Basics of Capital Market and Money Market:1

Since the beginning of the process of liberalization, globalization and other reforms in various sectors of the economy in 1991, the character, complexion and profile  of the Indian Financial Markets have undergone cataclysmic changes.  The Indian financial market is now integrated with the global financial markets more directly than at any point of time in the past.  The policy of the Government of India, Reserve Bank of India, SEBI and the provisions of the Companies Act are all now being fine tuned in line with international practices of  accounting, transparency, disclosure, risk management  and corporate governance etc to take care of interest of all the stake holders in financial markets and also to provide stability,  depth and width to the system.

Often the terms ‘Financial Markets’ and ‘Capital Markets’ are used interchangeably and for many, ‘Financial markets’ mean only ‘Capital markets’, but internationally, Capital Market is only a small  part of the financial market.

The major constituents of financial markets are:

1.    Capital market: Equity and Debt Market
2.    Money market
3.    Credit Market
4.    Foreign exchange markets
5.    Securitisation, Factoring and Forfaiting Markets
6.    Commodities futures markets
7.    Financial Options and derivatives markets
8.    Overseas financial markets for Indian Corporates viz. Debt Market/Equity Market.

In this article, the working of the capital and money markets have been explored.  The discussions are restricted basically  to the operations of banks in these markets.  Because of the challenges thrown open by the process of competition in the credit market and imposition of prudential norms for classification, valuation and operations of investment portfolio by banks, they have to concentrate more on investment in capital and money markets compared to credit markets. Even though CRR/SLR requirements have been reduced drastically, the bank’s investment in SLR securities these days  are much higher than the prescribed requirements

1.    Capital Market:

The Capital market consists of the Equity market  and the debt market. While shares are traded in equity market,  bonds and other debt instruments are traded in the debt markets. Again in both equity market and debt market, there are Primary and Secondary Markets.  The Primary market consists of issue of initial public offers wherein the issuer directly allots the shares/debt to the investor.  In the secondary market, one investor sells to another investor through the  stock exchange. 

In the Primary Capital Market, the public issue could be either equity i.e. equity shares or debts like debentures, bonds etc.

Again, the public issue can be kept open to public or on  private placement basis.  In private placement, specified informed  investors invest i.e. the general public or individual investors are not allowed to invest.  In such cases the issue is also not publicized. 

Primary issue could be at par i.e. is sold at the face value of the share/debenture or it could be at a premium or discount.    The primary issue is publicized by issue of an offer document called prospectus containing  the details of the issue and the past performance/future plans of the issuer.  Public issues are offered by public limited companies. 

The structure of the capital market is given in the following chart :

Chart
Basics of Capital Market and Money Market:1

Need for Capital Markets:

1.    Capital Market ensure wide spread shareholdings i.e. the ownership of wealth is distributed and dispersed.
2.    It is possible to mobilize funds from various investors through the existence of capital markets.
3.    Capital market helps companies to establish brand equity. It helps the companies to mobilize funds for their expansion etc.
4.    It helps the growth in economy. The aim of the capital market is to bridge gap between the savers and investors
5.    Capital Markets enable good Corporate Governance.  The companies are forced to ensure transparency in accounts etc.
6.    Existing profit making  and dividend paying companies are enabled  to issue shares at a premium..
7.    Through capital markets, companies are in a position to directly borrow from the market through debt instruments or increase their equity through equity issue.  Companies with good track record are in  a position to raise funds at reasonably cheaper rates.
8.    Companies have the option to go in for equity or debt instruments instead of resorting to costly outside borrowings
9.    In case of borrowed funds, companies have to service the interest periodically say monthly or quarterly.  But in case of equity issue, the outflow is only in the form of dividend and is normally paid once a year.
10.    It helps the companies to raise their equity and reduce their debt equity ratio.
11.    Similarly, in case of debentures, companies are in a position to raise debt at reasonably low rates of interest.  In case of convertible debentures, conversion can be planned according to the  convenience of the company depending upon the time frame to increase the equity capital.
12.     It gives liquidity to the investors

Incidentally, Ministry of Finance, Government of India and also Exchange Control Department, Reserve Bank Of India  have liberalized the process of Indian Corporates accessing the overseas market for raising equity through ADR/GDR route. Even ADR/GDR now have been made two-way fungible.

History of Indian Capital Markets and role of SEBI:

The Indian capital market is one of the oldest, being  more than 125 years old.  BSE was established in 1875 as Native Share and Stockbrokers Association.   The framework of regulation of securities was originally controlled by the Companies Act 1956 and the Securities Contracts Regulation Act 1956. In 1992, the Government abolished the Controller of Capital Issues to allow free pricing of issues. SEBI (Securities and Exchange Board of India) was formed in 1988 through an administrative order, and it became a statutory body in 1992. The SEBI is governed by a six member Board of Governors appointed by the GOI and RBI.  Its objective is to protect the investors and to regulate the financial system in order to bring about a healthy development. It has wide powers to issue rules, regulations and guide lines in respect of both the primary and secondary market, intermediaries like brokers, merchant bankers, underwriters, bankers to the issue etc.   Thus SEBI brings primary and secondary market intermediaries in  to a regulatory framework.

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