Chapter--------------1Introduction to Financial Services.

IntroductionFinance is the life blood of business. The two main area of finance are:

1) Financial Management 2) Financial Services.

Financial Management is concerned with duties of the finance manager in an organisation and who perform the duty of preparing budgets, financial forecasting, cash management, credit analysis, investment decision making, fund management etc.,. Financial Services is concerned with the design and delivery of advice and Financial products to individuals and business in the area of Banking and insurance, personal financial planning, investment in real and financial assets etc.,. Financial Services constitute an important component of the financial system. Financial Services, through the network of element such as financial institutions, financial markets and financial instruments, serve the need of individuals, institutions and corporates. Considering its nature and importance, financial services are regarded as the fourth element of the financial system.

Meaning And Concepts: The term 'Financial Services' can be defined as, ''Activities, Benefits and

Satisfactions, connected with the sale of money, that offer to users and customers, financial related value.'' Financial Service organisation provides services to industrial enterprises and ultimate consumer markets. Following are the institutional financial service suppliers:

1) Banks and Non- Banking Finance Companies.

2) Insurance Companies

3) Mutual Fund Companies

4) Stock Exchanges

5) Housing finance societies.

6) Leasing companies.

7) Credit Rating companies.

Features of Financial services: Like any other service, the financial services have the following characteristics:

i) Intangibility: For Financial services to be successfully created and marketed, the institutions providing them must have a good image and enjoy the confidence of their clients. Quality and innovativeness of service are the focus points for building credibility and gaining the trust of the clients.

ii) Dynamic: Financial Services have to be constantly redefined and redefined on the basis of socio-economic changes occurring in the economy, such as disposable income, standard of living, level of education, etc.,.

iii) Customer Orientation: The responsibility of any financial services organisation is to protect customer's interest and it is not only important in banking and insurance, but also in other sectors of the financial services.

iv) Inseparability: The functions of production and supply of financial services have to be carried out simultaneously. This calls for a perfect understanding between the financial services firms and their clients.

v) Geographical Dispersion: Financial Services must have both appeal and wider application. To ensure this, the service providing organisation must have massive branch networks so that benefit of convenience are enjoyed by local, national and international customers.

vi) Information Based: Financial Services involves creation, dissemination, and use of information. Information is the very important element in the creation of financial services. Cost of processing information is quite irrelevant in the best production and supply of financial services.

Problems in the Financial Service SectorThe Indian financial services industry has been making rapid progress in the

financial services. In the past recession environment, this sector is fast integrating with global financial markets. However, the financial service sector faces many problems, some of these problems are discussed below:

1) Lack of Experience: To implement the financial service schemes, the institutions and professional bodies have no specialised knowledge to manage this sector in India.

2) Limited Innovations: The growth and development of financial system is measurable in terms of the width and depth of the range of products offered by it. There has been limited innovation in the financial products. For instance, a number of tailor-made and imaginatively designed financial products.

3) Inefficient Technology: One of the basic problem faced by Indian financial services firms is that they lack adequate and time tested technology to efficiently create and deliver the financial products to their clients.

4) Restrictions in Operations: The scope of operations relating to financial service is currently restricted to certain areas only. For example, the venture capital operations in India is restricted to provide finance for start- ups, high-tech projects, and to convert R&D efforts into Commercial production.

5) Lack of institutional mechanisms: There must be a wide range of financial services available too. The establishment of a sound institutional mechanism, whereby the existing financial institutions, banks and insurance companies are allowed to open fully-fledged subsidiaries, is therefore, called for.

Types of Financial Services

Financial Services provided by various financial institutions, commercial banks and merchant bankers can be broadly classified into two categories:

1) Asset Based/Fund based Services.

2) Fee Based/Advisory Services.

The Fund based/Asset Based Services include:-

a. Equipment Lease Financing.

b. Hire Purchase and Consumer Credit.

c. Venture capital.

d. Housing Finance.

e. Bill discounting.

f. Factoring.

g. Insurance Services.

h. Securitization of debt.

The Fee based/ Advisory Services include:-

a. Issue Management.

b. Portfolio Management.

c. Loan Syndication.

d. Capital Restructuring.

e. Stock Broking.

f. Credit Rating.

The various Fund based and Fee based financial services provided by banking and non-banking financial institutions are discussed below:

(1) Equipment Leasing/ Lease Financing

Lease is a legal contract, and thus enforceable by all parties under the contract law of applicable jurisdiction. A lease should be contracted to a license, which may entitle a person (called a licensee) to use property, but which is subject to termination at the will of the owner of the property (called the licensor). Leasing is an alternative to purchase of an asset in order to acquire the services of that asset. By leasing an asset the lessee essentially acquires it use value from the lessor, who actually purchase and owns the assets. The lease agreement provides for a number of obligations on the part of the lessee which do not form part of his implied obligations under the legislative frame work. The legal framework and the lease agreements provides the regulatory framework of lease financing in India. Leasing industry in India is a growing business activity in the country.

(2) Hire Purchase and Consumer Credit

It is an agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement. Hire purchase is used as a source of finance, usually for acquiring relatively low cost assets such as auto-mobiles, office equipments etc.,. Consumer credit includes all asset based financing plans offered to individuals to help them for acquiring durable consumer goods in a consumer credit transaction. The consumer pay a part of the cash purchase price at the time of the delivery of the goods and

pay the balance amount with interest over a specified period of time. It is an asset based financial service in India.

(3) Venture Capital

Venture Capital means the investment of long term risk equity finance where the primary reward for its provider, the venture capitalist, is an eventual capital gain, rather than interest income or dividend yield. Venture capital financing is one of the most recent entrants in the Indian Capital Market. Moreover the guidelines issued by the government for the setting up of venture capital companies are too non-restrictive and unrealistic and have come in the way of their growth. A venture capital investment is illiquid, i.e., not subject to repayment on demand as with an overdraft or following a loan repayment schedule. The investment is realised when the company is sold or achieve a stock market listing. It is lost when as sometimes occurs, the company goes into liquidation. Venture Capital is risk financing at its extreme.

(4) Housing Finance

The responsibility to provide housing finance rested with the government of India till the mid-80s. The setting up of the National Housing Bank (NHB), a fully owned subsidiary of the Reserve Bank of India (RBI) in 1998 as the apex institution, marked the beginning of the emergence of housing finance as a fund based financial service in India. The NHB was established in 1988 under the NHB Act, 1987, to operate as a principal agency to promote Housing Finance Institutions (HFIs), at both local and regional level, and to provide financial and other support to them. The HFIs include institutions, whether incorporated or not, that primarily transact or have as one of their principal objects viz. Transacting business of providing finance for housing, either directly or indirectly. Making of loans and advances or rendering other forms of financial assistance, whatsoever, for housing activities to HFIs, banks, state cooperatives, agricultural and rural development banks or any other institutions, class of institutions notified by the government.

5) Bill Discounting

Bill Discounting is an attractive fund based financial service provided by the finance companies. It emerged as a profitable business in the early 90s for finance

companies and represented a diversification in their activities in tune with the emerging financial scene in India. According to the Indian Negotiable Instrument Act,1881, ''The Bill of Exchange is an instrument in writing containing an unconditional order, signed by the maker, directing certain people to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of that instrument.'' The Bill of Exchange (B/E) is used for financing the transactions in goods which means that it is essentially a trade-related instrument. The seller can take over the accepted B/E to a discounting agency and obtain ready cash. The margin between the ready money paid and the face value of the bill is called the discount and is calculated at a rate percentage per annum on the maturity value. The maturity of B/E is defined as the date on which payment will fall due. Normal maturity periods are 30, 60, 90 or 120 days but bills maturity within 90 days are seems to be the most popular.

6) Factoring

Factoring as a fund based financial service, provides resources to finance receivables as well as facilitates the collection of receivables. Accounting to the international institute for unification of private law (UNIDROIT) Rome. Factoring means an agreement between a factor and his client that includes at-least two of the following services provided by the factor:

(a) Finance.

(b) Maintenance of accounts.

(c) Collection of debts and

(d) Protection against credit risk.

At present, Factoring in India is rendered by only a few financial institutions on a recourse basis. However, the report of the working group on money market (Vulva Committee) constituted by the RBI has recommended that banks should be encouraged to set up factoring divisions to provide speedy and healthy finance to the corporate entities.

7) Insurance Services

Insurance is a form of risk management primarily used to hedge against the risk of a contingent loss. It is to be defined as the transfer of risk of a potential loss from one to another, in exchange for a premium. Insurance applies to situations

where a loss may or may not occur. It cannot be applied to situations where loss is expected to happen. Insurance Contracts pay insurance benefits or compensation in the event of adverse outcome like deaths, accidents, or losses from other causes. Until 1999, the insurance organisation in India comprised two state- owned monolithic institutions, namely, the Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC) and its four subsidiaries. In order to improve the quality of insurance services in the country, the Malhotra Committee (1993) had recommended a comprehensive framework of reform in the insurance sector. The insurance sector in the country is emerging in response to the follow-up action on the recommendation of the committee.

8) Securitization of Debt

Securitization, as a financing technique, originated in the United States during the 1970s when the Government National Mortgage Association started trading in securities backed by pools of mortgage loans. These securities known as 'mortgage pass through securities' facilitated investors in purchasing fractional undivided interest in a pool of mortgage loans by providing for a share in the income and principal payments generated by the underlying assets in to securities, securities into liquidity, and subsequently into assets on an ongoing basis, increasing thereby the turnover of business and profit while also providing for flexibility in yield, pricing pattern, issuing risk, and marketability of instruments used to the advantage of both borrowers and lenders. Simply Banks and Financial Institutions make loans and advances for the purchase of assets such as cars, houses, trucks, machinery etc.,. Therefore, they hold a pool of individual loans and receivables that generate cash flows. Securities are then created against them, which are rated and sold to investors.

9) Issue Management

The management of issues for raising funds through various types of instruments by Companies is known as 'Issue Management'. The function of capital issue management in India is carried out by Merchant bankers who have the requisite professional skills and competence. A fast growing economy like India offers tremendous scope for issue management and the merchant bakers provide their skills and expertise to companies in the management of capital issues. This essentially aims at challenging households saving into the corporate sector through issue of corporate securities.

10) Portfolio Management

Th term portfolio means the total holdings of securities belonging to any person. A list of all those services and facilities that are provided by a portfolio manager to its client, relating to the management and administration of portfolio of securities or funds of the clients, is referred to as 'Portfolio Management Services'. The objective of portfolio management is to develop a portfolio that has a maximum return at whatever level of risk the investor deems appropriate. According to SEBI, Portfolio Manger means 'any person who pursuant to a contract or arrangement with a client, advices or directs or undertakes on behalf of the client the management or administration of a portfolio securities on the funds of the clients, as the case may be.

11) Corporate Restructuring

Corporate Restructuring implies activities related to expansion or contraction of a firm's operations or changes in its assets or financial or ownership structure. The most common form of corporate restructuring are mergers/amalgamation and acquisitions/turnovers, financial restructuring, divestitures/de-mergers and buyouts. Portfolio growth constitute one of the prime objectives of most of the firms. It can be achieved internally through the process of introduction and development of new products, expanding the capacity of existing products. Alternatively, the growth process can be facilitated externally through mergers, acquisitions, amalgamations, turnovers, absorption, consolidation and so on.

12) Loan Syndication

This is a specialised services in preparation of projects, loan applications for raising short term as well as long term credit from various banks and financial institutions for financing the project or meeting the working capital requirements. They also manage Euro issues and help in raising funds abroad. The institutions of Finance with which the merchant bankers syndicate include Industrial Finance Corporation of India(IFCI), Industrial Development Bank of India(ICICI), Industrial Reconstruction Bank of India(IRBI), and shipping credit and investment company of India Ltd. (SCICI Ltd.). In addition, Commercial Banks, Mutual Funds and Venture Capital Firms are also involved in the Loan Syndication for meeting the working capital requirement of trade and industry.

13) Stock Broking

The process by which buyers and sellers of stock of securities are brought together under a common platform called the stock exchange is known as 'Stock Broking'. Stock Broking is essentially the job of a financial service intermediary. Stock Broking is carried by brokers and sub brokers who are permitted by the SEBI. A stock broker may be an individual or a corporate. Stock Broking services are provided both online as well as offline to suit the requirements of clients. Stock Broking activities are carried out by banking as well as non-banking financial companies. Stock Brokers offer the services to both domestic as well as overseas clients. Most popular among the domestic company stock brokers include Share-Khan, ICICI Credit Kotak Securities, IDBI Capital Markets, India Bulls, Geojit, Reliance Money, India Infoline etc.,.

14) Credit Rating

Credit Rating is the symbolic indicator of the current opinion of the rating agency regarding the relative ability of the issue of financial instruments to meet the service obligations as and when they arise. It provides a relative thinking of credit quality of financial instrument or their grading according to investment qualities. In other words, credit rating provides a simple system of gradation by which the relative capacities of companies make timely repayment of of interest and principal on a particular type of financial instrument can be noted. As a fee based financial advisory service, credit rating is, obviously extremely useful to investors, corporates, banks and financial institutions. For Investors, it is an indicator expressing the underlying credit quality of an issue programme.

Financial EconomicsFinancial Economics means the application of economic theory to problems

that arise in finance. Much of economic theory begins with the concept of competition and competitive markets. From the implication of competitive markets one learns that price in competitive markets are pulled or pushed into equality with the marginal cost of producing the goods or services traded in the market. If there are no barriers to competitions, economic forces erode the excessive profit of those firms which are able to produce revenues from sales greatly exceeding costs. Competitive markets are a conceptual benchmark upon which economic analysis of industries and firms is built and area touchstone from which to begin to analyse the performance and prospects of an industry.

Financial services in IndiaThe Indian Financial System was unorganized upto the 1970s. With the nationalisation of the 14 major private sector banks on 19th July 1969, the Indian Banking system became predominantly owned by the government. Interest rates were controlled by the reserve bank of India. The state developed monolithic finance companies to provide financial services:

Industrial Development Corporation of India -1948

Industrial Development Bank of India -1964

Life Insurance Corporation -1956

General Insurance Corporation -1973

Unit Trust of India -1964

The financial services sector and financial markets were targets for financial sector reforms in the period after 1991 and structural changes were introduced in the financial sector.