Question Bank 030030610: Management of Financial Services...

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B.V. Patel Institute of Business Management, Computer & Information

Technology, Uka Tarsadia University

Question Bank 030030610: Management of Financial Services

Unit1: Introduction: Financial Services and Market I

Answer the following. (1 mark)

1. Which year SEBI was established?

1992

2. What comprises financial market?

It encompasses capital market, money market and the foreign market.

3. Which Act define the term „securities‟?

The term „securities‟ has been defined in the „Securities Contract (Regulation) Act, 1956.

4. Name the risk is involved in Government bonds.

Interest rate risk or the market risk.

5. What is meant by perishability of Services?

Services cannot be stored. Once the services are produced, the customer has to consume it

because services have been delivered to fulfill the requirements of the customers.

6. What Comprises in financial services?

It includes money management, portfolio management, stock broking and custodial

services.

7. Which bounds are known as Government bonds?

Treasury bonds

8. Which bounds are known as conventional bonds?

„Plain vanilla‟

9. Which is maximum the tenure of T-Bills issued by the RBI?

364 days.

10. What is the nature of corporate advisory service? Give an example

Corporate advisory services are diverse in nature. Example price securities, private

placement of securities.

TYBBA-Finance

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11. Write an example customer centric financial service.

Housing loan in which each loan account is based on the mortgage of the property.

12. State any two final services marked trough brokers and agent.

Insurance and mutual fund schemes are sold through the brokers and agent.

13. List one key area of control in a financial system.

Money supply

14. List the components of Indian financial services.

Banking sector, insurance sector, FIs, the Non-Banking Financial Companies (NBFCs)

and the Housing Finance Companies (HFCs).

Briefly answer the following. (2 marks)

1. Why financial service is required?

It needed in the mobilization of capital, payment and settlement of funds, risk

management and project financing.

2. Define financial service?

Financial service refers to those services rendered by banks, FIs, Insurance companies

and other intermediaries in the financial market intermediaries.

3. State the institutions that are engaged in the provision of financial services?

Insurance companies, investment banks or merchant banks, hire purchase finance

companies, leasing companies, rating companies and venture capital companies.

4. What is an intangibility financial service?

Financial services can be availed bur they are not visible in nature.

5. What is meant by heterogeneity in financial services?

Financial services cannot be uniform for all clients. Services cannot be standardized.

Different formats are for the marketing of financial services. Some are addressed to

individuals and some are addressed to institutions or companies.

6. What is meant by financial engineering?

The term 'financial engineering' means the development and the creative application of

financial technology to solve financial problems, exploit financial opportunities, and to

otherwise add value.

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7. Explain the financial inclusion.

“Financial inclusion is the process of ensuring access to financial services and timely and

adequate credit where needed by vulnerable groups such as weaker section and low-

income groups at an affordable cost”.

8. What is capital market?

Capital market deals with long-term securities. Equity, preference shares, bonds issued by

companies and the government bonds are the capital market instruments.

9. What is meant by money market?

It deals with instruments of short-term duration like T-bills, commercial papers, etc.

10. What is capital market instrument?

Capital market instruments are the financial instruments or the securities issued by the

companies, government or the mutual funds.

11. Name some of the regulatory agencies that govern the function of financial system.

Reserve Bank of India (RBI)

Securities and Exchange Board of India (SEB)

Insurance Regulatory and Development Authority (IRDA)

Ministry of Corporate Affairs (MCA)

Ministry of Finance (MOF)

12. What is the role of commercial bank in Indian financial system?

Banks facilitate the mobilisation of savings of individuals and institutions and lend the

same as loans and advances to the companies.

13. What is the impact of MICR technology in financial services?

Magnetic Ink Character Recognition (MICR) technology has reduced the processing

float in the clearing process.

Answer the following (limit 250 words). (5 marks)

1. Explain the characteristics of financial services.

1. Intangibility: Financial services can be availed bur they are not visible in nature. It

can neither be displayed, nor can it be stored. Even though 'financial products' are

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sold in the financial markets, in reality what we really find is the offering of

'financial service' and not any physical products.

2. Inseparability: In a service business, the customers are fully involved in the

production of service. Financial services also seek high involvement of the users.

The services are customer centric. E.g. housing loan in which each loan account is

based on the mortgage of the property. Each loan is a unique financial product

because of the differences in the customer profile, their needs, the term of the loan

and the property available.

3. Heterogeneity: Financial services cannot be uniform for all clients. As stated in. the

previous point, services vary from one customer to the other. Services cannot be

standardised. We have different formats for the marketing of financial services.

Some are addressed to individuals and some are addressed to institutions or

companies.

4. Perishability: Services cannot be stored. Once the services are produced, the

customer has to consume it because services have been delivered to fulfill the

requirements of the customers.

5. Advisory: Financial services may be a fund-based or a fee-based activity or both. In

the case of fee-based services, the advisory function is dominant. Corporate

advisory services are diverse in nature. It ranges from the issue management to

corporate valuation services for mergers and takeovers. Pricing of securities, private

placement of securities and risk management are certain other financial services

which are of advisory nature.

6. Marketing of financial services: Financial services are delivered through different

channels of marketing. Some services are directly sold to the users. For example, the

issue management service is offered to the company by the merchant bankers.

Services like insurance and mutual fund schemes are sold through the brokers and

agents. Services could also be offered as an Over-the-Counter (OTC) product.

Automated service dispensation is available through the Automated Teller Machines

(ATMs) and the credit card usage points.

7. Techno savvy: Financial service industry's growth can be attributed to the use of

information technology in its operations. Delivery of services has become more

efficient because of the application of technology. In the case of banks, the

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mechanised cheque processing by using Magnetic Ink Character Recognition

(MICR) technology has reduced the processing float in the clearing process. There is

a large scale use of electronic modes of payment in the country. Payment gateways

enable an error free and faster means of effecting the payments across the countries.

2. List major players of financial system. Discuss the role played by regulators,

commercial bank, financial institution, NBFC.

Regulators

Commercial banks

Financial institutions

NBFCs

Insurance companies and the HFCs

Mutual funds

1. Regulators: The Government of India, Reserve Bank of India (RBI), Securities

and Exchange Board of India (SEB), Insurance Regulatory and Development

Authority (IRDA), the Ministry of Corporate Affairs (MCA) and the Ministry of

Finance (MOF) are some of the regulatory agencies that govern the functioning of

the financial system. Besides the basic statutes relating to the functioning of banks

and other FIs, we also have the guidelines, circulars, orders and instructions issued

by the regulatory agencies from time to time regarding their operations in the

financial market.

2. Commercial banks: Commercial banks form the major segment of the financial

system. A strong network of commercial banks comprising of the public sector

banks, private sector banks, foreign banks and co-operative banks exists in the

Indian financial system. Banks facilitate the mobilisation of savings of individuals

and institutions and lend the same as loans and advances to the companies. Thus,

banks do a financial intermediation job. In line with the Basel norms, stringent

capital adequacy requirements are adopted by banks. Further, the RBI ensures a

close monitoring and supervision of commercial banks in the country through the

Board for Financial Supervision.

3. Financial institutions: These institutions, started by the government, serve as

pillars of industrial and trade development. Therefore, these institutions are

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described as the Development. Finance Institutions (DFls) which include

Industrial Finance Corporation of India (IFCI), Industrial Development Bank of

India (IDBI), Small Industries Development Bank of India (SIDBI), Infrastructure

Development Finance Company (IDFC), the National Banx for Agriculture and

Rural Development (NABARD), Export-Import Bank of India (EXIM Bank)

National Housing Bank (NHB), State Finance Corporations (SFCs) and Export

Credit and Guarantee Corporation (ECGC) are also included in this category.

4. NBFCs: Within this category there are deposit taking and non-deposit taking

NBFCs and Residuary Non-Banking Companies (RNBCs). NBFCs play a key

role in consumer credit, equipment leasing and vehicle financing through hire-

purchase finance.

3. What are the various functions of financial system? Explain any five of them.

Mechanism for mobilising savings

Mechanism for storing wealth

Liquidity

Credit mechanism

Payment system

Risk management

Policy implementation

Information provider

1. Mechanism for mobilising savings: A financial system has demanders of funds in

certain sectors and suppliers of funds in certain other sectors like the household and

the foreign sectors. The role of a financial system lies in channeling the money

(savings) from the 'surplus' sector to the 'deficit' sector. Financial instruments are used

for this purpose.

2. Mechanism for storing wealth: Financial system facilitates the investors to store their

wealth in the form of financial instruments. These instruments generate income for

the investor and help them preserve the value of the assets they hold. The risk of loss

is much less in financial instruments as compared to other forms of stored wealth.

3. Liquidity: The financial markets provide the most important attribute of the securities

namely, liquidity. Financial market provides a means of converting financial

instruments in to cash or vice versa.

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4. Credit mechanism: Financial system facilitates the process of extending credit through

the banking sector as well as through other FIs to the households, business firms and

the government.

5. Risk management: Financial markets offer a wide range of insurance products to

manage the life, health, property and income risks. Further, the risks arising from the

currency exposures in international transactions could be managed through the

forward contracts or the currency option contracts.

4. Briefly explain the following

Treasury Bills

Dated Government Securities

Certificate of Deposits

Commercial Papers

Treasury Bills: T-Bills are the 'IOUs' (l owe yous) of the government. These are issued

to raise short-term funds. T-Bills are auctioned by the RBI regularly. Currently, three

types of T-Bills are issued by the RBI With tenures of 91, 182 and 364 days. T-Bills are

issued at discount to the face value and at maturity, the face value of the bill is paid. The

discount represents the interest rate on the instrument. The average interest rate on T-Bills

provides a basis for all other short-term interest rates.

T-Bills are available for a minimum amount of Rs 25,000 and in multiples of Rs 25,000

and are issued on auction basis. Although 91-day T-Bills are auctioned every week on

Wednesdays, 182-day and 364-day T-Bills are auctioned every alternate week on

Wednesdays.

Dated Government Securities: Governments, both central and state, regularly raise

resources by issuing market loans. Since the date of maturity is specified in these

securities, they are described as 'dated securities'. For example. an 8.24% GOI 2018 Bond

is a Central Government Security maturing in 2018, and it carries a coupon of 8.24%,

payable half yearly. The government bonds have long-term maturities. At present there

are central government dated securities with a tenor up to 30 years. The dated securities

a~ sold through auctions conducted through the Negotiated Dealing System (NDS). NDS

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facilitate the electronic submission of bids/application by members for primary issuance

of G-Secs by RBI through auction and floatation.

Certificate of Deposits: CDs are the usance promissory notes issued by the banks. The

CDs are akin to term deposits or fixed deposits bur with the difference that they are

negotiable. They are issued at discount to face value and the maturity ranges from 7 days

to 1 year. CDs can be transferred by endorsement and delivery. Issue of CDs is subject to

stamp duty being payable as per the Stamp Act. 1899. All scheduled banks can issue CDs

to individuals, corporations, trusts and associations. The CDs are (faded in the secondary

market.

CDs, introduced in India in June 1989, are essentially securitised short-term time

deposits, which provide greater flexibility to investors for deploying their short-term

surplus funds. They are issued by banks during periods of tight liquidity at relatively

higher discount rates as compared with term deposit rates. The interest rates on CDs were

deregulated in 1992.

Commercial Papers: CPs are the unsecured promissory notes issued by the corporates.

Issue of CPs is one of the methods of raising short-term funds for the companies. CPs

were introduced in India in 1990. It is an unsecured short-term borrowing by the reputed

companies, PDs and FIs. It is an additional source of short-term borrowings available to

the corporates and other institutions. The issuers of CPs, who are the users of the credit,

can directly approach the investors in the financial market.

5. Explain repos and reverse repos.

Repos: Ready forward contracts, or the repurchase options, are described as 'Repos' in

the money market terminology. Repo transactions are common in the inter-bank market.

In the banking system, one bank may need securities to fulfil the SlR requirements and

there may be another bank that is in need of cash. Under such circumstances, the need for

a repo transaction arises.

A repo is a repurchase agreement which involves the sale of a security with a

commitment by the seller to repurchase the security at a specified price at a future date.

Similarly, the buyer purchases the securities, agreeing to resell the same on an agreed date

in future at a pre-fixed price. In a ready forward deal, or repo, the seller of the security is

the borrower and the buyer is the lender of funds. Repos may be an overnight repo or a

term repo which has a longer time horizon.

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Reverse Repos: In the repo deals, if you look at the transaction from the purchaser's

angle, It is called a reverse repo deal. The buyer purchases the securities agreeing to

sell the same at a future date at a predetermined price. It is a collateralised loan

extended to the seller, the collaterals being the securities. The motivation for a reverse

repo is the interest income on the funds that would have remained idle with the buyer.

The major players in the repo and reverse repo market tend to be commercial banks

that hold large portfolios of G-Secs. Besides the banks, the PDs are also active players

in the repo and reverse repo market.

6. Differentiate between capital issue by unlisted company and public issue by a listed

company.

Capital issues by an unlisted company: An unlisted company is one whose shares are

not yet listed in the trading list of stock exchanges'. Many public limited companies

remain as unlisted at least for some length of time and once they decide to go for a public

issue of securities, they have to fulfill certain norms. The public issue in these cases is

described as the IPOs. The company can opt for an IPO on fixed price basis or on the

book-building basis. The SEBI norms are:

The company has a net worth of at least Rs 1 crore in each of the preceding

full 1 year period.

It has a track record of distributable profits for at least 3 years out of the

preceding 5 years.

The aggregate of the proposed new issue and any other issues made during the

same financial year should not exceed five times the size of the pre-issue net

worth.

The company has net tangible assets of at least R~ 3 crores in each of the

preceding full 3-year period, of which not more than 50% of it is held in

monetary assets.

Public issue by a listed company: A company which is already a listed company

may plan for raising capital through public issues. Such issues are described as the

further public· offers or the Follow-on Public Offers (FPOs). The company is eligible

to go for public issue, provided, the issue size does not exceed 5 times the size of its

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pre-issue net worth. The company can opt for either the book-building route or the

fixed price route to issue the securities.

7. Summarise the positive roles of SEBI in the secondary market development in India.

1. Secondary Market Guidelines: SEBI as the market regulator has issued several

guidelines on matters pertaining to secondary market operations. All the market

intermediaries associated with the stock trading activities are brought under these

guidelines. Stock exchanges, stock brokers, sub-brokers, depositories, depository

participants and clearing corporations are some of the intermediaries whose

functioning is regulated by SEB!. Here, we discuss some of those measures.

2. Recognition of Stock Exchanges: The SCRA provides for the recognition of

stock exchanges and the admission of members of stock exchange. The procedure

for corporatisation and demutualisation and de-recognition of exchanges have

been outlined by SEB!. The government has the power to supersede the governing

body of the stock exchange and suspend the business in a stock exchange. The

NSE and the Over-the-Counter Exchange of India (OTCEI) are the two

demutualised stock exchanges in the country.

3. Registration of Brokers, Sub-brokers and Other Intermediaries: Trading in

stocks at the stock exchanges is executed through the stock brokers. The stock

brokers and the sub-brokers are not allowed to trade through the trading platform

of the stock exchanges, unless they are registered with SEB!. A broker or sub-

broker has to comply with the code of conduct prescribed by SEB!. The admission

of a broker as a member of the stock exchange is based on factors such as the

corporate status, track record, capital adequacy, education and experience of the

individuals. The other market intermediaries are also subject to the registration

with SEBI. A merchant banker has to be authorised by SEBI to carry out the issue

management and other advisory services. Similarly, regulations prescribe that the

Registrars to the issue, bankers to the issue, underwriters, debenture trustees,

custodians and credit rating agencies have to be authorised by SEBI.

4. Listing of Securities: Shares and other securities issued have to be listed in the

stock exchange for the purpose of trading. Listing is the formal admission of

security into the trading platform of the stock exchange. For this purpose, the

issuing company has to enter into a listing agreement with the stock exchange.

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The provisions of the Companies Act, the Securities Contract (Regulation) Act,

various clauses of the listing agreement and the circulars issued by SEBI govern

the process of listing. Listing norms are, by and large, uniform in all stock

exchanges. However, certain additional norms could be prescribed by the stock

exchanges. The norms form part of the bye-laws of the stock exchange. SEBI has

come out with the norms for delisting of a security through the SEBl (Delisting of

Securities) Guidelines 2003. If the promoter of a company wishes to delist the

company, he may do so by announcing the exit price which shall be determined

through the book-building method. Delisting in this case is a voluntary move by

the promoters. In addition, delisting can be done for non-compliance of the listing

agreement also. The company in such cases might have been suspended for a

minimum period of 6 months.

5. Trading in Securities: Once the securities are listed, the trading is permitted. All

the stock exchanges follow the screen based trading system. National Stock

Exchange was the first stock exchange in the country to introduce the screen-

based trading system. This allows a large number of participants to trade with one

another irrespective of their geographical location. SEBI has permitted the use of

internet as an order routing system for communicating the clients' orders to the

exchanges through brokers. SEBI registered brokers can introduce internet-based

trading after obtaining permission from stock exchanges.

6. Controlling Volatility: Excessive volatility in share prices is a matter of concern

to investors and the policy makers. Therefore, adequate measures are usually

taken by SEBI by introducing price bands and circuit breakers to bring about a

coordinated trading halt in both the equity markets and the derivative markets.

The circuit breaker system is based on the movement of indices, namely, Sensex

and the S&P CNX NIFTY The circuit breakers are triggered when the index moves

either way by l0%, 15% and 20%. So there are three stages at which the breakers

are applied and the trading is brought to halt. Price bands are applied for

individual scripts also. For individual scripts, a price band of 20% is applicable.

However, no price band applies to those scripts for which derivative products

exist or if the scrip is included in the index for which derivatives are available.

7. Risk Management: Risk management is an essential attribute of investor

protection measures. In this direction, SEBI has put in place appropriate systems

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to control and monitor the trading in securities. It administers an efficient market

surveillance system. Capital adequacy requirements, margin money requirements,

limits on exposure/turnover, indemnity insurance, online position monitoring and

automatic disablement of brokers from trading, etc. are some of the measures

implemented to manage the risks.

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Unit 2: Financial Services – I


1. Who facilitates the issuers of securities to raise capital from the financial market?

Merchant banker

2. What kind of firm „Goldman Sachs‟?

Goldman Sachs is a leading global investment banking firm with diverse services

provided worldwide.

3. State any two functions of factoring.

a. Mode of financing

b. Contractual service

c. Receivables into cash flows

d. A continuous arrangement

e. Outright sale of book debts

f. Undertakes the services

4. Write the full form of „CARE‟.

Credit Analysis & Research Ltd.

5. Write the objective of credit rating.

It is to determine the capacity of the issuer in generating cash flow in future to service the

debt obligations.

6. Mention some advertising flash line seen in the home page of a factoring firm.

(i) Manage cash flows

(ii) Instant cash

(iii) Credit protection and

(iv) Reduce time on credit control

7. What is focuses of rating methodology.

It focuses on identifying the business risk and financial risk through industry and

company analysis.

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8. How credit rating is revealed?

Credit rating is revealed through „Symbols‟ e.g. „AAA‟, „AA‟, etc.

9. How can firm measures its debt servicing ability?

Coverage indicator

10. Name the leading credit rating agencies in India.

CRISIL, Investment Information, Credit Rating Agency of India Ltd., CARE and Fitch

India.

11. What is done in process of credit rating?

Collects a lot of information and an elaborate analysis of financial and non-financial

factors.

12. What does credit rating agencies offer?

It offers a whole range of rating services ranging from rating of ordinary corporate debt to

grading of IPOs.


1. What is a merchant banker?

Merchant banker is one who is engaged in the business of issue management either by

making arrangements regarding selling, buying or subscribing to the securities as

manager, consultant, advisor or rendering corporate advisory services in relation to such

issue managmenet.

2. State the role of “The Mergers and Acquisitions” advisory.

Mergers and Acquisitions (M&As) advisory is a broad area with cases of acquisitions,

divestitures, mergers, joint ventures, restructuring, recapitalisations, offs and leveraged

buy-outs.

3. Define „Factoring‟.

„Factoring is a „continuous arrangement‟ between a financial institution (the factor) and a

business firm (the client) that sells goods and services whereby the factor purchases the

client‟s book debts or the accounts receivable‟.

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4. Write the benefits of factoring.

a. Factoring substitutes market credit

b. Effective receivables management

c. Liquidity

d. No collaterals

e. Cash discounts

f. Reduction in operating cycle time

g. Credit management

h. Benefits to exporters and importers

i. Advisory

5. What are the commonly rated instruments in credit rating?

Fixed deposits, preference shares, CPs, structured finance arrangements and securitised

papers are the commonly rated instruments.

6. What is the use of „past financial performance‟ in credit rating.

„Past financial performance‟ provides a key to understand the impact of business risk and

financial risk factors.

7. State some important indicators of financial performance.

Profitability, liquidity, leverage, interest coverage and cash flow adequacy.

8. State the function of a merchant banker.

i. Corporate finance services.

ii. Project finance services.

iii. International finance services.

iv. Miscellaneous services .

9. List five miscellaneous Function of merchant banker.

i. Stock broking, for both institutional and retail investors.

ii. Distribution of financial products.

iii. Dealing in currency derivatives.

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iv. Insurance broking.

v. Asset management.

10. Mention two feature of full factoring.

Sales ledger administration, collection of accounts receivable and assuming the credit

risk are the standard features of full factoring.


1. Discuss the functions of a merchant banker.

The functions of a merchant banker are:

i) Corporate finance services.

ii) Project finance services.

iii) International finance services.

iv) Miscellaneous services .

Corporate Finance Services: The most visible function of a merchant banker is the

function of mobilising funds for the companies. Starting from public issue of securities, it

extends to private placements, bought-out-deals, Euro-issues and corporate valuations.

Generally, companies are not willing to handle the public issue of capital themselves

because the merchant bankers' services are available for a fee. The merchant bankers are

good at the nuances of the public issue process. Merchant banker undertakes the legal,

administrative and the marketing responsibilities of a public issue. Issue management

covers the IPOs, FPOs, Qualified Institutional Placements (QIPs), open offers, buy-back

offers, delisting offers, and preferential issues. The merchant banker examines the clients'

needs for funds and the various options available to fulfill those needs. In short, he

advises the client about the instrument to be issued after studying the debt-equity ratio

implications of the proposed issue. The merchant banker would structure the issue in a

way that suits the requirements of the issuer and then package it for the investor. Besides

advising on the timing of the issue, the merchant banker would also advise on the pricing

of the securities.

Project Finance Services: The second major activity of a merchant banker is project

financing services. He should carry out an independent appraisal of a project. Besides

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advising clients on project feasibility, they also find the best package of financing mix

necessary for such project. If there is foreign currency element in the project finance, the

role of a merchant banker's advice on the financing package becomes very important due

to the financial risk arising from exchange rate fluctuations. A merchant banker should be

closely associated with the project right from its inception. He will be able to provide the

expertise in determining the project size, capital structuring, amount of capital to be

mobilised, sourcing of funds, the type of instruments to be issued and providing inputs on

when to raise the resources. Arranging bridge finance, loan syndication and structured

finance are the other activities under the project financing services.

International Financing Services: Companies have gone to overseas capital markets to

raise capital. GDRs, American Deposirory Receipts (ADRs) and FCCBs are issued

foreign investors. In this, the domestic merchant bankers and foreign investment banks

playa major role. Large merchant banking outfits in India have entered strategic alliances

with international investment bankers and tapped the international markets for resources.

Merchant banks playa role in arranging External Commercial Borrowings (ECBs).

Miscellaneous Functions

Stock broking, for both institutional and retail investors.

Distribution of financial products.

Dealing in currency derivatives.

Insurance broking.

Asset management.

Underwriting.

Investment research.

Portfolio management services.

Commodities broking.

Forex advisory services.

Advisory services for joint ventures.

Strategic services relating to M&As.

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2. What are various obligations of a merchant banker? Explain any five of them.

The following are the obligations of merchant bankers:

High standards

Due diligence

Dealing with competing merchant bankers

No tall claims

Cost-effective service

Confidentiality

Disclosure of information

Avoid market manipulative practices

Restraint on advisory role

1. High standards: In dealing with the clients, the merchant bankers are expected to

keep high standards of integrity and fairness in all their dealings.

2. Due diligence: The merchant bankers have to render high standards of service,

exercise due diligence, ensure proper care and exercise professional judgment in

delivering their service. They should disclose to clients all possible sources of

conflict of duties and interests.

3. Dealing with competing merchant bankers: In the course of their business,

competition with other merchant bankers is inevitable. During the process of

prospecting for clients or during the execution of their services to a client, a

merchant banker should not make a statement harmful to other merchant banks or

is likely to place the other merchant banker in a disadvantageous position.

4. No tall claims: While dealing with the clients, a merchant banker shall not make

an exaggerated statement, either orally or in a written form, about his capabilities

to render certain service or about his achievements with regard to services

rendered to other clients.

5. Cost-effective service: A merchant banker shall always endeavour to do the best

possible advice to clients. He should ensure that all professional dealings are

effected in a prompt, efficient and cost-effective manner.

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3. Summarize the benefits of factoring.

The following are the benefits of factoring:

1. Factoring substitutes market credit: Factoring has an important role in working capital

finance. Generally, bank borrowings supplements the market credit or suppliers' credit.

Factoring replaces high-cost market credit.

2. Effective receivables management: Factoring accelerates the receivables turnover and

improves the return on capital. Outstanding receivables are turned over into cash

quickly through factoring.

3. Liquidity: Factoring helps the client to raise cash, even up to 90% of the invoice value,

almost instantly. This builds the liquidity position of the client.

4. No collaterals: Only the invoices are assigned to the factor. No other collateral or

security is required.

5. Cash discounts: The client can utilise the available cash to go for cash purchases of

raw materials or use the cash to make prompt payment to the suppliers and avail the

cash discounts. This enables cost cutting by the clients.

6. Reduction in operating cycle time: The average receivables collection period is

reduced substantially and as a consequence the total operating cycle time of the client

is reduced. This contributes to efficient working capital management.

7. Credit management: Factoring eases the burden of the client with regard to managing

the credit sales. The time and money involved in maintaining a credit department are

saved to a greater extent. In identifying the factorable debts, only prompt customers are

chosen. Investigation of customers' credit standing is done by the factor. Sales ledger

administration, collection and follow up of the customer accounts is the responsibility

of the factor It saves the time devoted by the client in chasing the slow paying

receivables. The client can concentrate on the core activities such as, production,

marketing, etc.

8. Benefits to exporters and importers: While discussing the mechanism of international

factoring in the previous section, we have highlighted the advantages of international

factoring. The main advantage is that factoring helps in trading through open account

terms. Exporters get the credit protection and there is no need for ECGC risk cover.

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For the importers, the cost of opening the L/C and the associated financing costs are

saved because the imports can! made without opening the L/C.

9. Advisory: Factoring companies offer advisory services to its clients including credit

assessment for its overseas buyers through its own network or through the

correspondent factors.

4. Elaborate any four forms of factoring.

In the factoring industry, a few technical terms are l to describe the types or the forms of

factoring they are as follows:

1. Full Factoring: Full factoring is the most comprehensive type of factoring

arrangement. It is also called standard or old-line factoring. In this type of factoring,

all services are included apart from financing. Sales ledger administration, collection

of accounts receivable and assuming the credit risk are the standard features of full

factoring. Since the credit risk is undertaken in this case, it is 'without recourse'

factoring. Normally, the factor establishes a credit limit for each of the client because

of the higher risk involved. Most of the international factoring arrangements are

'without recourse' type. However, in India, we have full factoring with a difference

that the factoring contracts are always 'with recourse‟

2. Recourse and Non-recourse Factoring: Recourse factoring or 'with recourse'

factoring means that the factor does not assume the credit risk. The factor can recover

the bad debt losses from the client firm. Otherwise, all other services are performed as

in full factoring. On the other hand, in a 'without recourse' or 'non-recourse' factoring,

the factor absorbs the risk of inability of customers to pay the outstanding bills. The

fact that most of the 'open account' credit transactions are subjected to factoring must

be reckoned at this point. The risks in such transactions are covered by the factor in a

non-recourse factoring.

3. Advance Factoring: This is the typical factoring mechanism which we have been

explaining from the beginning of this chapter. Once the factorable debts are identified,

the drawing limit is made available to the client. The advance payment is limited to

about 80%-90% of the debts or invoices identified for factoring. Provision of advance

against (he factored invoices is the way to finance the fund requirements of the client

firms. Further, this may be of either 'with recourse' or 'without recourse' arrangement.

21

4. Maturity Factoring: Maturity factoring is also known as collections factoring. In this

type, unlike the standard factoring mechanisms, no advance financing is made by the

factor to the client. The factor administers the sales ledger, renders the debt collection

service and pays the factored amount at the end of the credit period. Again, the

factoring could be with or without recourse. The emphasis is on collection of

receivables and the factor plays the role of a collection agent of the client.

5. Undisclosed Factoring: In an undisclosed factoring, the customers are not notified

about the arrangement between the factor and the client. Even though the debts are

assigned to the factor, the client continues to maintain the sales ledger. The factor

receives the copies of the invoice and provides finance or risk cover or both as

required by the client. Debts are collected by the client firm in the usual manner and

passed on to the factor, if advances have been received by the client. This type of

factoring is common in the Indian factoring industry.

6. Invoice Discounting: Strictly speaking, invoice discounting is not a form of

factoring, but another line of business for a factoring company. The business profiles

of many factoring firms in India as advertised in their brochures include invoice

discounting as one of their activities. For example, Canbank Factors, in its website,

describes invoice discounting as a variant of factoring. In invoice discounting, the

factor provides finance against invoices backed by the Letter of Credits (LlCs) of

banks. Finance is provided by the factor only when the LlC opening bank confirms

the due date of payment. No other services are rendered to the client. Customers pay

to the client, and the client, in rum, pays to the factor.

7. Purchase Bill Factoring: Purchase bill factoring or reverse factoring is the reverse of

the regular factoring transactions. If of sales invoices being financed, the purchase

bills are financed by the factor. For example, SBI F offers a scheme called 'Cash 4

Purchase' that is a case of purchase bill factoring. Generally, this fa is offered in

conjunction with the export factoring and only the bills of regular suppliers of the I

are considered for financing in this type of factoring.

8. Export Factoring: Factoring of receivables arising from the domestic trade, called as

domestic factoring, was the of our discussion so far. In addition to this, factoring is a

popular instrument in the international trade also. It is called international factoring or

export factoring. Under export factoring, the inv drawn on the overseas buyers

22

(importers) is factored. The factor provides finance up to 90% invoice amount

immediately. In international factoring, a two-factor system that involves and an

factor and an import factor facilitates the process. The factor who handles the

collection of ex receivables is called the export factor and the factor in importer's

country who handles collection receivables and credit protection is called the import

factor. It is in this context that organisation like FCI playa coordinating role between

the factors located in different countries.

5. What are the rating methodologies? Explain the following.

Industry analysis

Management quality

Financial flexibility

The rating methodology involves the following:

1. Industry analysis

2. Market position

3. Operational efficiency

4. Project risks

5. Management quality

6. Financing policies

7. Financial flexibility

Industry analysis: Industry analysis is about studying the industry characteristics which

influences the risk factor. Variations in the earnings are caused by the industry-related

factors. The existing state of the industry, product demand, competitiveness of the

industry, government policies, entry barriers, exit barriers, availability of raw materials

and threat of substitutes are examined to assess the industry position. Generally, an

industry with a lower risk with a low cash-generating capacity is favourably viewed

compared to another with a higher cash flow potential but has a higher volatility.

implementation schedule, status of the project, track record of the technology provider,

financing arrangements and tie-up of raw material sources are some of those factors.

Management quality: The management's goals, philosophy and strategies are analysed.

Views of the management about the past performance and the future plans are obtained.

The 'key man' factor as well as the succession planning is ascertained. Other factors

examined in this regard include labour relations, performance of group companies and the

responsiveness of the management to environmental change.

23

Financial flexibility: Debts are serviced from the cash flows generated from the

operations, or what is called as 'primary cash flows'. Financial flexibility refers to the

ability of the firm to draw on other internal or external sources of cash flows in times of

difficulties. Such sources include marketable investments, unutilised lines of credit from

the banks, financial strengths. of group companies, and its relationship with the banks and

financial institutions.

6. What is credit rating? What are the features of credit rating.

Credit rating is an opinion on the credit quality of a debt instrument offered by a credit

rating company. It is a symbolic indicator of the current opinion of the rating agency

regarding the capability of an issuer of debt to service the debt obligations in future as per

the terms of the contract. Credit rating is an independent professional opinion on the

borrower's ability to honour his commitments or discharge his obligations. It is an easily

understood indicator because standard symbols are used for expressing the risks

associated with an instrument of debt.

Features of Credit Rating

1. Credit rating is an expression of opinion of the credit rating agency about the risk of

a security. This opinion is subject to change over the life of the security.

2. Credit rating indicates relative grading of risk in a security. Risk quality is

expressed on a comparative basis.

3. Credit rating is revealed through symbols such as 'AAN., 'AA', etc.

4. The ratings are instrument specific. It can differ for different instruments of the

same company.

5. Ratings being the opinions or perceptions of the rating agency, there could be a

difference in the rating of the same instrument by different agencies.

6. Rating is reflecting the relative credit risk; it does not reflect other investment risks

that arise due to changes in the market conditions, namely, interest rates or liquidity.

7. Credit rating is not an investment recommendation. It indicates just one aspect of

investment, risk. Other aspects like yield, risk preferences of investor, etc. are not

considered.

8. Credit rating is not a one-time task that is over with the assignment of ratings. It is

continuous process. The ratings assigned are subject to surveillance and if

conditions change, the rating may be revised.

24

Unit 3: Financial Services-II:


1. How lease finance is useful to firms?

Lease finance facilitates firms to acquire assets or avail the use of assets.

2. Define lessor?

Legal owner of the asset

3. Define lessee?

Lessee is a person who possesses and uses the asset on payment for a specified period.

4. What is meant by residual value?

The value of the leased asset at the end of the lease period.

5. Give the application processing fee of lease financing facility of National Small

Industries corporation.

Upto a maximum of Rs. 2500/-

6. State the year in which the concept of „mutual fund‟ came in existence.

1963.

7. What is the investment portfolio of income scheme?

Consists of fixed income securities such as bonds, debentures, government securities and

money market instruments.

8. What is load fund?

Means a scheme that charges some fees as a percentage of the NAV for entry or exist.

Each time when an investor buys or sells units in a fund, a charge will be payable by him.

9. Why do mutual funds invest in diversified securities?

To reduce the investment risks

10. What is the aim of money market schemes.

To provide easy liquidity and preservation of capital

11. What is „load‟?

A load is a fee charged by the mutual fund from the investor.

25

12. What is the primary goal of insurance?

Provide protection to the family

13. What is insurance?

Insurance stands for a mechanism to protect against risks, hazards or dangers to life and

property


1. Define Lease.

“contract between two parties for the hire of a specific asset wherein the lessor retains

ownership of the asset while the lessee has possession and use of the asset on payment of

specified rentals over a period of time.

2. What is a mutual fund?

A mutual fund is an institution that pools the savings of small investors for investment in

capital market and money market securities.

3. What are the different classifications of mutual fund?

a. By structure

b. Investment objectives

c. By geographic location

d. By nature of Portfolio

4. How mutual fund is benefit in taxation?

Investors need not pay taxes on the dividends received from mutual funds. Tax saving

schemes and pension schemes give the investors the benefit of deduction under section 88

of the Income Tax Act.

5. What is marine insurance?

The insurer undertakes to indemnify the insured against marine losses pirates, war perils,

jettison, etc. It may cover different insurable interests such as hull insurance, freight

insurance, loss of hire insurance and loss of profit insurance.

26

6. What is meant by endowment policy?

It combines the advantages of risk cover and financial savings. The sum assured is

payable even if the insured survives the term of the policy. In case of death during the

tenure of the policy, the sum assured is just as any other pure risk cover.

7. Briefly describe the diversification of mutual fund.

The mutual funds have a large corpus and therefore, diversification of the portfolio is

easier.

8. What is it believe that mutual fund are cost effective?

Mutual funds enjoy the scale advantage because of the large number of investors and the

large corpus available for investment. The transaction costs of a mutual fund in its

operations will be low owing to its large-scale operations.

9. How flexibility exists in mutual fund investment?

Regular withdrawal plans and sector-specific plans are also available. The investor can

also switch from one scheme to another.

10. What is meant by transparency feature of mutual fund?

Mutual funds regularly publish the NAV of the schemes on a daily basis.


1. Explain the types of lease.

The lease transaction can be structured in many ways and for each of such transactions a

name is assigned. This leads to various types of lease. The two basic types of leases are:

Finance Lease: According to International Accounting Standard No. 17, a finance lease

is a lease that transfers substantially all the risks and rewards incidental to ownership of

an asset. Title mayor may not eventually be transferred. In other words, the key risks

being assumed by the lessor are financing risks rather than risks associated with the asset

being financed. All other leases are operating leases. Institute of Chartered Accountants

of India (lCAl) defines a financial lease as a lease under which value of the minimum

lease payments at the inception of the lease, exceeds, or is equal to, the whole of fair

value of the leased asset. In other words, close to the entire investment in lease is

recovered by the lessor during the primary lease period. Otherwise, it is deemed to be;

operating lease Finance lease is a lease in form but in substance it is more like a secured

loan. It will normally, be for a term which matches with the economic life or the useful

27

life of the leased asset. It is non-cancellable during the primary period of the lease.

Primary period is the period during which the lessor would have recovered his

investments in the asset through the lease rentals. In a finance lease, lessee, rather than the

lessor, will have the operating know-how and will be responsible for insurance and

maintenance of the leased assets. The risk of loss or damage to the asset is borne by the

lessee.

Operating Lease: A lease other than a financial lease is usually called as operating lease.

An operating lease is known as service lease or maintenance lease. An operating lease is a

contract between the lessee such that the cost of the asset is not fully recovered from a

single lessee. An operating lease be for a term less than the economic life of the leased

equipment or the leased asset. Generally, lease periods will be of short durations and there

will be multiple lessees for the asset. The contract of lease in an operating lease contains a

cancellable clause. The risk of obsolescence is borne by the lessor and he is responsible

for repair and maintenance. An operating lease involves technological skills, ability to

maintain and manage fleets of equipment and training of personnel on the part of the

lessor.

2. Discuss different mutual fund scheme as classified under „by investment objectives‟.

The classification of schemes according to the investment objectives of the scheme

consists of a growth scheme, income scheme, balanced schemes and money market

scheme. A brief description of the schemes that are based on the investment objectives.

Growth scheme: Growth schemes are known as equity schemes. The main objective of

the scheme is to provide capital appreciation over the medium to long term. Growth

schemes normally invest a major part (70%-80%) of their funds in equity shares of

companies. In terms of risk, growth schemes have a higher degree of risk. Growth

schemes provide different options to the investors like dividend option, capital

appreciation option, etc. and the investors have to indicate their preferences at the time of

applying for the scheme. These schemes suit those investors with a longer time horizons

and are interested in the capital appreciation.

Income scheme: In an income scheme, the objective is to provide a regular income to the

investors. The investment portfolio of such schemes generally consists of fixed income

securities such as bonds, debentures, government securities and money market

instruments. A greater proportion (as high as 80%) of the portfolio consists of debt

28

securities. That is die reason for calling these schemes as 'debt oriented' schemes or debt

schemes. These are comparatively less risky than growth schemes. The capital

appreciation potential in schemes is very limited.

Balanced scheme: The aim of balanced scheme is to provide both regular income growth

in the value of investments. Accordingly, the portfolio of such scheme comprises income

securities and equity shares in the proportion (may be 50:50 or 40:60) as in the offer

documents. The NAVs of these schemes are likely to be less volatile than those pure

equity funds.

Money market scheme: This scheme invests exclusively in money market instruments

as T-bills, certificate of deposits, commercial papers, government bonds and interbank

loan market. The aim of the scheme is to provide easy liquidity and preservation of

capital. The schemes also yield moderate income and it is another example of an income

Companies find these schemes useful for them to park the surplus funds temporarily and

nominal returns.

3. Discuss the following schemes of mutual funds.

1. Tax saving scheme

2. Index scheme

3. Sector-specific scheme

4. Exchange-traded funds

5. Fund-of-funds (FoFs)

6. Load fund/no load fund

1. Tax saving scheme: Under Section 88 of the Income Tax Act, investments made in

Equity Linked Savings Schemes (ELSS) and pension schemes are eligible for

deduction in computing the total taxable income of the investor. This deduction serves

as an incentive for savings. Basically, the scheme is a growth scheme and the funds

are invested predominantly in equines.

2. Index scheme: An index fund replicates the portfolio composition of the familiar

market indices such as BSE Sensex, S&P CNX Nifty, etc. The investment is made

only in those stocks that are included in the index number. Further, the amount of

investment in each scrip will be in the same proportion as that of the particular scrip

in the index number. The NAVs of the scheme would rise or fall in accordance with

the rise and fall of the specific index number.

29

3. Sector-specific scheme: In this type, investment is made in the securities of specific

industry or sector. For example, one would find schemes for Fast Moving Consumer

Goods (FMCG) sector, infrastructure sector, information technology sector, energy

sector, pharmaceutical sector, etc. in the mutual fund scenario in India. The returns in

these funds are dependent on the performance of the respective sectors/industries.

Although these funds may give higher returns, they are more risky compared to

diversified funds.

4. Exchange-traded funds: An ETF is a mutual fund scheme in which the units of the

scheme are listed in a stock exchange in the same way as company stocks are listed.

Such funds may be an index fund or a sector-specific fund or a commodity fund. For

an example, a gold exchange-traded fund scheme means a mutual fund scheme that

invests primarily in gold or gold-related instruments.

5. Fund-of-funds (FoFs): It means a mutual fund scheme that invests primarily in other

schemes of the same mutual fund or other mutual funds. Just as a mutual fund that

holds securities in different companies, a FoF holds units of different mutual fund

schemes. FoF schemes have the advantage of greater diversification and ease of

selection. But this scheme is yet to make headway in the Indian market. The returns

from these funds are found to be lower than diversified funds.

6. Load fund/no load fund: One of the frequently used terms in the mutual fund

industry is the 'load'. A load is a fee charged by the mutual fund from the investor. A

load fund means a scheme that charges some fees as a percentage of the NAV for

entry or exit. Each time when an investor buys or sells units in a fund, a charge will be

payable by him. This charge is revenue for the mutual fund and it is used by the

mutual fund to meet the marketing and distribution expenses. From the investor's

angle, a load is a cost item and it should be reckoned while making investment

decisions. Contrary to the load fund, no additional charges are payable on purchase or

sale of units in a no-load fund.

4. Mention the benefits received by the investor in a mutual fund. Explain any five of

them.

1. Affordable:

2. Professional management:

3. Diversification

4. Convenience

30

5. Liquidity

6. Multiple products

7. Cost effective

8. Flexibility

9. Transparency

10. Regulation

11. Taxation benefits

1. Affordable: Investing in a mutual fund scheme is possible even with small

amounts. In this sense, it offers an affordable opportunity for small investors.

With small sums, one may not be able to buy the shares of leading companies. But

through the mutual fund route he may be able to derive the benefits of such shares

even with smaller amounts

2. Professional management: Portfolios of mutual funds are managed by

professional fund managers. The fund managers are skilled individuals with

investment experience in the capital market. These managers conduct investment

research before the selection of a particular security for investment. By investing

in a mutual fund, an investor derives the benefit of expertise of professional fund

managers which otherwise would have been costlier for them.

3. Diversification: Diversification is the basic investment strategy to reduce the

risks. Mutual funds operate on the basis of 'pooled diversification'. The mutual

funds have a large corpus and therefore, diversification of the portfolio is easier.

By investing in a mutual fund scheme he can avail the benefits of diversification.

4. Transparency: Mutual funds regularly publish the NAV of the schemes on a daily

basis. They also send the newsletters to the unit holders regularly that gives details

of the portfolio and performance of the schemes vis-a-vis certain bench mark

indices.

5. Taxation benefits: Mutual funds are tax efficient entities. Investors in mutual

fund schemes need not pay taxes on the dividends received from mutual funds. In

the same way, tax saving schemes and pension schemes give the investors the

benefit of deduction under Section 88 of the Income Tax Act.

31

5. Summaries different benefits covered under life insurance scheme.

The benefits of life insurance as follows:

1. Risk cover: Life insurance gives full protection against the risk of death of the

policyholder. In the event of death of the holder, the insurance money (sum

assured) along with bonuses accrued is paid to the family.

2. Savings habit: Life insurance encourages the habit of savings or thrift among the

public. Premiums can be paid in installments. For example, the monthly deduction

from salary on account of premium under the salary savings scheme is a

convenient means of savings for the individuals.

3. Liquidity: Life insurance policy can serve as a security to avail the loans. Even

for other commercial loans, the insurance policy is accepted as a security. The

main benefit is that it results in immediate liquidity to the holder.

4. Tax benefits: Insurance is one of the comrnon methods adopted co derive savings

in Income tax. The premiums paid on life insurance policies are allowed as a

deduction in computing the taxable income of the individuals. Because of the tax

relief available, the effective cost of the premiums raid by the holder of the policy

will be less.

5. Earmarking: Life insurance policies-, are sometimes taken with a specific goal in

mind. Children's education, marriage and retirement are some of the specific goals

with which the policy is introduced.

6. Write an essay on „general insurance‟.

Insurance other than life insurance is called general insurance or non-life insurance.

Liabilities to pay compensation to third parties due to the occurrence of an event such as

accident are covered by general insurance. Other losses covered under general insurance

include loss of income, losses due to business interruptions and personal losses such as

death, sickness or accident.

Fire insurance: Fire insurance is a contract to indemnify the insured against the loss due

co destruction of property caused by fire. Only the actual loss incurred by the insured

person will be considered even if the property has been insured for a higher value. Loss of

profits insurance falls under the special type of fire insurance policies. Under this type,

32

the insured is indemnified for the loss of profits that he faces due to interruption or

cessation of business as a result of fire.

Marine insurance: A contract of marine insurance is one in which the insurer undertakes

to indemnify the insured against marine losses, that is, losses incidental to marine adven-

ture. Marine insurance policies may cover different insurable interests such as hull

insurance, freight insurance, loss of hire insurance and loss of profit insurance. Marine

insurance offers protection against perils of the seas such as pirates, war perils, jettison,

etc

Motor insurance: Motor vehicle insurance is one of the largest segments of the general

insurance business. The insurance policy covers only a limited liability to third parties

and own damage or damages to the vehicle. Personal accidents cover for owner - driver is

another aspect covered by the policy. A comprehensive motor vehicle insurance policy,

on the other hand, contains an increased cover for the third party liability for bodily injury

and/or death, damage to the property of third parties and loss or damage to the vehicle

insured.

Other insurances: Social security insurance in the form of pension plans, disability

benefits, etc. to the weaker sections of the society, crop insurance, flood insurance,

earthquake insurance, cattle insurance and personal accident insurance are some of the

general insurance products available in the industry.

33

Unit 4: Financial Services – III:


1. Who controls the activities of NBFCs?

Reserve Bank of India

2. State the other name of „miscellaneous non-banking company.

Chit Fund Company

3. Name some of the leading hire-purchase finance providers in India.

Sundaram Finance Limited and Shriram Transport Finance Limited

4. What should be the minimum NOF to continue as an NBFC for companies?

The companies should have a minimum NOF (Net Owned Fund) of Rs. 25 lakhs

5. Who regulates „chit funds‟?

RBI and the registrar of chits

6. Who regulates housing finance companies?

NHB (National Housing Bank)

7. Who regulates stock broking and merchant banking companies?

SEBI (Securities and Exchange Board of India and Insurance Companies)

8. Who prescribes the ceiling rate for NBFCS?

Reserve Bank of India

9. What is a stock broker?

Means a member of a recognized stock exchange

10. Which services is required to handle huge volumes of securities?

Custodial services

11. Write down the reclassification of NBFCs.

a. Asset Finance Company (AFC) b. Investment Company (IC)

b. Loan Company (LC)

34

12. State the brokerage charges received by brokers.

a. Brokerage charges charged by member broker

b. Penalties arising on specific default on behalf of client (investor)

c. Service tax as stipulated

d. STT as applicable


1. State the types of activities carried by NBFCs.

The activities range from extending loans to discounting bills, providing hire-purchase

finance, leasing and investment in securities, chit finance and microfinance.

2. What is custodian?

A custodian is a corporate body who serves as an intermediary between the company and

the real owners of the financial claims viz., individual holders of securities, mutual funds,

FIIs, etc.

3. Which types of services are included in custodial services?

Safeguarding of financial claims, clearing and settlement of trades, and collecting

principal and interest or dividend income or the investments hold.

4. Which code of conduct for stock brokers contains in schedule II of SEBI

regulations?

Maintain high standards of integrity, promptitude and fairness in the conduct of his

business.

5. Who is „share transfer agent‟?

Any person, who on behalf of anybody corporate maintains the record of holders of

securities issued by such body corporate and deals with all matters connected with the

transfer and redemption of its securities.

6. Define „Registrars.

35

Registrars serve as an intermediary and play a vibrant role in the capital market, and

discharge a host of services ranging from drafting an application form to allotment of

shares to the shareholders.

7. What is the role of transfer agent of shares?

Transfer agents handle all investor related services like maintaining the records of the

shareholders on behalf of the company and are authorized agents for dealing all matters

related to transfer of shares as well as redemption of securities.

8. What does tier-2 layers consists in computing the capital adequacy requirement of

prudential regulation.

It consists of preference shares revaluation reserves, general provision and loss reserves

and other subordinated debt items.

9. What is hire- purchase finance?

It is a significant method of financing in the Indian financial system. It is popular in truck

financing sector. The HP finance industry has a long history in India.

10. Explain of loan granting activity of NBFCs.

The RBI classification has 'loan companies' as one of the categories. Inter-corporate

loans are common among the companies. Broadly grouped as 'loans and advances' this

category specialises in loans. It, however, excludes housing finance activities of HFCs

and lease finance activities of leasing companies.

11. State the condition for grant of certificate to a sub broker.

1. He has to pay the prescribed fee

2. He takes adequate steps for redressal of investor grievances within one month of the

receipt of the complaint and keeps SEBI informed about the number, nature and other

particulars of the complaints.

3. He is authorised in writing by a broker for affiliation in buying, selling or dealing in

securities.

36


1. Explain the salient features of NBFCs.

1. Registration: It is mandatory that every NBFC should be registrered under the RBI Act

to commence or carry on its business. This applies to both deposit-taking as well as

non-deposit-taking NBFCs. Exemptions are given to venture capital firms, merchant

banking firms, stock broking firms from registration because those firms are regulated

under the SEBI Act. Insurance companies, Nidhi companies and chit fund companies

and housing finance companies are also exempt from registration with the RBI.

2. Acceptance of deposits: Public deposits are one of the sources of funding for the

NBFCs. However, all NBFCs are not entitled to invite deposits from the public. Only

those NBFCs who have obtained the authorisation from the RBI can accept public

deposits. This is subject to the company fulfilling the stipulated Net Owned Fund

(NOF) requirements and complying with the norms for investments in liquid assets

and necessary reserve requirements.

3. Regulation by the RBI: NBFCs are well regulated now by the RBI. The regulations

govern the deposit acceptance, maintenance of liquid assets and creation of reserve

fund. Prudential norms pertaining to CRAR, asset classification, non-performing

assets, etc. have been implemented by the RBI to strengthen the sector. The exact

quantitative restrictions and limits with regard to these norms are discussed in another

section of this chapter.

4. Supervision by the RBIs: The RBI has an effective supervisory mechanism for

NBFCs. The objective of such supervision is to ensure that NBFCs function on healthy

lines and avoid excessive risk taking. The RBI follows a four pronged supervisory

framework: on-site inspection, off-site monitoring, market intelligence and exception

reports of statutory auditors. The selection of supervisory mechanism depends on the

asset size and whether the NBFC is a deposit-taking firm or otherwise. The system of

on-site examination is structured on the basis of Capital, Assets, Management,

Earnings, Liquidity and Systems and Procedures (CAMELS)

2. Discuss any five types of NBFCs activities.

1. Equipment leasing: leasing finance is a dominant line of business for NBFCs. leasing

finance is provided for use of fixed assets by business firms. In India, financial lease

37

is a predominant activity of the leasing companies. First Leasing Company of India

Limited is an example of a leasing finance company.

2. Hire-purchase finance: It is a significant method of financing in the Indian financial

system. It is popular in truck financing sector. The HP finance industry has a long

history in India. Backed by the Indian Hire Purchase Act, the industry is well

regulated. Sundaram Finance Limited and Shriram Transport Finance Limited are

some of the leading HP finance providers in the country.

3. Investment activities: NBFCs invest the deposits in approved securities as a

mandatory requirement. Besides this, the main line of business for many firms might

be investment in money market instruments. For example, a Primary Dealer is an

example of an IC Primary Dealers purchase government securities as an investor and

also serve as market makers in government securities. IDBI Gilts Limited is an

example of Primary Dealers in India.

4. Loans: Granting loans is another activity of NBFCs. The RBI classification has 'loan

companies' as one of the categories. Inter-corporate loans are common among the

companies. Broadly grouped as 'loans and advances' this category specialises in loans.

It, however, excludes housing finance activities of HFCs and lease finance activities

of leasing companies.

5. Housing loans: HFCs extend housing loans for construction, purchase and renovation

of houses. These loans are long term in nature and are based on mortgage of the

property in favour of the HFC Besides loans to individual borrowers, HFCs fund

bigger projects in urban infrastructure development. HDFC Limited is an example of

a housing finance company.

6. Mutual benefit funds: Mutual benefit funds or Nidhis are primarily in the business of

deposit acceptance and loan granting exclusively to members of the society or Nidhi.

Registered under the Companies Act, these institutions serve the public in a particular

location. It was more regional in nature. Chennai was one place where there was a

concentration of Nidhis. Bur in the recent years, these institutions have run into rough

weather and many Nidhis have ceased to do their business.

7. Residuary Non-banking Companies (RNBCs): At present, there are only two RNBCs

in India but their deposits are almost 99% of the total deposits of the NBFCs. The

RNBCs collect deposits through various schemes and they usually invest in

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government securities. Peerless General Finance is one of the two RNBCs in India.

The RBI has directed these companies to revise their existing business model.

3. What is stock broking? Discuss the guidelines by SEBI.

Stock broking in India is now a mature service sector with all the checks and balances put

in place by the market regulator - SEBl. Earlier this service was confined to metros and to

the elite who are in the trade. But now the service is available at all locations even in

remote towns because of the use of technology and the increased interest in stock market

activities. In the traditional setup, the whims and fancies of the stock broker played havoc

on the interests of investors. But now, the current regulatory system has removed all the

inefficient elements in the trade by putting in place appropriate regulations and evolving a

code of conduct for the market participants. Stock broking is now a well-regulated

professional service in India. Given the present situation of increased market volatility, the

stock brokers face challenging tasks in their business.

The SEBI registration of stock brokers is conditional in nature. According to the

regulations, SEBI may grant a certificate of registration subject to the fulfilment of certain

conditions which are as follows:

(a) He holds the membership of any stock exchange.

(b) He shall abide by the rules, regulations and bye-laws of the stock exchange or stock

exchanges of which he is a member.

(c) In case of any change in the status and constitution, he shall obtain prior permission of

SEBI to continue to buy, sell or deal in securities in any stock exchange.

(d) He shall pay the amount of fees for registration in the prescribed manner.

(e) He shall take adequate steps for redressal of grievances of the investors within one

month of the date of the receipt of the complaint and keep SEBI informed about the

number, nature and other particulars of the complaints.

Sub-brokers are also required to be registered with SEBI for engaging in stock broking

activities. The grant of certificate is subject to the conditions that:

1. He has to pay the prescribed fee

2. He is authorized in writing by a broker for affiliation in buying, selling or dealing in

securities.

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3. He takes adequate steps for redressal of investor grievances within one month of the

receipt of the complaint and keeps SEBI informed about the number, nature and other

particulars of the complaints.

4. Discuss the code of conduct for stock brokers.

1. General: The SEBI regulations provide for a code of conduct for stock brokers and

sub brokers. Schedule II of SEBI regulations contains a detailed code of conduct for

the stock brokers. The stock brokers should maintain high standards of integrity,

promptitude and fairness in the conduct of his business. They have to exercise skill,

care and due diligence in the conduct of business. Excessive speculation by brokers is

discouraged. Besides this, a stock broker is expected to comply with the provisions of

the SEBI Act, rules and regulations and orders issued by SEBI.

2. Duties to investor: Section B of the Code of Conduct in Schedule II deal with the

duties of the broker to the investors. A stock broker has the duty to rake up the order

of the customer and execute it. He has to deliver the payment for sale of securities or

deliver the securities to the investor in case of buying of securities. The information

about execution or non-execution should be given to the investor promptly. Stock

brokers should maintain the confidentiality of the information pertaining to the

investment transactions of the clients

3. Stock broker vis-a-vis other stock brokers: A stock broker carries out transaction

on behalf of his clients. In the process, he has to deal with other stock brokers who are

at the other end of the transaction. He has to comply with his obligations in

completing the settlement of transactions with them. A stock broker should cooperate

with other stock brokers in protecting the interests of investors with regard to their

right to dividends, bonus shares, rights shares, etc.

5. Discuss the fair practices code given by RBI in case of NBFCs as a guideline for

corporate governance.

Corporate governance issues have been given due attention in the case of NBFCs. In this

connection, the RBI in September 2006 has advised that the NBFCs and RNBCs to adopt

a fair practices with the approval of the Board of the respective companies. The

guidelines in this regard contain the following features:

1. Application form: The loan application forms should include necessary information

which affects the interests of the borrower so that a meaningful comparison can be

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made with terms and conditions offered by other NBFCs before he arrives at a

decision.

2. Acknowledgement: NBFCs should devise a system of acknowledging the receipt of I,

applications and indicate the time frame within which the processing of applications

will done.

3. Sanction letter: NBFCs should convey in writing to the borrower through a sanction

lei indicating the amount sanctioned, the terms of borrowing, interest rates, etc. The

company should get a letter of acceptance of the terms from the borrower and keep

them on record.

4. Notify changes: The NBFC should give notice to the borrower of any changes in the

terms and conditions of loans including the disbursement schedule, interest rates,

service charges, prepayment charges, etc.

5. Comply with loan agreement: Any move to recall or accelerate payment or

performance under the agreement should be in consonance with the loan agreement.

6. Release of securities: NBFCs should release all securities to the borrower on

repayment all dues on the loan. They can do so subject to any legitimate right or lien

for any other claim against the borrower.

7. Non-interference: The NBFCs should refrain from interference in the affairs of the

borrower except for the purposes provided in the terms and conditions of the

agreement.

8. Transfer of account: In case the borrower requests for transfer of his account, the NB

should convey its consent or objection to such request within 21 days.

6. What comprise the obligations and responsibilities of custodial services?

1. A registrar to issue and share transfer agent shall maintain high standards of integrity

and fairness in all their dealings with their clients and other registrars to issue and share

transfer agents in the conduct of their business.

2. A registrar to issue and share transfer agent shall act with due skill, diligence and care

in the conduct of all their activities.

3. A registrar to issue and share transfer agent shall not indulge in unfair competition,

which is likely to be harmful to the interest of other registrars to issue and share

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transfer agents or is likely to place such other registrars to issue and share transfer

agents in a disadvantageous position in relation to the registrar to issue and share

transfer agent, while completing for or executing any assignment.

4. A registrar to issue and share transfer agent shall not make any exaggerated statement,

whether oral or written to the clients either about their qualifications or capability to

render certain services or their achievements in regard to services rendered to other

clients.

5. A registrar to issue and share transfer agent shall not divulge to other clients, press or

any other party any confidential information about their clients, which have come to

their knowledge.

6. A registrar to issue and share transfer agent shall endeavour to ensure that:

Inquiries from investors are adequately dealt with.

Adequate steps are taken for proper allotment of securities and refund of

application monies without delay as per the law.

7. A registrar to issue ad share transfer agent shall not generally and particularly in

respect of any dealings in securities be party to:

a. Creation of false market.

b. Price rigging of false market

c. Passing of unpublished price sensitive information to brokers, members of the

stock exchanges and other intermediaries in the securities market to take any other

action which is not in the interest of the investors.

d. No registrar to issue and share transfer agent or any of its directors, partners or

manager having the management of the whole or substantially the whole of affairs

of their business shall either or their respective accounts or through their associates

or family members, relatives or friends indulge in any insider trading.

8. A registrar to issue and share transfer or any of his employees shall not render, directly

or indirectly, any investment advice about any security in the publicly accessible

media, whether real-time or non-real time unless a disclosure of his interest including

long or short position in the said security has been made, while rendering such advice.

Question Bank 030030610: Management of Financial Services...

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