FINANCIAL SERVICE S

VI SEMESTER
CORE COURSE

B Com
(Specialization Finance)
(2011 Admission)

UNIV ERSITY OF
CALICUT
SCHOO L OF DISTANCE
EDUCATION
Calicut university P.O, Malappuram Kerala, India
673 635.

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UNIVERSITY OF CALICUT
SCHOOL OF DISTANCE EDUCATION

STUDY MATERIAL

Core Course
B Com (Specialization Finance)
VI Semester
FINANCIAL SERVICES
Preparedby:

Sri.PraveenMV,
Asst.Professor,
Dept.ofCommerce,
Govt.College,Madappally.

Scrutinized by:

Dr. K. Venugopalan,
Associate Professor,
Department of Commerce,
Govt. College,
Madappally..Madappally.

Layout:

Computer Section, SDE

Reserved

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MODULE

PAGENO.

FINANCIALSERVICES

MERCHANTBANKING

14

MUTUALFUNDS

25

LEASEFINANCING

33

VENTURECAPITAL

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MODULEI
FINANCIALSERVICES
Introduction
The Indian financial services industry has undergone a metamorphosis since1990. Before its
emergencethecommercialbanksandotherfinancialinstitutionsdominatedthefieldandtheymetthe
financialneedsoftheIndianindustry.Itwasonlyaftertheeconomicliberalisationthatthe
financialservicesectorgainedsomeprominence. Nowthissectorhasdevelopedintoanindustry.
In fact, one of the worlds largest industries today is the financial services industry.
Financialserviceisanessentialsegmentoffinancialsystem.Financialservicesarethefoundation
ofamoderneconomy.Thefinancialservicesectorisindispensablefortheprosperityofanation.

MeaningofFinancialServices
In general, all types of activities which are of financial nature may be regarded as financial
services.Inabroadsense,thetermfinancialservicesmeansmobilisationandallocationofsavings.
Thus,itincludesallactivitiesinvolvedinthetransformationofsavingsintoinvestment.
Financialservicesrefertoservicesprovidedbythefinanceindustry.Thefinanceindustryconsists
ofabroadrangeoforganisationsthatdealwiththemanagementofmoney.Theseorganisationsinclude
banks, credit card companies, insurance companies, consumer finance companies, stock brokers,
investmentfundsandsomegovernmentsponsoredenterprises.
Financialservicesmaybedefinedastheproductsandservicesofferedbyfinancialinstitutionsfor
thefacilitationofvariousfinancialtransactionsandotherrelatedactivities.

Financialservicescanalsobecalledfinancialintermediation.Financialintermediationisa
processbywhichfundsaremobilisedfromalargenumberofsaversandmakethemavailabletoall
thosewhoareinneedofitandparticularlytocorporatecustomers.Therearevariousinstitutions
which render financial services. Some of the institutions are banks, investment companies,
accounting firms, financial institutions, merchant banks, leasing companies, venture capital
companies,factoringcompanies,mutualfundsetc.Theseinstitutionsprovidevarietyofservicesto
corporate enterprises. Such services are called financial services. Thus, services rendered by
financialserviceorganisationstoindustrialenterprisesandtoultimateconsumermarketsarecalled
financialservices.Thesearetheservicesandfacilitiesrequiredforthesmoothoperationofthe
financial markets. In short, services provided by financial intermediaries are called financial
services.

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Functionsoffinancialservices
1.

Facilitatingtransactions(exchangeofgoodsandservices)intheeconomy.

2.

Mobilizingsavings(forwhichtheoutletswouldotherwisebemuchmorelimited).

3.

Allocatingcapitalfunds(notablytofinanceproductiveinvestment).

4.

Monitoringmanagers(sothatthefundsallocatedwillbespentasenvisaged).

5. Transformingrisk(reducingitthroughaggregationandenablingittobecarriedbythosemore
willingtobearit).
CharacteristicsorNatureofFinancialServices

Fromthefollowingcharacteristicsoffinancialservices,wecanunderstandtheirnature:
1. Intangibility: Financial services are intangible. Therefore, they cannot be standardized or
reproducedinthesameform.Theinstitutionssupplyingthefinancialservicesshouldhaveabetter
image andconfidenceofthecustomers.Otherwise,theymay notsucceed.They havetofocuson
qualityandinnovationoftheirservices.Thenonlytheycanbuildcredibilityandgainthetrustofthe
customers.
2. Inseparability: Both production and supply of financial services have to be performed
simultaneously.Hence,thereshouldbeperfectunderstandingbetweenthefinancialserviceinstitutions
anditscustomers.
3. Perishability: Likeotherservices,financialservicesalsorequireamatchbetweendemand and
supply.Servicescannotbestored.Theyhavetobesuppliedwhencustomersneedthem.
4. Variability: Inordertocateravarietyoffinancialandrelatedneedsofdifferentcustomersin
differentareas,financialserviceorganisationshavetoofferawiderangeofproductsandservices.This
meansthefinancialserviceshavetobetailormade totherequirementsofcustomers. The service
institutionsdifferentiatetheirservicestodeveloptheirindividualidentity.
5. Dominance of human element: Financial services are dominated by human element. Thus,
financialservicesarelabourintensive.Itrequirescompetentandskilledpersonneltomarketthequality
financialproducts.
6. Information based: Financial service industry is an information based industry. It involves
creation,disseminationanduseofinformation.Informationisanessentialcomponentintheproduction
offinancialservices.
ImportanceofFinancialServices
The successful functioning of any financial systemdependsupontherangeoffinancialThe
services offered by financial service organisations. importanceoffinancialservicesmaybe
understoodfromthefollowingpoints:
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1.

Economic growth: The financial service industry mobilises the savings of the people, and
channelsthemintoproductiveinvestmentsbyprovidingvariousservicestopeopleingeneraland
corporateenterprisesinparticular.Inshort,theeconomicgrowthofanycountrydependsupon
thesesavingsandinvestments.

2.

Promotion of savings: The financial service industry mobilises the savings of the people by
providingtransformationservices.Itprovidesliability,assetandsizetransformationserviceby
providinghugeloanfromsmalldepositscollectedfromalargenumberofpeople.Inthisway
financialserviceindustrypromotessavings.

3.

Capitalformation: Financialserviceindustryfacilitatescapitalformationbyrendering various

capitalmarketintermediaryservices.Capitalformationistheverybasisforeconomicgrowth.

4.

Creation of employment opportunities: The financial service industry creates and provides
employmentopportunitiestomillionsofpeopleallovertheworld.

5.

ContributiontoGNP:RecentlythecontributionoffinancialservicestoGNPhasbeenincreasing
yearafteryearinalmostcountries.

6.

Provisionofliquidity:Thefinancialserviceindustrypromotesliquidityinthefinancialsystemby
allocatingandreallocatingsavingsandinvestmentintovariousavenuesofeconomicactivity.It
facilitateseasyconversionoffinancialassetsintoliquidcash.
TypesofFinancialServices

Financialserviceinstitutionsrenderawidevarietyofservicestomeettherequirementsof
individualusers.Theseservicesmaybesummarizedasbelow:
1. Provisionoffunds:

(a)
(b)
(c)
(d)
(e)
(f)
2.
(a)
(b)
(c)

Venturecapital
Bankingservices
Assetfinancing
Tradefinancing
Creditcards
Factoringandforfaiting
Managinginvestiblefunds:
Portfoliomanagement
Merchantbanking
Mutualandpensionfunds

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3.

Riskfinancing:

(a) Projectpreparatoryservices
(b) Insurance
(c) Exportcreditguarantee
4.

Consultancyservices:

(a) Projectpreparatoryservices
(b) Projectreportpreparation
(c) Projectappraisal
(d) Rehabilitationofprojects
(e) Businessadvisoryservices
(f) Valuationofinvestments
(g) Creditrating
(h) Merger,acquisitionandreengineering
5.

Marketoperations:

(a) Stockmarketoperations
(b) Moneymarketoperations
(c) Assetmanagement
(d) Registrarandsharetransferagencies
(e) Trusteeship
(f) Retailmarketoperation
(g) Futures,optionsandderivatives
6.

Researchanddevelopment:

(a) Equityandmarketresearch
(b) Investoreducation
(c) Trainingofpersonnel
(d) Financialinformationservices

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ScopeofFinancialServices
Thescopeoffinancialservicesisverywide.Thisisbecauseitcoversawiderangeofservices.
Thefinancialservicescanbebroadlyclassifiedintotwo:(a)fundbasedservicesand(b)nonfund
services(orfeebasedservices)
FundbasedServices
Thefundbasedorassetbasedservicesincludethefollowing:
1. Underwriting
2. Dealinginsecondarymarketactivities
3. ParticipatinginmoneymarketinstrumentslikeCPs,CDsetc.
4. Equipmentleasingorleasefinancing
5. Hirepurchase
6. Venturecapital
7. Billdiscounting.
8. Insuranceservices
9. Factoring
10. Forfaiting
11. Housingfinance
12. Mutualfund

NonfundbasedServices
Today, customers are not satisfied with mere provision of finance. They expect more from
financialservicecompanies.Hence,thefinancialservicecompaniesorfinancialintermediariesprovide
servicesonthebasisofnonfundactivitiesalso.Suchservicesarealsoknownasfeebasedservices.
Theseincludethefollowing:
1. Securitisation
2. Merchantbanking
3. Creditrating
4. Loansyndication
5. Businessopportunityrelatedservices
6. Projectadvisoryservices
7. ServicestoforeigncompaniesandNRIs.
8. Portfoliomanagement
9. Mergerandacquisition
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10.
11.
12.
13.

Capitalrestructuring
Debenturetrusteeship
Custodianservices
Stockbroking

Themostimportantfundbasedandnonfundbasedservices(ortypesofservices)maybebriefly
discussedasbelow:

A. Asset/FundBasedServices
1. Equipmentleasing/Leasefinancing:Aleaseisanagreementunderwhichafirmacquiresaright
tomakeuseofacapitalassetlikemachineryetc.onpaymentofanagreedfeecalledleaserentals.The
person(orthecompany)whichacquirestherightisknownaslessee.Hedoesnotgettheownershipof
theasset.Heacquiresonlytherighttousetheasset.Theperson(orthecompany)whogivestherightis
knownaslessor.
2. Hirepurchaseandconsumercredit:Hirepurchaseisanalternativetoleasing.Hirepurchaseisa
transactionwheregoodsarepurchasedandsoldontheconditionthatpaymentismadeininstalments.
Thebuyergetsonlypossessionofgoods.Hedoesnotgetownership.Hegetsownershiponlyafterthe
paymentofthelastinstalment.Ifthebuyerfailstopayanyinstalment,thesellercanrepossessthe
goods.Eachinstalmentincludesinterestalso.
3. Billdiscounting:Discountingofbillisanattractivefundbasedfinancialserviceprovidedbythe
financecompanies.Inthecaseoftimebill(payableafteraspecifiedperiod),theholderneednotwait
tillmaturityorduedate.Ifheisinneedofmoney,hecandiscountthebillwithhis
banker. After deducting a certain amount (discount), the banker credits the net amount in the
customers account. Thus, the bank purchases the bill and credits the customers account with the
amountofthebilllessdiscount.Ontheduedate,thedraweemakespaymenttothebanker.Ifhefailsto
makepayment,thebankerwillrecovertheamountfromthecustomerwhohasdiscountedthebill.In
short,discountingofbillmeansgivingloansonthebasisofthesecurityofabillofexchange.
4. Venturecapital:Venturecapitalsimplyreferstocapitalwhichisavailableforfinancingthenew
businessventures.Itinvolveslendingfinancetothegrowingcompanies.Itistheinvestmentinahighly
riskyprojectwiththeobjectiveofearningahighrateofreturn.Inshort,venturecapitalmeanslong
termriskcapitalintheformofequityfinance.
5. Housing finance: Housing finance simply refers to providing finance for house building. It
emergedasafundbasedfinancialserviceinIndiawiththeestablishmentofNationalHousingBank
(NHB)bytheRBIin1988.Itisanapexhousingfinanceinstitutioninthecountry.Tillnow,anumber
ofspecialisedfinancialinstitutions/companieshaveenteredinthefiledofhousingfinance.Someofthe
institutionsareHDFC,LICHousingFinance,CitiHome,IndBankHousingetc

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6.Insuranceservices:Insuranceisacontractbetweentwoparties.Onepartyistheinsuredandthe
otherpartyistheinsurer.Insuredisthepersonwhoselifeorpropertyisinsuredwiththeinsurer.
Thatis,thepersonwhoseriskisinsurediscalledinsured.Insureristheinsurancecompanyto
whomriskistransferredbytheinsured.Thatis,thepersonwhoinsurestheriskofinsurediscalled
insurer.Thusinsuranceisacontractbetweeninsurerandinsured.Itisacontractinwhichthe
insurancecompanyundertakestoindemnifytheinsuredonthehappeningofcertaineventfora
paymentofconsideration.Itisacontractbetweentheinsurerandinsuredunderwhichtheinsurer
undertakestocompensatetheinsuredforthelossarisingfromtheriskinsuredagainst.
According to Mc Gill, Insurance is a process in which uncertainties are made certain. In the
words of Jon Megi, Insurance is a plan wherein persons collectively share the losses of risks.
Thus,insuranceisadevicebywhichalosslikelytobecausedbyuncertaineventisspreadovera
largenumberofpersonswhoareexposedtoitandwhovoluntarilyjointhemselvesagainst
suchanevent.Thedocumentwhichcontainsallthetermsandconditionsofinsurance(i.e.the written
contract) is called the insurance policy. The amount for which the insurance policy is takeniscalled
sum assured. The consideration in return for which the insurer agrees to make goodthe loss is known
as insurance premium. This premium is to be paid regularly by the insured.It
maybepaidmonthly,quarterly,halfyearlyoryearly.

7. Factoring: Factoring is an arrangement under which the factor purchases the account
receivables(arisingoutofcreditsaleofgoods/services)andmakesimmediatecashpaymenttothe
supplierorcreditor.Thus,itisanarrangementinwhichtheaccountreceivablesofafirm(client)
arepurchasedbyafinancialinstitutionorbanker.Thus,thefactorprovidesfinancetotheclient
(supplier)inrespectofaccountreceivables.Thefactorundertakestheresponsibilityofcollecting
the account receivables. The financial institution (factor) undertakes the risk. For this type of
serviceaswellasfortheinterest,thefactorchargesafeefortheinterveningperiod.Thisfeeor
chargeiscalledfactorage.
8. Forfaiting:Forfaitingisaformoffinancingofreceivablesrelatingtointernationaltrade.Itis
anonrecoursepurchasebyabankeroranyotherfinancialinstitutionofreceivablesarisingfrom
exportofgoodsandservices.Theexportersurrendershisrighttotheforfaitertoreceivefuture
paymentfromthebuyertowhomgoodshavebeensupplied.Forfaitingisatechniquethathelpsthe
exportersellshisgoodsoncreditandyetreceivesthecashwellbeforetheduedate.Inshort,
forfaitingisatechniquebywhichaforfaitor(financingagency)discountsanexportbillandpay
readycashtotheexporter.Theexporterneednotbotheraboutcollectionofexportbill.Hecanjust
concentrateonexporttrade.
9. Mutualfund:Mutualfundsarefinancialintermediarieswhichmobilisesavingsfromthepeople
andinvesttheminamixofcorporateandgovernmentsecurities.Themutualfundoperatorsactively
managethisportfolioofsecuritiesandearnincomethroughdividend,interestandcapitalgains.The
incomesareeventuallypassedontomutualfundshareholders.

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NonFundBased/FeeBasedFinancialServices
1.Merchantbanking:Merchantbankingisbasicallyaservicebanking,concernedwithproviding
nonfund based services of arranging funds rather than providing them. The merchant banker
merelyactsasanintermediary.Itsmainjobistotransfercapitalfromthosewhoownittothose
whoneedit.Today,merchantbankeractsasaninstitutionwhichunderstandstherequirementsof
thepromotersontheonehandandfinancialinstitutions,banks,stockexchangeand
moneymarketsontheother.SEBI(MerchantBankers)Rule,1992hasdefinedamerchantbanker as,
any person who is engaged in the business of issue management either by making
arrangements regarding selling, buying or subscribing to securities or acting as manager,
consultant, advisor, or rendering corporate advisory services in relation to such issue management.
2. Creditrating:Creditratingmeansgivinganexpertopinionbyaratingagencyontherelative
willingnessandabilityoftheissuerofadebtinstrumenttomeetthefinancialobligationsintime
and in full. It measures the relative risk of an issuers ability and willingness to repay both interest
andprincipalovertheperiodoftheratedinstrument.Itisajudgement about a firms financial and
businessprospects.Inshort,creditratingmeansassessingthecreditworthinessofacompanybyan
independentorganisation.
3. Stockbroking:Nowstockbrokinghasemergedasaprofessionaladvisoryservice.Stockbrokeris
amemberofarecognizedstockexchange.Hebuys,sells,ordealsinshares/securities.Itiscompulsory
foreachstockbrokertogethimself/herselfregisteredwithSEBIinordertoactasabroker.Asa
memberofastockexchange,hewillhavetoabidebyitsrules,regulationsandbylaws.
4. Custodial services: In simple words, the services provided by a custodian are known as
custodialservices(custodianservices).Custodianisaninstitutionorapersonwhoishandedover
securitiesbythesecurityownersforsafecustody.Custodianisacaretakerofapublicpropertyor
securities.Custodiansareintermediariesbetweencompaniesandclients(i.e.securityholders)and
institutions (financial institutions and mutual funds). There is an arrangement and agreement
betweencustodianandrealownersofsecuritiesorpropertiestoactascustodiansofthosewho
handoverit.Thedutyofacustodianistokeepthesecuritiesordocumentsundersafecustody.The
work of custodian is very risky and costly in nature. For rendering these services, he gets a
remunerationcalledcustodialcharges.
Thuscustodialserviceistheserviceofkeepingthesecuritiessafeforandonbehalfofsomebodyelse
foraremunerationcalledcustodialcharges.
5.Loansyndication:Loansyndicationisanarrangementwhereagroupofbanksparticipatetoprovide
fundsforasingleloan.Inaloansyndication,agroupofbankscomprising10to30banksparticipateto
providefundswhereinoneofthebanksistheleadmanager.Thisleadbankisdecidedbythecorporate
enterprises,dependingonconfidenceintheleadmanager.

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A single bank cannot give a huge loan. Hence a number of banks join together and form a
syndicate.Thisisknownasloansyndication.Thus,loansyndicationisverysimilartoconsortium
financing.

6.Securitisation(ofdebt):Loansgiventocustomersareassetsforthebank.Theyarecalledloan
assets.Unlikeinvestmentassets,loanassetsarenottradableandtransferable.Thusloanassetsare
notliquid.Theproblemishowtomaketheloanofabankliquid.Thisproblemcanbesolvedby
transforming the loans into marketable securities. Now loans become liquid. They get the
characteristicofmarketability.Thisisdonethroughtheprocessofsecuritization.Securitisationisa
financialinnovation.Itisconversionofexistingorfuturecashflowsintomarketablesecuritiesthat
canbesoldtoinvestors.Itistheprocessbywhichfinancialassetssuchasloanreceivables,credit
card balances, hire purchase debtors, lease receivables, trade debtors etc. are transformed into
securities.Thus,anyassetwithpredictablecashflowscanbesecuritised.
Securitisationisdefinedasaprocessoftransformationofilliquidassetintosecuritywhichmaybe
traded later in the opening market. In short, securitization is the transformation of illiquid, non
marketable assets into securities which are liquid and marketable assets. It is a process of
transformationofassetsofalendinginstitutionintonegotiableinstruments.
Securitisationisdifferentfromfactoring.Factoringinvolvestransferofdebtswithouttransforming
debtsintomarketablesecurities.Butsecuritisationalwaysinvolvestransformationofilliquidassetsinto
liquidassetsthatcanbesoldtoinvestors.
Challengesfacedbythefinancialservicesector.
Financialservicesectorhastofacelotofchallengesinitswaytofulfiltheevergrowingfinancial
demandoftheeconomy.Someoftheimportantchallengesarelistedbelow:
1. Lackofqualifiedpersonnelinthefinancialservicesector.

2. Lackofinvestorawarenessaboutthevariousfinancialservices.
3. Lack of transparency in the disclosure requirements and accounting practices relating to
financialservices.
4. Lackofspecialisationindifferentfinancialservices(specialisationonlyinoneortwoservices).

5. Lackofadequatedatatotakefinancialservicerelateddecisions.
6. Lackofefficientriskmanagementsysteminthefinancialservicesector.
Theabovechallengesarelikelytoincreaseinnumberwiththegrowingrequirementsofthe
customers. However, the financial system in India at present is in a process of rapid
transformation,particularlyaftertheintroductionofneweconomicreforms.

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MODULEII
MERCHANTBANKING
The word merchant banking was originated among the Dutch and Scottish traders. Later on it
was developed and professionalised in the UK and the USA. Now this has become popular
throughouttheworld.
MeaningandDefinitionofMerchantBanking
Merchantbankingisnonbankingfinancialactivity.Butitresemblesbankingfunction.Itisa
financialservice.Itincludestheentirerangeoffinancialservices.
Thetermmerchantbankingisuseddifferentlyindifferent countries.Sothere isnouniversal
definitionformerchantbanking.Wecandefinemerchantbankingasaprocessoftransferring
capitalfromthosewhoownittothosewhouseit.AccordingtoRandomHouseDictionary,merchant
bank is an organization that underwriterssecuritiesforcorporations,advicessuchclients
onmergersandisinvolvedintheownershipofcommercialventures.Theseorganizationsare
sometimes bankswhicharenotmerchants andsometimes merchants whoarenotbankersand
sometimeshouseswhich neither merchants nor banks. According to SEBI (Merchant Bankers)
Rules 1992, A merchant banker has been defined as any person who is engaged in the business of
issuemanagementeitherbymakingarrangementsregardingselling,buyingorsubscribingto
securities oracting as manager, consultant advisororrendering corporate advisoryservices in
relation to such issue management. In short, merchant bank refers to an organization that
underwritessecuritiesandadvisessuchclientsonissueslikecorporatemergers,involvinginthe
ownership of commercial ventures.

Thusmerchantbankinginvolvesawiderangeofactivitiessuchasmanagementofcustomer
services, portfolio management, credit syndication, acceptance credit, counseling, insurance,
preparationoffeasibilityreportsetc.Itisnotnecessaryforamerchantbankertocarryoutallthe
abovementionedactivities.Amerchantbankermayspecialiseinoneactivity,andtakeupother
activities,whichmaybecomplementaryorsupportivetothespecializedactivity.
Inshort,merchantbankinginvolvesservicinganyfinancialneedoftheclient.
DifferencebetweenMerchantBankandCommercialBank
Merchantbanksaredifferentfromcommercialbanks.Thefollowingaretheimportantdifferences
betweenmerchantbanksandcommercialbanks:
1.Commercial banks basically deal indebt and debt related finance. Their activities are clustered
aroundcreditproposals,creditappraisalandloansanctions.Ontheotherhand,theareaofactivityof
merchantbankersisequityandequityrelatedfinance.Theydealwithmainlyfundsraisedthrough
moneymarketandcapitalmarket.
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2. Commercial banks lending decisions are based on detailed credit analysis of loan proposals
andthevalueofsecurityoffered.Theygenerallyavoidrisks.Theyareassetoriented.Butmerchant
bankersaremanagementoriented.Theyarewillingtoacceptrisksofbusiness.
3. Commercialbanksaremerelyfinanciers.Theydonotundertakeprojectcounselling,corporate
counselling,managingpublicissues,underwritingpublicissues,advisingonportfoliomanagement
etc.Themainactivityofmerchantbankersistorenderfinancialservicesfortheirclients.They
undertake project counselling, corporate counselling in areas of capital restructuring, mergers,
takeoversetc.,discountingandrediscountingofshorttermpaperinmoneymarkets,managingand
underwritingpublicissuesinnewissuemarketandactingasbrokersandadvisorsonportfolio
management.
Functions(Services)ofMerchantBankers(ScopeofMerchantBanking)
Merchantbankshavebeenplayinganimportantroleinprocuringthefundsforcapitalmarketfor
the corporate sector for financing their operations. They perform some valuable functions. The
functionsofmerchantbanksinIndiaareasfollows:

1. Corporate counseling: One of the important functions of a merchant banker is corporate

counseling. Corporate counseling refers to a set of activities undertaken to ensure efficient
functioningofacorporateenterprisethrougheffectivefinancialmanagement.Amerchantbanker
guidestheclientonaspectsoforganizationalgoals,vocationalfactors,organizationsize,choiceof
product,demandforecasting,costanalysis,allocationofresources,investmentdecisions,capital
andexpendituremanagement,marketingstrategy,pricingmethodsetc.Thefollowingactivitiesare
includedincorporatecounseling:
(a) Providing guidance in areas of diversification based on the Governments economic and
licensingpolicies.
(b) Undertakingappraisalofproductlines,analyzingtheirgrowthandprofitabilityandforecasting
futuretrends.
(c) Rejuvenatingoldlinecompaniesandailingsickunitsbyappraisingtheirtechnologyandprocess,
assessingtheirrequirementsandrestructuringtheircapitalbase.
(d) Assessmentoftherevivalprospectsandplanningforrehabilitationthroughmodernizationand
diversificationandrevampingofthefinancialandorganizationalstructure.
(e) Arranging for the approval of the financial institutions/banks for schemes of rehabilitation
involvingfinancialrelief,etc.
(f) Monitoringofrehabilitationschemes.
(g) Exploringpossibilitiesfortakeoverofsickunitsandprovidingassistanceinmakingconsequential
arrangements and negotiations with financial institutions/banks and other interests/authorities
involved.

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2.Projectcounseling: Projectcounselingrelatestoprojectfinance.Thisinvolvesthestudyof the

project,offeringadvisoryservicesontheviabilityandproceduralstepsforitsimplementation.Project
counselinginvolvesthefollowingactivities:
(a) Undertakingthegeneralreviewoftheprojectideas/projectprofile.

(b) Providingadviceonproceduralaspectsofprojectimplementation.
(c) Conductingreviewoftechnicalfeasibilityoftheprojectonthebasisofthereportpreparedbyown
expertsorbyoutsideconsultants.
(d) Assistinginthepreparationofprojectreportfromafinancialangle,andadvisingandactingon
various procedural steps including obtaining government consents for implementation of the
project.
(e) Assistinginobtainingapprovals/licenses/permissions/grants,etcfromgovernmentagenciesinthe
formofletterofintent,industriallicense,DGTDregistration,andgovernmentapprovalforforeign
collaboration.
(f) Identificationofpotentialinvestmentavenues.

(g) Arrangingandnegotiatingforeigncollaborations,amalgamations,mergers,andtakeovers.
(h) Undertakingfinancialstudyoftheprojectandpreparationofviabilityreportstoadviseonthe
frameworkofinstitutionalguidelinesandlawsgoverningcorporatefinance.
(i)

Providing assistance in the preparation of project profiles and feasibility studies based on
preliminaryprojectideas,coveringthetechnical,financialandeconomicaspectsoftheproject
fromthepointofviewoftheiracceptancebyfinancialinstitutionsandbanks.

(j)

Advisingandassistingclientsinpreparingapplicationsforfinancialassistancetovariousnational
financialinstitutions,statelevelinstitutions,banks,etc.

3.Preinvestmentstudies: Anotherfunctionofamerchantbankeristoguidetheentrepreneurs in
conductingpreinvestmentstudies.Itinvolvesdetailedfeasibilitystudytoevaluateinvestmentavenues
toenabletodecidewhethertoinvestornot.Theimportantactivitiesinvolvedinpreinvestmentstudies
areasfollows:
(a) Carrying out an indepth investigation of environment and regulatory factors, location of raw
materialsupplies,demandprojectionsandfinancialrequirementsinordertoassessthefinancial
andeconomicviabilityofagivenproject.
(b) Helpingtheclientinidentifyingandshortlistingthoseprojectswhicharebuiltupontheclients
inherent strength with a view to promote corporate profitability and growth in the long run.
(c) Offering a package of services, including advice on the extent of participation, government
regulatoryfactorsandanenvironmentalscanofcertainindustriesinIndia.
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4. Loan syndication: A merchant banker may help to get term loans from banks and financial
institutionsforprojects.Suchloansmaybeobtainedfromasinglefinancialinstitutionorasyndicateor
consortium.Merchantbankershelpcorporateclientstoraisesyndicatedloansfromcommercialbanks.
Thefollowingactivitiesareundertakenbymerchantbankersunderloansyndication:

(a) Estimatingthetotalcostoftheprojecttobeundertaken.
(b) Drawingupafinancingplanforthetotalprojectcostwhichconformstotherequirementsofthe
promoters and their collaborators, financial institutions and banks, government agencies and
underwriters.
(c) Preparingloanapplicationforfinancialassistancefromtermlenders/financialinstitutions/banks,
andmonitoringtheirprogress,includingpresanctionnegotiations.
(d) Selectinginstitutionsandbanksforparticipationinfinancing.
(e) Followupoftermloanapplicationwiththefinancialinstitutionsandbanks,andobtainingthe
approvalfortheirrespectiveshareofparticipation.
(f) Arrangingbridgefinance.
(g) Assistingincompletionofformalitiesfordrawingoftermfinancesanctionedbyinstitutionsby
expediting legal documentation formalities, drawing up agreements etc. as prescribed by the
participatingfinancialinstitutionsandbanks.
(h) Assessingworkingcapitalrequirements.

5.Issuemanagement: Issuemanagementinvolvesmarketingorcorporatesecuritiesbyoffering
them to the public. The corporate securities include equity shares, preference shares, bonds,
debenturesetc.Merchantbankersactasfinancialintermediaries.Theytransfercapitalfromthose
whoownittothosewhoneedit.Thesecurityissuefunctionmaybebroadlyclassifiedintotwo
preissue management and postissue management. The preissue management involves the
followingfunctions:
(a) Publicissuethroughprospectus.
(b) Marketingandunderwriting.
(c) Pricingofissues.
Thesemaybebrieflydiscussedasfollows:
(a)Publicissuethroughprospectus:Tobeingoutapublicissue,merchantbankershavetocoordinate
theactivitiesrelatingtoissuewithdifferentgovernmentandpublicbodies,professionalsandprivate
agencies. First the prospectus should be drafter. The copies of consent of experts, legal advisor,
attorney,solicitor,bankers,andbankerstotheissue,brokersandunderwritersaretobeobtainedfrom
thecompanymakingtheissue.Thesecopiesaretobefiledalongwiththeprospectus
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totheRegistrarCompanies.Aftertheprospectusisready,ithastobesenttotheSEBIforclearance.It
isonlyafterclearancebySEBI,theprospectuscanbefiledwiththeRegistrar.Thebrokerstotheissue,
principalagentandbankerstoissueareappointedbymerchantbankers.

(b) Marketingandunderwriting:AftersendingprospectustoSEBI,themerchantbankersarrange
ameetingwithcompanyrepresentativesandadvertisingagentstofinalisearrangementsrelatingto
dateofopeningandclosingofissue,registrationofprospectus,launchingpublicitycampaignsand
fixingdateofboardmeetingtoapproveandpassthenecessaryresolutions.Theroleofmerchant
bankerinpublicitycampaignstohelpselectingthemedia,determiningthesizeandpublicationsin
whichtheadvertisementshouldappear.Themerchantbankshalldecidethenumberofcopiestobe
printed,checkaccuracyofstatementsmadeandensurethatthesizeoftheapplicationformand
prospectus are as per stock exchange regulations. The merchant banker has to ensure that he
materialisdeliveredtothestockexchangeatleast21daysbeforetheissueopensandtothebrokers
totheissue,andunderwritersintime.
(c) Pricingofissues:Pricingofissuesisdonebycompaniesthemselvesinconsultationwiththe
merchantbankers.Anexistinglistedcompanyandanewcompanysetupbyanexistingcompany
with5yeartrackrecordandexistingprivatecloselyheldcompanyandexistingunlistedcompany
goinginforpublicissuesforthefirsttimewith2yearstrackrecordofconstantprofitabilitycan
freelypricetheissue.Thepremiumcanbedeterminedaftertakingintoconsiderationnetasset
value,profitearningcapacityandmarketprice.Thepriceandpremiumhastobestatedinthe
prospectus.
Postissuemanagementconsistsofcollectionofapplicationformsandstatementofamountreceived
frombankers,screeningapplications,decidingallotmentprocedures,mailingofallotmentletters,share
certificates and refund orders. Merchant bankers help the company by coordinating the above
activities.
6.Underwritingofpublicissue:Inunderwritingofpublicissuetheactivitiesperformedbymerchant
bankersareasfollows:
(a) Selectionofinstitutionalandbrokerunderwritersforsyndicating/underwritingarrangements.
(b) Obtainingtheapprovalofinstitutionalunderwritersandstockexchangesforpublicationofthe
prospectus.
(c) Coordinationwiththeunderwriters,brokersandbankerstotheissue,andtheStockExchanges.

7.Portfoliomanagement:Merchantbankersprovideportfoliomanagementservicetotheirclients.
Today every investor is interested in safety, liquidity and profitability of his investment. But
investorscannotstudyandchoosetheappropriatesecurities.Merchantbankershelptheinvestorsin
thisregard.Theystudythemonetaryandfiscalpoliciesofthegovernment.Theystudythefinancial
statementsofcompaniesinwhichtheinvestmentshavetobemadebyinvestors.Theyalsokeepa
closewatchonthepricemovementsinthestockmarket.

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Themerchantbankersrenderthefollowingservicesinconnectionwithportfoliomanagement:
(a) Undertakinginvestmentinsecurities.
(b) Collectionofreturnoninvestmentandreinvestmentofthesameinprofitableavenues,investment
advisoryservicestotheinvestorsandotherrelatedservices.
(c) Providingadviceonselectionofinvestments.

(d) Carryingoutacriticalevaluationofinvestmentportfolio.
(e) SecuringapprovalfromRBIforthepurchase/saleofsecurities(forNRIclients).
(f) Collectingandremittinginterestanddividendoninvestment.
(g) Providingtaxcounselingandfilingtaxreturnsthroughtaxconsultants.
8. Mergerandacquisition:Amergerisacombinationoftwoormorecompaniesintoasingle
companywhereonesurvivesandotherslosetheircorporateexistence.Atakeoverreferstothe
purchasebyonecompanyacquiringcontrollinginterestinthesharecapitalofanotherexisting
company. Merchant bankers are the middlemen in setting negotiation between the offeree and
offeror.Beingaprofessionalexperttheyareapttosafeguardtheinterestoftheshareholdersinboth
the companies. Once the merger partner is proposed, the merchant banker appraises
merger/takeoverproposalwithrespecttofinancialviabilityandtechnicalfeasibility.Henegotiates
purchaseconsiderationandmodeofpayment.Hegetsapprovalfromthegovernment/RBI,drafts
schemeofamalgamationandobtainsapprovalfromfinancialinstitutions.
9. Foreigncurrencyfinancing:Thefinanceprovidedtofundforeigntradetransactionsiscalled
Foreign Currency Finance. The provision of foreign currency finance takes the form of export
importtradefinance,eurocurrencyloans,Indianjointventuresabroadandforeigncollaborations.The
mainareasthatarecoveredinthistypeofmerchantactivityareasfollows:
(a) Providingassistanceforcarryingoutthestudyofturnkeyandconstructioncontractprojects.
(b) Arrangingforthesyndicationofvarioustypesofguarantees,lettersofcredit,preshipmentcredit,
deferredpostshipmentcredit,bridgeloans,andothercreditfacilities.
(c) Providingassistanceinopeningandoperatingbankaccountsabroad.
(d) Arranging foreign currency loans under buyers credit scheme for importing goods.
(e) Arrangingdeferredpaymentguaranteesundersupplierscreditschemeforimportingcapitalgoods.
(f) ProvidingassistanceinobtainingexportcreditfacilitiesfromtheEXIMbankforexportofcapital
goods,andarrangingforthenecessarygovernmentapprovalsandclearance.
(g) Undertaking negotiations for deferred payment, export finance, buyers credits, documentary
credits,andotherforeignexchangeserviceslikepackingcredit,etc.
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10.Workingcapitalfinance:Thefinancerequiredformeetingthedaytodayexpensesofan
enterpriseisknownas Working Capital Finance. Merchant bankers undertake the following
activitiesaspartofprovidingthistypeoffinance:
(a) Assessmentofworkingcapitalrequirements.
(b) Preparingthenecessaryapplicationtonegotiationsforthesanctionofappropriatecreditfacilities.
11. Acceptancecreditandbilldiscounting: Merchantbanksacceptanddiscountbillsofexchange
onbehalfofclients.Merchantbankersgiveloanstobusinessenterprisesonthesecurityofbillof
exchange. For this purpose,merchant bankers collect credit information relating tothe clients and
undertakeratingtheircreditworthiness.
12. Venturefinancing:Anotherfunctionofamerchantbankeristoprovideventurefinancetoprojects.It
referstoprovisionofequityfinanceforfundinghighriskandhighrewardprojects.
13. Leasefinancing:Leasingisanotherfunctionofmerchantbankers.Itreferstoprovidingfinancial
facilities to companies that undertake leasing. Leasing involves letting out assets on lease for a
particularperiodforusebythelessee.Thefollowingservicesareprovidedbymerchantbankersin
connectionwithleasefinance:
(a) Providing advice on the viability of leasing as an alternative source for financing capital
investmentprojects.
(b) Providingadviceonthechoiceofafavourablerentalstructure.
(c) Providing assistance in establishing lines of lease for acquiring capital equipment, including
preparationofproposals,documentations,etc.
14. Relieftosickindustries:Merchantbankersrendervaluableservicesasapartofprovidingrelief
tosickindustries.
15. Projectappraisal: Projectappraisalreferstoevaluationofprojectsfromvariousanglessuchas
technology, input, location, production, marketing etc. It involves financial appraisal, marketing
appraisal,technicalappraisal,economicappraisaletc.Merchantbankersrendervaluableservicesinthe
aboveareas.
Thefunctionsofmerchantbankercanbesummarizedasfollows:

(a) Issuemanagement.
(b) Underwritingofissues.
(c) Projectappraisal.
(d) Handlingstockexchangebusinessonbehalfofclients.
(e) Dealinginforeignexchange.
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(f)
(g)
(h)
(i)
(j)
(k)
(l)
(m)
(n)
(o)
(p)
(q)
(r)

Floatationofcommercialpaper.
Actingastrustees.
Shareregistration.
Helpinginfinancialengineeringactivitiesofthefirm.
Undertakingcostaudit.
Providingventurecapital.
Arrangingbridgefinance.
Advisingbusinesscustomers(i.e.mergersandtakeovers).
UndertakingmanagementofNRIinvestments.
Largescaletermlendingtocorporateborrowers.
Providingcorporatecounselingandadvisoryservices.
Managinginvestmentsonbehalfofclients.
Actingasastockbroker.

ObjectivesofMerchantBanking
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.

Theobjectivesofmerchantbankingareasfollows:
Tohelpforcapitalformation.
Tocreateasecondarymarketinordertoboosttheindustrialactivitiesinthecountry.
Toassistandpromoteeconomicendeavour.
Toprepareprojectreports,conductmarketresearchandpreinvestmentsurveys.
Toprovidefinancialassistancetoventurecapital.
Tobuildadatabankashumanresources.
Toprovidehousingfinance.
Toprovideseedcapitaltonewenterprises.
Toinvolveinissuemanagement.
Toactasunderwriters.
Toidentifynewprojectsandrenderservicesforgettingclearancefromgovernment.
Toprovidefinancialclearance.
Tohelpinmobilizingfundsfrompublic.
Todivertthesavingsofthecountrytowardsproductivechannel.
Toconductinvestorsconferences.
Toobtainconsentofstockexchangeforlisting.

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17.
18.
19.
20.
21.
22.
23.

Toobtainthedailyreportofapplicationmoneycollectedatvariousbranchesofbanks.
Toappointbankers,brokers,underwritesetc.
TosupervisetheprocessonbehalfofNRIsfortheirventures.
Toprovideserviceonfundbasedactivities.
Toassistinarrangementofloansyndication.
Toactasanacceptancehouse.
Toassistinandarrangemergersandacquisitions.

RoleofMerchantBankersinManagingPublicIssue
Inissuemanagement,themainroleofmerchantbankersistohelpthecompanyissuingsecurities
inraisingfundsforthepurposeoffinancingnewprojects,expansion/modernization/diversificationof
existingunitsandaugmentinglongtermresourcesforworkingcapitalrequirements.
Themostimportantaspectofmerchantbankingbusinessistofunctionasleadmanagerstothe
issue management.The role ofthe merchantbankerasanissuemanager can be studiedfromthe
followingpoints:
1.

Easyfundraising: Anissuemanageractsasanindispensablepilotfacilitatingapublic/rights
issue. This is made possible with the help of special skills possessed by him to execute the
managementofissues.

2.

Financialconsultant:Anissuemanageressentiallyactsasafinancialarchitect,byprovidingadvice
relatingtocapitalstructuring,capitalgearingandfinancialplanningforthecompany.

3.

Underwriting: Anissuemanagerallowsforunderwritingtheissuesofsecuritiesmadeby corporate

enterprises.Thisensuresduesubscriptionoftheissue.

4.

Duediligence:TheissuemanagerhastocomplywithSEBIguidelines.Themerchantbankerwill
carry out activities with due diligence and furnish a Due Diligence Certificate to SEBI. The
detaileddiligenceguidelinesthatareprescribedbytheAssociationofMerchantBankersofIndia
(AMBI)havetobestrictlyobserved.SEBIhasalsoprescribedacodeofconductformerchant
bankers.

5.

Coordination: Theissuemangerisrequiredtocoordinatewithalargenumberofinstitutions and

agencieswhilemanaginganissueinordertomakeitsuccessful.

6.

LiaisonwithSEBI:Theissuemanager,asapartofmerchantbankingactivities,shouldregister
withSEBI.Whilemanagingissues,constantinteractionwiththeSEBIisrequiredbywayoffiling
ofofferdocuments,etc.Inaddition,theyshouldfileanumberofreportsrelatingtotheissues
beingmanaged.

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MerchantBankinginIndia
Prior to the enactment of Indian Companies Act, 1956, managing agents acted as merchant
bankers.Theyactedasissuehousesforsecurities,evaluatedprojectreports,providedventurecapital
fornewfirmsetc.Fewsharebrokingfirmsalsofunctionedasmerchantbankers.

Withtherapidgrowthinthenumberandsizeoftheissuesmadeintheprimarymarket,the
needforspecializedmerchantbankingservicewasfelt.GrindlaysBank(foreignbank)openedits
merchantbankingdivisionin1967,followedbyCitibankin1970.SBIstarteditsmerchantbanking
divisionin1972anditfollowedupbysettingupafullyownedsubsidiaryin1980,namelySBI
Capital Markets Ltd. The other nationalized banks and financial institutions, like IDBI, IFCI,
ICICI,SecuritiesandFinanceCompanyLtd.,CanaraBank(CanBankFinancialServicesLtd.),
BankofIndia(BOIFinanceLtd.)andprivatesectorfinancialcompanies,likeJMFinancialand
Investment Consultancy Services Ltd., DSP Financial Consultancy Ltd. have also set up their
merchantbankingdivisions.
Withover1,100merchantbankersoperatinginthecountry,theprimarymarketactivityispicking
up.Merchantbankingserviceshaveassumedgreaterimportanceinthepresentcapitalmarketscenario.
Withtheinvestorbecomingmorecautiousanddiscerning,theroleofmerchantbankerhasgainedmore
prominence.

In India, apart from the overall control by the RBI, merchant bankers operations are closely
supervisedbytheSEBIfortheirproperfunctioningandinvestorprotection.
SettingupandmanagementofmerchantbanksinIndia
InIndiaacommonorganizationalsetupofmerchantbankerstooperateisintheformofdivisionsof
IndianandForeignbanksandfinancialinstitutions,subsidiarycompaniesestablishedbybankerslike
SBI,CanaraBank,PunjabNationalBank,BankofIndia,etc.somefirmsarealsoorganizedbyfinancial
andtechnicalconsultantsandprofessionals.SecuritiesandexchangesBoardofIndia
(SEBI)hasdividedthemerchantbankersintofourcategoriesbasedontheircapitaladequacy.Each
category is authorized to perform certain functions. From the point of Organizational set up Indias
merchantbankingorganizationscanbecategorizedinto4groupsonthebasisoftheirlinkagewith
parentactivity.Theyare:
a)InstitutionalBase:
Merchant banks function as an independent wing or as subsidiary of various Private/ Central
Governments/StateGovernmentsFinancialinstitutions.MostofthefinancialinstitutionsinIndiaarein
publicsectorandthereforesuchsetupplaysaroleonthelinesofgovernmentalprioritiesandpolicies.
b)BankerBase:
Thesemerchantbankersfunctionasdivision/subsidiaryofbankingorganization.Theparentbanksare
eithernationalizedcommercialbanksortheforeignbanksoperatinginIndia.Theseorganizationshave
broughtprofessionalisminmerchantbankingsectorandtheyhelptheirparentorganizationtomakea
presenceincapitalmarket.
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c)BrokerBase:
IntherecentpasttherehasbeenaninflowofQualifiedandprofessionallyskilledbrokersinvarious
Stock Exchanges of India. These brokers undertake merchant banking related operating also like
providinginvestmentandportfoliomanagementservices.
d)PrivateBase:

These merchant banking firms are originated in private sectors. These organizations are the
outcomeofopportunities andscopeinmerchant bankingbusinessandtheyareprovidingskill
oriented specialized services to their clients. Some foreign merchant bankers are also entering
eitherindependentlyorthroughsomecollaborationwiththeirIndiancounterparts.PrivateSectors
merchantbankingfirmshavecomeupeitherassoleproprietorship,partnership,privatelimitedor
publiclimitedcompanies.Manyofthesefirmswereinexistenceforquitesometimebeforethey
addedanewactivityintheformofmerchantbankingservicesbyopeningnewdivisiononthelines
ofcommercialbanksandAllIndiaFinancialInstitution(AIFI).
CategoriesofMerchantBanks
MerchantbankersareclassifiedintofourcategoriesaccordingtotheSEBI(MerchantBanking)
Regulations1992.Theseareasfollows:
(a) CategoryI:Tocarryonanyactivityrelatingtoissuemanagementandactasadviser,consultant
manager,underwriterandportfoliomanagerforcapitalissues.
(b) CategoryII:Toactasadviser,consultant,comanager,underwriterandportfoliomanagerfor
capitalissues.
(c) CategoryIII:Toactasunderwriter,adviser,andconsultanttoanissue.
(d) CategoryIV:Toactonlyasadviserorconsultanttoanissue.
Weaknessofmerchantbanks/Problemsofmerchantbanks
1. SEBI guidelines haveauthorisedmerchant bankers toundertake issue relatedactivities onlywith an
exceptionofportfoliomanagement.Itrestrictsthescopeofmerchantbankactivities.

2. SEBIguidelinesstipulateaminimumnetworthofRs.1croreforauthorisationofmerchantbankers.
Smallbutprofessionalmerchantbankersarefacingdifficultyforadheringsuchnetworthnorms.
3. Noncooperationoftheissuingcompaniesintimelyallotmentofsecuritiesandrefundapplication
moneyisanotherproblemofmerchantbankers.
4. Unhealthycompetitionamonglargenumberofmerchantbankscompelsthemtoreducetheirprofit
margin,commissionetc.
5. Thereisnoexactregulatoryframeworkforregulatingandcontrollingtheworkingofmerchantbanks
inIndia.
6. Fraudulentandfakeissueofsharecapitalbythecompaniesarealsoposingproblemsformerchant
bankswhoactasleadmanagerorissuemanagerofsuchissues.

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MODULEIII
MUTUALFUNDS
Mutualfundsrepresentoneofthemostimportantinstitutionalforcesinthemarket.Theyare
institutional investors. They play a major role in todays financial market. The first mutual fund
wasestablishedinBostonin1924(USA).
MeaningofMutualFunds
Smallinvestorsgenerallydonothaveadequatetime,knowledge,experienceandresourcesfor
directlyenteringthecapitalmarket.Hencetheydependonanintermediary.Thisfinancialintermediary
iscalledmutualfund.

Mutualfundsarecorporationsthatacceptmoneyfromsaversandthenusethesefundstobuy
stocks,longtermfundsorshorttermdebtinstrumentsissuedbyfirmsorgovernments.Theseare
financialintermediariesthatcollectthesavingsofinvestorsandinvesttheminalargeandwell
diversifiedportfolioofsecuritiessuchasmoneymarketinstruments,corporateandgovernment
bondsandequitysharesofjointstockcompanies.Theyinvestthefundscollectedfrominvestorsin
awidevarietyofsecuritiesi.e.throughdiversification.Inthiswayitreducesrisk.
Mutual fund works on the principle of small drops of water make a big ocean. It is a form of
collectiveinvestment.Togetthesurplusfundsfrominvestors,itadoptsasimpletechnique.Each
fund is divided into a small share called units ofequalvalue.Eachinvestorisallocatedunitsin
promotiontothesizeofhisinvestment.
Mutualfundisatrustthatpoolsthesavingsofinvestors.Themoneycollectedistheninvested
infinancialmarketinstrumentssuchasshares,debenturesandothersecurities.Theincomeearned
throughtheseinvestmentsandthecapitalappreciationsrealizedaresharedbyitsunitholdersin
proportion to the number of units owned by them. Thus mutual fund invests in a variety of
securities(calleddiversification).Thisreducesrisk.Diversificationreducestheriskbecauseall
stockand/ordebtinstrumentsmaynotmoveinthesamedirection.
AccordingtotheMutualFundFactBook(publishedbytheInvestmentCompanyInstituteof
USA), a mutual fund is a financialserviceorganizationthatreceivesmoneyfromshareholders,
investsit,earnsreturnonit,attemptstomakeitgrowandagreestopaytheshareholdercash demand
for the current value of his investment.

SEBI(mutualfunds)Regulations,1993defines a mutual fund as a fund established in the

formofatrustbyasponsor,toraisemoniesbythetrusteesthroughthesaleofunitstothepublic,
underoneormoreschemes,forinvestinginsecuritiesinaccordancewiththeseregulations.

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Inshort,amutualfundcollectsthesavingsfromsmallinvestors,investsthemingovernmentand
othercorporatesecuritiesandearnsincomethroughinterestanddividends,besidescapitalgains.

FeaturesofMutualFunds
Mutualfundpossessesthefollowingfeatures:
1.

Mutualfundmobilizesfundsfromsmallaswellaslargeinvestorsbysellingunits.

2.

Mutualfundprovidesanidealopportunitytosmallinvestorsanidealavenueforinvestment.

3.

Mutualfundenablestheinvestorstoenjoythebenefitofprofessionalandexpertmanagementof
theirfunds.

4.

Mutualfundinveststhesavingscollectedinawideportfolioofsecuritiesinordertomaximize
returnandminimizeriskforthebenefitofinvestors.

5.

Mutualfundprovidesswitchingfacilitiestoinvestorswhocanswitchfromoneschemetoanother.

6.

Variousschemesofferedbymutualfundsprovidetaxbenefitstotheinvestors.

7.

InIndiamutualfundsareregulatedbyagencieslikeSEBI.

8.

Thecostofpurchaseandsaleofmutualfundunitsislow.

9.

Mutualfundscontributetotheeconomicdevelopmentofacountry.

TypesofMutualFunds(ClassificationofMutualFunds)
Mutualfunds(ormutualfundschemes)canbeclassifiedintomanytypes.Thefollowingchart
showstheclassificationofmutualfunds:
MutualFunds

Onthebasisof
Operation

onthebasisof
Return

Onthebasisof
Investment

Openended

Incomefund

Equityfund

Closeended

Growthfund

Bondfund

Conservativefund

Balancedfund
Moneymarketmutualfund
Taxationfund
Leveragedfund
Indexbondfund

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Thesemaybebrieflydescribedasfollows:
A.OnthebasisofOperation
1.Closeendedfunds: Underthistypeoffund,thesizeofthefundanditsdurationarefixedin
advance.Oncethesubscriptionreachesthepredeterminedlevel,theentryofinvestorswillbeclosed.
Aftertheexpiryofthefixedperiod,theentirecorpusisdisinvestedandtheproceedsaredistributedto
theunitholdersinproportiontotheirholding.
FeaturesofCloseendedFunds

(a) Theperiodandthetargetamountofthefundisfixedbeforehand.
(b) Oncetheperiodisoverand/orthetargetisreached,thesubscriptionwillbeclosed(i.e.investors
cannotpurchaseanymoreunits).
(c) Themainobjectiveiscapitalappreciation.
(d) Atthetimeofredemption,theentireinvestmentisliquidatedandtheproceedsareliquidatedand
theproceedsaredistributedamongtheunitholders.
(e) Unitsarelistedandtradedinstockexchanges.

(f) Generallythepricesofunitsarequotedatadiscountofupto40%belowtheirnetassetvalue.
2.Openendedfunds:Thisisthejustreverseofcloseendedfunds.Underthisschemethesizeofthe
fundand/ortheperiodofthefundisnotfixedinadvance.Theinvestorsarefreetobuyandsellany
numberofunitsatanypointoftime.
FeaturesofOpenendedFunds

(a) Theinvestorsarefreetobuyandsellunits.Thereisnotimelimit.
(b) Thesearenottradeinstockexchanges.
(c) Unitscanbesoldatanytime.
(d) Themainmotiveincomegeneration(dividendetc.)
(e) Thepricesarelinkedtothenetassetvaluebecauseunitsarenotlistedonthestockexchange.
DifferencebetweenOpenendedandCloseendedSchemes
1.

Thecloseendedschemesareopentothepublicforalimitedperiod,buttheopenendedschemes
arealwaysopentobesubscribedallthetime.

2.

Closeendedschemeswillhaveadefiniteperiodoflife.Butheopenendedschemesaretransacted
inthecompany.

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3.

Closeended schemes are transacted at stock exchanges, where as openended schemes are
transacted(boughtandsold)inthecompany.

4.

Closeendedschemesareterminatedattheendofthespecifiedperiod.Openendedschemescan
beterminatedonlyifthetotalnumberofunitsoutstandingafterrepurchasefallbelow50%ofthe
originalnumberofunits.
B.Onthebasisofreturn/income
1.Incomefund:Thisschemeaimsatgeneratingregularandperiodicalincometothemembers.Such
fundsareofferedintwoforms.Thefirstschemeearnsatargetconstantincomeatrelativelylowrisk.
Thesecondschemeoffersthemaximumpossibleincome.
FeaturesofIncomeFunds

(a) Theinvestorsgetaregularincomeatperiodicintervals.
(b) Themainobjectiveistodeclaredividendandnotcapitalappreciation.
(c) Thepatternofinvestmentisorientedtowardshighandfixedincomeyieldingsecuritieslikebonds,
debenturesetc.
(d) Itisbestsuitedtotheoldandretiredpeople.

(e) Itfocusesonshortrungainsonly.
2. Growthfund:Growthfundofferstheadvantageofcapitalappreciation.Itmeansgrowthfund
concentratesmainlyonlongrungains.Itdoesnotoffersregularincome.Inshort,growthfundsaimat
capital appreciation in the long run. Hence they have been described as Nest Eggs investments
orlonghaulinvestments.
FeaturesofGrowthFunds
(a) It meets the investors need for capital appreciation.
(b) Fundsareinvestedinequitieswithhighgrowthpotentialsinordertogetcapitalappreciation.
(c) Ittriestogetcapitalappreciationbytakingmuchrisk.
(d) Itmaydeclaredividend.Butthemainobjectiveiscapitalappreciation.
(e) Thisisbestsuitedtosalariedandbusinesspeople.
3.Conservativefund:Thisaimsatprovidingareasonablerateofreturn,protectingthevalueofthe
investmentandgettingcapitalappreciation.Hencetheinvestmentismadeingrowthorientedsecurities
thatarecapableofappreciatinginthelongrun.

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C.OnthebasisofInvestment
1.

Equityfund:itmainlyconsistsofequitybasedinvestments.Itcarriedahighdegreeofrisk.Such
fundsdowellinperiodsoffavourablecapitalmarkettrends.

2.

Bond fund: It mainly consists of fixed income securities like bonds, debentures etc. It
concentratesmostlyonincomeratherthancapitalgains.Itcarrieslowerrisk.Itofferssecureand
steadyincome.Butthereisnochanceofcapitalappreciation.

3.

Balanced fund: It has a mix of debt and equity in the portfolio of investments. It aims at
distributing regular income as well as capital appreciation. This is achieved by balancing the
investmentsbetweenthehighgrowthequitysharesandalsothefixedincomeearningsecurities.

4.

Fundoffundscheme:Inthiscasefundsofonemutualfundareinvestedintheunitsofothermutual
funds.

5.

Taxationfund:Thisisbasicallyagrowthorientedfund.Itofferstaxrebatestotheinvestors.Itis
suitabletosalariedpeople.

6.

Leveragefund: Inthiscasethefundsareinvestedfromtheamountsmobilizedfromsmall
investorsaswellasmoneyborrowedfromcapitalmarket.Thusitgivesthebenefitofleverage
tothemutualfundinvestors.Themainaimistoincreasethesizeofthevalueofportfolio.This
occurswhenthegainsfromtheborrowedfundsaremorethanthecostoftheborrowedfunds.
Thegainsaredistributedtounitholders.

7.

Indexbonds: Thesearelinkedtoaspecificindexofshareprices.Thismeansthatthefunds
mobilized under such schemes are invested principally in the securities of companies whose
securitiesareincludedintheindexconcernedandinthesameproportion.Thevalueoftheseindex
linkedfundswillautomaticallygoupwheneverthemarketindexgoesupandviceversa.

8.

Moneymarketmutualfunds:Thesefundsarebasicallyopenendedmutualfunds.Theyhaveall
thefeaturesofopenendedmutualfunds.Buttheinvestmentismadeishighlyliquidandsafe
securities like commercial paper, certificates of deposits, treasury bills etc. These are money
marketinstruments.
Offshoremutualfunds:Thesourcesofinvestmentsforthesefundsarefromabroad.

9.

10. Guiltfunds:Thisisatypeofmutualfundinwhichthefundsareinvestedinguiltedgedsecurities
likegovernmentsecurities.Itmeansfundsare notinvestedincorporate securitieslike shares,
bondsetc.
ObjectivesofMutualFunds

1.

Tomobilisesavingsofpeople.

2.

Toofferaconvenientwayforthesmallinvestorstoenterthecapitalandthemoneymarket.

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3.

Totapdomesticsavingsandchannelizethemforprofitableinvestment.

4.

Toenabletheinvestorstosharetheprosperityofthecapitalmarket.

5.

Toactasagentsforgrowthandstabilityofthecapitalmarket.

6.

Toattractinvestmentsfromtheriskaversers.

7.

Tofacilitatetheorderlydevelopmentofthecapitalmarket.

Advantages(Importance)ofMutualFunds
Mutualfundsaregrowingallovertheworld.Theyaregrowingbecauseoftheirimportanceto
investorsandtheircontributionsintheeconomyofacountry.Thefollowingaretheadvantagesof
mutualfunds:
1. Mobilise small savings: Mutual funds mobilize small savings from the investors by offering
variousschemes.Theseschemesmeetthevariedrequirementsofthepeople.Thesavingsofthepeople
arechannelizedforthedevelopmentoftheeconomy.Intheabsenceofmutualfunds,thesesavings
wouldhaveremainedidle.
2. Diversified investment: Small investors cannot afford to purchase the shares of the highly
establishedcompaniesbecauseofhighmarketprice.Themutualfundsprovidethisopportunitytosmall
investors.Evenaverysmallinvestorcanaffordtoinvestinmutualfunds.Theinvestorscanenjoythe
wideportfoliooftheinvestmentsheldbythefund.Itdiversifieditsrisksbyinvestinginavarietyof
securities(equityshares,bondsetc.)Thesmallandmediuminvestorscannotdothis.
3. Providebetterreturns: Mutualfundscanpoolfundsfromalargenumberofinvestors.Inthis
wayhugefundscanbemobilized.Becauseofthehugefunds,themutualfundsareinapositiontobuy
securities at cheaper rates and sell securities at higher prices. This is not possible for individual
investors.Inshort,mutualfundsareabletogivegoodandregularreturnstotheirinvestors.
4. Better liquidity: At any time the units can be sold and converted into cash. Whenever
investorsrequirecash,theycanavailloansfacilitiesfromthesponsoringbanksagainsttheunit
certificates.
5. Lowtransactioncosts:Thecostofpurchaseandsaleofmutualfundunitsisrelativelyless.The
brokeragefeeortradingcommissionetc.arelower.Thisisduetothelargevolumeofmoneybeing
handledbymutualfundsinthecapitalmarket.
6. Reducerisk: Thereisonlyaminimumriskattachedtotheprincipalamountandreturnforthe
investmentsmadeinmutualfunds.Thisisduetoexpertsupervision,diversificationandliquidityof
units.
7. Professionalmanagement: Mutualfundsaremanagedbyprofessionals.Theyarewell trained.
Theyhaveadequateexperienceinthefieldofinvestment.Thusinvestorsgetqualityservicesfromthe
mutualfunds.Anindividualinvestorwouldnevergetsuchaservicefromthesecuritiesmarket.
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8. Offertaxbenefits:Mutualfundsoffertaxbenefitstoinvestors.Forinstance,undersection80L
oftheIncomeTaxAct,asumofRs.10,000receivedasdividendfromamutualfund(incaseofUTI,it
isRs.13,000)isdeductiblefromthegrosstotalincome.
9. Supportcapitalmarket: Thesavingsofthepeoplearedirectedtowardsinvestmentsin capital
marketsthroughmutualfunds.Theyalsoprovideavaluableliquiditytothecapitalmarket.Inthisway,
themutualfundsmakethecapitalmarketactiveandstable.
10. Promoteindustrialdevelopment:Theeconomicdevelopmentofanynationdependsuponits
industrial advancement and agricultural development. Industrial units raise funds from capital
marketsthroughtheissueofsharesanddebentures.Mutualfundssupplylargefundstocapital
markets.Besides,theycreatedemandforcapitalmarketinstruments(share,debenturesetc.).Thus
mutual funds provide finance to industries and thereby contributing towards the economic
developmentofacountry.
11. Keepthemoneymarketactive:Anindividualinvestorcannothaveanyaccesstomoneymarket
instruments.Mutualfundsinvestmoneyonthemoneymarketinstruments.Inthisway,theykeepthe
moneymarketactive.
MutualFundRisks
Inspiteoftheadvantagesofferedbymutualfunds,therearesomerisksalso.Thisissobecause
mutualfundsinvesttheirfundsinthestockmarketonshares.Thesesharesaresubjecttorisks.Hence,
thefollowingrisksareinherentinthedealingsofmutualfunds:
1. Marketrisks:Theserisksareunavoidable.Theseariseduetofluctuationsinshareprices.

2.

Investment risks: Generally mutual funds make investments on the advice sought from Asset
ManagementCompany.Iftheadvicegoeswrong,thefundhastosufferaloss.

3.

Businessrisk: Mutualfundsinvestmostlyinequitysharesofcompanies.Ifthebusinessofthe
companiessuffersanysetback,theycannotdeclaredividend.Ultimately,suchcompaniesmaybe
woundup.Asaresult,mutualfundswillsuffer.

4.

Political risk: Change in government policies brings uncertainty in the economy. Every player
includingmutualfundshastofacethisriskanduncertainty.

5.

Schemerisks:Therearecertainrisksintheschemesthemselves.Risksaregreaterincertainschemes,
e.g.,growthschemes.

OperationofMutualFunds
Amutualfundinvitestheprospectiveinvestorstoparticipateinthefundbyofferingvarious
schemes.Itoffersdifferentschemestosuitthevariedrequirementsoftheinvestors.Thesmalland
mediumresourcesfromtheinvestorsarepooledtogether.Thenthepooloffundisdividedintoa
largenumberofequalsharescalledunits.Theseareissuedtoinvestors.Theamountsocollectedis
investedincapitalmarketinstrumentslikeshares,debentures,governmentbondsetc.Investmentis
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alsomadeinmoneymarketinstruments liketreasurybills,commercialpapersetc.Usuallythe
moneyisinvestedindiversifiedsecuritiessoastominimizetheriskandmaximizereturn.The
incomeearnedonthesesecurities(aftermeetingthefundexpenses)isdistributedtounitholders
(investors)intheformofinterestaswellascapitalappreciation.Thereturnontheunitsdepends
uponthenatureofthemutualfundschemes.
MutualFundsinIndia
InIndiathefirstmutualfundwasUTI.Itwassetupin1964underanActofparliament.
Duringtheyear19871992,sevennewmutualfundswereestablishedinthepublicsector.In1993,
thegovernmentchangeditspolicytoallowtheentryofprivatecorporatesandforeigninstitutional
investorsintothemutualfundsegment.NowthecommercialbanksliketheSBI,CanaraBank,
Indianbank,BankofIndia,PunjabNationalBanketc.haveenteredintothefield.LICandGIC
havealsoenteredintothemarket.BytheendofMarch2000,therewas36mutualfunds,9inthe
publicsectorand27intheprivatesector.HoweverUTIdominatedthemutualfundsector.InIndia
mutualfundsarebeingregulatedbyagencieslikeSEBI.Mutualfundsplayanimportantrolein
promotingsavingandinvestmentwithinthecountry.Therearearound196mutualfundschemes,
andtheamountofassetsundertheirmanagementwasRs.47,000croresin1993,Rs.80,590crores
in2003anditwentuptoRs.2,17,707croresby31.3.2006.Thusmutualfundsaregrowingin
India.However,theirgrowthrateisveryslow.
ReasonsforSlowGrowthofMutualFundsinIndia
1.

ThereisnostandardformulaforcalculatingNetAssetValue.Differentcompaniesapplydifferent
formulae.ThusthereisnouniformityinthecalculationofNAV.

2.

MutualfundsinIndiaarenotprovidingadequateinformationandmaterialstotheinvestors.There
isnotgoodrapportbetweenmutualfundsandinvestors.Inshort,thereisnotransparencyinthe
dealingsofmutualfunds.

3.

Mutualfundsarerenderingpoorservicestoinvestors.Hencemutualfundsfailtobuildupinvestor
confidence.

4.

In India, most of the funds depend upon outside agencies for collecting data and conducting
research.
InIndia,professionalexpertsinsecurityanalysisandportfoliomanagementarerare.

5.
6.

Investorsdonotknowthatunitsarelowrisklongterminvestment.Theydonothavethepatience
towaitforlongtimetogetgoodreturns.Theyalwayswantreturnintheshortrun.Henceunitsare
notmuchpopularinIndia.

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MODULEIV

LEASEFINANCING
Meaningofleasing
Leasingisaprocessbywhichafirmcanobtaintheuseofacertainfixedassetsforwhichitmust
payaseriesofcontractual,periodic,taxdeductiblepayments.Thelesseeisthereceiveroftheservices
ortheassetsundertheleasecontractandthelessoristheowneroftheassets.Therelationshipbetween
thetenantandthelandlordiscalledatenancy,andcanbeforafixedoranindefiniteperiodoftime
(calledthetermofthelease).Theconsiderationfortheleaseiscalledrent.
Leasecanbedefinedasthefollowingways:
1. Acontractbywhichoneparty(lessor)givestoanother(lessee)theuseandpossessionofequipment
foraspecifiedtimeandforfixedpayments.
2. Thedocumentinwhichthiscontractiswritten.

3. Agreatwaycompaniescanconservecapital.
4. Aneasywayvendorscanincreasesales.
AleasetransactionisacommercialarrangementwherebyanequipmentownerorManufacturer
conveystotheequipmentusertherighttousetheequipmentinreturnforarental.Inotherwords,
leaseisacontractbetweentheownerofanasset(thelessor)anditsuser(thelessee)fortherightto
usetheassetduringaspecifiedperiodinreturnforamutuallyagreedperiodicpayment(thelease
rentals).Theimportantfeatureofaleasecontractisseparationoftheownershipoftheassetfrom
itsusage.
ImportanceofLeaseFinancing
LeasefinancingisbasedontheobservationmadebyDonaldB.Grant:
Why own a cow when the milk is so cheap? All you really need is milk and not the cow.
Leasingindustryplaysanimportantroleintheeconomicdevelopmentofacountrybyproviding
moneyincentivestolessee.Thelesseedoesnothavetopaythecostofassetatthetimeofsigning
the contract of leases. Leasing contracts are more flexible so lessees can structure the leasing
contractsaccordingtotheirneedsforfinance.Thelesseecanalsopassontheriskofobsolescence
tothelessorbyacquiringthoseappliances,whichhavehightechnologicalobsolescence.Today,
mostofusarefamiliarwithleasesofhouses,apartments,offices,etc.
Theadvantagesofleasinginclude:
a. Leasing helps to possess and use a new piece of machinery or equipment without huge
investment..

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b. Leasingenablesbusinessestopreservepreciouscashreserves.
c. Thesmaller,regularpaymentsrequiredbyaleaseagreementenablebusinesseswithlimited
capitaltomanagetheircashflowmoreeffectivelyandadaptquicklytochangingeconomic
conditions.
d. Leasingalsoallowsbusinessestoupgradeassetsmorefrequentlyensuringtheyhavethelatest
equipmentwithouthavingtomakefurthercapitaloutlays.
e. It offers the flexibility of the repayment period being matched to the useful life of the
equipment.
f. It gives businesses certainty because asset finance agreements cannot be cancelled by the
lendersandrepaymentsaregenerallyfixed.
g. However,theycanalsobestructuredtoincludeadditionalbenefitssuchasservicingof
equipment or variable monthly payments depending on a businesss needs.
h. Itiseasytoaccessbecauseitissecuredlargelyorentirelyontheassetbeingfinanced,
ratherthanonotherpersonalorbusinessassets.
i.

Therental,whichsometimesexceedsthepurchasepriceoftheasset,canbepaidfromrevenue
generatedbyitsuse,directlyimpactingthelessee'sliquidity.

j.

easeinstalmentsareexclusivelymaterialcosts.

k. Usingthepurchaseoption,thelesseecanacquiretheleasedassetatalowerprice,astheypay
theresidualornondepreciatedvalueoftheasset.
l.

Forthenationaleconomy,thiswayoffinancingallowsaccesstostateofthearttechnology
otherwiseunavailable,duetohighprices,andoftenimpossibletoacquirebyloanarrangements.
Limitationofleasing
a. Itisnotasuitablemodeofprojectfinancingbecauserentalispayablesoonafterenteringinto
leaseagreementwhilenewprojectgeneratecashonlyafterlonggestationperiod.
b. Certaintaxbenefits/incentives/subsidiesetc.maynotbeavailabletoleasedequipments.
c. Thevalueofrealassets(landandbuilding)mayincreaseduringleaseperiod.Inthiscaselessee
maylosepotentialcapitalgain.
d. Thecostoffinancingisgenerallyhigherthanthatofdebtfinancing.
e. Amanufacturer(lessee)whowanttodiscontinuebusinessneedtopayhugepenaltytolessorfor
preclosingleaseagreement
f. Thereisnoexclusivelawforregulatingleasingtransaction.
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g. Inundevelopedlegalsystems,leasearrangementscanresultininequalitybetweentheparties
duetothelessor'seconomicdoinance,whichmayleadtothelesseesigninganunfavourable
contract.
TYPESOFLEASE

(a) Financiallease
(b) Operatinglease.
(c) Saleandleaseback
(d) Leveragedleasingand
(e) Directleasing.
1) Financiallease
Longterm,noncancellableleasecontractsareknownasfinancialleases.Theessentialpointof
financialleaseagreementisthatitcontainsaconditionwherebythelessoragreestotransferthe
titlefortheassetattheendoftheleaseperiodatanominalcost.Atleaseitmustgiveanoptionto
thelesseetopurchasetheassethehasusedattheexpiryofthelease.Underthisleasethelessor
recovers90%ofthefairvalueoftheassetasleaserentalsandtheleaseperiodis75%ofthe
economiclifeoftheasset.Theleaseagreementisirrevocable.Practicallyalltherisksincidentalto
theassetownershipandallthebenefitsarisingtherefromaretransferredtothelesseewhobears
thecostofmaintenance,insuranceandrepairs.Onlytitledeedsremainwiththelessor.Financial
leaseisalsoknownas'capitallease.InIndia,fnancialleasesareverypopularwithhighcostand
hightechnologyequipment.
2) Operationallease
An operating lease stands in contrast to the financial lease in almost all aspects. This lease
agreementgivestothelesseeonlyalimitedrighttousetheasset.Thelessorisresponsibleforthe
upkeepandmaintenanceoftheasset.Thelesseeisnotgivenanyuplifttopurchasetheassetatthe
endoftheleaseperiod.Normallytheleaseisforashortperiodandevenotherwiseisrevocableata
shortnotice.Mines,Computershardware,trucksandautomobilesarefoundsuitableforoperating
leasebecausetherateofobsolescenceisveryhighinthiskindofassets.
3) Saleandleaseback
Itisasubpartoffinancelease.Underthis,theownerofanassetsellstheassettoaparty(the
buyer),whointurnleases backthesameasset totheownerinconsideration ofleaserentals.
However,underthisarrangement,theassetsarenotphysicallyexchangedbutitallhappensin
recordsonly.Thisisnothingbutapapertransaction.Saleandleasebacktransactionissuitablefor
thoseassets,whicharenotsubjecteddepreciationbutappreciation,sayland.Theadvantageofthis
methodisthatthelesseecansatisfyhimselfcompletelyregardingthequalityoftheassetandafter
possessionoftheassetconvertthesaleintoaleasearrangement.
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4) Leveragedleasing
Underleveragedleasingarrangement,athirdpartyisinvolvedbesidelessorandlessee.Thelessor
borrowsapartofthepurchasecost(say80%)oftheassetfromthethirdpartyi.e.,lenderandthe
assetsopurchasedisheldassecurityagainsttheloan.Thelenderispaidofffromtheleaserentals
directlybythelesseeandthesurplusaftermeetingtheclaimsofthelendergoestothelessor.The
lessor,theowneroftheassetisentitledtodepreciationallowanceassociatedwiththeasset.
5) Directleasing
Under direct leasing, afirm acquiresthe right to use an asset fromthe manufacture directly.The
ownershipoftheassetleasedoutremainswiththemanufactureritself.Themajortypesofdirectlessor
include manufacturers, finance companies, independent lease companies, special purpose leasing
companiesetc
Othertypesofleasing:
1) FirstAmendmentLease:Thefirstamendmentleasegivesthelesseeapurchaseoptionatoneor
more defined points with a requirement that the lessee renew or continue the lease if the
purchaseoptionisnotexercised.Theoptionpriceisusuallyeitherafixedpriceintended
to approximate fair market value or is defined as fair market value determined by lessee
appraisalandsubjecttoafloortoinsurethatthelessor'sresidualpoitionwillbecoveredifthe
purchaseoptionisexercised.
2) FullPayoutLease:Aleaseinwhichthelessorrecovers,throughtheleasepayments,all
costsincurredintheleaseplusanacceptablerateofreturn,withoutanyrelianceupontheleased
equipment'sfutureresiualvalue.
3) Guideline Lease: A lease written under criteria established by the IRS to determine the
availabilityoftaxbenefitstothelessor.
4) NetLease:Aleasewhereinpaymentstothelessordonotincludeinsuranceandmaintenance,
whicharepaidseparatelybythelessee.
5) OpenendLease:Aconditionalsaleleaseinwhichthelesseeguaranteesthatthelessorwill
realizeaminimumvaluefromthesaleoftheassetattheendofthelease.
6) SalestypeLease:Aleasebyalessorwhoisthemanufacturerordealer,inwhichthelease
meetsthedefinitionalcriteriaofacapitalleaseordirectfinancinglease.
7) SyntheticLease:Asyntheticleaseisbasicallyafinancingstructuredtobetreatedasaleasefor
accountingpurposes,butasaloanfortaxpurposes.Thestructureisusedbycorporationsthat
areseekingoffbalancesheetreportingoftheirassetbasedfinancing,andthatcanefficiently
usethetaxbenefitsofowningthefinancedasset.

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8) TaxLease:Aleasewhereinthelessorrecognizesthetaxincentivesprovidedbythetaxlaws
forinvestmentandownershipofequipment.Generally,theleaseratefactorontaxleasesis
reducedtoreflectthelessor'srecognitionofthistaxincentive.
9) TrueLease:AtypeoftransactionthatqualifiesasaleaseundertheInternalRevenueCode.It
allowsthelessortoclaimownershipandthelesseetoclaimrentalpaymentsastaxdeductions.

Differencesbetweenfinancialleaseandoperatinglease
1. Whilefinancialleaseisalongtermarrangementbetweenthelessee(useroftheasset)andthe
owneroftheasset,whereasoperatingleaseisarelativelyshorttermarrangementbetweenthe
lesseeandtheownerofasset.
2. Underfinancialleaseallexpensessuchastaxes,insurancearepaidbythelesseewhileunder
operatingleaseallexpensesarepaidbytheowneroftheasset.
3. Theleasetermunderfinancialleasecoverstheentireeconomiclifeoftheassetwhichisnotthe
caseunderoperatinglease.
4. Underfinancialleasethelesseecannotterminateorendtheleaseunlessotherwiseprovidedin
thecontractwhichisnotthecasewithoperatingleasewherelesseecanendtheleaseanytime
beforeexpirationdateoflease.
5. Whiletherentwhichispaidbythelesseeunderfinancialleaseisenoughtofullyamortizethe
asset,whichisnotthecaseunderoperatinglease.
RegulatoryframeworkforLeasinginIndia
AsthereisnoseparatestatueforleasinginIndia,theprovisionsrelatingtobailmentintheIndian
ContractActgovernequipmentleasingagreementsaswellsection148oftheIndianContractAct
definesbailmentas:

The delivery of goods by one person to another, for some purpose, upon a contract thattheyshall,
when the purpose is accomplished, be returned or otherwise disposed off according to the
directionsof the person delivering them. The person delivering the goods is called the bailor and
the person towhomtheyaredeliverediscalledthe bailee.
Sinceanequipmentleasetransactionisregardedasacontractofbailment,theobligationsofthe
lessorandthelesseearesimilartothoseofthebailorandthebailee(otherthanthoseexpressly
specifiedintheleastcontract)asdefinedbytheprovisionsofsections150and168oftheIndian
ContractAct.Essentiallytheseprovisionshavethefollowingimplicationsforthelessorandthe
lessee.
1. Thelessorhasthedutytodelivertheassettothelessee,tolegallyauthorisethelesseetousethe
asset,andtoleavetheassetinpeacefulpossessionofthelesseeduringthecurrencyofthe
agreement.
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2. Thelessorhastheobligationtopaytheleaserentalsasspecifiedintheleaseagreement,to
protect the lessors title, to take reasonable careoftheasset,andtoreturntheleasedasseton the
expiryoftheleaseperiod.
Contentsofaleaseagreement:Theleaseagreementspecifiesthelegalrightsandobligationsofthe
lessorandthelessee.Ittypicallycontainstermsrelatingtothefollowing:
1. Descriptionofthelessor,thelessee,andtheequipment.

2. Amount,timeandplaceofleaserentalspayments.
3. Timeandplaceofequipmentdelivery.
4. Lessees responsibility for taking delivery and possession of the leased equipment.
5. Lessees responsibility for maintenance, repairs, registration, etc. and the lessors right in
caseofdefaultbythelessee.
6. Lessees right to enjoy the benefits of the warranties provided by the equipment
manufacturer/supplier.
7. Insurancetobetakenbythelesseeonbehalfofthelessor.
8. Variationinleaserentalsifthereisachangeincertainexternalfactorslikebankinterestrates,
depreciationrates,andfiscalincentives.
9. Optionsofleaserenewalforthelessee.
10. Returnofequipmentonexpiryoftheleaseperiod.
11. Arbitrationprocedureintheeventofdispute.
ProblemsofleasinginIndia
LeasinghasgreatpotentialinIndia.However,leasinginIndiafacesserioushandicapswhich
maybaritsgrowthinfuture.Thefollowingarethesomeoftheproblems.

1.UnhealthycompetitionThereisoversupplyoflessorinIndia.Thestiffcompetition
betweentheselessorsareforcethemtoreducetheirprofitmargintobareminimumlevel.
Moreoversubsidiariesofbanksandfinancialinstitutionhavecompetitiveedgeoverprivate
sectorlessorduetheircheapsourceoffinance.
2. Lackofqualifiedpersonnel leasingrequiresqualifiedandexperiencedpersonnelatthe
helmofitsaffairs.InIndia,leasingisofrecentoneandhenceitisdifficulttogetrightmanto
dealwithleasingbusiness.
3.TaxConsiderationIn reality, the lessees tax shelter is lessors burden.Theleasebecomes
economicallyviableiflessorseffectivetaxrateislow.moreovertaxeslikesales

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tax,wealthtax,additionaltax,surchargeetc,addtothecostofleasing.Itmakesleasing
relativelymoreexpensive.
4. StampDutyStatestreatstheleasingtransactionasasaleforthepurposeofmakingthem
eligibletosalestax.Onthecontrary,forstampduty,thetransactionistreatedaspurelease
transactions.Accordinglyheavystampdutyimposedonleasedocument.
5. DelayedpaymentandbaddebtsTheproblemofdelayedpaymentofrentsandbaddebts
addtothecostoflease.Thisproblemwoulddisturbprospectsofleasingbusiness.
HIREPURCHASE

ConceptandMeaningofHirePurchase
Hirepurchaseisatypeofinstalmentcreditunderwhichthehirepurchaser,calledthehirer,agrees
totakethegoodsonhireatastatedrental,whichisinclusiveoftherepaymentofprincipalaswell
as interest,withanoptiontopurchase.Underthis transaction, thehirepurchaseracquires the
property(goods)immediatelyonsigningthehirepurchaseagreementbuttheownershiportitleof
thesameistransferredonlywhenthelastinstalmentispaid.
ThehirepurchasesystemisregulatedbytheHirePurchaseAct1972.ThisActdefinesahirepurchase
as

An agreement under which goods are let on hire and under which the hirer has an option to
purchasetheminaccordancewiththetermsoftheagreementandincludesanagreementunder
which:
1) Theownerdeliverspossessionofgoodsthereoftoapersononconditionthatsuchpersonpaysthe
agreedamountinperiodicinstalments.
2) Thepropertyinthegoodsistopasstosuchpersononthepaymentofthelastofsuchinstalments,
and
3) Such person has a right to terminate the agreement at any time before the property so passes.
LegalframeworkofHirepurchasetransactions
The hire purchase system is regulated by the Hire Purchase Act 1972. In a hirepurchase
transaction,assetsareletonhire,thepriceistobepaidininstalmentsandhirerisallowedan
optiontopurchasethegoodsbypayingalltheinstalments.AHirePurchaseagreementusually
requiresthecustomertopayaninitialdeposit,withtheremainderofthebalance,plusinterest,paid
overanagreedperiodoftime.Underhirepurchaseagreement,you:
1. Purchasegoodsthroughinstalmentpayments
2. Usethegoodswhilepayingforthem
3. Donotownthegoodsuntilyouhavepaidthefinalinstalment
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Rightsofthehirer
Thehirerusuallyhasthefollowingrights:
1. TobuythegoodsatanytimebygivingnoticetotheownerandpayingthebalanceoftheHPprice
lessarebate
2. Toreturnthegoodstotheownerthisissubjecttothepaymentofapenalty.
3. withtheconsentoftheowner,toassignboththebenefitandtheburdenofthecontracttoathird
person.
4. Wheretheownerwrongfullyrepossessesthegoods,eithertorecoverthegoodsplusdamagesforloss
ofquietpossessionortodamagesrepresentingthevalueofthegoodslost.
Additionalrights
1. Rightsofprotection
2. Rightsofnotice
3. Rightsofrepossession
4. RightsofStatement
5. Rightsofexcessamount
Obligationsofhirer
Thehirerusuallyhasfollowingobligations:
1. Topayhireinstalments,
2. Totakereasonablecareofthegoods
3. Toinformtheownerwheregoodswillbekept.
Owners rights
Theownerusuallyhastherighttoterminateagreementwherehirerdefaultsinpayingtheinstalments
orbreachesanyoftheothertermsinagreement.
Thisentitlestheowner:

1.Toforfeitthedeposit.
2. Toretaintheinstalmentsalreadypaidandrecoverthebalancedue.
3. Torepossessthegoods(whichmayhavetobebyapplicationtoaCourtdependingonthenatureof
thegoodsandthepercentageofthetotalpricepaid.

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4.Toclaimdamagesforanylosssuffered.
FeaturesofHirePurchase
1. ImmediatepossessionunderHP,thebuyertakesimmediatepossessionofgoodsbypaying
onlyaportionofitsprice.
2. HireChargesunderHP,eachinstalmentistreatedashirecharges.
3. Propertyingoodsownershipispassedtothehireronlyafterpayinglastorspecifiednumber
ofinstalments
4. Downpaymenthirerhastopay20to25%ofassetpricetothevendorasdownpayment.
5. RepossessionHirevendor,ifdefaultinpaymentofinstalmentmadebyhirer,canreposesthe
goodsandhecanresellthegoods.
6. Returnofgoodshirerisfreetoreturnthegoodswithoutbeingrequiredtopayfurtherinstalment
fallingdueafterthereturn.
7. Depreciationdepreciationandinvestmentallowancescanbeclaimedbythehirereventhough
heisnotanexactowner.
Hire purchase should be distinguished from instalment sale wherein property passes to the
purchaserwiththepaymentofthefirstinstalment.ButincaseofHP(ownershipremainswiththeseller
untilthelastinstalmentispaid)buyergetsownershipafterpayingthelastinstalment.HPalsodiffers
fromleasing
DifferencesbetweenleaseandHirepurchase
1. Ownershipinlease,ownershiprestswiththelessorthroughoutandthehirerofthegoodsnotbecomes
ownertillthepaymentofspecifiedinstalments.
2. MethodoffinancingleasingisamethodoffinancingbusinessassetswhereasHPisfinancingboth
businessandnonbusinessassets.
3. Depreciationinleasing,depreciationandinvestmentallowancescannotbeclaimedbythelessee,
inHP,depreciationandIAcanbeclaimedbythehirer.
4. Taxbenefitstheentireleaserentalistaxdeductibleexpense.Onlytheinterestcomponentofthe
HPinstalmentistaxdeductible.
5. Salvagevaluethe lessee, not being the owner of the asset, doesnt enjoy the salvagevalueofthe
asset.Thehirer,inHP,beingtheowneroftheasset,enjoyssalvagevalueoftheasset.
6. Depositlesseeisnotrequiredtomakeanydepositwhereas20%depositisrequiredinHP.
7. NatureofdealwithleasewrentandwithHPwebuythegoods.

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8. ExtentofFinanceinleasefinancingis100%financingsinceitisrequireddownpayment,whereasHP
requires20to25%downpayment.
9. Maintenancecostofmaintenancehiredassetsisbornebyhirerandtheleasedasset(otherthanfinancial
lease)isbornebythelessor.
10. ReportingHPassetsisabalancesheetiteminthebooksofhirerwhereasleasedassetsare shownas
offbalancesheetitem(shownasFootnotetoBS)

RBIguidelinesforHPbusiness
Under section6(I)(0) ofBankingRegulationAct1949,theGovt.OfIndiahaspermittedbanksto
engageinHPbusiness.FollowingaresomeoftheimportantguidelinesofRBIforHBbusinessof
banks;
1. Banksshallnotthemselvesundertakedirectly(departmentally)thebusinessofhirepurchases.
2. BanksdesirousofundertakingHPbusinessthroughanexistingcompaniesornewsubsidiarieswill
requirepriorapprovalofRBI.
3. BanksinvestmentsinthesharesofsubsidiariesengaginginleasingandHPbusinessshallnotexceed
10%ofthepaidupsharecapitalandreservesofthebanks.
4. WithoutpriorapprovalofRBI,banksshallnotactaspromotersofotherhirepurchasecompanies.
5. PriorclearanceofRBIisrequiredforthepurposeofanyapplicationtotheControllerofCapitalissue
incaseofIPOofnewsubsidiaryandFPOofexistingsubsidiariesofBanks.
6. BankshallfurnishnecessaryinformationregardingitsHPorequipmentleasingsubsidiaries,asand
whenRBIdemands.
AdvantagesofHP:
1. Spread the cost of finance Whilst choosing to pay in cash is preferable,. A hire purchase
agreementallowsaconsumertomakemonthlyrepaymentsoveraprespecifiedperiodoftime;
2. InterestfreecreditSomemerchantsoffercustomerstheopportunitytopayforgoodsandservices
oninterestfreecredit.
3. HigheracceptanceratesTherateofacceptanceonhirepurchaseagreementsishigherthanother
formsofunsecuredborrowingbecausethelendershavecollateral.
4.SalesAhirepurchaseagreementallowsaconsumer to purchase sale items when they arent ina
positiontopayincash.
5.DebtsolutionsConsumersthabuyoncreditcanpursueadebtsolution,suchasdebtengagement
plan,shouldtheyexperiencemoneyproblemsfurtherdowntheline.

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ProblemsofHPbusinessinIndia
Hire purchase transactions are very uncommon transactions in India. Meaning there by the
awareness of this concept is very lesser in India. All segment of Indias population treat the hire
purchasetransactionasahypothecationloanbutthereisaslightdifferentiationamongallprocesses
relatedtohirepurchases.AlmostforthepopulationofIndiathehirepurchasetransactionisvery
similartotheloans&hypothecation.Personwhowantstopurchaseanyassetthenthebestoption
& wayforhimorherwouldbe loanorhypothecation. Because thepublic is not aware with
transactionnamedhirepurchases.Hirepurchasetransactionisoftwotypesthecashcredit&asset
hirepurchases.PeopledonotgoforhirepurchasesinIndiabecauseinIndiabusinesspeopleare
verylesssotheycannothiretheassetsforalongerperiodoftime.Finally,wewouldliketoendup
overherethat,lackofawarenessleadstooccurrenceofproblemindealingwithhirepurchase.
OtherproblemsofHPareasfollows:
1.Personal debt A hire purchse agreement isyet another form ofpersonal debt itis monthly
repaymentcommitmentthatneedstobepaideachmonth;
2. Final payment A consumer desnt have legitimate title to the goods until the final monthly
repaymenthasbeenmade;
3. BadcreditAllhirepurhaseagreementswillinvolveacreditcheck.Consumersthathaveabad
creditratingwilleitherbeturneddownorwillbeaskedtopayahighinterestrate;
4. Creditor harassment Opting to bu on credit can create money problems should a family
experienceachangeofpersonalcircumstances;
5. Repossessionrights sellerisenitled to snatch back any goods when less than a third of the
amounthasbeenpaidback.
FACTORING
Whenafirmsellsgoodsoncredit,cashisnotreceivedimmediately.Thismeansthereisatime
gapbetweensaleofgoods/servicesandreceiptofcashoutofsuchsale.Theoutstanding
amountsgetblockedforaperiod. Thisperioddependsuponthecreditperiodallowedtobuyers.
The outstanding amounts are called Debtors or Accounts Receivables. If the debts are not
collectedintime,thefirmwillbehandicappedduetolackofsufficientworkingcapital.Theother
sideisthatifthedebtswerecollectedspeedilytheamountcouldbeusedproductively.Further,itis
verydifficulttocollectdebts.Moreover,thereistheproblemofdefaults(i.e.baddebts).Inshort,
debtors or accounts receivables involve risks. So, business enterprises are always looking for
sellingthedebtorsforcash,evenatadiscount.Thisispossiblethroughafinancialservice.Sucha
financialserviceisknownasfactoring.
Factoringisoneoftheoldestformsofcommercialfinance.Somescholarstraceitsorigintothe
RomanEmpire.SomeotherstraceitsoriginevenfurtherbacktoHammurabi,4000yearsago.

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MeaningandDefinitionofFactoring
Likesecuritisation factoringalsoisafinancialinnovation. Factoringprovidesresourcesto
financereceivables.Italsofacilitatesthecollectionofreceivables.Thewordfactorisderivedfrom
theLatinword facere.Itmeanstomakeordoortogetthingsdone.Factoringsimplyrefersto
sellingthereceivablesbyafirmtoanotherparty.Thebuyerofthereceivablesiscalledthefactor.
Thusfactoringreferstotheagreementinwhichthereceivablesaresoldbyafirm(client)tothe
factor(financialintermediary).Thefactorcanbeacommercialbankorafinancecompany.When
receivables are factored, the factor takes possession of the receivables and generally becomes
responsibleforitscollection.Italsoundertakesadministrationofcrediti.e.creditcontrol,sales
accountingetc.
Thusfactoringmaybedefinedassellingthereceivablesofafirmatadiscounttoafinancial
organisation (factor). Thecashfromthesaleofthe receivables providesfinancetotheselling
company(client).Outofthedifferencebetweenthefacevalueofthereceivablesandwhatthe
factorpaysthesellingcompany(i.e.discount),itmeetsitsexpenses(collection,accountingetc.).
Thebalanceistheprofitofthefactorforthefactoringservices.
Factoring can take the form of either a factoring agreement or an assignment (pledging)
agreement.Thefactoringagreementinvolvesoutrightsaleofthe firms receivables to a finance
company (factor) without recourse. According to this agreement the factor undertakes the
receivables,thecredit,thecollectiontask,andtheriskofbaddebt.Thefirmsellingitsreceivables
(client)receivesthevalueofthereceivablesminusacommissionchargeascompensationforthe
risksthefactorassumes.Thereafter,customersmakedirectpaymentstothefactor.Insomecases
receivables are sold to factor at a discount. In this case factor does not get commission. The
discountisitscommission.Fromthisitsexpensesandlosses(collection,baddebtetc.)aremet.
Thebalancerepresentstheprofitofthefactor.
Inanassignment(pledging)agreement,theownershipofthereceivablesisnottransferred;the
receivables are given to a finance company (factor) with recourse. The factor advances some
portionofthereceivablesvalue,generallyintherangeof5080%.Thefirm(client)isresponsible
forservicechargesandinterestontheadvance(duetothefactor)andlossesduetobaddebts.
Accordingtothisarrangement,customersmakedirectpaymenttotheclient.
Itshouldbenotedthatbothfactoringandsecuritisationprovidefinancingsourceforreceivables.
Infactoring,thefinancingsourceisthefactor.Butinsecuritisation,thepublic(investors)whobuysthe
securitiesisthefactoringsource.
ObjectivesofFactoring
Factoringisamethodofconvertingreceivablesintocash.Therearecertainobjectivesoffactoring.
Theimportantobjectivesareasfollows:
1.

Torelievefromthetroubleofcollectingreceivablessoastoconcentrateinsalesandothermajor
areasofbusiness.

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2.

Tominimizetheriskofbaddebtsarisingonaccountofnonrealisationofcreditsales.

3.

Toadoptbettercreditcontrolpolicy.

4.

To carry on business smoothly and not to rely on external sources to meet working capital
requirements.

5.

To get information about market, customers credit worthiness etc. so as to make necessary
changesinthemarketingpoliciesorstrategies.
TypesofFactoring
Therearedifferenttypesoffactoring.Thesemaybebrieflydiscussedasfollows:

1. RecourseFactoring:Inthistypeoffactoring,thefactoronlymanagesthereceivableswithouttaking
anyrisklikebaddebtetc.Fullriskisbornebythefirm(client)itself.
2. NonRecourseFactoring:Herethefirmgetstotalcreditprotectionbecausecompleteriskoftotal
receivablesisbornebythefactor.Theclientgets100%cashagainsttheinvoices(arisingoutof
credit sales by the client) even if bad debts occur. For the factoring service, the client pays a
commissiontothefactor.Thisisalsocalledfullfactoring.
3. MaturityFactoring: Inthistypeoffactoring,thefactordoesnotpayanycashinadvance.The
factorpaysclientsonlywhenhereceivesfunds(collectionofcreditsales)fromthecustomersor
whenthecustomersguaranteefullpayment.
4. AdvanceFactoring:Herethefactormakesadvancepaymentofabout80%oftheinvoicevalueto
theclient.
5. Invoice Discounting: Under this arrangement the factor gives advance to the client against
receivablesandcollectsinterest(servicecharge)fortheperiodextendingfromthedateofadvance
tothedateofcollection.
6. UndisclosedFactoring: Inthiscasethecustomers(debtorsoftheclient)arenotatallinformed
aboutthefactoringagreementbetweenthefactorandtheclient.Thefactorperformsallitsusual
factoringservicesinthenameoftheclientorasalescompanytowhichtheclientsellsitsbook
debts.Throughthiscompanythefactordealswiththecustomers.Thistypeoffactoringisfoundin
UK.
7. Crossboarderfactoring:Itissimilartodomesticfactoringexceptthattherearefourparties,viz,

a) Exporter,
b) ExportFactor,
c) ImportFactor,and
d) Importer.
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It is also called twofactor system of factoring. Exporter (Client) enters into factoring
arrangementwithExportFactorinhiscountryandassignstohimexportreceivables.Export
FactorentersintoarrangementwithImportFactorandhasarrangementforcreditevaluation
&collectionofpaymentforanagreedfee.Notationismadeontheinvoicethatimporterhas
tomakepaymenttotheImportFactor.ImportFactorcollectspaymentandremitstoExport
FactorwhopassesontheproceedstotheExporterafteradjustinghisadvance,ifany.Where
foreigncurrencyisinvolved,factorcoversexchangeriskalso.
ProcessofFactoring(FactoringMechanism)
Thefirm(client)havingbookdebtsentersintoanagreementwithafactoringagency/institution.
Theclientdeliversallordersandinvoicesandtheinvoicecopy(arisingfromthecreditsales)tothe
factor.Thefactorpaysaround80%oftheinvoicevalue(dependsonthepriceof
factoring agreement), as advance. The balance amount is paid when factor collects complete
amount of money due from customers (clients debtors). Against all these services, the factor
chargessomeamountsasservicecharges.Incertaincasestheclientsellsitsreceivablesatdiscount,
say,10%.Thismeansthefactorcollectsthefullamountofreceivablesandpays90%(inthiscase)of
thereceivablestotheclient.Fromthediscount(10%),thefactormeetsitsexpensesandlosses.The
balanceistheprofitorservicechargeofthefactor.

Thustherearethree parties to the factoring. They are the buyers of the goods (clientsdebtors),
thesellerofthegoods(clientfirmi.e.sellerofreceivables)andthefactor.Factoringisafinancial
intermediarybetweenthebuyerandtheseller.
Features(Nature)ofFactoring
Fromthefollowingessentialfeaturesoffactoring,wecanunderstanditsnature:
1. Factoringisaserviceoffinancialnature.Itinvolvestheconversionofcreditbillsintocash.Account
receivablesandothercreditduesresultingfromcreditsalesappearinthebooksofaccountasbook
credits.
2. The factor purchases the credit/receivables and collects them on the due date. Thus the risks
associatedwithcreditareassumedbythefactor.
3. Afactorisafinancialinstitution.Itmaybeacommercialbankorafinancecompany.Itoffers
servicesrelatingtomanagementandfinancingofdebtsarisingoutofcreditsales.Itactsasa
financialintermediarybetweenthebuyer(clientdebtor)andtheseller(clientfirm).
4. Afactorspecialisesinhandlingandcollectingreceivablesinanefficientmanner.
5. Factorisresponsibleforsalesaccounting,debtcollection,credit(creditmonitoring),protection
frombaddebtsandrenderingofadvisoryservicestoitsclients.
6. Factoringisatechniqueofreceivablesmanagement.Itisusedtoreleasefundstiedupinreceivables
(creditgiventocustomers)andtosolvetheproblemsrelatingtocollection,delaysanddefaultsof
thereceivables.
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FunctionsofaFactor
Factorisafinancialinstitutionthatspecialisesinbuyingaccountsreceivablesfrombusinessfirms.
Afactorperformssomeimportantfunctions.Thesemaybediscussedasfollows:
1. Provisionoffinance:Receivablesorbookdebtsisthesubjectmatteroffactoring.Afactorbuys
thebookdebtsofhisclient.Generallyafactorgivesabout80%ofthevalueofreceivablesasadvance
totheclient.Thusthenonproductiveandinactivecurrentassetsi.e.receivablesareconvertedinto
productiveandactiveassetsi.e.cash.
2. Administrationofsalesledger:Thefactormaintainsthesalesledgerofeveryclient.Whenthecredit
salestakeplace,thefirmpreparestheinvoiceintwocopies.Onecopyissenttothe
customers.Theothercopyissenttothefactor.Entriesaremadeintheledgerunderopenitem method.
In this method each receipt is matched against the specific invoice. The customers
accountclearlyshowsthevariousopeninvoicesoutstandingonanygivendate.Thefactoralsogives
periodicreportstotheclientonthecurrentstatusofhisreceivablesandtheamountreceivedfrom
customers.Thusthefactorundertakestheresponsibilityofentiresalesadministrationoftheclient.
3. Collectionofreceivables:Themainfunctionofafactoristocollectthecreditorreceivableson
behalfoftheclientandtorelievehimfromalltensions/problemsassociatedwiththecreditcollection.
Thisenablestheclienttoconcentrateonotherimportantareasofbusiness.Thisalsohelpstheclientto
reducecostofcollection.
4. Protectionagainstrisk:Ifthedebtsarefactoredwithoutresource,allrisksrelatingtoreceivables
(e.g.,baddebtsordefaultsbycustomers)willbeassumedbythefactor.Thefactorrelievestheclient
fromthetroubleofcreditcollection.It alsoadvisestheclientonthecreditworthinessofpotential
customers.Inshort,thefactorprotectstheclientsfromriskssuchasdefaultsandbaddebts.
5. Creditmanagement:Thefactorinconsultationwiththeclientfixescreditlimitsforapproved
customers.Withintheselimits,thefactorundertakestobuyalltradedebtsofthecustomer.Factor
assessesthecreditstandingofthecustomer.Thisisdoneonthebasisofinformationcollectedfrom
credit relating reports, bank reports etc. In this way the factor advocates the best credit and
collection policies suitable for the firm (client). In short, it helps the client in efficient credit
management.
6. Advisoryservices:Theseservicesariseoutofthecloserelationshipbetweenafactorandaclient.
Thefactorhasbetterknowledgeandwideexperienceinthefieldoffinance.Itisa
specialisedinstitutionformanagingaccountreceivables.Itpossessesextensivecreditinformation
about customers creditworthiness and track record. With all these, a factorcanprovidevarious
advisoryservicestotheclient.Besides,thefactorhelpstheclientinraisingfinancefrom
banks/financialinstitutions.

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AdvantagesofFactoring
Afirmthatentersintofactoringagreementisbenefitedinanumberofways.Someofthe
importantbenefitsoffactoringaresummarisedasfollows:
1. Improvesefficiency:Factoringisanimportanttoolforefficientreceivablesmanagement.Factors
providespecialisedserviceswithregardtosalesledgeradministration,creditcontroletc.Factoring
relievestheclientsfrombotherationofdebtcollection.
2. Highercreditstanding:Factoringgeneratescashforthesellingfirm.Itcanusethiscashforother
purposes.Withtheadvancepaymentmadebyfactor,itispossiblefortheclienttopayoffhis
liabilitiesintime.Thisimprovesthecreditstandingoftheclientbeforethepublic.
3. Reducescost:Theclientneednothaveaspecialadministrativesetuptolookaftercreditcontrol.
Henceitcansavemanpower,timeandeffort.Sincethefactoringfacilitatessteadyandreliablecash
flows,clientcancutcostsandexpenses.Itcanavailcashdiscounts.Further,itcanavoidproduction
delays.
4. Additionalsource:Fundsfromafactorisanadditionalsourceoffinancefortheclient.Factoring
releasesthefundstiedupincreditextendedtocustomersandsolvesproblemsrelatingtocollection,
delaysanddefaultsofthereceivables.
5. Advisoryservice:Afactorfirmisaspecialisedagencyforbettermanagementofreceivables.
Thefactorassessesthefinancial,operationalandmanagerialcapabilitiesofcustomers.Inthis
waythefactoranalyseswhetherthedebtsarecollectable.Itcollectsvaluableinformationabout
customersandsuppliesthesameforthebenefitsofitsclients.Itprovidesallmanagementand
administrativesupportfromthestageofdecidingcreditextensiontothecustomerstothefinal
stageofdebtcollection.Itadvocatesthebestcreditpolicysuitableforthefirm.
6. Accelerationofproductioncycle:With cash available for credit sales, client firms liquiditywill
improve.Inthiswayitsproductioncyclewillbeaccelerated.
7.Adequatecreditperiodforcustomers:Customersgetadequatecreditperiodforpaymentof
assigneddebts.
8.Competitivetermstooffer:Theclientfirmwillbeabletooffercompetitivetermstoitsbuyers.
Thiswillimproveitssalesandprofits.
LimitationsofFactoring

Themainlimitationsoffactoringareoutlinedasbelow:
1. Factoringmayleadtooverconfidenceinthebehaviouroftheclient.Thisresultsinovertradingor
mismanagement.
2. Therearechancesoffraudulentactsonthepartoftheclient.Invoicingagainstnonexistentgoods,
duplicateinvoicingetc.aresomecommonlyfoundfrauds.Thesewouldcreateproblemstothe
factors.
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3. Lackofprofessionalismandcompetence,resistancetochangeetc.aresomeoftheproblemswhich
havemadefactoringservicesunpopular.
4. Factoring is not suitable for small companies with lesser turnover, companies with speculative
business,companieshavinglargenumberofdebtorsforsmallamountsetc.
5. Factoringmayimposeconstraintsonthewaytodobusiness.Fornonrecoursefacoringmost
factorswillwanttopreapprovecustomers.Thismaycausedelays.Further,thefactorwill
applycreditlimitstoindividualcustomers.

Forfaiting
Generallythereisadelayingettingpaymentbytheexporterfromtheimporter.Thismakesit
difficultfortheexportertoexpandhisexportbusiness.However,forgettingimmediatepayment,the
conceptofforfeitingshallcometothehelpofexporters.
TheconceptofforfaitingwasoriginallydevelopedtohelpfinanceGermanexportstoEastern
blockcountries.Infact,itevolvedinSwitzerlandinmid1960s.
MeaningofForfaiting

The term forfait is a French world. It means to surrender something or give up ones right.
Thus forfaiting means giving up the right of exporter to the forfaitor to receive payment in
futurefromtheimporter.

Itisamethodoftradefinancingthatallowsexporterstogetimmediate

cashandrelievefromallrisksbysellingtheirreceivables(amountduefromtheimporter)ona
without recource basis. This means that in case the importer makes a default the forfaitor cannot
gobacktotheexportertorecoverthemoney.Underforfaitingtheexportersurrendershisrighttoa
receivabledueatafuturedateinexchangeforimmediatecashpayment,atanagreeddiscount.
Heretheexporterpassestotheforfaitorallrisksandresponsibilitiesincollectingthedebt.The
exporterisabletoget100%oftheamountofthebillimmediately.Thushegetsthebenefitofcash
sale.However,theforfaitordeductsthediscountchargesandhegivesthebalanceamounttothe
exporter.Theentireresponsibilityofrecoveringtheamountfromtheimporterisentrustedwiththe
forfaitor.Theforfaitormaybeabankoranyotherfinancialinstitution.
Inshort,thenonrecoursepurchaseofreceivablesarisingfromanexportofgoodsandservicesby
aforfaitorisknownasforfaiting.
Forfaitingisnotthesameasinternationalfactoring.Thetenureofforfaitingtransactionislong.
Internationalfactoringinvolvesshorttermtradetransactions.Incaseofforfaiting,politicalandtransfer
risksarealsobornebytheforfaitor.Butininternationalfactoringtheserisksarenotbornebythe
factor.
CharacteristicsofForfaiting

Themaincharacteristicsofforfaitingare:
1.

Itis100%financingwithoutrecoursetotheexporter.

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2.

Theimporters obligation is normally supported by a local bank guarantee (i.e., aval).

3.

Receivablesareusuallyevidencedbybillsofexchange,promissorynotesorlettersofcredit.

4.

Financecanbearrangedonafixedorfloatingratebasis.

5.

Forfaitingissuitableforhighvalueexportssuchascapitalgoods,consumerdurables,vehicles,
constructioncontracts,projectexportsetc.
Exporterreceivescashuponpresentationofnecessarydocuments,shortlyaftershipment.

6.

AdvantagesofForfaiting
Thefollowingarethebenefitsofforfaiting:
1.

Theexportergetsthefullexportvaluefromtheforfaitor.

2.

Itimprovestheliquidityoftheexporter.Itconvertsacredittransactionintoacashtransaction.

3.

Itissimpleandflexible.Itcanbeusedtofinanceanyexporttransaction.Thestructureoffinance
canbedeterminedaccordingtotheneedsoftheexporter,importer,andtheforfaitor.

4.

Theexporterisfreefrommanyexportcreditriskssuchasinterestraterisk,exchangeraterisk,
politicalrisk,commercialrisketc.
Theexporterneednotcarrythereceivablesintohisbalancesheet.

5.
6.

Itenhancesthecompetitiveadvantageoftheexporter.Hecanprovidemorecredit.Thisincreases
thevolumeofbusiness.

7.

Thereisnoneedforexportcreditinsurance.Exportersavesinsurancecosts.Heisrelievedfrom
thecomplicatedproceduresalso.

8.

Itisbeneficialtoforfaitoralso.Hegetsimmediateincomeintheformofdiscount.Hecanalsosell
thereceivablesinthesecondarymarketortoanyinvestorforcash.
DifferencebetweenFactoringandForfaiting

Forfaitingandfactoringhavesimilarities.Bothhavesimilarfeaturesofadvancepaymentand
nonrecoursedealing.Buttherearesomedifferencesbetweenthem.Thedifferencesareasfollows:
1.
2.
3.

Factoring
Usedforshorttermfinancing.
Maybewithorwithoutrecourse.
Applicabletobothdomesticandexport
receivables.

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1.
2.
3.

Forfaiting
Usedformediumtermfinancing.
Alwayswithoutrecourse.
Applicabletoexportreceivablesonly.

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4.

Normally 70 to 85% of the invoice

valueisprovidedasadvance.

5.

Thecontractorisbetweenthefactor
andtheseller.

6.

7.
8.

4.

100%financeisprovidedtotheexporter.

5. Thecontractisbetweentheforfaitor
andtheexporter.

Otherthanfinancing,severalotherthings 6. Itisafinancingarrangementonly.
likesalesledgeradministration,debt
collectionetc.isprovidedbythefactor.
Abulkfinanceisprovidedagainsta7.Itisbasedonasingleexportbillresulting
numberofunpaidinvoices.
fromonlyasingletransaction.
Nominimumsizeoftransactionis
8.Thereisaminimumspecifiedvalueper

specified.

transaction.

Billsdiscounting
Billdiscountingisbookdebtfinancing.Thisisdonebycommercialbanks.
MeaningofBillsDiscounting
Whengoodsaresoldoncredit,thereceivablesorbookdebtsarecreated.Thesupplierorseller
ofgoodsdrawsabillofexchangeonthebuyerordebtorfortheinvoicepriceofthegoodssoldon
credit.Itisdrawnforashortperiodof3to6months.Sometimesitisdrawnfor9months.After
drawingthebill,thesellerhandsoverthebilltothebuyer.Thebuyeracceptsthesame.Thismeans
hebindshimselfliabletopaytheamountonthematurityofthebill.Afteracceptingthebill,the
buyer(drawee)givesthesametotheseller(drawer).Nowthebilliswiththedrawer.Hehasthree
alternatives.Oneistoretainthebilltilltheduedateandpresentthebilltothedraweeandreceive
theamountofthebill.Thiswillaffecttheworkingcapitalpositionofthecreditor.Thisisbecause
hedoesnotgetimmediatepayment.Thesecondalternativeistoendorsethebilltoanycreditorsto
settlethebusinessobligation.Thethirdorlastalternativeistodiscountthebillwithhisbanker.
Thismeansheneednotwaittilltheduedate.Ifheisinneedofmoney,hecan
discountthebillwithhisbanker.Thebankerdeductscertainamountasdiscountchargesfromthe
amount of the bill and balance is credited in the customers (drawers or holders) account. Thus the
bankprovides immediate cashbydiscountingtrade bills.Inotherwords,thebankeradvances
moneyonthesecurityofbillofexchange.Ontheduedate,thebankerpresentsthebilltothe
draweeandreceives payment. Ifthedraweedoesnotmakepayment, thedrawerhastomake
payment to the banker. Here the bank is the financier. It renders financial service. In short,
discountingisafinancialservice.

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AdvantagesofBillDiscounting/BillFinancing
1.

Itoffershighliquidity.Thesellergetsimmediatecash.

2.

Thebankergetsincomeimmediatelyintheformofdiscount.

3.

Billsarenotsubjecttoanyfluctuationsintheirvalues.

4.

Proceduresaresimple.

5.

Evenifthebillisdishonoured,thereisasimplelegalremedy.Thebankerhastosimplynote
and protest the bill and debit in the customers account.
ThebillsareusefulasabaseforthemaintenanceofreserverequirementslikeCRRandSLR.

6.

DifferencebetweenBillDiscountingandFactoring
BillsDiscounting
1. Financealoneisprovided.

2. Advancesaremadeagainstbills.
3. Drawerorholderisthecollectorof
receivables.
4. Itisindividualtransactionoriented.

Factoring
1. Inadditiontotheprovisionoffinance,severalother
services like maintenance of sales ledger, advisory
servicesetc.areprovided.
2. Receivablesarepurchasedbyassignment
3. Factoristhecollectorofreceivables.
4. Bulkfinanceisprovided(i.e.,basedon
wholeturnover).
5. Itisoffbalancesheetmethodfinance.

5. Itisnotanoffbalancesheetmethodof
finance.
6. Stampdutyischargedonbills.
6. Nostampdutyischargedoninvoices.
7. Thegraceperiodforpaymentisusually7.Thegraceperiodishigher.3
days.
8. Doesnotinvolveassignmentofdebts.8.Itinvolvesassignmentofdebts.
9. Billsdiscountedmayberediscounted
severaltimesbeforetheduedate.
10. Itisalwayswithrecourse.

9. Debtspurchasedcannotberediscounted;
theycanonlyberefinanced.
10.Itmaybewithorwithoutrecourse.

SecuritisationofDebt/Assets
Loansgiventocustomersareassetsforthebank.Theyarecalledloanassets.Unlikeinvestment
assets,loanassetsarenottradableandtransferable.Thusloanassetsarenotliquid.The
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problemishowtomaketheloanofabankliquid.Thisproblemcanbesolvedbytransformingthe
loans into marketable securities. Now loans become liquid. They get the characteristic of
marketability. This is done through the process of securitization. Securitization is a financial
innovation.Itisconversionofexistingorfuturecashflowsintomarketablesecuritiesthatcanbe
soldtoinvestors.Itistheprocessbywhichfinancialassetssuchasloanreceivables,creditcard
balances,hirepurchasedebtors,leasereceivables,tradedebtorsetc.aretransformedintosecurities.
Thus,anyassetwithpredictablecashflowscanbesecuritized.
Securitizationisdefinedasaprocessoftransformationofilliquidassetintosecuritywhichmaybe
tradedlaterintheopeningmarket.Inshort,securitizationisthetransformationofilliquid,non
marketable assets into securities which are liquid and marketable assets. It is a process of
transformation of assets of a lending institution into negotiable instruments. Securitization is
different from factoring. Factoring involves transfer of debts without transforming debts into
marketable securities. But securitization always involves transformation of illiquid assets into
liquidassetsthatcanbesoldtoinvestors.
PartiestoaSecuritisationTransaction
Thereareprimarilythreepartiestoasecuritisationdeal,namely
a. TheOriginator:Thisistheentityonwhosebookstheassetstobesecuritisedexist.Itistheprime
moverofthedeali.e.itsetsupthenecessarystructurestoexecutethedeal.Itsellstheassetsonits
booksandreceivesthefundsgeneratedfromsuchsale.Inatruesale,theOriginatortransfersboththe
legalandthebeneficialinterestintheassetstotheSPV.
b. TheSPV:TheissueralsoknownastheSPVistheentity,whichwouldtypicallybuytheassets
(tobesecuritised)fromtheOriginator.TheSPVistypicallyalowcapitalisedentitywithnarrowly
definedpurposesandactivities,andusuallyhasindependenttrustees/directors.Asoneofthemain
objectivesofsecuritisationistoremovetheassetsfromthebalancesheetoftheOriginator,theSPV
playsaveryimportantroleisasmuchasitholdstheassetsinitsbooksandmakestheupfront
paymentforthemtotheOriginator.
c. TheInvestors:TheinvestorsmaybeintheformofindividualsorinstitutionalinvestorslikeFIs,
mutual funds, provident funds, pension funds, insurance companies, etc. They buy a participating
interestinthetotalpoolofreceivablesandreceivetheirpaymentintheformofinterestandprincipalas
peragreedpattern.Besidesthesethreeprimaryparties,theotherpartiesinvolvedinasecuritisationdeal
aregivenbelow:
a) TheObligor(s):TheObligoristheOriginator'sdebtor(boroweroftheoriginalloan).Theamount
outstandingfromtheObligoristheassetthatistransferredtotheSPV.Thecreditstandingofthe
Obligor(s)isofparamountimportanceinasecuritisationtransaction.
b) TheRatingAgency:Sincetheinvestorstakeontheriskoftheassetpoolratherthanthe Originator,
anexternalcreditratingplaysanimportantrole.Theratingprocesswouldassessthestrengthofthe
cashflowandthemechanismdesignedtoensurefullandtimelypaymentbythe

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processofselectionofloansofappropriatecreditquality,theextentofcreditandliquiditysupport
providedandthestrengthofthelegalframework.
c) AdministratororServicer:ItcollectsthepaymentduefromtheObligor/sandpassesittotheSPV,
follows up with delinquent borrowers and pursues legal remedies available against the defaulting
borrowers.SinceitreceivestheinstalmentsandpaysittotheSPV,itisalsocalledtheReceivingand
PayingAgent.
d) Agent and Trustee: It accepts the responsibility for overseeing that all the parties to the
securitisation deal perform in accordance with the securitisation trust agreement. Basically, it is
appointedtolookaftertheinterestoftheinvestors.
e) Structurer: Normally,aninvestmentbankerisresponsibleasstructurerforbringingtogetherthe
Originator,creditenhancer/s,theinvestorsandotherpartnerstoasecuritisationdeal.Italsoworkswith
theOriginatorandhelpsinstructuringdeals.

The different parties to a securitisation deal have very different roles to play. In fact, firms
specialiseinthoseareasinwhichtheyenjoycompetitiveadvantage.Theentireprocessisbroken
upintoseparatepartswithdifferentpartiesspecialisinginoriginationofloans,raisingfundsfrom
thecapital markets,servicingofloans etc.Itisthiskindofsegmentationofmarketroles that
introducesseveralefficienciessecuritisationissooftencreditedwith.
Basicprocessofsecuritization

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Theadvantagesofsecuritisation:
1. Additionalsourceoffundbyconvertingilliquidassetstoliquidandmarketableassets.
2. Greaterprofitabilitysecuritisationleadstofasterrecyclingoffundandthusleadstohigherbusiness
turnoverandprofitability.

3. EnhancementofCARSecuritisationenablesbanksandfinancialinstitutionstoenhancetheir capital
adequacyratio(CAR)byreducingtheirriskyassets.

4. SpreadingCreditRisks securitisationfacilitatesthespreadingofcreditriskstodifferent parties

involvedintheprocessofsecuritisationsuchasSPV,insurancecompanies(creditenhancer)etc.

5.Lowercostoffundingoriginatorcanraisefundsimmediatelywithoutmuchcostofborrowing.
6.Provisionofmultipleinstrumentsfrominvestorspointofview,securitisationprovidesmultiple
instrumentssoastomeetthevaryingrequirementsoftheinvestingpublic.
7. Higher rate of return when compared to traditional debt securities like bonds and debentures,
securitisedassetsprovideshigherratesofreturnalongwithbetterliquidity.

8.Preventionofidlecapitalintheabsenceofsecuritisation,capitalwouldremainidleintheformof
illiquidassetslikemortgages,termloansetc.
Retailbankingservices

Retailbankingistypicalmassmarketbankingwhereindividualcustomersuselocal
branches of larger commercial banks. Services offered include: savings and checking accounts,
mortgages, personal loans, debit cards, credit cards, and so. The Retail Banking environment
todayischangingfast.Thechangingcustomerdemographicsdemandstocreateadifferentiated
application based on scalable technology, improved service and banking convenience. Higher
penetrationoftechnologyandincreaseingloballiteracylevelshassetuptheexpectationsofthe
customer higher thannever before.Increasing useofmodern technology has furtherenhanced
reachandaccessibility.Themarkettodaygivesusachallengetoprovidemultipleandinnovative
contemporaryservicestothecustomerthroughaconsolidatedwindowassotoensurethatthe banks
customer gets Uniformity and Consistency of service delivery across time and at every
touchpoint across allchannels. Thepaceofinnovation is accelerating andsecurity threathas
becomeprimeofallelectronictransactions.Highcoststructurerenderingmassmarketservicingis
prohibitivelyexpensive.Presentdaytechsavvybankersarenowmorelookingatreductionintheir
operatingcostsbyadoptingscalableandsecuretechnologytherebyreducingtheresponsetimeto
theircustomerssoastoimprovetheirclientbaseandeconomiesofscale.Thesolutionliesto
marketdemandsandchallengesliesininnovationofnewofferingwithminimumdependenceon
branches a multichannel bank and to eliminate the disadvantage of an inadequate branch
network.Generationofleadstocrosssellandcreatingadditionalrevenueswithutmostcustomer
satisfactionhasbecomefocalpointworldwideforthesuccessofaBank.
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Retailbankingmeansmobilizingdepositformindividualsandprovidingloanfacilitiestotheminthe
formofhomeloans,autoloans,creditcards,etc,isbecomingpopular.Thisusedtobeconsideredby
thebanksasatoughpropositionbecauseofthevolumeofoperationsinvolved.Butduringthelast
coupleofyearsorso,banksseemtohaverealizedthattheonlysustainablewaytoincreasedepositsis
to look at small and middle class consumer retail deposit and not the price sensitive corporate
depositors.Withfinancialsectorreformsgatheringmomentum,thebankingsystemisfacingincreasing
companiesfromnonbanksandthecapitalmarket.Moreandmorecompaniesaretappingthecapital
marketdirectlyforfinance.Thisisoneofthemainreasonsforthebankstofocusvigorouslyonthe
muchignoredretaildeposits.Anotherreasonisthecurrentliquiditythemarginsare1to2percent
abovetheprimerate;inretailmarkettheyare3to4percent.

Todays retail banking sector is characterized by three basic characteristics:

1. Multipleproducts(deposits,creditcards,insurance,investmentsandsecurities)
2. Multiplechannelsofdistribution(callcentre,branch,internet)
3.Multiplecustomergroups(consumer,smallbusiness,andcorporate).
ScopeforRetailBankingInIndia
AllroundincreaseineconomicactivityIncreasesthepurchasingpower.Theruralareashavethelarge
purchasingpowerattheirdisposalandthisisanopportunitytomarketRetailBanking.India
has 200 million households and 400 million middle class populations. More than 90% of the
savings come from the house hold sector. Falling interest rates have resulted in a shift. Now
People Want To Save Less And Spend More.. Nuclear family concept is gaining much
importancewhichmayleadtolargesavings.Largenumberofbankingservicestobeprovidedareday
bydayincreasing.Taxbenefitsareavailableforexample,incaseofhousingloanstheborrowercan
availtaxbenefitsfortheloanrepaymentandtheinterestchargedfortheloan.
AdvantagesofRetailBanking
Retailbankinghasinherentadvantages.Advantagesareanalyzedfromtheresourceangleandasset
angle.
Resourceside

Retaildepositsarestableandconstitutecoredeposits.
Theyareinterestinsensitiveandlessbargainingforadditionalinterest.
Theyconstitutelowcostfundsforthebanks.
Effective customerrelationshipmanagementwiththeretail customers builtastrong
customerbase.
Retailbankingincreasesthesubsidiarybusinessofthebanks.

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Assetsside
Retailbankingresultsinbetteryieldandimprovedbottomlineforabank.
Retailsegmentisagoodavenueforfundsdeployment
ConsumerloansarepresumedtobeoflowerriskandNPAperception.
Helpseconomicrevivalofthenationthroughincreasedproductionactivity.
Improveslifestyleandfulfilsaspirationsofthepeoplethroughaffordablecredit.
Innovativeproductdevelopmentcredit.
Retailbankinginvolvesminimummarketingeffortsinademanddriveneconomy.
Diversified portfolio due to huge customer base enables bank to reduce their
dependenceonfeworsingleborrower
Bankscanearngoodprofitsbyprovidingnonfundbasedorfeebasedserviceswithout
deployingtheirfunds.
Disadvantagesofretailbanking
a. Designingownandnewfinancialproductsisverycostlyandtimeconsumingforthe
bank.
b. Customersnowadaysprefernetbankingtobranchbanking.Thebanksthatareslowin
introducingtechnologybasedproducts,arefindingitdifficulttoretainthecustomers
whowishtooptfornetbanking.
c. Customersareattractedtowardsotherfinancialproductslikemutualfundsetc.
d. Thoughbanksareinvestingheavilyintechnology,theyarenotabletoexploitthesame
tothefullextent.
e. Amajordisadvantageismonitoringandfollowupofhugevolumeofloanaccounts
inducingbankstospendheavilyinhumanresourcedepartment.
f.

Longtermloanslikehousingloanduetoitslongrepaymenttermintheabsenceof
properfollowup,canbecomeNPAs.

g. Thevolume ofamountborrowedbyasinglecustomer isverylowascomparedto

wholesalebanking.Thisdoesnotallowbankstoexploittheadvantageofearninghuge
profitsfromsinglecustomerasincaseofwholesalebanking.
RetailbankingProducts/services
Bankskeeponintroducingnewservicesandnewproductsaimedatsatisfyingthevariedrequirements
ofretailcustomers.Toquoteafew:
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1. Housingfinance
2. Vehicleloans
3. Doctorsloans
4. Teachersloans
5. Goldloans
6. Rentalloans
7. Loansforwomen
8. LoansforSolarWaterHeaters
9. Loansforpensioners
10. Consumerloans
11. Personalloans
12. Educationalloans
13. Marriageloans,consumptionloansetc.
1. Housing finance/loan

Providing shelter to the needy, poor, disabled and backward classes is one of the important
economicactivitiesoftheGovernmentBesidesthis,investmentinhousinghasbecomeanecessity
foronesownshelterandforhisfamily.Moreover,investmentinhousingisconsideredasahedge
againstinflation,since,inmostcasestheriseinlandvaluesismorethantheriseininflationrates.
In spite of these advantages, housing development has been rather slow in many developing
countries. Itis sobecause housing is ahugeinvestment requiring longterm finance. Housing
constructionisaspecialcategoryofindustrywhichneithercomesundermanufacturingsectornor
underservicessector.However,housingisimportanttodevelopmentinbotheconomicandwelfare
terms.
RisksinHousingFinance
Tillrecently,housingfinancewasconsideredtobeariskyventurefromthepointofviewoffinancial
institutionsduetothefollowingreasons:
2. Large Investment

Generally,houseconstructionorpurchaseofland/homerequiresalargeamountofinvestment.Hence,
lendinginstitutionshesitatetolockuptheirfundsheavilyononeprojectinvitinghugerisk.

(ii)Longtermadvance
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Againhouseconstructionorpurchaserequiresfinanceforalongerperiodsay20to25years.Since
mostoftheresourcesofthelendinginstitutionsareshortterminnature,theyhesitatetolockuptheir
fundsforlongerperiods.
(iii)HighInflationRate
Inmanycountries,theinflationratesaregoinguplikeanythingwhicheatsawaytheinterestrates
chargedbythelendinginstitutions.
(iv)HighStampDuty
Creatingalegalchargeinthehouses/landsisverycostlysincethestampdutiesareveryheavy.Again,
propertieshavetobereconvenedonrepaymentofloans.Italsocallsforadditionalstampduties.

(v)DefectiveTitle
IIisverydifficulttoascertainthelegaltitleoftheborrower.Successionlaws,Tenancylawsetc.,vary
fromregiontoregionandfromreligiontoreligion.Itbecomesallthemoredifficulttofindoutthe
genuinetitleoftheborrower.
(vi)HighDelinquencyRate
Inrecenttimes,nonperformingloansareontheincreaseinthehousingfinancesector.Thegrowing
nonrepaymentproblemcausesmuchconcerntothelendinginstitutions.
(vii)KeenCompetition

Thereisakeencompetitioninthehousingfinancesectorresultinginverylowinterestratesalso.
HOUSINGFINANCEADOMINANTRETAILFINANCING
Todayonecanwitnessaparadigmshifttohousingfinance.Housingfinancehasbecomea
lucrativebusinesstomanybankingandnonbankingcompanies.Almostallfinancialinstitutions
seemtoconcentrateonretailfinancingratherthanwholesalefinancing.Lendingtocorporates
andbiginstitutionalborrowersiscalledwholesalelendingorfinancing.Ontheotherhand,lending
toindividuals andgroupofindividuals comeunderthecategoryof retailfinancing.Inretail
financing, housingfinance grows atan impressive ratedue tovarious reasons.Easyaccess at
affordablerateshasacceleratedthetempoofhousingactivitiesinrecenttimes.Differentfinancial
productshavebeenintroducedtocatertothevasthousingrequirementsofvariedpeople.Housing
loansaregivennotonlyforconstruction,butalsoforextension,improvementsetc.Loansaregiven
forfurnishinghousesandalsoforpayingstampduties.Bankshavecomeforwardtowaivethe
processing fees. Housing loans are sanctioned with flexible repayment schedule which can be
decidedbythecustomersthemselves.Housingloansaresanctionedforfamilyplanningclinics,
health centers, educational, social, andcultural andotherinstitutions also.Shoppingcenters in
residentialareascanalsoavailofhousingloanfacilities.
Housing/homeloanproducts
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Generally,thefollowingfinancialproductsareavailableinthehousingmarket.
3. Housing loan for purchase of homes This product is available purely for the
purchase of either new houses or flats or existing ones.

(ii)HouseconstructionloanThisproductisavailableonlyfortheconstructionofnewhouses.
(iii) HomeextensionloanThisisavailablepurelyforexpandinganalreadyexistinghome.
(iv) HomeimprovementloanThisisgrantedforrenovatinganexistinghome.
(v)FlexiblerepaymentplanThistypeofhousingloanpermitstheborrowertofixtherepayment
scheduleasperhisoption.
(vi)FlexibleloaninstallmentplanUnderthistypeofhousingloan,theborrowercandecidethe
amountofinstallmenttobepaidaccordingtohisdiscretiononthebasisofhisfutureearnings.
(vii)HometransferorconversionloanThisproductisavailabletothosewhohavealreadyavailed
ofhousingloansandwanttomovetoanotherhouseforwhichadditionalfundsarerequired.Under
this type,theexistinghousingloanistransferredtothenewhousingloanamountwithoutthe
necessityofsettlingthepreviousloanaccount.
(viii)HomefurnishingloanThisproductisavailabletofurnishahousefully.
(ix) Housing repayment or refinance loan This loan is available to redeem the prior debts
incurredforthepurchaseofhomesfromfriends,relativesandotherprivatesources.
(x) HousingloantransferplanThisloanisavailabletopayoffanexistinghousingloanwitha
higherinterestrateandenjoyanewloanwithalowerrateofinterest.
(xi) BridgeloanforhousingThisproductisavailabletothosewhowishtoselltheiroldhomes
andpurchaseanother.Thisloanisavailableforthenewhomeuntilasuitablebuyerisfoundforthe
oldhome.
(xii) Stampduty/DocumentingLoanthisistheHLproductmeantforpaymentofstampdutyand
otherdocumentationchargesinconnectionwithhousepurchases.
Housingfinanceinstitutions
Anumberofinstitutionsplayadominantroleinthefieldofhousingfinance.Themostimportantones
arethefollowing:

I.
National Housing Bank
(NHB)II.CommercialBanks
III.CooperativeBanks
IV.

HousingandUrbanDevelopmentCorporationLtd.(HUDCO)

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V.
VI.

HousingDevelopmentFinanceCorporation(HDFC)andotherPrivateFinanceCompanies
Insurancecompanies.

NationalHousingBank
TheNationalHousingBankwassetuponJuly9,1988asanapexinstitutiontomobilizeresourcesfor
thehousingsectorandtopromotehousingfinanceinstitutions,bothonregionalandlocallevels.Itwas
establishedasasubsidiaryoftheRBIwithaviewtocoordinatinganddevelopinghousingfinance
schemes.FollowingarethemainfunctionsoftheNHB:
4. To promote and develop specialized housing finance institutions for mobilizing
resources and supplying credit for house construction.

(ii) Toproviderefinancefacilitiestohousingfinanceinstitutionsandscheduledbanks.
(iii) Toprovideguaranteeandunderwritingfacilitiestohousingfinanceinstitutions.
(iv)Topromoteschemesformobilizationofresourcesandextensionofcreditforhousingespeciallyfor
economicallyweakersectionsofthesociety.
(v)Tocoordinatetheworkingofallagenciesconnectedwithhousing.

CommercialBanks
Foralongtime,thecommercial bankswereratherreluctanttoenterintothefieldofhousing
financesinceitisofalongtermnature.But,today,bothpublicandprivatesectorbankshave
changed their outlook completely and they have started to look at housing finance as a very
lucrative business. Many banks have set up their own subsidiaries exclusively for providing
housing finance especially to meet the housing requirements of the lower and middle income
groups.Someofthesubsidiariesestablishedbycommercialbankstoprovidehousingfinanceare
thefollowing:
NameoftheBank

NameoftheHousingFinanceCompany(Subsidiarycompanies)

(i) StateBankofIndia

StateBankofIndiaHousingFinance(SBIHF)

(ii) PunjabNationalBank

PunjabNationalBankHousingFinanceLtd.(PNBHFL)

(iii) AndhraBank

AndhraBankHousingFinanceLtd.(AHFL)

(v)CanaraBank

CanFinHomesLtd.(CFHL)

(vii) VijayaBank

VBankHousingFinanceLtd.(VHFL)

(viii) BankofIndia

IndianBankHousingFinanceLtd.(IBHFL)

Cooperative
Banks
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Besidesprovidingfinance,thesebanks/societiespayaspecialattentiontotheprovisionof
allamenitiesnecessaryforacomfortableliving.Thesesocietiesalsoextendfinanceforpurchaseof
residentialplotsdevelopedbythem.TheStateLevelApexCooperativeHousingFinanceSociety
(ACHFS)coordinatesthehousingfinancialrequirementsofvariouscooperativehousingsocieties.
ItiseligibletogetrefinancefacilityfromtheNHB.
HousingandUrbanDevelopmentCorporationLtd.
The HUDCO was incorporated as a fully owned Government Company with the main
objectiveoffinancingtheurbaninfrastructuredevelopmentprojects,approvedbytheGovernment.
Sincetheproblemofhousingisveryacuteinurbanareas,itconcentratesonurbandevelopment
projectsbyprovidingsheltertothepoorandforlowincomegroups.Itisthenodalagencyfor
implementingvariousgovernmenthousingprogrammes.
HDFCandOtherPrivateHousingFinanceCompanies
TheHousingDevelopmentandFinanceCorporation(HDFC)wassetupintheprivatesectorin
1977byinstitutionslikeICICI,IFC(InternationalFinanceCorporation)etc.Todayithasbecome
thelargestproviderofhousingfinanceinIndia.Ithaspioneeredavarietyofhousingloanslike
group loans, housing complexes, housing societies etc. It lends to companies employers and
institutionstofinancetheirhouseconstructionrequirementsfortheiremployees,staffquartersetc.
Italsoprovidesloanstoindividuals,groupsandsocieties.ApartfromtheHDFC,manyhousing
financecorporationshavecomeintoexistenceintheprivatesector.Someoftheseinstitutionsare:
a. BirlaHomeFinanceLtd.(NHFL)
b. SundaramHomeFinanceLtd.(SHFL)
c. GlobalHousingFinanceCorporationLtd.(GHFCL)
d. DewanHousingFinanceCorporationLtd.(DHFCL)
e. MaharishiHousingFinanceCorporationLtd.(MHFCL)
f. HomeTrustHousingFinanceCorporationLtd.(HHFCL).
Theseinstitutionshavedesignedsomeinnovativehousingfinanceproductssoastocatertothe
requirementsofvarioustypesofborrowers.
InsuranceCompanies
TheLIChassetuptheLICHousingFinanceLtd.in1989withtheobjectiveofprovidinglong
termfinanceforpurchase/constructionofhouses/flatstoitspolicyholdersdirectlythroughoutIndia.It
offersavarietyofhousingloansforreconstructions,renovationsetc.Ithasdesignedspecialschemes
forprofessionals,NRIsetc.
The General Insurance Corporation is also actively engaged in providing housing finance
indirectlythroughotherinstitutionslikeHUDCOorthroughStateGovernments.Ithasalsosetupa
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separate company viz., GIC Housing Finance Ltd. to activate the home loan process. Thus, the
insurancecompanieshaveemergedasvibranthousingfinanceinstitutionsinrecentyears.
ReasonsforthePopularityofHousingFinance(Advantages)
Thebankfinancetothehousingsectorhasbecomeanattractivechannelduetothefollowingreasons:
5. Safety Advances

Housingfinance,thoughalongtermfinanceisconsideredtobeasafeadvancesinceitisbackedby
mortgageofhouse.
(ii)RefinanceFacility
AlmostallbanksareeligibletogetrefinancefromtheNHBfortheiradvancestothehousingsector.
Hence,therewillbenofinancialcrunchonthepartofthebankers.
(iii)AssetLiabilityManagement(ALB)
The longer tenures of housing finance facilitate ALB. Since the RBIs guidelines permit banks to
elongaterepaymentperiodsquotingvariableinterestrates,theALMbecomesaneasytask.
(iv)PrioritySectorAdvance
HousingloansuptoRs.10lakhshavebeenbroughtunderthecategoryofprioritysectoradvances.It
enablesthecommercialbankstofulfilltheirprioritysectoradvancestarget.
(v)LowDefault
Bankshavefoundoutthatthedefaultriskisverylowinthecaseofhousingfinance.Hence,thereisno
problemofNPAmanagement.
(vi)ReductioninRiskWeightage
Again,theRBIhasreducedtheriskweightagefrom100%to50%forloansgrantedforacquiring
residentialhouses.Ithelpscommercialbankstosatisfythecapitaladequacynormsalso.
(vii)PassingofSARFAESlAct2002
ThepassingoftheSecuritizationandReconstructionofFinancialAssetsandEnforcementof
SecurityInterestActhaspavedwayforthecommercialbankstodirectlydealwiththesecurityby
givingwideprocess,insteadofundergoingacumbersomeprocedureofapproachingacourttodeal
withsuchsecuritiesincaseanydefaultiscommittedbyborrowers.
(viii)EstablishmentofAssetReconstructionCompany(ARC)
TheestablishmentofARChasgivenanotherboosttohousingfinancesinceitfacilitatessecuritization
ofmortgagedhousingloans.
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(x)MortgagedCreditGuaranteeScheme
TheNHBhascomeforwardtogiveguaranteetothedebentures,bondsandothersecuritiesissuedby
commercialbanksforthepurposeofraisingadequateresourcesforhousingfinance.
Today,housingfinanceisnolongerariskyadvance.Ithasbecomeaverylucrativebusinessfor
bankers.TheRBIhas deregulated theinterestrates givinggreater freedomtobanks toprice their
housingfinancialproductsaccordingtotheirdiscretion.
(II)CONSUMERLOAN/CONSUMERCREDIT

The services of banks which facilitate finance for purchasing consumer durables is called
consumerloanorcreditorfinance.Itreferstotheraisingoffinancebyindividualsformeeting
theirpersonalexpenditureorfortheacquisitionofdurableorsemidurablegoods.Itisanimportant
assetbasedfinancialserviceinIndia.Theobjectiveofconsumerfinanceistoprovidecrediteasily
to the consumer at his door steps. This include credit merchandising deferred payments,
instalments,instalmentbuying,hirepurchase,payoutofincomescheme,payasyouearnscheme,
easypayment,creditbuying,instalmentcreditplan,creditcardsetc.
Featuresofconsumercredit
1. Acquisitionofdurableassetsitisamethodoffinancingforacquiringdurableandsemidurable
assets
2. Individualfinancingunderconsumercreditscheme,financeisprovidedtoindividualorto joint
individuals.
3. Immediatepossessionconsumergetpossessionofassetsimmediatelywhenafractionofprice is
paid
4. Paymentininstalments underconsumercreditschemeassetspriceispaidthroughnumberof
instalments.
5. Shortormediumtermfinancedurationoffinancenormallyrangesbetween3monthsto5years.
6. Agreement when there are only 2 parties to the contract, it is called a bipartite agreement
(customeranddealercumfinancier)andwheretherearethreeparties,suchagreementcalledtripartite
agreements(thecustomer,dealerandfinancier).
7. Multiplestructurestructureoffinancingmaybywayofhirepurchase,conditionalsaleorcredit
sale.
8. Downpaymentitinvolvesdownpaymentnormallyrangingfrom20to25%ofassetprice.

Forms/TypesofConsumercredit

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1.RevolvingCredit:itisanongoingcreditarrangement.Itissimilartooverdraftfacility.Hereacredit
limitwillbesanctionedtothecustomerandthecustomercanavailcredittotheextentofthatlimit.Eg.
Creditcard.
2.Cashloan:thebuyerconsumergetreadycashfrombanksandfinancialinstitutions.
3. SecuredCredit:inthisform,thefinancieradvancesmoneyonthesecurityofappropriatecollateral.
4. Unsecuredcredit:whenfinancieradvancesfundwithoutanysecuritysuchadavancescalledunsecured
credit.Butitisallowedonlytoreputedcustomers.
5.Fixedcredit:inthisform,financeismadeavailabletothecustomersasatermloanforfixedperiod
say,foroneyear,for5yearsandsoon.
AdvantagesofConsumerCredit
1. Compulsory saving: it promotes compulsory saving habit among the people. To make periodical
installmentsknowinglyorunknowinglypeoplecutshorttheirotherexpensesandsave.
2. Convenience: considering nature and types of consumers, credit facility offers schemes to the
convenience of the consumers. Eg. Walk in, Drive out, Pay as you earn.
3. Emergencies: Consumer credit is also available to meet personal urgent requirements like family
requirements,festivalrequirements,marriagerequirementsetc.
4. Assiststomeettarget:whenthedealerthemselvesarrangecreditfacilitytotheconsumers,more
andmorecustomerswillbeattractedsothatsalestargetcanbeeasilyachieved.

5.Assiststomakedreamstoreality:Consumercreditfacilitatesanopportunitytopossessandown
thosedreamsonconvenientterms.
6. Enhanceslivingstandard:consumercreditenhanceslivingstandardofthepeoplebyproviding latest
articlesandamenitiesatreasonableandaffordableterms.
7. AcceleratesIndustrialInvestments:increasingdemandforconsumerdurablesresultsintoflowof
moreinvestmentinrelatedindustry.
8. Economiesoflargescaleproduction:Moredemandleadstomoreproductionwhichleadstolarge
scaleoperationandthusleadstopricereductionforconsumers.
9. EconomicDevelopmentandnationalImportance:abovesaidfactorswillpromotesemployment
opportunities,nationalincome,economicbalanceetc.ofacountry.

DisadvantagesofConsumerCredit
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1. Promotesblindbuyingfacility to purchase at somebody elses money tempts people to buyblindly

andunnecessaryarticles.
2. LeadstoInsolvency:blindbuyingofgoodsmakethesepeopleinsolvent/bankruptwithinashort
spanoftime.
3. Itiscostlier:alongwiththeconveniencethatitoffersitchargethecustomersforalltheseconvenience
offered.Thusitbecomescostlier.
4. Artificialboom:theeconomicdevelopmentposedbytheimpactofconsumercreditisnotrealbut
artificial.
5. BaddebtRisk:bywhatevernamecalledcreditisalwayshaveinherentcreditrisk.Defaultisa major
threatofconsumercredit.
6. EconomicInstability:artificialboomanddepressionleadstoeconomicinstabilityandcauseschaos
ineconomicprogress.
(iii)VEHICLELOANS
Vehicleloansaregiventopurchaseaneworusedvehicleofanymaketoindividuals,professionalsand
businesspeople.
Features
Purpose:Vehicleloansareofferedtopurchasefourwheelersandtwowheelerssuchasmotor
bikesandscooters.
Eligibility:Individuals,professionalsandbusinessmenwithminimumgrosssalary/incomeof
Rs.75,000p.a.andsalariedpersonswith40%nettakehomesalaryafterloandeductionare
eligibleforthisloan.PrivatebankshavefixedtheminimumamountofRs.1,20,000p.a.forthis
facility.
LoanAmount:NewVehide90%oftheinvoicevaluewithnoceilingonmaximumamount.
Old Vehicle75% of the original value or negotiated purchase price of assessed vehicle
whicheveristheleastsubjecttoamaximumofRs.6lakh.Someprivatesectorbankshavefixed
themaximumlimittoRs.20lakhfornewvehicleandRs.3lakhforusedcars.
Repaymentperiod:Maximumrepaymentperiodis72monthsinpublicsectorbanks.Inprivate
banksitisrestrictedtofiveyears.
SecurityHypothecationofvehicleandpersonalguarantee.15%ofRoadpricefornewvehicle
and40%ofthepurchasepriceormarketvaluewhicheverislowgenerallyforoldvehicle.

(IV)

GOLDLOANS

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Purpose: To meet the medical expenses and other unforeseen commitments/contingencies,

investmentpurposesanddomesticpurposes.
Eligibility:ThecustomershouldbeaSavingsBankaccountholder.Newcustomersintroduced
bywellknownpersonsandcreditworthyborrowersarealsoeligible.
QuantumofLoan: MinimumRs.5,000andmaximumamountuptoRs.3lakh.Some private
bankersprovidegoldloanuptoRs.5lakh.
Repayment:24monthsto30monthsdependingontheconvenienceoftheborrowerinEquated
MonthlyInstallments.
Security:Goldornaments,goldjewelleryandgoldcoins.

(V) EDUCATIONALLOANS
Educationalloansareextendedbybankstomeritoriousstudentstopursuetheirhigherstudiesand
therebyspreadingeducationinthecountry.
Features

Purpose: Loans are given to meritorious students who study in schools, colleges and also
foreignuniversities..
QuantumofLoan:Maximum:Rs.7.5lakhforstudyinIndia.Rs.15lakhforstudyabroad.
Margin:UptoRs.4lakhNilAboveRs.4lakh5%inIndia15%abroadonestimate.
Interest:UptoRs.2lakh11%,AboveRs.2lakhuptoRs.7.5lakh11.5%,AboveRs.7.5
lakh10%
Security:Nosecurityisinsisteduponforeducationalloan.
Somebanksoffer1%concessionininterestincaseofsecuritygivenfortheloan:
Repayment:Sixmonthsaftercompletionofthecourse.Ifthestudentgetsemployedinsix
monthsaftercompletion,repaymentstartsimmediately.
Repaymentperiodis5to7yearsdependingupongenerationofincome.Interestischargedforthe
amountdisbursedandtobepaidduringthecourseofstudy.
Advantages

Fromthestudentspointofviewthefollowingaretheadvantages:
TimelyFinance: Studentsareabletopursuetheirstudiesasfinanceisnoproblemfor them.
Loansaregrantedforthetotalexpensesofthestudycoveringthecollegefee,examinationfee
andalsohostelexpenses.Thestudentsavailloanseasilyastheformalitiesconnectedwiththe
sanctioningoftheloanissimple.
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NoSecurity:Nosecurityisinsistedforeducationloan.Sopoor,butmeritoriousstudentscan
availofthisfacility.
NoburdenforParents:Theparentsarerelievedfromtheburdenofarrangingmoneyforthe
paymentofexamfees,messchargesandotherexpensesasandwhentheyarise.
CreatesConfidence: Theobligationtorepaytheloanamountaftercompletionofthe course
makesthestudentsseriousabouttheirstudiesandcreatesconfidenceinthem.
AdvantagesForBanks:TheadvantagesofextendingEducationalLoanforbanksarethefollowing:
It helps spreading of education, particularly higher education among poor but meritorious
candidates.
By this, the banks are fulfilling the social objective of spreading education and thereby
dischargingtheirsocialresponsibility.
Disadvantages

TherearecertaindisadvantagesingivingEducationalLoanfromthepointofviewofbankers.
Repayment:Loansaresanctionedinthestudentsname.Theinterestduringtheholidayperiod
i.e.,duringcourseofstudyistobepaidbytheparentsconcerned.Manyparentsareunableto
paytheinterestduringtheperiod.
Follow up: The follow up and recovery is a major problem in this type of loan. The
beneficiariesfailtointimatethebanksaboutthechangeofaddress,placeofemploymentetc.
Hence,thebankscouldnotfollowandrecoverthedues.
Recovery:Asnosecurityisofferedbythestudentsthebankershavenoholdingsandrecovery
isaproblem.

(Vi)DOCTORSLOANS/MEDICALSERVICELOANS
Purpose:Toconstructhospitalbuilding,hospitalbuildingcumresidence,settingupofnursing
home,polyclinicsetc.,forexpansion/modernizationofexistinghospitalpremises.Topurchase
medicalequipments,ambulanceandotheritemsnecessaryforthehospital.
Eligibility: Individuals, partnership firms, limited companies and Trusts. In case of firms,
companiesandTrusts,oneofthepartners/directors/trusteesshouldbeamedicalpractitioneror
theyshouldengagetheservicesofRegisteredMedicalPractitionerinthehospital.
QuantumofCredit:UptoamaximumofRs.15lakh.
Repayment:Repaymentshallbefixedonthebasisofincomegenerationoftheborrowerand
theperiodshallnotexceed7years.

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Security:Thesecurityistheonecreatedoutoffinance.Insomecasescollateralsecurityisalso
insistedbythebanker.
Margin:Generally,10%to25%marginisprescribedforthistypeofloan.

(VII) TEACHERSLOANS
Purpose:Tomeetthepressingneedslikeeducationalexpensesofchildren,medicaltreatmentof
selfandfamily,marriagesofchildrenetc.
Eligibility: Teaching and nonteaching staff in confirmed service in schools and colleges
drawingsalariesthroughthebranchesconcerned.
QuantumofLoan:Generally6monthsnetsalaryorRs.llakhwhicheverisless.

Repayment:Repaymentupto36months.Security:Coobligationofsuitableperson.
(VIII)RENTALLOANS
Purpose:Tomeetthefinancialrequirementoftheownerofthebuilding.
Eligibility:Ownersofbuildingsandcommercialpropertiesinsemiurban/urban/metroareas
whicharetoberentedoralreadyrentedtobusinesshouses,banksandreputedcorporates.
LoanAmount:75%oftherentreceivablelessTDSifany,overaperiodof36monthsor
residuallease/rentagreementperiodwhicheverislowersubjecttoamaximumofRs.50lakh.
Security:Thebuildingagainsttherentalsofwhichtheloanissanctioned.Assignmentofrent
receivablefromlessorisnecessary.Incase,thelesseeagreestoremittherentdirectlytothe
loanaccountoftheborrower,apowerofattorneywillbeobtainedfromthelessorandlessee.

Repayment:5yearsorresiduallease/rentagreementperiodwhicheverisless.
Margin:25%onfuturerenttobereceivedlessTDSorresiduallease/rentagreementperiod
whicheverislower.
(IX) LOANSFORWOMEN
Thisisanexclusiveloanschemeforwomen.Workingandnonworkingwomenbetweenthe
agegroupof18and55areeligibleforthisloan.
ThisloanenableswomentoavailcredituptoRs.50,000tomeetpersonalneedssuchasbuying
householdarticles,gifts,jewelleryetc.Repayment2to3years.
(X) LOANFORPENSIONERS

Purpose:Tomeetmedicalandothergenuinepersonalneedsofpensioners.
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Eligibility: Pensioners of Central/State Government, public sector undertakings, corporate

pensionersandpensionersofbanksdrawingpensionsthroughthebranch.
QuantumofLoan:Upto6monthspensionamountorRs.50,000whicheverisless.
Repayment:Repaymentupto24months.
Security:Coobligationofspouse/suitableperson.

(xi)

PERSONALLOANS

Purpose:Formeetinggenuineneedsoffinance.Eligibility:Employees(confirmedservice)of

a) Publicsectorundertakings.
b) Privateandpubliclimitedcompanies.
c) CentralandStateGovernmentemployees.
d) Teachersincollegesanduniversities.
e) Employeesdrawingsalarythroughbanks.Nettakehomesalarytobe40%ofthegrosssalary.

QuantumofLoan:Upto6monthsgrosssalaryorRs.1lakhwhicheverisless.
Repayment:Repaymentin60equatedmonthlyinstalments.
Security:Coobligationofasuitableperson.
CreditCardandDebitCard
Acreditcardisasmallplasticcardissuedtousersasasystemofpayment.Itallowsitsholderto
buygoodsandservicesbasedontheholderspromisetopayforthesegoodsandservices.The
issuerofthecardcreatesarevolvingaccountandgrantsalineofcredittotheconsumer(orthe
user)fromwhichtheusercanborrowmoneyforpaymenttoamerchantorasacashadvancetothe
user.
Creditcardcanbedefinedinmanywayswithdifferentsenses.Itisdifficulttogiveaperfectdefinition
ofcreditcard.Followingstatementsareattemptstohelpyouderiveitsnarrowandbroadmeaning.
6. In General sense,

Credit card is a suitable alternative for cash payment or credit payment or deferred (instalment)
payment.Itisusedtoexecutethosetransactionswhicharecompiledthroughelectronicdeviceslike a
card swapping machine, computer with internet facility, etc.

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7. In a Financial perspective,

Credit card is a facility provided by a bank or nonbankingfinancialcompany(NBFC)which

givesitscustomerapreferencetohaveashorttermborrowingoffundsusuallyatthepointof
transaction (while purchasing something or carrying out sale).
8. In terms of Business,

Credit card is a laminated plastic card issued by a bank or nonbankingfinancialcompany(NBFC) to

giveitscardholderapreferencetoborrowfundsonashortperiodbasis.Interestisimposedforlending
shorttermfinancetothecardholder.Thisinterestisgenerallychargedeitherafteramonth
or 3045 days later, once creditcard transactions have occurred. The card limit is pre
communicated in written correspondence with cardholder.
Featuresofcreditcard
9. Alternative to cash

Credit card is a better alternative to cash. It removes the worry of carrying various currency
denominationstopayatthetradecounters.Asanalternative,creditcardhelpsacardholdertotravel
anywhereintheworldwithoutaneedtocarryanampleamountofcash.Italsoreducesthepossible
riskofmoneytheftandgivesitsuseracompletepeaceofmind.
10. Credit limit

The credit cardholder enjoys the facility of a credit limit set on his card. This limit of credit is
determinedbythecreditcardissuingentity(bankorNBFC)onlyafteranalyzingthecreditworthiness
ofthecardholder.
Thecreditlimitisoftwotypes,viz.,

1. Normalcreditlimit,and
2. Revolvingcreditlimit.
NormalcreditlimitisusualcreditgivenbythebankorNBFCatthetimeofissuingacreditcard.
Revolvingcreditlimitvarieswiththefinancialexposureofthecreditcardholder.
11. Aids payment in domestic and foreign currency

Creditcardaidsitscardholdertomakepaymentsinanycurrencyofchoice.Inotherwords,itgivesits
holderauniquefacilitytomakepaymentseitherindomestic(native)currencyorifnecessary,alsoin
foreign(nonnative)currency,thattooasandwhenrequired.Creditcardreducesthecumbersome
processofcurrencyconversion.
12. Record keeping of all transactions

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CreditcardissuingentitieslikebanksorNBFCskeepsacompleterecordofalltransactionsmadeby
theircreditcardholders.Sucharecordhelpstheseentitiestoraiseappropriatebillingamountspayable
bytheircardholders,eitheronamonthlyorsomeperiodicbasis.
13. Regular charges

Regularchargesarebasicroutinechargeschargedbythecreditcardissuingentityontheusageofcredit
cardbyitscardholder.Thesechargesarenominalinnature.Theregularchargesareprimarilyclassified
intotwotypes,viz.,
1. Annualcharges,and

2. Additionalcharges.
14. Grace period

The grace period is referred to those minimum numbers of additional days within which a credit
cardholderhastopayhiscreditcardbillwithoutanyincurringinterestorfinancialcharges.
15. Higher fees on cash withdrawals

CreditcardissuermakeschargesoncashwithdrawalsmadethroughcreditcardattheATMoutletsand
otherdesks.Generally,cashwithdrawalfeesarequitehigherthanfeeschargedbythebankorNBFC
fortheotherregularcredittransactions.
16. Additional charges for delay in payment

Thecreditcardpaymentissupposedtobemadewithinaduedateasmentionedonthebillofacredit
card.Ifpaymentisnotpaidontime,thenacreditcardissuerchargessomeadditionalcosts,whichare
resultedduetodelayinpayment.
17. Service tax

Servicetaxisincludedinthetotalamountchargedtothecreditcardholder.Thismandatoryservicetax
imposedbythegovernmentalsoincreasesthefinalendcostbaredbyacreditcardholder.
10.Bonuspoints
Thecompetitionamongthecreditcardprovidersisunbending(adamant).Offeringvariousincentivesis
usually a trendy (fashionable) way to improve the sale of the products in the ordinary course of
business.Followingthistrend,creditcardprovidersalsogivebonuspointsonthefinancialvalueofthe
transactionscompiledbytheircustomers.
Atalaterstage(i.e.aftercrossingpredeterminednumberofbonuspoints)accumulatedbonus
points are redeemed either by converting them into gifts, cash back offers, or any other similar
compellingoffers.Tocollectmanybonuspoints,thecreditcardholderhastocarryoutaconsiderable
numberoftransactionsthroughhiscreditcard.

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Elements/parts/anatomyofcreditcard
Thefrontsideofacreditcardshowsfollowingdetails:
18. Logoofissuingentity.
19. Logoofpaymentprocessor.
20. Hologram.
21. Expirationdate.
22. Cardholders name.
23. Cardnumber.
24. Individualaccountidentifiernumber.
25. Issueridentifiernumber(IIN).
26. Embeddedmicrochip.
27. Majorindustryidentifier(MII).
28. Issuedate
29. Bankidentificationnumber(BIN).
Thebacksideofacreditcardshowsfollowingdetails:
1. Securitycode(cardverificationnumber).
2. Magneticstripe.
3. Signaturepanel.
4. Additionalinformation.
TypesofCreditCard
Creditcardsnowareofvarioustypeswithdifferentfees,interestratesandrewardingprograms.When
applyingforacreditcard,itisimportanttolearnoftheirdiversetypestoknowtheonebestsuitedto
their lifestyle and financial status. Different types of credit cards available by banks and other
companies/organizationsarebrieflydescribedbelow.
1. StandardCreditCard:Thisisthemostcommonlyused.Oneisallowedtousemoneyuptoa
certainlimit.Theaccountholderhastotopuptheamountoncethelevelofthebalancegoes
down.Anoutstandingbalancegetsapenaltycharge.
2. PremiumCreditCard:Thishasamuchhigherbankaccountandfees.Incentivesareoffered
inthisoverandabovethatinastandardcard.Creditcardholdersareofferedtravel
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incentives,rewardpoints,caskbackandotherrewardsontheuseofthiscard.Thisisalsocalled
theRewardCreditCard.Someexamplesare:airlinesfrequentfliercreditcard,cashbackcredit
card,automobilemanufacturersrewardscreditcard.PlatinumandGold,MasterCardandVisa
cardfallintothiscategory.
3. SecuredCreditCard:Peoplewithoutcredithistoryorwithtarnishedcreditcanavailthis

card.Asecuritydepositisrequiredamountingtothesameasthecreditlimit.Revolving
balanceisrequiredaccordingtothebuyingandsellingdone.
4. Limited Purpose Credit Card: There is limitation to its use and is to be used only for
particularapplications.Thisisusedforestablishingsmallcreditssuchasgascreditsandcredit
atdepartmentalstores.Minimalchargesarelevied.
5. ChargeCreditCard:Thisrequiresthecardholdertomakefullpaymentofthebalanceevery
monthandthereforethereisnolimittocredit.Becauseofthespendingflexibility,thecard
holderisexpectedtohaveahigherincomelevelandhighcreditscore.Penaltyisincurrediffull
paymentofthebalanceisnotdoneintime.
6. Specialty Credit Card: is used for business purposes enabling businessmen to keep their
businessestransactionsseparatelyinaconvenientway.Chargecardsandstandardcardsare
availableforthis.Also,studentsenrolledinanaccredited4yearcollege/universitycoursecan
availthisbenefit.
7. PrepaidCreditCard:Here,moneyisloadedbythecardholderontothecard.Itislikeadebit
cardexceptthatitisnottiedupwithabankaccount
Advantagesofcreditcard
1. Theyallowyoutomakepurchasesoncreditwithoutcarryingaroundalotofcash.This
allowsyoualotofflexibility.
2. Theyallowaccuraterecordkeepingbyconsolidatingpurchasesintoasinglestatement.
3. Theyallowconvenientremotepurchasingordering/shoppingonlineorbyphone.They
allowyoutopayforlargepurchasesinsmall,monthlyinstalments.
4. Undercertaincircumstances,theyallowyoutowithholdpaymentformerchandisewhich
provesdefective.
5. Theyarecheaperforshorttermborrowinginterestisonlypaidontheremainingdebt,
notthefullloanamount.
6. Manycardsofferadditionalbenefitssuchasadditionalinsurancecoveronpurchases,cash
back,airmilesanddiscountsonholidays.

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Disadvantagesofcreditcard
1. Youmaybecomeanimpulsivebuyerandtendtooverspendbecauseoftheeaseofusingcredit
cards.Cardscanencouragethepurchasingofgoodsandservicesyoucannotreallyafford.
2. Credit cards are a relatively expensive way of obtaining credit if you dont use them
carefully,especiallybecauseofthehighinterestratesandothercosts.
3. Lostorstolencardsmayresultinsomeunwantedexpenseandinconvenience.
4. Theuseofalargenumberofcreditcardscangetyouevenfurtherintodebt.
5. Usingacreditcard,especiallyremotely,introducesanelementofriskasthecarddetailsmay
fall into the wrong hands resulting in fraudulent purchases on the card. Fraudulent or
unauthorizedchargesmaytakemonthstodispute,investigate,andresolve.
Debitcard
Adebitcard(alsoknownasabankcardorcheckcard)isaplasticcardthatprovidesthecardholder
electronicaccesstohisorherbankaccount/satafinancialinstitution.Somecardshaveastoredvalue
againstwhichapaymentismade,whilemostrelayamessagetothecardholder sbanktowithdraw
fundsfromadesignatedaccountinfavourofthepayeesdesignatedbankaccount.Thecardcanbe
usedasanalternativepaymentmethodtocash

whenmakingpurchases.Insomecases,thecardsaredesignedexclusivelyforuseontheInternet,
andsothereisnophysicalcard.Inmanycountriestheuseofdebitcardshasbecomesowidespread
thattheirvolumeofusehasovertakenorentirelyreplacedthecheckand,insomeinstances,cash
transactions.Likecreditcards,debitcardsareusedwidelyfortelephoneandInternetpurchases.
However,unlikecreditcards,thefundspaidusingadebitcardaretransferredimmediatelyfromthe
bearersbankaccount,insteadofhavingthebearerpaybackthemoneyatalaterdate.Debitcards
usuallyalsoallowforinstantwithdrawalofcash,actingastheATMcardforwithdrawingcashand
asacheckguaranteecard.Merchantsmayalsooffercashbackfacilitiestocustomers,wherea
customercanwithdrawcashalongwiththeirpurchase.
DebitcardandATMcards
ObviouslythereisadifferencebetweenanATMcardandadebitcard.AnATMcardonlyallows
youtodrawcashfromyouraccountthroughanATM(AutomatedTellerMachine).Adebitcard
allowsyoutomakefinancialtransactions(purchasesmostly)withoutpayingcash.Thepaymentis
madebyswipingyourdebitcardinamachineatashopwhereyoumadethepurchase.Thevalueof
yourpurchaseisautomaticallydeductedfromyourbalanceinyourbankaccount.
Nowadays,banksprovideATMdebitcards,whichcanbeusedforboththepurposesmentionedabove.
Similarly,ATMcreditcardsarealsoavailable.Acreditcardalsoallowsyoutomakepaymentson
purchaseswithoutpayingcash.Butinsteadofdebitingthevalueofthepurchasestothebalanceinyour
bankaccountafterswipingthecardatashop,thebanksettlesthebillonits
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ownandsendsyouastatementshowingthedifferenttransactionsenteredintobyyouusingyour
creditcard.Youhavetosettletheamountwiththebankwithinastipulatedtime.Additionally,
creditcardsallowyoutomakecashwithdrawalsuptocertainlimitsfromATMsusingyourATM
credit card which has to be repaid within a stipulated period. Obviously credit cards have no
relationtoyourbankbalance.
DifferencesbetweenCreditcardandDebitcard
Creditcard
Debitcard
1

It is a pay later product

Thecardholdercanavailofcreditfor30 Customersaccountisdebitedimmediately

45days
Nosophisticatedcommunicationsystem

It is pay now product

sophisticatedcommunicationnetwork/

isrequiredforcreditcardoperation

systemisrequiredfordebitcardoperation
(eg.ATM)

Openingbankaccountandmaintaining

Openingbankaccountandmaintaining

requiredamountarenotessential
Possibilityofriskoffraudishigh

requiredamountareessential
RiskisminimisedthroughusingPIN

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MODULEV
VENTURECAPITAL
Therearesomebusinessesthatinvolvehigherrisks.Inthecaseofnewlystartedbusiness,the
riskismore.Thenewbusinessesmaybepromotedbyqualifiedentrepreneurs.Theylacknecessary
experienceandfundstogiveshapetotheirideas.Suchhighrisk,highreturnventuresareunableto
raisefundsfromregularchannelslikebanksandcapitalmarkets.Generallypeoplewouldnotlike
toinvestinnewhighriskcompanies.Somepeopleinvestmoneyinsuchnewhighriskcompanies.
Eventhoughtheriskishigh,thereisapotentialofgettingareturnoftentimesmoreinlessthan
fiveyears.Theinvestorsmakingsuchinvestmentsarecalledventurecapitalists.Themoneyinvestd
innew,highriskandhighreturnfirmsiscalledventurecapital.Venturecapitalistsnotonlyprovide
moneybutalsohelptheentrepreneurwithguidanceinformalizinghisideasintoaviablebusiness
venture. They get good return on their investment. The percentage of the profits the venture
capitalistsgetiscalledthecarry.
Origin/HistoryofVentureCapital
In the 1920s and 1930s, the wealthy families of individual investors provided the startup
moneyforcompaniesthatwouldlaterbecomefamous.EasternAirlinesandXeroxarethemore
famousventurestheyfinanced.AmongtheearlyVCfundsetupswastheonebytheRockfeller
familywhichstartedaspecialfundcalledVenrockin1950,tofinancenewtechnologycompanies.
GeneralGeorgesDoriot(thefatherofventurecapital),aprofessoratHarvardBusinessSchool,in
1946 set up the American Research and Development Corporation (ARD). ARDs approach was a
classic VC in the sense that it used only equity, invested for long term. ARDs investment in
DigitalEquipmentCorporation(DEC)in1957wasawatershedinthehistoryofVCfinancing.Whilein
itsearlyyearsVCmayhavebeenassociatedwithhightechnology,overtheyears,theconcepthas
undergoneachangeand,asitstandstoday,itimpliespooledinvestmenttounlistedcompanies.
MeaningofVentureCapital
The term venture capital comprises of two words, namely, venture and capital. The term
venture literally means a course or proceeding, the outcome of which is uncertain (i.e.,
involvingrisk).Thetermcapitalreferstotheresourcestostarttheenterprise.Thusventurecapital
refers to capital investment in a new and risky business enterprise. Money is invested in such
enterprisesbecausethesehavehighgrowthpotential.
Ayounghitechcompanythatisintheearlystageoffinancingandisnotyetreadytomakea
publicissuemayseekventurecapital.Suchahighriskcapitalisprovidedbyventurecapitalfundsin
theformoflongtermequityfinancewiththehopeofearningahighrateofreturnprimarilyintheform
ofcapitalgain.Infact,theventurecapitalistactsasapartnerwiththeentrepreneur.
Venturecapitalisthemoneyandresourcesmadeavailabletostartupfirmsandsmallbusiness
withexceptionalgrowthpotential(e.g.,IT,infrastructure,realestateetc.).Itisfundamentallya
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longtermriskcapitalintheformofequityfinanceforthesmallnewventureswhichinvolverisk.Butat
thesametime,itathestrongpotentialforthegrowth.Itthrivesontheconceptofhighriskhighreturn.
Itisameansofequityfinancingforrapidlygrowingprivatecompanies.

Venture capital can be visualized as your ideas and our money concept of developing
business. It is patient capital that seeks a return through long term capital gain rather than
immediateandregularinterestpaymentsasinthecaseofdebtfinancing.

When venture capitalists invest in a business, they typically require a seat on the companys
boardofdirectors.Butprofessionalventurecapitalists actasmentorsandprovidesupportand
advice on a number of issues relating to management, sales, technology etc. They assist the
companytodevelopitsfullpotential.Theyhelptheenterpriseintheearlystageuntilitreachesthe
stageofprofitability.Whenthebusinessstartsmakingconsiderableprofitsandthemarketvalueof
thesharesgouptoconsiderableextent,venturecapitalistsselltheirequityholdingsatahighvalue
andtherebymakecapitalgains.
Inshort,venturecapitalmeansthefinancialinvestmentinahighlyriskprojectwiththeobjective
ofearningahighrateofreturn.
CharacteristicsofVentureCapital

Theimportantcharacteristicsofventurecapitalfinanceareoutlinedasbellow:
1.

Itisbasicallyequityfinance.

2.

Itisalongterminvestmentingrowthorientedsmallormediumfirms.

3.

Investmentismadeonlyinhighriskprojectswiththeobjectiveofearningahighrateofreturn.

4.

In addition to providing capital, venture capital funds take an active interest in the
managementoftheassisted firm. It is rightly said that, venture capital combines the qualities
of banker,stock market investor and entrepreneur in one.

5.

Theventurecapitalfundshaveacontinuousinvolvementinbusinessaftermakingtheinvestment.

6.

Oncetheventurehasreachedthefullpotential,theventurecapitalistsellshisholdingsatahigh
premium.Thushismainobjectiveofinvestmentisnottoearnprofitbutcapitalgain.
TypesofVentureCapitalists

Generally,therearethreetypesofventurecapitalfunds.Theyareasfollows:
1.

Venturecapitalfundssetupbyangelinvestors(angels):Theyareindividualswhoinvesttheir
personalcapitalinstartupcompanies.Theyareabout50yearsold.Theyhavehighincomeand
wealth.Theyarewelleducated.Theyhavesucceededasentrepreneurs.Theyareinterestedinthe
startupprocess.

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2.

Venture capital subsidiaries of Corporations: These are established by major corporations,

commercialbanks,holdingcompaniesandotherfinancialinstitutions.

Privatecapitalfirms/funds:Theprimarysourceofventurecapitalisaventurecapitalfirm. It
takeshighrisksbyinvestinginanearlystagecompanywithhighgrowthpotential.
MethodsorModesofVentureFinancing(FundingPattern)/DimensionsofVentureCapital

3.

VenturecapitalistypicallyavailableinfourformsinIndia:equity,conditionalloan,incomenote
andconventionalloan.
Equity:AllVCFsinIndiaprovideequitybutgenerallytheircontributiondoesnotexceed49per cent
ofthetotalequitycapital.Thus,theeffectivecontrolandmajorityownershipofthefirmremainwith
theentrepreneur.Theybuysharesofanenterprisewithanintentiontoultimatelysellthemofftomake
capitalgains.
Conditionalloan:Itisrepayableintheformofaroyaltyaftertheventureisabletogeneratesales.No
interestispaidonsuchloans.InIndia,VCFschargeroyaltyrangingbetween2and15percent;actual
rate depends on the other factors of the venture, such as gestation period, costflow patterns and
riskiness.
Income note: It is a hybrid security which combines the features of both conventional loan and
conditionalloan.Theentrepreneurhastopaybothinterestandroyaltyonsales,butatsubstantiallylow
rates.
Conventionalloan:Underthisformofassistance,theenterpriseisassistedbywayofloans.On the
loans,alowerfixedrateofinterestischarged,tilltheunitbecomescommerciallyoperational.Whenthe
companystartsearningprofits,normalorhigherrateofinterestwillbechargedontheloan.Theloan
hastoberepaidasperthetermsofloanagreement.

Otherfinancingmethods:Afewventurecapitalists,particularlyintheprivatesector,havestarted
introducinginnovativefinancialsecuritieslikeparticipatingdebenturesintroducedbyTCFC.
StagesofVentureCapitalFinancing
Venturecapitaltakesdifferentformsatdifferentstagesofaproject.Thevariousstagesinthe
venturecapitalfinancingareasfollows:
1. Earlystagefinancing:Thisstagehasthreelevelsoffinancing.Thesethreelevelsare:

(a) Seedfinancing:Thisisthefinanceprovidedattheprojectdevelopmentstage.Asmallamount
ofcapitalisprovidedtotheentrepreneursforconcepttestingortranslatinganideaintobusiness.
(b) Startupfinance/firststagefinancing:Thisisthestageofinitiatingcommercialproductionand
marketing.Atthisstage,theventurecapitalistprovidescapitaltomanufactureaproduct.
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(c)Secondstagefinancing:Thisisthestagewhereproducthasalreadybeenlaunchedinthemarketbut
hasnotearnedenoughprofitstoattractnewinvestors.Additionalfundsareneededatthisstagetomeet
thegrowingneedsofbusiness.Venturecapitalfirmsprovidelargerfundsatthisstage.
2.Laterstagefinancing:Thisstageoffinancingisrequiredforexpansionofanenterprisethat is
alreadyprofitablebutisinneedoffurtherfinancialsupport.Thisstagehasthefollowinglevels:
(a) Third stage/development financing: This refers to the financing of an enterprise which has
overcome thehighlyriskystageandhasrecordedprofitsbutcannotgoforpublicissue.Henceit
requiresfinancialsupport.Fundsarerequiredforfurtherexpansion.
(b) Turnarounds: This refers to finance to enable a company to resolve its financial difficulties.
Venturecapitalisprovidedtoacompanyatatimeofseverefinancialproblemforthepurposeof
turningthecompanyaround.
(c) Fourthstagefinancing/bridgefinancing:Thisstageisthelaststageoftheventurecapitalfinancing
process.Themaingoalofthisstageistoachieveanexitvehiclefortheinvestorsandfortheventureto
gopublic.Atthisstagetheventureachievesacertainamountofmarketshare.
(d) Buyouts:Thisreferstothepurchaseof a company or the controlling interest of a companys
share.Buyoutfinancinginvolvesinvestmentsthatmightassistmanagementoranoutsidepartyto
acquirecontrolofacompany.Thisresultsinthecreationofaseparatebusinessbyseparatingit
fromtheirexistingowners.
AdvantagesofVentureCapital

Venturecapitalhasanumberofadvantagesoverotherformsoffinance.Someofthemare:
1.

Itislongtermequityfinance.Hence,itprovidesasolidcapitalbaseforfuturegrowth.

2.

Theventurecapitalistisabusinesspartner.Hesharestherisksandreturns.

3.

Theventurecapitalistisabletoprovidestrategicoperationalandfinancialadvicetothecompany.

4.

5.

Theventurecapitalisthasanetworkofcontactsthatcanaddvaluetothecompany.Hecanhelpthe
companyinrecruitingkeypersonnel,providingcontractsininternationalmarketsetc.
Venturecapitalfundhelpsintheindustrializationofthecountry.

6.

Ithelpsinthetechnologicaldevelopmentofthecountry.

7.

Itgeneratesemployment.

8.

Ithelpsindevelopingentrepreneurialskills.

9.

Itpromotesentrepreneurshipandentrepreneurisminthecountry.

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VentureCapitalinIndia
In India, the venture capital plays a vital role in the development and growth of innovative
entrepreneurships.Venturecapitalactivityinthepastwaspossiblydonebythedevelopmentalfinancial
institutionslikeIDBI,ICICIandstatefinancialcorporations.Theseinstitutionspromotedentitiesinthe
privatesectorwithdebtasaninstrumentoffunding.
Foralongtime,fundsraisedfrompublicwereusedasasourceofventurecapital.Andwiththe
minimum paid up capital requirements being raised for listing at the stock exchanges, it became
difficultforsmallerfirmswithviableprojectstoraisefundsfromthepublic.
th

InIndia,theneedforventurecapitalwasrecognisedinthe7fiveyearplanandlongtermfiscal
policy of the Government of India. In 1973, a committee on development of small and medium
enterpriseshighlightedtheneedtofosterVCasasourceoffundingnewentrepreneursandtechnology.
VC financing really started in India in 1988 with the formation of Technology Development and
InformationCompanyofIndiaLtd.(TDICI)promotedbyICICIandUTI.

ThefirstprivateVCfundwassponsoredbyCreditCapitalFinanceCorporation(CEF)and
promoted by Bank of India, Asian Development Bank and the Commonwealth Development
Corporation,namely,CreditCapitalVentureFund.Atthesametime,GujaratVentureFinanceLtd.
andAFIDCVentureCapitalLtd.werestartedbystatelevelfinancialinstitutions.Sourcesofthese
fundswerethefinancialinstitutions,foreigninstitutionalinvestorsorpensionfundsandhighnet
worthindividuals.TheventurecapitalfundsinIndiaarelistedinthefollowingTable:
LegalAspectsofVentureCapital
ThelegalaspectsrelatingtoventurecapitalinIndiamaybebrieflyexplainedasfollows:
RegulatoryStructure: TheSEBIregulates venturecapital industryinIndia.Itannouncedthe
regulations forthe venture capital funds in 1996,withthe primaryobjective ofprotecting the
interest of investors and providing enough flexibility to the fund managers to make suitable
investmentdecisions.Venturecapitalfundsappointanassetmanagementcompanytomanagethe
portfolioofthefund.Anycompanyproposingtoundertakeventurecapitalinvestmentsisrequired
toobtaincertificateofregistrationfromSEBI.Venturecapitalfundcaninvestupto40%ofthe
paidupcapitaloftheinvestedcompanyorupto20%ofthecorpusofthefundinoneundertaking.
Atleast80%offundsraisedbyVCFshallbeinvestedinequitysharesorequityrelatedsecurities
issuedbycompany whoseshares arenotlistedonrecognisedstockexchange.Venturecapital
investmentsarerequiredtoberestrictedtodomesticcompaniesengagedinbusinessofsoftware,
informationtechnology,biotechnology,agriculture,andalliedsectors.
GuidelinesfortheVentureCapitalCompanies
TheGovernmentofIndiahasissuedthefollowingguidelinesforvariousventurecapitalfunds
operatinginthecountry.

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1.

Thefinancialinstitutions,StateBankofIndia,scheduledbanks,andforeignbanksareeligibleto
establishventurecapitalcompaniesorfundssubjecttotheapprovalasmayberequiredfromthe
ReserveBankofIndia.

2.

3.

TheventurecapitalfundshaveaminimumsizeofRs.10croresandadebtequityratioof1:1.5.If
theydesiretoraisefundsfromthepublic,promoterswillberequiredtocontributeminimumof
40%ofthecapital.
TheguidelinesalsoprovideforNRIinvestmentupto74%onanonrepatriablebasis.

4.

Theventurecapitalfundsshouldbeindependentoftheparentorganisation.

5.

Theventurecapitalfundswillbemanagedbyprofessionalsandcanbesetupasjointventures
evenwithnoninstitutionalpromoters.

6.

Theventurecapitalfundswillnotbeallowedtoundertakeactivitiessuchastrading,broking,and
moneymarketoperationsbuttheywillbeallowedtoinvestinleasingtotheextentof15%ofthe
totalfundsdeployed.Theinvestmentorrevivalofsickunitswillbetreatedasapartofventure
capitalactivity.

7.

Apersonholdingapositionofbeingafulltimechairman,chiefexecutiveormanagingdirectorof
acompanywillnotbeallowedtoholdthesamepositionsimultaneouslyintheventurecapital
fund/company.

8.

The venture capital assistance should be extended to the promoters who are now, and are
professionallyortechnicallyqualifiedwithinadequateresources.

SEBI(VentureCapitalFunds)(Amendment)Regulations,2000andSEBI(ForeignVentureCapital
Investors)Regulations,2000

A.FollowingarethesalientfeaturesoftheSEBI(VentureCapitalFunds)(Amendment)Regulations,
2000:

1. Definition of venture capital fund: The venture capital fund is now defined as a fund
establishedintheformofaTrust,acompanyincludingabodycorporateandregisteredwithSEBI
which:
(a) hasadedicatedpoolofcapital;
(b) raisedinthemannerspecifiedundertheRegulations;and
(c) toinvestinventurecapitalundertakingsinaccordancewiththeRegulations.
2.Definitionofventurecapitalundertaking:Venturecapitalundertakingmeansadomestic
company:

(a) WhosesharesarenotlistedonarecognisedstockexchangesinIndia

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(b)Whichisengagedinbusinessincludingprovidingservices,productionormanufactureofarticlesor
things,ordoesnotincludesuchactivitiesorsectorswhicharespecifiedinthenegativelistbytheBoard
withtheapprovaloftheCentralGovernmentbynotificationintheOfficialGazetteinthisbehalf.The
negativelistincludesrealestate,nonbankingfinancialservices,goldfinancing,activitiesnotpermitted
undertheIndustrialPolicyoftheGovernmentofIndia.
3. Minimumcontributionandfundsize:TheminimuminvestmentinaVentureCapitalFundfrom
anyinvestorwillnotbelessthanRs.5lakhsandtheminimumcorpusofthefundbeforethefundcan
startactivitiesshallbeatleastRs.5crores.
4. Investmentcriteria: Theearlierinvestmentcriteriahavebeensubstitutedbyanew investment
criteriawhichhasthefollowingrequirements:
(a) Disclosureofinvestmentstrategy;
(b) Maximuminvestmentinsingleventurecapitalundertakingnottoexceed25%ofthecorpusofthe
fund;
(c) Investmentintheassociatedcompaniesnotpermitted;
(d) Atleast75%oftheinvestiblefundstobeinvestedinunlistedequityshares orequitylinked
instruments.
(e) Notmorethan25%oftheinvestiblefundsmaybeinvestedbywayof;
(i)subscriptiontoinitialpublicofferofaventurecapitalundertakingwhosesharesareproposedto
belistedsubjecttolockinperiodofoneyear.
(ii)Debtordebtinstrumentofaventurecapitalundertakinginwhichtheventurecapitalfundhas
alreadymadeaninvestmentbywayofequity.
Ithasalsobeenprovidedthatventurecapitalfundseekingtoavailbenefitundertherelevant
provisionsoftheIncomeTaxActwillberequiredtodivestfromtheinvestmentwithinaperiodofone
yearfromthelistingoftheventurecapitalundertaking.

5. Disclosureandinformationtoinvestors: Inordertosimplifyandexpeditetheprocessof
fundraising,therequirementoffilingtheplacementmemorandumwithSEBIisdispensedwithand
insteadthefundwillberequiredtosubmitacopyofPlacementMemorandum/copyofcontribution
agreemententeredwiththeinvestorsalongwiththedetailsofthefundraisedforinformationto
SEBI.Further,thecontentsofthePlacementMemorandumarestrengthenedtoprovideadequate
disclosureandinformationtoinvestors.SEBIwillalsoprescribesuitablereportingrequirement
fromthefundontheirinvestmentactivity.
6. QIBstatusforventurecapitalfunds:Theventurecapitalfundswillbeeligibletoparticipatein
theIPOthroughbookbuildingrouteasQualifiedInstitutionalBuyersubjecttocompliancewithSEBI
(VentureCapitalFund)Regulations.

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7. Relaxationintakeovercode:Theacquisitionofsharesbythecompanyoranyofthepromoters
fromtheVentureCapitalFundunderthetermsofagreementshallbetreatedonthesamefootingasthat
ofacquisitionofsharesbypromoters/companiesfromthestatelevelfinancialinstitutionsandshallbe
exemptfrommakinganopenoffertoothershareholders.
8. Investmentsbymutualfundsinventurecapitalfunds:Inordertoincreasetheresourcesfor
domesticventurecapitalfunds,mutualfundsarepermittedtoinvestupto5%ofitscorpusinthe
caseofopenendedschemesandupto10%ofitscorpusinthecaseofcloseendedschemes.Apart
fromraisingtheresourcesforventurecapitalfundsthiswouldprovideanopportunitytosmall
investorstoparticipateinventurecapitalactivitiesthroughmutualfunds.
9. Government of India guidelines: The government of India (MOF) guidelines for overseas
venture capital investment in India dated September 20, 1995 will be repealed by the MOF on
notificationofSEBIVentureCapitalFundRegulations.
10. The following will be the salient features of SEBI (Foreign Venture Capital Investors)
Regulations,2000.
a. Definitionofforeignventurecapitalinvestor:Anyentityincorporatedandestablishedoutside
India and proposes to make investment in venture capital fund or venture capital undertaking and
registeredwithSEBI.
b. Eligibilitycriteria: EntityincorporatedandestablishedoutsideIndiaintheformof investment
company, trust partnership, pension fund, mutual fund, university fund, endowment fund, asset
management company, investment manager, investment management company or other investment
vehicleincorporatedoutsideIndiawouldbeeligibleforseekingregistrationfromSEBI.
SEBIforthepurposeofregistrationshallconsiderwhethertheapplicantisregulatedbyan
appropriateforeignregulatoryauthority;orisanincometaxpayer;orsubmitsacertificatefromits
banker of its or its promoters track record where the applicantisneitheraregulatedentitynotan
incometaxpayer.
C. Investmentcriteria:

(a) Disclosureofinvestmentstrategy;
(b) Maximum investment in single venture capital undertaking not to exceed 25% of the funds
committedforinvestmenttoIndia.However,itcaninvestitstotalfundcommittedinoneventure
capitalfund.
(c) Atleast75%oftheinvestiblefundstobeinvestedinunlistedequityshares orequitylinked
instruments.
(d) Notmorethan25%oftheinvestiblefundsmaybeinvestedbywayof;
(1) Subscriptiontoinitialpublicofferofaventurecapitalundertakingwhosesharesareproposedtobe
listedsubjecttolockinperiodofoneyear;

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(2) Debtordebtinstrumentofaventurecapitalundertakinginwhichtheventurecapitalfundhas
alreadymadeaninvestmentbywayofequity.

11. Hasslefreeentryandexit:Theforeignventurecapitalinvestorsproposingtomakeventure
capitalinvestmentundertheRegulationswouldbegrantedregistrationbySEBI.SEBIregistered
foreign venture capital investors shall be permitted to make investment on anautomatic route
within the overall sectoral ceiling of foreign investment under Annexure III of Statement of
IndustrialPolicywithoutanyapprovalfromFIPB.Further,SEBIregisteredFVCIsshallbegranted
ageneralpermissionfromtheexchangecontrolangleforinflowandoutflowoffundsandnoprior
approval of RBI would be required for pricing, however, there would be expost reporting
requirementfortheamounttransacted.
12. Tradinginunlistedequity:TheBoardalsoapprovedtheproposaltopermitOTCEItodevelopa
tradingwindowforunlistedsecuritieswhereQualifiedInstitutionalBuyers(QIB)wouldbepermitted
toparticipate.

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