Final Project - FINANCIAL MARKETS IN INDIA AND ITS COMPARISON

8/7/2019 Final Project - FINANCIAL MARKETS IN INDIA AND ITS COMPARISON

http://slidepdf.com/reader/full/final-project-financial-markets-in-india-and-its-comparison 1/50

FINANCIAL MARKETS IN INDIA AND ITSFINANCIAL MARKETS IN INDIA AND ITS

COMPARISONCOMPARISON

Name of learner: Melinda D’Souza

Registration No.: 200718191

Program Name: Post Graduate Diploma in Business Administration

Address: 304 Sai-link C.H.S, Gautam Buddh Lane Orlem, Malad (West), Mumbai- 400 064,

India

Name of the Institute: SCDL, Pune, Academic Year- 2007

1



DECLARATION BY LEARNER

This is to declare that I have carried out this project work myself in part fulfillment of the

Distance Learning Program of SCDL.

The work is original, wherever references to past research have been made, credits have been

given in the references, and this has not been copied from anywhere else and has not been

submitted to any other University/Institute for any award of any degree/diploma.

Date: 28.02.2010

Place: Mumbai.

__________________

Melinda D’Souza

2





TABLE OF CONTENTS

Page Nos.

INTRODUCTION TO FINANCIAL MARKET 4

CHAPTER I: INSURANCE INDUSTRY

• Introduction 8

• A perspective on the Life Insurance Sector 9

• Challenges faced by the Life Insurance Sector 11

• Growth in Life Insurance 12

• Products in Life Insurance 12

• Advantages and Disadvantages 16

CHAPTER II: MUTUAL FUND INDUSTRY

• Introduction 17

• Types of Mutual funds schemes and various details 19

• Challenges in the Mutual Fund Industry 29

• Growth/ Advantages & its Disadvantages 33

CHAPTER III: BANKING INDUSTRY

• Introduction 36

• Challenges / Major Banking Services 37/40

CONCLUSION 43

CASE STUDY

BIBLIOGRAPHY

4



FINANCIAL MARKETS IN INDIA AND ITS COMPARISONFINANCIAL MARKETS IN INDIA AND ITS COMPARISON

1. Introduction

The global meltdown in the FINANCIAL MARKETS has given “risk” an altogether new

dimension. Financial markets go by many terms, including capital markets, Wall Street, even

the markets. Some experts even simply refer to it as the stock market, even though they are

referring to stocks, bonds and commodities. While returns will continue leading the pack of

financial products, the dangers of being at full throttle have been ingrained in the minds of investors and will continue to guide their investment decisions. Hence risk will come to play

a dominant role in investment decisions.

Today--with the ‘FEEL GOOD' factor about India in the global arena rising, increased

confidence of the investors in the Indian market, Sensex looking more attractive than ever

before, foreign exchange reserves at an all-time high of more than $140 billion --is the most

susceptible period for the regulators of the Indian financial sector, particularly SEBI and

RBI. In spite of the strict vigilance by the regulators, the investors find Indian market veryattractive.

In recent years, the Indian economy has seen a great transformation from a closed,

controlled, slow growing economy to a more open, liberalized and one of the fastest growing

economies of the world. Economic reforms in India since July 1991 have accelerated growth,

enhanced stability and strengthened both external and financial sectors.

The rate of savings in India is constantly rising. The gross domestic savings in the year 2005-

06 is estimated at 1156809. The rise in the savings rate has with an increase in the rate of

growth of GDP over the last three years, suggesting that the economy is transiting to a

sustainable, higher growth trajectory.

5



Therefore, Indian markets provide good opportunities to investors from all over world.

Investments in Indian market are considered as the safest investment by the investors. The

financial markets are - any type of financial transaction that you can think of that helps

businesses grow and investors make money. Here is an overview of the financial markets,

from the simple to the complex.

Financial Intermediaries

A structural change was noticed in the Indian financial system with the establishment of a

host of financial intermediaries during the second phase of evolution of the system. Financialintermediaries comprises of public financial institutions, NBFCs, mutual funds, commercial

banks, housing bank etc.

Foreign Currency Borrowings

In India, External debt exposure to financial intermediaries is regulated. Their foreign

currency borrowings have been subject to the prudential limit of 25 per cent of their Tier-I

capital. These limits amounted to US $ 2.7 billion as of March 31, 2006. With a view to

enabling banks to raise resources overseas, the latest monetary policy announcement on

October 31, 2006 has enhanced this limit to 50 per cent of their Tier I capital, or US $ 10

million, whichever is higher. With a move towards fuller capital account convertibility,

banks are likely to access forex markets more, underscoring the need for further enhancement

of the risk management capabilities of the banking system.

6



Banking Companies

The banking sector is the soul-life-blood of the financial system in India. Significant progress

has been made with respect to the banking sector in the post liberalization period. The

financial health of the commercial banks has improved manifolds with respect to capitaladequacy, profitability, asset quality and risk management. Further, deregulation has opened

new opportunities for banks to increase revenue by diversifying into investment banking,

insurance, credit cards, depository services, mortgage, securitization, etc. Liberalization has

created a more competitive environment in the banking sector. The aggregate foreign

investment (FDI plus FII) limit for the private sector banking has been raised to 74 percent in

the recent country budget. The competition has increased within the banking sector (with the

emergence of new private banks and foreign banks) as well as from other segments of the

financial sector such as mutual funds, Non Banking Finance Companies, post offices and

capital markets.

Structure

The central bank of the country is the Reserve Bank of India (RBI), established in April1935.

Reserve Bank of India was nationalised in the year 1949. The banks in the Indian Banking

System are broadly classified into Scheduled Banks and Non-Scheduled Banks. Nationalised

Banks, State Bank, State Co-operative Banks and Regional Rural Banks come under the

purview of Scheduled Banks whereas Private Sector Banks forms the Non-Scheduled Group.

Asset-wise position of Banks

The total assets of the Public sector banks in aggregate amounts to Rs.2014898.35 crore as

per the last Balance Sheet. The Nationalised banks hold assets worth Rs1234462.40 crores.

The Private Sector Banks hold assets worth Rs. 571407.59 crores. Foreign Banks in India

hold total assets worth Rs.201585.69 crores.

(Source: Balance Sheet of respective banks)

Indian Banking structure also includes the unorganised indigenous sector, which is a mix of

diverse institutions. The Reserve Bank of India is constantly making efforts to bring the

unorganised sector under their regulatory framework.

Cash Reserve Ratio (CRR)

7



CRR is the amount of cash reserve that is required to be maintained by commercial banks in

India with the RBI under Section 42 of the RBI Act, 1934. The RBI hiked the CRR by 50

basis points to 5.5 per cent in two stages on 23 December 2006 and 6 January 2007.

Currently the CRR is 5.75% of the net demand and time liability. From the fortnight

beginning from March 3, 2007, the CRR will be 6%. (Source: RBI)

Statutory Liquidity Ratio (SLR)

SLR is an instrument in the hands of RBI regarding the maintenance of liquid assets by banks

to impose supplementary reserve requirements on the banking system. The maximum limit of

SLR in India is 40%. It was 20% in 1963 and rose to 38.5% in 1990. The current limit is

25%. The Government has issued ordinance giving more flexibility to the RBI to fix SLR

below the current stipulated limit of 25%.

Specialized financial entities – Housing finance companies

A company, which mainly carries on the business of housing finance or has as one of the

main objects in its Memorandum of Association, business of providing finance for the

housing. To start business of housing finance, the Housing Finance Companies has to get it

registered with the National Housing Bank. The principal mandate of the Bank is to promote

housing finance institutions to improve/strengthen the credit delivery network for housing

finance in the country. The Bank has played a facilitator role in this regard instead of itself opening such dedicated housing finance institutions.

Non- Banking Finance Companies

Non-Banking Financial Companies are under the regulatory framework of Reserve Bank of

India by virtue of powers vested in Chapter III B of the Reserve Bank of India Act, 1934. At

the end of June 2006, there were 13014 NBFCs registered with the Reserve Bank of India,

including 428 NBFCs, which are accepting public deposits. During the year 2005-06, Net-

owned funds of NBFCs increased by 562 crores despite a decline in the number of reporting

NBFCs. Total assets/liabilities of NBFCs (excluding reporting NBFCs) at the end of March

2006 were Rs. 35561 crores, down marginally by 1.2 percent from 36003 crores at end of

March 2005. in the year 2005-06, there was a significant decline in fee-based income of the

NBFCs while there was a marginal increase in fund-based income.

8



Stocks and Stock Investing

Stocks are shares of ownership of a public corporation which are sold to investors to allow

the companies to raise a lot of cash at once. The investors profit when the companies increase

their earnings which keeps the U.S. economy growing. It is easy to buy stocks, but takes a lot

of knowledge to buy stocks in the right company.

Chapter I: Insurance Industry

Our everyday life is subjected to an innumerable risk like risk of premature death, poor

health, unemployment, loss due to natural calamities etc. which are out of our control.

Insurance provides us an opportunity to cover the risk at least in monetary terms. Insurance is

a long-term business and it is not feasible to predict the interest rates over such a long tenure.

Insurance may be described as a social device to reduce or eliminate risk of loss to life and

property. Under the plan of insurance, a large number of people associate themselves by

sharing risks attached to individuals. The risks, which can be insured against, include fire, the

perils of sea, death and accidents and burglary. Any risk contingent upon these, may be

insured against at a premium commensurate with the risk involved. Thus collective bearing

of risk is insurance. The business of insurance is broadly classified into life insurance and

non- life insurance or general insurance as discussed below:

Since the beginning of the year 2000, the insurance industry mainly comprises of two

players- The Life Insurance Corporation of India for effecting life insurance and The General

Insurance Corporation of India with its four subsidiaries for effecting fire insurance, marine

insurance and other miscellaneous insurance. From then, a number of insurance companies

have emerged both in the public and private sector to cater to the needs of the society.

As all other markets, the insurance market is also highly regulated. The Insurance Act, 1938

was the first legislation governing not only life insurance but also the non-life insurance

business in India. After the nationalisation of the insurance business in 1956, Insurance

Regulatory and Development Authority (IRDA) regulate the insurance business in India.

9

http://useconomy.about.com/od/stocksandstockinvesting/f/Stocks.htm

http://useconomy.about.com/od/stocksandstockinvesting/f/Stocks.htm



Insurance is a contract whereby, in return for the payment of premium by the insured, the

insurers pay the financial losses suffered by the insured as a result of the occurrence of

unforeseen events. The term "risk" is used to describe all the accidental happenings, which

produce a monetary loss.

Insurance is a pool in which a large number of people exposed to a similar risk make

contributions to a common fund out of which the losses suffered by the unfortunate few, due

to accidental events, are made good. The sharing of risk among large groups of people is the

basis of insurance. The losses of an individual are distributed over a group of individuals.

Future Planning and Insurance

Every insurance plan revolves around the financial consequences of a premature death. By

nature of its business, insurance is closely related to saving and investing. Obviously, the

consequences are too large to ignore and cannot be totally covered by an individual's

personal resources.

Basically, life insurance is nothing but a contract where the insured party or the purchaser of

insurance pays a premium that protects him against specific losses. when planning the life

insurance portfolio, one must consider the family's recurring needs like medical expenses,

house rent, provision costs for instance as well as long-term needs that involve reinstating

one family's set standard of living and their future such as higher education and marriages.

The insurance industry in particular has been subjected to numerous changes in the last few

decades since the need for insurance is more evident now than earlier. People's spending

patterns are changing and more & more resources are needed for immediate consumption.

With a huge population base and large untapped market, insurance industry is a big

opportunity area in India for national as well as foreign investors. In 2003, the Indian

insurance market ranked 19th globally and was the fifth largest in Asia and is growing at 32-

34% annually. Although it accounts for only 2.5% of premiums in Asia, it has the potential to

become one of the biggest insurance markets in the region. This impressive growth in the

market has been driven by liberalization, with new players significantly enhancing product

awareness and promoting consumer education and information. The strong growth potential

10



of the country has also made international players to look at the Indian insurance market.

Moreover, saturation of insurance markets in many developed economies has made the

Indian market more attractive for international insurance players, according to "Booming

Insurance Market in India (2008-2011)”.

Life insurance premiums account to 2.5% and general insurance premiums account to 0.65%

of India's GDP. The Indian Insurance sector has gone through several phases and changes,

especially after 1999, when the Govt. of India opened up the insurance sector for private

companies to solicit insurance, allowing FDI up to 26%.

Total life insurance premium in India is projected to grow Rs 1,230,000 Crore by 2010-11.

Total non-life insurance premium is expected to increase at a CAGR of 25% for the period

spanning from 2008-09 to 2010-11.

With the entry of several low-cost airlines, along with fleet expansion by existing ones and

increasing corporate aircraft ownership, the Indian aviation insurance market is all set to

boom in a big way in coming years.

Home insurance segment is set to achieve a 100% growth as financial institutions have made

home insurance obligatory for housing loan approvals.

Health insurance is poised to become the second largest business for non-life insurers after

motor insurance in next three years.

A booming life insurance market has propelled the Indian life insurance agents into the ‘top

10 country list’ in terms of membership to the Million Dollar Round Table (MDRT) — an

exclusive club for the highest performing life insurance agents.

Life Insurance Sector – A perspective

Life-Insurance Market

The life insurance industry in India dates back to 1818, when a British firm Oriental Life

Insurance Company opened its office in Kolkata, followed by the 'Bombay Life Assurance

Company in 1823. During the British rule in India, the Indian Life Assurance Companies Act

was passed in 1912, which was followed by the Indian Insurance Companies Act, 1928,

11



enabling the government to collect the data regarding life and non-life business conducted by

both Indian and foreign insurance companies. The Life Insurance market in India is an

underdeveloped market that was only tapped by the state owned LIC till the entry of private

insurers. The penetration of life insurance products was 19 percent of the total 400 million of

the insurable population. LIC expanded its network to all parts of the country and emerged as

one of the largest corporations in India. The state owned LIC sold insurance as a tax

instrument, not as a product giving protection. Most customers were under- insured with no

flexibility or transparency in the products. With the entry of the private insurers, customers

are now more responsive and informed about the insurance services.

The 18 private insurers in the life insurance market have already grabbed nearly 35.64

percent of the market in terms of premium income. The new business premiums of the 18

private players have reached to Rs 22503.87 crore in 2007- 08 over last year. Meanwhile,

state owned LIC's new premium has touched 40624.04 crore.

Innovative products, smart marketing and aggressive distribution are the triple good

combinations that have enabled fledgling private insurance companies to sign up Indian

customers faster than anyone ever expected. Indians, who have always seen life insurance as

a tax saving device, are now suddenly turning to the private sector and snapping up the new

innovative products on offer.

The growing popularity of the private insurers shows in other ways. They are coining money

in new niches that they have introduced. The state owned companies still dominate segments

like endowments and money back policies. But in the annuity or pension products business,

the private insurers have already wrested over 35.64 percent of the market. And in the

popular unit-linked insurance schemes they have a virtual monopoly, with over 94 percent of

the customers. The new, private insurers focused on providing customized products -products

that contain innovative features -to the customers. It was observed that in the Indian market,

only endowment and money back policies were popular among consumers.

Private insurers came up with need-based insurance policies such as whole life policies, term

insurance policies as well -products designed according to needs of the customer

12



The private insurers also seem to be scoring big in other ways- they are persuading people to

take out bigger policies. For instance, the average size of a life insurance policy before

privatization was around Rs 50,000. That has risen to about Rs 80,000. But the private

insurers are ahead in this game and the average size of their policies is around Rs 1.1 lakh to

Rs 1.2 lakh- way bigger than the industry average.

PRODUCTS IN LIFE INSURANCE

Whole life policy:

These are low-cost insurance plans where the sum assured is payable on the death of the

insured. A typical whole life policy runs as long as the policyholder is alive. In other words,

the risk is covered for the entire life of the policyholder, which is why it is known as whole

life policies. The policy money and the bonus are payable only to the nominee of the

beneficiary upon the death of the policyholder. The policyholder is not entitled to any money

during his or her own lifetime, i.e. there is no survival benefit. Whole life policies are fairly

rigid and inflexible and are suitable only in a few, very specific cases.

Endowment policy:

Under these plans, the sum assured is pay-able on the maturity of the policy or in case of

death of the insured individual before maturity of the policy. Endowment policies cover the

risk for a specified period at the end of which the sum assured is paid back to the

policyholder along with the entire bonus accumulated during the term of the policy. It is this

feature - the payment of the endowment to the policyholder upon the completion of the

policy’s term, which rightly accounts for the popularity of endowment policies. The original

sum assured and the accumulated bonus - received back comes handy from the endowment

can either be used for buying an annuity policy to generate a monthly pension for the whole

life, or put it in any other suitable investment of his choice.

As compared to whole life policies, the premium rates for endowment policies are higher and

the bonus rates lower. On the plus side, these polices offer an endowment - representing a

13



return on his premium payments payable to him in his own lifetime when the policy comes to

an end.

Money back policy:

Unlike ordinary endowment insurance plans where the survival benefits are payable only at

the end of the endowment period, money back policies provide for periodic payments of

partial survival benefits during the term of the policy, as long as the policy holder is alive.

An important feature of this type of policy is that in the event of death at any time within the

policy term, the death claim comprises full sum assured without deducting any of the

survival benefit amounts, which may have already been paid as money-back components.

Similarly, the bonus is also calculated on the full sum assured.

By buying such policies one can receive income at regular intervals other than the risk cover

it provides. Also a good amount of bonus on the full sum assured is quite a good bargain

Annuity (Pension Plan):

These plans provide for either immediate or deferred pension for life. The pension payments

are made till the death of the annuitant (per-son who has a pension plan) unless the policy has

provision of guaranteed period. An annuity is an investment that one makes, either in a single

lump sum or through installments paid over a certain number of years, in return for which

one receive back a specific sum every year, every half-year or every month, either for life or

for a fixed number of years. After the death of the annuitant or after the fixed annuity period

expires for annuity payments, the invested annuity fund is refunded, perhaps along with a

small addition, calculated at that time. Annuities differ from all the other forms of life

insurance - an annuity does not provide any life insurance cover but, instead, offers a

guaranteed income either for life or a certain period.

Typically annuities are bought to generate income during one’s retired life, which is why

they are also called pension plans. Annuity premiums and payments are fixed with reference

to the duration of human life.

14



Term policy:

Under these plans, the sum assured is payable only on the death of the insured individual

before expiry of the policy. Term policies; cover only the risk during the selected term

period. If the policyholder survives the term, the risk cover comes to an end. A Term plan isdesigned to meet the needs of people who are initially unable to pay the larger premium

required for a whole life or an endowment assurance policy, but they hope to be able to pay

for such a policy in the near future. No surrender, loan or paid-up values are granted under

these policies because reserves are not accumulated. If the premium is not paid with the days

of grace, the policy will lapse without acquiring a paid-up value. Accident and / or Disability

benefits are not granted on policies under the Term plan.

Market Linked Policy -ULIPS:

Market Linked policies provide a combination of life insurance protection and investment.

The proposer offers to pay a certain sum towards premium. Out of the premium, a certain

amount is adjusted towards the cost of the insurance (death) cover and some portion is

adjusted towards charges. The balance, called the allocated premium is invested in a fund

that the proposer chooses, from among a set of options. The allocated premium is more in the

second year and still more in the third and later years because some charges are not levied inevery year. The allocated premium is used to buy a certain number of units in the chosen

fund at the price at which the units are being offered on that day. The death benefit is fixed

but the maturity benefit is not guaranteed. The maturity benefit depends on the market

conditions and the fund in which the premium has been invested, on the date of maturity.

Joint life policy:

Joint life policies are similar to endowment policies in as much as these policies also offer

maturity benefits to the policyholders, apart form covering the risks as all life insurance

policies. But these are categorized separately as these cover two lives together thus offering a

unique advantage in some cases; notable, for a married couple or for partners in a business

firm. Under a joint life policy the sum assured is payable on the first death and again on the

15



death of the survivor during the term of the policy. Vested bonuses would also be paid

besides the sum assured after the death of the survivor. If one or both the lives survive to the

maturity date, the sum assured as well as the vested bonuses are payable on the maturity date.

The premiums payable cease on the first death or on the expiry of the selected term,

whichever is earlier..

These benefits are available with respect to both lives if :

Both lives perish simultaneously owing to an accident. To avoid such an eventuality,

nomination is allowed under the policy OR Both die within the specified period as a result of

the same accident OR The second life also dies in the same policy year as result of another

accident. To avoid such an eventuality, nomination is allowed under the policy.

Particularly for couples - Joint life policies provide dual-purpose income and risk protection

for both belonging to every income group and class of society.

Under a joint life plan though the premium payment stops after the first life's death, bonuses

continue to accrue on the basic Sum Assured till Maturity Date or till the death of the second

life, if earlier.

Group insurance:

Group Insurance offers life insurance protection under group policies to various groups such

as employer-employee, professionals, co-operatives, weaker sections of society etc. Besides

providing insurance coverage, it also offers group schemes to employers, which provide

funding of gratuity and pension liabilities of the employer’s Group insurance plans have low

premiums. Such plans are particularly beneficial to those for whom other regular policies are

a costlier proposition. As such the premium one needs to pay is comparatively lower and at

the same time one can avail of insurance benefits.

The main features of the schemes are low premium and simple insurability conditions.

Premiums are based upon age combination of members, occupation and working conditions

of the group.

A number of group insurance schemes have been designed for various groups. These include

employer-employee groups, associations of professionals (such as doctors, lawyers, etc.), and

16



members of cooperative banks, welfare funds, credit societies and weaker sections of society.

Group insurance schemes providing uniform cover can be granted to outstanding loans.

These groups are Members of primary housing societies where housing loans are granted by

State Apex housing societies, borrowers granted loans by Institutional agencies in

Public/Joint Sectors for housing purposes and borrower members of cooperative

societies/banks formed by employees of the same employers.

Special plan:

Special plans are insurance policy plans available from the national insurance providers to

serve the needs of citizens that cannot be commonly classified or segregated. These special

plans are designed to satisfy needs ranging from debt-clearance in event of the death of the

insured to financial aid in the event of a medical mishap. Special plans also provide financial

assistance for handicapped dependants as well as emergency surgery required if and when a

medical condition arises. Since special plans are designed for people with diverse and

specific needs, the average citizen may not necessarily need or use them. Yet, in the normal

course of life, situations may arise when one may need to provide for unplanned or

unexpected contingencies and mishaps.

Advantages and Disadvantages:

Term Life Insurance

Advantages:

1) Initial premiums are generally lower than those for permanent life insurance, allowing you

to buy higher levels of coverage at a younger age when the need for protection is often the

greatest.

2) Its good for covering needs that may disappear in time, such as mortgages, car loans or

education funding.

Disadvantages:

17



1) Premiums increase as you grow older.

2) Coverage may terminate at the end of the term or become too expensive to continue.

3) The policy generally doesn’t offer cash value or paid-up insurance.

Permanent Insurance

Advantages:

1) As long as premiums are paid, protection is guaranteed for life. Premium costs can be

fixed or flexible to meet personal financial needs.

3) The policy accumulates a cash value against which you can borrow–remember that loans

must be paid back with interest or your beneficiaries will receive a reduced death benefit.

4) You can borrow against the policy’s cash value to pay premiums or use the cash value to

provide paid-up insurance.

5) The policy’s cash value can be surrendered- in total or in part- for cash or converted into

an annuity.

Disadvantages:

1) Required premium levels may make it hard to buy enough protection.

2) It may be more costly than term insurance if you don’t keep the policy long enough

Challenges in the Insurance Sector

In the interregnum the country has realized how the monopoly enjoyed by the public sector

insurance companies has proved detrimental to the interests of policy-holders. To cite one

instance, the decrease in the mortality rate should have had a beneficial impact on the life

insurance business. In other words, the premium rates should have come down. This did not

happen. Consequently, a majority of the life insurance policy holders, who took the policies

only because they were either compulsory or had some tax benefits built into them, feel

cheated.

18



Even in the case of general insurance, where a moderate competition was sought to be

provided by allowing four companies to compete against one another, the experience of the

policy holders has not been any different. With the liberalization of the insurance sector in

India public sector giants have prepared themselves to compete with the new entrants. Of

course, there is enough ground for all of them to play. That the LIC covers only five per cent

of the population shows the gargantuan size of the untapped market. The need for innovative

schemes that can attract a large section of the uninsured population cannot be

overemphasized. For the common people, lower premiums will be the main determinant.

This holds true for general insurance, too, where quick settlement of claims is central to the

success of an insurance company. Unfortunately, this is not one of the strong points of the

GIC and its subsidiaries which have, over the years, become more and more bureaucratic and

corruption-driven. It is, therefore, no surprise that the claim rate has been going up, be it in

motor insurance or marine insurance. The head start LIC and GIC enjoy by virtue of the vast

networks of agents and other infrastructure at their disposal is the envy of the new players.

Seen in this perspective, the public sector companies have to work hard to sustain their

insurance business growing.

GROWTH TREND IN LIFE INSURANCE MARKET

The Life Insurance Company underwrote a premium of Rs 131400 crores till December 31,

2008 as of Rs. 6314 crores in March 2008. The Private Insurers contribute to 35.64% in 2008

from 27.80% in 2005.

There has been a tremendous growth in the past 3 years with respect to all aspects of business

ie: premiums, no. of policies & no of lives covered.

During the period of 2008 - 09, the industry witnessed a growth of 216 per cent in renewal

premiums for regular unit linked insurance plan (ULIPs) at Rs 26,600 crore as against Rs

8,400 crore in the corresponding period last year

19



50000000

60000000

70000000

Chapter II: Mutual funds

Introduction

“Put not your trust in money, put your money in trust”- is the perfect way by which we can

understand the concept of mutual funds. Different investment avenues and opportunities are

available to the investors. The small investors who lack expertise to choose the right kind of investment for themselves opt for a kind of collective investment vehicle like Mutual Funds

which pool their marginal resources, invest in a wide range of securities and distribute the

returns. Like all investments, they also carry certain risks.

The pioneer in the field of mutual fund is Unit Trust of India established in 1964.

Netmobilisation of resources by mutual funds increased by more than four-fold to Rs.

104950 crores in 2006 from Rs. 25454 crore in 2005. The share of UTI and other public

sector mutual funds in the total amount mobilised was around 22.5% in 2005 and 17.8% in

2006. The total assets under the management of mutual funds during the end of 2006 was

recorded at 323598 crores.

The investors should compare the risks and expected yields after adjustment of tax on

various instruments while taking investment decisions. The investors may seek advice from

experts and consultants including agents and distributors of mutual funds schemes while

20



making investment decisions. What was once just another obscure financial instrument is

now a part of our daily lives. In fact, to many people, investing means buying mutual funds.

After all, its common knowledge that investing in mutual funds is (or at least should be)

better than simply letting your cash waste away in a savings account, but, for most people,

that's where the understanding of funds ends.

Year 2009 could be termed a watershed year for the Indian Mutual Fund (MF) industry. The

winds of change have arrived. In fact the India Mutual Fund industry has been ahead of the

world in adopting change and the forces of change have begun to chart a new course for the

industry. No matter what type of investor you are, there is bound to be a mutual fund that fits

your style. With an objective to make the investors aware of functioning of mutual funds, an

attempt has been made to provide information in question-answer format which may help the

investors in taking investment decisions.

What is a Mutual Fund?

Mutual fund is a mechanism for pooling the resources by issuing units to the investors and

investing funds in securities in accordance with objectives as disclosed in offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and

thus the risk is reduced. Diversification reduces the risk because all stocks may not move in

the same direction in the same proportion at the same time. Mutual fund issues units to the

investors in accordance with quantum of money invested by them. Investors of mutual funds

are known as unit holders.

The profits or losses are shared by the investors in proportion to their investments. A mutual

fund is required to be registered with Securities and Exchange Board of India (SEBI) which

regulates securities markets before it can collect funds from the public.

What is the history of Mutual Funds in India and role of SEBI in mutual funds

industry?

Unit Trust of India was the first mutual fund set up in India in the year 1963. In early 1990s,

Government allowed public sector banks and institutions to set up mutual funds. In the year

21



1992, Securities and exchange Board of India (SEBI) Act was passed. The objectives of

SEBI are – to protect the interest of investors in securities and to promote the development of

and to regulate the securities market.

As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual

funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in

1993. The regulations were fully revised in 1996 and have been amended thereafter from

time to time. SEBI has also issued guidelines to the mutual funds from time to time to protect

the interests of investors.

All mutual funds whether promoted by public sector or private sector entities including those

promoted by foreign entities are governed by the same set of Regulations and there is no

distinction in regulatory requirements for these mutual funds.

Mutual funds are distributed through five channels of distribution, namely, direct channel,

advice channel, retirement plan channel, fund supermarket channel, and institutional channel.

Apart from these channels, mutual banking is also adopted, where cross-selling is used in

association with banks to sell the fund schemes through the banks’ branches.

Mutual fund marketers use advertising, sales promotions, brand communications, and public

relations to attract investors and to increase their sales. Advertising includes print and

electronic media, including the Internet. Fund marketers give away incentives and gifts to the

investors for investing in their funds and such incentives and gifts may act as a catalyst for

attracting more sales. They also give incentives (in cash or kind) to their trade partners and

their representatives. Further, the fund houses have started the process of overhauling their

brand image to promote themselves more effectively to the customers. AMFI, the industry

association, has been actively involved in public relations (PR), by promoting the mutual

fund industry, both at the domestic level and in the international arena.

How is a mutual fund set up?

A mutual fund is set up in the form of a trust, which has sponsor, trustees, Asset Management

Company (AMC) and custodian. The trust is established by a sponsor or more than one

sponsor who is like promoter of a company. The trustees of the mutual fund hold its property

22



for the benefit of the unit holders. Asset Management Company (AMC) approved by SEBI

manages the funds by making investments in various types of securities. Custodian, who is

registered with SEBI, holds the securities of various schemes of the fund in its custody. The

trustees are vested with the general power of superintendence and direction over AMC. They

monitor the performance and compliance of SEBI Regulations by the mutual fund.

SEBI Regulations require that at least two thirds of the directors of trustee company or board

of trustees must be independent i.e. they should not be associated with the sponsors. Also,

50% of the directors of AMC must be independent. All mutual funds are required to be

registered with SEBI before they launch any scheme.

What is Net Asset Value (NAV) of a scheme?

The performance of a particular scheme of a mutual fund is denoted by Net Asset Value

(NAV). Mutual funds invest the money collected from the investors in securities markets. In

simple words, Net Asset Value is the market value of the securities held by the scheme. Since

market value of securities changes every day, NAV of a scheme also varies on day to day

basis. The NAV per unit is the market value of securities of a scheme divided by the total

number of units of the scheme on any particular date. For example, if the market value of

securities of a mutual fund scheme is Rs 200 lakhs and the mutual fund has issued 10 lakhs

units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs.20. NAV is

required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending

on the type of scheme.

What are the different types of mutual fund schemes?

Schemes according to Maturity Period: A mutual fund scheme can be classified into open-

ended scheme or close-ended scheme depending on its maturity period.

Open-ended Fund/ Scheme

An open-ended fund or scheme is one that is available for subscription and repurchase on a

continuous basis & does not have a fixed maturity period. Investors can conveniently buy

23



and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis.

The key feature of open-end schemes is liquidity.

Close-ended Fund/ Scheme

A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years & is open for

subscription only during a specified period at the time of launch of the scheme. Investors can

invest in the scheme at the time of the initial public issue and thereafter they can buy or sell

the units of the scheme on the stock exchanges where the units are listed. In order to provide

an exit route to the investors, SEBI Regulations stipulate that at least one of the two exit

routes is provided to the investor i.e. either repurchase facility or through listing on stock

exchanges. These mutual funds schemes disclose NAV generally on weekly basis.

Schemes according to Investment Objective: A scheme can also be classified as growth

scheme, income scheme, or balanced scheme considering its investment objective. Such

schemes may be open-ended or close-ended schemes as described earlier.

Growth / Equity Oriented Scheme

The aim of growth funds is to provide capital appreciation over medium to long- term. Such

schemes normally invest a major part of their corpus in equities. Such funds have

comparatively high risks. These schemes provide different options to the investors like

dividend option, capital appreciation, etc. and the investors may choose an option depending

on their preferences. Growth schemes are good for investors having a long-term outlook

seeking appreciation over a period of time.

Income / Debt Oriented Scheme

The aim of income funds is to provide regular and steady income to investors. Such schemes

generally invest in fixed income securities such as bonds, corporate debentures, Government

securities and money market instruments. Such funds are less risky compared to equity

schemes. These funds are not affected because of fluctuations in equity markets. However,

long term investors may not bother about these fluctuations.

24



Balanced Fund Scheme

The aim of balanced funds is to provide both growth and regular income as such schemes

invest both in equities and fixed income securities in the proportion indicated in their offer

documents. They generally invest 40-60% in equity and debt instruments. These funds are

also affected because of fluctuations in share prices in the stock markets. However, NAVs of

such funds are likely to be less volatile compared to pure equity funds.

Money Market or Liquid Fund

These funds are also income funds and their aim is to provide easy liquidity, preservation of

capital and moderate income. These schemes invest exclusively in safer short-term

instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank

call money, government securities, etc. Returns on these schemes fluctuate much less

compared to other funds. These funds are appropriate for corporate and individual investors

as a means to park their surplus funds for short periods.

Gilt Fund

These funds invest exclusively in government securities. Government securities have no

default risk. NAVs of these schemes also fluctuate due to change in interest rates and other

economic factors as is the case with income or debt oriented schemes.

Index Funds

Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index,

S&P NSE 50 index (Nifty), etc. These schemes invest in the securities in the same weightage

comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise

or fall in the index, though not exactly by the same percentage due to some factors known as

"tracking error" in technical terms. Necessary disclosures in this regard are made in the offer

document of the mutual fund scheme.

What are sector specific funds/schemes?

25





important. A no-load fund is one that does not charge for entry or exit. It means the investors

can enter the fund/scheme at NAV and no additional charges are payable on purchase or sale

of units.

Can a mutual fund impose fresh load or increase the load beyond the level mentioned in

the offer documents?

Mutual funds cannot increase the load beyond the level mentioned in the offer document.

Any change in the load will be applicable only to prospective investments and not to the

original investments. In case of imposition of fresh loads or increase in existing loads, the

mutual funds are required to amend their offer documents so that the new investors are aware

of loads at the time of investments.

What is the sale or repurchase/redemption price?

The price or NAV a unit holder is charged while investing in an open-ended scheme is called

sales price. It may include sales load, if applicable.

Repurchase or redemption price is the price or NAV at which an open-ended scheme

purchases or redeems its units from the unit holders. It may include exit load, if applicable.

What is an assured return scheme?

Assured return schemes are those schemes that assure a specific return to the unit holders

irrespective of performance of the scheme. A scheme cannot promise returns unless such

returns are fully guaranteed by the sponsor or AMC and is disclosed in the offer document.

Investors should carefully read the offer document whether return is assured for the entire

period of the scheme or only for a certain period. Some schemes assure returns one year at a

time and they review and change it at the beginning of the next year.

Can a mutual fund change the asset allocation while deploying funds of investors?

Considering the market trends, any prudent fund managers can change the asset allocation

i.e. he can invest higher or lower percentage of the fund in equity or debt instruments

compared to what is disclosed in the offer document. It can be done on a short term basis on

defensive considerations i.e. to protect the NAV. In case the mutual fund wants to change the

27





later date for the purpose of dividend or repurchase. Any changes in the address, bank

account number, etc at a later date should be informed to the mutual fund immediately.

What should an investor look into an offer document?

An abridged offer document, which contains very useful information, is required to be given

to the prospective investor by the mutual fund. The application form for subscription to a

scheme is an integral part of the offer document. SEBI has prescribed minimum disclosures

in the offer document. An investor, before investing in a scheme, should carefully read the

offer document. Due care must be given to portions relating to main features of the scheme,

risk factors, initial issue expenses and recurring expenses to be charged to the scheme, entry

or exit loads, sponsor’s track record, educational qualification and work experience of key

personnel including fund managers, performance of other schemes launched by the mutual

fund in the past, pending litigations and penalties imposed, etc.

When will the investor get certificate or statement of account after investing in a mutual

fund?

Mutual funds are required to dispatch certificates or statements of accounts within six weeks

from the date of closure of the initial subscription of the scheme. In case of close-ended

schemes, the investors would get either a demat account statement or unit certificates as these

are traded in the stock exchanges. In case of open-ended schemes, a statement of account is

issued by the mutual fund within 30 days from the date of closure of initial public offer of the

scheme. The procedure of repurchase is mentioned in the offer document.

Can a mutual fund change the nature of the scheme from the one specified in the offer

document?

Yes. However, no change in the nature or terms of the scheme, known as fundamental

attributes of the scheme e.g. structure, investment pattern, etc. can be carried out unless a

written communication is sent to each unit holder and an advertisement is given in one. The

unit holders have the right to exit the scheme at the prevailing NAV without any exit load if

they do not want to continue with the scheme. The mutual funds are also required to follow

29



similar procedure while converting the scheme form close-ended to open-ended scheme and

in case of change in sponsor.

How will an investor come to know about the changes, if any, which may occur in the

mutual fund?

There may be changes from time to time in a mutual fund. The mutual funds are required to

inform any material changes to their unit holders. Apart from it, many mutual funds send

quarterly newsletters to their investors.

In the meantime, new investors are informed about the material changes by way of

addendum to the offer document till the time offer document is revised and reprinted.

How to know the performance of a mutual fund scheme?

The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on

daily basis in case of open-ended schemes and on weekly basis in case of close-ended

schemes. The NAVs of mutual funds are required to be published in newspapers. The NAVs

are also available on the web sites of mutual funds. All mutual funds are also required to put

their NAVs on the web site of Association of Mutual Funds in India (AMFI)

www.amfiindia.com and thus the investors can access NAVs of all mutual funds at one place

The mutual funds are also required to publish their performance in the form of half-yearly

results which also include their returns/yields over a period of time i.e. last six months, 1

year, 3 years, 5 years and since inception of schemes. The mutual funds are also required to

send annual report or abridged annual report to the unit holders at the end of the year

Investors can compare the performance of their schemes with those of other mutual funds

under the same category. They can also compare the performance of equity oriented schemes

with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc.

How to know where the mutual fund scheme has invested money mobilised from the

investors?

The mutual funds are required to disclose full portfolios of all of their schemes on half-yearly

basis which are published in the newspapers. Some mutual funds send the portfolios to their

unit holders.

30

http://www.amfiindia.com/

http://www.amfiindia.com/



The scheme portfolio shows investment made in each security i.e. equity, debentures, money

market instruments, government securities, etc. and their quantity, market value and % to

NAV. These portfolio statements also required to disclose illiquid securities in the portfolio,

investment made in rated and unrated debt securities, non-performing assets (NPAs), etc.

If schemes in the same category of different mutual funds are available, should one

choose a scheme with lower NAV?

Some of the investors have the tendency to prefer a scheme that is available at lower NAV

compared to the one available at higher NAV. Sometimes, they prefer a new scheme which is

issuing units at Rs. 10 whereas the existing schemes in the same category are available at

much higher NAVs. Investors may please note that in case of mutual funds schemes, lower

or higher NAVs of similar type schemes of different mutual funds have no relevance. On the

other hand, investors should choose a scheme based on its merit considering performance

track record of the mutual fund, service standards, professional management, etc. This is

explained in an example given below.

Suppose scheme A is available at a NAV of Rs.15 and another scheme B at Rs.90. Both

schemes are diversified equity oriented schemes. Investor has put Rs. 9,000 in each of the

two schemes. He would get 600 units (9000/15) in scheme A and 100 units (9000/90) in

scheme B. Assuming that the markets go up by 10 per cent and both the schemes perform

equally good and it is reflected in their NAVs. NAV of scheme A would go up to Rs. 16.50

and that of scheme B to Rs. 99. Thus, the market value of investments would be Rs. 9,900

(600* 16.50) in scheme A and it would be the same amount of Rs. 9900 in scheme B

(100*99). The investor would get the same return of 10% on his investment in each of the

schemes. Thus, lower or higher NAV of the schemes and allotment of higher or lower

number of units within the amount an investor is willing to invest, should not be the factors

for making investment decision. Likewise, if a new equity oriented scheme is being offered

at Rs.10 and an existing scheme is available for Rs. 90, should not be a factor for decision

making by the investor.

How to choose a scheme for investment from a number of schemes available?

31



As already mentioned, the investors must read the offer document of the mutual fund scheme

very carefully. They may also look into the past track record of performance of the scheme or

other schemes of the same mutual fund. They may also compare the performance with other

schemes having similar investment objectives. Though past performance of a scheme is not

an indicator of its future performance and good performance in the past may or may not be

sustained in the future, this is one of the important factors for making investment decision. In

case of debt oriented schemes, apart from looking into past returns, the investors should also

see the quality of debt instruments which is reflected in their rating. They may also seek

advice of experts.

Are the companies having names like mutual benefit the same as mutual funds

schemes?

Investors should not assume some companies having the name "mutual benefit" as mutual

funds. These companies do not come under the purview of SEBI. On the other hand, mutual

funds can mobilise funds from the investors by launching schemes only after getting

registered with SEBI as mutual funds.

Is the higher net worth of the sponsor a guarantee for better returns?

In the offer document of any mutual fund scheme, financial performance including the net

worth of the sponsor for a period of three years is required to be given. The only purpose is

that the investors should know the track record of the company which has sponsored the

mutual fund. However, higher net worth of the sponsor does not mean that the scheme would

give better returns or the sponsor would compensate in case the NAV falls.

Can an investor appoint a nominee for his investment in units of a mutual fund?

Yes. The nomination can be made by individuals applying for / holding units on their own

behalf singly or jointly. Non-individuals including society, trust, body corporate, partnership

firm, Karta of Hindu Undivided Family, holder of Power of Attorney cannot nominate.

If mutual fund scheme is wound up, what happens to money invested?

32



In case of winding up of a scheme, the mutual funds pay a sum based on prevailing NAV

after adjustment of expenses. Unit holders are entitled to receive a report on winding up from

the mutual funds which gives all necessary details.

Short-Comings in Operation of Mutual Fund

The mutual fund has been operating for the last five to six years. Thus, it is too early to

evaluate its operations. However one should not lose sight to the fact that the formation years

of any institution is very important to evaluate as they could be able to know the good or bad

systems get evolved around this time.

Following are some of the shortcomings in operation of mutual fund.

1. The mutual funds are externally managed and do not have employees of their own. Also

there is no specific law to supervise the mutual funds in India. While UTI is governed by its

own regulations, the banks are supervised by Reserved Bank of India, the Central

Government and insurance company mutual regulations funds are regulated by Central

Government.

2. Sponsorship of mutual funds has a bearing on the integrity and efficiency of fund

management which are key to establishing investor's confidence. So far, only public sector

sponsorship or ownership of mutual fund organisations had taken care of this need.

3. At present, the investors in India prefer to invest in mutual fund as a substitute of fixed

deposits in Banks; About 75 percent of the investors are not willing to invest in mutual funds

unless there was a promise of a minimum return

4. Unrestrained fund rising by schemes without adequate supply of scripts can create severe

imbalance in the market and exacerbate the distortions

5. The increase in the number of mutual funds and various schemes have increased

competition. Hence it has been remarked by Senior Broker “mutual funds are too busy trying

to race against each other”. As a result they lose their stabilising factor in the market.

33





In the interest of investor protection, SEBI has been given wide-ranging power to oversee the

constitution as well as the operations of mutual funds. It is also empowered to impose penalty

on mutual funds if they fail to comply with its guidelines.

TYPES OF DISTRIBUTION CHANNELS

Individual agents

An agent is essentially broker between a fund and the investor. Mutual fund agents are not

exclusive but usually sell other financial products as well. The system has the advantage that

the distributor has a broader knowledge of financial services available, and is therefore

potentially in a position to act as investment advisors. Investors expect the right kind of

recommendations from the agents. However, the drawback can be converted into a benefit

for the funds, if the agents are properly trained in their role and responsibility as financial

advisors to investors.

Distribution companies

Availing of the services of established distribution companies is a practice accepted by

mutual funds internationally. This practice evolved with a view to circumvent the hugeadministrative mechanism required to support a large agent force. Instead of having to deal

with several agents, a fund can interact with a distribution company which has several

employees or sub-brokers under it. A distribution company usually manages distribution for

several funds simultaneously and receives commissioned for its service.

Banks and NBFCs

Banks are an important marketing vehicle for mutual funds, given that banks themselves

have a large depositor/client base of their own. Several banks, particularly private and

foreign banks are involved in fund distribution by providing services similar to those of

distribution companies, on a commission basis. Some NBFCs are also providing such

services.

35



Direct marketing

Direct marketing means that the mutual funds sell their own products without the use of any

intermediaries. Usually, this takes the form of the sales officers and employees of the AMC

who approach the investors and accept their contributions directly. However, in India,

independent agents may really be treated as a direct marketing channel, in the sense that they

do not form a well-knit independent and organised single entity and act more like fund

employees. Other channels like the distribution companies or banks or even stockbrokers are

clearly distinct and independent intermediaries.

Growth in Mutual Fund Industry

The Indian mutual funds industry is witnessing a rapid growth as a result of infrastructural

development, increase in personal financial assets, and rise in foreign participation. With the

growing risk appetite, rising income, and increasing awareness, mutual funds in India are

becoming a preferred investment option compared to other investment vehicles like Fixed

Deposits (FDs) and postal savings that are considered safe but give comparatively low

returns, according to “Indian Mutual Fund Industry”.

MF penetration is low at around 14% of GDP (GDP = Approx. Rs. 53 lakh crore - Source:

Statistical Outline of India 2008-09; Total Industry AUM = Rs. 7.4 lakh crore - Source:

AMFI). As per the Invest India Incomes and Savings Survey 2007 of individual wage

earners in the age group of 18 to 59 years, conducted by IIMS Data works, only 1.6 percent

are invested in mutual funds (Source: KPMG-CI I Report ) .

The Indian mutual funds retail market, growing at a CAGR of about 30%, is forecasted

to reach US$ 300 Billion by 2015.

Income and growth schemes made up for majority of Assets Under Management

(AUM) in the country.

36



At about 84% (as on March 31, 2008), private sector Asset Management Companies account

for majority of mutual fund sales in India.Individual investors make up for 96.86% of the

total number of investor accounts and contribute 36.9% of the net assets under management.

Year

Amount Rs. (cr.) private sector mutual funds Growth %

2005-06 231862 64.50

2006-07 326388 71.03

2007-07 505152 64.61

Size of Schemes

A study of the schemes launched by all mutual funds excluding UTI reveals the following:

37



a. Of the total number of schemes launched 84% are from Public sector mutual funds, while

remaking 16% are from Private sector mutual funds.

No. of schemes Corpus size

27 > - 50 Cr 28 50 – 100 Cr

23 100 – 200 Cr

12 200 – 500 Cr

05 < - 500 Cr

% of Public Sector Mutual

Fund

% of Private Sector Mutual

Fund

Corpus Size

57 60 > - 100 cr.

26 13 100 - 200 cr.

17 27 < - 200 cr.

Investor Profile

Investor profile of Indian Mutual Fund Industry shows dominance of individual investors

followed by Corporate. Trust and other investors respectively.

Investors % age

Individual 61

Corporate 27

Trusts 04

Others 08

Advantages of Mutual Funds:

• Professional Management - The primary advantage of funds (at least theoretically) is the

professional management of your money. Investors purchase funds because they do not have

the time or the expertise to manage their own portfolio. A mutual fund is a relatively

inexpensive way for a small investor to get a full-time manager to make and monitor

38



investments.

• Diversification - By owning shares in a mutual fund instead of owning individual stocks or

bonds, your risk is spread out. The idea behind diversification is to invest in a large number

of assets so that a loss in any particular investment is minimized by gains in others. In other

words, the more stocks and bonds you own, the less any one of them can hurt you (think

about Enron). Large mutual funds typically own hundreds of different stocks in many

different industries. It wouldn't be possible for an investor to build this kind of a portfolio

with a small amount of money.

• Economies of Scale - Because a mutual fund buys and sells large amounts of securities at a

time, its transaction costs are lower than you as an individual would pay.

• Liquidity - Just like an individual stock, a mutual fund allows you to request that your

shares be converted into cash at any time.

• Simplicity - Buying a mutual fund is easy! Pretty well any bank has its own line of mutual

funds, and the minimum investment is small. Most companies also have automatic purchase

plans whereby as little as $100 can be invested on a monthly basis.

Disadvantages of Mutual Funds:

• Professional Management- Did you notice how we qualified the advantage of professionalmanagement with the word "theoretically"? Many investors debate over whether or not the

so-called professionals are any better than you or I at picking stocks. Management is by no

means infallible, and, even if the fund loses money, the manager still takes his/her cut. We'll

talk about this in detail in a later section.

• Costs - Mutual funds don't exist solely to make your life easier--all funds are in it for a

profit. The mutual fund industry is masterful at burying costs under layers of jargon. These

costs are so complicated that in this tutorial we have devoted an entire section to the subject.

• Dilution - It's possible to have too much diversification (this is explained in our article

entitled "Are You Over-Diversified?"). Because funds have small holdings in so many

different companies, high returns from a few investments often don't make much difference

on the overall return. Dilution is also the result of a successful fund getting too big. When

money pours into funds that have had strong success, the manager often has trouble finding a

39



good investment for all the good money.

• Taxes - When making decisions about your money, fund managers don't consider your

personal tax situation. For example, when a fund manager sells a security, a capital-gain tax

is triggered, which affects how profitable the individual is from the sale. It might have been

more advantageous for the individual to defer the capital gains liability.

Chapter III: Banking Industry

Today the Indian banking system is among the best in the world and the years to come may

see them taking on the global behemoths. Banking system occupies an important place in a

nation’s economy. It plays a pivotal role in the economic development of a country and

forms the core of the money market in an advanced country.

They are the biggest purveyors of credit, and they also attract most of the savings from the

population. Dominated by public sector, the banking industry has so far acted as an efficient

partner in the growth and the development of the country. Government took major steps in

the Indian Banking Sector Reform after Independence. Two phases of nationalization,

introduction of Regional Rural Banks in 1975 (to focus on rural spread on banking) and

permission to new private banks to set up operations since 1993-94 are some of the major

changes undergone.

Apart from the traditional functions of a commercial bank, they are taking steps to build

themselves into a one stop financial centre wherein all the financial products would be

available. Banks have started catering to the retail segment to improve their deposit portfolio.

Banks traditionally involved in working capital financing have started offering consumer

loans and housing loans. Some of the banks have started offering travel loans as well. Retail

financing is the other area where the banks have started to concentrate. In order to have a

maximum share in this segment, most of the banks have been introducing new products. The

delivery channels have also been shifted from branches to ATMs, phone banking, net

banking, Electronic Fund Transfer, Electronic Cheque etc.

40



Technology has become an important medium of not only attracting new customers but also

in retaining them. The new generation private sector banks have made a strong presence in

the most lucrative business areas in the country because of technology upgradation.

Mergers and Acquisitions have also started playing their role in the banking industry wherelots of players are trying to consolidate their position. The recent merger of HDFC Bank with

Centurion Bank of Punjab and ICICI Bank with Bank of Madura are important steps in this

direction. In recent times, most of the new private sector banks have shown interest in

inducting a foreign partner in their operations. Most of the banks have entered the insurance

business and as they already have an extensive distribution network, this new business has

resulted in substantial revenues. But with most of the top league players planning to enter this

business, the more efficient and pro active players would be able to take a lead.

As the central bank of the country the Reserve Bank of India performs both the traditional

functions of a central bank and a variety of developmental and promotional functions. The

Reserve Bank of India Act, 193 confers upon it the powers to act as note-issuing authority,

banker’s bank and banker to the government.

MAJOR BANKING SERVICES

Bank Account

The most common and first service of the banking sector. There are different types of bank

account in Indian banking sector. The bank accounts are as follows:

Bank Savings Account - Bank Savings Account can be opened for eligible person / persons

and certain organisations / agencies (as advised by Reserve Bank of India (RBI) from time to

time)

Bank Current Account - Bank Current Account can be opened by individuals / partnership

firms / Private and Public Limited Companies / HUFs / Specified Associates / Societies /

Trusts, etc.

Bank Term Deposits Account - Bank Term Deposits Account can be opened by

individuals / partnership firms / Private and Public Limited Companies / HUFs/ Specified

Associates / Societies / Trusts, etc.

41



Bank Account Online - With the advancement of technology, the major banks in the public

and private sector has facilitated their customer to open bank account online. Bank account

online is registered through a PC with an internet connection. The advent of bank account

online has saved both the cost of operation for banks as well as the time taken in opening an

account.

Credit Card

Credit cards in India are gaining ground. A number of banks in India are encouraging people

to use credit card. Credit card in India became popular with the introduction of foreign banks

in the country. Credit cards are financial instruments, which can be used more than once to

borrow money or buy products and services on credit. Basically banks, retail stores and other

businesses issue these. Some examples of major banks issuing credit cards in India are SBI

credit card, Bank of Baroda credit card, ICICI credit card, HSBC credit card, ABN AMRO

credit card etc. Some of the plus features of credit card in India are hotel discounts, travel

fare discounts, lost baggage insurance, Accident insurance, Household insurance etc.

Loans

The following loans are given by almost all the banks in the country:

Personal Loan: One can get a sanctioned loan amount between Rs 25,000 to 10, 00,000

depending upon the profile of person applying for the loan. SBI, ICICI, HDFC, HSBC are

some of the leading banks which deals in Personal Loan.

Car Loan: Almost all the banks have jumped into the market of car loan which is also

sometimes termed as auto loan. It is one of the fast moving financial product of banks. Car

loan / auto loan are sanctioned to the extent of 85% upon the ex-showroom price of the car

with some simple paper works and a small amount of processing fee.

Home loan: Is the latest craze in the banking sector with the development of the

infrastructure. Now people are moving to township outside the city. More number of

townships are coming up to meet the demand of 'house for all'. The RBI has also liberalised

the interest rates of home loan inorder to match the repayment capability of even middle

42



class people. Almost all banks are dealing in home loan today.

Educational loan: It can also be termed as student loan; is a good banking product for the

mass. Students with certain academic brilliance, studying at recognised colleges/universities

in India and abroad are generally given education loan / student loan so as to meet the

expenses on tuition fee/ maintenance cost/books and other equipment.

Money Transfer

Beside lending and depositing money, banks also carry money from one corner of the globe

to another. This act of banks is known as transfer of money. Banks generally issue Demand

Drafts, Banker's Cheques, Money Orders or other such instruments for transferring the

money. This is a type of Telegraphic Transfer or Tele Cash Orders. It has been only a couple

of years that banks have jumped into the money transfer businesses in India. The

international money transfer market grew 9.3% from 2003 to 2004 i.e. from US$213 bn. to

US$233 bn. in 2004. Economists say that the market of money transfer will further grow at a

cumulative 10.1% average growth rate through 2008. This service provides peace of mind to

either the NRIs or to the visitors to India. The Banks that have been into the business of

money transfer in India are Allahabad Bank, Bank of America (Asia) Ltd., Central Bank of

India, HSBC, Development Credit Bank, Export-Import Bank of India, Indian Overseas

Bank, Reserve Bank of India, Punjab National Bank and State Bank of India.

Challenges facing Banking industry in India

The banking industry in India is undergoing a major transformation due to changes in

economic conditions and continuous deregulation. These multiple changes happening one

after other has a ripple effect on a bank (Refer fig. 2.1) trying to graduate from completely

regulated sellers market to completed deregulated customers market.

43



Deregulation: This continuous deregulation has made the Banking market extremely

competitive with greater autonomy, operational flexibility, and decontrolled interest rate and

liberalized norms for foreign exchange. The deregulation of the industry coupled with

decontrol in interest rates has led to entry of a number of players in the banking industry. At

the same time reduced corporate credit off take thanks to sluggish economy has resulted in

large number of competitors battling for the same pie.

New rules: The market place has been redefined with new rules of the game. Banks are

transforming to universal banking, adding new channels with lucrative pricing and freebees

to offer. Natural fall out of this has led to a series of innovative product offerings catering to

various customer segments, specifically retail credit.

Efficiency: This in turn has made it necessary to look for efficiencies in the business. Banks

need to access low cost funds and simultaneously improve the efficiency. The banks are

facing pricing pressure, squeeze on spread and have to give thrust on retail assets

44



Diffused Customer loyalty: This will definitely impact Customer preferences, as they are

bound to react to the value added offerings. Customers have become demanding and the

loyalties are diffused. There are multiple choices; the wallet share is reduced per bank with

demand on flexibility and customization.

Misaligned mindset: These changes are creating challenges, as employees are made to adapt

to changing conditions. There is resistance to change from employees and the Seller market

mindset is yet to be changed coupled with Fear of uncertainty and Control orientation.

Acceptance of technology is slowly creeping in but the utilization is not maximised.

Competency Gap: Placing the right skill at the right place will determine success. The

competency gap needs to be addressed simultaneously otherwise there will be missed

opportunities. The focus of people will be on doing work but not providing solutions, on

escalating problems rather than solving them and on disposing customers instead of using the

opportunity to cross sell.

Strategic options with banks to cope with the challenges

Leading players in the industry have embarked on a series of strategic and tactical initiatives

to sustain leadership. The major initiatives include:

• Investing in state of the art technology as the back bone of to ensure reliable service

delivery.

• Leveraging the branch network and sales structure to mobilize low cost Current and

savings deposits.

• Making aggressive forays in the retail advances segment of home and personal loans

• Implementing organization wide initiatives involving people, process and technology

to reduce the fixed costs and the cost per transaction.

• Focusing on fee based income to compensate for squeezed spread, (e.g. CMS, trade

services).

• Innovating Products to capture customer ‘mind share’ to begin with and later the

wallet share.

45



CONCLUSION:

Comparison between types of investments

Fixed Deposits versus Mutual Funds

Fixed Deposits are the favorite for low risk profile people but who are unaware about the

Mutual Fund product that can also provide similar capital guarantee as well as more returns

compare with FD's. A comparison of both will give an exact idea about both instruments to

these guys.

1. FD is a pure debt instrument with enough guarantee to the capital. This is a suitable

investment instrument for those who have very low risk profile and are always worrying

about any kind of loss of their money. Mutual Funds provide an option to an investor to

select funds depending on their risk taking capacity. Money market, debt and liquid funds are

good for low risk profile investors to park their money and sleep well. Equity, diversified and

balanced fund options are there for investors who are ready to take risk as well as get good

returns compare with the previous options.

2. Mutual fund returns to an investor is upon his fund selection and performance of that fund.

Good diversified Mutual funds are able to deliver 8% to100% returns to investor in the place

of an FD that can provide maximum 10 to 12% returns to the customer. Debt mutual funds

are better than FD returns because they can go till 15% if the fund is a good one.

3. Returns from Mutual Fund investment are calculated on the compounded basis but, FD

returns are in flat rate.

Life insurance versus mutual fund

Unit-linked plans are only if you want insurance cover and not as an investment avenue to

participate in the equity or debt market. How can one compare them as both these

instruments are designed to serve different purposes and are not comparable which are

aggressively promoted as investment products?

1. A unit-linked plan from an insurance company is an insurance policy designed to pay a

lump sum on maturity or on death if earlier. Premium paid under these plans is eligible for

46

http://technorati.com/tag/money+market

http://technorati.com/tag/investment

http://technorati.com/tag/money+market

http://technorati.com/tag/investment



tax deduction under Section 88 of the Income Tax Act. On the other hand, mutual funds are

investment avenues to participate in the growth of financial markets and do not provide any

tax deduction (except ELSS and pension funds).

2. For a unit-linked insurance plan, providing life cover is the most important function;

returns are just an added benefit, which gets magnified, given the tax rebates. Though unit-

linked plans offer transparency in returns in terms of net asset value and flexibility in

investment options in debt, equity or a mix of both, these advantages remain secondary.

Whereas for a mutual fund, the main objective is to provide returns.

3. Moreover, unit-linked plans are not as liquid as mutual funds. There is a lock-in of three

years. Even if one redeems after three years, you would be at a loss because of higher initial

administrative charges. For Example

MFs Vs Unit-linked Plans: A Comparison

Equity Mutual funds Equity-linked Insurance Plans

Initial load/administrativecharges 0-2%

20-27% of premium for theinitial few years

Annual expenses/adm. Charges

1.0-2.5% (including mgmt.fee)

A flat charge of Rs 180-240 per year

Management fee 0.8-1.5% 0.80-1.25%

Life cover Nil Yes

Lock-in Nil 3 years

Unit-linked plans and mutual funds invest in the same financial markets. If the equity market

is doing well, both equity-linked insurance plans and equity mutual funds will do well. But as

an investment tool, you would be better off investing in mutual funds rather than unit-linked

plans due to high fees charged by insurance companies. However, one has to forego that for

the life cover that they offer. Thus, by design, unit-linked plans and mutual funds are notcomparable and are meant to suit different objectives.

Fixed Deposit versus Unit-Linked Insurance plans

47



A good investment strategy requires choosing the right mix of safe and risky investments.

Among safe investments, fixed deposits (FD) are the most popular. But think before

investing in FD because there are some other investment avenues that provide you much

better returns such as ULIPs.

1. With FDs you deposit a lump sum of money for a fixed period ranging from a few weeks

to a few years and earn a pre-determined rate of interest. In ULIP you invest money regularly

and after a period of time you will receive the lump sum amount. The return on ULIPs will

be normally greater than the return on FD.

2. The returns on ULIPs are normally higher than the mutual funds as they do not face

redemption pressures as the insurance money is for longer term and hence offers room for

fund managers to design better, disciplined investment strategies.

3. Unit-linked insurance plans have caught the fancy of investors in urban centers. ULIPs

not only provided life cover, but also brought in a lot of transparency in the way the

policyholders' money is invested. Birla Sun Life Insurance Company revolutionalized the life

insurance industry in India with its decision to offer only ULIPs

Bibliography

Invest India by DR. Uma Shashikant.

48



Banking Law and Practice by P.N.Varshney

www.ficci.com

http://moneycontrol.com/mf/index.php

http://valueresearchonline.com

http://www.sebi.gov.in/Index.jsp?contentDisp=MutualFunds

www.outlookmoney.com

www.amfi.com

www.investor.com

www.rbi.org.in

www.irda

2007

49

http://www.outlookmoney.com/

http://www.investor.com/

http://www.rbi.org.in/

http://www.irda/

http://www.outlookmoney.com/

http://www.investor.com/

http://www.rbi.org.in/

http://www.irda/



2008

Documents

Final Project - FINANCIAL MARKETS IN INDIA AND ITS COMPARISON