Shift of Household Savings from Banks to Mutual Funds and Capital Markets including in futures and options (F&O)

Shift of Household Savings from Banks to Mutual Funds and Capital Markets including in futures and options (F&O)

Sub: Eco

Sec: Financial market

• Change in Consumer Behaviour:
  • Traditional Preference: Historically, households preferred banks for their savings.
  • Current Trend: Increasing shift towards capital markets and other financial intermediaries.
• Impact on Bank Deposits:
  • Decline in Share: Bank deposits, while still dominant, are declining in percentage of household financial assets.
  • Diversification: Savings are being increasingly allocated to Mutual Funds, Insurance Funds, and Pension Funds.
• Implications for Banking Sector:
  • Credit-Deposit Gap: Banks are turning to short-term borrowings and certificates of deposit to bridge the gap.
  • Liquidity Management Challenges: Increased sensitivity to interest rate movements.
• Need for Vigilance and Adaptation:
  • CASA Deposits: Shift away from Current Account Savings Account deposits.
  • Risk Management: Emphasis on improving credit underwriting standards and pricing of risks.
• Learning from Global Banking Crises:
  • US and Switzerland (2023): Highlighted risks and vulnerabilities in certain business models.
  • Resilience Building: Importance of learning from these crises to enhance banking sector resilience.
• Growth of F&O Trading:
  • Unexpected Increase: Significant rise in F&O trading volumes and losses, especially among young investors.
• Macro-Level Concerns:
  • Economic Disruption: Household savings diverted to speculative activities rather than capital formation.
  • Systemic Risk: The potential for a black-swan event and its implications on the capital market ecosystem.
• Data-Driven Regulation:
  • Flexible Approach: SEBI will adapt its views based on data and changing facts.
• Statistics on F&O Trading:
• Turnover Growth:
  • Index options turnover increased from ₹4.5 lakh crore (2018) to ₹140 lakh crore (2024).
  • Overall turnover in derivative segment increased from ₹210 lakh crore (2018) to ₹500 lakh crore (2024).
  • Individual Investor Participation: Increased from 2% to 41% in the same period.

Derivatives and Their Types

Derivatives are financial instruments whose value is derived from an underlying asset. The price of a derivative changes in relation to changes in the value of the underlying asset. Derivatives are used primarily for hedging risks but can also be used for speculative purposes.

1. Futures

• Exchange-traded contracts to buy or sell a specific amount of a commodity or financial instrument at a predetermined price at a specified time in the future.
• Standardization: Futures contracts are standardized in terms of quality, quantity, and delivery time.
• Trading: Highly liquid due to their standardization and presence on exchanges.
• Use Case: Manufacturers can use futures to secure raw materials at set prices, mitigating the risk of price fluctuations.

2. Forwards

• Customized contracts traded over-the-counter (OTC) between two parties to buy or sell an asset at a specified future date for a price agreed upon today.
• Flexibility: Terms such as delivery date, price, and contract size are negotiable between the parties.
• Execution: Generally held to maturity for actual delivery of the underlying asset.
• Use Case: Typically used for hedging against price movements in commodities.

3. Swaps

• Contracts in which two parties exchange cash flows or other financial instruments over a period of time.
• Types: Common types include interest rate swaps and commodity swaps.
  • Interest Rate Swap Example: One party pays a fixed rate while the other pays a floating rate.
  • Commodity Swap Example: An airline company pays a fixed price for kerosene while a bank pays the spot price.
• Use Case: Swaps are used to manage exposure to fluctuations in interest rates or commodity prices.

4. Options

• Contracts that provide the holder the right, but not the obligation, to buy (call) or sell (put) an underlying asset at a predetermined price (strike price) within a specified time frame.
• Types of Settlements:
  • Physical Delivery: The underlying asset is delivered upon exercising the option.
  • Cash Settlement: The difference between the spot price and the strike price is paid in cash.
• Positions:
  • In the Money (ITM): Strike price is more favorable than the spot price.
  • At the Money (ATM): Strike price is equal to the spot price.
  • Out of the Money (OTM): Strike price is less favorable than the spot price.
• Use Case: Options are widely used for hedging purposes, offering the potential for profit with limited risk.