Essay on the Concept and Structure of Indian Capital Market

Normally, a business enterprise needs finance for two purposes: (i) for buying capital equipment and fixed assets, such as machinery, tools and implements, power plant, construction of factory building and workshops, etc.; which are referred to as long-term capital requirements, and (ii) for buying raw materials, holding the stock of finished goods, for payment of wages, etc., which are referred- to as short-term capital requirements.

Thus, an industrial house has to borrow short-term funds as well as long-term funds. The money-market caters to the short-term needs only. The long-term capital needs are satisfied by the capital market.

Concept of Capital Market:

The term “capital market” is used to describe the institutional arrangements for facilitating the borrowing and lending of long-term funds.

Usually, stress is laid on the markets for long-term debt and equity claims, government securities, bonds, mortgages, and other instruments of long-term debts.

Thus, the capital market embraces the system through which the public takes up long-term securities, either directly or through intermediaries.

It consists of a series of channels through which the savings of the community are mobilised and made available to the entrepreneurs for undertaking investment activities.

Conventionally, short-term credit contracts are usually classified as money market instruments, while long- term debt contracts and equities are regarded as capital market instruments.

In practice, however, there is a thin line of demarcation between the money market and the capital market, because, quite often, the same institutions participate in the activities of both the markets, and there is flow of funds between the two markets.

Institutional Structure of Indian Capital Market:

The structure of any capital market is composed of the sources of demand for, and supply of, long- term capital (money capital).

The Demand for Capital:

The demand for capital comes from various categories of borrower such as the central and state governments, local authorities and private industrial and manufacturing groups (joint- stock companies).

In India, the government constitutes an important source for demand of capital funds on account of widespread expansion of the public sector initiated by the planning era.

There has been an increasing trend of public borrowings in the country during the last three decades.

The central and state governments as well as local public bodies have floated loans by issuing securities, bonds, etc., the durations of which range from five to fifteen years.

In the private sector, a large demand for long- term capital comes from the joint-stock companies. These companies raise funds by the following methods: (i) issuing shares, (ii) selling debentures, (iii) borrowing from specialised financial institutions called “Development Banks”, and (iv) inviting fixed deposits from the general public.

The local public bodies such as municipal corporations, etc. have also been borrowing on a large scale in recent years. They borrow in order to finance lumpy capital expenditure.

In particular to cover a planned expenditure, local bodies resort to the capital market. According to the study by the Reserve Bank of India on this issue, the outstanding debt of local bodies has increased from Rs. 89.5 crores in 1951 to Rs. 283 crore by 1965, registering a three-fold rise in the process.

The Supply of Capital:

There are many channels for the supply of funds to the capital market. A large part of the funds is obtained directly from individual investors through equity capital.

There are specialised financial institutions such as the development banks, which also supply capital funds to industries.

In India, there are terms financing institutions like the Industrial Reconstruction Corporation of India, and the Unit Trust of India, which are playing a very significant role in industrial finance since Independence.

It reveals the trend of loans sanctioned to the industrial sector by Term Financing Institutions.

In the capital market of India, there are other sources known as financial intermediaries. These are the Life Insurance Corporation and other insurance companies.

It may be observed that within two years (1978- 80), the loans sanctioned by the term financing institutions had increased by more than 60 per cent.

Again, in recent years, Provident Funds are becoming a very significant medium of saving for the working classes, but their money does not flow into the private sector investment market, because it is mostly invested in government securities, government small savings, and other trustee securities.

In recent years, commercial banks are also indirectly coming into the picture of the capital market.

Though, basically, commercial banks are confined to short-term lending, they are, at present, showing an interest in catering to the medium and long-term credit needs of industry and agriculture, through subscribing to the share capital and debentures of special financial institutions like IFCI, SFCs and ICICI.

Again, banks underwrite shares and the debentures issued by joint-stock companies. There are, however, certain inherent factors which restrict the scope of Indian commercial banks in the field of term financing.

Firstly, the liquidity rate of commercial banks is under pressure on account of slower rate of deposit growth against the upsurge of demand for credit by the industrial sector.

Secondly, term-lending, being a specialised task, cannot be easily undertaken by every bank or every branch of a bank.

Thirdly term-lending involves high risks. The Reserve Bank of India, however, remarks that “there is scope for commercial banks’ extension of medium term credits, within the limits, which safeguard their liquidity, in view of their greater experience in the finance of working capital requirements, their closer knowledge of the credit worthiness of borrowers and absence of rigid procedural delays in their dealings.”