In
general term finance means management of money for your expenses. Finance is
also a money budget management. In broad
term finance is the science of funds management. The field of finance deals
with how money is spent and budgeted. It also deals the concepts of time, money
and risk and how they are interrelated. Finance includes saving money and often
includes lending money. The general areas of finance are business finance,
personal finance, and public finance. Finance is used by individuals as
personal finance, by governments as public finance, by businesses as corporate
finance, as well as by a wide variety of organizations. Finance is the need of
the today world economy. A financial system is a network of
financial institutions, financial markets, financial instruments and financial
services to facilitate the transfer of funds. The system consists of savers,
intermediaries, instruments and the ultimate user of funds. The level of
economic growth largely depends upon and is facilitated by the state of
financial system prevailing in the economy. Efficient financial system. India
has a financial system that is regulated by independent regulators in the
sectors of banking, competition, insurance, capital markets, and different
services sectors. In finance, the financial system is the system that allows
the transfer of money between savers and borrowers. It comprises a set of
complex and closely interconnected financial institutions, services, markets,
instruments practices, and transactions. In Banking finance, the
financial system is the system that allows the transfer of money between savers
and borrowers. It comprises a set of complex and closely interconnected
financial institutions, markets, instruments, services, practices, and
transactions. Financial systems are crucial to the allocation of resources in a
modern economy. They channel household savings to the corporate sector and
allocate investment funds among firms; they allow intertemporal smoothing of
consumption by households and expenditures by firms; and they enable households
and firms to share risks. These functions are common to the financial systems
of most developed economies. Yet the form of these financial systems varies
widely.
---------------------------------------------------------------------------------------------------------------------Associate
Professor, Economics & Banking Deptt. Dr. Subhash Mahila College,Junagadh.
The
Indian banking sector has been remarkably successful
in some respects. Its immense size and enormous penetration in rural areas are
exemplary among developing countries, as is its solid reputation for stability
among depositors. The penetration in rural areas has been associated with a
reduction of poverty and a diversification out of agriculture (Burgess and
Pande, 2003). However in recent years it has been widely viewed as being both
expensive and inept. In particular it has been argued that most banks are
overstaffed,
that a large fraction of their assets are non-performing (NPA) and that they
under-lend, in the sense of not putting enough effort
into their primary task of financing industry (Narasimhan committee, Government
of India, 1991). A wide range of remedies have been suggested ranging from
strengthening the legal system to punish defaulters, to abolishing the targeted
lending programs (the so-called priority sector rules), to privatization of the
entire banking system
1. Types
of finance found in the current economy--
There are
mainly 2 types of finance found in the current economy. They are a personal
finance and a corporate finance.
*Personal-finance
In
this finance decisions may involve paying for education, financing durable
goods such as real estate and cars, buying insurance, e.g. health and property
insurance, investing and saving for retirement. Personal financial decisions
may also involve paying, for a loan or debt obligations.
*Corporate-finance
It is the task of providing the funds for a corporation's activities.
Corporate finance can easily categorize in two categories. First one is Short
term finance which generally involves balancing risk and profitability, while
attempting to maximize an entity's wealth and the value of its stock. Long term
funds are provided by ownership equity and long-term credit, often in the form
of bonds. The balance between these forms the company's capital structure.
Short-term funding or working capital is mostly provided by banks extending a
line of credit.
2.STRUCTURE
OF FINANCIAL SYSTEM IN INDIA Financial structure
refers to the mix of financial institutions, instruments and markets that
channel savings and other funds to businesses and other borrowers. In a
bank-based system, banks play the major role in channeling funds to businesses.
In a market-based system, capital market including the stock and bond markets is
the more important source of funds.
*Financial
Institution: - Financial
Institution can be classified as banking and non banking institutions. Banking
Institutions are creators and purveyors of credit while non banking financial
institution are purveyors of credit.
*Financial Markets: - Financial Markets can be classified as
primary and secondary markets. A Primary Market deals with new issues and
secondary markets is meant for trading in existing securities.
*Financial
Instruments: - A financial
instrument is a claim against an institution or a person for payment at a
future date of a sum of money in the form of dividend.
Financial Services:
- Financial services are those, which help with borrowing and funding, buying
and selling securities, lending and investing, making and enabling payments and
settlements and managing risk exposures in financial markets.
3. IN INDIA THE FUNCTIONS OF
FINANCING SYSTEM
Functions performed by financial system are:
•Saving function: Public saving find their way into the hands of
those in production through the financial system. Financial claims are issued
in the money and capital markets which promise future income flows. The funds
with the producers result in production of goods and services thereby increasing
society living standards.
•Liquidity function: The financial markets provide the investor
with the opportunity to liquidate investments like stocks bonds debentures
whenever they need the fund.
•Payment function: The financial system offers a very convenient
mode for payment of goods and services. Cheque system, credit card system etc
are the easiest methods of payments.The cost and time of transactions are
drastically reduced.
•Risk function: The financial markets provide protection against
life, health and income risks. These are accomplished through the sale of life
and health insurance and property insurance policies. The financial markets
provide immense opportunities for the investor to hedge himself against or
reduce the possible risks involved in various investments.
• Policy function: The government intervenes in the financial
system to influence macroeconomic variables like interest rates or inflation so
if country needs more money government would cut rate of interest through
various financial instruments and if inflation is high and too much money is
there in the system then government would increase rate of interest.
4.
METHODS OF FINANCE—
Financial controls and monitoring
methods have a dual role in supporting internal needs & external requirements. There are five key
aspects to financial controls and monitoring. These include:
*Accounting
Records (or Accounts Receivable and
Payable):Establish a process that records every financial transaction by
maintaining paper files, an electronic database, and copying all records in a
virtual library. Accounting records should be consistent. Choose a method and
regular schedule for tracking income and expenses that works for your
organization. .
Your organization needs to be able to demonstrate what funds were
received and how funds were spent. Accounting records should be
consistent. Choose a method and regular schedule for tracking income and
expenses that works for your organization. This is important in case
the organization is audited or if a funder requests information for a
specific item or transaction. A system should also be developed
to track donations from individuals to keep donors updated of the organization’s
progress or to solicit annual and repeat contributions. A separate
accounting system should be developed for funding from foundations with
the original proposal and budget, dates of receipt of funds, notes
on allowable expenditures, and reporting requirements so that you can
respond to funders’ requests for financial records or in case of audits
*Financial
Planning: Financial planning converts an organization’s
objectives into a budget. Financial planning allows you to review your
organization, examining successes and challenges in the past. Planning also
enables you to make projections and set targets, informing strategies for
future success. .
*
Asset-based
lending - A secured business loan in which
the borrower pledges as collateral any assets used in the conduct of his/her
business.
*Capital
budget - A plan to finance long-term outlays,
such as for fixed assets like facilities and equipment
5. DATA OF A BETTER
PERFORMING INDIAN PUBLIC SECTOR BANK-
We use data from loan portfolios of a
better-performing Indian public sector bank.The loan folders include
information on profit, sales, credit sanctions, and interest rates, as well as
figures loan officers are
required to calculate (e.g. his projection of the bank’s future turnover, his
calculation of the bank’s credit needs, etc.) to determine the amount to be
lent. Our sample includes 253 firms (including 93 newly eligible firms), from
1997 to 1999.Through much of this section we will estimate an equation of the
form
yit − yit−1 = αyBI Gi + βyP
OS Tt + γyBI Gi ∗ P OS Tt + ²yit
with y taking the role of
the various outcomes of interest (credit, revenue, profits, etc.) and the dummy P
OS T representing the post January
period. We are in effect comparing how the outcomes change for the big firms after January,
with how they change for the small firms. Since y is always a growth rate, this
is, in effect, a triple difference–we can allow small firms and big
firms have different rates
of growth, and the rate of growth to differ from year to year, but we assume that there would have been no
differential changes in the rate of growth
of small and large firms in the year., absent the change in the priority sector
regulation. Using, respectively, the log of the credit limit and the log of
next year’s sales (or profit) in place of y in equation 1, we obtain the first
stage and the reduced form of a regression of sales on credit, using the
interaction BI G ∗ P OS T as an instrument for
credit.
RESULTS
1. Estimation of equation 1 using bank credit as the outcome shows
that the change in the regulation greatly affected who got priority sector credit. The sample of firms where
there was a change in credit limit,
the coefficient of the interaction BI
G ∗ P OS T is
0.24, with a standard error of 0.09.
2.This increase in credit was not accompanied by a change in
the rate of interest It did not lead
to reduction in the rate of utilization of the limits by the big firms the ratio
of total turnover (the sum of all debts incurred during the year) to credit
limit is not associated with the interaction BI G ∗ P OS T. The additional credit limit
thus resulted in an increase in bank credit utilization by the firms. This
additional credit in turn led to an increase in sales.
The coefficient of the interaction BI G ∗ P OS T in the sales equation, in the
sample where the limit was increased, is 0.21, with a standard error of 0.09
3 .By contrast, in the sample where there was no increase in limit, the interaction BI G ∗ P OS T is close to zero (0.05) and
insignificant which suggests that the result is not driven by a failure of the
identification assumption.
The coefficient of the interaction BI G ∗ P OS T is 0.24 in the credit regression, and 0.21 in the sales
regression:
Thus, sales increased almost as fast as loans
in response to the reform. This is an indication that there was no substitution
of bank credit for non-bank credit as a result of the reform, and that firms are
credit constrained.we present the effect of the reform on profit. The effect is even bigger than that of sales: 0.75, with a standard error
of 0.38. Note that the effect of the reform on profit is due to the gap between the marginal
product of capital and the bank interest rate: in other words, it combines the
subsidy effect and the credit constraint effect. Even if firms were not credit
constrained, their profit would increase after the reform if more subsidized
credit is made available to them, because they substitute cheaper capital for
expensive capital. Here again, we see no effect of the interaction BI G ∗ P OS T in the sample without a change in limit .
6 FINANCING MONITORING AND REPORTING-
Drawing
from the information in the accounting records, an organization can create
internal reports that help monitor progress by comparing budgets to actual
expenses. Frequent reviews and monitoring allows the governing board and staff
to measure your organization’s progress and helps inform decision-making about
the organization’s or a project’s future. Internal reports, sometimes called
management reports allow you to be forward thinking as you assess the financial
status of the organization and what will be needed to realize your goals.
Accounting records are also the source for creating external financial reports
that demonstrate to funders and other stakeholders how funds have been spent.
Funders may require financial reports at the completion of the project or
periodically during the project’s implementation.
6.
GOVERNING BODY-
A governing board, whether comprised by
a board of directors or leadership from the community, serves as stewards of an
organization’s resources. Governing boards should participate in approving
budgets, financial monitoring and reviews, and agree upon and ensure that
internal controls are implemented. The board treasurer who has skills in
accounting should be the lead person in working with the staff in ensuring
financial accountability
7. INTERNAL CONTROLs
Controls are organizational practices that
help safeguard an assets and ensure that money is being handled properly.
Controls help detect errors in accounting, prevent fraud or theft, and help
support the people responsible for handling an organization’s finances.Financial
services refer to services provided by the finance industry. The finance
industry encompasses a broad range of organizations that deal with the
management of money. Among these organizations are banks, credit card
companies, insurance companies, consumer finance companies, stock brokerages,
investment funds and some government sponsored enterprises. As of 2004, the
financial services industry represented 20% of the market capitalization of the
S&P 500 in the United States. People used to
always use cash envelopes to control their monthly spending, but very few do in
today's card swiping culture. The envelope system is a key component of the
Total Money Makeover plan because it works.
8.POLICY
RESPONCES-
Credit in India
does not necessarily seem to flow to the people who have the greatest use for
it. It seems that making lending rules more responsive to current profits and
projections of future profits may be a way to both target better and guard
against potential NPAs, largely because 13poor profitability seems to be a good
predictor of future default. But choosing the right way to include profits in
the lending decision will not be easy. If a firm is and will continue to be
unprofitable, it makes sense to for the bank to seek to wind up the firm. On the
other hand, cutting off
credit to a profitable firm suffering
a temporary shock may push it into default. The difficulty lies in distinguishing the two. One
solution may be to categorize firms into three groups: (1) Profitable to highly
profitable firms. Here, lending should respond to profitability, with more
profitable firms getting more credit. (2) Marginally profitable to loss-making
firms that were recently highly profitable, but have been hit by a temporary
shock. For these firms the existing rules for lending might work well. (3) Firms
with a long track record of losses, or which have been hit by a negative
permanent shock (e.g., removal of tariffs
for a good in which For these firms, lending should be discontinued, though in a
way that offers enough
to the firm that it prefers to cooperate rather than default. Of course it is
not always going to be easy to distinguish permanent shocks from the temporary,
but loan officers should
use information from previous performance, as well as the experience of the
industry as a whole. If loan officers
are corrupt, or afraid to act for fear of appearing corrupt, it may not be
advisable to give them this additional responsibility, without changing the
incentive structure they face. A number of small steps that may go some
distance towards this goal. First, to
avoid a climate
of fear, there should be a clear separation between investigation of loans and
investigations of loan officers.
The loan should be investigated first (could the original sanction amount have
made sense at the time it was given, were there obvious warning signs, etc.).
Only if a prima facie case that the failure of the loan could have been
predicted can be made should the loan officer
know of the investigation. The authorization to investigate a loan officer should be based on the
most objective available measures of the life-time performance of the loan officer across all the loans
where he made decisions and weight should be given both to successes and
failures. A loan officer
with a good track record should be allowed a number of mistakes (andeven
suspicious looking mistakes) before he is open to investigation. Banks should
also create a division staffed
by bankers with high reputations with a mandate to make some high risk loans. Officers posted to this division
should be explicitly protected from investigation for loans made while in this
division. Giving banks a stronger incentive to lend by cutting the interest
rate on government borrowing will also help. The evidence reported above is
only suggestive, but it does indicate that lower government interest rates can
have a strong effect on
the willingness of bankers to make loans to the private sector. The one
reasonably effective
incentive system now in place is the rule that banks have to lend to the
priority sector–most public banks do lend the legally stipulated 40% to the
priority sector. While it is argued that priority sector loans are an inefficient allocation of capital
, our evidence suggests the contrary: priority-sector in our sample have very
high marginal products of capital, and while they are slightly more likely to
default, the amount of the default is smaller. There is therefore no reason to
believe that abolishing the priority sector will improve bank
performance
substantially, and it may end up reinforcing the tendency of the banks make
only conservative loans. We do think the
eligibility criteria for priority sector loans could be rationalized. For
example, based on the evidence above, we favor a higher limit for value of
plant and machinery. However, the increase of the limit could be combined with
a time limit for eligibility: after a certain number of years, firms should
establish a reputation as reliable borrowers, and begin borrowing from the
market. A priority sector client that has borrowed from a bank for some time
without convincing the bank of its creditworthiness is perhaps not worth
saving. Second, the size of the gap between the marginal product of capital and
the interest rate suggests the possibility of letting banks charge
substantially higher interest rates to the priority sector than they are
currently permitted, making it more attractive to lend to the priority sector.
This increase could be gradual, making it easier for the firm to endure early
growing pains. There is however a basic incentive problem in bank lending: to
diversify risks, banks should be large, but in large banks it is difficult for a loan officer to have any significant
stake in the profitability of the bank. Therefore bank privatization, and in
particular sale to large multinationals, is unlikely to solve the problem of
under-lending, though it will probably help This is not to defend the other
concessions to the priority sector–in particular the reservation of specific goods
for the priority sector. remove some of the most egregious examples of inaction
and surely reduce the degree of overstaffing.
It is probably also true that the public sector banks are more responsive to
the directives to carry out social banking than private banks will be: most of
the new private banks do not lend to the priority sector, instead placing an
equivalent amount of money in low-return government bonds. This simply
transfers the responsibility to identify and nurture new talent back to the government.
Privatization without stricter enforcement of the requirement to lend to the
priority sector will probably end up hurting the smaller firms. This is not to
say that privatization is not a reasonable option, but rather that it should be
accompanied by some efforts
to reach out more effectively
to the smaller and less well-established firms, not just on equity grounds, but also
because these firms may have the highest returns on capital. A possible step in
this direction would be to encourage established reputable firms in the corporate
sector as well as multinationals to set up small specialized companies whose
only job is to lend to smaller firms in a particular sector (and possibly in
particular locations).
CONCLUSION-
Just as organizations create a plan, it may wish to
Document its financial systems, its methods for financial Management and its plans
for sustainability. A written Document can serve as an important reference
point for an Organization and assist in the periodic reviews and Planning
sessions. It also helps build confidence among Stakeholders that one have a long-term vision and plan for an
organization’s operations. Employing
financial systems that help build checks and balances, support a program
planning ability, and increase a success with budgeting and assessing progress
in programming, can significantly advance an organization’s capacity to begin
thinking about long-term plans and financial sustainability. In other
words these would be the equivalents of the many finance companies that do
extensive lending all over India, but with links to a much bigger corporate
entity and therefore creditworthiness. The banks would then lend to these
entities at some rate that would be somewhat below the cost of capital (instead
of doing priority sector lending) and these finance companies would then make
loans to the firms in their domain, at a rate that is at most x per cent higher
than their borrowing rates. By being small and connected to a particular
industry, these finance companies would have the ability to acquire detailed
knowledge of the firms in the industry and would have incentives to make loans
that would appear adventurous to outsiders
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REFERENCES-
***Banerjee,
Abhijit (2003) “Contracting Constraints, Credit Markets, and Economic
Development,’ Econometric Society, Volume III. Cambridge University Press, pp.
1-46.
***Government
of India (1991) “Report of the Committee on the Financial Sector,” chairman M.
Narsimhan, Ministry of Finance, Delhi.
