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FINANCIAL SERIVICES
UNIT-I
Introduction to Indian Financial System-Financial Markets and Types-Financial
Institutions in India-Reserve Bank of India-Commercial Banks-State Bank of India-
Development Financial Institutions NABARD, SIDBI, EXIMBank and IFCI.
UNIT-II
Asset/Fund Based Financial Services-Leasing-Types and its Evaluation. Hire
purchase Finance and Consumer Credit-Factoring and Forfaiting.
UNIT-III
Other Services-Bills Discounting-Housing Finance-National Housing Bank-
Other housing financing Institutions-Insurance Services-Insurance Regulatory and
Development Authority (IRDA)- Venture Capital Financing.
UNIT-IV
Merchant Banking Services-Issue Management-Pre Issue and Post Issue
Management.
UNIT-V
Merger/Amalgamation-Stock Broking-Types, Credit Rating Agencies.Process
and Methodology.
UNIT –I
I. INTRODUCTIONThe growth of output in any economy depends on the increase in the proportion
of savings/ investment to a nation’s output of goods and services. The financial
system and financial institutions help in the diversion of rising current income into
savings/investments.
A financial system may be defined as a set of institutions, instruments and
markets which foster savings and channels them to their most efficient use. The
system consists of individuals (savers), intermediaries, markets and users of savings.
Economic activity and growth are greatly facilitated by the existence of a financial
system developed in terms of the efficiency of the market in mobilizing savings and
allocating them among competing users.
Well developed financial markets are required for creating a balanced financial
system in which both financial markets and financial institutions play important roles.
Deep and liquid markets provide liquidity to meet any surge in demand for liquidity in
times of financial crisis. Such markets are also necessary to derive appropriate
reference rates for pricing financial assets.
II. FINANCIAL MARKET
Marketing require institutions that impartially enforce contract and property
rights. The state must create the right kind of institutional environment and must be
strong enough to enforce institutional rights. Economic growth depends on the
existence of a well-functioning financial market. Market efficiency would be reflected
in wide dissemination of information, reduction of transaction costs and allocation of
capital to the most productive uses.
II.a)FUNCTIONS OF FINANCIAL MARKET:
The primary function of the financial markets is to facilitate the transfer of
funds from surplus sectors (lenders) to deficit sectors (borrowers). Normally,
households have excess of funds or savings which hey lend to borrowers in the
corporate and public sectors whose requirements of funds exceed their savings. A
financial market consists of investors or buyers, sellers, dealers and brokers and does
not refer to a physical location. The participants in the market are linked by formal
trading rules and communication networks for originating and trading financial
securities.
Financial markets trade in money and their price is the rate of return the buyer
expects the financial asset to yield. The value of financial assets change with the
investors’ expectations on earning or interest rates. Investors seek the highest return
for a given level of risk (by paying the lowest price) and users of funds attempt to
borrow at the lowest rate possible.
To sum up, the three important functions of financial markets are:
Price discovery process which results from the interaction of buyers and sellers
in the market when they trade assets
Provision of liquidity by providing a mechanism for an investor to sell financial
assets and
Low cost of transactions and information.
The financial markets also promote financial product innovation. Our primary
markets have seen a big explosion of financial product innovation. First, we have
convertible debentures which attracted large subscriptions. Later, especially in the last
five years, our merchant bankers and financial institutions have introduced
Participating debentures
Convertible debentures with options
Partly convertible debentures
Convertible debentures redeemable at a premium
Debt equity swaps
Zero coupon convertible notes
Secured premium notes with detachable warrants
Zero interest fully convertible debentures
Zero interest partly convertible debentures with detachable warrants and
Floating rate bonds and warrants
All-India Financial Institutions have issued zero coupon bonds, easy exit
regular income and retirement bonds, step-up liquid bonds, growth
bonds, lakhpati bonds, encash bonds, index bonds, deep discount bonds
and capital gain bonds.
The financial markets abroad have seen a wide variety of asset-backed
securities, junk bonds and indexed bonds.
II.b)TYPES OF MARKETS:
Money Market
The financial system consists of the money market and capital market as found
elsewhere in the world. The money or credit market is the centre for dealings in
monetary assets of short-term nature generally below one year. The money market has
organized players are the Reserve Bank of India, Life Insurance Corporation, General
Insurance Corporation, Unit Trust of India, Securities Trading Corporation of India
Ltd and Discount and Finance House of India.
The role of the unorganized sector in providing finance for trade has
considerably diminished with the geographical coverage of the organized banking
sector and increase in the flow of bank finance to small borrowers.
Self-help Groups
In this connection, the novel scheme of self-help groups (SHGs) of the National
Bank for Agriculture and Rural Development (NABARD) may be noted, which is
likely to reduce the dependence on money lenders in the unorganized sector,
especially in the rural areas. NABARD found that lending to the poor through SHGs
is a viable proposition. SHGs are voluntary associations of people formed to attain
some common goal. The groups have a similar identity, heritage, caste or traditional
occupations and come together for a common cause and manage resources for the
benefit of the group members. These groups generally deal with thrift and credit as an
important component of their activities.
Capital Market:
The capital market consists of primary and secondary markets. The primary
market deals with the issue of new instruments by the corporate sector such as equity
shares, preference shares and debentures. The public sector consisting of Central and
State governments, various public sector industrial units (PSU), statutory and other
authorities such as state electricity boards and port trusts also issue bonds and shares
especially as a part of disinvestment of government holdings.
Foreign exchange market
In view of the contemplated convertibility of the rupee, the foreign exchange
market would be intimately linked to the interbank or call money market since the
players in the two markets are the same, commercial banks. Further the link between
foreign exchange markets is being fostered by permitting banks to borrow and deposit
funds abroad. The exchange rate instead of being determined by supply and demand
would be governed in future by interest differentials.
Foreign exchange markets provide the mechanism for exchanging different
monetary units for each other. If the currency is widely accepted as in the case of US
$ it can pay in its own currency. Actually, dollars remain in circulation among
international traders.
III. COMMERCIAL BANKS
III.a)CHARACTERISTICS OF BANKS:
Among the financial institutions the role of commercial banks is unique.
Firstly, bank demand deposit liabilities that constitute a large proportion.
Secondly, commercial banks are the primary vehicle through which credit and
monetary policies are transmitted to the economy. Credit and monetary policies are
implemented through action on bank reserves, margin requirements and the rate at
which scheduled banks can borrow from the RBI. These affect the supply, availability
and cost of credit at banks.
Thirdly, the nature of lending and investing by commercial banks is multi-
functional. They deal in a wide variety of assets and accommodate different types of
borrowers. They facilitate the spread of the impact of monetary policy to non-bank
lenders and to other sections of the economy. Further, the operations of commercial
banks are highly flexible since they provide facilities for financing different types of
borrowers which enables them to channel funds according to specified priorities and
purposes.
III.b)DEFINITION OF BANKING
The Banking Regulation Act, 1949, defines banking as accepting for the
purpose of lending or investment, of deposits of money from the public, repayable on
demand or otherwise and with-drawable on demand by cheque, draft or-order
otherwise.
III.c)FUNCTIONS OF COMMERCIAL BANK
The functions of a commercial bank are:
1. To change cash for bank deposits and bank deposits for cash.
2. To transfer bank deposits between individuals and/or companies.
3. To exchange deposits for bills of exchange, government bonds, the secured
and unsecured promises of trade and industrial units.
4. To underwrite capital issues. They are also allowed to invest 5% of three
incremental deposit liabilities in shares and debentures in the primary and
secondary markets.
5. They also offer their constituents services to pay insurances, advise on tax
problems and undertake executive and trustee services.
III.d) Payment Systems
1. Commercial banks are institutions which combine various types of
transactions services with financial intermediation. Bank provides three
types of transactions to convert deposits into notes and coins to enable
holders of deposits to undertake transactions in cash.
2. Secondly, bank deposits are used as a means of settling debts.
3. Thirdly, where exchange control do not exist, banks exchange cash and
deposits from one currency
Commercial banks earlier had a monopoly on transaction services. Other
financial intermediaries such as savings and loans, saving banks and credit unions in
the United States have been authorized to offer transaction accounts. Money market
mutual funds, another type of financial service organizations have developed financial
product against which checks may be written.
Commercial banks are at the very centre of the payment systems. Bank money
constitutes 38 per cent of the money supply of the Indian economy. An efficient
payment system is vital to a stable and growing economy and the banks role is
important. In advanced economics commercial banks are also at the heart of the
electronic payment system which is replacing paper based payment methods.
Finally, Swift (the Society for Worldwide Interbank Financial
Telecommunication) based in Brussels is operated by 2000 banks, brokerage firms
and non-banking financial institutions worldwide.
Intermediation
Commercial banks undertake the important process of financial intermediation
whereby the funds or savings of the surplus sectors are channeled to deficit sectors.
Commercial banks along with other financial institutions channel the funds of surplus
economic units to those wanting to spend on real capital investments.
Financial intermediaries including banks buy and sell the right to future
payments. Banks collect deposits from savers by offering interest.
Through their intermediary activities banks provide a package of information
and risk sharing services to their customers. While doing so they take on part of their
risk. Banks have to manage the risks through appropriate structuring of their activities
and hedge risks through derivative contracts to maximize their profitability.
Transformation Services
Banks combine various types of transformation services with financial
intermediation. They provide three transformation services when they undertake
intermediation process. Firstly, liability, asset and size transformation consisting of
mobilization funds and their allocation (provision of large loans on the basis of
numerous small deposits). Secondly, maturity transformation by offering the savers,
the relatively short-term claim on liquid derposits they prefer and providing borrowers
long-term loans which are better matched to the cash flows generated by their
investment. Finally, risk transformation by transforming and reducing the risk
involved in direct lending by acquiring more diversified portfolios than individual
savers can.
Transformation Services and Risks:
Banks incur while undertaking transformation services. In the past three
decades banks abroad assumed new roles and accepted new forms of financial
intermediation by undertaking currency and interest rate swaps and of dealing in
financial futures, options and forward agreements. These new instruments reflect
considerable flexibility in responding to market situations and adjusting continually
assets and liabilities both on and off balance sheet, while enhancing profitability.
III.e) Analysis of Assets and Liabilities of scheduled Commercial Banks:
Number:
As at the end of March 2000 there was 101 scheduled commercial banks
(SCBs) comprising 27 public sector banks (PSBs), 32 private sector banks and 42
foreign banks. The public sector banks (PSBs) dominate the banking system with
more than 80% share in the total assets of SCBs.
Size:
Assets of Rs.11,10,368 crores consist of cash in hand and balances with RBI of
Rs. 85,371 crores(7.69% of total assets), assets with banking system of Rs. 81,019
crores(7.30%) investments of Rs.4,13,871 crores(37.27%) bank credit of Rs.4,43,469
crores(39.94%).
Liabilities of all scheduled commercial banks, Rs.11,10,368 crores consist of
capital of Rs.18,447 crores(1.66%) reserves and surplus of Rs.43,834 crores(3.95%)
and deposits from public of Rs. 9,00,307 crores(81.1%).
Liabilities
Paid-up Capital and Reserves
Paid-up capital of Rs.18, 447 crores and reserves of Rs.43, 834 crores in 1999-
2000 together constituted 5.61% of liabilities of scheduled commercial banks.
IV.RESERVE BANK OF INDIA
a)Introduction:
The Reserve Bank of India was established on April 1, 1935, under the Reserve
Bank of India Act, 1934. The Bank’s share capital was Rs.5 crores. In the terms o the
Reserve bank (Transfer to Public Ownership) Act, 1948, the entire share capital was
deemed to be transferred to the Central Government. The Reserve Bank entered upon
its career as a state-owned institution from January 1, 1949. The Act of 1948
empowered the Central Government to issue such directions to the Bank as it might,
after consultation with the Governor of the Bank, consider necessary in the public
interest.
b)Functions of the Bank:
The main functions of the Bank are to act as the note-issuing authority,
Banker’s Bank, Banker to the government and to promote the growth of the economy
within the framework of the general economic policy of the government, consistent
with the need to maintain price stability. The Bank also performs a wide range of
promotional functions to support the pace of economic development. The Reserve
Bank is the controller of foreign exchange. It is the watchdog of the entire financial
system. The Bank is the sponsor bank of a wide variety of top-ranking banks and
institutions such as SBI, IDBI, NABARD and NHB. The Bank sits on the board of all
banks and it counsels the Central and State governments and public sector institutions
on monetary and money matters. No central bank, even in the developed world, is
saddled with such onerous responsibilities and functions.
c)Issue of Currency:
The Reserve Bank is the sole authority for the issue of currency in India. Rupee
coins/notes and subsidiary coins are issued by the government of India but they are
put into circulation only through the Reserve Bank. Currency notes are legal tender in
payment or on account, without limit. One rupee notes and coins are legal tender for
unlimited amounts, fifty paise coins for a sum not exceeding ten rupees and smaller
coins for any sum not exceeding one rupee.
The Act permits the issue of notes in the denominations of rupees two, ten,
twenty, fifty, hundred, five hundred, one thousand, five thousand and ten thousand. At
present denominations up to Rs.1000 are being used. The affairs of the bank relating
to note issue and its general banking business are conducted through two separate
departments, the Issue and Banking Department.
The Issue Department deals directly with the public in exchange of currency for
coins and vice versa and exchange of notes of one denomination for another. The
assets which form the backing for the note issue are kept wholly distinct from those of
the Banking Department.
The expansion and contraction of currency in circulation is effected through the
Banking Department. Cash deposits and withdrawals by scheduled banks are handled
by the Banking Department.
d)Public Debt:
Public debt management policy determines the composition of debt while the
size of the debt is determined by budgetary requirement. The introduction of the
auction system for treasury bills and securities has let the interest rate to be market-
determined. The Reserve Bank manages the public debt and issues new loans on
behalf of the Central Government and state governments.
SECONDARY DEBT MARKET
Debt management policy can be effective if there is a secondary market with
depth. The move to market –related rates of interest is likely to strengthen the
development of the secondary market.
The system of primary dealers would enable the development of an orderly
market. They are not final investors but should have the financial capacity and skills
to bid in the primary auctions and hold the securities till they are able to access them
in the secondary market. Primary dealers are approved by the RBI and help in the
placement of government securities in primary issues by committed participation in
auctions.
e) RESERVE REQUIREMENTS
Cash Reserve Ratio
The variation of reserve requirement changes the amount of cash reserves of
banks and affects their credit-creating capacity. The requirements may e stipulated as
a proportion of aggregate outstanding deposits or on the increment after a base date.
Reserve Bank regulates the liquidity of the banking system through two
complementary methods: cash reserve ratio(CRR) involving deposit of cash by the
bank with the Reserve Bank of a proportion of deposits; and statutory liquidity ratio
involving the maintenance by the bank, of a proportion of its deposit liabilities in the
form of specified liquid assets. The cash reserve ratio could be varied between 3 per
cent and 15 per cent of their total demand and time liabilities.
V.NATIONAL BANK FOR AGRICULTURE AND RURAL DEVELOPMENT (NABARD)a)Introduction
NABARD is apex rural credit institution which plays an active role in
implementation of various Rural Development Programmes. The NABARD came
into existence in July 1982. It took over the function of providing rural credit from the
Reserve Bank of India and also the refinancing and development function of
Agricultural Refinance and Development Corporation (ARDC). NABARD provides
refinance for promoting agricultural activities as well as non-farm sectors particularly
programme covered under poverty alleviation.
NABARD plays the key role of a leader in rural credit management. NABARD
has to ensure that there is adequate flow of credit for seasonal agricultural operation to
maintain agriculture production. Similarly, NABARD has to accelerate the flow of
credit for long term investment in agricultural sector. NABARD provides support
through formulation of some innovative non-farm schemes, which are very helpful in
raising the income level of rural people and bring them above the poverty line.
NABARD has two funds to finance agricultural operations. They are,
a) National Rural Credit(Long-term Operation) Fundb) National Rural Credit(Stabilisation) Fund
The contributions to these funds are received mostly from the Reserve Bank of
India. Apart from these funds, NABARD has general lines of credit from the Reserve
Bank of India for meeting the credit requirements of seasonal and other than
agricultural operations. Some important promotional activities supported by
NABARD are discussed below:
b) Nabard strategies
For enlarging the scope for catalyzing credit follow, NABARD has formulated
the following strategies:
a) Involving state level functional and financial-cum-developmental
corporations, voluntary agencies, Khadi and village commission under
automatic refinance facility as also under group/bulk lendings.
b) Supporting units jointly with Small Industries Development Bank of
India and formulating credit linked area development plans.
c) Increasing the limits under composite and integrated loans
d) Removal of certain constraints under agro-industries and service sector
units.
Remember, like a commercial bank, NABARD does not extend direct credit
facilities to production units/individual borrowers. A major portion of the money
(usually between 70 and 90 percent) lent by commercial, co-operative and regional
rural banks for agricultural and other approved activities will be refinanced by
NABARD at certain interest rate. It also extends refinance facilities to Land
Development Banks. The total quantum of agricultural credit provided by commercial
banks, co-operative banks and regional rural banks with or without assistance from
NABARD amounted to Rs. 31,698 crore during 1997-98. This credit is expected to
increase further to Rs. 38,054 crore in 1998-99 as per NABARD Annual Report for
1998-99.
c)PROMOTIONAL ROLES BY NABARD
Besides the above, NABARD plays the following promotional roles for the
development of Indian Rural Economy:
1. Training and skill up gradation through Training-cum-Production
Centres, rural entrepreneurship development, training by and of master
craftsmen, market oriented training for rural artisans and training for
rural artisans and training the beneficiaries of development credit
2. Development and dissemination of technology, employment oriented
production technology, area planning for rural industrialization.
The Reserve Bank of India set up the Committee to Review Arrangements for
Institutional Credit for Agriculture and Rural Development (CRAFICARD) in March
1979. This Committee submitted its final report in March 1981 making far reaching
recommendations. The main recommendation being the setting up of a new apex bank
called the NATIONAL BANK FOR AGRICULTURE AND RURAL DEVELOPMENT
(NABARD)as an ‘organizational device for providing undivided attention, forceful
direction and pointed focus’ to the credit problems arising out of integrated approach
to rural development. The Committee has recommended that this new apex bank
should take over from the Reserve Bank the overseeing of the entire rural credit
system.
Accordingly, the Government of India set up the National Bank for Agriculture
and Rural Development on 12 July, 1982 with an authorized share capital of Rs.500
crores and paid-up capital of Rs.100 crores to be contributed equally by the Reserve
Bank of India and the Government of India. In 1996, the capital was increased from
Rs.500 crores to Rs. 2000 crores to give a thrust to the flow of credit to the
agricultural sector.
The Bank has been assigned the task of serving as a refinance institution for
short term credit to agriculture, rural small scale industries. Cottage and village
industries, handicrafts and rural crafts and other allied economic activities integrating
rural development. It will also provide refinance to various banks for their term
lending operations in agriculture.
Further, the CRAFICARD has recommended the reorganization of the co-
operative credit structure. It has advocated a speedy reorganization of primary
agricultural credit societies into multipurpose service institutions. They should
provide all types of credit including long term credit for agriculture covering all types
of population in the rural areas within a period of three years.
The Committee has further recommended that preference should be given to
Regional Rural Banks with regard to licensing of branches in rural areas and the
Commercial banks should be encouraged to transfer the eligible business of their rural
branches to RRBs.
d)Functions of National Bank for Agriculture and Rural Development
(NABARD)
With the establishment of National Bank for Agriculture and Rural
Development (NABARD) in July 1982 on the basis of the recommendations of
CRAFICARD, all the functions of the Reserve Bank of India relating to Rural Credit
have been handed over to this apex bank NABARD. The assets and Liabilities of the
RBI relating to rural credit were also transferred to this Bank. The two Funds, namely,
The National Agricultural Credit(Stabilization) Fund, and National Agricultural
Credit( Long-term Operations) Fund held by the Reserve Bank of India was renamed
as National Rural Credit(Stabilization) Fund and National Rural Credit(Long-term
Operations) Fund and handed over to NABARD. The Agriculture Refinance
Development Corporation (ARDC) was merged with NABARD.
The NABARD being the apex bank for rural credit, sanctions credit limits and
refinances co-operative Banks, State Land Development Banks and the Regional
Rural Banks for supplementing their resources for short-term and medium term loans
of various agricultural and non agricultural purposes, including the investment credit
provided by them under various schemes. In the case of commercial banks, NABARD
provides refinance against the term loans issued by them under schematic lending for
agricultural and certain non-agricultural purposes, as the commercial banks are
expected to meet the short-term requirements out of their own resources.
The NABARD can provide refinance facilities to any financial institution
approved by the Reserve Bank of India and the refinancing assistance is given for the
following activities:
a) Any agricultural operation or marketing of crops;
b) Distribution and marketing of agricultural inputs for the purpose of rural
development;
c) Bonafide commercial transactions or trade transactions;
d) Production and marketing activities of village artisans, small-scale
industries etc.
Besides short-term and medium-term loans, NABARD can provide ling-term loans by
way of refinancing through financial institutions like Land Development Banks,
Regional Rural Banks, Scheduled Banks, and State Co-operative Banks.
Besides NABARD is also authorized to advance loans to State Governments
for periods not exceeding 20 years to enable them to subscribe directly or indirectly,
the share capital of co-operative societies. It can also contribute or invest in the
securities of any institutions connected with agricultural or rural development.
During drought and famine conditions, the NABARD can convert short-term
loans into medium-term loans granted to State Co-operative Banks and Regional
Rural Banks.
e)Performance of NABARD
As studied already, with the establishment of NABARD, all assets and
liabilities relating to Rural Credit of the Reserve Bank of India were transferred and
taken over by NABARD. On the date of establishment of NABARD, loans and
advances issued by the Reserve Bank and outstanding against State Cooperative
Banks and RRBs aggregating to Rs.759 crores were transferred to NABARD. As
indicated already, this apex institution NABARD does not deal directly with the
farmers and other rural people; but grants assistance to them through the cooperative
banks, commercial banks, RRBs etc.
In the year 2003 - 2004, towards short-term assistance to institutions operating
in the field of rural credit, NABARD sanctioned Rs.6,948 crores for financing
seasonal agricultural operations and also a sum of Rs.927 crores for purposes other
than seasonal agricultural operations. During the years 2006 - 2007 and 2007 - 2008
the amount sanctioned was Rs.12,708 crores and 12,989 crores respectively.
Further, it sanctioned medium term credit limits amounting to Rs. 8 crores in
the calendar year 2006 for approved agricultural purposes. A sum of Rs.59 crores was
sanctioned in 2006 - 2007, in order to enable State Cooperative Banks and District
Cooperative Central Banks to convert short-term agricultural loans into medium-term
loans when the farmers were affected by droughts, floods and other natural calamities.
In the year 2006 - 2007 it sanctioned Rs. 59 crores.
Regarding long-term loans, by way of refinance, under various schemes,
NABARD sanctioned Rs. 3232 crores in the year 2006 - 2007, covering nearly 12,814
schemes.
NABARD has also provided financial assistance to non-farm sector as well,
with a view to promoting integrated rural development and also securing prosperity
for the rural areas. Financial assistance has been provided to small-scale and cottage
industries, industrial cooperative societies for meeting their working capital and block
capital requirements.
NABARD has also initiated a rehabilitation programme in respect of State
Cooperative Banks and District Cooperative Central Banks in the country which are
financially weak, such as high level of overdue, inadequate internal resources,
inefficient management and untrained staff.
Finally, this institution has set up a Research and Development Fund for granting
assistance to Land Development Banks, State Cooperative Banks and Regional Rural
Banks.
The three main functions of NABARD are refinancing, institutional
development and inspection of client banks. Of these, the first function, viz,
refinancing has attracted larger attention of this apex institution.
f)PARTICIPATION IN THRUST AREAS
NABARD
participation
SGSY scheme
Women children development
Training centres
SHG
Monitoring and evaluation research
activities
HRD
Inspection for co – operative BK &
RRB
External aid project
VVVP
1. Integrated Rural Development Programme
IRDP is a scheme devised by Government of India for generating self-
employment opportunities in the rural sector and for the economic
development of rural areas. Banks are advised to extend cheap credit
facilities to the people/group selected under this programme. NABARD
then provide refinance to banks.
Swaranjayanthi Gram Swarozgar Yojana(SGSY) Scheme:
In the past years there were many self employment schemes were in
operation for the upliftment of rural poor. Effective from April, 1999
Government of India have merged all such Self Employment Schemes
into one and launched the new SGSY scheme.
2. Development of Women and Children in Rural Areas
NABARD prepared guidelines for promoting group activities under the
programme and provided 100% refinance support.
3. Training-cum-production centre for Women
NABARD provides grants to voluntary/development agencies for setting
up of centres which aim at providing vocational/entrepreneurship
training centres for women exclusively.
4. Self-Help Group
NABARD has been making efforts to establish linkages between Self-
Help Group organized by some voluntary agencies for poor people in
rural areas and official credit agencies. This would augment the flow of
credit for production purposes and reduce their dependence on informal
credit sources.
5. Scheme of Monitoring Evaluation and Research Activities
NABARD conducts studies of on-going schemes and completed studies
to obtain feedback on performance of those projects. The NABARD has
system of District Oriented Monitoring studies in which a cross section
of schemes sanctioned in a district to various banks is studied.
6. Vikas Volunteer Vahini Programe
NABARD has been organizing farmers club in association with
voluntary agencies in rural areas particularly in tribal areas, which have
proved very helpful for credit institutions in extending credit to poor
farmers.
7. External Aid Project
NABARD has been implementing various foreign aided projects. The
projects are assisted by World Bank Group, Organisation of Petroleum
Exporting Countries Fund for International Development etc.
8. Inspection and Supervision of Co-operative Banks and Regional Rural
Banks
NABARD has been entrusted with the responsibility of supervision of
Co-operative and Regional Rural Banks. For this purpose, it conducts
inspections of Co-operative Banks and Regional Rural Banks. These
banks are also to submit periodical information to NABARD for
monitoring purposes. NABARD gives its recommendations to RBI with
the matter relating to licensing of Co-operative Banks and Regional
Rural Banks.
9. Human Resource Development(HRD)
NABARD provides assistance and support or the training of staff of
other credit institutions engaged in credit dispensation for agriculture and
rural development. Training facilities are extended at its two training
institutions-Bankers Institute for Rural Development (BIRD) and
Regional Training Centres (RTCs)
g)RESOURCES OF NABARD
NABARD has been providing financial assistance to various financial
institutions engaged in Rural Credit Delivery System. These agencies
include Co-operative Credit Institutions, Regional Rural Banks and
Commercial Banks. The demand for funds for rural development has
come up considerably in recent times. To meet the increasing demand of
rural credit, NABARD raises funds from the following sources:
a) Capital It went up from Rs.100 crore in March
1992 to Rs. 1500 crore in March 1998 and further
Rs. 2000 crore in 1999. The total Capital of
NABARD is contributed by Government of India and
RBI.
b) Deposits The deposit mainly come from Rural Infrastructural
Development Fund (RIDF) introduced in Central
Government Budget from the year 1995-96.
c) Borrowings NABARD raises funds through market borrowings,
Loans from Union Government and borrowings in
Foreign Currency from abroad. Apart from these they
also borrow funds from RBI.
d) Reserves and Surplus The excess of income over expenditures is
generally accumulated as ‘Reserves and surplus’.
e) Nation Rural CreditThese funds were earlier provided by RBI Funds
(Long term to NABARD in connection with Operation Fund &
assistance under Agriculture sector. These Stabilisation Fund) were
given out of profits earned by RBI.
f) Rural Infrastructural Development Fund (RIDF)
The setting up of RIDF was announced in the Union Budget for
1995-96. The RIDF was set up with a contribution of Rs. 2000 crore mainly
to provide assistance to State Governments to take up infrastructure projects
pertaining to irrigation, rural roads, bridges and flood control measures.
Contributions to this Fund came from Indian Scheduled Commercial Banks
(other than RRBs) which failed to achieve the minimum agricultural lending
target of 18 percent of net bank credit.
VI.STATE BANK OF INDIA
The State Bank of India is a statutory institution like the RBI and is governed
by the SBI Act in 1955.
a)Evolution of State Bank OF India:
The evaluation of the State Bank of India can be divided into four periods. Such
classification is given below:
1
2
3
4
Establishment of SBI
Before 1921
From 1921 to 1934
From 1934 to 1955
After 1955
Before 1921, there were three Presidency Banks of Bombay, Calcutta and
Madras. In 1921, by the amalgamation of these three banks the Imperial Bank was
established. It was governed by the Imperial Bank of India Act of 1920. The Imperial
Bank was mainly a commercial bank owned by private shareholders. But it was
simultaneously performing some of the functions of Central Bank such as the banker
to the government, bankers’ bank and national clearing house.
The Imperial Bank was functioning on this line till 1934 when a separate
central bank i.e., RBI was established. Then the Imperial Bank of India Act was
amended by the Imperial Bank (amendment) Act of 1934. Besides its regular
functions, the Imperial Bank acted as the agent of the Reserve Bank of India in all
places where the later had no branches of its own.
b)NATIONALISATION OF THE IMPERIAL BANK
Proposals for the nationalization of the Imperial Bank were under consideration
ever since the attainment of independence in 1947. It was nationalized in 1955
according to the recommendations of Rural Credit Survey Committee. The committee
recommended that the government should establish a strong government owned
commercial bank, which would undertake rapid expansion of banking facilities in rural
areas. For this purpose, it suggested the government to nationalize the Imperial Bank
and other state associated banks.
c)MANAGEMENT OF THE BANK
The bank is administered by a central board of directors consisting of:
Members Number
(a) Chairman (appointed by the Central Government 1
in consultation with RBI)
(b) Vice-Chairman (appointed by the Central Government 1
in consultation with RBI)
(c) Managing Directors (appointed by the Central board with 2
the approval of the central Government)
(d) Directors (Elected) (elected by the shareholders other 6
than RBI
(e) Directors (Nominated)(nominated by the central
government in consultation with RBI to represent
territorial and economic interest having commerce, 8
industry, banking or finance)
(f) Director (Nominated)(nominated by the
central government) 1
(g) Director (Nominated)(nominated by RBI) 1
Total members 20
d)FUNCTIONS OF STATE BANK OF INDIA
The functions of SBI can be grouped under two categories, viz., the Central
Banking functions and ordinary banking functions.
i)Central Banking Functions:
The SBI as agent of the RBI at the places where the RBI has no branch.
Accordingly, it renders the following functions:
a) Banker to the government
b) Banker to banks in a limited way
c) Maintenance of currency chest
d) Acts as clearing house
e) Renders promotional functions
(1)Banker to the Government: The SBI functions as the banker to the central
and state governments. It receives and pays money on behalf of the
governments.
(a) collection of charges on behalf of the government e.g. collection of
tax and other payments
(b)grants loans and advances to the governments
(c) provides advises to the government regarding economic conditions
etc.
(2)Banker’s Bank: Commercial Banks have accounts with SBI. When the
banks face financial shortage, the SBI provides assistance to them as it is
considered a big brother in the banking industry. It discounts the bills of the
other commercial banks.
(3)Currency Chest: The RBI maintains currency chests at its own offices. But
RBI Offices are situated only in big cities. SBI, buy its wide network of
branches operate in urban as well as rural areas.
(4)Acts as Clearing House: In all the places, where RBI has no branch, the SBI
renders the functions of clearing house.
(5)Renders Promotional Functions: State Bank of India also renders various
promotional functions. It provides various facilities to the following priority
sectors:
(i) Agriculture
(ii)Small-Scale Industries
(iii) Weaker sections of the society
(iv) Co-operative sectors
(v)Small-traders
(vi) Unemployed youth
(vii) Others
In this respect SBI is like any other commercial bank.
ii)General Banking Functions
Besides the above specialized functions, the SBI renders the following
functions under Section 33 of the Act.
1. Accepting deposits from the public under current, savings,
fixed and recurring deposit accounts.
2. Advancing and lending money and opening cash credits upon the
security of stocks, securities etc.
3. Drawing, accepting, discounting, buying and selling of bills of exchange
and other negotiable instruments.
4. Investing funds, in specified kinds of securities
5. Advancing and lending money to court of wards with the previous
approval of State Government.
6. Issuing and circulating letters of credit.
7. Offering remittance facilities such as demand drafts, mail transfers
telegraphic transfers etc.
8. Acting as administrator, executor, trustee or otherwise.
9. Transacting pecuniary agency business on commission stocks.
10.Buying and selling of gold and silver
11.It operates Public Provident Fund Accounts for the general public.
12.It operates Non-Resident External Accounts and Foreign Currency
Accounts.
13.Providing Factoring service(through subsidiaries)
14.Provides shipping finance
15.Promotes Export through Export Credit. Provides Project Export
Finance.
16.Provides Merchant Banking Facilities.
17.Provides specialized services like “Global Link Services”.
18.Promotes housing finance through “SBI Home Finance Ltd”.
19.Provides Leasing Finance and Project Finance Facilities
20.Participates in Lead Bank Scheme
21.The State Bank may with the sanction of the Central Government, enter
into negotiations for acquiring the business of any other Banking
Institutions.
e)STATE BANK OF INDIA AND AGRICULTURAL AND RURAL FINANCE
One of the basic objectives with which the SBI established is to provide
banking facilities to rural areas. The Rural Credit Survey Committee envisaged a
dominant part for the State Bank in rural finance. The SBI provides agricultural and
rural finance in the following ways:
1. Expansion of Rural Branches. Direct finance to farmers
2. Loans and advances to co-operative banks
3. Loans and advances to co-operative marketing and processing societies
4. Financial assistance to Central Land Development Banks
5. Small Farmers Scheme
6. Farm Graduates Schemes
7. Agricultural Development Branches
8. Village Adoption Scheme and Service Area Approach
9. Sponsoring Regional Rural Banks
10.Ware Housing Finance
11.Integrated Rural Development Programme(now merged with SGSY
scheme)
f)STATE BANK OF INDIA AND SMALL SCALE INDUSTRIES
Development of small scale industry and small business is another important
aim of the State Bank of India.
In small scale industry the following categories of business units are included.
(a) Small Scale Industry
Industrial units, engaged in manufacturing, processing, preservation, repairing
or service operations with original investments in plant and machinery not
exceeding Rs.300 crore are classified as Small Scale Industries.
(b) Tiny Sector
Small scale industrial units with investment in plant and machinery up to Rs.25
lakh are classified as TinySector Industries.
(c) Small Business
(i) Any business established mainly for the purpose of providing any service
other than professional services.
(viii) Original cost price of the equipment used for the purpose of
business should not exceed Rs. 10 lakh.
(ix) Working capital limits granted to such an enterprise should
not exceed Rs. 5 lakh.
(x) The aggregate of term loan and working capital limits should
not exceed Rs.10 lakh.
g)SBI ASSISTANCE TO SMALL UNITS
The SBI helps the small units in the following ways:
1. Offers working capital
2. Medium-term Loans and Installment Credit
3. Discounting of bills
4. Entrepreneur Development Programmes
5. Encouraging Women Entrepreneur
6. Promotion of village and cottage industry
7. Encouraging self-employment schemes
8. Provides technical and financial consultancy services
9. Special Village Industries Division
10.Project uptech.
VII. Industrial Finance Corporation of India (IFCI) This was first in the chain of establishment of financial corporations to provide
financial assistance for industrial development. This was established on July 1, 1948
under the Act of the Parliament. IFCI provides assistance to the industrial concerns in
the following ways:
(i) Long-term loans; both in rupees and foreign currencies,
(ii) Underwriting of equity, preference and debenture issues. Subscribing to equity,
preference and debenture issues. Guaranteeing the deferred payments in
respect of machinery imported from abroad or purchased in India; and
Guaranteeing of loans raised in foreign currency from foreign financial
institutions.
a)Role of IFCI
Financial assistance of IFCI can be availed by any Limited Company in the public,
private or joint sector, or by a co-operative society incorporated in India, which is
engaged or proposes to be engaged in the specified industrial activities. Such financial
assistance will be available for the setting up of new industrial projects and also for the
expansion, diversification, renovation or modernization of existing ones. The IFCI also
provides financial assistance on concessional terms for setting up industrial projects in
industrially less developed districts in the States or Union Territories notified by the
Central Government.
The paid-up Capital of IFCI as on 31st March 2007 was Rs. 380-crores
subscribed by the Industrial Development Bank of India (50%) and by scheduled banks,
cooperative banks, insurance concerns and investment trusts.
The IFCI raises its resources by way of
(a) issue of bonds in the market;
(b) borrowing from Industrial Development Bank of India and the Central Government; (c)
foreign credit secured from foreign financial institutions and borrowings in the international
capital markets.
In recent years, the range of activities undertaken by the IFCI has widened. It
now undertakes Merchant Banking and other financial services, equipment financing,
promotional services in the form of Technical Consultancy Support, Risk Capital
Assistance, Up gradation of Managerial skills, Entrepreneurship development, etc.
Since its inception up to March 2007 the financial assistance sanctioned by IFCI
aggregated to Rs.44,900 corers against which total disbursements amounted to rs 15,380
corers fertilizers , cement industries industrial machinery , and power generation
industries were beneficiary .
VIII.EXIM BANK OF INDIA
a)Introduction
Export-Import Bank of India was created by an Act of Parliament, the Export-
Import Bank of India Act, 1981. The Bank came into existence in 1982, for he purpose
of financing, facilitating and promoting foreign trade of India. It is the principal financial
institution in the country for coordinating and working of institutions engaged in
financing exports and imports.
Organization
The Export-Import Bank of India is ful ly owned by the Government of India
and is managed by a Board of Directors with representation from the government,
financial institutions, banks, and the business community The Board of Directors of the
EXIM Bank consists of:
a) chairman and a managing, director appointed by the Central Government:
provided that the same person may be appointed to function both as chairman and as
managing director.
b) One director is nominated by the RBI.
c) One director nominated by the Development Bank.
d)One director is nominated by the Export Credit and
Guarantee Corporation Limited.
e) Not more than twelve directors nominated by the central government of
whom:
(i) Five directors are nominated by the central government
(ii) Not more than three directors are from the schedule banks,
(iii) Not more than four directors are persons who have special
knowledge of, or professional experience in, export or import or both.
Committees
The Board may constitute such committees whether consisting wholly of
directors or wholly of other persons or partly of directors and partly of other persons for
such purpose or purposes as it may think fit.
b)Resources of the EXIM Bank
The resources of the EXIM Bank are:
1. Loans by central government.
2. Borrowings and Acceptance of Deposits by EXIM Bank
3. Loans in foreign currency
4. Grants, donations etc., to EXIM Bank.
5. Export development fund.
c)Functions of the EXIM Bank
The export finance is the main function of EXIM Bank, and also involves a
significant extent in other kinds of export promotional activities. Another salient
feature is the extensive involvement of developing Indian economy. The EXIM Bank
facilitates the following functions:
1. It provides loans and advances by itself or along with any bank or financial
institution whether in or outside India for the purpose of export or import.
2. It also carries on and transacts all or any of the following functions relating to
export and import business, namely:
(a) Granting loans and advances to a scheduled bank or any other banks or
financial institution by way of refinance of loans and advances granted by it for
purposes of export or import.
(b) Underwriting the issue of stocks, shares, bonds or debentures of any
company engaged in export or import.
(c) Issuing bid bonds or guarantees in or outside India by itself or in participation
with any government, bank or financial institution in or outside India.
(d) Accepting, collecting, discounting, re-discounting, purchasing, selling or
negotiating in or outside India, Bills of exchange or promissory notes arising out of
transactions relating to export or import and granting of loans and advances in or
outside India against such / bills or promissory notes.
(e) Granting, opening, issuing, confirming or endorsing letters of credit and
negotiating or collecting bills and other documents drawn there under.
(f) Undertaking any transactions involving a combination of government to
government and commercial credit for the purposes of export or import.
(g) Granting loans and advances outside India for any Indian joint venture,
3. It renders services mentioned in the act for consideration like commission ,
brokerage , interest and remuneration or fees as may be agreed upon
4. it grants any loan or advance or other financial accommodation on the security of
its own bonds or debentures
UNIT-II
I.LEASING SERVICES
a)Introduction:
Leasing, like long-term debt, is a process by which a firm can obtain the use of
certain fixed assets for which it must make a series of contractual, periodic, tax-
deductible payments.
b)The Concept of Leasing:
Leasing is an alternative to purchase an asset in order to acquire the services of
that asset. By leasing an asset the lessee essentially acquires its use value from the
lessor, who actually purchased and owns (retains title to) the asset. Simply stated,
ownership of a productive asset conveys two types of ‘property rights’ to the owner
(i) to use the asset throughout its productive life and
(ii) to sell or dispose of it for its salvage value.
In this context, the lessee acquires all or a portion of the “use value” of the asset
in return for making a set of rental payments to the lessor. The lessor retains title to
the asset and hence the right to sell or dispose of it for its salvage value. Thus, leasing
distributes the rights of ownership by separating the asset’s use value from its salvage
value.
c)Types of Leasing:
The ever growing complexity of the law and the various diverse circumstances
of the “lessees” and “lessors” lead to a number of variations in the standard financial
and operating leases.
Financial Lease:
A financial lease is a contract that is non-cancelable and the lease period is
usually shorter than the useful life of the asset being leased. During the life of the
contract all of the cost of the property plus financing and servicing charges should be
recovered through periodic payments.
In this kind of ‘lease agreement’ the leasing company will act simply as a
financial institution. The lessee will specify the equipment needed and act as the
lessor’s agent in the matters of ordering it, inspecting it and maintaining it. The lessor
is simply interested in the equipment as its legally owned asset. The lessor will raise
the money, accept the invoice from the supplier and pay accordingly.
(i) Floating rental rate lease contracts:
This kind of lease permits a lessee to undertake the risk and awards of interest rate
variations.
(ii) Non-tax base leasing:
Lessor, in general, enjoys the benefits of tax deductions and various grants
extended by governments to the new capital investment in the industry.
(iii) Net Lease:
In a net lease, the lessee pays the costs associated with partnership. These costs
include property taxes, insurance premiums and capital and maintenance expenses.
USE VS. OWNERSHIP
Financial leasing is a means of financing the use rather than the ownership of
an asset.
Operating Lease:
Operating leasing is a service available for which there is an established leasing
and second-hand market. Computers and television sets are the items most widely
leased on an operating basis in the commercial and consumer fields, respectively.
Different kinds of operating lease writing:
(a)Service lease
A service lease resembles to ‘Contract Hire’ but has a different legislative outlook.
In this kind of lease, the ‘lessor’ renders the services of the equipment, generally
automobiles, office and domestic equipment, for a relatively short period. The rentals
do not have any direct correlation towards the recovery of capital costs, interest and
lessors’ profit in the lease period. Lessors’ primary objective while offering the lease
rentals is to have a regular income and the interest on the capital. Moreover these
rentals are fixed keeping in view the useful working life of the equipment.
(b)Captive lease
This kind of leasing was introduced by certain manufacturers who wanted to
contest the second-hand market of the equipment which they are manufacturing to
maintain the monopoly of their products in the market. This type of leasing is
significantly popular in computers, machine tools etc.
Sale and Lease Back:
Sale and lease back leasing was designed as an alternative to the
‘hypothecation’ of fixed assets to raise funds by an organization in the traditional
financial circles. Under this type a sole and leaseback arrangement consists of the sale
of machinery, equipment, or building by a firm to a financial institution that in turn
leases the assets back to the firm .
New assets are frequently sold and leased back. For example, a firm may be
building a new plant. During the construction period, the firm takes construction loans
from a bank to handle the financing.
LEVERAGE LEASE
Under leverage lease the ‘lessee’ assigns his interest in a purchase order to
‘lessor’ who agrees to advance only a portion of the total equipment cost, and
arranges to borrow the remaining portion from institutional lenders.
There are number of participants in a leverage lease and the role of each is
described below:
(a) Broker: A leverage lease is organized and managed by a broker. Once the
broker has found a company interested in acquiring an asset by means of a leverage
lease, he has to find two other parties to participate in the financing of the asset: a
lender prepared to lend long-term debt funds to a lessor which then adds sufficient of
its own funds to the borrowed funds in order to purchase the required asset.
(b) Lender: This role is performed by one or more institutional lenders which lend a
majority proportion of the cost of the asset to the lessor. The lender will receive
interest and principal repayments paid out of the lease payments.
(c) Lessor (equity participants): The lessor comprises one or more banks or finance
companies with sufficient profits to take the full tax advantage, of the depreciation
charges and investment allowances allowable on the asset. The lessor provides the
additional funds not provided by the lender and purchases the asset. The lesser
receives only a very small cash flow from the lease payments as the major proportion
of the lease payments is paid out as interest and principal repayments to the lender.
(d) Lessee: The lessee enters into a normal lease agreement agreeing to lease the asset
for a specified period of time and to make specified lease payments. Usually, the
period of the lease is shorter than the economic life of the asset.
SALE-AID LEASING:
By the advent of intensive competition in product marketing, a number of
companies adopted this technique as a marketing tool because under this scheme, a
manufacturer directly extends facility of leasing either by one of his own subsidiaries
or through a third party, a leasing company.
TAX BENEFIT TRANSFER LEASE:
The objective of these kinds of leases is to make the economically distressed
companies to encash the benefits of investment tax credits and other various fiscal
incentives which they were not in a position to enjoy because of the non-tax paying
conditions of the company. In this kind of leasing, the lessor pays a down payment on
the capital cost of the equipment and executes a note exactly identical to the lease
rentals to be received from lessee.
CROSS BORDER LEASE:
When a lessor leases equipment to a lessee who is not falling in the jurisdiction
of the lessor’s territory then the lease written is known as Cross Border leasing.
Equipment financed by cross border leasing displays one or more of the following
characteristics:
Undisputed title( giving rise to registration);
Used in an economically essential sector with strong and lasting
profitability;
Long life and a good second hand value in many different countries; and,
Relative mobility.
d)ADVANTAGES AND DISADVANTAGES:
The merits of leasing from a potential lessee’s point of view are stated below:
1. Equipment procurement
2. Additional source of finance
3. Debt capacity
4. Certainty
5. Availability
6. Taxation
7. Flexibility
8. Limited claims in the event of bankruptcy or
re-organisation
9. Hedging risks
10.Convenience
11.Avoiding of the risk of obsolescence
12.Increase in liquidity
13.Step-by-step financing
14.Flotation costs
15.Disposal problem
16.Higher incomes
17.A well-defined cost
18.Maintenance is cheap and certain
The disadvantages are:
1. Ownership flexibility
2. Residual value
3. Taxation
4. Early disposal
5. Security value
6. Understatement of assets
7. Prestige
8. High cost of leasing
9. Prohibited property improvements
10.Obsolescence considerations
e) FINANCIAL EVALUATION OF LEASING:
The process of financial appraisal in a lease transaction generally involves three
steps:
(i) appraisal of the client in terms of financial strength and credit worthiness
(ii) evaluation of the security/collateral security offered and
(iii) financial evaluation of the proposal.
LESSEE’S PERSPECTIVE
Finance lease effectively transfers the risks and rewards associated with the
ownership of an equipment from the lessor to the lessee. A lease can be evaluated
either as an investment decision or as a financing alternative. The lease evaluation
from the lessee’s point of view, thus, essentially involves a choice between debts
financing versus lease financing. Evaluation of lease financing from the view point of
lessee is presented.
The decision-criterion used is the Net Present Value of Leasing [NPV (l)]/Net
Advantage of Leasing (NAL). The discount rate used is the marginal cost of capital
for all cashflows other than lease payments and the tax cost of debt for lease
payments. The value of the interest tax shield id included as a foregone cash flow in
the computation of NPV (L)/NAL.
NPV (L)/NAL = Investment cost
Less: Present value of lease payment (discounted by Kd),
Plus: Present value of tax shield on lease payment (discounted by
Kc)
Less: Management fee
Plus: Present value of tax shield on management fee (discounted by
K)
Minus: Present value of depreciation shield (discounted by Kc)
Minus: Present value of interest shield (discounted by Kc)
Minus: Present value of residual/salvage value (discounted by Kc)
Where Kc = Post-tax marginal cost of capital
Kd = Pre-tax cost of long-term debt
If the NAL/NPV (L) is positive, the leasing alternative should be used,
otherwise the borrowing alternative would be preferable.
An alternative approach is to determine the present values of the cash outflows
after taxes under the leasing and the borrowing alternatives. The decision-criterion is
to select the alternative with the lower present value of cash outflows.
BREAK-EVEN LEASE RENTAL:
The break-even lease rental (BELR) is the rental at which the lessee is
indifferent between lease financing and borrowing and buying. Alternatively, BELR
has NAL as zero. It reflects the maximum level of rental which the lessee would be
willing to pay. If the BELR exceeds the actual lease rental, the lease proposal would
be accepted, otherwise rejected.
i)LESSOR’S VIEWPOINT:
The lease evaluation from the point of view of the lessor aims at ascertaining
whether to accept a lease proposal or to choose from alternative proposals. As in the
case of the evaluation by a lessee, the appraisal method used is the discounted cash
flow technique based on the lessor’s cash flows. The lease-related cash flow from his
angle consist of
a) outflows in terms of the initial investment/acquisition cost of the asset at
the inception of the lease; income-tax on lease payments, sales-tax on
lease transaction, if any; lease administration expenses such as rental
collection charges, expenses on suits for recovery and other direct cost
and so on.
b) Inflows such as lease rentals, management fee, tax shield on
depreciation, residual value and security deposit, if any and so on.
Break-Even Lease Rental:
From the viewpoint of a lessor, the break-even lease rental represents the
minimum (floor) lease rental which he can accept. The NAL/NPV (L) at this level of
rental is zero. The discount rate to compute the NAL is the marginal over-all cost of
funds to the lessor.
Negotiation of Lease Rentals:
The break-even rentals of the lessor and the lessee represent the range of
acceptable level of rentals. The break-even lease rental of the lessor sets the lower
limit, while the break-even rental of the lessee sets the upper limit of the range. The
actual rental has to be negotiated within the range. A rental within the range implies a
positive NAL/NPV (L) both for the lessor and the lessee. In a way, the difference
between the break-even lease rental for the lessor and the lessee (i.e., the spread)
represents the bargaining area for the negotiation of the actual lease rental for a lease
proposal.
II. HIRE-PURCHASE FINANCE AND CONSUMER CREDIT:
a)Introduction:
Historically, hire-purchase finance has been associated with financing of
commercial vehicles for road transport operators. It has emerged as a source of
equipment financing in recent years as an alternative to lease financing.
b)Meaning and Characteristics:
Hire-purchase is a mode of financing the price of the goods to be sold on a
future date. In a hire-purchase transaction, the goods are let on hire, the purchase price
is to be paid in installments and the hirer is allowed an option to purchase the goods
by paying all the installments. A hire-purchase agreement is defined as peculiar kind
of transaction in which the goods are let on hire with an option to the hirer to purchase
them with the following stipulations:
(a) Payment to be made in installments over a specified period;
(b)The possession is delivered to the hirer at the time of entering into the
contract;
(c) The property in the goods passes to the hirer on payment of the last
installment;
(d)Each installment is treated as hire charges so that of default is made in
payment of any installment, the seller becomes entitles to take away the
goods; and
(e) The hirer/purchaser is free to return the goods without being required to pay
any further installments falling due after the return.
Thus a hire-purchase agreement has two aspects, firstly, an aspect of bailment
of goods subject to the hire-purchase agreement, and secondly, an element of sale
which fructifies when the option to purchase is exercised by the intending purchaser.
Though the option to purchase is allowed in the very beginning, it can be exercised
only at the end of the agreement.
The interest component of each hire-purchase installment is computed on the
basis of a flat rate of interest and the effective rate of interest is applied to the
declining balance of the original loan amount to determine the interest component of
each installment.
c)Parties to Hire-Purchase Contract:
Basically, there are two parties in a hire-purchase contract, namely, the
intending seller and the intending purchaser or the hirer. Now a days, however, hire-
purchase contracts generally involve three parties, namely, the seller, the financier and
the hirer.
1. The dealer contracts a finance company to finance hire-purchase deals
submitted by him.
2. The customer selects the goods and expresses his desire to acquire them on
hire-purchase.
3. The customer then makes cash down payment on completing the proposal
form.
4. The dealer then sent the documents to the finance company requesting them to
purchase the goods and accept the hire-purchase transactions
5. The finance company, if it decides to accept the transactions, signs the
agreement and sends a copy to the hirer along with the instructions as to the
payment of the installments.
6. The dealer delivers the goods to the hirer against acknowledgments and the
property in the goods passes on to the finance company.
7. The hirer makes payment of the hire installment periodically.
8. On completion of the hire-term, the hirer pays the last installment and the
property in the goods passes to him on issue of a completion certificate by the
finance company.
Sales of Goods Act:
In a contract of hire-purchase, the element of sale is inherent as the hirer always
has the option to purchase the movable asset by making regular payment of hire
charges and the property in the goods passes to him on payment of the lase
installment.
d)Contract of Sales of Goods:
A contract of sales of goods is a contract whereby the seller transfers or agrees
to transfer the property in goods to the buyer for a price. It includes both an actual
‘sale’ and an ‘agreement to sell’ which vastly differ from each other. A contract in
which the property in the goods is transferred from the seller to the buyer, the contract
is called a sale, but where the transfer of property in the goods is to take place at a
future time, or subject to some conditions to be fulfilled later, it is called an agreement
to sell. An agreement to sell becomes a sale when the time elapses or the conditions
are fulfilled subject to which the property in the goods is to be transferred.
Sales Vs Bailment:
In case of bailment (or leasing), there is a mere transfer of possession of the
goods from the bailor to the bailee with no conveyance intended. The goods are
delivered for a certain purpose, on the condition that when that purpose is over the
goods will be returned in specie.
Sale Vs Hire-purchase:
A hire-purchase agreement is a kind of bailment whereby the owner of the
goods lets them on hire to another person called hirer, on payment of certain
stipulated periodical payments as hire charges or rent. If the hirer makes the payment
regularly, he gets an option to purchase the goods on making the full payment. Before
this option is exercised, the hirer may return the goods without any obligation to pay
the balance rent. The hirer is, however, under no compulsion to exercise the option
and purchase the goods at the end of the agreement period.
Goods:
The subject-matter of a contract of sale is the ‘goods’. ‘Goods’ means every
kind of movable property excluding money and actionable claims. Besides, growing
crops, grass, standing trees and other things attached to, or forming part of the land,
also fall in the meaning of ‘goods’, provided these are agreed to be severed from land
before sale or under the contract of sale.
e)Nature of Hire-purchase Agreement:
The Act defines a hire-purchase agreement as a peculiar kind of transaction in
which the goods are sold with the following stipulations:
1. Payment is to be made in installments over a specified period;
2. The possession is delivered to the purchaser at the time of entering into the
contract;
3. The property in the goods passes to the purchaser on payment of the last
installment;
4. Each installment is treated as hire charges so that if default is made in
payment of any one installment, the seller becomes entitled to take away the
goods; and
5. The hirer/purchaser is free to return the goods without being required to pay
any further installments falling due after the return.
Thus, a hire-purchase agreement has two aspects:
(a)An aspect of bailment of goods subjected to the hire-purchase agreement,
and
(b)An element of sale which fructifies when the option to purchase is exercised
by the intending purchaser/hirer.
The essence of the agreement is that the property in the goods does not pass at
the time me of the agreement but remains in the intending seller, and only passes later
when the option is exercised by the intending purchaser.
f)Form and Contents of a Hire-Purchase Agreement:
There is no prescribed form for a hire-purchase agreement, but it has to be in
writing and signed by both the parties to it. Where a hire-purchase agreement involves
a guarantee, the agreement must be signed by the surety also, otherwise the agreement
shall be avoidable at the option of the owner.
A hire-purchase agreement must contain the following particulars:
(a) The hire-purchase price of the goods;
(b) The cash price of the goods i.e., the price at which the goods may be
purchased by the hirer for cash;
(c) The date of commencement of the agreement;
(d) The number of installments in which the hire-purchase price is to be
paid, the amount, due date, the person to whom and the place where each of
the installments is to be paid; and
(e) The description of the goods, in a manner sufficient to identify them.
Implied Warranties:
A hire-purchase agreement has the following implied warranties
Quiet Possession: The owner undertakes a warranty that the hirer shall have and
enjoy quiet possession of the goods.
Free of Encumbrances: The goods are warranted as free from any charge or
encumbrance in favour of any third party, at the time the property in the goods is to
pass. Thus, where the goods are already pledged or hypothecated, and the owner
enters into a hire-purchase agreement, it amounts to a breach of warranty.
Implied Conditions:
The following conditions are implied in hire-purchase agreement:
Perfect Title: That the owner has the right to sell the goods at the time the
property is to pass to the hirer.
Merchantable Quality: That the goods are of merchantable quality, that is
reasonably fit for the purpose for which they have been produced and marketed.
However, no such conditions are implied:
(a) As regards any latent or hidden defects in the goods, which would not have
been revealed on a reasonable examination;
(b)As regards defects specified in the agreement;
(c) As regards defects which ought to have been revealed when the hirer examined
the goods or a sample;
(d)As regards second-hand goods, when there is a statement to that effect in the
contract.
Fitness for Hirer’s Purpose: That the goods are fit for the hirer’s purpose, where the
hirer expressly or implicitly informs the owner, or any other person through whom the
negotiations were conducted, the purpose for which he requires the goods.
As per Sample: That the goods correspond with the sample and the hirer has a
reasonable opportunity to compare the bulk with the sample.
As per Description: That the goods correspond with the description, where the goods
are delivered under description.
Hire-Purchase Charges
A restriction on hire-purchase charges is imposed in order to prevent
exploitation of hirers by the dealers and finance companies. Under this provision, the
net hire-purchase charges must not exceed the ‘statutory charges’. Statutory charges,
for this purpose, are calculated as: ‘Net hire-purchase charges’ represents the
difference between the net hire-purchase price and the net cash price.
Passing of Property:
Property in the goods under a hire-purchase agreement passes to the hirer only
on the completion of the purchase, in the manner laid down in the agreement.
g) Rights of Hirer:
To purchase with Rebate: The hirer has a right to purchase the goods under the
agreement, at any time during the continuance of the agreement, by giving to the
owner at least 14 days’ notice of his intention to do so. For making the purchase, the
hirer has to pay to the owner, the balance of hire-purchase price after deducting a
rebate, calculated in the following manner:
Balance of hire-purchase
Rebate = 2/3 × price not yet due × (Hire-purchase price-cash price)
–––––––––––––––––––––
Hire-purchase price
The right of the hirer cannot be taken away by an agreement to the contrary.
However, where the agreement provides for a higher rebate, the hirer is entitled to it.
To Terminate Agreement: The hirer has a right to terminate the agreement at any
time before the final hire purchase installment falls due. For this purpose, the hire has
to give to the owner at least 14 days’ notice of this intention to terminate the
agreement. The hirer is required to return the goods to the owner and pay the
installments which have fallen due but have not been paid, up to the date of
termination.
To Appropriate Payments: Where the hirer is required to pay several hire-purchase
installments under two or more agreements to the same owner, and he makes a
payment which is not sufficient to discharge the total amount when due under all the
agreements, he may appropriate the payment to such agreement(s) as he likes. If the
hirer does not exercise his right of appropriation, the owner gets the right to apply the
payment to the agreements in the order of their time.
To Assign and Transmit: The hirer has right to assign his right, title and interest
under the agreement, with the consent of the owner. If the owner unreasonably
withholds his consent, the hirer may make assignment without his consent.
The owner’s consent is deemed to be unreasonably withheld of he demands any
consideration thereof. When the owner refuses to give his consent on a request by the
hirer, the hirer may apply to the court for a declaration that the consent has been
unreasonably withheld. If the court makes such an order, consent is deemed to have
been reasonably withheld.
To Refund on seizure of Goods: Where the owner seizes the goods in exercise of his
right, the hirer has a right claim refund of an amount equal to: Total amount paid to
the date of seizure plus value of the goods on the date of seizure less hire-purchase
price. If the owner fails to refund the amount within 30 days after receiving notice
from the hirer, he is liable to pay interest @ 12 percent on that amount, after the
expiry of the notice period.
h)Obligations of Hirer:
To Comply with Agreement: The hirer must pay the hire installment in accordance
with the agreement and also comply with the terms of the agreement.
To take Care of Goods: The hirer is required to take as much care of the goods as a
person of ordinary prudence would take of his own goods of the same bulk, quality
and value under similar circumstances. If the hirer exercises so much care, he is not
liable for any loss, destruction or deterioration of the goods.
Not to Make Unauthorised Use: The hirer must not use the goods for any purpose
not authorized in the agreement, otherwise he is liable for any loss or damage to the
goods.
To Give Information: If the owner asks the hirer about the where house abouts of the
goods, the hirer must inform the owner where the goods are at he is giving or posting
the information. The hirer must inform the owner within 14 days; if he fails to do so
without reasonable cause, he is punishable with fine upto Rs. 200.
Rights of Owner:
Rights to Terminate Agreement: The owner has the right to terminate the agreement
in the following cases:
(a) When the hirer fails to make payment of more than one hire installments, the
owner may terminate the agreement after giving the hirer a notice of writing.
(b)When the hirer makes any unauthorized use of the goods or breaks an express
condition of the agreement, on breach of which the owner becomes entitled to
terminate the agreement.
Rights on Termination:
To Retain Hire: The owner has the right to retain the hire which has already been
paid and to recover the arrears due up to the date of termination. This is, however,
subject to the hirer’s right to refund in case of seizure of goods.
To Forfeit Initial Deposit: The owner has the right to forfeit the initial deposit of the
agreement so permits.
To enter Premises and seize goods: The owner has the right to enter the premises of
the hirer and seize the goods, unless there is a contract to the country.
To Recover Possession: The owner has the right to recover possession of the goods
either by an application to the court for recovery of protected goods or by means of a
suit.
To Recover Damages: Where the hirer delays the return of goods, the owner has the
right to recover damages for non-delivery of the goods, for the period between the
date of termination of agreement and the date of delivery.
Obligations of Owner:
The owner has the following obligations:
1. To supply, free of cost, a true copy of the agreement, signed by him, to the hirer
immediately after execution of the agreement.
2. To supply on demand, a copy of the agreement to the surety.
3. To supply on demand by the hirer, the following information, via:
(a) The amount paid by or on behalf of the hirer;
(b)The amount due and unpaid, the date on which each unpaid installment
becomes due and the amount of each such installment:
(c) The amount which is to e payable, the dates on which such installments
are to become due and the amount of each such installment.
III.FACTORING AND FORFAITING
a)INTRODUCTION:
Factoring, as a fund-based financial service, provides resources to finance
receivables as well as facilitates the collection of receivables.
b)CONCEPT AND MECHANISM:
Concept: In the absence of any uniform codified law, the term “factoring” has
been defined in various countries in different ways. International Institute for the
Unification of Private Law (UNIDROIT), Rome during 1988, recommended, in
general terms the definition of factoring as:
“Factoring means an arrangement between a factor and his client which
includes at least two of the following services to be provided by the factor: (i) Finance
(ii) Maintenance of accounts (iii) Collection of debts (iv) Protection against credit risk
(v) across national boundaries (vi) to trade or professional debtors (vii) when notice of
assignment has been given to the debtors.
Mechanism: Credit sales generate the factoring business in ordinary course of
business dealings. Realisation of credit sales is the main function of factoring
services. Once sale transaction is completed, the factor steps in to realize the sales.
Thus, factor works between the seller and the buyer and sometimes with seller’s
banks together.
The Buyer:
(a) Buyer negotiates terms of purchasing the material with the seller;
(b)Buyer receives delivery of goods with invoice and instructions by the seller
to make payment to the factor on due date;
(c) Buyer makes payment to factor in time or gets extension of time or in the
case of default is subject to legal process at the hands of factor.
The Seller:
(a) Memorandum of understanding (MOU) with the buyer in the form of letter
exchanged between them or agreement entered into between them’
(b)Sells goods to the buyer as per MOU;
(c) Delivers copies of invoice, delivery challan, MOU instructions to make
payment to factor given to buyer;
(d)Seller receives 80 per cent or more payment in advance from factor on
selling the receivables from the buyer to him;
(e) Seller receives balance payment from factor after deduction of factor’s
service charges, etc.
c)The Factor:
(a) The factor enters into agreement with seller for rendering factor services to
it;
(b)On receipt of copies of sale documents as referred to above makes payment
to the seller of the 80 per cent of the price of the debt;
(c) The factor receives payment from the buyer on due dates and remits the
money to seller after usual deductions;
(d)The invoice, bills or other documents drawn by the seller should contain a
clause that these payments arising out of the transaction as referred to or
mentioned in might be factored;
(e) The seller should confirm in writing to the factor that all payments arising
out of these bills are free from any encumbrances, charge, lien, pledge,
hypothecation or mortgage or right of set-off or counter-claim from another
etc;
(f) The seller should execute a deed of assignment in favour of the factor to
enable him to recover the payment at the time or after default;
(g)The seller should confirm( by a letter of confirmation) that all conditions to
sell-buy contract between him and the buyer have been complied with and
the transactions complete; and
(h)The seller should procure a letter of waiver from a bank in favour of factor
in case the bank has charge over the assets sold out to buyer and the sale
proceeds are to be deposited in the account of the bank.
d)FUNCTIONS OF A FACTOR:
Depending on the type/form of factoring, the main functions of a factor, in
general terms, can be classified into five categories:
Maintenance/administration of sales ledger;
Collection facility/of accounts receivable;
Financing facility/trade debts;
Assumption of credit risk/ credit control and credit protection; and
Provision of advisory services.
Administration of Sales Ledger: The factor maintains the clients’ sales
ledgers. On transacting a sales deal, an invoice is sent by the client to the customer
and a copy of the same is sent to the factor. The ledger is generally maintained under
the open-item method in which each receipt is matched against the specific invoice.
The customer’s account clearly reflects the various open invoices outstanding on any
given date. The factor also gives periodic (fortnightly/ weekly depending on the
volume of transaction) reports to the client on the current status of his receivables,
receipts of payments from the customers and other useful information.
Provision of Collection Facility: The factor undertakes to collect the
receivables on behalf of the client relieving him of the problems involved in
collection and enables him to concentrate on other important functional areas of the
business. This also enables the client to reduce the cost of collection by way of
savings in manpower, time and efforts.
Financial Trade Debts: The unique feature of factoring is that a factor
purchases the book debts of his client at a price and the debts are assigned in favour of
the factor that is usually willing to grant advances to the extent of 80-85 per cent of
the assigned debts. The balance 15-20 per cent is retained as a factor reserve.
Credit Control and Credit Protection: Assumption of credit risk is one of the
important functions of a factor. This service is provided where debts are factored
without recourse. The factor in consultation with the clients fixes credit limits for
approved customers. Within these limits, the factor undertakes to purchase all trade
debts of the customer without recourse. In other words, the factor assumes the risk of
default in payment by customers.
Advisory Services: These services are spin-offs of the close relationship
between a factor and a client. By virtue of their specialized knowledge and experience
in finance and credit dealings and access to extensive credit information, factors can
provide a variety of incidental advisory services to their clients such as:
Customer’s perception of the client’s products, changes in marketing
strategies, emerging trends and so on;
Audit of the procedures followed for invoicing, delivery and dealing with
sales returns;
Introduction to the credit department of a bank/subsidiaries of banks
engaged in leasing, hire-purchase, merchant banking and so on.
Cost of Services: The factors provide the various services at a charge. The
charge for collection and sales ledger administration is in the form of a commission
expressed as a per cent of the value of debt purchased. It is collected up-front/in
advance. The charge for short-term financing in the form of advance part-payment is
in the form of interest charge for the period between the date of advance payment and
the date of collection/guaranteed payment date. It is also known discount charge.
Types/ Forms of Factoring:
Depending upon the features built into the factoring arrangement to cater to the
varying needs of trade/clients, there can be different types of factoring. The collection
of receivables and sales-ledger administration is a common feature of practically all
factoring transactions.
Recourse and Non-recourse Factoring: Under a recourse factoring arrangement, the
factor has recourse to the client (firm) if the debt purchased/receivables factored turns
out to be irrecoverable. In other words, the factor does not assume credit risks
associated with the receivables. If the customer defaults in payment, the client has to
make good the loss incurred by the factor. The factor is entitled to recover from the
client the amount paid in advance in case the customer does not pay on maturity.
The factor does not have the right of recourse in the case of non-recourse
factoring. The loss arising out of irrecoverable receivables is borne by him, as a
compensation for which he charges a higher commission.
Advance and Maturity Factoring: The factor pays a pre-specified portion,
ranging between three-fourths to nine-tenths, of the factored receivables in advance,
the balance being paid upon collection/ on the guaranteed payment date. A drawing
limit, as a pre-payment, is made available by the factor to the client as soon as the
factored debts are approved/the invoices are accounted for.
An extension of advance factoring is Bank Participation Factoring, under
which a bank provides an advance to the client to finance a part, say 50 per cent, of
the factor reserve, that is, the factored debt less advance given by the factor.
The maturing factoring is also known as Collection Factoring. Under such
arrangements, the factor does not make a pre-payment to the client. The payment is
made either on the guaranteed payment date or on the date of collection.
Full Factoring: This is the most comprehensive form of factoring combining
the features of almost all the factoring services specially those of non-recourse and
advance factoring. It is also known as Old Line Factoring.
Disclosed and undisclosed Factoring: In disclosed factoring, the name of the
factor is disclosed in the invoice by the supplier-manufacturer of the goods asking the
buyer to make payment to the factor. The name of the factor is not disclosed in the
invoice in undisclosed factoring although the factor maintains the sales ledger of the
supplier-manufacturer.
Domestic and Export/Cross-Border/International Factoring: In the domestic
factoring, the three parties involved, namely, customer (buyer), client (seller-supplier)
and factor.
The process of export factoring is almost similar to domestic factoring except
in respect of the parties involved. While in domestic factoring three parties are
involved, there are usually four parties to a cross-border factoring transaction. They
are:
(i) Exporter (client) (ii) importer(customer),(iii) export factor and (iv) import
factor. Since two factors are involved in the deal, international factoring is
also called Two-Factor System of Factoring.
The two-factor system results in two separate but inter-linked agreements.
(a) Between the exporter (client) and the export factor and
(b) Between the export factor and import factor.
International factoring provides a non-recourse factoring deal. The clients
(exporters) have cent per cent protection against bad debt loss on credit-approved
sales. The factors take requisite assistance and avail facilities provided in the
exporting country for export promotion. They handle exporter’s overseas sales on
credit terms.
f) LEGAL ASPECTS OF FACTORING: FACTORING CONTRACT:
There is no codified legal framework/code to regulate factoring services in
India. Factoring contract is like any other sale-purchase agreement regulated under the
law of contract. The legal relationship between a factor and a client is largely
determined by the terms of the factoring contract entered into before the factoring
process starts.
Some of the contents of a factoring agreement and legal obligations of the
parties:
a) The client gives an undertaking to sell and the factor agrees to purchase
receivables subject to terms and conditions mentioned in the agreement.
b) The client warrants that the receivables are valid, enforceable, undisputed and
recoverable. He also undertakes to settle disputes, damages and deductions
relating to the bills assigned to the factor.
c) The client agrees that the bills purchased by the factor on a non-recourse
basis(i/e., approved bills) will arise only from transactions specifically
approved by the factor or those falling within the credit limits authorized by the
factor.
d) The client agrees to serve notices of assignments in the prescribed form to all
those customers whose receivables have been factored.
e) The client agrees to provide copies of all invoices, credit notes, etc., relating to
the factored accounts, to the factor and the factor in turn would remit the
amount received against the factored invoices to the client.
f) The factor acquires the power of attorney to assign the debts further and to
draw negotiable instruments in respect of such debts.
g) The timeframe for the agreement and the mode of termination are specified in
the agreement.
h) The legal status of a factor is that of an assignee. The customer has the same
defence against the factor as he would have against the client.
i) The customer whose account has been factored and has been notified of the
assignment is under legal obligation to remit the amount directly to the factor
failing which he will not be discharged from his obligations to pay the factor
even if he pays directly to the client unless the client remits the amount to the
factor.
IV.FORFAITING:
a) Introduction:
Forfeiting is a form of financing of receivables pertaining to international trade.
It denotes the purchase of trade bills/promissory notes by a bank/financial institution
without recourse to the seller. The purchase is in the form of discounting the
documents covering the entire risk of non-payment in collection. All risks and
collection problems are fully the responsibility of the purchaser (forfeiter) who pays
cash to seller after discounting the bills/notes. The salient features of forfeiting:
b)Salient Features:
(a) In pursuance of a commercial contract between an exporter and importer, the
exporter sells and delivers the goods to the importer on a deferred payment
basis.
(b)The importer draws a series of promissory motes in favour of the exporter for
payment including interest charge. Alternatively, the exporter draws a series of
bill which are accepted by the importer. The bills/notes are sent to the exporter.
The promissory notes/bills are guaranteed by a bank which may not necessarily
be the importer’s bank. The guarantee by the bank is referred to as an Aval,
defined as an endorsement by a bank guaranteeing payment by the buyer
(importer).
(c) The exporter enters into a forfeiting arrangement with a forfeiter which is
usually a reputed bank including exporter’s bank. The exporter sells the avalled
notes/bills to the bank (forfeiter) at a discount without recourse. The agreement
provides for the basic terms of the arrangement such as cost of forfeiting,
margin to cover risk, commitment charges, days of grace, fee to compensate the
forfeiter for loss of interest due to transfer and payment delays, period of
forfeiting contract, installment of repayment, usually bi-annual installment, rate
of interest and so on.
(d)Payment to forfeiter to the exporter of the face value of the bill/note less
discount.
(e) The forfeiter may hold these notes/bills till maturity for payment by the
importer’s bank. Alternatively, he can securitize them and sell the short-term
paper in the secondary market as high-yielding unsecured paper.
c)FORFAITING Vs EXPORT FACTORING:
Forfeiting is similar to cross-border factoring to the extent both have common
features of non-recourse and advance payment. But they differ in several important
respects:
a) A forfeiter discounts the entire value of the note/bill. The implication is
that forfeiting is hundred percent financing arrangement of receivables
finance.
b) The availing bank which provides an unconditional and irrevocable
guarantee is a critical element in the forfeiting arrangement. The
forfeiter’s decision to provide financing depends upon the financial
standing of the availing bank.
c) Forfeiting is a pure financing arrangement while factoring also includes
ledger-administration, collection and so on.
d) Factoring is essentially a short-term financing deal. Forfeiting finances
notes/bills arising out of deferred credit transaction spread over 3-5
years.
e) A factor does not guard against exchange rate fluctuations; a forfeiter
charges a premium for such risk.
d)ADVANTAGES AND EVALUATION:
Factoring is to improve the financial discipline of the firm.
Higher credit standing
Improved efficiency
More time for planning, production, planning
Reduction of cost and expenses
Additional source
Evaluation framework
Costs associated with In-house Management
1. Cash discount
2. Cost of funds invested in receivables
3. Bad debts
4. Lost contribution on foregone sales and
5. Avoidable costs of sales ledger administration and credit monitoring.
Costs associated with Recourse and Non-recourse Factoring
1. Factoring commission
2. Discount charges
3. Cost of long-term funds invested in receivables
Benefits associated with recourse Factoring
They are in the terms of the costs associated with the in-house
management alternative with the exception of item (3), namely, bad debt
loss.
Benefit associated with Non-recourse Factoring
e)Operational Problems:
The factoring service in India is still at a nascent stage. Its quantitative growth
is relatively limited. Its future depends on the removal of a number of genuine
operational obstacles.
Credit Information:
The factors do not have access to any authentic common source of information.
They have to depend on their own data-base for credit evaluation of clients.
Stamp Duty:
The assignment of debt attracts stamp duty charged by the States which is as
high as 15 per cent on the amount exceeding Rs 2 lakh. It inflates the cost of
operations of service and erodes the profitability of the factors.
Legal Framework:
Changes are also called for in other components of the present legal framework
to ensure success of factoring in India.
Funding:
The factors in India are not allowed access to wider funding sources on scales
available to other finance companies. Virtual dependence on equity funds does not
permit them to have optimal funding.
Disclaimer Certificate:
To purchase a book debt of its clients, a factor needs a disclaimer certificate
from banks.
Limited Coverage:
At present only domestic factoring of the advance with recourse is permitted
and offered in India. It is high time to provide export factoring to Indian exporters.
Unit III
I.Bill discounting
a)INTRODUCTIONBill discounting as a fund-based activity, emerged as a profitable business in the early
nineties for finance
Companies and represented a diversification in their activities in (Line with the
emerging financial scene in India. In the post-1992 (scam) period its importance has
substantially declined primarily due to restrictions imposed by the Reserve Bank of
India-concept According to the Indian Negotiable Instruments Act, 1881: "The bill of
exchange is an instrument in writing containing an unconditional order, signed by the
maker, directing a certain person 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 a transaction in good which means that it is essentially a
trade-related instrument.
b) Creation of a B/ESuppose a seller sells goods or merchandise to a buyer. In most cases, the seller
would like to be paid immediately but the buyer would like to pay only after some
time, that is, the buyer would wish to purchase on credit. To solve this problem, the
seller draws a B/E of a given maturity on the buyer. The seller has now assumed the
role of a creditor; and is called the drawer of the bill. The buyer, who is the debtor, is
called the drawee. The seller then sends the bill to the buyer who acknowledges his
responsibility for the payment of the amount on the terms mentioned on the bill by
writing his acceptance on the bill. The acceptor could be the buyer himself or any
third party willing to take on the credit risk of the buyer
Discounting of a B/E
The seller, who is the holder of an accepted B/E has two options:
1. Hold on to the B/E till maturity and then take the payment from the buyer.
2. Discount the B/E with a discounting agency. Option (2) is by far more
attractive to the seller. The seller can take over the accepted B/E to a
discounting agency [bank. NBFC, company, high net worth individual] and
obtain ready cash. The act of handing over an endorsed B/E for ready money
is called Financial Services ,
discounting the B/E. The margin between the ready money paid and the face
value of the bill is called discount and is calculated at a rate percentage per
annum on the maturity value.
The maturity a B/E is defined as the date on which payment will fall due.
Normal maturity periods 30, 60, 90 or 120 days but bills maturing within 90
days seem to be the most popular.
c)Types of Bills
There are various types of bills. They can be classified on the basis of when
they are due for payment whether the documents of title of goods accompany such
bills or not, the type of activity they finance, i so on. Some of these bills are:
Demand Bill this is payable immediately "at sight" or "on presentment" to the
drawee. A bill which no time of payment or "due date" is specified is also termed as a
demand bill.
Usance Bill this is also called time bill. The term usance refers to the lime
period recognised custom or usage for payment of bills.
Documentary Bills These are the B/Es that are accompanied by documents that
confirm that a tri has taken place between the buyer and the seller of goods. These
documents include the invoices and oil documents of title such as railway receipts,
lorry receipts and bills of lading issued by custom officials Documentary bills can be
Bills
Demand Usance bill Documentry Clean
D/a bills D/p bills
further classified as: (i) Documents against acceptance (D/A) bills i (ii) Documents
against payment (D/P) bills.
D/A Bills In this case, the documentary evidence accompanying the bill of
exchange is deliverable against acceptance by the drawee. This means the
documentary bill becomes a clean bill after delivery the documents.
D/P Bllls In case a bill is a "documents against payment" bill and has been
accepted by the drawee, documents of title will be held by the bank or the finance
company till the maturity of the B/E.
Clean BillS These bills are not accompanied by any documents that show that a
trade has taken between the buyer and the seller. Because of this, the interest rate
charged on such bills is higher than rate charged on documentary bills.
d)Advantages
The advantages of bill discounting to investors and banks and finance
companies are as follows:
TO Investors
1. Short-term sources of finance;
2. Bills discounting being in the nature of a transaction is outside the purview
of Section 370 of Indian Companies Act 1956. that restricts the amount of
loans that can be given by group companies;
3. Since it is not a lending, no tax at source is deducted while making the
payment charges which is v convenient, not only from cash flow point of
view, but also from the point of view of companies that do envisage tax
liabilities;
4. Rates of discount are better than those available on ICDs; and
5. Flexibility, not only in the quantum of investments but also in the duration
of investments.
TO Banks:
Safety of Funds The greatest security for a banker is that a B/E is a negotiable
instrument bearing signatures of two parties considered good for the amount of
bill; so he can enforce his claim easily-
Certainty of Payment A B/E is a self-liquidating asset with the banker knowing
in advance the date of its maturity. Thus, bill finance obviates the need for
maintaining large, un utilised, ideal cash balances as under the cash credit system. It
also provides banks greater control over their drawls.
Profitability Since the discount on a bill is front-ended, the yield is much
higher than in other loans and advances, where interest is paid quarterly or
half yearly.
Evens out Inter-Bank Liquidity Problems The development of healthy parallel
bill discounting market would have stabilized the violent fluctuations in the call
money market as banks could buy and sell bills to even out their liquidity
mismatches.
Discount Rate and Effective Rate of Interest Banks and finance companies
discounting bills prefer to discount L/C (letter of credit)-backed bills
compared to clean bills. The rate of discount applicable to clean hills is
usually higher than the rate applicable to L/C-based bills. The bills are
generally discounted up-front, that is, the discount is payable in advance. As a
consequence, the effective rate of interest is higher than the quoted rate
(discount). The discount rate varies from time to time depending upon the
short-term interest rate
e)BILL MARKET SCHEMES
The development of bill discounting as a financial service depends upon the
existence of a full-fledged bill market. The Reserve Bank of India (RBI) has
constantly endeavoured to develop the commercial bills market. Several committees
set-up to examine the system of bank financing and money market had strongly
recommended a gradual shift to hills finance and phase-out of the cash credit system.
The most notable of these were;
(i) Dehejia Committee, 1969,
(ii) Tandon Committee, 1974,
(iii) (iii) Chore Committee, 19SO and
(iv) (iv) Vaghul Committee, 1985. This Section briefly outlines the efforts made
by the RBI in the direction of the development of a full-fledged bill market.)
e.(i).Bill Market Scheme, 1952
The salient features of the scheme were as follows:
(i) The scheme was announced under Section 17(4)(c) of RBI Act which enables it to
make advances to scheduled hanks against the security of issuance of promissory
notes or bills drawn on and payable in India and arising out of bonafide commercial or
trade transaction bearing two or more good signatures one of which should be that of
scheduled bank and maturing within 90 days from the date of advances;
(ii) The scheduled banks were required to convert a portion of the demand promissory
notes obtained by them from their constituents in respect of loans/overdrafts and cash
credits granted to them into usance promissory notes maturing within 90 days to be
able to avail of refinance under the scheme;
(iii) The existing loan, cash credit or overdraft accounts were, therefore, required to be
split up into two parts, that is:
(a) one part was to remain covered by the demand promissory notes, in this account
further withdrawals or repayments were as usual being permitted;
(b) the other part, which would represent the minimum requirement of the borrower
during the next three months would be converted into usance promissory notes
maturing within ninety days
(iv) This procedure did not bring any change in offering same facilities as before by
banks to their — constituents. Banks could lodge the usance promissory notes with
RBI for advances as eligible
security for borrowing so as to replenish their loanable funds. (y) The amount
advanced by the RBI was not to exceed the amount lent by the scheduled banks to the
respective borrowers.
(vil The scheduled bank applying for accommodation had to certify that the paper
presented by it as collateral arose out of bonafide commercial transactions and that
the party was creditworthy.
(vii)The RBI could also make such appropriate enquiries as it deemed fit, in
connection with eligibilityof bills and call for any further information from the
scheduled banks concerned
(viil) Advances to hanks under the scheme, in the initial stages, were made at one-half
of one per cent below the bank rate. The concessional rate of interest was withdrawn
in two stages of one quarter of one per cent each and ceased to be operative from
November 1956,
(ix) As a further inducement to banks, the RBI agreed to bear half the cost of the
stamp duty incurred converting demand bills into time bills.
e.(ii)Bill Market Scheme, 1970
In pursuance of the recommendations of the Dehejia Committee, the RBI
constituted a working group (Narsimham Study Group) to evolve a scheme to enlarge
the use of bills. Based on the scheme suggested by the study group, the RBI
introduced with effect from November 1, 1970, the new bill market scheme in order to
facilitate the re-discounting of eligible bills of exchange by banks with it.
Eligible Institutions All licensed scheduled banks and those which do not
require a licence (i.e. the State Bank of India, its associate banks and natioanlised
banks) are eligible to offer bills of exchange to the RBI for rediscount.
Eligibility of Bills The eligibility of bills offered under the scheme to the RBI is
determined by the statutory provisions embodied in section 17(2)(a) of the Reserve
Bank of India Act, which authorise the purchase, sale and rediscount of bills of
exchange and promissory notes, drawn on and payable in India
Procedure for Rediscounting Eligible banks are required to apply to the RBI in
the prescribed —form giving their estimated requirements for the 12 month ending
October of each year and limits are sanctioned/renewed for a period of one year
running from November 1 to October 31 of the following year. The RBI presents for
payment bills of exchange rediscounted by it and such bills have to be taken delivery
of by the rediscounting banks against payment, not less than three working days
before the dates of maturity of the hills concerned. In case bills are retired before the
dates, pro-rata refund of discount is allowed by the RBI.
For rediscounting purposes, bills already rediscounted with RBI may be lodged
with it. The unexpired period of the usance of the hills so offered should not he less
than 30 days and the bills should not bear the endorsement of the discounting hank in
favour of a party other than the RBI.
Credit Assessment Banks and NBCFs (the main discounting agencies)
undertake a detailed appraisal of a customer and thoroughly assess his
creditworthiness before providing the bills discounting (BD» facility. Regular credit
limits arc fixed by banks and NBFCs for individual parties for purchase and dis-
counting of clean bills and documentary bills separately. These limits are renewed
annually and are based on the following considerations:
(i) Quantum of business undertaken by the party, that is, turnover of inventory;
(ii) Credit worthiness of drawer (client);
(Hi) Credit worthiness of drawee and details of dishonour, if any;
(iv) Nature of customer's industry
The earlier sanctioned limits are fully utilised by the client',
The bills were promptly paid on maturity date;
(iii) In case of unpaid bills, funds were paid by the drawer.
Once the party is granted a bill discounting limit, the party approaches the finance
company for each and every bill for discounting. The following documents are
submitted alongwith the letter of request:
(a) Invoice;
(b) Challan;
(c) Receipt of goods acknowledged by buyer;
(d) Hundi/Promissory note;
(e) Truck receipt/Railway receipt;
(f) Post dated cheque for the interest amount.
While fixing the limit for bill discounting the balance sheet and profit and loss
account are properly analysed and various ratios are calculated to arrive at a sound
business decision.
Precautions The finance companies take following precautions while discounting
bills:
(i)The bills are not accommodation bills but are genuine trade bills.
(ii) Bills are drawn on the places where the finance company is operating or
has a branch office as itwould facilitate contact with drawee in case of
exigencies.
(iii)The goods covered by the documents are those in which they party
deals.
(iv)The amount of the bills commensurate with the volume of business
turnover of the party.Bills are drawn on a place where the goods have been
consigned,
(v)The credit report on the drawee is satisfactory.
(vi) The description of goods mentioned in the invoice and railway
receipt/truck receipt are same.
(vii) The goods are not consigned directly to the buyer.
(viii) The goods are properly insured.
(ix) The usance bill is properly stamped.
(x) Bills offered for discount do not cover goods whose prices fluctuate too
much.
(xi) The goods covered under the bill are not of perishable nature.
(xii) The bills are not stale.
(xiii) The truck receipt is in the form of prescribed by the Indian Banks
Association.
(xiv) The bills are drawn in favour of the finance company and have been
accepted by the drawee.
Dealing with Default
The cycle of liabilities in a bill discounting transaction is as follows: The
"drawee is liable to the drawer; and the drawer to the discounting agency. However,
the bank/NBFC looks mainly to its customer (drawer or drawee) for recovery of its
dues. In case of default, the discounting agency can resort to noting and protesting as
laid down by the negotiable instrument act
II. Housing Finance
II.a)Introduction
The responsibility to provide housing finance largely rested with the
Government of India till the mid-eighties. The setting up of the National Housing
Bank (NHB), a fully owned subsidiary of the Reserve Bank of India (RBI) in 1988, as
the apex institution, marked the beginning of the emergence of housing finance as a
fund-based financial service in the country. It has grown in volume and depth with the
entry of a number of specialised financial institutions/companies in the public, private
and joint sectors, although it is at an early stage of development.\Section I of the
Chapter profiles the NHB. The NHB housing finance companies (HFCs) directions
and guidelines relating to (i) acceptance of deposits, (ii) prudential norms, (Hi)
directions to auditors, (iv) miscellaneous matters are comprehensively covered in
Section 2. Sections 3-4 describe respectively the NHB's equity and refinance supports
to the HFCs. While Section 5 sketches the housing finance systems in the country,
mortgage-based securitisation by the NHB is illustrated in Section 6. A brief account
of securitisation is given in Appendix 8-A. The main points are summarised in the last
Section.
b)NATIONAL HOUSING BANK (NHB)
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 levels, 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 the transacting of the business of providing finance for housing,
either directly or indirectly
The general superintendence, direction and management of the affairs and
business of the NHB is vested in its Board of Directors, which exercises all powers
and executes all acts and things on its behalf. Subject to the provisions of the NHB
Act. the Board, while discharging its functions, has to act on business principles, with
due regard to public interest. In general,
(a) the Chairman, if he is a whole-time Director or if he is holding offices
both as a Chairman and a Managing Director (CMD) or
(b) the MD. if the Chairman is not whole-time director or is absent, can also
exercise these powers of the Board. The MD has to follow, in the discharge of
his powers and functions, all directions given by the Chairman, In the discharge of its
functions. the NHB is to be guided by the directions given in writing by the
Government in consultation with the RBI,/or by the RBI in matters of policy
involving public interest.
The Board of Directors of the NHB consists of
A Chairman and a Managing Director (CMD),
two Directors from amongst experts in the field of housing, architecture,
engineering, sociology, finance, law, management and corporate planning, or in any
other field, special knowledge of which is considered useful to Ihe NHB,
two Directors who are persons with experience in the working of institutions
involved in providing finance for housing or engaged in housing development or have
experience in the working of financial institutions/hanks,
two Directors elected by shareholders other than the RBl Business
NHB is authorised to transact all/any of the following kinds of business:
(a) Promoting, establishing, supporting/aiding in the promotion/establishment/ support
of housing financing institutions (HPIs);
(b) Making of loans and advances or rendering any other form of financial assistance,
whatsoever, for housing activities to HHs. banks, slate cooperative, agricultural and
rural development banks or any other institution/class of institutions notified by the
Government;
(c) Subscribing to/purchasing stocks, shares, bonds, debentures and securities of every
other description;
(d) Guaranteeing the financial obligations of HPIs and underwriting the issue of
stocks/shares/bonds/ debentures/other securities of HFIs
(e) Drawing, accepting, discounting/rediscounting, buying/selling and dealing in bills
of exchange/ promissory notes, bonds/debentures, hundies. coupons/other instruments
(f) Promoting/forming/conducting or associating in promotion/formation/conduct of
companies/moit-1 gage banks/riubsidiaries/soeicties/trusta/olher associations of
persons it may deem fit for carrying, out all/any of its functions under the NHB Act;
(g) Undertaking research and surveys on construction techniques and other studies
relating to/connected with shelter/housing and human settlement;
(h)Formulating schcme(s) for purposes of mobilisation of resources and extension of
credit for housing;
(i) Formulating scheme(s) for the economically weaker sections of society, which
may be subsidised by the Government or any other source
(j) Organising training progninimes/.seminars/symposia on matters relating to
housing;
(k)Providing guidelines to HFIs to ensure their growth on sound lines'
(l)Providing technical/administrative assistance to HFI.s '
(m) Generally, doing of all such matters and things as may be incidental to
orconsequential upon the exercise of its powers or the discharge of its duties under the
NHB ActT
Borrowing and Acceptance of Deposits For purposes of carrying out its functions, the
NHBmay:
(a) issue and sell bonds and debentures with or without the guarantee of the Central
Government, such manner and on such terms as may be prescribed
borrow money from the Central Government, banks, financial institutions, mutual
funds and from any other authority or organisation or institution approved by the
Government on such terms and conditions as may be agreed upon;
(c) accepting deposits repayable after such period and. such terms -as may generally
or specially be approved by the RBI;
(d) borrow money from the RBI fi) by way of loans and advances and, generally,
obtain financial assistance in a manner specified by the RBI; (ii) out of the National
Housing Credit (long-term . operations) Fund established under Section 46-D of the
RBt Act;
(e) receive, for services rendered, remuneration, commission, commitment charges,
consultancy charges. service charges, royalties, premia, licence fees and other
considerations of any description;
(f) receive gifts, grants, donations or benefactions from the Government or any other
source.
Loans in Foreign Currency The NHB may borrow in foreign currency from any
bank/financial institution in India/abroad in such manner and on such conditions as
may be prescribed in consultation with the RBI and with the prior approval of
Government. The NHB may also provide guarantee as to payment of interest and
other incidental charges, as well as repayment of the principal.
Assistance to Borrow Where any person/institution seeks any financial
assistance from the NHB on the security of any (i) movable property belonging to
him/institution or (ii) the property of some other person offered as collateral for such
assistance, a written declaration would have to be executed in the prescribed form
stating the particulars of the security/collateral security and agreeing that the dues
relating to the assistance would be a charge on such property.. With the prior approval
of the NHB, the above declaration may be varied/revoked at any time by the
concerned person/institution
Amount/Security to be Held in Trust Any sum received by a borrowing
institution in repayment/ realisation of loans/advances financed/refinanced
wholly/partly by the NHB, to the extent of the accommodation granted by it and
remaining outstanding, would be deemed to have been received by it in trust and
should accordingly be paid by the institution to the NHB.
Power to Transfer Rights The rights and interests of the NHB in relation to any
loan/advance made or any amount recoverable may be transferred by it wholly or
partly in any form. Not with standing such transfer, the NHB may act as a trustee for
the transferee in terms of Section 3 of the Indian TrustsAct. 1882 Power to
Acquire Rights The NHB has the right to acquire, by transfer/assignment, the rights
and interests of any institution in relation to any loan/advance made/amount
recoverable wholly or partly by the execution/issue of any instrument or by the
transfer of any instrument or in any other manner in which the rights and interests in
relation to such loan/advance may be lawfully transferred.
/
Exemption from Registration Subject to Section 17(1) of the Registration Act,
1908, (a) any instrument in the form of debt obligations/trust certificates of beneficial
interest/other instruments, by whatever name called, issued by the NHB to securities
loans granted by HFIs/banks and not creating/ declaring/assigning/limiting
/extinguishing any right/title or interest to or in immovable property, except in so far
as it entitles the holder to an undivided interest offered by a registered instrument,
whereby the NHB has acquired the rights/interests in relation to such loans and in
securities there form or (b) any transfer of the above instruments would not require
compulsory registration
Recovery of Dues as Arrears on Land Revenue Where any amount is due under
an agreement to it acting as a trustee, or otherwise, in respect of the securitisation of
loans of HFIs/banks, in addition to any other mode of recovery NHB may approach a
state government for its recovery in the same manner as arrears of land revenue
Power to Impose Conditions To protect its interests, the NHB may impose such
conditions as it may think necessary/expedient in respect of any transaction entered
into with any borrowing institution
Access to Records The NHB would have free access to all such records of the
institution/persons) availing of any credit facilities from it/the institution, the perusal
of which may be necessary in connection with the provision of finance or other
assistance to the institution
Validity of Loans/Advances The validity of any loan/advance by the NHB
cannot be questioned merely on grounds of non-compliance with the requirements of
any other law/resolution/contract or any instrument relating to the constitution of the
borrowing institution
Prohibition on Loans Against Own Bonds/Debentures Loans/advances against
the security of its own bonds/debentures, by the NHB, is totally prohibited.
Power to Inspect The NHB has the power to inspect the books/accounts/other
documents of any institution to which it has made any loan/advance or granted any
other financial assistance on its own or on direction from the RBI
Power to collect and Publish Credit Information To discharge its functions
efficiently, the NHB may direct an institution at any time. to submit to its credit
information in the specified form and within the time specified by it from time to
time. Credit information refers to any information relating to (i) the amount of
loans/advances/other credit facilities granted for housing purposes, (ii) the nature of
security taken for them, (iii) the guarantees furnished and (iv) any information that
which has a bearing on the borrowers' credit worthiness.
Advisory Services The NHB is authorised to provide advisory services to the
Goverment(s), local authorities/other agencies connected with housing in respect of
(a) formulation of overall polices aimed at promoting the growth of housing and HPI,
and (b) legislation relating to matters having a bearing on shelter, housing and
settlement.
e)Deposits with Housing Finance Institutions
Registration and Net Owned Funds to commence/carry on business, every HFI
set-up as a company should (a) obtain a certificate of registration from the NHB and
(b) have net owned funds of Rs 25 lakhs or other such higher amounts as may be
specified by the NHB from time to time. Net owned funds (NOFs) refer to (a) the
aggregate of the paid-up equity capital and free reserves as disclosed in the latest
balance sheet of the HFI, minus accumulated balance of loss, deferred revenue
expenditure and other intangible assets and (b) further reduced by the amount
representing (1) investments in shares of subsidiaries/group companies/all other HFIs
that are companies and (2) book value of debenture s/bonds/outstanding
loans/advances (including hire purchase and lease finance) made to, and deposits with,
subsidiaries and group companies to the extent such amount exceeds 10 per
f)cancellation of Registration The registration of a HFI can be cancelled by the NHB
if it (a) ceases to carry on business, (b) has failed to comply with any condition,
subject to which the registration was issued, (c) at any time fails to fulfil any of the
conditions laid down for grant of registration, discussed above, (d) fails (i) to comply
with any direction issued by the NHB (ii) to maintain accounts in accordance with the
requirement of any law/any order/direction issued by the NHB and (iii) to
submit/offer for inspection its books of accounts/other relevant documents when so
demanded by an inspecting authority of the NHB and (e) has been prohibited from
accepting deposits by an order made by the NHB, which has been in force for at least
three months
Furnishing of Statements All HFIs are required to furnish the
statements/information/particulars called for in the form,-prescribed by the NHB and
comply with any direction given to them in relation to | acceptance of deposits
g)Powers and Duties of Auditors of HFIs The auditors should enquire whether HFIs
have i furnished the NHB with the statements, information, or particulars relating to,
or connected, with deposits ' received by them, as required under the provisions of the
NHB Act. Except where satisfied on such enquiry about compliance, they should
submit a report to the NHB giving the aggregate amount of deposits held by them
Power of the NHB to Prohibit Acceptance of Deposits The NHB may prohibit any HFI
from accepting any deposit on violation of provisions or failure to comply with any
direction/order given by it in relation to the acceptance of deposits. In addition, it may,
if necessary in public/depositors' interest, direct such a HFI not to sell, transfer, create
charge/mortgage or deal in any manner with its property and assets without the NHB's
prior written permission, for a period not exceeding six months from the date of the
order
Filing of Winding-Up Petition On being satisfied that a HFI (i) is unable to pay
its debt, (ii) ha^ become disqualified in terms of registration and net owned funds
requirements to carry on business, (iii) has been prohibited by the NHB from
receiving deposits, by an order in force for a period of at least three months, (iv)
continuing in business is detrimental to the public interest/interest of depositors, NHB
may file an application for its winding-up under the Companies Act.
Inspection To verify the correctness/completeness of any statements/
information/particulars furnished to the NHB or to obtain any information/particulars
which the HFI has failed to furnish, on being called up, the NHB may conduct an
inspection by its officers) (inspecting authority). Every Director/member of any
committee or other body/any person for the time being vested with the management of
the whole/part of the affairs of the HFI and accepting deposits and other
officers/employees would be duty bound to produce to the inspecting all books,
accounts and other documents in custody / power to furnish any statement /
information related to the business of the HFI, required within the specified time
NHB ‘ S HOUSING FINANCE COMPANIES DIRECTIONS
The NHB had issued the Housing Finance Companies (HFCs) Directions in
1989 in public interest. It had also issued guidelines to them on prudential norms on
income recognition, accounting standards, asset classification, provisioning for bad
and doubtful debts, capital adequacy and concentration of credit/investments. The
NHB Act was amended comprehensively in 3000 to enable the NHB to safeguard the
interest of depositories and promote healthy and universal growth of HFCs in the
country
h)Acceptance of Public Deposits
Any HFC having NOFs of less than Rs 25 lakh cannot accept public deposits.
NOFs mean Net Owned Fund (NOF) defined under Section 29-A of the NHB,
including paid-up preference shares compulsorily convertible into equity capital A
public deposit means a deposit but does not include the following; '
(a) Amount received from (i) the Central government and state government, (ii) any
other source whose repayment is guaranteed by the Central Government or a slate
government, (iii) a local authority
(b) Amount received from the NHB, Industrial Development Bank of India, Life
Insurance Corporation of India, General Insurance Corporation of India and its
subsidiaries
©Amount received from another company
(d)Amount received by way of subscription to any shares, stock, bonds,
(e) Amount received from a person who at the time of receipt of the amount was a
Director of the HFC
(f)Amount raised by the issue of bonds debentures secured by the mortgage of any
immovable property of the HFC
(g)Amount brought in by the promoters by way of unsecured loan, subject to the
conditions that (I) the loan is brought in pursuance of the stipulations imposed by the
lending public financial institution)* ie a public financial institution in terms of
Section 4-A of the Companies Act/a State Financial or Industrial
Corporation/bank/General Insurance Corporation/any other institution notified by the
NHB) in fulfillment of the obligation of the promoters to contribute such finance, (ii)
the loan is provided by the promoters themselves and/or by their relatives, but not
from their friends and business associates and (iii) the exemption would be available
only till the loan of the lending public financial institution is repaid
(h)Any amount received from mutual funds
(i) Amount received as hybrid/subordinated debt with a maturity period of at least five
years
(j)Amount received from a relative of a director of a HFC
i)Prudential NormsThe NHB guidelines to HFCs on prudential norms for income recognition,
income from investments, accounting standards, accounting for investments, asset
classification, provisioning requirements, capital adequacy and concentration of
credit/investments are discussed below
Income Recognition Income recognition should be based on recognised
accounting principles.
Income including interest/discount or any other charges on NPAs should be
recognised only when it is actually realised.)Any such income recognised before the
asset became NPA should be reversed.
Where hire purchase instalments/lease rentals ar£ overdue for more than twelve
months, income should be recognised only when they are actually received.
Income from Investments Income from dividend on shares of corporate bodies
and units of 'natural funds should be taken into account on cash basis. But when such
dividend has been declared in the annual general meeting and .the HFC's right to
receive payment is established, such income may be taken into account on accrual
basis.
Income from bonds/debentures of corporate bodies and from Government
securities/bonds may be taken into account on accrual basis if the interest on these
instruments is predetermined, is serviced regularly and in not in arrear
j)Accounting Standards
Accounting Standards and Guidance Notes issued by the Institute of Chartered
Accountants of India (ICAI) should be followed in so far as they are not inconsistent
with any of these directions.
Accounting for Investments All investments in securities should be classified as
current and long-term investments. A current investment is an investment that is by
nature readily realisable and is intended to be held for not more than one year from the
date on which such investment is made
Quoted Current Investment Quoted current investments should, for the purposes
of valuation, he grouped into the following categories:
(a) equity shares:
(b) preference shares;
(c) debentures and bonds;
(d) Government securities, including treasury bills;
(e) units of mutual funds and
(f) others. Quoted current investments for each category should be valued at cost or
market value, whichever is
Unquoted Equity Shares This, in the nature of current investments should be
valued at cost or break-up value, whichever is lower. However, MFCs may substitute
fair value for break-up value of the shares, if considered necessary. Where the balance
sheet of the investce company is not available for two years, such shares should be
valued at one rupee only. While "fair value" refers to the mean of the earning value
and the break-up value, the "earning value" means the value of an equity share
computed by taking the average of profits after tax as reduced by the preference
dividend and adjusted for extraordinary and non-recurring items, for the immediately
preceding three years, and further divided by the number of equity shares of the
investee company and capitalised at 8 per cent, 10 per cent and 12 percent in the case
of predominantly (i) manufacturing company, (ii) trading company and (iii) any other.
III.Insurance servicesINTRODUCTION
Insurance is pooling of risks. In a contract of insurance, the insurer (insurance
company) agrees/undertakes, in consideration of a sum of money (premium), to make
good the loss suffered by the insured against a specified risk such as fire and any other
similar contingency or compensate the insured/beneficiaries on the happening of a
specified event such as accident or death. Thus, there are two parties to an insurance
contract:
insurer/assurer/underwriter and
(ii) insured/ass ured/beneficiary. The document laying down the terms of the contract
is called (insurance) policy. The property which is insured is the subject-matter of
insurance. It may be insured against loss arising from uncertain
events/casualties/perils in the form of destruction of, or damage to, the property or
death/disablement of a person. The interest which the insured has in the subject-matter
of insurance is known as insurable interest Life insurance, under which a specified
amount becomes payable on the death of the insured or upon
the expiry of a specified period of time, whichever is earlier.A General insurance,
which covers losses caused by fire, accident and marine adventures and so on
b ) INSURANCE ACT. 1938
The Insurance Act provides the broad framework for the insurance
sector/industry/services in the country
Eligibility
Any class of insurance business in India can be carried out only by
a public company,
a cooperative society,
an insurance cooperative society, having paid-up capital of Rs 100 crore,
a body corporate other than a private company incorporated in any country outside
India) However, only Indian insurance companies arc permitted to carry out any class
of insurance business after the enactment of the IRDA Act. 1999 An Indian insurance
company is defined as a company formed/registered under the Companies Act in
which the aggregate holding of equity shares by a foreign company, cither by itself or
through subsidiaries/nominees, docs not exceed 26 per cent paid-up equity capital and
whose sole purpose is to carry on life/general/insurance business Life business means
the business of effecting contracts of insurance upon human life, including any
contract whereby the payment of money is assured on death except death by accident
only) or the happening of any contingency dependent on human life- and any contract
which is subject to payment of premiums for a term dependent on human We, and
should be deemed to include
(a) grant of disability
(b) grant of annuities upon human life and
(c) grant of superannuation allowance/annuities payable out of "any fund
applicable solely to the relief and maintenance of persons engagedGeneral insurance
business is defined to mean fire, marine/miscellaneous insurance business whether
carried on singly or in combination with one/more of them. tire insurance business
means the business of effecting, other than incidental, to some other class of insurance
business, contracts of insurance against loss by or incidental to fire other occurrence
customarily included among the risks insured against in fire insurance policies
Marine insurance business means the business of effecting contracts of insurance upon
vessels of any description including cargos, freights and other interests which may be
legally insured in or in relation to such vessels, cargos and freights,
goods/warcs/merchan disc/ properly of whatever description insured for any transit
by land or water or both and whether or noi including warehouse risks or similar risks
in addition or as incidental to such transit, and includes any other risks customarily
included among the risks insured in marine insurance policies
C )INSURANCE REGULARITY AND DEVEVELOPEMENT AUTORITY (IRDA)
Following the recommendations of the Malhotra Committee, pending the enactment
of a comprehensive legislation, on January 23, 1996, the Government of India to
regulate the insurance sector approved the setting up of the interim Insurance
Regulatory Authority (IRA) that would replace the controller of Insurance (COI) and
be under the overall control of the Ministry of Finance. It had been entrusted with the
task of preparing a comprehensive legislation to establish a statutory, autonomous
IRA on the pattern of the Securities and Exchange Board of India (SEBI).\
c. (i).Salient Features of Interim IRA
The chairman of the IRA was the ex-officio COI under the Insurance Act, 1938, and
exercised all powers vested with the COI. The interim IRA was authorised to examine
the powers withdrawn from the COI or modified through government notifications
issued from time to time or delegated to the LIC/GIC under nationalising enactments
of the insurance business that needed to be restored to the COI. While undertaking this
exercise, the IRA had to bear in mind the possibility of privatisation of the insurance
industry, wholly/ partially and make appropriate recommendations regarding the role
and powers which it would need in such a scenario. It could also examine the powers
of the government under the Insurance Act, 1938, which could be transferred to the
IRA as and when it would be set up-
c.(ii)Insurance Regulator/ and Development Authority (IRDA) Act, 1999
In order to provide better insurance cover to citizens and also to augment the flow of
long-term sources of financing infrastructure, the government reiterated its
announcement of 1996 in its budget speech, 1998. to open up the insurance sector and
also set up a statutory IRDA- The IRDA Act was enacted in 1999 to provide for the
establishment of the IRDA to protect the interests of policy holders, to regulate,
promote and ensure orderly growth of the industry and for matters connected
therewith/incidental thereto and also to amend the. Insurance Act, 1938, the LIC Act,
1956, and the General Insurance Business (Nationalisation) Act, 1972.
Composition of IRDA The IRDA would consist of a chairperson and not more than
nine members of whom not more than five would be full-time members, to be
appointed by the government from amongst persons of ability, integrity and standing
who have knowledge/experience of life insurance/general insurance/actuarial service,
finance/economics/law/accountancy/administration/any other discipline which in the
opinion of the government would be useful to it-
Duties/Powers/Functions of IROA: Duties The duty of the IRDA is to regulate,
promote and
ensure orderly growth of the insurance and reinsurance businesses.
c.(iii)Powers and Functions The powers and functions of the IRDA, inier-alia, are
stated below:
a) Issue to the applicant a certificate of registration: to renew, modify, withdraw,
suspend or cancel such registration; preference in registration to be given to
companies providing with health insurance
(b) Protection of the interests ofpolicyholders in matters concerning assigning of
policy, nomination by y policy-holders, insurable interest, settlement of insurance
claim, surrender value of policy, and other terms and conditions of contracts of
insurance
(C)Specifying requisite qualifications and practical training for insurance
intennediaries
(d)Specifying the code of conduct for surveyors and loss assessors
(e) Promoting efficiency in the conduct of insurance business ,
(f) Promoting and regulating professional organisations connected with the insurance
and reinsurance business; levying fees and other charges for carrying out the purposes
of the IRDA Act
(g) Calling for information from, undertaking inspection of, conducting enquiries and
investigations. including audit of insurers, insurance, intermediaries and other
organisations connected with the insurance business
h) Control and regulation of the rates, terras and conditions that may be offered by
insurers in respect of general insurance business not $o controlled and regulated by
the Tariff Advisory Committee under Section 64U of the Insurance Act. 1938
(i) Specifying the form and manner in which books of account would be maintained
and statement of accounts rendered by insurers and insurance intermediaries
j) Regulating investment of funds by insurance companies; regulating maintenance of
margin of solvency
k)Adjudication of disputes between insurers and intermediaries or insurance
intermediaries
(L). --Supervising the functioning of the Tariff Advisory Committee
(m)- Specifying the percentage of premium income of the insurer to finance schemes
for promoting and
(n) regulating professional organisations referred to above
Specifying the percentage of life insurance and general insurance business' by me
insurer in the rural or social sector
(o) Exercising such other powers as may be prescribed
Power to Make Regulations The IRDA may make regulations consistent with the
Insurance Act/rules/regu) aliens to carry out its provisions to provide, in particular, for
ail or any of the following
Matters relating to registration of insurers The manner of suspension or cancellation
of registration
Such fee, not exceeding Rs 5,000, as may be determined by the issue of a
.1 duplicate certificate of registration Matters relating to renewal of
registration (y-) The manner and procedure for divesting excess share capital (vi)-
Preparation of the balance sheet, profit and loss account and a separate account of
receipt said payments and revenue account
The manner in which an abstract of the report of the actuary is to be specified
The form and the manner in which the statement of business in force .should be
appended The time, manner and the other conditions of investment of assets held by
an insurer.
The minimum information to be maintained by an insurer in their books, the manner
in which such information should be maintained, the checks and other verifications to
be adopted by insurers in that connection and alt other matters incidental thereto
The manner of making an application, the manner asd the fee for issuing a licence to
act as an insurance agent
(xii) The fee and the additional fee to be determined for renewal of licence of an
insurance agent . The requisite qualifications and practical training to act as an
insurance agent
(xiv) he passing of examination to act as an insurance agent
(xv)- The code of conduct of an insurance agent "
(xvi)The fee not exceeding Rs 50 for the issue of a duplicate licence
(xvii) The manner and the fees for the issue of a licence to aRyinlermerttaryor an
insurance intermedi-
(xviii) The fee and the additional fee be determined for the renewal of licence of
intermediaries or
insurance intermediaries
(xix)The requisite qualifications and practical training of intermediaries or insurance
intermediaries The examination to be passed to act as an intermediary or insurance
intermediary , The code of conduct for an intermediary/insurance intermediary
(xx) The fee for the issue of a duplicate licence Such matters as relating to the Tariff
Advisory Committee
(xxi) Matters relating to the licensing of surveyors and loss assessors, their duties,
responsibilities and other professional requirements
asset or assets as may be specified for evaluating the purposes of ascertaining
sufficiency of assets
The valuation of assets and liabilities
(xxii)Matters relating to the sufficiency of assets
(xxiii)'Matters relating to reinsurance
IV. VENTURE CAPITAL FINANCING
Introduction
Venture capital institutions which emerged the world over to fill gaps in the
conventional financial mechanism focused on new entrepreneurs, commercialisation
of new technologies and support to small and medium enterprises in the
manufacturing and the service sectors. Over the years, the concept of venture capital
has undergone significant changes. The modus operand! has shifted from technology-
oriented manufacturing organisations to being very close to "private equity class" for
unlisted new companies in all sectors of the economy, irrespective of the nature of
their projects. They also maintain a close rapport and a 'hands-on' approach in
nurturing investments during their association with the assis led/in vestee companies
as active partners rather than as passive investors.
The initial steps for the institutionalisation of venture capital in India were taken by
the Government in November, 1988. when guidelines were issued for setting up of
venture capital funds/companies (VCFs/VCCs) for investing in unlisted companies
and to avail of a concessional facility of capital gains tax.
b)Features
Venture capital has, somehow, come to acquire various connotations. It is defined as
an equity/equity-related investment in a growth-oriented small/medium business to
enable investees to accomplish corporate objectives, in return for minority
shareholding in the business or the irrevocable right to acquire it.
Venture capital is a way in which investors support entrepreneurial talent with finance
and business skills to exploit market opportunities and, thus, to obtain long-term
capital gains let is the provision of risk-bearing capital, usually in the form of
participation in equity, to companies with high-growth potential.
In addition, it provides some value addition in the form of management advice and
contribution to overall strategy. The relatively high risks are compensated by the
possibility of high return, usually through substantial capital gains in the medium
term.
According to a very widely-accepted definition, venture capital is described as a
separate asset class, often labelled as private equity
Venture capital is basically equity finance in relatively new companies when it is too
early to go ta\ the capital market to raise funds
It is a long-term investment in growth-oriented small/medium firms. The
acquisition of outstanding shares from other shareholders cannot be considered
venture capital investment''^ is new, long-term /capital that is injected to enable the
business to grow rapidly.
There is a substantial degree of active involvement of the venture capital institutions
with the promoters of the venture capital A venture capital financing involves high
risk-return spectrum Some of the ventures yield very high returns to more than
compensate for heavy losses on others which also may have had potential of profitable
returns. The returns in such financing are essentially through capital gains at the time
of -exits from disinvestments in the capital market.
Venture capital is not technology finance though technology finance may form a sub-
set of venture capital financing
c)The Stages of Financing The selection of investment by a VCI is closely related to
the stages and type of investment. From analytical angle, the different stages of
investments are recognised and vary as regards the time-scale, risk perceptions and
other related characteristics of the investment decision process of the VCIs
c.(i)Earty Stage Financing
Seed Capital This stage is essentially an 'applied research' phase where the concepts
and ideas of the promoters constitute the basis of a pre-commercialisation research
project usually expected to end in a prototype which may or may not lead to a
business launch The main risk at this stage is marketing related. The commercial
acumen of the promoter to take advantage of the market opportunity, awareness of
competition, the timing of launching the product and so on, are important elements of
the appraisal. The risk perception of investment at this stage is extremely high.
However, very few VCIs invest in this pre-commercialisalion/seed stage of product
development.
c.(ii)Start-Up This is the stage when commercial manufacturing has to commence.
Venture capital financing here is provided for product development and initial
marketing. The essence of this stage is that the product/ service is being
commercialised for the first time in association with the VCIs
c.(iii).Second Round Financing This represents the stage at which the product has
already been launched in the market but the business has not, yet, become profitable
enough for public offering to attract new investors. The promoter has invested his own
funds but further infusion of funds by the VCIs is necessary
Stages of Financing The selection of investment by a VCI is closely related to the
stages and type of investment. From analytical angle, the different stages of
investments are recognised and vary as regards the time-scale, risk perceptions and
other related characteristics of the investment decision process of the VCIs
c.(iv).laterStage Financing This stage of venture capital financing involves established
businesses which require additional financial support but cannot take recourse to
public issues of capital. It includes mezzanine/development capital, bridge/expansion,
buyouts and turnarounds.
Mezzanine/Development Capital This is financing of established businesses which
have overcome the extremely high-risk early stage, have recorded profits for a few
years but are yet to reach a stage when they can go public and raise money from the
capital market/conventional sources
Bridge/Expansion This finance by VCIs involves low risk perception and a time-
frame of one to three years. Venture capital undertakings use such finance to expand
business by way of growth of their own productive asset or by the acquisition of other
firms/assets of other
BuyOuts These refer to the transfer of management .control. They fall into two
categories:
management buyouts (MBOs) and management buyins
'anagement BuyOuts In MBOs, VCIs provide funds to enable the current operating
management/ investors to acquire an existing product line/business.
Management Buyins MBIs are funds provided to enable an outside group [of
manager(s)] to buy an Ongoing company. They usually bring three elements together:
a management team, a target company and an investor Buyouts involve a time-frame
from investment to public offering of one to three years with low risk perception.
Turnarounds These are a sub-set of buyouts and involve buying the control of a sick
company. Two Kinds of inputs are required in a turnaround namely, money and
management. The VCIs have to identify good management and operations leadership.
Such form of venture capital financing involves medium to high risk and a time-frame
of three to .five years. It is gaining widespread acceptance and increasingly becoming
the focus of attention of VCIs
Stages of Investments As pointed out earlier, the methods of portfolio valuation of
shares depend on the stage of venture capital investments.
Unquoted Venture Investments Unquoted venture investments are defined as
investments in immature companies, namely, seed, start-up and early stage, until the
companies stabilise and grow. They should generally be valued at cost as their market
value is not available
Unquoted Development Investments Unquoted development in vestments, are
investments in mature companies with a profit record and where an exit can be
reasonably foreseen,
quoted Investments Quoted investments in companies which have achieved a possible
exit by floatation of issues. They are valued at market quotations. In case of
restrictions/limitations on the sale of shares, a suitable discount should be applied to
the market value of the shares
d) Debt Instruments VCIs provide, in addition to equity capital, debt finance. From
the point of view of their valuation as a part of the overall portfolio (fund), they are
divided into
convertible,
non-convertible and
leveraged
Convertible Debt Debt instruments are generally valued at cost. But convertible debts
are converted into equity at a specified price and time.;
Market Value Method This is appropriate for quoted convertible debt investments on
the basis of the -same principles as are applicable to quoted investments.
Value Method This is appropriate, as in the case of unquoted equity investments, for
unquoted convertible debt investments. As pointed out earlier, the valuation according
to this method is based on the price agreed upon in an open and unrestricted market
Non-convertible Debt This debt supplied by VCIs can be of two types: fixed interest
bearing such as bonds/debentures and mortgages and non-interest bearing such as
zero interest bonds and secured premium notes.
Fixed Interest Non-convertible Debt This should be valued by relating the nominal
yield of the investment to an appropriate current yield which depends upon a number
of factors such as interest yield on the date of valuation, maturity date of the issue,
safety of the principal, debt-service coverage, stability and growth of the earnings of
the venture and so on.
Non-interest Non-convertible Debt A factor of critical importance in this case is the
solvency of the venture. If it is doubtful, an appropriate discount rate may be used to
the value computed according to the method used for valuating fixed interest non-
convertible debt
EXIT
The last stage in venture capital financing is the exit to realise the investment so as to
make a profit/ minimise losses. In fact, the potential exit in terms of the realisation
horizon (exit timing) has to be planned at the time of the initial investment itself. The
precise timing of exit depends on several factors such as nature of the venture, the
extent and type of financial stake, the state of actual and potential competition, market
conditions, the style of functioning as well as perception of VCIs and so on. For
example, early stage financing typically takes a long-term view of eventual
realisation/exit from five to seven years. In case of later stage financing, the
realisation horizon could be shorter in the range of three to fives
e) VENTURE CAPITAL FUNDS
Nodal Agency for VCFs
To simplify procedure, the Finance Act, 2000 has made SEBI the single-point nodal
agency for registration and regulation of both domestic and overseas Venture Capital
funds (VCFs). No approval of VCFs by tax authorities is required. VCFs shall enjoy a
complete pass-through status. There will be no tax on distributed or undistributed
income of such funds. The income distributed by the funds will only be taxed in the
hands of investors at the rates applicable to the nature of income.
e.(i) Investment Restrictions
The following restrictions apply to investments by VCFs:
(a) VCF has to disclose the investment strategy at the time of application for
registration,
(b) A VCF cannot invest more than 25% corpus of the fund in one venture capital
undertaking (VCU)/
(c) VCF cannot invest in the associated companies, and
(d) VCF have to make investment in the VCU as per following:
(i) At least 75% of the investible fund has to be invested
'
(ii) Not more than 25% of the investible funds may be invested by way of subscription
to IPO
E(ii).Regulations of VCFs
SEBI amended regulations for VCFs. The salient amendments are:
(i) VCF is a fund established in he form of a trust/a company including a body
corporate and registered with SEBI. It has a dedicated pool of capital, raised in the
specified manner and invested in VCUs in accordance with the regulations
(ii)The minimum investment in a VCF from any investor would not be less than Rs. 5
lakh and the minimum corpus of the fund before it could start activities should be at
least Rs. 5 crore.
(iii) The norms of investment were modified. A VCF seeking to avail benefit under the
relevant provisions of the Income Tax Act will be required to divest from the
investment within a period of one year from the listing of the VCU
(iv)The VCF will be eligible to participate in the IPO through book building route
as'Qualified Institutional Buyer.
(v) The mandatory exit requirement by VCF from the investment within -one year of
the listing of the shares of VCUs to seek tax pass-through was removed under the
SEBI (VCF) Regulation to provide for flexibility in exit to VCFs.
'
(vi)The VCFs were directed to provide with the information pertaining '—-to their
venture capital activity for every quarter starting form the quarter ending
December 31, 2000.
(viii) Automatic exemption was granted from applicability of open offer requirements
in case of transfer of shares form VCFs in Foreign Venture Capital Investors (FVCIs)
to promoters of a VCU
There were 35 VCFs registered with SEBI as at end June 2001. During the year 2000-
01, 13 new domestic VCFs and only 1 FVCI were registered. All VCFs are now
required to provide information pertaining to their venture capital activity for every
quarter starting from the quarter ending December 2000
SBI ASSISANCE TO SMALL UNITS
The SBI helps the small units in the following ways:
1.offers working capital
2.Medium term loans and installment credit .
3.Discounting of bills.
4.Entrepreneur development programmes.
5.Encouraging women entrepreneur.
6. Promotion of village and cottage industry.
7.Encouraging self employment schemes .
8.Provides technical and financial consultancy services.
9.Special village industrial division.
10.Project uptech.
UNIT -IV
I. MERCHANT BANKINGa)INTRODUCTION:
Merchant banking which is synonymous with financial services has been
identified in India with just issue management in academic and popular parlance. It is
quite common to come across references to merchant banking and financial services
as thought they are distinct categories. Actually, merchant banking includes the entire
range of financial services. The services provided by a merchant bank outfit, however,
are subject to their inclination and resources, technical and financial.
Merchant bankers (Category I) however are mandated by SEBI to manage
public issues (as lead managers). Issue management activity has a big fall out on the
integrity of the market. It affects inventors’ interest and hence transparency has to be
ensured. There are also areas where compliance can be monitored and enforced.
b)BANKING COMMISSION REPORT, 1972
The banking commission in its report in 1972 has indicated the necessity of
merchant banking service in view of wide industrial base of the Indian economy. The
Commission was in favour of a separate institution (distinct from commercial banks
and term leading institutions) to render merchant banking services. The commission
suggested that they should offer investment management and advisory services
particularly to the medium and small savers. The commission also suggested that they
should be able to manage provident funds, pension funds and trusts of various types.
c)MERCHANT BANKING IN INDIA
Merchant banking activity was formally initiated into the Indian capital markets
when Grindlays Bank received the license from Reserve Bank in 1967. Grindlays
which started with management of capital issues recognized the needs of an emerging
class of entrepreneurs for diverse financial services ranging from production planning
and systems design to market research. Apart from meeting specially, the needs of
small scale units, it provided management consultancy services to large and medium
sized companies.
d)SERVICES RENDERED BY MERCHANT BANKS
The working of merchant banking agencies and subsequent units formed to
offer merchant banking services has shown that merchant banks are rendering diverse
services and functions such as organizing and extending finance for investment in
projects, assistance in financial management, acceptance of house business, raising
Eurodollar loans and issue of foreign currency bonds, financing local authorities,
financing export of capital goods, ships, hydropower installation, railways, financing
of hire-purchase transactions, equipment leasing, mergers and takeovers, valuation of
assets, investment management and promotion of investment trusts.
e) REGULATION
Merchant banking activities are regulated by (1) Guidelines of SEBI and
Ministry of Finance, (2) Companies Act, 1956 and (3) Listing guidelines of Stock
Exchanges and (4) Securities Contracts (Regulation) Act, 1956.
Merchant banking activities especially those covering issue and underwriting of
shares and debentures are regulated by the Merchant Bankers Regulations of
Securities and Exchange Board of India (SEBI). Merchant banking activities are of
course, organized and undertaken in several forms. Commercial banks, Indian and
foreign Development Finance Institutions (DFIs) have organized them through
formation of divisions; nationalized banks have formed subsidiary companies; and
share brokers and consultancies constituted themselves as private limited companies
or firms, partnerships or proprietary concerns.
f)NATURE OF MERCHANT BANKING
Merchant banking is a skill-based activity and involves servicing any financial
need of the client. It requires a focused skill base to provide for the requirements of a
client. SEBI has made the quality of manpower as one of the criteria for renewal of
merchant banking registration. These skills should not be concentrated in issue
management and underwriting alone, which may cause an adverse impact on business
as witnessed in 1995. Merchant bankers can turn to any of the activities mentioned
above, depending on resources, such as capital, foreign tie-ups for overseas activities
and skills.
g)ORIGIN OF MERCHANT BANKING-ABROAD
The origin of merchant banking is to be traced to Italy in late medieval times
and France during the seventeenth and eighteenth centuries. The Italian merchant
bankers introduced in England not only the bill of exchange but also all the
institutions and techniques connected with an organized money market. In France,
during seventeenth and eighteenth centuries a merchant banker ( Merchant Banquer)
was not merely a trader but an entrepreneur par excellence. He invested his
accumulated profits in all kinds of promising activities. He added banking business to
his merchant activities and became a merchant banker.
II.REGULATIONS OF MERCHANT BANKING
a)NOTIFICATIONS OF THE MINISTRY OF FINANCE AND SEBI
Merchant bankers have to be organized as body corporate. They are governed
by the Merchant Bankers Rules (MB Rules) issued by the Ministry of Finance and
Merchant Bankers Regulations (M B Regulations) issued by SEBI (22.12.1992)
RATIONALE OF NOTIFICATIONS
Investor’s confidence is a prerequisite for an orderly growth and development
of the securities market. In the primary market, investor’s confidence depends in a
large measure on the efficiency of the issue management function which covers
drafting and issue of prospectus or letter of offer after submitting it to SEBI and
timely dispatch of share certificates or refund orders.
III.OBJECTIVES OF THE MERCHANT BANKERS REGULATIONS
M B regulations which seek to regulate the raising of funds in the primary
market would assure the issuer a market for raising resources effectively and easily, at
a low cost, to ensure a high degree of protection of the interests of the investors and
provide for the merchant banker a degree of protection of interests of the investors and
provide for the merchant banker a dynamic and competitive market with high standard
of professional competence, honesty, integrity and solvency. The regulations would
promote a primary market which is fair, efficient, flexible and inspires confidence.
IV.DEFINITION OF MERCHANT BANKER
The notification of the Ministry of Finance defines a merchant banker as, “ any
person who is engaged in the business of issue management either by making
arrangements regarding selling, buying or subscribing to securities as manager,
consultant, advisor or rendering corporate advisory service in relation to such issue
management.
AUTHORISED ACTIVITIES
The authorized activities would include issue management which consists of
preparation of prospectus and other information relating to the issue, determining
financing structure, tie-up of finances and final allotment and/or refund of
subscription, corporate advisors to the issue, managers, consultants or advisors to
issue and underwriting. Other authorized activities would be portfolio management
services.
CRITERIA FOR AUTHORISATION
The criteria for authorization takes into account (a) professional qualification in
finance, law or business management (b) infrastructure like adequate office apace,
equipment and manpower, (c) employment of two persons who have the experience to
conduct the business of merchant bankers (d) capital adequacy and (e) past track
record, experience, general reputation and fairness in all their transactions.
V.PROSPECTUS (FILING AND REGISTRATION)
The Registrar of Companies (ROC) has also been advised that prospectus for
public issue can only be filed by merchant bankers who are authorized by SEBI and
given a code number. Further, the Registrar of Companies is required not to register a
prospectus where he has been informed by SEBI that the contents of the prospectus
are in contravention of the provisions of any law or statutory rules and regulations.
Registration of Merchant Bankers
SEBI abolished on 5-9-1997 all categories of merchant bankers below category
I, Merchant bankers operating in the categories below I have to apply for category I
status or take up some other activity. Portfolio management requires separate
registration. Underwriting could be done without any additional registration. Merchant
bankers can carry on any activity of issue management, which will inter alia consist
of preparation of prospectus and other information relating to the issue determining
financial structure, tie-up of financiers and final allotment and refund of the
subscription and act in the capacity of managers, advisor or consultant to an issue,
portfolio manager and underwriter.
Networth
Minimum networth is Rs.5 crores. Registration fee is Rs. 2.5 lakhs annually in
the first two years and Rs. 1 lakh in third year and Rs. 1 lakh to pay annually. Number
of lead managers: The number of lead managers depends on the size of the public
issue. The guidelines stipulate that for an issue of upto Rs.50 crores, the number of
lead managers should not exceed two, for issues between Rs.50-100 crores maximum
of three, for issues between Rs.100-200 crores,four,for issues above Rs.200 crores but
less than Rs.400 crores, five, and for issues above Rs. 400 crores, five or as may be
agreed by SEBI.
Code of Conduct
The code of conduct stipulates that in the performance of duties, merchant
bankers should act in an ethical manner, inform the client that he is obliged to comply
with the code of conduct, render high standard of service and exercise due diligence,
not to indulge in unfair practices, not to make misrepresentations, give best advice,
not to divulge confidential information about the clients, endeavor to ensure that true
and adequate information is provided to investors and to abide by all rules,
regulations, guidelines, resolutions issued by the Government of India and SEBI from
time to time.
VI.GENERAL OBLIGATIONS AND RESPONSBILITIES
Merchant bankers have to furnish annually to SEBI copies of balance sheet,
profit and loss account and such other documents for preceding five accounting years
as required.
Merchant bankers are required to submit to SEBI half-yearly working results
with a view to monitor the capital adequacy. Books, records and documents should be
preserved for five years. Auditor’s report should be acted upon within two months.
Merchant bankers should execute an agreement with the issuing company setting out
their mutual rights, liabilities and obligations, relating to such issue and in particular
to disclosures, allotment and refund.
VII.PROCEDURES FOR INSPECTION
SEBI may inspect books of accounts, records and documents of merchant
bankers to ensure that the books of account are maintained in the required manner,
that the provisions of the act, rules, and regulations are being complied with, to
investigate complaints against the merchant bankers and to investigate suo moto in the
interest of securities business or investor’s interest into the affairs of the merchant
bankers. SEBI may either give reasonable notice or undertake inspection without
notice in the interest of the investor. The findings of inspection report are
communicated to the merchant banker. SEBI may appoint a qualified auditor to
investigate into the books of account or the affairs of merchant banker.
Penalties for compliance of conditions: for registration and contravention of the
provisions of MB regulations include suspension or cancellation of registration. SEBI
categorized defaults and the penalty points they attract.
The details regarding defaults of merchant bankers and penalty points are as
follows:
Defaults Penalty points
1. General default 1
2. Minor default 2
3. Major default 3
4. Serious default 4
VIII.defaults
a)General Defaults:
For the purpose of penalty point, the following activities fall under general
default and attract one penalty point
(a) Non-receipt of draft prospectus/letter of offer from the lead manager by SEBI,
before filing with Registrar of Companies/Stock Exchange.
(b)Non-receipt of inter se allocation of responsibilities of lead managers in an
issue by SEBI prior to the opening of issue.
(c) Non-receipt of due diligence certificate in the prescribed manner by SEBI,
before opening of the issue.
(d)Failure to ensure submission of certificate of minimum 90 per cent subscription
to the issue as required under Government of India, press note No. F2/14/cci$90
dated 6th April, 1990.
(e) Failure to ensure publicing of dispatch of refund orders, shares/debentures
certificates, filing of listing application by the issuer as required under
Government of India press notification No.2/6/cci/89 dated 10-1-1990.
b)Minor Defaults:
The following activities are categorized under minor defaults and attract two
penalty points.
(a) Advertisement, circular, brochure, press release and other issue related
materials not being in conformity with contents of the prospects.
(b)Exaggerated information or information extraneous to the prospectus is given
by the issuer or associated merchant banker in any press conference, investor
conference, brokers conference or other such conference/meet prior to the issue
for marketing of the issue arranged/participated by the merchant banker.
(c) Failure to substantiate matters contained in highlights to the issue in the
prospectus.
(d)Violation of the Government of India letter number F 1/2/SE/86 dated 24 th
March 1986 and/or Government of India letter number F 1/23/SE/86 dated 24th
June 1987 regarding advertisement on new capital issues.
(e) Failure to exercise due diligence in verifying contents of prospectus/letter of
offer.
(f) Failure to provide adequate and fair disclosure to investors and objective
information about risk factors in the prospectus and other issue literature.
(g)Delay in refund/allotment of securities.
(h)Non handling of investor grievances promptly.
c)Major Defaults:
The following activities are categorized under major defaults and attract three
penalty points:
a) Mandatory underwriting not taken by lead managers.
b) Excess number of lead managers than permissible under SEBI press
release of 28th February, 1991.
c) Association of unauthorized merchant banker in an issue.
d)Serious Defaults:
The following activities are categorized under serious defaults and attract four
penalty points:
a) Unethical practice by merchant banker and/or violation of code of
conduct.
b) Non cooperation with SEBI in furnishing desired information,
documents, evidence as may be called for.
A merchant banker on reaching cumulative penalty points of eight (8) attracts
action from SEBI in terms of suspension/cancellation of authorization.
To enable a merchant banker to take corrective action, maximum penalty points
awarded in a single issue managed by a merchant banker are restricted to four.
In the event of joint responsibility, same penalty point is awarded to all lead
managers jointly responsible for the activity. In the absence of receipt of inter se
allocation of responsibilities, all lead managers to the issue are awarded the penalty
points.
Defaults in Prospectus:
If highlights are provided, the following deficiencies will attract negative points:
i) Absence of risk factors in highlights.
ii) Absence of listing in highlights
iii) Extraneous contents to prospectus, if stated in highlights.
The maximum grading points of prospectus will be 10 and prospectuses scoring
greater than or equal to 8 points are categorized as A+, those with 6 or less than 8
points as A, with 4 or less than 6 points as B and with score of less than 4 points, the
prospectus falls into Category C.
> 8 A+
> 8 6 A
< 6 4 B
< 4 C
Merchant bankers are advised to take note of the above system of prospectus
grading and should endeavour to give fair and adequate disclosures in prospectus for
the benefit of investors.
General Negative Marks:
If at all ‘Highlights’ are provided in the issue,
i) Risk factors should form part of ‘Highlights’, otherwise it will attract
negative point of -1
ii) Listing details, should form a part of ‘Highlights’, otherwise it will attract
negative point of -0.5
iii) Any matter extraneous to the contents of the prospectus if stated in
highlights, will attract negative point of -0.5.
IX.PRE-ISSUE AND POST-ISSUE OBLIGATIONS AND OTHER
REQUIREMENTS
PRE-ISSUE OBLIGATIONS:
Due Diligence:
The lead merchant banker should exercise due diligence. The standard of due
diligence should be such that he should satisfy himself on all the aspects of offering,
veracity and adequacy of disclosure in the offer documents. Such a liability on his part
would continue even after the completion of the issue process.
Memorandum of Understanding (MOU)
To make an issue of a security through a public or right issue, an MOU must be
entered into between the lead manager (merchant banker) and the issuing company,
specifying their mutual rights, liabilities and obligations relating to the issue.
Due Diligence Certificate
The lead merchant banker should furnish to the SEBI a due diligence certificate
along with the draft prospectus. In case of debenture issues, he should also furnish to
the SEBI a due diligence certificate given by the debenture trustees as specified in
along with the offer document.
Undertaking:
The issuer should submit an undertaking to the SEBI to the effect that
transactions in securities, by the promoter/promoter group and their immediate
relatives, during the period between the date of filing the offer document with the
Registrar of Companies (ROCs/stock exchange(s) and date of the closure of the issue
would be reported to the stock exchange concerned, within 24 hours of the
transaction(s).
Merchant Bankers:
A merchant banker who is associated with the issuer company as a
promoter/director/associate should not lead/manage its issue. However, a merchant
banker holding securities of a company can lead/manage its issue.
Co-managers:
The lead merchant bankers must ensure that the number of co-managers does
not exceed the number of merchant bankers to an issue, and there is only one advisor
to the issue.
Other Intermediaries:
It is the responsibility of the lead merchant bankers to ensure that other
intermediaries being appointed are duly registered with the SEBI, wherever
applicable. They should independently assess their capability/capacity to carry out the
assignment.
They should further ensure that (i) issuer companies would enter into an MOU
with intermediary/intermediaries concerned, whenever required and (ii) bankers to the
issue are appointed in all the mandatory collection centres.
Underwriting:
The lead merchant banker(s) should:
Satisfy themselves about the ability of the underwriters to discharge their
underwriting obligations;
Incorporate a statement in the offer document to the effect that in their opinion
the underwriters’ assets are adequate to meet their underwriting obligations;
Obtain written consent of the underwriters before including their names in the
offer document;
Undertake in respect of every underwritten issue a minimum underwriting
obligation of five per cent of the total underwriting commitment or Rs.25 lakh,
whichever is less; the outstanding underwriting commitments of a merchant
banker should nor exceed 20 times of its networth at any point of time;
Ensure that the relevant details of underwriters are included in the offer
document.
Agreement with Depositories:
The lead managers should ensure that (i) the issuer company has entered into an
agreement with depository(ies) for dematerialization (demat) of securities, (ii) an
option be given to the investors to receive allotment of securities in demat format.
X.POST-ISSUE OBLIGATIONS/REQUIREMENTS
Post-Issue Monitoring Reports:
Irrespective of the level of subscription, the post-issue lead merchant banker
must ensure the submission of the post-issue monitoring reports.
(a) 3-day monitoring report for book-built portion, in case of issue through book
building; the due date of the report would be the third day from the date of
allocation in the book-built portion
(b)3-day monitoring report in other cases, including fixed price portion of book-
built issue
(c) final post-issue monitoring report for all issues
Redressal of Investor’s Grievances
The post-issue lead merchant banker should actively associate himself with
post-issue activities namely, allotment, refund and dispatch and regularly monitor the
redressal of investors’ grievances arising there-from.
Stockinvest:
The lead merchant banker should ensure compliance with the instructions
issued by the RBI on the handling of stockinvest by any person, including registrars to
an issue.
Underwriters:
If the issue is proposed to be closed at the earliest closing date, the lead
merchant banker must satisfy himself that the issue is fully subscribed before
announcing closure of the issue. In case there is no definite information about
subscription figures, the issue should be kept open for the required number of days to
take care of the underwriters’ interests and avoid any dispute, at a later date, by the
underwriters, with respect to their liability.
Bankers to an Issue:
The post-issue lead merchant banker should ensure that money (es) received
pursuant to the issue and kept in separate bank (i.e. bankers to an issue), as per the
provisions of Section 73(3) of the Companies Act, 1956, is released by the bank only
after the listing permission has been obtained from all the stock exchanges where the
security was proposed to be listed as per the offer document.
UNIT V
I.MERGERS/AMALGAMATIONS AND
ACQUISITION/TAKEOVERS
a)Introduction
Following the economic reforms in India in the post-1991 period, there is a
discernible trends among promoters and established corporate groups towards
consolidation of market share and diversification into new areas through
acquisition/takeover of companies but in a more pronounced manner through mergers/
amalgamations The acquisition/takeover bids fall under the purview of SEBI. The
terms mergers and amalgamations on the one hand and acquisitions and takeovers on
the other are treated here synonymously/interchangeably
The terms merger and amalgamation are used interchangeably as a form of
business organisation to seek external growth of business- A merger is a combination
of two or more firms in which only one firm would survive and the other would cease
to exist, its assets/liabilities being taken over by the surviving firm. An amalgamation
is an arrangement in which the assets/liabilities of two or more firms become vested in
another firm. As a legal process, it involves joining of two or more firms to form a
new entity or absorption of one/more firms with another. The outcome of this
arrangement is that the amalgamating firm is dissolved/wound-up and loses its
identity and its shareholders become shareholders of the amalgamated firm
b)Scheme of Merger/Amalgamation
Whenever two/more companies agree to merge with each other, they have to
prepare a scheme of amalgamation. The acquiring company should prepare the
scheme in consultation with its merchant banker financial consultants. The main
contents of a model scheme, inter-aUa, are as listed below.
Description of the transfer and the transfree company and the business of the
transferor.
A. Their authorised, issued and subscribed/paid-up capital.
Change of name, object clause and accounting year.
Protection of employment.
Dividend position and prospects.
Management: Board of directors, their number and participation of transfree
companys' directors on the board.
Application under sections 391 and 394 of the Companies Act, 1956, to obtain
High Court's approval.
c)Expenses of amalgamation.
Conditions of the scheme to become effective and operative, effective date of
amalgamation
Essential Features of Scheme of Amalgamation The essential features or pre-
requisites ror any scheme of amalgamation are as enumerated below
Determination of Transfer Date (Appointed Date) This involves fixing of the
cut-off date from which all properties, movable us well as immovable and rights
attached thereto are sought to be transferred from amalgamating company to the
amalgamated company..
Determination of Effective Date by when all the required approvals under
various statutes, viz, the Companies Act 1956. The Companies (Court) Rules 1959,
Income Tax Act, 1961. Sick Industrial Companies (Special Provisions) Act, 1985,
would be obtained and the transfer and vesting of the undertaking of amalgamating
company with the amalgamated company would take effect. This date is called
effective date. A scheme of amalgamation normally should also contain conditions to
be satisfied for the scheme to become effective
Approve from Shareholders In terms of Section 391, shareholders of both the
amalgamating and the amalgamated companies should hold their respective meetings
under the directions of the respective high courts and consider the scheme of
amalgamation. A separate meeting of both preference and equity shareholders should
be convened for this purpose
Approval from Creditors/Financial Institutions/Banks Approvals are required
from the creditors, banks and financial institutions to the scheme of amalgamation in
terms of their respective agreements/arrangements with each of the amalgamating and
the amalgamated companies as also under
Approvals from Respective High Court(s) Approvals of the respective high
court(s) in terms of Sections 391-394, confirming the scheme of amalgamation are
required. The courts issue orders for dissolving the amalgamating company without
winding-up on receipt of the reports from the official liquidator and the regional
director. Company Law Board, that the affairs of the amalgamating company have not
been conducted in a manner prejudicial to the interests of its members or to public
interests
Step-wise Procedure for amalgamation is detailed below.
Object Clause The first step is to examine the objects clauses of the
memorandum of association of the transferor and the transferee companies so as to
ascertain whether the power of amalgamation exists or not. The objects clause of
Transferee Company should allow for carrying on the business of the transferor
company. If it is not so, it is necessary to amend the objects clause. Similarly, it
should be ascertained whether the authorised capital of the transferee company would
be sufficient after the merger/ amalgamation.
Preparation of a scheme of amalgamation on the lines explained earlier.
Meetings/Information
(i) Holding of meetings of the board of directors of both the transferor and the
transferee companies
(a) To decide the appointed date and the effective date,
(b) To approve the scheme of amalgamation and exchange ratio and
(c) To authorise directors/officers to make applications to the
appropriate high court for necessary action.
(i) Inform the stock exchanges concerned about the proposed
amalgamation immediately after the board meetings.
ii) The shareholders and other members of the companies should
also be informed through press release.
(iii) The transfer or the and transferee companies should inform the
financial institutions, bankers/ debenture-trustees at least 45 days
before the board meeting so that their approval is available to the
proposed amalgamation at the time of board meeting.
d)Application for Amalgamation
An application for amalgamation can be submitted by the company,Members or
even any of the creditors. A member, In this context means any person who has
agreed to be a member and whose name appears on the register of members. A
creditor includes all persons having pecuniary claims against the company for some
amount whether present or future, definite or contingent. Even one member or one
such creditor can make an application for amalgamation. Where the application is
proposed to be made by the company, only a person authorised by the company in this
behalf can make an application for amalgamation. It is, therefore, essential that the
company should authorise the director(s) or other officer(s) to make an applicalion to
the appropriate high courts and take necessary action as may be required from time to
time
Procedure for Application to the High Court The procedure for making
application to the high court has been laid down under the Companies (Court) Rules,
1959. An application under section 391(1) for an order convening a meeting of
creditors and/or members or any class of them should be by a judge's summons
supported by an affidavit. A copy of the proposed compromise or arrangement should
be annexed to the affidavit
On receipt of" the application by the high court, hearing takes place in the
judge's chamber, and after the hearing the judge may cither dismiss the summons or
order a meeting of the members or may give such directions as he may think
necessary On being not satisfied with the scheme, the court may not even order the
calling of meeting of creditors and/or members.
Holding of Meeting The next step is to hold separate meetings of the
shareholders and creditors of me company to seek approval to the scheme. The
resolution approving the scheme may be passed by voting in person or by proxy as per
the directions of the high court. At least three-fourth in value of the members or
claims of members or creditors must vote in favour of the resolution approving the
scheme of amalgamation,
The members and the creditors are require to be classified into different classes
for the purpose of convening meetings. This process has to be followed immediately
on receipt of application under section 391(1). If meetings of incorrect classification
are convened and objection is taken with regard to any particular creditor of having
interest competing with others, the company runs the risk of the scheme being
dismissed
For the purpose of convening meetings the court may give directions as it may
deem fit regarding the following:
(i) Determining the class or classes of creditors and/or members whose
meeting(s) have to be held for considering the proposed compromise or
arrangement;
(ii) Fixing the time and place of such meeting(s);
(iii) Appointing a chairman or chairmen for the meeting(s) to be held,
as the case may be;
(iv) Fixing the quortum and the procedure to be followed at the
Meeting (s) including voting by proxy;
(v) Determining the values of creditors and/or the members of any
Class, as the case may be, whose meetings have to be held;
(vi) Notice to be given of the meeting(s) and the advertisement of such
notice;
(vii) The time within which the chairman of the meeting is to report to
the court the results of the
meeting; and such other matters as the court may deem necessary. The notice of
the meetings of members and/or creditors, should be:
(a) Sent to the members/creditors;
(b) sent to them individually by the chairman appointed for the meeting or if the court
so directs, by the company or any other person as the court may direct, by post
under certificate of posting to the last known address at least 21 clear days
before the date of the meeting;
(c) Accompanied by a copy of the proposed scheme of compromise or arrangement
and of the statement required to be furnished under section 393 and also a form
of proxy
e) REPORT of Chairman to the Court
The chairman of the meeting must within the time fixed byThe court or where
no time is fixed within 7 days of the date of the meeting, report the result of the
meeting to the court. The report should state accurately the number of creditors or
class of creditors or the numbers of members or class of members, as the case may be,
who were present who voted at the meeting either in person or by proxy, their
individual values and the way the voted.
Presenting Petition Before the Court After the proposed scheme is agreed to
with or without modification in terms of section 391(2), the company must within
seven days of the filing of the report by the chairman, present a petition to the court
for confirmation of the compromise or arrangement. A copy of the petition should
also be submitted to the regional director, company law board and others as directed
by the court. The court would not sanction a scheme simply because it is
recommended by the board of directors and approved by a statutory majority of the
company. The court would have to see itself whether the scheme is reasonable and fair
to all parties. A scheme which is proper on the face of it and in respect of which no
fraud is alleged would not be rejected unless the objector shows any valid ground
against
Application for Direction If necessary, an application for direction of the court
to provide for all or any matters indicated in Section 394(1) These are
(i) The transfer to the transfree company of the whole or any part of the
undertaking, property or liabilities of any transferor company;
(ii) The allotment or appropriation by the transfree company of any shares,
debentures, policies, or other like interests in that company which, under the
compromise or agreement, are to be allotted or appropriated by that
company to or for any person;
(iii) The continuation by or against the transfree company of any legal
proceedings pending by or against any transferor company;
(iv) The dissolution, without winding-up, of any transferor company;
(v) The provision to be made for any persons who, within such time and in such
manner as the court directs, dissents from the compromise or
arrangement; and
(vi) Such incidental, consequential and supplemental matters as are necessary to
secure that the reconstruction or amalgamation would be fully and
effectively carried out.
The court would pass an order. Alternatively, by adding a suitable prayer in
the main application, the court could be requested to give direction in regard to the
above
Certificate A certified copy of the order of the court dissolving the
amalgamating company or giving approval to the scheme of merger, should be filed
with the Registrar of Companies concerned within 30 days of the date of the court's
order.
Court order A copy of the order of the court should be to attached to the
memorandum and articles of association of the transfree company
f)Financing Techniques in Mergers After the value of firm has been determined on
the basis of the preceding analysis, the next step is the choice of the method of
payment of the acquired firm
Ordinary Share Financing When a company is considering the use of common
(ordinary) shares to finance a merge. the relative price-earnings (P/E) ratios of two
firms are an important consideration. For instance, for;. firm having a high P/E ratio,
ordinary shares represent an ideal method for financing mergers and acquisitions/
Debt and Preference Shares Financing . financing of mergers and acquisitions
with equity shares is advantageous both to the acquiring firm and the acquired firm
when the P/E ratio is high. However, since some firms may have a relatively lower
P/E ratio as also the requirement of some investors might be different, other types of
securities, in conjunction with/in lieu of equity shares, may be used for the purpose
Deferred Payment Plan Under this method, the acquiring firm, besides making
an initial payment, also undertakes to make additional payments in future years to the
target firm in the event of the former being able to increase earnings consequent to the
merger. Since the future payment is linked to the firm's earnings, this plan is also
known as earn-out plan base-period earn-out. Under this plan, the shareholders of the
target firm are to receive additional shares for a specified number of future years, if
the firm is able to improve its earnings vis-a-vis the earnings of the base period (the
earnings in the previous year before the acquisition firm
Tender Offer A tender offer, as a method of acquiring a firm, involves a bid by
the acquiring firm for controlling interest in the acquired firm. The essence of this
approach is that the purchaser approaches the shareholders of the firm rather than the
management to encourage them to sell their shares generally at a premium over the
current market
Merger as a Capital Budgeting Decision the merger should be evaluated as a
capital budgeting decision. The target firm should be valued in terms of its potential to
generate incremental future cash inflows
Like the capital budgeting decision, the present value of the expected benefits
from the merger are to be compared with the cost of the acquisition of the target firm.
Acquisition costs include the payment made to the largel firm's shareholders and
debenture-holders, the payment made to discharge the external liabilities. estimated
value of the obligations assumed, liquidation expenses to be met by the acquiring firm
and so on less cash proceeds expected to be realised by the acquiring firm from the
sale of certain asset(s) of the target firm
Adjusted Present Value (APV) Approach The APV approach is a variant
of the DCF approach used to value the target firm. This approach is very
appropriate for valuing companies with changing capital structures (such as
leveraged buyout targets) and for valuing target companies which are having
capital structures substantially different from those of acquiring companies
The APV based valuation has its genesis in the Modigliani-Millcr (MM)
propositions on capital structure can affect the valuation only through taxes and other
market imperfection ions and distortions
Tax Aspects Related to Amalgamation/Mergers . According to Section 2 (1 B)
'amalgamation', in relation to companies, means the merger of one or more companies
with another company or the merger of two or more companies to form one company
(the company or companies that so merge are referred to as the amalgamating
company or companies and the company with which they merge or which is formed
as a result of the merger is the amalgamated company in such a manner that:
(i) All the property/liabilities of the amalgamating company(ie) immediately before
the amalgamation, becomes the property/liabilities of the amalgamated
company by virtue of the amalgamation
(ii) Shareholders holding not less than three-fourths (in value) of the shares in the
amalgamating company(ies) (other than shares already held therein
immediately before the amalgamation by the amalgamated company, its
subsidiary or by a nominee of the said company) become shareholders of the
amalgamated company by virtue of the amalgamation.
g)Tax Concessions to Amalgamated Company The following are the major benefits
available to the amalgamation i. Carry Forward and Set off of Business Losses and
Unabsorbed Depreciation/ According to section 72 A, the amalgamated company is
entitled to carry forward accumulated losses as well as unabsorbed depreciation of the
amalgamating company, provided the following conditions are fulfilled:
(i) The amalgamated company continuously holds, for a minimum period of 5 years,
from the date of amalgamation at least three-fourths of the above value of fixed
assets of the amalgamating company,
acquired in the scheme of amalgamation.
(ii) The amalgamated company continues the business of the amalgamating company
for a minimum period of 5 years from the date of amalgamation.
(iii) The amalgamated company fulfils such other conditions as may be prescribed to
ensure the revival of the business of the amalgamating company or to ensure
that the amalgamation is for genuine business purposes.
(iv) The amalgamation should be of a company owning an industrial undertaking or
ship
2, Expenditure on Scientific Research
3. Expenditure on Acquisition of Patent Rights or Copy
Rights 4. Expenditure on Know-how
5. Expenditure for Obtaining License to Operate
Telecommunication Services
6. Preliminary Expenses
7. Expenditure on Prospecting of Certain
8. Capital Expenditure on Family Planning
9. Bad Debts
Tax Concessions to Amalgamating Company The tax concessions to the
amalgamating are summarised below.
(i) Free of Capital Gains Tax According to Section 47 where there is a transfer
of any capital asset by an amalgamating company to any Indian amalgamated
company, such transfer will not be considered as a transfer for the purpose of
capital gain.
(ii) Free of Gift-Tax According to Section 45 (b) of the Gift Tax Act, where
there is a transfer of any asset by an Indian amalgamating company, gift tax
will not be attracted
II.STOCK-BROKERS
a) introduction
Stockbroker is a member of a recognised stock exchange who buys, sells or
deals in securities. A certificate Registration from SEBI is mandatory to act as a
broker. SEBI is empowered to impose conditions while granting the certificate. As a
member of a stock exchange, he will have to abide by its rules, regulations and by-
laws, pay the prescribed fee and take adequate steps for redressal of investors'
grievances within one month of the receipt of the complaint and keep SEBI informed
about the number, nature and other particulars of such complaints.
b)Registration
A broker, seeking registration with SEBI, has to apply through the stock
exchange of which he is a member. The application must be forwarded by the
exchange to SEBI within 30 days from the date of receipt. While forwarding the
application, the exchange should also include a statement to the effect that no
complaints/ arbitration cases are pending against the applicant for granting registration
to the broker, SEBI checks whether or not he is eligible to be a member of a stock'
exchange, has the necessary infrastructure including manpower to effectively
discharge his activities, has past experience in the business of buying, selling or
dealing in securities and is subject to disciplinary proceedings under the rules,
regulations and by-laws of the stock exchange with respect to his business and is a lit
and proper person.
Payment of Fee Every registered broker has to pay the SEBI a specified
registration fee based on the annual turnover, that is. the aggregate of the sale and
purchase prices of securities received and receivable by the stockbroker during any
financial year, on his own account as well as on account of his clients. For an annual
turnover up to Rs 1 crore, a sum of Rs 5,000 is to be paid as fee to the SEBI. For an
annual turnover in excess of Rs 1 crore, the registration fee is Rs 5,000 plus one
hundreth of one per cent of the turnover in excess of Rs I crore, for each financial
year. Code of Conduct Registered stockbrokers have to abide by a code of conduct
specified as follows:
General First, a stockbroker has to maintain high standards of integrity,
promptness and fairness with due skills, care and diligence in the conduct of all his
business. He should not indulge in manipulative, fraudulent or deceptive transactions
or schemes or spread rumours with a view to distorting the market equilibrium or
making personal gains
c)Duty to the Investor
1) To his dealings with clients and the general investing public, he should
faithfully execute the orders for buying and selling of securities at the best
available market price and not refuse to deal with a small investor merely on the
grounds of the volume of business involved He should promptly inform his
client about the execution or non-execution of an order, make prompt payment
in respect of securities sold and arrange for prompt delivery of securities
purchased by clients;
2. He should issue his clients, or clients of the broker, without delay, a contract
note for all transactions in the form specified by the stock exchanged
3 to avoid breach of trust, he should not disclose or discuss with any other
person or make improper use of the details uf personal investments and other
informationfif a confidential nature regarding his clients, which he comes to
know in the course of his business
4 Merely for generating business, with the sole objective of earning commission
and brokerage, he should riot encourage sales or purchases of securities and/or
furnish false or misleading quotations or give any other false or misleading
advice or information to the clients
5) He should avoid dealing or transacting business knowingly, directly or
indirectly with a client who Has faned to carry out his commitments in relation
to securities with another stockbrokey
(6) When dealing with a client, he is required to disclose whether he is acting as
a principal or as an agent and should ensure. at ihe same time, that no conflict
of interest arises between him and the client in the even of such a conflict, he
must inform the client accordingly and not seek to gain a direct or direct
personal advantage from the situation, and not consider the client's interest
inferior to his own
(7) He should not give investment advice to any client who might be expected
to rely thereon to acquire, depose of, retain any securities unless he has
reasonable grounds for believing that the recommendation suitable for such a
client upon the basis of the facts, if disclosed by such a client as to his own
security holdings, financial situation and objectives of such investment. The
stockbroker should seek such information from clients whenever he feels is
appropriate to do so:
(7-A) A stockbroker or any of his employees should render investment advice
directly or indirectly, about any security in the publicly accessible media,
whether real-time or non-real-time, only after disclosing his interest/interest of
his independent family members and the employer, including their short long
position in the security, while rendering such advice. The employee should also
disclose the interest of his dependent family members and the employer
including their short/long position; and
8A stockbroker should have adequately trained staff and arrangements to render
fair, prompt and competent services to his clients
Stockbrokers vis-a-vis Other Stockbrokers The code of conduct of stockbrokers
in relation to other brokers are related to/covers the following aspects N Conduct of
Dealings A broker should cooperate with other brokers in comparing unmatched
transactions delivery Protection of Clients' Interests He should extend full
cooperation to other brokers in protecting the interests of his clients regarding their
rights to dividends, bonus shares, rights issues and any other I rights related to such
securities. .
Transactions With Stockbrokers While carrying out his transactions with other
brokers, he comply with his obligations in completing the settlement of transactions
with them.
Advertisement and Publicly A stockbroker should not advertise his business
publicly unless permitted by the stock exchange Inducement of Clients He should not
resort to unfair means to induce clients from other stock False or Misleading Returns
A stockbroker should not neglect or fail or refuse to submit the required returns and
not make any false or misleading statement on returns required to be submitted to the
SEB1 and the stock exchange
d)General Obligations and Responsibilities
Every stock broker is required to keep and maintain the following books of
accounts, records and documents:
(a) Register of transactions
(b) Client ledger (c) General ledger(d) Journals
(e) Cash book
(f) Bank pass book
(g) Documents register containing, inter alia, particulars of securities received
and delivered in physical rbrmtnd the statement of account and other records
relating to receipt and delivery of securities provided by the depository
participant in respect of dematerialised (demat) sec uri ties
(h) Member's contract books showing details of all contracts entered into by
him with other members of the same exchange, or counterfoils of duplicates of
confirmationptnemos issued to such other Membe
(j) Counterfoils or duplicates of contract notes issued to clienisi (it Written
consent of clients in respectof contracts entered into as principals
(k) Margin deposit book
(L) Registers of accounts of sub-brokers/
(m) An agreement with a sub-broker specifying the scope of mutual authority
and responsibilities, of accounts and other records should be preserved for at
least five years
(i)An agreement With the sub-broker and with the client of the sub-broker to
establish priority of contract between the stock broker and the client of the sub-broker.
appointment of Compliance Officer Every stock broker should appoint a compliance
officer to monitor the compliance of the SEBI He should immediately and
independently report any non-compliance observed by him to the SEBI.
e)Stock Broker Not to Deal with Unregistered Sub-broker
A stock broker should not deal with any person as a sub-broker unless he
has obtained a certificate of registration from the SEBI.)
Procedure for Inspection
The SEBI is empowered to appoint one or more persons as inspection authority
to inspect the books of accounts, other records and documents of the stockbroker.
The SEBI can also appoint a qualified auditor to carry out
inspection/investigation into the records of the brokers.
Liability for Contravention of the SEBI Act, Rules/Regulations A stock broker
or a sub-broker who contravenes any of the provisions of the SEBI Act, rules or
regulations would be liable for any one or more of the following actions lability for
Monetary Penalty A stock broker or a sub-broker would be liable for monetary
penalty in respect of the following violations, namely:
Failure to file any return or report with the SEBI.
Failure to furnish any information, books or other documents within 15 days of
issue of notes by 1the SEBI.
Failure to maintain books of account or records as per the SEBI Act, rules or
regulations. Failure to redress the grievances of investors within 30 days of
receipts of notice from the SEBI.
Acting as an unregistered sub-broker or dealing with unregistered sub-brokers.
(xv) Failure to comply with directions issued by the SEBI under the SEBI Act or the
regulations. (wi) Failure to exercise due skill, care and diligence
(xvii) Failure to seek prior permission of the SEBI in case of any change in its status
and constitution. (xviii) Failure to satisfy the net worth or capital adequacy
norms, if any, specified by the SEBI. Extending use of trading terminal to any
unauthorised person or place.) Violations for which no separate penalty has
been provided
Liability for Action Under the Enquiry Proceeding Regulations A stock broker
or a sub-broker would be liable for any action as specified in the SEBI Regulation,
including suspension or cancellation of his certificate of registration, if he Ceases to
be a member of a stock exchange; or '' (ii) Has been declared defaulter by a stock
exchange as a member within a period of six months or : Surrenders his certificate of
registration to the SEB1or fails to pay the prescribed fee; or) Fails to comply with the
rules, regulations and bye-laws of the stock exchange of which he is a member
(x) Fails to cooperate with the inspecting or investigating authority; or
(x) Fails (o abide by any award of the Ombudsman or decision of the SEBI
under the SEBI (Ombudsman) Regulations, 2003; or
d) Fails to pay the penalty imposed by the adjudicating officer; or J(Xti)
Indulges in market manipulation of securities or index
(xiii) Indulges in insider trading in violation of SEBI (Prohibition of Insider
Trading) Regulations, 1992;
(vi) Fails to comply with the circulars issued by the SEBI: or
(xv) Commits violations specified pertaining to liability for monetary penalty
which in the opinion of the SEBI are of a grievous nature
Liability for Prosecution A stock broker or a sub-broker would be liable for
prosecution under iction 24 of the SEBI Act for any of the following violations,
namely:-
We dealing in securities without obtaining certificate of registration from the
SEBI.
(ii) Dealing in securities or providing trading floor or assisting in trading outside the
recognised stock exchange in violation of provisions of the Securities Contract
(Regulation) Act, or rules made or notifications issued thereunder.
(iii) Market manipulation of securities or index. . ,
(iv) Indulging in insider trading in violation of SEBI() Regulations 1992.
Violating the SEBI (Prohibition of Fraudulent and Unfair Trade Practices
relating to Securities
Market Regulations 2003
Failure to pay penalty imposed by the adjudicating officer or failure to comply
with any of his directions or orders.
f)Capital Adequacy Norms for Brokers
Base Minimum Capital An absolute minimum of Rs 5 lakh should be
maintained as a deposit with the stock exchange by member brokers of the Mumbai
and Kolkata Stock Exchanges, and Rs 3.5 lakh tor those of Delhi and Ahmedabad
Exchanges, irrespective of the volume of business. In case of the other stock
exchanges, the minimum requirement is Rs 2 lakh- aditional Capital Related to
Volume of Business The additional or optional capital required from a member
should, at any point of time, be such that together with the base minimum capital, it is
not less than 8 per cent of the gross outstanding business in the stock exchange
defined as the ciggregate of up to date sales and purchases by a member-broker in all
the securities put together
Calculation the capital of a member-broker is computed by adding capital and
fee reserves less non-allowable assets, that is,
(a) fixed assets, (b) pledged securities, (c) member's card, (d) non-allowable
securities, (e) bad deliveries, (f) doubtful debts and advances/overdue for more than
three months or given toissociates(g) prepaid expenses, (h) tangible assets and, (i) 30
per cent of marketable securities
The members who do not maintain proper books of accounts/submit copies of
their audited accounts in the stipulated time are liable to be asked to deposit additional
capital in the form of cash with the stock exchange
Sub brokers
A sub-broker acts on behalf of a stockbroker as an agent or otherwise for
assisting investors in buying, selling or dealing in securities through such brokers, but
he is not a member of a stock exchange. To act as a sub-broker, a certificate of
registration from the SEBI is required. It grants a registration certificate to a sub-
broker subject to the condition that he (a) pays the prescribed fee, (b) takes adequate
steps for redressal of investor grievances within one month of the receipt of the
complaint and keeps the SEBI informed about the number, nature and other
particulars of the complaints and (c) is authorised in writing by a broker for affiliation
in buying, selling or dealing in securities Sub-brokers wanting to do business with
more than one broker need to be separately registered with the SEBI for each broker
g)Registration of Sub-Brokers
According to the SEBI regulations currently in force, a sub-broker is required to
submit along with the application (1) a recommendation from a stockbroker with
whom he will be affiliated and (2) two references, including one from his banker. The
application has to be submitted to the concerned stock exchange
h)General Obligations
Payment of Fee The annual fee payable by a sub-broker is Rs 1,000 for an
initial period of five years; After the expiry of five years, an annual fee ofRs 500 is
payable as long as the certificate remains in force.
Code of Conduct The sub-brokers have to follow the code of conduct as
detailed below:
General A sub-broker should maintain high standards of integrity, promptness
and fairness and act with due skill, care and diligence in the conduct of all investment
business.
Duty to the Investors A sub-broker, in his dealings with the clients and the
general investing public, should faithfully execute the orders for buying and selling of
securities at the best available market price and promptly inform his client about the
execution or non-execution of an order He should render necessary assistance to his
client in obtaining the contract note from the stock broker.
A sub-broker should not disclose or discuss with any other person or make
improper use of the details of personal investments and other information of
confidential nature about the client) which he comes to know in the course of his
business. '
A sub-broker should not deal or transact business knowingly, directly or
indirectly, or execute an order for a client who has failed to carry out his Conduct of
Dealings A sub-broker should cooperate with his broker in comparing unmatched
transactions. He should knowingly and willfully deliver documents that constitute
bad delivery.
Protection Of Clients Interests A sub-broker should extend full cooperation to
his stockbroker in protecting the interests of the clients regarding the latter's rights to
dividends, bonus shares, or any other rights related to such securities.
Transactions With Brokers A sub-broker should not fail to carry out his stock
broking transactions with his broker nor should he fail to meet his business liabilities
or show negligence in completing the settlement of transactions with them legal
Agreement between Brokers A sub-broker should execute an agreement or contract
with his affiliating brokers that would clearly specify the rights and obligations of the
sub-brokers and the principal broker.
Advertisement and Publicity A sub-broker should not advertise his business
publicly unless permitted by the stock exchange.
Inducement of Clients A safe-Woker should not resort to unfair means to
induce clients from other brokers
TRADING AND CLEARING/SELF-CLEARING MEMBERS
A trading member is a member of a derivative exchange/derivative segment of
a stock exchange who .settles the trade in the clearing corporation or clearing house
(i.e. clearing corporation/house of a recognised stock exchange to clear and settle
trades in securities) through a clearing mcmber A self-clearing member means a
member of a clearing corporation house (CC/CH) who may clear and settle
transactions on its own account or on account of its clients only. He cannot clear/settle
transactions in securities for any other trading member(s)
III.FOREIGN BROKERS
Foreign institutional investors (FIIs) now play a significant role in stock
markets
a)Registration with the SEBI
While applying for registration, a foreign broker has to, inter-alia, disclose to
the SEBI namefs registration number(s) of the overseas stock exchanges where he is
registered in the capacity of a broker-dealer together with an undertaking that he
would operate and assist only on behalf of registered FTIs and would not deal in
securities on his own account as principal in India
IV.Credit Rating
a)IntroductionCredit rating is, essentially, the symbolic indicator of the current opinion of the
rating agency regarding the relative ability and willingness of the issuer of a financial
(debt) instrument to meet the (debt) service obligations as and when they arise. It
provides a relative ranking of the credit quality of debt/financial instruments 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 (borrowers)
to make timely repayment of interest and principal on a particular type of
debt/financial instrument. The first rating agency, the Credit Rating Information
Services of India Ltd(CRISIL), was started in 1988. since 1991 by the
Government/SEBI, credit rating has emerged as a critical element in the functioning
of the Indian debt/financial markets. In response to the ever increasing role of credit
rating, two more agencies were set up, the Information and Credit Rating Services
(ICRA) Ltd in 1990 and the Credit Analysis and Research (CARE) Ltd in 1990 and
1993, respectively.
b)REGULATORY FRAMEWORK
Credit rating agencies are regulated by the SEBI. The main elements of its
Credit Rating Agencies Regulations are: (i) their registration, (ii) their general
obligations, (iii) restrictions on the rating of securities, (iv) procedure for inspection
and investigation and (v) action in case of default.
c)Eligibility Criteria
The eligibility criteria for a rating agency are as specified below. The agency:
Is set up and registered as a company
has specified rating activity as one of its main objects in its Memorandum of
Association;
as a minimum networth of Rs 5 crore;
has adequate infrastructure;
its promoters have professional competence, financial soundness and a general
reputation of fairness and integrity in business transactions, to the satisfaction of
the SEBI;
is in all respects a fit and proper person for the grant of the certificate;
Grant of Certificate of Registration
The SEBI will grant to eligible applicants a certificate of registration on the
payment of a fee of Rs 5,00,000, subject to the conditions specified below:
Code of Conduct
A credit rating agency should:
Make all efforts to protect the interests of investors.
In the conduct of its business, observe high standards of integrity, dignity and
fairness in the conduct of its business.
Fulfil its obligations in a prompt, ethical and professional manner.
Hava in place a rating process that reflects consistent and international rating
standards.
Not render, directly or indirectly any investment advice about any security in the
public accessible media.
Provide adequate freedom and powers to its compliance officer for the effective
discharge of his duties.
Ensure that good corporate policies and corporate governance are in place.
V.CREDIT RATING AGENCIES
a)Crisil Ltd
As the first credit rating agency in India, the CRISIL was promoted in 1987
jointly by the ICICI Ltd and the Unit Trust of India. Other shareholders include the
Asian Development Bank, Life Insurance Corporation of India, HDFC Ltd, General
Insurance Corporation of India and several foreign and Indian banks. It commences
operation on January 1,1988. As a matter of fact, it pioneered the concept of credit
rating in the country and has, since, been the vanguard of innovations by introducing
new concepts in rating services and has diversified into related areas of information
and advisory activites.
Initially, the CRISIL was set up to rate debt obligations that would guide
investors as to the risk of timely payment of interest and principal.
Objectives:
To assist both individual and institutional investors in making investment
decisions in fixed interest securities;
To enable companies to mobilize funds in large amounts from a wide investor
base, at a fair cost;
To enable intermediaries to place debt instruments with investors by providing
them with an effective marketing tool,
To provides regulators with a market-driven system for bringing about
discipline and a healthy growth of capital markets.
Credit Rating Services (CRS)
The principal function of the CRISIL is to rate mandated debt obligations of
Indian companies, chit funds, real estate developers, LPG/kerosene dealers, non-
banking finance companies, Indian states and so on.
Rating of Debt Obligations
The CRISIL has developed a framework for the composite rating of real estate
projects. Such a rating is expected to help prospective investors to identify and narrow
down their investment options.
Bond Fund Ratings
This rating is an opinion of the credit quality of bond funds underlying portfolio
holdings.
(i) Credit associated with securities in the fund portfolio; (2) the systems and
procedures followed by funds and (3) management quality and expertise.
Bank Loan Rating
The creditworthiness of a bank’s borrower-clients is assessed by CRISIL,
offering comments on the likelihood of repayment of loans to banks.
(1)For the borrower-manufacturing client company’s underlying assets liquidity
profile, operating systems and risk management initiative of the management;
(2) For non-banking finance companies quality-of-assets portfolio, loans and
investments.
Collective Investment Schemes Rating
This covers the rating of collective investment schemes of plantations and other
companies, offering opinions on the degree of certainty of the scheme to deliver the
assured returns in terms of the quantity of produce and/or cash, as mentioned in the
offer document.
Grading for Healthcare Institutions
The CRISIL’S grading for healthcare institutions is an opinion on the relative
quality of healthcare delivered by the institution to its patients.
Grading Scale and Definition
The grading scale has two components. The first is the hospital classification,
such as: nursing home, general secondary care, specialty secondary care, multi-
specialty tertiary care and single-specialty tertiary care. The second component of the
grading scale is the hospital’s grading, within that classification, on a four-point scale.
Grade A Reflects Very Good Quality
Grade B Reflects Good Quality
Grade C Reflects an Average Quality
Grade D Reflects Poor Quality
The CRISIL Advisory Services(CAS)
The CAS offers consultancy services that aim identifying is transaction and
policy level assignments in the areas of energy, transport and urban structures,
banking and finance, and disinvestment, privatization and valuation. The CRISIL has
a pact with National Economic Research Associates (NERA), USA to strengthen its
research advisory services.
CRISIL Research and information Services (CRIS)
The CRISIL Research and information Services (CRIS) disseminates, value-
added research and undertakes customized studies in four areas, namely: Indian
economy, Indian capital markets, Indian industries and the Indian corporate studies in
four areas, large client base, both in India and overseas, comprising institutional
investors, investment bankers, commercial banks, financial institutions, corporate
planners, mutual funds and asset management companies. The services rendered
earlier by the CRISIL as the CRISIL Card services and CRISIL Economic services
have been reorganized and assimilated under the CRIS.
CRISIL Sector wise
The contents of the CRISIL Sector wise include the following:
(I) A brief of history of the industry Structure of the industry, and its
characteristics;
(II) Structure of the industry, and its characteristics;
(III) An analysis of the different projects in the industry, based on factors like
product specifications, cost structure, capacities, technology, sector use;
(IV) Demand supply analysis, both present and future;
(V) An analysis of the major players in the industry;
(VI) Government policies;
(VII) Industry risks/constraints;
(VIII) International competitiveness;
(IX) Key factors and
(X) The CRISIL’S outlook on the industry.
CRISIL VIEW
The CRISIL VIEW is based on the CRISIL’ s IN-DEPTH understanding of the
industry in which the company operates, as well as its understanding of the relevant
qualitative and quantitative factors affecting the company’s performance. It present a
powerful report on listed corporate in India, serving as a comprehensive and
interactive tool for business managers, investors, creditors and corporate decision
makers.
CRISIL Markets Wire
The CRISIL Marketwise, established in October 2001, is the leading source of
news and commentary on India’s fixed-income market. With about 20 experienced
journalists, the news service provides a blow-by-blow account of developments in all
segments of this market.
Capital Markets Group
The Capital Markets Group at the CRISIL provides customized research and
advisory assistance to meet specific transactional and strategic requirements of clients.
The Group is supported by the CRISIL Research and information services, which
continuously tracks over 50 sectors and 500 corporate’s.
CRISIL Training services
The CRISIL is the only rating agency in the country that provides technical
assistance and training to the Malaysian Rating agency (RAM) and Israeli
Securities Rating Agency (MAALOT).
ICRA Ltd
The ICRA Ltd has been promoted by the IFCI Ltd as the main promoter to meet
the requirements of the companies based in the northern parts of the country. Apart
from the main promoter, which holds 26 percent of the share capital, the other
shareholders are the Unit Trust of India, banks, LIC,GIC, Exim Bank, HDFC Ltd and
ILFS Ltd. It stared operations in 1991. In order to bring international experience and
practices to the Indian capital markets, the ICRA has entered into a MOU with
Moody’s investors services to provide, through is company Financial programmers
inc (FPI), credit education, risk management software, credit research and consulting
services to banks, financial/investment institutions, financial services companies and
mutual funds in India. As in the case of the CRISIL, the main objectives of the ICRA
are:
To assist investors, both individual and institutional, in making well
informed decisions;
To assist issuers in raising funds, from a wider investor base, in large
amounts and at a lower cost for highly rated entities;
To enable banks, investment bankers, brokers in placing dept with
investors by providing them with a marketing tool and
To provide regulators with market driven systems to encourage the
healthy growth of the capital markets in a disciplined manner,
without additional burden on the government.
Over the years, the ICRA has diversified the range of its services. It currently
provides three types of services:
(1) rating services;
(2) information services and
(3) advisory services.
b)CARE Ltd
The CARE is a credit rating and information services company promoted by the
Industrial Development Bank of India (IDBI) jointly with financial institutions,
public/private sector banks and private finance companies. It commenced its credit
information and equity research. Unlike the CRISIL and the CRISIL and the ICRA,
the CARE is very cautious in entering new areas of business. Currently, it offers the
following services:
Credit Rating
The CARE undertakes credit rating of all types of dept instruments, both short-
term and long-term.
Advisory Service The CARE provides advisory services in the areas of:
Securitization transactions;
Structuring financial instruments;
Municipal finances.
FITCH Ratings INDIA Ltd
It is the latest in the credit rating business in the as a joint venture between the
international credit rating agency Duff and Phelps and JM Financial and Alliance
Group. In addition to debt instruments, it also rates companies and countries, on
request.
RATING PROCESS AND METHODOLOGY
The process/procedure followed and the methodology used generally by CRAs
Rating process/procedure
All the four rating agencies in the country adopt a similar rating process. The
steps followed by them in the rating process are illustrated with reference to
(1) New issues/instruments
(2) Review of rating and
(3) Flow chart of rating.
Rating process of New Issues
The following steps are involved in rating the issuers of instruments for the first
time, before going public.
Rating Agreement and Assignment of Analytical Team
The process of rating starts with the issue of the rating request letter by the
issuer of the instrument and the signing of the rating agreement. On receipt of the
request, the rating agency (CRA) assigns an analytical team, comprising two/more
analysts, one of whom would be the lead analyst and would serve as the relevant
business areas are responsible for carrying out the rating assignments.
Meeting with Management
Prior to meeting with the issuer, the analytical team obtains and analyses
information relating to its statements, cash flow projections and other relevant
information details blow:
(I) Annual reports for the past five years and interim reports for the past three
years
(II) Two copies of the latest prospectus offering statements and applications for
listing on any major stock exchanges.
(III) Consolidated financial statements for the past three fiscal years by the
principal, subsidiary or division.
(IV) Two copies of the statements of projected sources and application of funds,
balance sheets and operating statements for at least the next three years.
Along with assumptions on which projections have been based.
(V) Copies of the existing loan agreements along with recent compliance letters,
if any.
(VI) A certified copy of the resolution adopted by the board of the company
authorizing the issuance of commercial paper and or other short-term dept
instruments, including the name of authorized signatories.
(VII) List of the banks, showing lines or credit and contact officers for each, along
with duty completed short-term borrowings from them, in the prescribed
format.
(VIII) If applicable, the name of commercial paper dealer of the company, the
planned use of proceeds from the scale of commercial paper, the amount of
commercial paper to be used, and a specimen copy of the commercial paper
note.
(IX) Biographical information on the company’s principal officers and the names
of the board members. There is no prescribed format for supplying the above
information. Hence, any format could be flexibly used to cover all the
required information adequately.
A complete brief followed by a Discussions with the management philosophy
and plans should also be obtained.
Rating Committee
After meeting with the management, the analysts present their report to a rating
committee, which then decides on the rating. The rating committee meeting is the only
aspect of the process in which the issuer does not participate directly.
Communication to the Issuer
After the committee has assigned the rating, the decision is communicated to
the issuer, with the reasons or rationale supporting the rating.
For a rating to have value or an issuer or an investor, the CRA must have
credibility. The thoroughness and transparency of its rating methodology and the
integrity and fairness of its approach are important factors in establishing and
maintaining credibility. The CRAs are therefore, always willing to discuss with the
management, the critical analytical factors that the committee focused on while
determining the rating and also any factors that the company feels may not have been
considered while assigning the rating.
In the event that the issuer disagrees with the rating outcome, he may appeal the
decision for which new/additional information, which is material to the appeal and
specifically address the concerns expressed in the rating rationale, need to be
submitted to the analysts.
Dissemination to the Public
Once the issuer accepts the rating, the CRAs disseminate it, along with the
rationale, through the print media.
RATING Review for Possible Change
In the case of rated instruments, the rated company is on the surveillance
system of the CRA, and from time to time, the earlier rating is reviewed. The CRA
constantly monitors all ratings with reference to new political, economic and financial
developments and industry trends.
New Data of Company
Analysts review the new information or data available on the company, which
might be sent to it by the company or it might have been procured through routine
channels, as strategic information under its surveillance approach.
Rating Change
On preliminary analysis of the new data, if the analysts feel that there is a
possibility for changing the rating, then the analysts request the issuer for a meeting
with is management and proceed with a comprehensive rating analysis.
Credit Rating Watch
During the review monitoring or surveillance exercise, rating analysts might
become aware of imminent events like mergers and so on, which affect the rating and
warrants a rating change. In such a possibility, the issuer’s rating is put on ‘credit
watch’ indicating the direction of a possible change and supporting reasons for a
review.
‘Credit watch’ indicates four situations for changing the rating, namely:
(1) “Negative” change, indicating the possibility of a
downgrade;
(2) “Positive” change, indicating an upgrade;
(3) “Stable”, implying no change in rating and
(4) ‘Developing”, implying an unusual situation in which the future
events are so unclear that the rating may be changed either in negative or
positive directions.
Rating Methodology
The rating methodology involves an analysis of the industry risk, the issuer’s
business and financial risks. A rating is assigned after all the factors that could affect
the credit worthiness of the entity. A rating is assigned after assessing all the factors
that could affect the credit worthiness of the entity. Typically, the industry risk
assessment sets the stage for analyzing more specific company risk factors and
establishing the priority of these factors in the evaluation. For instance, if the industry
is highly competitive, careful assessment of the issuer’s market position is stressed. If
the company has large capital requirements, the examination of cash flow adequacy
assumes importance. The ratings are based on the current information provided by the
issuer or facts obtained from reliable sources. Both qualitative and quantitative criteria
are employed in evaluating and monitoring the ratings. The rating methodology is
illustrated blow with reference to
(i) Manufacturing companies and
(ii) Financial services companies.
For Manufacturing Companies
The main elements of the rating methodology for manufacturing companies are
outlined below.
Business Risk Analysis
The rating analysis begins with an assessment of the company’s environment,
focusing on the strength of the industry prospects, pattern of business cycles as well as
the competitive factors affecting the industry.
The nature of competition is different for different industries, based on price,
product quality, distribution capabilities, image, product differentiation, service and so
on. The industries characterized by a steady growth in demand, ability to maintain
margins without impairing future prospects, flexibility in the timing of capital outlays,
and moderate capital intensity are in a stronger position.
Industry Risk
Nature and basis of competition, key success factors, demand and supply
position, structure of industry, cyclical/seasonal factors, government policies and so
on.
Market Position of the Issuing Entity Within the Industry
Market share, competitive advantages, selling and distribution arrangements,
product and consumer diversity and so on.
Operating Efficiency of the Borrowing Entity
Vocational advantages, labor relationships, cost structure, technological
advantages and manufacturing efficiency as compared to competitors and so on.
Legal position
Terms of the issue document/prospectus, trustees and their responsibilities,
systems for timely payment and for protection against fraud/forgery and so on.
While the CRAs do not have a minimum size criterion for any given rating
level, the size of the company is a critical factor in the rating decision as smaller
companies are move vulnerable to business cycle swings as compared to larger
companies. In general, small companies are more concentrated in terms of product,
number of customers and geography and, consequently, lack the benefits of
diversification that can benefit larger firms.
Financial Risk Analysis
After evaluating the issuer’s competitive position and operating environment,
the analysts proceed to analyze the financial strength of the issuer. Financial risk is
analyzed largely through quantitative means, particularly by using financial rations.
As ratings rely on audited data (the rating process does not entail a company’s
financial records), the analysis of the audited financial results begins with a review of
accounting quality. The purpose is to determine whether rations and statistics derived
from financial statements can be used to accurately measure a company’s performance
and its position, relative to both its peer group and the larger universe of companies.
Accounting Quality
Overstatement/understatement of profits, auditors qualifications, method of
income recognition, inventory valuation and depreciation policies, off-balance sheet
liabilities and so on.
Earnings prospects
Source of future earnings growth, profitability rations, earnings in relation to
fixed income charges and so on.
Adequacy of Cash Flows
In relation to dept and working capital needs, stability of cash flows, capital
spending flexibility, working capital management and so on.
Financial Flexibility
Alternative financing plans in times of stress, ability to raise funds, asset
deployment potential and so on.
Management Risk
A proper assessment of dept protection levels requires an evaluation of the
management philosophies and its strategies. The analyst compares the company’s
business strategies and financial plans (over a period of time) to provide insights into
a management’s abilities, with respect to forecasting and implementing of plans.
Specific areas reviewed include:
(I) Track record of the management planning and control systems,
depth of managerial talent, succession plans;
(II) Evaluation of capacity to overcome adverse situations and
(III) Goals, philosophy and strategies.
Financial services sector
When rating dept instruments of financial institutions, banks and non-banking
finance companies, in addition to the financial analysis and management evaluation
outlined above, the assessment also lays emphasis on the following factors:
Regulatory and Competitive Environment
(I) structure and regulatory framework of the financial system;
(II) Trends in regulation and their impact on the company/institution.
Fundamental Analysis
Fundamental analysis should include:
Capital Adequacy
Assessment of the true net worth of the issuer, its adequacy in relation to the
volume of business and the risk profile of the assets.
Resources
Overview of funding sources; funding profile; cost and tenor of various sources
of funds.
Asset Quality
Quality of the issuer’s credit risk management; systems for monitoring credit;
sector risk; exposure to individual borrowers, management of problem credits and so
on.
Liquidity Management
Capital structure; term matching of assets and liabilities; policy on liquid assets
in relation to financing commitments and maturing deposits.
Profitability and Financial Position
Historic profits; spreads on funds deployment; revenues on non-fund based
services; accretion to reserves and so on.
Interest and Tax Sensitivity
Exposure to interest rate changes; tax law `changes and hedging against interest
rate.