Unorganised Financial Institutions
(a) Organised Financial Institutions: The organised non-banking financial institutions include:
1. Development Finance Institutions. These include
(i)The institutions like IDBI, ICICI, IFCI, IIBI, IRDC at all India level
(ii) State Finance Corporations (SFCs). State Industrial Development Corporations (SIDCs) at
the state level
(iii) Agriculture Development Finance Institutions as NABARD, LDBS etc.
Development banks provide medium and long term finance to the corporate and industrial sector and also takes
up promotional activities for economic development of the country
2. Investment Institutions, It includes those financial institutions which mobilise savings of the public at
large through various schemes and invest these funds in corporate and government securities These include
LIC, GIC, UTI, and mutual funds in detail in separate chapters of this book.
(b) Unorganised Financial Institutions
The unorganised non banking financial institutions include a number of non-banking financial companies
(NBFCs) providing a whole range of financial services. These include hire purchase and consumer finance
companies, leasing companies, housing finance companies, factoring companies, credit rating agencies,
merchant banking companies etc. NBFCS mobilise public funds and provide loanable funds. There has been a
remarkable increase in the number of such companies since 1990's.
Non Banking Financial Institutions
An essential feature of the evolution of financial system has been the emergence of non-banking financial
institutions, outside the traditional banking system including finance companies, leasing companies, merchant
banks and trust and investment companies. The deep and broad-based financial system has invariably
enhanced access to finance at a reasonable cost, and reduced volatility thereby reducing risk by improving
transparency, inducing competition and diversifying products and services and also efficient delivery of them.
They are financial intermediaries engaged primarily in business of accepting deposits and delivering credit.
They play an important role in channelizing the scarce financial resources to capital [Link] Indian
financial sector has witnessed the emergence of a wide range of financial institutions over the years that cater
to the economy’s diverse financial needs. The NBFIs play a very critical role among these financial
institutions. The NBFIs along with the banking sector have immensely contributed to the inclusive growth and
development of the economy by increasing the access to financial services, enhancing competition and
diversifying the financial sector among others.
The NBFCs in India owe their roots to the highly-regulated banking sector in the 1980s as this tight regulatory
framework led to the emergence of a host of NBFCs that were powered by factors like flexibility, timeliness
in meeting credit needs and low operating cost. Over a period of time, these NBFCs evolved into a
heterogeneous group of institutions that performed financial intermediation in a variety of ways like accepting
deposits, making loans and advances, leasing, hire purchase, etc.
RBI classifies NBFCs into three groups viz.
1. Asset finance companies: AFCs are companies that finance real/physical assets for productive/
economic activity.
2. Loan companies: These companies include any financial institution whose principal business is
to provide finance, whether through loans or advances or otherwise for any activity other than its own
(excluding any equipment leasing or hire-purchase finance activity).
3. Investment companies: Investment companies mean any financial intermediary whose principal
business is that of buying and selling securities.
Importance and the role of NBFIs
The role and importance of non-bank financial intermediaries is clear from the various functions performed by
these institutions. Major functions of the NBFIs are as follows:
1. Financial Intermediation:
The most important function of the non-bank financial intermediaries is the transfer of funds from the savers
to the investors. Financial intermediation is economical and less expensive to both small businesses and small
savers, (a) It provides funds to small businesses for which it is difficult to sell stocks and bonds because of
high transaction costs, (b) It also benefits the small savers by pooling their funds and diversifying their
investments.
2. Economic Basis of Financial Intermediation:
Handling of funds by financial intermediaries is more economical and more efficient than that by the
individual wealth owners because of the fact that financial intermediation is based on (a) the law of large
numbers, and (b) economies of scale in portfolio management.
3. Inducement to Save:
Non-bank financial intermediaries play an important role in promoting savings in the country. Savers need
stores of value to hold their savings in. These institutions provide a wide range of financial assets as store of
value and make available expert financial services to the savers. As stores of value, the financial assets have
certain special advantages over the tangible assets (such as, physical capital, inventories of goods, etc.). They
are easily storable, more liquid, more easily divisible, and less risky.
4. Mobilisation of Saving:
Mobilisation of savings takes place when the savers hold savings in the form of currency, bank deposits, post
office savings deposits, life insurance policies, bills, bond's equity shares, etc. NBFI provides highly efficient
mechanism for mobilising savings. There are two types of NBFTs involved in the mobilisation of savings;
(a) Depository Intermediaries, such as savings and loan associations, credit unions, mutual saving banks etc.
These institutions mobilise small savings and provide high liquidity of funds.
(b) Contractual Intermediaries, such as life insurance companies, public provident funds, pension funds, etc.
These institutions enter into contract with savers and provide them various types of benefits over the long
periods.
5. Investment of Funds
The main objective of NBFIs is to earn profits by investing the mobilised savings. For this purpose, these
institutions follow different investment policies. For example, savings and loan associations, mutual saving
banks invest in mortgages, while insurance companies invest in bonds and securities.
Important NBFCs are discussed below
Insurance Companies
Insurance is a contract to indemnify the risk. It could be life or non-life (general) insurance. The business
of insurance is to bring together persons with common insurance interest (sharing same risk), collect the share
or contribution (called premium) from all of them and pay out compensation (called claims) to those who
suffer
Insurance companies are a special class of financial institutions in the financial system. They collect insurance
premiums by issuing insurance policies and invest these premiums in financial assets and markets to generate
cash flows to pay future claims. Thus insurers are liability driven financial intermediaries. Unlike other
financial institutions, insurance companies have to hold risk capital or solvency capital to ensure their
obligation to the insured.
Insurance companies collect premium from policy holders and invest this money in Govt. bonds, corporate
securities and other approved investment avenues. Hence, insurance companies are helpful in providing capital
for new ventures or expansion of existing businesses.
Insurance Business in India
Depending on the nature of the subject matter insured, insurance business in India is broadly classified into two
categories; (i) Life Insurance and (ii) Non-Life Insurance [General Insurance)
Life insurance is a long term contract between the insured and insurer. Life insurance is a contract of guarantee
where the subject matter of insurance is the life of the insured. Life insurer agrees to pay a fixed amount to the
insured. If he/she survives the term of the contract or to some others legally eligible to receive the money on
his/her death during the term of the contract. The insured pays premiums to the insurance company as
consideration of the contract.
In India non-life insurance is popularly called as general insurance. General insurance is a contract of
indemnity . The subject matter of general insurance is some assets other than the life of the insured. General
insurance contracts are basically one year contracts renewable every year. It includes real insurance, motor
insurance, marine insurance and miscellaneous insurance business (like personal accident insurance, health
insurance, burglary insurance etc
History of insurance in India
Insurance has a fairly long history in India. The Bruins hugh the insurance companies of the UK to India
insurance began in India in 1818 by the British company mamed the Oriental Life Insurance Co. Ltd But it was
in 1e that the Bombay Mutual Life Assurance Society, the fir Indian insurance company was formed this was
followed by he krmation of amber of insurance companies/corporations
In 1956, 170 companies and 75 provident fund societies doing insurance business were nationalised and the
Life Insurance Corporation of India was formed on September through the LIC Act 19 Similarly in 1972 the
General Insurance Business Nationalisation Act (GIENA 1972 was passed to nationalise 107 general insurance
companies Through this get the General Insurance CorporationS & tia (GIC) Lad was formed as an apex body
to control the actions of its four subsidiary general insurance companies- namely national Insurance Company
Ltd., New Andis Assurance Company Ltd.. Oriental Insurance Company Ltd and United India Insurance
Company Ltd.
IRDA and insurance Sector
Both LIC and GIC (and its subsidiaries functioned as monopoly companies in Indian insurance industry till
August 2000 This sector was finally thrown open to the private sector in 2006. The Insurance Regulatory and
Development Authority was set up in 2000 under the IRDA Act 1999 as an autonomous insurance regulator
. Banks, financial institutions are non-banking financial companies (NEFC are permitted to enter insurance
sector Foreign insurers also entered the market with joint ventures with Indian companies
As of now there are 41 insurance companies operating in the Indian insurance market. Life insurance
companies are 23 including LIC. There are 18 general insurance companies including public sector companies.
The average Annual growth rate of life insurance business is 28% and 16% for non-life.
Few known names of life insurance companies are; LIC, Bajaj Allianz Life Insurance Co. Ltd., Birla Sun-Life
Insurance Co. Ltd., ICICI Prudential Life Insurance Co. Ltd., TATA AIG Life Insurance Co. Ltd., etc. ICICI
Lombard General Insurance Co. Ltd., Cholamandalam General Insurance Co. Ltd., IFFCO-Tokio General
Insurance Co. Ltd., Reliance General Insurance Co. Ltd, etc are some non-life insurers
Life insurance accounts for 81% of the insurance market in India and general insurance business accounts for
the remaining 19%
Pension Funds and Provident Funds
The provident/pension funds represent the most important form of long-term contractual saving of the
household sector. The annual contribution to them is currently running at double the rate of annual contribution
to life insurance.
1. Pension Fund ; Pension fund is any plan, fund, or scheme which provides retirement income. It is a fund
established by an employer to facilitate and organize the investment of employees' retirement funds contributed
by the employer and employees. The pension fund is a common asset pool meant to generate stable growth
over the long term, and provide pensions for employees when they reach the end of their working years and
commence retirement.
Pension funds are commonly run by some sort of financial intermediary for the company and its employees,
although some larger corporations operate their pension funds in-house. Pension Funds are managed by
Pension Fund Managers. Pension funds control relatively large amounts of capital and represent the largest
institutional investors in many nations.
Pension funds invest long-term contractual savings in various financial instruments. Currently, investment
avenues for pension funds are restricted to central and state government securities; special deposit schemes,
bonds of public sector undertakings and public sector financial institutions, and certificates of deposit with
banks. Investment in equity instruments is not permitted. This has inhibited the emergence of long-term
players in the capital market.
Pension Fund Regulatory and Development Authority (PFRDA) is established by Government of India on 23rd
August, 2003 to act as a regulator for the pension sector. It is established as an authority to promote old age
income security by establishing, developing and regulating pension funds and to protect the interest of
subscribers of such pension fund schemes. New Pension Scheme (NPS) has been introduced by the central
govt. for its employees. In recent years, the insurance and the mutual fund industry in India has also started
offering pension plans. Pension Fund E... LIC Pension Fund, SBI Pension Fund, Reliance Pension Fund etc.
Provident Fund is a social security scheme. Every month a certain rate of amount is deducted from the salary
of the employee and is credited to the fund. The employer also makes his own contribution to this fund. The
contributions are invested in securities or deposited in banks so that it may interest. The provident funds are
required to invest at least 30% of their accruals in Govt. and other approved securities, with at least 15% in
central govt. securities. When the employee retires from service he will get the amount of lump sum along with
interest.
Provident fund can be classified into four, Statutory Provident Fund (SPF), Recognized Provident Fund (RPF),
Unrecognized Provident Fund (URPF) and Public Provident Fund (PPF) PPF is meant for public, and is
managed by SBI and its subsidiaries. Statutory Provident Fund is generally maintained by Govt. and Semi-
Govt employees. Recognized Provident Fund maintains scheduled banks, factories and several business
houses. Any organization can maintain Unrecognized Provident Fund Employees Provident Fund Organisation
(EPFO) is the major player in the organized sector.
Mutual Funds
Mutual fund is a special type of investment institution, which pools the savings of the community and invests
them in the capital market i.e., in shares, debentures and other securities. The income earned from these
investments and the capital appreciations are shared by its unit holders in proportion to the number of units
owned by them It is a new tool in the kit of capital market mechanism. The small investors could now
participate in corporate activities by subscribing to the units of the mutual funds.
The mutual fund institutions employ professionally qualified and well experienced investment consultants and
fund managers who invest the pooled money in a variety of Blue chip companies.
Institutions that collectively manage the funds obtained from different investors are commonly known as
mutual funds . As the name indicates, it is a type of co-partnership between the public and the financial
institutions. The ownership of the lund is thus joint or mutual. The fund belongs to all investors and ownership
is proportionate to the amount contributed by the investor.
The Mutual fund scheme may be an open ended one or close ended one. An open ended fund is one that is
available for subscription at any time. They do not have a fixed maturity Close ended schemes have a pre-
specified maturity. They can be purchased at the time of the initial issue.
In India, mutual funds as a financial intermediary came into existence with the establishment of UTI Act in
1963 Since then it has grown into a dominant player in the industry with assets over Rs.76,547 crores. Unit
1964 was the first and largest scheme launched by UTI. Later on new schemes were invented to cater to the
different needs of different classes of investors. Unit linked insurance plan (ULIP) was established in 1971.
During 1986 children's gift growth fund and master scheme here launched.
Private sector mutual funds entered into the scene in 1993. Major private MPs are Birla Sunlife, ING Vysya,
Kotak Mahindra, Reliance etc Along with this foreign fund management companies were also allowed to
operate in the country. They include ABN-AMRO, DSP Merrill Lynch, Prank Templeton, Morgan Stanley,
BNP Paribas etc.
Structure of Mutual Funds
SEBI has constituted a four-tier system for managing the affairs of mutual funds. Accordingly, there are 4
constituent parties to MF., viz,
(i) The sponsor,
(ii) The Asset Management Company (AMC),
(iii) The trustees
(iv) The custodian.
I. Sponsors : Sponsor means any company who, acting alone or in collaboration with another body corporate,
establishes a Mutual Fund (MF). They are the promoters of mutual fund
[Link] : The board of trustees of the MF are persons who holds the property of mutual fund They keep
the properties in trust for the benefit of unit holders. They have responsibility to safeguard the interest of
investors.
III. Asset Management Company (AMC) : An Asset Management Company is formed and registered
under the Companies Act 1956 and approved the SEBI for managing the funds of the various schemes of MF
A MF can operate only by a separately established agency. AMC operates under the supervision and
guidance of t trustees, The AMC has the specific task of mobilising funds under various schemes
The primary objective of an AMC is to manage the assets of MF and other activities, viz, managing the
pension fund, entering into venture capital fund etc. SEBI insist that AMC should have a minimum net worth
of 10 crores. This to be available with the AMC on a continuous basis to be monitored by the board of
trustees.
IV. Custodian : A custodian means any person carrying on the activities of safe keeping of the securities or
participating in any clearing system on behalf of the clients to effect deliveries of the securities. The custodian
shall be registered with SEBI. The custodian needs sound track record and experience in the field. They
should have sufficient infrastructure, office and personnel to provide custodian service