Financial Institutions Long Answer Type Questions

Financial Institutions Long Answer Type Questions

Question 1.
What is a bank? Explain the various types of banks.
Answer:
A bank is a financial institution and a financial intermediary that accepts deposits and channels those deposits into lending activities, either directly by loaning or indirectly through capital markets. A bank is a connection between customers that have capital deficits and customers with capital surpluses.

The various types of banks are as follows:
(a) Commercial banks:
A commercial bank is a prot-seeking business rm, dealing in money and credit. It is a nancial institution dealing in money in the sense that it accepts deposits of money front the public to keep them in its custody for safety. So also, it deals in credit, i.e., it creates credit by making advances out of the funds received as deposits to needy people. It thus, functions as a mobiliser of saving in the economy. A bank is, therefore like a reservoir into which ow the savings, the idle surplus money of households and from which loans are given on interest to businessmen and others who need them for investment or productive uses.

(b) Industrial Banks:
Industries require a huge capital for a long period to buy machinery and equipment. Industrial banks help such industrialists. They provide long term loans to industries. Besides, they buy shares and debentures of companies, and enable them to have xed capital. Sometimes, they even underwrite the debentures and shares of big industrial concerns. The industrial banks play a vital role in accelerating industrial development. In India, after attainment of independence, several industrial banks were started with large paid up capital. They are, The Industrial Finance Corporation (I.F.C.), The State Financial Corporations (S.F.C.), Industrial Credit and Investment Corporation of India (ICICI) and Industrial Development Bank of India (IDBI) etc.

(c) Savings Banks:
These banks were specially established to encourage thrift among small savers and therefore, they were willing to accept small sums as deposits. They encourage savings of the poor and middle class people. In India we do not have such special institutions, but post offices perform such functions. After nationalisation most of the nationalised banks accept the saving deposits.

(d) Agricultural Banks:
Agriculture has its own problems and hence there are separate banks to nance it. These banks are organised on co-operative lines and therefore do not work on the principle of maximum prot for the shareholders. These banks meet the credit requirements of the farmers through term loans, viz., short, medium and long term loans.

(e) Exchange Banks;
These banks nance mostly for the foreign trade of a country. Their main function is to discount, accept and collect foreign bills of exchange. They buy and sell foreign currency and thus help businessmen in their transactions. They also carry on the ordinary banking business.

(f) Miscellaneous Banks:
There are certain kinds of banks which have arisen in due course to meet the specialised needs of the people. In England and America, there are investment banks whose object is to control the distribution of capital into several uses. American Trade Unions have got labour banks, where the savings of the labourers are pooled together. In London, there are the London Discount House whose business is “to go about the city seeking for bills to discount.” There are numerous types of different banks in the world, carrying on one or the other banking busines.

(g) Retail banks:
Sometimes called high street banks, these are the banks that have branches on the street where ordinary customers have their bank accounts. Retail banks make most of their money from the interest payments on loans they lend to individuals and small businesses, and selling things like mortgages and insurance. Building Societies are also a form of retail banking.

(h) Investment banks:
Investment banks take money from investors such as companies or wealthy individuals and buy shares on the stock market. They also analyse the financial markets for their clients, and provide funding and advice for things like corporate takeovers – which is where one company ‘buys’ another. You can’t deposit money in an investment bank like you can in a retail bank, and investment banks make their money by taking a percentage of their clients’ profits on investments, or selling them financial advice.

(i) Central bank:
A central bank is where money is printed and monetary policy is set. Monetary policy deals with things like inflation and interest rates which influence a country’s economy. There is normally only one central bank in a country – such as the Bank of England in the UK – and they are often supposed to regulate the banking sector there. Although an individual or company can’t open an account with them, a central bank is where a government keeps its money, and they can sometimes lend money to other banks who get into financial trouble.

Question 2.
Explain the advantages of investing in mutual funds.
Answer:
The various advantages of investing in mutual funds are as follows:
(a) Professional Management:
The investor avails of the services of experienced and skilled professionals who are backed by a dedicated investment research team which analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme.

(b) Diversification:
Mutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion.

(c) Convenient Administration:
Investing in a mutual fund reduces paperwork and helps you to avoid many problems such as bad deliveries, delayed payments and unnecessary follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient.

(d) Return Potential:
Over a medium to long-term, mutual funds have the potential to provide a higher return as they invest in a diversified basket of selected securities.

(e) Low Costs:
Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors.

(f) Liquidity:
In open-ended schemes, you can get your money back promptly at net asset value related prices from the mutual fund itself. With close-ended schemes, you can sell your units on a stock exchange at the prevailing market price or avail of. the facility of direct repurchase at NAV related prices which some close-ended and interval schemes offer you periodically.

(g) Transparency:
Regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager’s investment strategy and outlook.

(h) Flexibility:
Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience.

(i) Choice of schemes:
Mutual Funds offer a family of schemes to suit the varying needs over a lifetime.

(j) Well Regulated:
All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations ‘ of Mutual Funds are regularly monitored by SEBI.

Question 3.
What is non banking financial institutions? Explain the various types of non banking financial institutions.
Answer:
A non-bank financial institution (NBFI) is a financial institution that does not have a full banking license or is not supervised by a national or international banking regulatory agency. NBFIs facilitate bank-related financial services, such as investment, risk pooling, contractual savings, and market brokering. The Reserve Bank of India, categorizes the NBFCs into various categories on the basis of their nature and activities:
(a) Equipment Leasing Company:
Equipment leasing company means any company, principal business of which is leasing of equipment or the financing of such activity.

(b) Hire Purchase Company:
Hire Purchase companies means any company whose principal business is hire-purchase or financing such transactions. Hire-purchase Company finances the price of the goods to be sold on a future date. The goods are in fact let on hire by the hire purchase company with a condition to pay the installments by the hirer and after all the installments are paid by the hirer will have an option to purchase it later.

(c) Housing Finance company:
Housing Finance company is a company which provides finance for acquisition and/or construction of houses, acquisition of land and development of plot/ land.

(d) Investment Company:
The main business of an Investment Company is to acquire securities and resale it later. They buy new issues from security issuers and make the arrangement of resale to the investing public.

(e) Loan Company:
Loan company is a company which carry on its principal business as the providing of finance whether by making loans or advances or otherwise for any activity other than its own. These activities exclude leasing and hire purchase.

(f) Mutual Benefit Financial Companies:
Mutual Benefit Financial companies are the companies usually the ‘nidhi’ which are notified by the Central Government under section 620A of the Companies Act 1956 (1 of 1956). These companies provide finance to the members of the companies and accept deposits form them.

The important features of these companies are:

• They mobilize deposits from their members and public with an assurance to provide credit*when required by depositors.
• They provide credit to those who are usually not financed by banks or out of reach of commercial banking.
• MBFCs are easily accessible, local in character and follow easy and simple procedures.
  They work on sound principles of banking. Their operations are governed by the directives of the RBI.
• MBFCs are very old financial institutions existing over 100 years operating mainly in South India.

(g) Miscellaneous Non-Banking Company (MNBC):
MNBC is a company or a financial institution performing all or any of the following activities:
→ Collection of money in one lump sum/installments by way of contributions/ subscriptions, sale of units and other instruments, granting membership admission fee or in any manner.

→ Manage/conduct/supervise transaction/arrangement relating to an agreement with the subscribers, each one of whom subscribes a certain sum in installments over a definite period, and is entitled to a prize amount on the basis of draw of lots or by auction/tender.

→ Carry on the activity in any other form of chit or kuri.

→ Undertake/carry on/ engage in any other business similar to the above.

(h) Residuary Non-Banking Company (RNBC):
RNBC is defined as a company that receives deposits under any scheme/ arrangement in one lump sum / installments by way of contributions / subscriptions or by sale of units/certificate/other instruments or in any other manner. Usually RNBCs mobilize deposits from a large number of small and uniformed deposits through field staff promising that their money would be invested in banks and government securities. They are in general small in size and all non-banking companies other than NBFCs and MNBCs fall into the category of RNBCs.

Question 4.
Explain the importance of non banking finance companies.
Answer:
Non-Banking Finance Companies play an expanded role to accelerate the pace of growth of the financial market. They also help to bridge the credit gap in several sectors. They play an important role in economic development. They play important role in the following ways:
→ Intermediary: They collect the savings of the people and lent to various parties like household, firm, small enterprises on sustained basis. In this ways they bring the savers and lenders together and this help in mobilizing resources in the economy.

→ Promotion of Business sector: It helps the business sector by financing it through loans, mortgages, purchase of bonds, shares etc. in flexible terms and procedures.

→ Help the Central, state and local government: NBFCs helps the local bodies by purchasing their bonds and by selling and purchasing the securities of the government.

→ Provide liquidity: NBFCs provide liquidity when they convert an asset in to cash easily and quickly without loss of value in terms of money.

→ Employment generation: NBFCs help in both direct and indirect employment generation. They have employed many persons to man their offices. Besides office staff, institutions need the services of experts which help them in finalizing lending proposals.

→ Specialized Credit Requirements: NBFCs provide various types of loans and financial sen/ices which are of special nature and differ from customer to customer. Banks can not meet their requirements as they are having lending policies confirming to the banking legislation.

→ Efficient and competitive sector: Advent of NBFCs has ensured a healthy, efficient and competitive financial sector which reinsured the quality financial services to the customers.

→ Capital formation: NBFCs help in mobilizing savings in very remote and unbanked areas and thereby contribute to the capital formation of the economy.

Question 5.
Define Commercial Bank. Explain the main sources for Commercial Bank.
Answer:
Paid up capital, Reserves and surpluses and various types of deposits constitute major sources of fund of commercial banks in India.
(i) Paid up capital:
Capital base of commercial banks in India is much smaller compared to that of banks in developed countries. In india the share of paid up capital in total . resources of these banks is only about 1 percent while in developed countries it is around 7-10 percent late there is an attempt to expand the capital base of commercial banks.

(ii) Reserves and surpluses:
Commercial banking operations hover around risk and liquidity. Therefore, it is obligatory on commercial banks to set aside at least 20% of their profits as reserves. Accumulated reserves and surpluses of commercial banks are now matching their paid-up capital. With greater diversification of banking activities into more profitable services, the share of reserves and surpluses in total resources of the banks is expected to increase.

(iii) Deposits:
Deposits from customers constitute a major source of funds for commercial banks. About 98 percent of total funds are obtained through Demand deposits, Savings deposits and time deposits. Three-fifths of total deposits are in the form of fixed deposits. They form the very basis for the lending operations of the banks.

Since the commencement of planning in 1951, total deposits with commercial banks have grown by more than 200 times. The growth is around, 50 times since the nationalisation at banks in 1969 deposits with banks are equivalent to about half the national income. Many factors have contributed to the phenomenal increase in bank deposits over the cast few decades, such as:

• Increase in national income
• Increase in the number of branches in the country.
• Expansion of branches in rural sectors.
• Introduction of a variety of new deposit schemes to suit different types of customers.
• Confidence of public in the nationalised banks.
• Higher rate of return on bank deposits.
• Comparatively lower public confidence in corporate business enterprises and defaults by them in payment of interest and payment of principal.
• Vigorous promotional efforts by banks.
• Inflow of deposits from non-resident Indians (NRIs) – both repatriable and non-repatriable.

Question 6.
Discuss in brief the various types of mutual funds and also the advantages of mutual funds.
Answer:
Types of Mutual Fund: The Mutual Funds in India offer a wide array schemes that cater to different needs suitable to any age, Financial position, risk tolerance and return expectations, some of the important types of mutual fund schemes are:
(i) Open ended mutual funds ;An open ended mutual funds is a fund with a non – fixed number of outstanding shares or units, that stands ready at any time to redeem them on demand. The fund itself buys back the shares surrendered and is ready to sell new shares.

(ii) Close – ended mutual funds: It is the fund where mutual fund managements sells a limited number of shares and does not stand ready to redeem them primary example of such mutual fund is UTI’s Master share. The shares of such mutual funds are traded in the secondary markets.

(iii) Income oriented schemes: The fund primarily offer fixed income to investors. Naturally, enough the main securities in which investments are made by such – funds are the fixed income yielding ones likes bonds.

(iv) Growth Oriented Schemes: These funds offer growth potentialities associated with investment in capital market namely : a) high source of income by way of dividend and b) rapid capital appreciation, both from hold of good quality scrips.

(v) Hybrid schemes ; These funds cater to both the investment needs of the prospective investors – namely fixed income as well as growth orientation. Therefore, investment targets of these Mutual Funds are judicious mix of both the fixed income securities like bonds and debentures and also sound equity scrips.

(vi) High Growth schemes: As the nomenclature depicts, these funds primarily invest in high risk and high return volatile securities in the market and induce
the investors with a high degree of capital appreciation.

(vii) Money market mutual funds; These funds invest in short term debt securities in the money market like certificates of deposits, commercial papers, government treasury bills etc. Owing to their large size, the funds normally get a higher yield on such short term investments than an individual investors.

(viii) Tax saving schemes : These schemes offer tax rebates to the investors under tax laws as prescribed from time to time. This is made possible because the government offer tax incentive for investment in specified avenues.

(ix) Special schemes : This category includes index schemes that attempt to replicate the performance of particular index such as the BSE, Sensex or the NSE – 50 or industry specific schemes or sectoral schemes.

(x) Real Estate Funds : These are close ended mutual funds which invest predominantly in real estate and properties.

(xi) Off-shore funds: Such funds invest in securities of foreign companies with RBI permission.

(xii) Leverage Funds : Such funds, also known as borrowed funds, increase the size and value of portfolio and offer benefits to members from out of the excess of gains over cost of borrowed funds. They tend to indulge in speculative trading and risky investments.

(xiii) Hedge Funds: They employ their funds for speculative trading, i.e. for buying shares whose prices are likely to rise and for selling shares whose prices are likely to dip.

(xiv) Fund of funds : They invest only in units of other mutual funds, such funds do not operate at present in India.

(xv) New Direction funds : They invest in companies engaged in scientific and technological research such as birth control, anti pollution; oceanography etc.

Advantages of Mutual Fund:
Mutual Funds are becoming very popular because of the its important advantages. They are:
(i) Diverrification:
The small savings investors their savings are pooled and entrusted to mutual funds and then these can be used to buy shares of many different companies. So, this diversification of investment ensures regular returns to investors.

(ii) Liquidity:
According to the regulations of SEBI, a mutual fund in India is required to ensure liquidity a paculiar advantage of a mutual fund is that investment mode in its scheme can be converted back into cash promptly without heavy expenditure on brokerage delay etc.

(iii) Expert supervision and management:
The mutual fund managers have Extensive research facilities at their disposal and they can analyse the performance and prospectus of various companies and take decisions in making investment.

(iv) Reduced Risk:
Mutual Funds which reduced risk factor. A mutual funds invest in large number of companies and are manager professionally, but on the other hand, it may not be in a position to minimize such risk.

(v) Tax advantage:
There are certain schemes of mutual funds which provide tax advantage under income tax act and the tax liability of an investor is also reduced when he invest in these schemes of the mutual funds.

(vi) Flexibility:
In case of mutual funds on investor can invest or withdraw funds according to his own requirements. It is flexible in nature.

(vii) Higher Returns;
Mutual funds are Expected to provide higher returns to the investors as compared to direct investment.

(viii) Investor Protection:
Mutual Funds which provides better protection to the investor, import a greater degree of flexibility and facilitate competition.

(ix) Low operating cost:
It reduced their operating costs by way of brokerage fees, commission etc. a small investor also gets the benefits of large scale economies and low operating costs.

Question 7.
What are the functions and problems of S.F.C.?
Answer:
The main function of SFC is to provide loans to small and medium scale industries engaged in the manufacture, preservation or processing of goods, mining, hotel Industry, generation and distribution of power, transportation, fishing, assembling, repairing etc., It provides financial assistance in the following forms.

• Granting of loans to industries repayable with in a period of not exceeding 20 years.
• Subscribing debentures of industries repayable within a period of more exceeding 20 years.
• Guaranteeing loans raised by industrial concern.
• Underwriting issue of stock, debentures, bonds and shares of industrial undertaking.
• Guaranteeing deferred payments.
• Acting as an agent of central government, state government or Industrial finance corporation of India in respect of any business with an industrial concern in respect of loan sanctioned to them.

SFC suffers from the following problems:

• SFC’s have not been able to collect the loan amount in time. This inturn leads to delay in payment of investments.
• SFC finds it difficult to assess the credit capacity of industrial concerns of small size since they do not have Standardised form of financial statements.
• SFC’s do not have expertise to assess the value of small scale firm as the documents are not maintained properly and at the same time they don’t have sufficient assets to offer it as security.
• SFC’s do not have technical person to make assessment of the value of firm and also the soundness of financial position.
• The needs of industries cannot be met because of in adequate funds.