31

[Link].
(ACCOUNTING & FINANCE)
SEMESTER - II

INNOVATIVE FINANCIAL
SERVICES

SUBJECT CODE : UA_FFSII.3

 © UNIVERSITY OF MUMBAI
Prof. Suhas Pednekar
Vice-Chancellor,
University of Mumbai

Prof. Ravindra D. Kulkarni Prof. Prakash Mahanwar

Pro Vice-Chancellor, Director,
University of Mumbai IDOL, University of Mumbai

Programme Co-ordinator : Prof. Rajashri Pandit

Asst. Prof. in Economic,
Incharge Head Faculty of Commerce,
IDOL, University of Mumbai, Mumbai

Course Co-ordinator : Mr. Vinayak Joshi

Assistant Professor, IDOL,
University of Mumbai, Mumbai

Course Writer : Dr. Madhura Kulkarni

Deputy Director, IDOL,
University of Mumbai, Mumbai

: Mr. Vinayak Joshi

Assistant Professor, IDOL,
University of Mumbai, Mumbai

: Dr. Lalita Mutreja

Assistant Professor,
Sahyadri Shikshan Seva Mandal’s Arts and
Commerce College,

: Mr. Sreevallaban Narayanan

Assistant Professor,
R A Podar College Of Commerce & Economics,

: Ms. Aksha Memom

Assistant Professor
Cosmopolitan’s Valia College of Arts, Commerce
And Science,

May 2022, Print - 1

Published by : Director,
Institute of Distance and Open Learning ,
University of Mumbai,
Vidyanagari, Mumbai - 400 098.

DTP Composed & : Mumbai University Press

Printed by Vidyanagari, Santacruz (E), Mumbai
 CONTENTS
Unit No. Title Page No.

1. Introduction to Financial Services 01

2. Banks and Non-Banking Financial Companies (NBFCs) 09
3. Regulatory Aspects in India 15
4. Factoring, Forfaiting and Bill Discounting 21
5. Issue Management and Intermediaries 29
6. Stock Broking 59
7. Securitization 83
8. Financial Services and Its Mechanism 99
9. Housing Finance 108
[Link] Capital Financing 118
[Link] Finance and Credit Rating 125


 Revised Syllabus of Courses of [Link]. (Accounting and Finance)
Programme at Semester II
with effect from the Academic Year 2022-2023
1. Elective Courses (EC)

3. Innovative Financial Services

Modules at a Glance

No. of
SN Modules
Lectures

1 Introduction to Traditional Financial Services 15

2 Issue Management and Securitization 15

3 Financial Services and its Mechanism 15

4 Consumer Finance and Credit Rating 15

Total 60
SN Modules/ Units
1 Introduction to Traditional Financial Services
a) Financial Services:
Concept, Objectives/Functions, Characteristics, Financial Service Market,
Financial Service Market Constituents, Growth of Financial Services in India,
Problems in Financial Services Sector, Banking and Non-Banking Companies,
Regulatory Framework
b) Factoring and Forfaiting:
Introduction, Types of Factoring, Theoretical Framework, Factoring Cost,
Advantages and Disadvantages of Factoring, Factoring in India, Factoring v/s
Forfaiting, Working of Forfaiting, Benefits and Drawbacks of Forfaiting,
Practical Problems.
c) Bill Discounting:
Introduction, Framework, Bill Market Schemes, Factoring V/s Bill Discounting in
Receivable Management.
2 Issue Management and Securitization
a) Issue Management and Intermediaries:
Introduction, Merchant Bankers/ Lead Managers, Underwriters, Bankers to an
Issue, Brokers to an Issue
b) Stock Broking:
Introduction, Stock Brokers, SubBrokers, Foreign Brokers, Trading and
Clearing/Self Clearing Members, Stock Trading ( Cash and Normal) Derivative
Trading
c) Securitization:
Definition, Securitization v/s Factoring, Features of Securitization, Pass Through
Certificates, Securitization Mechanism, Special Purpose Vehicle, Securitisable
Assets, Benefits of Securitization, New Guidelines on Securitization
3 Financial Services and its Mechanism
a) Lease and Hire-Purchase:
Meaning, Types of Lease - Finance Lease, Operating Lease, Advantages and
Disadvantages of Leasing, Leasing in India, Legal Aspects of Leasing.
Definition of Hire Purchase, Hire Purchase and Installment Sale Characteristics,
Hire Purchase and Leasing, Advantages of Hire Purchase, Problems of Hire
Purchase.
b) Housing Finance:
Introduction, Housing Finance Industry, Housing Finance Policy Aspect, Sources
of Funds, Market of Housing Finance, Housing Finance in India- Major Issues,
Housing Finance in India Growth Factors, Housing Finance Institutions in
India, National Housing Bank (NHB), Guidelines for Asset Liability Management
 SN Modules/ Units
c) Venture Capital:
Introduction, Features of Venture Capital, Types of Venture Capital Financing Stages,
Disinvestment mechanisms, Venture Capital Investment process, Indian Scenario
4 Consumer Finance and Credit Rating
a) Consumer Finance:
Introduction, Sources, Types of Products, Consumer Finance Practice in India,
Mechanics of Consumer Finance, Terms, Pricing, Marketing and Insurance of
Consumer Finance, Consumer Credit Scoring, Case for and against Consumer
Finance
b) Plastic Money:
Growth of Plastic Money Services in India, Types of Plastic Cards- Credit card-
Debit Card- Smart card- Add-on Cards, Performance of Credit Cards and Debit
Cards, Benefits of Credit Cards, Dangers of Debit Cards, Prevention of Frauds
and Misuse, Consumer Protection. Indian Scenario.
Smart Cards- Features, Types, Security Features and Financial Applications
c) Credit Rating:
Meaning, Origin, Features, Advantages of Rating, Regulatory Framework, Credit
Rating Agencies, Credit Rating Process, Credit Rating Symbols. Credit Rating
Agencies in India, Limitations of Rating

Note: Course No. 03 entitled Taxation - I (Indirect Taxes I) Semester II has been substituted to
Innovative Financial Services and to be implemented from the Academic Year 2022-2023
 Question Paper Pattern
(Theoretical Courses)

Maximum Marks: 75
Questions to be set: 05
Duration: 2 1/2 Hrs.
All Questions are Compulsory Carrying 15 Marks each.

Question Particular Marks

No

Q-1 Objective Questions 15 Marks

A) Sub Questions to be asked 10 and to be answered any 08
B) Sub Questions to be asked 10 and to be answered any 07
(*Multiple choice / True or False / Match the columns/Fill in the
blanks)

Q-2 Full Length Question 15 Marks

OR
Q-2 Full Length Question 15 Marks

Q-3 Full Length Question 15 Marks

OR
Q-3 Full Length Question 15 Marks

Q-4 Full Length Question 15 Marks

OR
Q-4 Full Length Question 15 Marks

Q-5 A) Theory questions 08 Marks

B) Theory questions 07 Marks
OR
Q-5 Short Notes 15 Marks
To be asked 05
To be answered 03

Note:
Theory question of 15 marks may be divided into two sub questions of 7/8 and 10/5Marks.
 1
INTRODUCTION TO FINANCIAL
SERVICES
Unit Structure
1.0 Objectives
1.1 Meaning of financial Services
1.2 Financial services in India– An Overview and Recent Developments
1.3 Characteristics of financial services
1.4 Functions of financial services
1.5 Classification / Types of financial services
1.6 Challenges in the Indian financial services sector

1.0 OBJECTIVES:
The objective of this chapter is

1. To introduce the learners to the concept of financial services.

2. The learners will become familiarized with the meaning and scope of
financial services in general and with reference to India.

3. The reader will also learn the financial services market constituents in
India.

4. Along with this, the user will also learn about the growth of the
financial services sector in India, problems with the Indian financial
services sector.

1.1 MEANING OF FINANCIAL SERVICES

Financial services are an important part of our economic ecosystem.
Financial services primarily refer to a broad range of activities like
banking, insurance, investment services, brokerage services, consumer
finance companies to name a few. Typically speaking, these services are
restricted to activities of financial services firms and their professionals.
These financial service providers provide financial products like different
investments and their instruments. In simple terms, we can say that all
types of activities which are financial in nature are a default part of
financial services.

1
Innovative Financial Services 1.2 FINANCIAL SERVICES IN INDIA – AN OVERVIEW
AND RECENT DEVELOPMENTS
India has a very diversified financial sector undergoing rapid expansion.
This rapid growth is witnessed in terms of existing financial services and
addition of new entrants to this market. Financial services sector in India
includes commercial banks, insurance companies, NBFCs (Non-Banking
financial companies), pension funds, mutual funds and scores of other
smaller financial entities. Banking sector has witnessed tremendous
growth with the introduction of new entrants like payment banks, Small
finance banks and digital growth in Banking. The Government of India is
relentlessly introducing liberalization reforms to enhance this industry.
RBI has changed the financial services landscape by allowing easy fund
access to Micro, Small and Medium Enterprises (MSMEs), setting up of
MUDRA (Micro Units Development and Refinance Agency). Not only
RBI, even SEBI and other regulatory agencies have aggressively changed
the financial services landscape in the country. The combined initiatives of
all the stakeholders have made the Indian financial services sector one of
the most vibrant and robust in the world.
Let us look at some latest statistics to understand the spread of financial
services in India. As of June 2021, Assets under management (AUM) of
the mutual fund industry alone stood at Rs.33.67 trillion (USD449.29
billion). SIP (Systematic Investment Plan) alone saw investments worth
Rs 96000 crore (USD 13.12 billion). Another important component of
India’s financial services sector is the Insurance industry. The amount of
premium collected by insurance companies as the first premium of life
insurance policies crossed Rs 2.60 lakh crore (USD 36.74 billion) in 2020.
IN the same period, USD 4.25 billion was raised through 55 IPOs (Initial
Public Offering). Explosive growth is seen across financial services
despite the financial problems brought upon by the pandemic.

1.3 CHARACTERISTICS OF FINANCIAL SERVICES

a. Customer centric activities - Most of the financial services are
heavily customer centric. Customer is at the centre of all the activities of
these firms. Financial services cater to the very specific requirements of
customers. Customers can be individuals as well as institutions. They are
in constant touch with their customers so that newer products and services
can be designed to cater to specific needs.
b. Information centric – Financial services are information centric. The
service provider needs to gather relevant information, analyze them, and
extract relevant pieces of information for suggesting customized services.
c. Intangibility – Intangibility is an important feature of services.
Financial services are no different. One cannot see the dimensions of
financial services like other goods and products, but one can experience
the service offering. Branding and brand image is also an important
element in maintaining the effectiveness of service offering.

2
 Introduction to Financial
d. Inseparability – The financial service providers and their services are Services
inseparable. Creation of financial services and delivery of these services
happen simultaneously.
e. Perishable – Like any other service, financial services are also
perishable in nature. These services also strike a match between demand
and supply. Like other regular services, they cannot be stored and will
have to be offered as and when they are demanded by the customers.
f. Human Centric – The human element is the most dominant force in
the financial services industry. Financial services require people who are
thorough professionals and competent in their respective fields. They have
to understand the customer requirements thoroughly and design and
recommend products and services.
g. Customization: Financial services are highly customized in their
product and service offering. Providing financial services also involves a
varying degree of advisory services as well. These elements have to be
customized. These services vary from one client to another. In simple
words, financial services are heterogenous in nature.

1.4 FUNCTIONS OF FINANCIAL SERVICES

Financial services require a perfect blend of financial markets, financial
intermediaries and financial products. When these three come together in
harmony, a robust financial service ecosystem is created which is able to
fulfill specific set of functions. You should remember that for orderly
development of the economy, financial services should be able to function
at the optimum level. Following are some of the key functions of financial
services.
a. Mobilization of funds – Idle funds in the form of savings needs to be
mobilized so that they can be put to productive use. The funds can be
mobilized from individuals, institutions and corporate entities alike. These
funds can be mobilized through financial instruments like shares, bonds &
debentures, mutual funds etc.
b. Utilization of mobilized funds – Once the funds are mobilized,
financial services are also responsible for ensuring their optimum
utilization. Factoring, securitization, retail investing and other ways are
used to ensure that the funds are utilized thoroughly. Maximum benefits
can be reaped when money is used prudently.
c. Economic Development – As discussed in the earlier two points,
mobilizing and channelizing savings into productive avenues of
investments will help in economic development.
d. Risk Management – Insurance is an essential financial service.
Insurance helps in effective risk management by transferring risk from the
insured to the insurer.

3
Innovative Financial Services e. Improving liquidity - Allocating and reallocating savings and
investments helps in improving the liquidity scenario in the economy.
Liquidity is important as it allows easy and smooth conversion of financial
assets into cash.
f. Employment Opportunities – The Financial services sector is one
of the largest employers in the country. Millions are employed by this
sector.

1.5 CLASSIFICATION / TYPES OF FINANCIAL

SERVICES
The term “financial services'' is like a box of assorted cookies. There are a
variety of institutions that provide means to save for the future, secure
against risk and organize capital for investment and consumption. A wide
range of services like raising funds, credit rating, underwriting, merchant
banking, commercial banking, depository services, mutual funds, factoring
and forfaiting and other services are covered.
Following are the ways and means in which we shall classify financial
services.
1. Traditional Financial Services – Traditional financial services include
all those that cater to both capital and money markets. Traditional
financial services can further be classified into two avenues; a. Fund based
services b. Fee based services
A) Fund Based Services – These are the services through which firms
and institutions raise funds by issuing equity shares, debentures. Banks
also play a vital role and provide loan capital to businesses. The broad
areas in which the fund based financial service providers operate are;
a. Primary market and secondary market activities and operations.
b. FOREX market services.
c. Financial innovation and financial engineering services.
d. Specialized financial services.
The following are the different examples of fund-based service providers;
a. Factoring and Forfaiting
b. Consumer loans and credit
c. Bill Discounting
d. Hire Purchase
e. Lease financing
f. Insurance
g. Venture Capital
h. Housing finance

4
 Introduction to Financial
B) Fee Based Services – Fee based financial services are those where Services
the financial institutions provide services where these firms earn a
substantial income in the form of fees, brokerage, commission or
dividends. The scope of operations of fee-based services include the
following;
a. Managing IPO’s and capital issues – Initial Public Offer refers to new
issue of shares to general public. The procedure is very detailed and
exhaustive. It requires assistance of merchant bankers, underwriters
and other professional entities.
b. Management consultancy projects – Firms may require advisory and
consultancy on many areas like legal, finance, regulatory to name a
few. Professional entities help firms to navigate such complex issues
for a fee.
c. Portfolio Management- Portfolio refers to holding of a basket of
different securities and assets for wealth creation. Professional
portfolio managers will render such services for a nominal fee.
d. Corporate Counselling – New firms, especially startup’s require help
for setting up of their operations and for upscaling. Corporate
counselling helps build corporate culture and a robust work
environment for internal efficiency.
e. Loan Syndication – Large activities requires huge loans. A single bank
may not be in a position to provide a huge loan. So a group of banks
come together to contribute a collective loan called loan syndication.
f. Stock Broking – Stock brokers are those intermediaries who help you
to buy and sell shares and charge a small fee for facilitating the same.
g. Capital Restructuring – Sometimes, firms require external assistance to
restructure their capital. It is required to maintain a healthy capital
structure and financial solvency.
h. Mergers and Acquisition – Companies may go for expansion through
merger with other companies or by acquiring other entities. The entire
process is super critical and requires professional expertise for
successful outcomes.
2. Modern Financial Services – Modern Financial Services are all
those financial services that have evolved over the years. They cater to
new and ever evolving requirements of clients.
Some of the modern financial services include but is not limited to the
following;
a. Hedging of risk (Hedging is a risk management process. It involves
financial risk management)
b. Project Advisory Services (Involves consultancy and advisory services
to help entities with new ventures / expansion etc)
5
Innovative Financial Services c. Rehabilitation and reconstructing of sick companies (It involves
activities that will try to improve the financial condition of sick
entities)
d. Registration and transfer, custodian, clearing services and credit rating
services.
e. Asset Liability Management (It involves managing the assets and
liabilities of the firm to ensure that the firm doesn’t default on its
liabilities and obligations).

1.6 CHALLENGES TO INDIAN FINANCIAL SERVICES

SECTOR
Financial services sector, especially in India, is highly vibrant and robust.
A wide variety of services cater to individual and institutional clients.
Exponential growth brings a series of challenges along with it. Let us look
at some of the challenges facing the Indian financial services sector.
1. Changing nature of regulations – The Indian financial sector has
always struggled with regulations. One might say that we are over
regulated and sometimes, these excessive regulations create problems
and hindrances. Excessive regulations prevent institutions from being
flexible. Our regulations should be such that investors rights are
protected and the institutions flourish.
2. Shortage of talented and qualified professionals – The growth of
financial services means there is a growing need for talented, certified
and qualified professionals. However, such qualified and eligible
workforce is not available. There is an urgent need to create a
qualified, financially literate and talented pool of labor force.
3. Changes in consumer preferences – Customer needs and wants are
ever changing. Their preferences are ever evolving. This means that
companies will have to come up with new ways to reach out to
customers. They have to innovate constantly. Changes in consumer
preference is indeed a challenge that needs urgent addressing.
4. Unconventional segmentation of the market – Indian markets are so
complex that navigating them is a challenge. This issue is magnified
when one realizes that Indian markets are segmented in
unconventional ways. There are problems with linkages due to this
disjointed segmentation.

6
 Introduction to Financial
Chapter wise questions for practice. Services

Multiple Choice Questions

1. The availability of cash and other cash like marketable instruments that
are useful in purchasesandinvestmentsarecommonlyknownas
a. Liquidity
b. Credit
c. Marketability

2. ________ are the challenges faced by financial services

entities in India
a. Shifting consumer preference
b. Complex segmentation of market
c. Both a and b

3. Project management and risk management is part of ___________

financial services
a. Traditional
b. Modern
c. Neo-Classical

4. Bill discounting and hire purchase is a _______ financial service

a. Fund based
b. Fee based
c. Commission based

5. Capital Issues and loan syndication are _____ financial services

a. Fund based
b. Fee based
c. Commission based

6. Issuing shares for the first time is part of __________ market

operations
a. Secondary
b. Primary
c. Tertiary\

7. Trading of listed shares is a part of ___________ market operations

a. Primary
b. Secondary
c. Tertiary

Explain the following terms in One or Two lines

a. Financial Services
b. Fund based services
c. Fee based services
d. Primary market
e. Secondary market
f. Liquidity
7
Innovative Financial Services Answer the following questions in detail
1. Define ‘Financial Services’ and explain the recent developments in
financial services arena.
2. What are the characteristics of financial services?
3. Explain the major functions of financial services
4. Explain the fund based and fee based financial services.
5. What are the challenges faced by financial services in India?



8
 2
BANKS AND NON-BANKING FINANCIAL
COMPANIES (NBFCS)
Unit Structure
2.0 Objectives of this chapter
2.1 Introduction to Banking in India
2.2 Evolution of Banking in India
2.3 Different types of banks in India
2.3.1 Central Banks
2.3.2 Commercial Banks
2.3.3 Co-operative Banks
2.3.4 Regional Rural Banks
2.3.5 Special Purpose Banks
2.3.6 Small Finance Banks and
2.3.7 Payments Banks.
2.4 Non- Banking Financial Companies
2.4.1 Meaning
2.4.2 Types of NBFC
2.4.3 Significance of NBFCs in India

2.0 OBJECTIVES OF THIS CHAPTER

 After going through this chapter, the learner will,
 Understand the importance of banking in India
 Realize the key role played by different banks
 Learn the different types of banks in India including neo - banking
entities.
 Understand the meaning of NBFCs.
 Learn the different types of NBFCs in India and their significance

9
Innovative Financial Services 2.1 INTRODUCTION TO BANKING IN INDIA
Banking system is one of the most important financial services out there.
It does the crucial function of mobilizing deposits and channelizing them
to productive areas of the economy. It is primarily responsible for
matching the demand and supply aspects of money in the economy.
Banking sector in India is governed and regulated by the Reserve Bank of
India (RBI). Banking sector is integral to economic growth and
development. It also plays an important role in implementing various
welfare schemes of the government. Overall, Banking aims to transform
the lives of people by bringing economic accessibility and prosperity.

2.2 EVOLUTION OF BANKING SYSTEM IN INDIA

Modern banking as we know, originated in the last decade of the 18th
century. One of the earliest banks established was the Bank of Hindustan
in 1770. It went bankrupt in1830. State Bank of India (SBI) is the largest
and one of the oldest banks still in existence. SBI began its journey as
Bank of Calcutta in June 1806. In 1809, it was renamed as the Bank of
Bengal. Bank of Bengal, Bank of Bombay and Bank of Madras merged in
1921 to form the Imperial Bank of India. This became the State bank of
India (SBI) in 1955. Reserve Bank of India was established as the central
bank of the country in 1935, under the Reserve Bank of India Act 1934.
Bank nationalization is a cornerstone event in the modern Indian Banking
[Link] 1969, 14 major private banks were nationalized. In 1980, 6
more private banks were nationalized. This ushered in major reforms in
the banking system and gave a boost to economic growth and
development. Even post recent mergers, these banks dominate the banking
sector even today due to their sheer size and widespread network.
The Indian banking sector is classified into two broad categories viz
scheduled and non-scheduled banks. The scheduled banks are those which
are included in the 2nd schedule of RBI Act 1934. The scheduled banks
include all nationalized banks, private banks and foreign banks. A
commercial bank is a generic term and both scheduled and non-scheduled
banks are part of commercial banks and they are governed by the Banking
Regulation Act, 1949.
The government constantly strives to make banking accessible to all and
also bring in continuous reforms in the banking sector. The Pradhan
Mantri Jan Dhan Yojana (PMJDY) and many other schemes promote
inclusive banking and has ensured that 99% of the eligible population has
a bank account. Small Finance BAnks (SFBs), Micro Finance Institutions
(MFIs) and Payments Banks have also made the banking scene more
exciting and robust.

2.3 A BRIEF UNDERSTANDING OF THE DIFFERENT

TYPES OF BANKS IN INDIA
In easy terms, banks as we know are financial institutions that perform the
functions of accepting deposits and giving loans. There are different types
10
 Banks and Non-Banking
of banks in India, each with their own set of functions and responsibilities. Financial Companies (NBFCs)
Each of these banks serve a unique purpose as well.
Let us have a look at some of the prominent types of banks in the country.

2.3.1 Central Bank

The Reserve Bank of India (RBI) is the central bank of the country. It is
the regulator of the banking sector in India and oversees the activities of
all the banks in our country. Every country has their own central bank. It
acts as the banker to the government. It is responsible for issuing currency
notes and for enforcing the monetary policy. It is also called the bankers
bank and is responsible for beginning innovation and reforms in the
banking system. It is the apex bank in the country and runs the country's
financial system.

2.3.2 Cooperative Bank

Cooperative banks are typically small sized banks that are governed by the
laws of the respective state governments where they are registered. Their
primary task is to promote social welfare by offering loans at concessional
rates. There are three levels of cooperative banks in the country. Tier 1
State cooperative banks are regulated by RBI, laws of the state
government and NABARD (National Bank for Agriculture and rural
Development). District Cooperative banks are at Tier 2 whereas village /
rural cooperative banks at Tier 3. These banks usually get concessions in
CRR and SLR requirements.

2.3.3 Commercial Banks

Commercial Banks include all Public sector banks, Private Banks and
even the Foreign Banks in the country. Social Welfare and generating
profits are their main motive. The primary source of funds is public
deposits and caters to the banking requirements of all. They operate in
urban, semi urban and rural regions.
2.3.4 Regional Rural Banks
Regional Rural Banks (RRBs) are a special kind of commercial bank that
specifically caters to the rural farm sector and focuses on agricultural and
allied lending. These banks are jointly owned by the central government,
state government and a commercial bank. They are governed by the
Regional Rural Bank Act, 1976. An interesting aspect is that an RRB
cannot open branches in more than three districts which are geographically
connected.

2.3.5 Special Purpose Banks

These banks cater to specific set of objectives. Some of the popular
Special Purpose banks are;
a. SIDBI - Small Industries Development Bank of India (SIDBI)
provides finance to small businesses to cater to their technology and
11
Innovative Financial Services equipment requirements. They are very vital for the growth of small
businesses in the country.
b. NABARD - National Bank for Agriculture and Rural Development
(NABARD) is a special bank that caters to the needs of people in rural
areas. Village industries, Handicrafts, agriculture and other agricultural
and allied industries depend on financial support from NABARD .
c. EXIM Bank - Export Import Bank of India (EXIM) is a special bank
that specifically finances Import Export transactions. It is a vital
institution that promotes foreign trade.
2.3.6 Small Finance Banks - Small Finance Banks (SFBs) cater to the
money requirements of small businesses, micro institutions and the largely
neglected unorganised sector. These banks are of recent origins and
provide banking to the vast unbanked segment in the unorganised sector.
2.3.7 Payments Banks - Payments Banks are of recent origin and
represent innovations in the banking sector. Payment Banks can only
accept deposits upto Rs 1,00,000. They cannot issue any loans or
undertake lending activity of any sort. They provide services like door to
door banking, internet and mobile banking, issuing ATM and debit cards
and other innovative mobile application based services like bill payments,
money transfers etc.

2.4 NON BANKING FINANCIAL COMPANIES (NBFC)

2.4.1 Meaning of NBFCs - A Non BankingFInancial Company (NBFC) is
not a bank, but is a company registered under Indian Companies Act,
1956. NBFCs provide loans and advances. They cannot accept deposits
from the public like a normal bank.
If NBFCs can also issue loans and advances, you must be wondering what
distinguishes them from a regular bank. Well, there are certain differences.
Following are the major differences between the both;
a. NBFCs cannot accept demand deposits from the general public. They
can only issue loans. Banks, however, are in the business of accepting
deposits and giving loans.
b. NBFCs are not part of the banking payment and settlement system.
This means that NBFCs cannot issue cheques to their customers.
c. The Deposit Insurance facility provided by the Deposit and Credit
Guarantee Corporation is available only to bank customers. This
facility is important in case a bank becomes bankrupt and deposit
holders are compensated. However, this facility is not available to
customers of NBFCs.
d. Another major difference is the manner in which NBFCs are
constituted. NBFCs are registered under Companies Act 1956 whereas
banks are governed by the Banking Regulation Act, 1949.

12
 Banks and Non-Banking
2.4.2 Types of NBFCs Financial Companies (NBFCs)
NBFCs are typically classified by their size and the nature of activity they
specialize in. Following are some of the different types of NBFCs;
a. Asset Finance Company - Asset Finance Company (AFC) is one of the
most popular and the most known type of NBFC. These institutions
finance purchase of assets and contribute to economic development.
These institutions finance buying of electronic items, automobiles and
other assets and equipment required for carrying out certain kinds of
specific businesses.
b. Investment Company - Investment Companies (IC) finance buying of
various securities like shares and bonds.
c. Infrastructure Finance Company - Infrastructure Finance Company
(IFC) are a special type of NBFC and they are required to deploy at
least 75% of their assets in infrastructure loans. They finance big ticket
infrastructure projects.
d. Loan Company (LC) - Loan Company is a special kind of NBFC that
provides loans of all types not covered by an Asset Finance Company.

2.4.3 Significance and Importance of NBFCs

NBFCs play a very vital role in promoting an all inclusive growth by
catering to different financial needs of entities not part of regular
mainstream banking. NBFCs are also leaders when it comes to creating
innovative financial products and services. In the process, they create huge
employment opportunities and bring in explosive growth in rural areas and
among the large unbanked segment by giving them access to credit. Their
primary customers also include MSMEs (Micro, Small and Medium
Enterprises) and NBFCs provide them the valuable finance they need
access to. Let us look at some more benefits that NBFCs bring with them.
1. They are important for mobilizing savings in the country and
converting into marningful investments.
2. Thye help in the development of financial markets and bring in more
depth and vibrancy in the markets.
3. Helps in economic development of the marginalised and economically
vulnerable groups and entities.
4. It aids to increase the capital stock of the company by aiding in capital
formation.
5. It has given huge impetus to growth of technology in the country. This
has led to growth of fintech (financial technology) based companies
and startups. Most NBFCs use technology intensively.

13
Innovative Financial Services Practice questions at the end of this chapter
Multiple Choice Questions
1. Bankingsectorcomesunderwhichofthefollowingsectors .
a. Marketingsector
b. Servicesector
c. Industrialsector
d.
2. NBFCperformsgreatroleforfinancein
a. Wholesalesector
b. BigScaleindustries
c. SmallscaleandRetailsector

3. NBFCisacompanyregisteredunder .
a. TheIndianContractAct
b. TheCompaniesAct,1956
c. TheRBIAct

4. --------------- cater to the micro finance needs of unorganized sector

a. Small Finance Banks
b. Reserve Bank of India
c. Foreign Banks

5. ________ caters to the financial needs of agriculture and allied

industries.
a. Small Finance Banks
b. NABARD
c. Unit Trust of India

Explain the meaning of the following terms in One or Two lines

a. Commercial Bank
b. Central Bank
c. NBFC
d. NABARD
e. Payments Banks.

Answer the following questions in detail

a. Explain the evolution of the banking sector in India
b. Write in detail the different types of banks in India
c. What is an NBFC. What are the differences between a Bank and an
NBFC
d. Explain the different types of NBFCs in India
e. Explain the significance of NBFCs.



14
 3
REGULATORY ASPECTS IN INDIA
Unit Structure
3.0 Objectives of this chapter
3.1 Introductions to regulations – Meaning of regulations, Two aspects of
regulations.
3.2 Regulators in India – 3.2.1 SEBI, 3.2.2 RBI, 3.2.3 IRDA

3.0 OBJECTIVES OF THIS CHAPTER

After the successful completion of this chapter, the learner will;

 Realize and understand the need and importance of regulations in

financial sector.

 Learn in brief about the role and functions of SEBI

 Learn in brief about the role and functions of RBI.

 Learn in brief about the role and functions of IRDA.

3.1 INTRODUCTION TO REGULATIONS

Regulations are an important part of and an integral aspect of any financial
system. Regulations are required for the orderly growth of the financial
sector and the entire economy. Regulations are required to maintain the
integrity of the financial system and its components. Failure of banks and
other financial services create larger systematic problems for the
economy. It is the job of different regulators to oversee regulations of
their respective domains. Sound regulations aim to enforce existing laws,
prevent scams and financial frauds, prosecute current cases of financial
misconduct, investigate complaints and protect the interests of investors
and clients. In simple terms, regulations ensure that all stakeholders have
confidence in the financial system.

There are two aspects of regulations;

1. Prudential Regulations: These norms are in place to ensure that firms
have the requisite amount of money to remain solvent. These
regulations are in place to make sure that the institutions and
intermediaries are governed properly and there are appropriate risk
controls measures in place. These rules prevent a systemic failure of
the financial services ecosystem.
2. Investor Protection: A vital aspect of regulations is protecting the
rights of investors. The Indian financial system is characterized by a
large number of small investors who bring in small savings and
15
Innovative Financial Services deposits into the system. It is absolutely essential that their interests
are protected. Investors' rights need to be managed properly and their
complaints need to be addressed at the earliest.

3.2 REGULATORS IN INDIA

The regulatory system in India is such that the regulators are placed at the
top of the hierarchy and they are responsible for managing all aspects of
that particular financial market / service. Following are some of the key
regulators in the Indian context.
3.2.1 Securities and Exchange Board of India (SEBI)
Securities and Exchange Board of India (SEBI) is the nodal regulator of
securities and commodities markets in India. It is directly placed under the
jurisdiction of the Ministry of Finance, Government of India. Although
SEBI was established in 1988, it gained statutory status and power only in
1992 under SEBI Act, 1992. Before SEBI was established, Controller of
Capital Issues was the regulator of Capital MArkets in India. It is
headquartered in Mumbai and has regional offices in New Delhi, Chennai,
Ahmedabad and Kolkata. The membership structure of SBI is such that it
has;
a. One chairman nominated by the Union Government of India.
b. Two members / officers nominated by the UNion Finance Ministry
c. One member nominated by the reserve Bank of India
d. The remaining five members are appointed by the Union
Government of India out of whom three shall be full time members.
The scope of SEBI covers the three broad groups of market participants;
a. Market Intermediaries
b. Issuers of securities
c. Investors
To ensure that SEBI does not falter in its functioning, it acts as a quasi
legislative, quasi judicial and quasi executive functions. These three
makes SEBI a very potent market regulator. Over the years, SEBI has
brought in plenty of market reforms which has made Indian markets at par
with the best in the world.
The functions of SEBI can be categorized into two areas a. Regulatory
Functions and b. Developmental Functions.

Regulatory Functions of SEBI

a. Regulation of Stock Exchanges and other related self regulated
organizations.

16
 Regulatory Aspects in India
b. Regulation of Brokers, Sub brokers, Registrars to the issue,
Underwriters etc.
c. Regulation of Portfolio Managers and collective investment schemes
like Mutual Funds.
d. Prevention of unfair market practices like insider trading and other
fraudulent practices.
e. Regulating any other areas concerning capital markets.

Developmental Functions of SEBI

a. Promoting Investor education and creating awareness about stock
markets.
b. Conducting market related research and publishing information useful
to all market participants.
c. Promotion of self regulatory organizations and drafting guidelines for
compliance and disclosure.
d. Undertaking training and development of different intermediaries.

3.2.2 Reserve Bank of India (RBI)

The Reserve Bank of India is the central bank of the country. It is the apex
bank and the principal regulator of the Banking sector in the country. The
main objectives of RBI is to issue currency notes and to create a stable
monetary policy. In other words, the actions of the RBI have a direct
bearing on the economic growth and stability of the country.
The Reserve Bank of India is driven by a 21 member central board of
directors. It has 1 Governor, 4 Deputy Governors, 10 Government
Nominated Directors, 2 Finance Ministry representatives (who usually are
Economic Affairs Secretary and FInance Affairs Secretary) and 4
Directors who represent the 4 local boards at New Delhi, Mumbai,
Kolkata and Chennai. Each of these Boards consist of 5 members who
adequately represent the regional banking landscape.
Following are some of the key functions of the Reserve Bank of India
1. Issuing Bank Notes - One of the most important functions of the RBI
is issuing currency notes and coins of all denominations except Re1
which is issued by the Ministry of Finance. Along with issuing notes
and coins, it is also responsible for the effective distribution of these
notes and coins across the length and breadth of the country.
2. Custodian of reserves of commercial banks - The RBI acts as the
custodian of cash reserves collected from other commercial banks.
Commercial Banks are required to maintain CRR (Cash reserve ratio)
at a rate decided in the monetary policy.

17
Innovative Financial Services 3. Banker to the Government - A major function of the central bank is to
act as the banker to the government. The RBI is responsible for
maintaining and operating all the deposit accounts of the central
government. In international financial institutions like IMF and World
Bank, RBI represents the government of India.
4. Custodian of foreign exchange reserves - RBI is responsible for
maintaining the nation’s FOREX reserve. It is absolutely essential
especially for dealing with any Balance of Payment crisis. FOREX
imbalance may cause an economic crisis of huge proportions.
5. Lender of Last Resort - The central bank acts as the banker to all
banks. In fact it is the responsibility of the RBI to monitor the financial
health of all banks in the country. RBI provides commercial banks
with loans in case the commercial bank is facing any financial crisis.
6. Controller of credit in the economy - To achieve the monetary policy
goals, the central bank is responsible for controlling the credit creation
function of commercial banks. RBI uses qualitative and quantitative
methods to regulate and control the flow of money in the economy.
Interest rates and money supply regulations are required to achieve
objectives related to inflation, consumption and liquidity.

3.2.3 Insurance Regulatory and Development Authority of India

(IRDAI)
Insurance Regulatory and Development Authority (IRDA) is the regulator
of the overall insurance business in India. It works under the directives of
the Ministry of Finance and is tasked with the important task of regulating
and licencing insurance and reinsurance business in the country. It was set
up under the IRDA Act, 1999 and is headquartered in Hyderabad,
Telangana.
Section 4 of the IRDA Act, 1999 gives guidelines about the composition
of governing members. IRDA is governed by a 10 member body which
comprises 1 chairman, 5 fulltime members and 4 part time members. All
the members are appointed by the Government of India.
Insurance business is classified into life and general insurance. Life
Insurance as the name suggests covers life insurance policies. General
Insurance on the other hand includes all the non life insurance business
like health insurance, motor vehicle insurance, commercial insurance,
travel insurance to name a few. We can see that the scope of IRDA is very
vast.
Following are some of the key functions of IRDA
a. IRDA has the sole authority over issuing, modifying, renewing,
suspending or cancelling the licenses of insurance companies.
b. Specifying the code of conduct and monitoring the activities of
surveyors and assessors.

18
 Regulatory Aspects in India
c. IRDA settles disputes between insurers and other insurance
intermediaries.
d. It is tasked with maintaining the overall financial soundness of
insurance companies.
e. A key primary function is to safeguard the rights and interest of the
policyholders.
f. IRDA is tasked with ensuring orderly growth of insurance business in
the country. This is to ensure that economic development through
insurance business is maintained at an optimum level.
g. IRDA also acts as a quasi judicial agency and is responsible for
settling disputes and redressing grievances of policy holders.
h. Another key function is monitoring the premium rates charged and
regulating any other business which benefits insurance business.
Practice questions at the end of the chapter;
Multiple Choice Questions
1. IRDA was established in the year ______
a. 2000
b. 1999
c. 1987

2. Regulation of capital markets is the job of ________

a. RBI
b. SEBI
c. PFRDA
3. Promoting investor awareness is a ______ function of SEBI
a. Regulatory
b. Developmental
c. Quasi-judicial
4. Motor vehicle insurance is a part of ______.
a. Life Insurance
b. General Insurance
c. Marine Insurance

19
Innovative Financial Services 5. The overall responsibility of regulating the entire banking sector lies
with _________
a. RBI
b. SEBI
c. IRDA
Explain the meaning of the following terms in One or Two lines
a. Regulations
b. Developmental functions of SEBI
c. Life Insurance
d. Composition of IRDA
e. Composition of SEBI
Answer the following questions in detail;
1. Explain the meaning of ‘Regulations’ and elaborate the need for
regulations in the financial sector in India.
2. Write a note on the key role and functions of SEBI
3. Explain the critical functions of RBI
4. Explain the need and importance of IRDA
5. Describe the set-up and composition of RBI and IRDA.




20
 4
FACTORING, FORFAITING AND BILL
DISCOUNTING
Unit Structure
1.0 Objectives
1.1 Introduction to Factoring
1.2 Types of Factoring
1.3 Factoring Process
1.4 Advantages and Disadvantages of Factoring
1.5 Introduction to forfaiting
1.6 Process of Forfaiting
1.7 Advantages and disadvantages of Forfaiting
1.8 Introduction to Bill Discounting
1.9 Difference between factoring and bill discounting

4.0 OBJECTIVES
 After the successful completion of this chapter, the learner shall;

 Understand the meaning and nature of factoring

 Learn the different types of factoring and the process involved in

factoring

 Learn the merits and demerits of using factoring services

 Understand the meaning and nature of forfaiting services

 Learn the process of forfaiting along with its benefits and

disadvantages

 Learn the meaning and process of bill discounting and differentiate

between factoring, forfaiting and bill discounting.

4.1 INTRODUCTION TO FACTORING

Factoring is an important financial service in a way that it helps businesses
to manage its accounts receivables in a better way. It is a type of debtor
finance in which a business will sell its accounts receivables invoices to a
third party at a discount against which it will receive cash. The third party
will recover the money from debtors at a subsequent date. This
21
Innovative Financial Services arrangement is important to meet current and immediate cash
requirements. The third party that buys the accounts receivables is called a
factor. The factor essentially becomes the funding source in this
arrangement. Factoring is an important function as it enables cash
injection into the business.

4.2 TYPES OF FACTORING SERVICES

1. Recourse Factoring - In this type of factoring services, if the factor
fails to recover the bill amount from the customer, the same is
collected from the seller of goods. The entire risk of bad debts lies
with the seller of goods. The commission charged by the factor is
comparatively low.
2. Non - Recourse Factoring - In this type of factoring, the risk of bad
debts lies with the factor. The factor bears the risk in case of the bill
default by the customer. For bearing this risk, the factor will charge a
higher commission.
3. Domestic Factoring - This is the type of factoring where the customer,
seller of goods and the factor are from the same country.
4. Export Factoring - This is also known as international factoring or
cross border factoring. This type of factoring involves 4 parties. It
involves the seller of goods (the exporter), exporter’s factor, the
customer (the importer) and the importer’s factor.
5. Disclosed and Undisclosed factoring - In case the bill / invoice
mentions the name of the factor, it becomes a disclosed factoring. If
the invoice has no mention of the details of the factor, it is called
undisclosed factoring.
6. Advance Factoring - This type of factoring provides the seller of goods
a pre advance on uncollected and non due receivables. A certain
mutually agreed rate of interest is charged.
7. Maturity Factoring - It is a type of factoring where the factor will settle
and pay the bill amount at the end of the collection period or when the
money is collected from the customer.

4.3 FACTORING FRAMEWORK

Factoring enables a business access to immediate capital based on future
income through receivables management. Accounts receivable represents
money owed to the business from its customers. Following is the
framework of factoring;
1. The seller sells the goods to the buyer on credit and raises the invoice.
2. The seller sells the invoice to the factor. The factor will verify the
authenticity of the invoice.

22
 Factoring, Forfaiting and Bill
3. After verification, the factor will pay around 75% - 80% of the bill Discounting
amount.
4. The factor will wait for the customer to pay the bill amount. Once the
bill amount is received by the factor, the factor will pay the balance to
the seller of the goods.
5. The agreement between the seller of goods and factor decides the type
of factoring agreement, interest charged and the rate of commission.
6. The commission / interest charged by the factor can be upfront or it
can be in arrears.
7. In case of a non-recourse factoring, the factor bears the risk of bad
debts. In such cases, the commission charged will be much higher.

4.4 ADVANTAGES AND DISADVANTAGES OF

FACTORING
The advantages are as follows;
1. Factoring services reduce the credit risk of the seller of the goods. The
risk usually gets managed by the factor.
2. The business is able to manage working capital requirements in a
better way. This is because the factor provides money against invoices.
3. Cash flow and liquidity is greatly improved in the organization.
23
Innovative Financial Services 4. The receivables collection cost of the business drastically gets reduced.
The disadvantages are as follows;
1. The cost of factoring is usually high. This is true especially in case of
non-recourse factoring.
2. The relations between the seller and the buyer of goods can become
stressful as the factor ends up collecting the money from the customer.
3. Bad behavior of the factor especially during bill collections can
damage the goodwill of the business.
4. Details like sales, customer details which usually a business will not
reveal to outside entities is shared with the factor.
4.5 FORFAITING
Forfaiting is a novel method similar to factoring which allows exporters to
obtain cash by selling their long term and medium term foreign accounts
receivable. The entire transaction is executed at a discount. Forfaiting is
usually without recourse only. The forfaiter could be a separate
department in a bank that provides such specialized services. Since
forfaiting is without recourse, the entire risk of default is borne by the
forfaiter. Although forfaiting seems very similar to factoring, one key
difference is forfaiters typically work with large exporters who sell capital
goods or commodities or are involved in large projects which require
extended periods of credit. This also ensures that the seller (exporter) is
completely protected against payment default by the importer. Complete
credit protection provides peace of mind for the seller (exporter).
4.6 Process of Forfaiting (sample chart provided below)

24
 Factoring, Forfaiting and Bill
1. Goods are sold by the exporter (seller) to the importer (buyer), on credit Discounting
which extends upto 5 years.
2. A series of bills / promissory notes are drawn by the importer in favour
of the exporter, for the bill amount to be paid in future. This also
includes a certain rate of interest.
3. The bills / promissory notes issued are guaranteed by a recognized
international bank, often importer’s banker. The guaranteeing bank
assures that it covers the failure in payment of the buyer if any. The
bank may recover the money from the importeer in case the importer
defaults.
4. The notes so availed, are sold by the exporter to the forfaiter (exporter’s
banker), at a discount on a non-recourse basis.
5. Now, when the forfaiter buys those notes, it can hold these notes until it
gets matured and recover the bill amount.

4.7 LET US NOW LOOK AT THE ADVANTAGES AND

THE DISADVANTAGES OF FORFAITING
Advantages of Forfaiting
 Forfaiting is a mechanism that ensures immediate cash to the exporter.
This improves the cash flow and liquidity management.
 Since forfaiting is without recourse, the seller (exporter) is protected
from the risk of non payment of dues and it also eliminates the
collection cost.
 Risk is quite low as banks of both the importer and the exporter are
involved in the process.
 For the banks, it becomes an excellent system for earning good profits
especially when currency appreciates.
 It is a completely easy to manage system as it converts credit sale into
cash sale

Disadvantages of Forfaiting
 Forfaiting deals with importers and exporters and involves bills in
foreign currencies. Forfaiting is not available in all currencies and only
a few major currencies are considered.
 Forfaiting reduces the risk for exporters, however, since the risk is
transferred to the forfaiter, it leads to a higher export cost.
 The higher export cost is borne by the importer, which is included in
the standard pricing.
 Forfaiting facility is not extended to all transactions. Only a select few
transactions become eligible under this scheme.
25
Innovative Financial Services 4.8 BILL DISCOUNTING
Bill discounting is an arrangement in which a company’s unpaid invoices
which are due are sold to a financier. The financier is usually a bank or a
specialised financial institution. This arrangement is to allow businesses to
have access to short term financial assistance. This also helps maintain
adequate liquidity and assist in the working capital management. Bill
discounting is also called invoice discounting. Bill Discounting is
applicable only on those trade debts which are supported by accounts
receivable.
Bill Discounting may sound like factoring at the outset. However there are
differences between Bill Discounting and Factoring.
4.9 Factoring V/s Bill Discounting (Please convert this table into an image
to avoid plagiarism)

BASIS FOR
BILL DISCOUNTING FACTORING
COMPARISON

Meaning Trading the bill before it A financial transaction

becomes due for in which the business
payment at a price less organization sells its
than its face value is book debts to the
known as Bill financial institution at a
Discounting. discount is known as
Factoring.

Arrangement The entire bill is The factor gives

discounted and paid, maximum part of the
when the transaction amount as advance
takes place. when the transaction
takes place and the
remaining amount at the
time of settlement.

Parties Drawer, Drawee and Factor, Debtor and

Payee Client

Type Recourse only Recourse and Non

Recourse

Governing statute The Negotiable No such specific act.

Instrument Act, 1881

Financier's Discounting Charges or Financier gets interest

Income interest for financial services
and commission for
other allied services.

26
 Factoring, Forfaiting and Bill
Practice questions at the end of the chapter Discounting
Multiple Choice Questions
1. Sales Ledger Administration is available in the following factoring
services
a. WithoutRecoursefactoring
b. Withrecoursefactoring

c. Invoicediscounting

2. CreditProtectionisavailablein

a. WithoutRecoursefactoring
b. Withrecoursefactoring
c. Noneofthe above

3. Underforfaitingtheclientisabletogetcreditfacilitytotheextentof

a. 100%ofthevalue oftheexportbill
b. 80%ofthe valueoftheexport bill
c. 90%ofthe valueoftheexport bill

4. Fullservicefactoringisoften

a. Recoursefactoring
b. Non-recoursefactoring
c. Agencyfactoring

5. The process of selling trade debt sofa client to afinancialinterme diary is

called

a. Factoring
b. Securitisation
c. Materialisation

27
Innovative Financial Services 6. services are mainly provided to foreign investors.

a. Custodial Services
b. Financial Services
c. Factoring Services

7. The Idea of providing factoring services was first thought of in India by .

a. Tandemcommittee
b. Malhotracommittee

c. Vaghulcommittee

Explain the following terms in One or Two lines

 Factoring

 Forfaiting

 With recourse factoring

 Without Recourse factoring

 Bill Discounting

Write the answers to the following questions in detail;

1. Explain the term ‘Factoring’ and explain the types of factoring
2. Describe the process of factoring with a suitable diagram
3. Distinguish between factoring and forfaiting
4. What is Forfaiting and explain its process with a suitable diagram
5. Explain the advantages and disadvantages of factoring
6. Explain the advantages and disadvantages of forfaiting
7. Distinguish between bill discounting and factoring.



28
 5
ISSUE MANAGEMENT AND
INTERMEDIARIES
Unit Structure
5.1 Introduction
5.1.1 Process of IPO
5.1.2 Process of issue of debt securities
5.2 Issue management
5.2.1 Indian scenario
5.2.2 Merchant banking in India
5.2.4 Reasons for growth of merchant banking
5.2.5 Organization that can offer merchant banking services in India
5.2.6 Merchant bankers in India
5.3 Functions of merchant bankers
5.4 Services of merchant bankers
5.5 Underwriter to an issue
5.5.1 Underwriting objectives
5.5.2 The following are the key characteristics of an underwriting
agreement
5.5.3 Different types of underwriting
5.5.4 Classification of underwriters
5.5.5 Capital adequacy requirement
5.5.6 Registration and renewal fee
5.5.7 Underwriting commission
5.5.8 General responsibilities
5.5.9 SEBI guidelines
5.6 Banker to an issue
5.6.1 Registration
5.6.2 Characteristics of bankers to an issue
29
Innovative Financial Services 5.6.3 General obligations and responsibilities
5.7 Brokers to the issue
5.7.1 Brokers' appointment
5.7.2 Conditions for grant of certificate of registration as broker
5.7.3 Conditions for brokerage
5.8 Summary
5.9 Exercise

5.0 LEARNING OBJECTIVES:

 To understand the process of fund raising through issue management.
 To understand the terminologies associated with issue management.
 To understand the activities involved in pre-issue and post- issue
management.
 To understand the legal environment for issue management.
5.1 INTRODUCTION
Every corporate form of organisation whether existing or new requires
funds for the starting the business or running or expansion of existing
business. One of the basic sources of finance is raising funds by issue of
shares. The process of issue management and listing involves the services
like suggesting of proper capital structure to reduce the cost of capital,
advising the clients on regulatory compliance, pre issue and post issue
management, legal compliances etc.

5.1.1PROCESS OF IPO

Step 1: Appointment of an Underwriter or Investment Bank: These

financial experts carry out the IPO process on behalf of the company.
They act as intermediaries between the company and the investors.

30
 Issue Management and
Step 2: This IPO step involves creating a registration statement along with Intermediaries
a draft prospectus, also known as the Red Herring Prospectus (RHP). The
Companies Act requires the submission of RHP.

Key components of RHP:

a. Definitions: Contains definitions of industry-specific terms.
b. Risk Factors: This section describes threats that can affect a company's
finances.
c. Using Proceeds from IPO: This section mentions how the funds raised
from investors are used.
d. Industry Description: This section describes the company's operations
across theindustry segment. For example, if a company belongs to
Pharma sector, the section contains forecasts and forecasts for that
sector.
e. Business Clause: This section describes the company's key business
activities.
f. Administration: This section contains information about key
personnel.
g. Financial Description: This section consists of financial statements and
audit reports.
h. Legal Information and Other Information: This section describes on
going proceedings against a company, along with other information.
This document must be submitted to the Corporate Registration Authority
3 days before offer open to public. In addition, the registration notification
submitted must comply with applicable rules. After submission, the
company can submit an IPO application to SEBI.
Step 3: Verification by SEBI
Market controller, SEBI then confirms the information provided by the
organization. After getting the confirmation from the SEBI, organization
can declare a date for its IPO.
Step 4: Making an application to the Stock Exchange
The company now has to make an application to the stock exchange for
floating its initial issue.
Step 5: Creating Buzz of IPO
Before an IPO opens to the public, the enterprise endeavours to create a
buzz withinside the marketplace with the aid of using roadshows. Over a
length of weeks, the executives and team of workers of the enterprise will
put it up for sale the approaching IPO throughout the country. This is
essentially an advertising and marketing and marketing tactic to draw
31
Innovative Financial Services capacity investors. The key highlights of the enterprise are shared with
diverse people, inclusive of commercial enterprise analysts and fund
managers. The executives undertake diverse user-pleasant measures, like
Question and Answer sessions, multimedia presentations, institution
meetings, on-line digital roadshows, and so on.
Step 6: Pricing of IPO
There are two types of IPO system:
a. Fixed rate issue: In a fixedrate issue, the rate at which stocks will be
offered and allotted is informed to the buyers in advance.
b. Book building issue: In book building issue, issuer offers a 20% range
within which buyers can bid for the stocks. The final issue price is
determined after the bidding is closed. This 20% range is known as an IPO
price bandwidth. Both retail and institutional consumers are known as to
publish their bids inside this price range.
Step 7: Allotment of Shares
Once the IPO price is finalised, the company alongwith the underwriters
will decide the number of shares to be allotted to every investor. In the
case of over-subscription, partial allotments may be made or the excess
application may be rejected. The IPO shares are normally allotted to the
bidders within 10 working days of the closing bidding date.
The book is the collection of bids which are available in for the IPO, is
open to all buyers. In different words, the call for the stocks supplied at
different price is to be held for all investors whether existing or potential.
No bid rate may be less than the IPO ground rate, that is the lower bound
of the band. Neither it can be more than the IPO cap rate, that is upper
bound of the band. The book is usually open for three days, and the
bidders can revise their bids as long as the book is open.
Issuers opts for book building issue over fixed price issue because this
system offers them the possibility to find out the rate and call for. This
way, the issuer is capable of ensuring that the difficulty generates as a
whole lot value in the direction in which marketis inclined. The rate at
which the shares is subsequently offered is known as the cut-off rate. This
is the best rate at which all of the shares are supplied may be offered.

5.1.2 PROCESS OF ISSUE OF DEBT SECURITIES

A company can also raise funds by issuing debt instruments in the form of
a public offering or a right offering. Primarily, the arrangements to be
made and the procedures involved are the same as in the case of an equity
issue. SEBI (Disclosure and Investor Protection) Guidelines 2000 still
include some unusual provisions. Some of its key provisions are
highlighted below.
a) The offer document for such an issue should include the following
information:
32
 Issue Management and
 the interest rate for debentures that can be freely determined by the Intermediaries
issuer company,

 The amount of the premium on conversion, the time period

of conversion,

 In the case of PCDs/NCDs, the redemption amount, maturity period,

and yield on redemption of the PCDs/NCDs

 Complete information about the terms of offer or purchase, including

the name(s) of the party offering to buy, the khokhas (non-convertible
portion of PCDs), and the khokhas (non-convertible portion of PCDs).

 The discount at which such an offer is made, as well as the effective

price for the investor as a result of that discount

 The current and future equity ratios, as well as the long-term debt
ratio,

 Servicing behaviour on existing debentures, payment of interest on

term loans and debentures on due dates
b) Such a public or rights issue of debt instruments (including
convertible instruments), regardless of maturity or conversion period, is
only permissible if a credit rating has been obtained and disclosed in the
offer document. All issues worth Rs100 crore or more will be rated by two
different credit rating agencies. All credit ratings, whether accepted or
rejected, must be disclosed in the offer document. Furthermore, all credit
ratings obtained by the issuer company for any listed security during the
three years preceding the issue should be disclosed.
c) If the issue is a debt with a maturity of more than 18 months, the
issuer must appoint debenture trustees holders regardless of whether the
debentures/bonds are secured or not. The offer document must include
their names. The issuer company must execute a trust deed in favour of the
debenture trustees within six months of the issue's closing. The trustees
should be given the necessary powers to protect the interests of debenture
holders. They also have the right, in consultation with the institutional
debenture holders, to appoint a nominee director to the company's board
of directors.
d) The offer document should list the assets that will be used to create
the security, as well as their charge ranking (s). The security/asset cover to
be maintained, the basis for its computation, the valuation methods, and
the frequency with which such valuation should be disclosed should all be
disclosed. The security must be created within six months of the issuance
of the debentures. If the issuing company intends to create a charge for
debentures with maturities of less than 18 months, the charge particulars
must be filed with the ROCs in accordance with the Companies Act.
Where no charge is to be created on such debentures, the issuer company
must ensure compliance with the provisions of the Companies
(Acceptance of Deposits) Rules, 1975, because unsecured
33
Innovative Financial Services debentures/bonds are treated as "deposits" for the purposes of the
Companies (Acceptance of Deposits) Rules, 1975.
e) While filing the draft offer document, the merchant banker should
file with SEBI certificates from their bankers stating that the assets on
which the security is to be created are free of encumbrances and that the
necessary permissions to mortgage the assets have been obtained from
financial institutions or banks in cases where such assets are encumbered.
f) In the following cases, a letter of option containing disclosures about
credit rating, debenture holders resolution, option for conversion,
justification for conversion price, and such other terms as SEBI may
prescribe from time to time should be filed with SEBI through an eligible
merchant banker:
In the case of a roll-over of non-convertible portions of partly convertible
debentures (PCDs)/non-convertible debentures (NCDs) issued by a listed
company, the non-convertible portions of PCDs/NCDs issued by a listed
company, the value of which exceeds Rs 50 lakh, can be rolled over
without changing the interest rate subject to the following conditions:

 Debenture holders are required to redeem their debentures in

accordance with the terms of the offer document.

 A roll-over is performed only when debenture holders have sent their

positive consent and not because their negative response has not been
received.

 Before a rollover, a new credit rating is obtained within six months of

the redemption date and communicated to debenture holders prior to
the rollover.

 When such a roll-over occurs, a new trust deed is executed; and

 In the case of rolled-over debentures, new security is created.

However, if the existing trust deed or security documents provide for
the continuation of the security until the redemption of debentures, no
new security may be created.
In the case of conversion of PCDs/FCDs into equity capital:

 If the convertible portion of any instrument issued by a listed

company, such as PCDs, FCDs, etc., exceeds Rs 50 lakh and the
conversion price was not fixed at the time of issue, holders of such
instruments should be given the mandatory option of not converting into
equity capital.

 In cases where such instrument holders are to be given an option, if

any instrument holder does not exercise the option to convert the
debentures into equity at a price determined in the general meeting of
shareholders, the company must redeem that portion of the debenture at a
price not less than its face value within one month of the last date by
34
 Issue Management and
which the option is to be exercised; the provision of sub-clause (c) above Intermediaries
would not apply if such redemption is made.

 If the non-convertible portion of PCDs or Non-Convertible

Bonds/Debentures are to be rolled over with or without a change in the
interest rate(s), debenture/bond holders who wish to withdraw from the
scheme will be given the option to do so. Rollover may be granted only
when debenture/bond holders have sent their positive consent and not
because their negative response has not been received. Before rolling over
any non-convertible bonds, debentures, or nonconvertible portion of
PCDs, a new credit rating must be obtained within six months of the
redemption date and communicated to bond/debenture [Link] letter
of option regarding roll over shall be filed containing disclosure with
regard to the credit rating, bond/debenture holder resolution, option for
conversion and such other terms which the Board may stipulate from time
to time.

 If the non-convertible portion of PCDs or Non-Convertible

Bonds/Debentures are to be rolled over with or without a change in the
interest rate(s), debenture/bond holders who wish to withdraw from the
scheme will be given the option to do so. Rollover may be granted only
when debenture/bond holders have sent their positive consent and not
because their negative response has not been received. Before rolling over
any non-convertible bonds, debentures, or nonconvertible portion of
PCDs, a new credit rating must be obtained within six months of the
redemption date and communicated to bond/debenture holders.

 Debentures cannot be issued for the purpose of acquiring shares or

making loans to any group company. This requirement would not apply to
the issuance of fully convertible debentures with a conversion period of 18
months or less. The issuer company should determine and disclose the
premium amount and time of conversion. The issuer company has
complete control over the interest rate on debentures.

Test your Understanding:

What is book building issue?
What is IPO?
What does PCD, FCD, NCD stands for?

5.2 ISSUE MANAGEMENT

Issue management involves issue of all kind of securities like equity
shares, preference shares and debentures or bonds in the procedures as
discussed above. The services of issue management also include
marketing of capital issues, of existing companies, including rights issues
and dilution of shares by letter of offer are included in [Link] issue
management activities are divided into two parts:
Pre-issue
35
Innovative Financial Services 5.2.1 INDIAN SCENARIO
In India the functions of issue management are carried out by the merchant
bankers. In India, a merchant banker is defined as “an individual who is
who is involved in the business of issue management either by making
arrangements regarding buying, selling or subscribing to the securities as a
manager, advisor, consultant in relation to such an issue management.”
Merchant banking in India was firstly set up in India by National
Grindlays in 1967; followed by the Citi Bank in 1970. SBI became the
first commercial bank to set up a distinct division for merchant banking in
the year 1972, followed by ICICI in 1973, and then various other
commercial banks started these services viz. PNB, Bank of India, UCO
Bank, [Link], the credit for increase in merchant banking in India
goes to introduction of FERA in 1973, after which, various banks such as
IDBI and IFCI entered into this market.

5.2.2 MERCHANT BANKING IN INDIA

A person may apply to the Board for the issuance of a certificate of
registration using Form A.
When submitting an application for registration, the applicant must pay a
non-refundable application fee of Rs. 50,000 via direct credit in the bank
account via NEFT/RTGS/IMPS or any other mode permitted by the RBI,
or by a demand draught made payable to the "Securities and Exchange
Board of India" and payable in Mumbai or the respective regional office.
The application under sub-regulation (1) shall be made for any one of the
following categories of the merchant banker namely:
(a) Category I, that is
(i) to carry on any activity of the 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 subscriptions; and
(ii) to act as adviser, consultant, manager, underwriter, portfolio manager
(b) Category II, that is to act as adviser, consultant, co-manager,
underwriter, portfolio manager;
(c) Category III, that is to act as underwriter, adviser, consultant to an
issue
(d) Category IV, that is to act only as adviser or consultant to an issue.

The minimum net worth requirement for acting as merchant banker

is given below
The minimum net worth requirement for acting as merchant banker is
given below

36
 Issue Management and
Category Net worth Intermediaries

Category I Rs. 5 cores

Category II Rs, 50 lakhs

Category III Rs. 20 lakhs

Category IV Nil

According to SEBI guidelines, any public issue or rights issue worth more
than Rs. 50 lakhs must be managed by a Merchant Banker who is
registered with SEBI. They will be governed by the code of conduct
outlined in the regulations. The number of Issue Managers who can be
associated with an Issue is limited by SEBI Regulations:

Size of the Issue Permissible No. of Lead Managers

Less than Rs. 50 crores 2

Rs. 50 crores but less then Rs. 100 3

crores

Rs. 100 crores but less than Rs. 4

200 crores

Rs. 200 crores but less than Rs. 5

400 crores

Rs. 400 crores and above 5 or more

Before accepting an assignment relating to an issue, all lead managers

must enter into an agreement with the relevant company outlining their
rights and obligations. If more than one lead manager is involved, their
responsibilities must be clearly defined. There will be a minimum
underwriting agreement. A Lead manager is unable to manage an issue
involving an associate company. During the issue period, no lead manager
may exit.
Issue managers play an important role in raising funds through public
securities offerings. Companies that are considering issuing new capital
decide on issue managers after conducting extensive due diligence and
carefully analysing the merchant banker's competence and capabilities to
handle the issue. They provide valuable services in the preparation and
drafting of the prospectus, pricing the issue, marketing and underwriting
the issue, coordinating the activities of various agencies/institutions
involved in this context to carry out legalities involved in the process,
deciding the basis of allotment, making the allotment, despatch of share
certificates/refund orders as the case may be, and finally, in the listing of
shares on stock exchanges.
37
Innovative Financial Services Activities of Merchant Banker:
SEBI has issued compendium of circulars to merchant bankers from time
to time and broadly has divided these activities into two groups i.e., Pre-
issue activities and Post-issue activities.
A. Pre-issue activities:Before a public offering, a merchant banker
must obtain consent from the stock exchange to appoint managers,
bankers, underwriters, and brokers, as well as advise the company on the
appointment of auditors, board of directors, prospectus, and obtain consent
from the company's legal counsel. Pre-issue management entails:
• obtaining SEBI approval;
• preparing a prospectus;
• selecting a registrar, advertising issues, underwriters, bankers, and
brokers; and
• determining the price for their issues.
Some important aspects about these activitiesare discussed here.
1. Obtaining SEBI approval: Before issuing any capital, ensure that the
proposed issue complies with the provisions of the SEBI guideline for
disclosure and investor protection in terms of issue pricing, promoters,
contribution, lock in period, reservation, and so on.
2. Holding of a General Meeting: If the Articles of Association require
that shareholder consent be obtained, then a shareholder meeting shall
be called.
3. Intimation to the Stock Exchange: A copy of the company's
Memorandum and Articles of Association must be sent to the stock
exchanges where the shares will be listed for approval.
4. Prospectus:A public issue is the sale of securities to the general public
in accordance with the Companies Act of 2013 and SEBI guidelines. A
public offering of equity shares is classified as
Public issue
Right issue
Preferential issue (Private Placement)
Content of a Prospectus:
 Date / country of incorporation
 Company principal activities
 Profit and loss a/c balance sheet and cash flow statement for the past
three years.
 Statement of accounting principle
 Auditors reports with name and address.
 Material relates to financial position
 Analysis of sales by geographical area etc.
 Detail regarding issues of shares / deposit agreement.
38
 Issue Management and
Type of prospectus: Intermediaries
a. Offer document: Prospectus in the case of a public offering and right
issue is filed with company registrars and stock exchanges. This offer
document contains all of the company's information and assists an investor
in making investment decisions.
b. Draft offer document: This refers to an offer document that is still in the
draft stage. The draft offer document must be filed with SEBI within 21
days prior to submitting the offer document to ROC. The draft offer
document should be posted on the SEBI website for public comment.
c. Red herring prospectus: This is a prospectus that does not include
information such as the exact price and number of shares being offered. It
contains information on the upper and lower price ranges.
d. Abridged prospectus: This prospectus is included with the application
form of the Public issue.
e. Shelf prospectus: Under the Companies Act 2013, any financial
institution or bank may file a shelf prospectus covering one or more
securities issues or classes of securities. Specified in the prospectus filed
with the company's registrar.
The benefit of a shelf prospectus is that the issuing institution does not
have to file a new prospectus. The shelf prospectus has a one-year validity
period.
5. Appointment of Intermediaries: a. Registrars to the issue: The
Registrar of an IPO, also known as an Initial Public Offering, is in charge
of processing the company's IPOs. These organisations are independent
financial institutions that are registered with stock exchanges and SEBI.
The company that is going public appoints these bodies. A registrar's
primary role when issuing an IPO is to process IPO applications, distribute
shares to applicants in accordance with SEBI guidelines, process refunds
via cheque and ECS, and transfer allocated shares to the applicant's
demand accounts.

 Banker to the issue: Merchant bankers assist in the selection of

appropriate bankers based on project proposals. Commercial bankers are
merely financiers, and their activities include credit proposal, credit
appraisal, and loan [Link] a new company wants to do new issues, the
banker must assist the following intermediary with newissue work.

 Underwriter: An underwriter agreement is a contract between the

issuing company and a person or institution in which the latter guarantees
that if the share is not fully subscribed. That person is referred to as an
underwriter. Subscription is thus guaranteed even if the general public
does not purchase from the issuing company. Underwriting forms and
types:
o Full underwriting: An underwriter who accepts the entire subscription
is referred to as a full underwriter.
39
Innovative Financial Services o Partial underwriting: A partial share subscription by an underwriter is
referred to as partial underwriting.
o Joint underwriter: More than two underwriters have subscribed as a
joint underwriter.
o Sub-underwriter: One underwriter may appoint another underwriter to
handle the subscription of shares.
o Firm underwriting: When an underwriter commits to purchasing or
subscribing to a specific number of shares from the public, this is
referred to as firm underwriting.

 Broker: Broker is a person who behaving as intermediary between

buyer and seller to by securities and subscribe the securities.

 Advertising: Any person engaged in the creation, preparation, and

display of advertisements concerning issues is referred to as an
advertising agency. A merchant banker arranges a meeting with
company representatives and an advertising agent to finalise the date
of issuer's opening and closing. The media for publication can be
finalised by the merchant banker.

 Printers: Printer is a person who prints the (i) Application form. (ii)
Prospectus and (iii) Other issue material.
6. Fixing price for their issues: Different types of public issues

 Initial public offering (IPO): The first time shares issued by a new
company are called an initial public offering (IPO), or the first sale of
stock by a private company to the stock market.

 Follow on public offer (FPO): Follow up on public shares issued by a

company that has already gone public through an IPO. An FPO is any
company formed after the initial public offering.

 Right Issue: A right issue is the sale of securities in the primary market
through the issuance of rights to be the existing shareholder.

 Offer for Sale: A company can list new shares in one of two ways.
o By an offer sale which is a public invitation by intermediary.
o By an offer for sale which is a public invitation by company.

 Green shoe option: A green shoe option is an option to allocate shares

in excess of those included in the public offering and to operate a post-
listing price stabilising mechanism for a period of no more than 30
days.

 E-IPO: A company that is preparing to offer securities to the public via

an online stock exchange system.

40
 Issue Management and
 Private placement/placement with FIs, MFs, and so on: Private Intermediaries
placement and preferential allotment involve only selling securities to
sophisticated investors such as financial institutions, material funds,
venture capital funds, and so on. The identity of investors in a preferential
allotment is revealed when the issuing company seeks shareholder
approval. In contrast, when the offer document is prepared for a private
placement, the identity of the investors is unknown.

 Bought out deal: Bought out deal is a process of investment by a

sponsor such direct investment is being made with understanding between
the company and the sponsor to go for public offering in mutually agree
time. A company will allot shares in full to sponsor. After certain period
of agreed upon between sponsor and the company.
7. Pricing the issues:In a public offering, one of the most important
challenges for a merchant banker is pricing. Appropriate pricing not only
ensures the issue's success, but also provides a good return to the
prospective well. Pricing is the value of a specific or per stock. Through
the book building process, an issuer may determine the price of specified
securities in consultation with the lead merchant banker.
Parameters of issue pricing:
 price to earning ratio (P/E Ratio)

 price to book value ratio etc.

Pricing strategies for an issue:
 Differential pricing: Listed and unlisted companies may issue shares
securities to firm allotment applicants at a price different from the
price at which the net offer to the public is made.

 Price band: The issuer or issuing companies may specify a 20% price
band in the document field with the SEBI. The final price will be
determined later.

 Payment of discounts/commissions: The issuer company/promoters

may not make any direct or indirect payment to any firm allotted in a
public offering, whether in the form of a discount/ commission/
allowance or otherwise.

 Share denomination: Any denomination of equity shares can be issued

in a public/rights issue.

B. Post issue management:

The stage following the issuance of securities to subscribers is known as
the post-issue obligation. The major post-issue obligations concern
participation in the allotment procedure, post-issue monitoring reports,
resolving investor grievances, and coordination with intermediaries,
among other things.

41
Innovative Financial Services 1. Procedure for allotment and the basis for allotment: The merchant
banker, in collaboration with the MD of the recognised stock exchange
and the issue's registrar, is responsible for ensuring that the basis of
allotment is finalised in a fair and proper manner in accordance with
Regulation 49 of the ICDR Regulations. Such shares should be allotted
in such a way that the minimum allotment equals the minimum
application size as determined and disclosed in the offer document.
2. Post-issue monitoring report: In the case of an IPO, the merchant
banker must submit a post-issue monitoring report on the third day
following the close of the issue's subscription.
3. Post-issue advertisement: Regulation 51 of the ICDR regulations
imposes a duty on merchant bankers to ensure that a post-issue
advertisement detailing subscription, the basis of allotment, the value
and percentage of all applicants, the date of filing of listing
application, and other details is published in at least one nationwide
English and Hindi newspaper within ten days of the date of various
activities.
4. Redressal of investors grievance: The Post-issue Lead Merchant
Banker shall actively participate in post-issue activities such as
allotment, refund, and despatch, and shall regularly monitor redressal
of investor grievances arising from such activities.
5. Coordination with intermediaries: It entails coordinating with various
agencies involved in post-issue activity, such as the registrar to issue,
bankers to the issue, self-certified banks, and underwriter.
6. Certificate regarding the realization of stock investors and other
requirement: : The Post-Issue Lead Merchant Banker shall submit to
the Board, within two weeks of the date of allotment, a Certificate
certifying that the stock investments on which the allotment was
finalised, have been realised.
7. SEBI's operational guidelines: Compliance requirements for merchant
banker(s) in relation to operational guidelines include submission of
draught and final offer documents, post-obligation instructions,
penalty point issuance, and so on. These guidelines are available on
the SEBI website.

5.2.4 REASONS FOR GROWTH OF MERCHANT BANKING

1. Globalization: After the reforms in 1991, the Indian economy got
opened to foreign companies. This led to funds inflow from the foreign
countries in Indian market. This led to growth of merchant banks in India
as to ensure these inflows through proper legal way.
2. Increased Competition: As the economy has become more globalised,
market scenarios have become more lucrative, and business opportunities
have been more appealing to a variety of people. These factors shifted the
Indian corporate sector, due to which there saw a significant expansion.

42
 Issue Management and
This led merchant bankers to play a vital role in the corporate world by Intermediaries
providing specialised services.
3. Changes in consumer trends: As a result of the entry of foreign
companies into the market, there has been a significant alteration in the
industrial and business sectors. The main benefit was that the Indian
masses began to receive higher-quality products as Indian enterprises
began to match the quality of foreign products. Financial products and
instruments grew more significant in such circumstances.
5. Government Reforms: The government's involvement was minimised,
while privatisation expanded. It also increased investment limitations and
reduced direct interference, leading to an increase in the offer of
international players.
5. Changes in consumer demographics: According to a Deloitte report
published in September 2017, India has 65 percent of its population under
65 years old and that:
a) it sits on a demographic goldmine,
b) it is estimated that India has around 390 million millennials and about
440 million millennials in the GEN Zcohort,
c) the median population age is 27.3 years, compared to 35 years in China
and 47 years in Japan.
With a growing workforce, there is a demand for more informed
investment decisions and a wider range of possibilities.
6. Technology Advancement: Today's technology is assisting in the
redefinition of operational modes and methodologies, allowing market
players to pursue novel avenues for superior investment strategies. One
example is the introduction of an electronic version of the
dematerialization account, also known as the Dematerialization Account.
5.2.5 ORGANIZATION THAT CAN OFFER MERCHANT
BANKING SERVICES IN INDIA
Here are the organizations that provide Merchant banking services in
India:
a. Commercial Banks and their sub-banks
b. Foreign Banks e.g.,Citi Bank, National Grindlays bank, etc.
c. State Level Financial Institutions are State Industrial Development
Corporations(SIDC’s) and State Financial Corporations (SFC).
d. India Financial Institutions and Development Bankse.g., ICICI, IFCI,
IDBI, etc.

43
Innovative Financial Services e. Private Financial Consultancy Firms and Brokers e.g., J.M. Financial
and InvestmentServices Ltd., DSP FinancialConsultants, Kotak
Mahindra, etc.
f. Professional Merchant Banking Houses.
g. Technical Consultancy Organisations.

5.2.6 MERCHANT BANKERS IN INDIA

There are more than 130 merchant bankers who are registered with SEBI.
Here is the list of some significant ones:

Public Sector Merchant Bankers

State Bank of Bikaner and Jaipur, Punjab National Bank, Bank of
Maharashtra, Karur Vysya Bank, SBI Capital markets Ltd., IFCI Financial
Services Ltd.

Private Sector Merchant Bankers

Yes, Bank Ltd., ICICI Securities Ltd., Kotak Mahindra Capital Company
Ltd., Axis Bank Ltd., Tata Capital Markets Ltd., Reliance Securities Ltd.,
Bajaj Capital Ltd., ICICI Bank Ltd.

Foreign Players in Merchant Banking

Barclays Securities (India) Pvt. Ltd, FedEx Securities Ltd., Goldman
Sachs (India) Securities Pvt. Ltd., DSP Merrill Lynch Ltd., Deutsche
Equities India Private Limited, Morgan Stanley India Company Pvt. Ltd.,
Deutsche Bank

5.3 FUNCTIONS OF MERCHANT BANKERS

a. Raising finance: Merchant bankers assist their customers in
obtaining funding through debenture issuances, stock purchases, bank
loans, and other means. Filming takes place in both domestic and
international markets. The funds generated by this strategy can be used to
start a new project or company, or to expand and modernise an existing
one.
b. Promotional activities are carried out by merchant bankers in the
capacity of industrial business promoters. They enable developers to
create innovations, define ventures, conduct feasibility studies, obtain
permits from government agencies, and capitalise on opportunities.
Merchant bankers may also help with political, technological, and
collaborative projects on occasion.
c. Managing public issue: They serve as consultants on the
terminology, form, and timing of corporate securities issues and helps
them to be tailored to customers and provides the issuing companies with
transparency and versatility.

44
 Issue Management and
d. Credit syndication: They offer professional services during project Intermediaries
planning, loan applications required to collect short- and long-term credit
from various institutions and companies, etc.
e. Handling government consent for industrial projects: They complete
all formalities for their client and allow the government to extend and
modernize their businesses and launch new companies
f. Special assistance to entrepreneurs and small companies: They offer
guidance and resources for market prospects for start-ups and small
businesses, discounts, grants, and government policy, and help them make
the best of this opportunity open to them.
g. The revival of sick units: They help to restore disabled
manufacturing units. They meet with various long-term financing
institutions and the Industrial and Financial Restoration Council.
h. Portfolio management of sick units: They give guidance on
investment choices to customers, typically institutional investors. They
purchase and sell shares and offer fund investment services and them.
i. Corporate restructuring: They help mergers acquisitions, selling and
disinvestment comprise them. Such protocols include careful discussions,
detailed planning, and delivery of various documentation and lengthy legal
formalities.
j. Brokers in stock exchanges: They buy and sell stock in the stock
market on behalf of consumers. They frequently conduct equities surveys,
reminding consumers of the share to be purchased, the date of purchase,
the amount of such acquisition, and the period during which these shares
will be exchanged.
k. Project management: They assist customers in a variety of ways
during the project management cycle. They direct the plant's position, the
writing of the plant study, feasibility reports, and project finance
preparation, as well as the sources of support, policy benefits, and
concessions.
l. Advice on modernization and expansion: Advice on amalgamation,
mergers, partnerships, partnerships, international alliances, market
diversification, technology upgrades, joint ventures, and so on.

5.4 SERVICES OF MERCHANT BANKERS

The services of the Merchant Banker

I. Service based functions:

a. Project counselling and pre-investment studies: Project counselling
entails preparing a project report, deciding on a project's funding strategy,
evaluating the project report, and securing cash from financial institutions
or banks, among other things. Merchant bankers advise corporate entities
on project report preparation, which includes technical feasibility,
45
Innovative Financial Services marketing survey, and other project-related information such as
management aspects, location, financing options, projected cost of
production, working results, cash flow statements, and balance sheets.
Project reports are prepared for the following reasons:
 to obtain project approval from the appropriate authorities,

 to obtain financial assistance from financial institutions, banks, and

other sources

 to make planned resource utilisation and project implementation

within the specifiedtime frame,

 to investigate the market for the proposed product

 to gain an understanding of the specified technical process and

engineering requirements for product manufacturing, and

 to make recommendations.
b. Credit syndication and project finance: Credit syndication refers to
merchant banks' services in arranging and raising credit from financial
institutions, banks, and other prominent investment organisations in order
to finance clients' project costs or meet working capital
[Link] are three types of periodic sources of funds, viz.,

 Short Term Funds: can be obtained from commercial banks, trade

credit, public deposits, business financing companies, and clients to cover
working capital needs. These funds are usually set up for a very short
period of time, such as a year.

 Medium Term Funds: State financial companies, commercial banks,

and all-India financial institutions, industrial financing corporations of
India (IFCI), industrial development bank of India (IDBI), investment
institutions, and the general public provide medium-term money in the
form of fixed deposits. These funds are often allocated for a period of five
years and are required for permanent working capital, expansion, or asset
replacement.

 Long Term Funds: Long term funds are those that are held for more
than five years and are used to start a new project, modernise or diversify
an existing unit of corporate entities, and for other purposes. Loan
syndication is essentially concerned with the arranging of borrowed funds
from various sources other than funds raised from the general public.
c. Capital Issue management:The management of issues for generating
funds through various forms of instruments by firms is referred to as
capital issue management. Merchant bankers in India provide a
professional service in the management of capital issues. In reality, issue
management is one of merchant bankers' primary responsibilities.
d. Underwriting of capital issues: Underwriting is a contract made
between an issuing company and another party known as an underwriter
46
 Issue Management and
who agrees to accept undersubscription of securities in exchange for a Intermediaries
commission. A fully underwritten public issue instils confidence in the
investing public, resulting in a favourable response to the issue. Keeping
this in mind, companies that issue public securities must have a thorough
understanding of the issue. Merchant bankers who manage an issue must
make a careful decision after thoroughly reviewing the issue's details and
the amount to be underwritten. Underwriters must be SEBI-authorized and
registered merchant bankers, brokers, banks, and financial institutions,
among other things.
e. Corporate counselling: Merchant banks provide expertise knowledge
to a corporate entity by providing guidance in connection with government
rules and regulations, appraising product lines and analysing their growth
and profitability, and forecasting future market [Link] is an
intermediary function that necessitates the ability to develop strategies,
expert knowledge, skills, and experience in order to solve business
[Link] ranges from managerial economics, financial and investment
management to corporates, compliance of laws and the relatedlegal
aspects etc.
f. Portfolio management: A portfolio is a collection of securities that
includes stocks, bonds, and money market instruments. Portfolio
management refers to the process of combining various asset classes in
order to achieve the best possible return with the least amount of risk.
Portfolio manager provides portfolio management services. Any person
who, pursuant to a contract or arrangement with a client, advises, directs,
or undertakes on behalf of the client the management or administration of
a portfolio of securities or the client's funds is referred to as a portfolio
manager. When performing portfolio management services, a merchant
banker must inquire about the investment needs of clients, their tax
bracket, risk tolerance, marketability and liquidity of securities, reasonable
return on investment, and so on.
g. Stock broking and dealership: A broker is a self-employed
individual or company who executes financial transactions on behalf of
another party. In most cases, a broker will charge a commission to execute
the orders.
The term "dealer" refers to an individual or a company who buys and sells
securities for their own account, either through a broker or on their own.
Dealers are an important and critical market entity. A dealer acts as a
principal in trading on his own account and plays a significant role, as
opposed to a broker, who is merely a middleman.

h. Venture capital financing: When it is too early for a company to go

to the capital market to raise funds, venture capital is essentially equity
financing in relatively new companies. It entails not only equity
investments, but also loan financing and convertible debt. The goal of
venture capital financing is to earn capital gains on equity investments,
with debt financing serving as a backup. Venture capital also provides
business skills to the investee firm, which is known as a 'hands-on'
47
Innovative Financial Services management approach. The risk-return spectrum of venture capital
financing is high.
i. Debenture trusteeship:A debenture trustee means a trustee of a trust
deed for securing any issue ofdebentures of a body corporate. They
provide services of safeguarding security and protect interest of
debentureholders both in case of private.

II. Fund based functions:

a. Bill discounting: The holder of a time bill (payable after a specified
period) does not have to wait until maturity or the due date. If he needs
money, he can negotiate a discount on the bill with his banker. The banker
credits the net amount in the customer's account after deducting a certain
amount (discount). As a result, the bank purchases the bill and credits the
customer's account with the bill amount less the discount. The drawee
makes payment to the banker on the due date. If he does not pay, the
banker will recover the money from the customer who has discounted the
bill.
b. Venture capital: As explained above, venture capital is equity
financing in relatively new companies, Here the merchant bankers provide
the finance by themselves instead of helping to arrange for the venture
capital.
c. Bought out deals: A bought out deal is a method of selling securities
to the general public via a sponsor or underwriter (a bank, financial
institution, or an individual). The securities are listed on one or more stock
exchanges within a mutually agreed-upon time frame between the
company and the sponsor. This option saves the issuing company the
expenses and time associated with a public offering. The company may
reimburse the cost of holding the shares, or the sponsor may offer the
shares to the public at a premium in order to profit.
d. A lease is an agreement in which a company obtains the right to use
a capital asset such as machinery in exchange for a fee known as lease
rentals. The person (or company) who acquires the right is referred to as
the lessee. He is not given ownership of the asset. He only obtains the
right to use the asset. The person (or company) who grants the right is
referred to as the lessor.
e. Leasing can be replaced with hire purchase. A hire purchase
transaction is one in which goods are purchased and sold on the condition
that payment is made in instalments. The buyer only receives possession
of the goods. He is not given ownership. He obtains ownership only after
the final instalment is paid.
f. Factoring: Factoring is an arrangement in which the factor purchases
account receivables (arising from credit sales of goods/services) and pays
the supplier or creditor in cash immediately. Thus, it is an arrangement in
which a financial institution or banker purchases a firm's (client's) account
receivables.
48
 Issue Management and
g. Forfaiting: Forfaiting is a type of financing for international trade Intermediaries
receivables. It is the non-recourse purchase of receivables arising from the
export of goods and services by a banker or other financial institution. The
exporter relinquishes his right to future payment from the buyer to whom
goods have been supplied to the forfaiter. Forfaiting is a technique that
allows an exporter to sell his goods on credit while receiving payment well
ahead of the due date.

Test your Understanding:

1. What are various types of prospectus?
2. What factors lead to Growth of Merchant bankers in India?
3. List the fee based services provided by the Merchant Banker.

5.5 UNDERWRITER TO AN ISSUE

Underwriters provide a guarantee for public subscriptions in exchange for
a commission. After merchant bankers, the Underwriters take the lead in
public offerings, where they play a critical role. The underwriting is
required for the public offering. The stock exchange regulations clearly
state that no stock broker may underwrite more than 5% of a public issue,
and the appointment of broker underwriters must be approved by the
relevant stock exchange. Typically, bankers can underwrite up to 10% of a
public offering.

5.5.1 UNDERWRITING OBJECTIVES

The following are the Underwriting objectives:

 It ensures the sale of securities at a desired price.

 It facilitates the provision of funds during the company's financial

crisis.

 The Underwriter assists the new company in registration.

5.5.2 THE FOLLOWING ARE THE KEY CHARACTERISTICS
OF AN UNDERWRITING AGREEMENT

 In some cases, the Underwriter may be unable to sell the issues.

Unsold securities are distributed amongst underwriters in the agreed-
upon proportion.

 The offering price must be maintained in order for the securities to be

distributed successfully.

 On the closing date, the company delivers the securities to the manager
and receives the payment.

 The manager must make the final accounting for each underwriter at
the end of the underwriting. He must also pay the commissions and
account for the expenses incurred.
49
Innovative Financial Services  Underwriting is insurance for newly issued public securities. It is one
of the methods used to sell securities.
5.5.3 Different Types of Underwriting
The various types of underwriting agreements are as follows:

 The Purchase Contract: In this case, shares are sold to underwriters at

a predetermined proportion. Several underwriters will come to an
agreement to buy the company's securities.

 Agreement between Underwriters and Representatives: This is a

contract between Underwriters and Representatives or Managers. The
agreement covers all aspects of the issuance of securities, including: to
fix the time of the offering; To reserve a proportion of securities for
the selected dealers and institutions; To place, date, and deliver
securities; Provisions for terminating and settling the underwriters'
account; Underwriters' responsibility

 The selling agreement: The selling agreement: In this method, the

issuer company will enter into a contract with the dealers to subscribe
for new securities. The agreement specifies the offering price, the
selling concession, and the delivery and payment terms.

5.5.4 CLASSIFICATION OF UNDERWRITERS

Underwriters in India may be classified into:
1. Institutional Underwriters: The Institutional Underwriters are as
follows:

 Development Banks: Development banks are also referred to as

industrial banks. They have long-term deposits and are capable of making
long-term investments. Industrial banks assist businesses by underwriting
their shares and debentures. When an Industrial Unit approaches an
industrial bank for underwriting shares and direct financial aid, the
industrial banks investigate the industry's prospects, the soundness of the
financial requirements, the feasibility and utility of the [Link] of
the Development banks are Industrial Finance Corporation of India (IFCI),
Industrial Development Bank of India (IDBI), Industrial Credit and
Investment Corporation of India (ICICI) among others

 Commercial Banks: Routine banking is handled by commercial

banks, also known as public banks. Their primary goals are lending and
underwriting. A few of them have been providing services as loan
syndicators and issue managers. Commercial banks typically act as
passive agents, supplying forms only on request rather than on their own
initiative, and earning brokerage as a result.

 Insurance Companies: Insurance companies are primarily

investment firms, not development organisations. The premier insurance
institutions in the country are the Life Insurance Corporation (LIC) and
the General Insurance Corporation (GIC). These two traditional
50
 Issue Management and
investment institutions provide funds primarily to provide liquidity to Intermediaries
investments for the development of the corporate sector. These
corporations' goals are direct lending to industry, subscription to shares
and bonds to special industrial financial institutions, and capital market
purchases of joint stock company securities.

 State Finance Corporations: The State Financial Corporations are

also involved in underwriting business for stimulating the capital market.

 Unit Trust of India: The Unit Trust of India is another traditional

investment institution that excels as an organisational tool due to certain
activities. It is involved in the continuous sale of units, the redemption of
units at Net Asset Value (NAV), and the convenience of small investors.

2. Non-Institutional Underwriters:
In India, there are two types of non-institutional underwriters:
 Stock brokers: Stock brokers act as intermediaries in the primary
and secondary markets for the purchase and sale of securities. These
individuals have a network of brokers working for them that stretches the
length and breadth of the country. They are referred to as sub-brokers.
These individuals spread the message and publicise the various issues in
the offering. They quickly provide application forms and even go so far as
to collect money from investors. They are extremely important in the field
of underwriting. Persuasion is a tool that brokers can use to influence their
clients.

 Individuals/Investment Companies: Individuals/Investment Companies

raise funds from a large number of investors by selling shares. The pooled
funds are managed by the experts for the purpose of purchasing financial
assets. The benefits of the capital market will outweigh those of the
shareholders. Investment companies are classified into two types: (a)
Fixed Investment Trusts and (b) Management Investment Trusts.

5.5.5 CAPITAL ADEQUACY REQUIREMENT

(1) The capital adequacy requirement referred to in sub-regulation (d) of
regulation 6 shall not be less than rupees twenty lakhs;
(2) Notwithstanding anything contained in sub-regulation (1),-
a) every stock broker who acts as an underwriter shall fulfil the capital
adequacy requirements specified by the stock exchange of which he is
a member;
(1) The capital adequacy requirement referred to in sub-regulation (d) of
regulation 6 shall not be less than rupees twenty lakhs;
(2) Notwithstanding anything contained in sub-regulation (1),-
a) every stock broker who acts as an underwriter shall fulfil the capital
adequacy requirements specified by the stock exchange of which he is
a member;
51
Innovative Financial Services (b) every merchant banker who acts as an underwriter shall fulfil the
capital adequacy requirements specified in regulation 7 of the
Securities and Exchange Board of India (Merchant Banker)
Regulations 1992.

5.5.6 REGISTRATION AND RENEWAL FEE

Underwriters had to pay 5 lakhs as registration fee and 2 lakhs as
renewal fee every three years from the fourth year from the date of initial
registration. Failure to pay renewal fee leads to cancellation of certificate
of registration.

5.5.7 UNDERWRITING COMMISSION

 It can be paid in cash, fully paid-up shares, debentures, or a

combination thereof

 Underwriting commission is not payable on amounts taken up by

promoters, employees, directors, friends, and business associates.

 Commission is payable on the entire issue underwritten, regardless of

whether the entire issue is taken over by the public.

 Unless otherwise specified, commission is calculated on the issue

price.

 Companies Act, 2013 provides that payment of commission should be

authorized by Articles of Association and the maximum commission
payable will be as under:

On amounts On amounts
developing on the subscribed by the
underwriters (%) public (%)

(A) Equity Shares 5% 5%

(B) Preference Shares/

Convertible and Non-
Convertible Debentures

For amounts upto 5 lacs 2.5% 2.5%

For amounts in excess of 5 2% 1%

lacs

5.5.8 GENERAL RESPONSIBILITIES

Other than the underwriting commission, an underwriter cannot benefit
directly or indirectly from underwriting the issue. An underwriter's
maximum obligation under all underwriting agreements cannot exceed
twenty times his net worth. The agreement requires underwriters to

52
 Issue Management and
subscribe for securities within 45 days of receiving notification from the Intermediaries
issuers.
Every Underwriter should keep the following accounts:
If the Underwriter is a body corporate:

 a copy of the balance sheet and profit and loss account as specified in
the Companies Act, 2013; and

 a copy of the auditor's report as specified in the Companies Act, 2013.

If the Underwriter is not a corporation,

 The records pertaining to all sums of money received and expended by

them; and the matters pertaining to the receipt and expenditure

 Their financial assets and liabilities

5.5.9 SEBI GUIDELINES

 According to the SEBI guidelines the following factors are to be

fulfilled:

 The minimum requirement of 90% subscription is mandatory for each

issue of capital to the public. This clause is applicable for both public
and rights issue.

 If the company is unable to collect the issued amount from the public
subscription and accepted development from the underwriters, the
amount is refunded.

 The underwriting agreement must be submitted to the stock exchanges.

 The underwriter's registration number must be quoted in all

correspondence with the SEBI, government authorities, and clients.

 The SEBI may issue warning letters or penalty advances in order to

forewarn underwriters about their omissions.

 The SEBI developed the model underwriting agreement to standardise

the legal relationship between the issuing company and the
underwriters.

 The total underwriting obligations under all agreements should not be

more than twenty times the underwriter's network.

Test your Understanding:

1. List the services provided by an Underwriter.
2. State guidelines provided by the SEBI for Underwriters.

53
Innovative Financial Services 5.6 BANKER TO AN ISSUE
'Banker to an Issue' refers to a scheduled bank or such other banking
company as the SEBI may specify from time to time, that engages in all or
any of the following activities:

 Acceptance of application and application monies;

 acceptance of allotment or call monies;

 refund of application monies;

 payment of dividend or interest warrants

5.6.1 REGISTRATION
To carry on activity as a banker to issue, a person must obtain a certificate
of registration
from the [Link] SEBI grants registration on the basis of all banker-
related activities, with particular attention to the following requirements:
a) The applicant has the necessary infrastructure, communication and data
processing facilities, and manpower to effectively carry out his
activities;
b) The applicant/any of the applicant's directors is not involved in any
securities market litigation/has not been convicted of any economic
offence;
c) The applicant is a scheduled bank; and
d) The grant of a certificate is in the best interests of the investors.

Fees for Registration

1. A non-refundable fee of 25,000 must be paid with an application for
registration under regulation 3 sub-regulation (1A) or a renewal
application under regulation 8 sub-regulation (1A).
2. Within 15 days of receiving intimation from the Board, each banker to
an issue must pay a registration fee of Rs. 10 lakhs at the time of the
Board's grant of certificate.
3. Every banker to an issue must pay a renewal fee of Rs. 5 lakhs every
three years, beginning with the fourth year from the date of initial
registration, within 15 days of receiving notice from the Board.

5.6.2 CHARACTERISTICS OF BANKERS TO AN ISSUE

Bankers to the issue, as the name implies, are in charge of ensuring that
funds are collected and transferred to Escrow accounts. While one or more
banks may act as both issuers and collectors of securities, others may only
collect applications for securities and remit remittances through their
54
 Issue Management and
numerous branches in various locations. Banks are expected to provide Intermediaries
timely information and records to the company and the lead manager in
order to monitor and progress the issue work.

5.6.3 GENERAL OBLIGATIONS AND RESPONSIBILITIES

 Every banker to an issue is required to keep books of account, records,

and documents.

 Every banker involved in an issue is required to provide information to

the SEBI when required.

 Every banker to an issue must enter into an agreement with the body
corporate acting as banker to an issue.

 Every banker to an issue must immediately notify the SEBI if the

Reserve Bank takes disciplinary action against the banker to an issue
in relation to issue payment work. Every banker involved in an issue
must follow the code of conduct.

 Each banker assigned to an issue must appoint a compliance officer

who is responsible for monitoring compliance with the Act, rules and
regulations, notifications, guidelines, instructions, and so on issued by
the SEBI or the Central Government and for redressal of investors’
grievances.

5.7 BROKERS TO THE ISSUE

Meaning: Brokers are persons who are primarily concerned with obtaining
subscriptions to the issue from prospective investors.

5.7.1 BROKERS’ APPOINTMENT

 The appointment of brokers is optional.

 There is no limit to the number of brokers who can be appointed.

 The performance of brokers is within the knowledge of the leading

merchant bankers acting as issue managers.

 The company consults with the stock exchange and sends letters to all
active brokers across all exchanges. It obtains their prior permission to
act as issue brokers.

 The prospectus should disclose the basic details such as the names and
addresses of the brokers, and it should be filed with the Registrar of
Companies along with a copy of the broker's consent letter.
5.7.2 CONDITIONS FOR GRANT OF CERTIFICATE OF
REGISTRATION ASBROKER

 He should be the member of any stock exchange.

55
Innovative Financial Services  He must follow the rules, regulations, and bye-laws of the stock
exchange to which he belongs.

 He must pay the registration fees in the manner specified in the

regulations.

 Within one month of receiving complaints, he must take appropriate

steps to address the investors' grievances.

5.7.3 CONDITIONS FOR BROKERAGE

 Brokerage may be paid within the limits and subject to the other
conditions specified.

 The brokerage rate for all types of public issues of industrial securities
is set at 1.5 percent, regardless of whether the issue is underwritten or
not.

 Brokerage on private placements of capital is permitted at a maximum

rate of 0.5 percent for listed companies.

 The mailing costs and other out-of-pocket expenses for canvassing

public issues must be borne by the stock brokers, and the companies
make no payment on that account.

 A provision to that effect must be included in the agreement between

the broker and the company.

 Brokerage is not permitted in the case of promotional directors, their

friends and employees, or in the case of rights issues taken up or
renounced by existing shareholders.

 Brokerage is not payable when applications are made by

institutions/bankers against their underwriting commitments or on
amounts devolving on them as underwriters as a result of the issues
being undersubscribed.

 The issuing company is expected to pay brokerage within two months

of the date of allotment and to provide the broker with the particulars
of allotments made against applications bearing their stamp free of
charge upon request.

 Cheques for brokerage on new issues and underwriting commissions

should be made payable at par at all locations where recognised stock
exchanges are located.

 The rate of brokerage payable must be is enclosed in the prospectus.

Test your Understanding:

1. Who can be a Banker to an issue?
2. State whether the following statement is true or false: It is compulsory
to appoint Broker to an issue.
56
 Issue Management and
5.8 SUMMARY Intermediaries

Before beginning issue management, a merchant banker assesses an

investment project's financial, technical, and economic viability. A project
can be funded in a variety of ways. Because of changes in economic
policy, the number and type of issues in the primary market increased
dramatically during the 1990s. The companies have attempted to raise
funds by issuing securities through public offerings, rights offerings, and
private placements. This necessitates meticulous planning and a well-
defined marketing strategy. Aside from a variety of pre- and post-issue
activities, certain activities relating to the stock exchange, SEBI, and other
agencies such as bankers, registers, and so on must be handled. Marketing
an issueentail launching an aggressive sales campaign, determining the
best media mix, and organising conferences. Furthermore, it is critical for
a merchant banker to determine the best time to launch the issue. Another
critical aspect of issue management is issue pricing, in which a merchant
banker must consider both qualitative and quantitative factors when
determining the premium component of the issue. A merchant banker's
primary concern should be investor protection. He must try to protect
investors from unjustified losses if the share price falls below the issue
price after listing. Some merchant bankers have retained a provision for
share buybacks under the safety net scheme. Managing an issue also
necessitates that the merchant banker adhere to the legal and regulatory
framework established by the Companies Act of 1956, the Securities
Contracts (Regulation) Act of 1957, and the SEBI guidelines. In recent
years, information technology has also had an impact on the issue
management process, and the concept of e-IPO has emerged.

5.9 EXERCISE
A. Choose the correct alternative:
1. The minimum number of Issue Managers who can be associated with an
Issue is limited by SEBI Regulations if the size of the issue is less than
50 crore is
(a) 2 (b) 3 (c) 4 (d) 5
2. To act as underwriter, adviser, consultant to an issuea merchant banker
has to register itself under
(a) Category I (b) Category II (c) Category III (d)
Category IV
3. Certificate of registration from _____ is mandatory for underwriters.
(a) State Bank of India (b) Insurance Regulatory and Development
Authority
(c) ICICI (d) Securities and Exchange Board of India

57
Innovative Financial Services 5. A banker to an issue is required to maintain books of accounts for a
minimum period of ____ years.
(a) 2 (b) 4 (c) 1 (d) 3
5. Prospectus is the most important document to come out with
___________ issue
(a) Private (b) Public (c) Company (d) Social Issue
1 – a; 2 – c; 3 – d; 4- (d)
B. State whether True or False
1. Appointment of Banker to an issue is the first step in the issue of share.
2. Banker to an issue is required to register with SEBI.
3. Merchant Banker are required to look after the process of issue only till
the issue is made.
5. Private banks cannot register as Merchant Bankers.
5. Stock Broker is a member of recognised stock exchange who deals in
securities on behalf of clients
1- False; 2 – True; 3. False; 5. False 5. True
B. Answer the following
1) Discuss the various sources of funding available to existing and new
businesses for project implementation.
2) What factors should be considered before deciding on a public issue
proposal?
3) Describe the key aspects of the post-issue activities in detail.
4) Steps for registration of “Banker to an issue”
5) Write a note on Underwriting commission

Reference:
[Link]
india/#:~:text=In%20India%2C%20a%20merchant%20banker,to%20such
%20an%20issue%20management.%E2%80%9D
[Link]
[Link]
[Link]



58
 6
STOCK BROKING
Unit Structure
6.0 Learning Objectives
6.1 Introduction
6.2 Stock Broker
6.2.1 Application for registration of stock broker.
6.2.2 Furnishing information, clarification, etc.
6.2.3 Consideration of application.
6.2.4 Criteria for fit and proper person.
6.2.5 Procedure for registration.
6.2.6 Conditions of registration.
6.2.7 Stock Brokers to abide by Code of Conduct.
6.2.8 Procedure where registration is not granted.
6.2.9 Effect of refusal of certificate of registration.
6.2.10 Payment of fees and the consequences of failure to pay fees.
6.3 Sub-broker
6.3.1 Registration as sub-broker.
6.3.2 Application for registration of sub-broker.
6.3.3 Procedure for registration.
6.3.4 Conditions of registration.
6.3.5 Procedure where registration is not granted.
6.3.6 Effect of refusal.
6.3.7 General obligations and inspection.
6.3.8 Director not to act as sub-broker.
6.4 Foreign Broker
6.5 Trading and clearing members
6.6.1 Application for registration of trading member or clearing
member.
59
Innovative Financial Services 6.6.2 Furnishing of information, clarification etc.
6.6.3 Consideration of application.
6.6.4 Procedure for registration.
6.6.5 Procedure where registration is not granted.
6.6.6 Effect of refusal of certificate of registration.
6.6.7 Payment of fees and consequences of failure to pay fees.
6.6.8 Trading member / clearing member [or self-clearing member]
to abide by the Code of Conduct etc.
6.6 Stock Trading (Cash and Normal)
6.6.1 Advantages of Cash Trading
6.6.2 Disadvantages of Cash Trading
6.7 Stock Trading (Derivatives)
6.7.1 Types of Derivatives
6.7.2 Participants of Derivatives Market
6.7.3 Advantages and Disadvantages of Derivatives
6.8 General obligations and responsibilities applicable to Broker/Sub-
Broker/Clearing member/Self-clearing member
6.8.1 General obligations and responsibilities (chapter IV)
6.8.2 Procedure for inspection (Chapter V)
6.8.3 Procedure for action in case of default (chapter VI)
6.9 Summary
6.10 Exercise

6.0 LEARNING OBJECTIVE:

After reading this learner will be able to:

 Understand the role of the stock broker and sub-broker.

 Discuss duties and responsibilities of the broker and sub-broker.
 Explain the code of conduct of the broker and sub-broker.

6.1 INTRODUCTION:
A stock market is an organised market in which securities are traded. It is
made up of investors, brokers or stock exchange members, stock
exchanges, companies, and regulatory authorities. Securities traded on the
stock exchange include a variety of long-term financial instruments issued
60
 Stock Broking
by corporations to meet their financial obligations. A recognised stock
exchange is defined as the one, which is recognised by the Government.
Every stock exchange provides a platform between the general public and
corporate entities seeking to raise long-term resources. As a result, it is
accountable for:
Maintaining fairness in stock exchange trading,
Maintaining discipline in the members' activities
Maintain operational transparency and efficiency.
Stock exchange transactions can be made only through the member. So let
us understand about the broker and sub broker in detail in this unit.

6.2 STOCK BROKER:

Stock broker is defined as “stock broker” means a member of a stock
exchange. A stockbroker is a regulated financial market representative
who facilitates the buying and selling of securities on behalf of financial
institutions, investor clients, and firms. A stockbroker may also be referred
to as a registered representative or a broker. Stock trading, as well as the
purchase and sale of stocks on national stock exchanges, is typically
handled by a stockbroker. Stockbrokers deal with both institutional and
retail customers. A stockbroker's primary responsibility is to obtain and
execute buy and sell orders. To invest in securities, many market
participants rely on stockbrokers' knowledge and expertise about market
dynamics. A stockbroker can work independently or as part of a brokerage
firm.
6.2.1 APPLICATION FOR REGISTRATION OF STOCK
BROKERS:

 A stock broker must submit an application for the issuance of a

certificate in 'Form A' to the stock exchange or exchanges to which he
is admitted as a member.

 The stock exchange shall forward the application form to the Board as
soon as possible but no later than thirty days after receipt.

 Any application made by a stock broker prior to these regulations came

into force in the ‘Form A’ shall be treated as an application made in
pursuance of sub-regulation (1) and dealt with accordingly provided
that the requirement of the payment of fees shall be the same as is
referred to in sub-regulation (1) of regulation 10.

6.2.2 FURNISHING OF INFORMATION, CLARIFICATION:

The Board may require the applicant to provide additional information or
clarifications regarding securities transactions and related matters in order
to consider the application for a certificate. If required, the applicant or its
principal officer must appear before the Board for personal representation.
61
Innovative Financial Services 6.2.3 CONSIDERATION OF APPLICATION
For the purpose of granting a certificate, the Board shall consider all
matters relating to buying, selling, or dealing in securities, particularly
whether the stock broker—
(a) is eligible to be admitted as a member of a stock exchange;
(b) has the necessary infrastructure, such as adequate office space,
equipment, and manpower, to effectively discharge his activities; and
(c) has any prior experience in the business of buying, selling, or dealing
in securities.
(d) is subjected to disciplinary proceedings under the rules, regulations,
and byelaws of a stock exchange involving himself or any of his
partners, directors, or employees in connection with his business as a
stockbroker;
(e) The Board may consider the criteria specified in Schedule II of the
Securities and Exchange Board of India (Intermediaries) Regulations,
2008 when determining whether an applicant or a stock broker, sub-
broker, trading member, or clearing member is a fit and proper person.

6.2.4 CRITERIA FOR FIT AND PROPER PERSON:

(1) The Board may consider any consideration it deems appropriate in
determining whether an applicant or intermediary seeking registration
under one or more of the relevant regulations is a "fit and proper person,"
including but not limited to the following criteria –
(a) Financial integrity;
(b) Absence of convictions or civil liabilities;
(c) Competence;
(d) Good reputation and character;
(e) Efficiency and honesty; and
(f) Absence of any disqualification to act as an intermediary as stipulated
in these regulations.
(2) If a person receives any of the following disqualifications, he will not
be considered a "fit and proper person" for the purposes of granting or
renewing a certificate to act as an intermediary or continuing to act as
an intermediary under any one or more of the relevant regulations.
(a) the applicant or the intermediary, as the case may be, or its whole-time
director or managing partner, has been convicted by a Court of any
crime involving moral turpitude, economic crime, securities laws, or
fraud;
(b) the applicant or the intermediary has been ordered for winding up;
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 Stock Broking
(c) the applicant or the intermediary, as the case may be, or its whole-time
director or managing partner, has been convicted by a Court of any
crime involving moral turpitude, economic crime, securities laws, or
fraud;
(d) the Board or any other regulatory authority has issued an order, other
than a suspension of certificate of registration as an intermediary,
restraining, prohibiting, or debarring the applicant or the intermediary,
or its whole-time director or managing partner, from dealing in
securities in the capital market or from accessing the capital market,
and the period specified in the order has not expired after three years.
(e) the Board has issued an order cancelling the applicant's or
intermediary's certificate of registration on the grounds of insider
trading, fraudulent and unfair trade practises, or market manipulation,
and three years have not passed since the order was issued;
(f) the Board or any other regulatory authority has issued an order
withdrawing or refusing to grant any licence / approval to the applicant
or the intermediary, or its full-time director or managing partner, that
has a bearing on the capital market, and the order has not expired after
three years;
Provided that the Board may for reasons to be recorded in writing, allow
the applicant or the intermediary, to seek registration before the lapse of
three years as specified in clauses (d), (e) and (f).
(g) the applicant or intermediary is financially unsound;
(h) any other reason, to be recorded in writing by the Board, that renders
such applicant or intermediary, or its full-time director or managing
partner, unfit to operate in the capital market in the Board's opinion.

6.2.5 PROCEDURE FOR REGISTRATION

When the Board is satisfied that the stockbroker is eligible, it shall issue a
certificate in 'Form D' to the stockbroker and notify the stock exchange or
exchanges, provided the stock broker holds a certificate of registration for
membership in a recognised stock exchange with nationwide trading
terminals is eligible for trading on the SME platform. SME platform
means a trading platform of a recognised stock exchange having
nationwide trading terminals and permitted by the Board to list the
securities issued.

6.2.6 CONDITIONS FOR GRANT OF REGISTRATION:

(a) the stock broker is a member of any stock exchange;
(b) he must follow the stock exchange's rules, regulations, and bye-laws
that apply to him;

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Innovative Financial Services (c) if the stock broker wishes to change his status or constitution, he must
obtain prior approval from the Board before continuing to act as such
after the change;
(d) he must pay fees charged by the Board in the manner specified in these
regulations; and
(e) Within one month of receiving the complaint, he shall take adequate
steps to address the investors' grievances and keep the Board informed
of the number, nature, and other details of the complaints received
from such investors.

6.2.7 STOCK BROKERS TO ABIDE BY CODE OF CONDUCT:

The stock broker holding a certificate shall at all times abide by the Code
of Conduct as specified in Schedule II

A. General:
(1) Integrity: A stockbroker must uphold high standards of integrity,
promptitude, and fairness in all aspects of his business.
(2) Exercise of due skill and care: A stockbroker must conduct all of his
business with due skill, care, and diligence.
(3) Manipulation: A stockbroker shall not engage in manipulative,
fraudulent, or deceptive transactions or schemes, nor shall he spread
rumours with the intent of distorting market equilibrium or gaining
personal gain.
(4) Malpractice: A stockbroker shall not, either alone or in concert with
others, create false markets or engage in any act detrimental to the
interests of investors or interfere with the fair and smooth operation
of the market. A stockbroker shall not engage in excessive
speculative trading in the market above reasonable levels that are not
commensurate with his financial soundness.
(5) Compliance with statutory requirements: A stockbroker must follow
all provisions of the Act as well as any rules or regulations issued by
the Government, the Board, or the Stock Exchange from time to time
that apply to him.

B. Obligation to the Investor

(1) Order Execution: In his dealings with clients and the general investing
public, a stockbroker shall faithfully execute orders for buying and selling
securities at the best available market price and shall not refuse to deal
with a Small Investor solely on the basis of the volume of business
involved. A stockbroker must promptly notify his client of the execution
or non-execution of an order, make prompt payment for securities sold,
and arrange for prompt delivery of securities purchased by clients.

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 Stock Broking
(2) Contract Note: A stockbroker shall issue a contract note to his client
[or client of the sub-broker, as the case may be] for all transactions in the
form specified by the stock exchange without delay.
(3) Breach of Trust: A stockbroker shall not disclose or discuss with any
other person, or make improper use of, the details of the client's personal
investments and other confidential information learned in the course of his
business relationship.
(4) Business and Commission:
(a) A stockbroker may not promote the sale or purchase of securities
solely to generate brokerage or commission.
(b) A stockbroker shall not provide false or misleading quotations to
clients or provide any other false or misleading advice or information with
the intent of inducing him to do business in particular securities and
thereby earning brokerage or commission.
(5) Dealings with Defaulting Clients: A stockbroker may not deal or
transact business with a client who has failed to fulfil his obligations in
relation to securities with another stockbroker, either directly or indirectly.
(6) Fairness to Clients: When dealing with a client, a stockbroker must
disclose whether he is acting as a principal or as an agent while also
ensuring that there is no conflict of interest between him and the client. In
the event of a conflict of interest, he shall notify the client and shall not
seek a direct or indirect personal advantage from the situation, nor shall he
regard the client's interests as inferior to his own.
(7) Investment Advice: A stockbroker shall not make an investment
recommendation to any client who may be expected to rely on it to
acquire, dispose of, or retain securities unless he has reasonable grounds to
believe that the recommendation is suitable for such a client.

Investment advice in publicly accessible media—

(a) A stock broker or any of his employees shall not render, directly or
indirectly, any investment advice about any security in the publicly
accessible media, whether real-time or non-real-time, unless he has
disclosed his interest, including the interest of his dependent family
members, and the employer's long or short position in the said security,
while rendering such advice.
(b) If an employee of the stock broker is providing such advice, he must
also disclose the interests of his dependent family members and the
employer, as well as their long or short positions in the security.
C. Stockbrokers in Relation to Other Stockbrokers
(1) Conduct of dealings: When comparing unmatched transactions, a
stockbroker must work with the other contracting party. A stockbroker
must not knowingly and wilfully deliver documents that are marked as bad
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Innovative Financial Services delivery, and must work with the other contracting party to replace
documents that are marked as bad delivery as soon as possible.
(2) Protection of Clients Interests: A stockbroker must work with other
stockbrokers to protect his clients' rights to dividends, bonus shares, right
shares, and any other right related to such securities.
(3) Stock-Broker Transactions: A stock-broker must carry out his
transactions with other stock-brokers and meet his obligations in
completing the settlement of those transactions.
(4) Publicity and Advertising: A stockbroker may not advertise his
business publicly unless the stock exchange permits it.
(5) Client Inducement: A stockbroker may not use unfair means to attract
clients from other stockbrokers.
(6) False or Misleading Returns: A stockbroker must not neglect, fail, or
refuse to submit required returns, and must not make any false or
misleading statements on any returns required to be submitted to the
Board and the stock exchange.

6.2.8 PROCEDURE WHERE REGISTRATION IS NOT

GRANTED:
(1) If an application for a certificate does not meet the requirements
specified, the Board may reject the application after providing a
reasonable opportunity to be heard.
(2) The Board shall communicate the refusal to grant the registration
certificate to the concerned stock exchange and to the applicant within
thirty days of such refusal, stating the reasons for the rejection.
(3) An applicant who is dissatisfied with the Board's decision may apply
to the Board for reconsideration of its decision within thirty days of
receiving such notification.
(4) The Board shall reconsider an application and communicate its
decision in writing to the applicant and the relevant stock exchange as
soon as possible.
6.2.9 EFFECT OF REFUSAL OF CERTIFICATE OF
REGISTRATION:
A stock-broker whose application for certificate grant has been denied by
the Board shall not buy, sell, or deal in securities as a stock-broker on or
after the date of receipt of the communication.

6.2.10 PAYMENT OF FEES AND THE CONSEQUENCES OF

FAILURE TO PAY FEES:
(1) Every applicant eligible for a certificate must pay the fees in the
manner specified. Provided, however, that if sufficient cause is shown, the

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 Stock Broking
Board may allow the stockbroker to pay such fees at any time before the
expiration of six months from the date such fees become due.
(2) If a stockbroker fails to pay the fees outlined in Regulation 10, the
Board may suspend the registration certificate, at which point the
stockbroker ceases to buy, sell, or deal in securities as a stockbroker.

Test your Understanding

1. State the concept of “fit and proper person” for appointment as Broker
2. State whether True or False: A broker has to be an individual.

6.3 SUB-BROKER
A sub-broker is defined as “sub-broker” means any person not being a
member of stock exchange who acts on behalf of a stock broker as an
agent or otherwise for assisting the investors in buying, selling or dealing
in securities through such stock brokers. A sub-broker is an agent who
works for a stock exchange trading member. A sub-broker must be
registered with both the Securities and Exchange Board of India (SEBI)
and a local stock exchange. Sub-brokers assist their clients in purchasing
and selling securities on the stock exchange. They provide them with
information on various securities. They also forward the trading orders of
their clients to the trading member or brokerage firm with which they are
affiliated. They receive a percentage of the brokerage commission in
exchange for the service provided.

6.3.1 REGISTRATION AS SUB-BROKER:

(1) No sub-broker shall act as such unless he possesses a certificate issued
by the Board in accordance with these regulations.
(2) Under sub-regulation (1), no new certificate is required if a sub-broker
simply changes his affiliation from one stock broker to another stock
broker who is a member of the same stock exchange.
(3) Subject to the provisions of regulation 12A, no new certificate under
sub-regulation (1) is required where a registered sub-broker is affiliated
with a stock broker who is eligible to trade on the SME platform.
SME platform means a trading platform of a recognised stock exchange
having nationwide trading terminals and permitted by the Board to list the
securities.

6.3.2 APPLICATION FOR REGISTRATION OF SUB-BROKER:

(1) An application by a sub-broker's for grant of the certificate must be
submitted in 'Form B.'
(2) A recommendation letter in 'Form C' from a stockbroker of a
recognised stock exchange with whom he is to be affiliated, as well as two
references, one from his banker, must be submitted with the application
for registration under sub-regulation (1) above.
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Innovative Financial Services (3) The application form must be submitted to the stock exchange of the
stockbroker with whom he will be affiliated.
(4) Upon receipt of an application under sub-regulation (3), the stock
exchange shall verify the information contained therein and certify that the
applicant meets the eligibility criteria set forth in sub-regulation (3).
(5) The eligibility criteria for registration as a sub-broker shall be as
follows, namely:
(i) In the case of an individual;
(a) the applicant is at least 21 years old;
(b) the applicant has not been convicted of any offence involving fraud or
dishonesty;
(c) the applicant has at least passed the 12th standard equivalent
examination from an institution recognised by the Government; and
(d) the applicant is a fit and proper person.
(ii) in the case of a partnership firm or a body corporate, the partners or
directors, as the case may be, shall comply with the requirements
contained in clauses (a) to (c) of sub-regulation (i);
(iii) the applicant has the necessary infrastructure, such as adequate office
space, equipment, and manpower, to carry out his activities effectively;
and
(iv) the applicant is a person recognised by the stock exchange as a sub-
broker affiliated to a member broker of the stock exchange.
(6) Within 30 days of receipt of the application, the stock exchange shall
forward to the Board the application in Form 'B' of such applicant, along
with the recommendation letter in Form 'C' issued by the stock broker with
whom he is affiliated and the recognition letter in Form 'CA' issued by the
stock exchange.

6.3.3 PROCEDURE FOR REGISTRATION:

(1) If the Board determines that the sub-broker is eligible, it shall issue a
certificate in 'Form E' to the sub-broker and notify the stock exchange or
exchanges, as applicable.
(2) Subject to the terms and conditions, the Board may issue a certificate
of registration to the applicant laid down in sub-regulation (1) of
regulation 12A.
6.3.4 CONDITIONS OF REGISTRATION: [UNDER
REGULATION 12A (1)]
Any registration granted by the Board under regulation 12 shall be subject
to the following conditions, namely
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(a) he shall abide by the stock exchange's applicable rules, regulations, and
bye-laws;
(b) where the sub-broker proposes to change his status or constitution, he
shall obtain prior approval of the Board for continuing to act as such after
the change; (c) he shall pay fees charged by the Board in the manner
provided in these regulations; and
(d) he shall take adequate steps for the redressal of the investors'
grievances within one month of the date of receipt of the complaint and
keep the Board informed about the number, nature, and other particulars
of the complaints received from such investors; and
(e) he is authorised in writing by a stock-broker who is a member of a
stock exchange to affiliate himself in buying, selling, or dealing in
securities.
(2) Nothing in clause (b) of sub-regulation (1) affects the obligation to
obtain a new registration under section 12 of the Act where applicable.
6.3.5 PROCEDURE WHERE REGISTRATION IS NOT
GRANTED:
(1) If an application for a certificate granted under regulation 11A does not
meet the requirements specified in regulation 11A, the Board may reject
the application after providing a reasonable opportunity to be heard.
(2) The Board shall communicate the refusal to grant the certificate to the
concerned stock exchange and to the applicant in writing within thirty
days of such refusal, stating the reasons for the rejection.
(3) An applicant who is dissatisfied with the Board's decision under sub-
regulation (2) may apply to the Board for reconsideration of its decision
within thirty days of receiving such intimation.
(4) The Board shall reconsider an application made under sub-regulation
(3) and communicate its decision in writing to the applicant and the
relevant stock exchange as soon as possible.

6.3.6 EFFECT OF REFUSAL:

A person whose application for the grant of a certificate has been refused
by the Board shall cease to carry on any activity as a sub-broker on and
from the date of the communication of refusal under regulation 13.

6.3.7 GENERAL OBLIGATIONS AND INSPECTION:

(1) The sub-broker shall
(a) pay the fees specified in Schedule III;
(b) abide by the Code of Conduct specified in Schedule II;

69
Innovative Financial Services (c) enter into an agreement with the stock-broker defining the scope of his
authority and responsibilities;
(d) comply with the stock exchange's rules, regulations, and bye-laws; and
(e) not be affiliated with more than one stock broker of one stock
exchange.
(2) Except for the books and documents referred to in clauses (h), (i), (j),
(l), and (m) of sub-regulation (1) of regulation 17, the sub-broker shall
keep and maintain the books and documents specified in regulation 17.

6.3.8 DIRECTOR NOT TO ACT AS SUB-BROKER:

No director of a stock broker shall act as a sub-broker to the same
stockbroker
Test your understanding:
1. State the procedure for registration of a Sub-Broker.
2. State whether true or false: Director of a stock broker shall act as a
sub-broker to the same stock broker.

6.4 FOREIGN BROKER

Stocks of companies within a geographical boundary of a country is
expected to be known to all residents of that country. Foreign stocks, on
the other hand, are the securities of companies based in countries other
than the domestic country. Giant companies that are not based in India are
a profitable investment option, just as blue-chip companies in India are.
Choose a broker who is based in India but has connections with foreign
brokers. All reputable and high-performing Indian stock brokers have
direct links and ties with their respective foreign brokers. An overseas
trading account in such a domain can be easily opened and operated,
allowing you to invest in foreign [Link] of the most active brokers
also have offices in India, making it easy for investors to visit them and
get answers to their questions. Some Indian mutual funds and exchange-
traded funds (ETFs) are similarly structured to invest in foreign markets.
As a result, investors can invest in such funds, with their money going
directly into foreign equities.
Investing Options:

 Through international funds, you can invest across borders.

 Regional investment is also facilitated by Regional Funds, which allow
investors to invest in regions such as Europe, Asia, and the Middle
East.
 Sector investment is also facilitated, as one can invest in sectors such
as gold, energy, and so on across a wide range of countries.
 Country funds facilitate country-wide investment.
 ADRs and GDRs

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6.5 TRADING AND CLEARING MEMBERS:
Trading Members: are members of SEBI-registered stock exchanges who
are authorised to trade on behalf of their clients or on their own account
(proprietary trades). According to SEBI regulations, each trading member
is assigned a unique TM-ID.
Trading cum Clearing Members (TCM): is a Clearing Member (CM) of
the exchange who is also a Trading Member (TM). The majority of large
brokers are TCMs. TCMs of this type can clear and settle their own
proprietary trades, client trades, and trades of other TMs and even
Custodial Participants.

6.5.1 APPLICATION FOR REGISTRATION OF

TRADING MEMBER OR CLEARING MEMBER
A trading member of a derivatives exchange or derivatives segment of a
stock exchange may apply for a certificate of registration in Form AA of
Schedule I, through the concerned derivatives exchange or derivatives
segment of a stock exchange of which he is a member.
A clearing member 34[or self-clearing member] of a clearing corporation
or clearing house of a derivatives exchange or derivatives segment of a
stock exchange shall apply for a certificate of registration in Form AA of
Schedule I, through the concerned clearing corporation or clearing house
of which he is a member.
Provided that a trading member who also seeks to act as a clearing
member 35[orself-clearing member] shall make separate applications for
each activity in Form AAof Schedule I.
The derivatives exchange, segment, clearing house, or corporation, as
applicable, shall forward the application to the Board as soon as possible
but no later than thirty days from the date of receipt.

6.5.2 FURNISHING OF INFORMATION, CLARIFICATION, ETC.

(1) To consider the application for a certificate, the Board may require the
applicant or the concerned stock exchange, segment, clearing house, or
corporation to provide any additional information or clarifications
regarding derivative trading and settlement and related matters.
(2) If required, the applicant or its principal officer must appear before the
Board for personal representation.

6.5.3 CONSIDERATION OF APPLICATION

(1) The Board shall grant a certificate relating to dealing and settlement in
derivatives, specifically whether the applicant—
(a) is eligible to be admitted as a trading member of a derivatives
exchange and/or a clearing member of a derivatives exchange or

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Innovative Financial Services derivatives segment of a stock-exchange or clearing corporation or house;
and
(b) has the necessary infrastructure, such as adequate office space,
equipment, and man-power, to effectively carry out its operations.
(c) is subjected to disciplinary proceedings under the rules, regulations,
and byelaws of any stock exchange involving himself or any of his
partners, directors, or employees in connection with his business as a stock
broker, member of a derivatives exchange or segment, or member of a
clearing house or corporation;
(d) Is subject to any financial liability owed to the Board under these
regulations.
(2) In addition to meeting the requirements of sub-regulation (1), an
applicant who wishes to act as a trading member must have a net worth as
specified by the derivatives exchange or segment from time to time, and
the trading member's approved user and sales personnel must have passed
a certification programme approved by the Board.
(3) In addition to meeting the requirements of sub-regulation (1), an
applicant who wishes to act as a clearing member must have a minimum
net worth of Rs. 300 lacs and deposit at least Rs. 50 lacs or more with the
clearing corporation or clearing house of the derivatives exchange or
derivatives segment in the form specified from time to time.
(4) In addition to meeting the requirements of sub-regulation (1), an
applicant who wishes to act as a self-clearing member must have a
minimum net worth of Rs. 100 lacs and deposit a sum of Rs. 50 lacs or
more with the clearing corporation or clearing house of the derivatives
exchange or derivatives segment in the form specified from time to time.
the expression‘net worth’ shall mean paid up capital and free reserves and
other securitiesapproved by the Board from time to time (but does not
include fixed assets, pledgedsecurities, value of member’s card, non-
allowable securities (unlisted securities), baddeliveries, doubtful debts and
advances (debts or advances overdue for more thanthree months or debts
or advances given to the associate persons of the member),prepaid
expenses, losses, intangible assets and 30% value of marketable securities

6.5.4 PROCEDURE FOR REGISTRATION

When the Board is satisfied that the applicant is eligible, it shall issue a
certificate in Form DA of Schedule I to the applicant and notify the
derivatives segment of the stock exchange, derivatives exchange, clearing
corporation, or clearing house, as applicable.

6.5.5 PROCEDURE WHERE REGISTRATION IS NOT GRANTED

(1) If an application for the grant of a certificate under regulation 16A
does not meet the requirements specified in regulation 16C of the

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Regulations, the Board may reject the applicant's application after giving
the applicant a reasonable opportunity to be heard.
(2) The Board shall communicate the refusal to grant the certificate of
registration within 30 days of such refusal to the concerned segment of the
stock exchange, clearing house, or corporation, as well as to the applicant,
stating the reasons for the rejection.
(3) If an applicant is dissatisfied with the Board's decision under sub-
regulation (2), he or she may apply to the Board within thirty days of
receiving such information for a review.
(4) The Board shall reconsider an application made under sub-regulation
(3) and communicate its decision in writing to the applicant and the
relevant segment of the stock exchange, clearing house, or corporation as
soon as possible.
6.5.6 EFFECT OF REFUSAL OF CERTIFICATE OF
REGISTRATION
An applicant whose application for the grant of a certificate of registration
has been denied by the Board shall not deal in or settle derivatives
contracts as a member of a derivatives exchange, derivatives segment,
clearing corporation, or clearing house on or after the date of receipt of the
communication under sub-regulation (2) or sub-regulation (4) of
regulation 16E.
6.5.7 PAYMENT OF FEES AND CONSEQUENCES OF FAILURE
TO PAY FEES
(1) Every applicant who is eligible for a certificate as a trading or clearing
member [or self-clearing member] must pay the fee and in the manner
specified in Schedule IV.
(2) If a trading or clearing member [or self-clearing member] fails to pay
the fees specified in sub-regulation (1), the Board may suspend or cancel
the registration certificate after giving the trading and clearing member [or
self-clearing member] an opportunity to be heard, and the trading and
clearing member [or self-clearing member] shall cease to deal in or settle
the derivatives contract as a member of the derivatives segment of the
exchange or derivatives exchange or clearing corporation or clearing
house.
6.5.8 TRADING MEMBER / CLEARING MEMBER [OR SELF-
CLEARING MEMBER] TO ABIDE BY THE CODE OF CONDUCT
ETC
(1) The code of conduct specified for stock brokers in Schedule II applies
mutatis mutandis to trading members and clearing members, and such
members must abide by it at all times.

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Innovative Financial Services (2) Trading and clearing members must follow the code of conduct
outlined in the rules, bye-laws, and regulations of the derivatives exchange
or derivatives segment of the exchange.
(3) Before executing an order on behalf of a prospective client, trading
members must obtain information about that client in the 'know your
client' format specified by the Board.
(4) The trading member must provide prospective clients with a 'risk
disclosure document' in the form specified, disclosing the risk inherent in
trading in derivatives.
(5) The trading or clearing member must deposit margin or any other
deposit and adhere to the position or exposure limits set by the Board or
the relevant exchange, segment, clearing corporation, or clearing house
from time to time.
(6) The provisions of sub-regulations (1) to (5) apply to a self-clearing
member in the same way.
(Mutatis mutandisis used when comparing two or more things to say that
although changes will be necessary in order to take account of different
situations, the basic point remains the same)

Test your Understanding:

1. Who is foreign broker?
2. State whether true or false: A person who is trading member can also
act a s clearing member
3. State the steps to be taken if the application for registration as Trading
member is rejected.

6.6 STOCK TRADING (CASH AND NORMAL):

Cash trading is simply the purchase and sale of securities with cash on
hand rather than borrowed capital or margin. Most brokers provide cash
trading accounts as the default account type. Since no margin is required,
these accounts are easier to open and maintain than margin accounts.
Long-term investors may prefer these accounts because they do not
typically buy securities on margin or require quick trading settlements.
The settlement date is the day when the transaction is considered to be
consummated and the buyer is required to complete full payment. Stock
trades in cash accounts used to take up to three business days to settle, but
that was reduced to two days in 2017. T+2 refers to the trade date plus two
business days in the market.

6.6.1 Advantages of Cash Trading

1. Unlike margin and derivative trading, there is no time limit for buying
and selling stocks in cash trading.
2. In the cash trading segment, one can hold the stocks for as long as one
wants until he or she achieves the desired profit.
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3. Cash trading has a higher chance of profit than other methods of trading
in the stock market.
4. In cash trading, one must pay the full price of the stocks that one wishes
to purchase; while this may appear to be a limitation, it will undoubtedly
prevent an investor from exceeding the limit.
6. Because one cannot invest more than the fund allows, one can
effectively control the loss, even if prices fall.

6.6.2 Disadvantages of Cash Trading

1. The most significant disadvantage of cash trading is the exorbitant
brokerage and taxation that you must pay for delivery trading.
2. Typically, the brokerage for cash trading is ten times that of margin
trading. Of course, you can reduce this brokerage rate by using online
stock trading portals, where the brokerage rate is significantly lower than
that of traditional brokerage houses, but it is still higher than the margin
trading brokerage.

6.7 STOCK TRADING (DERIVATIVES)

A Derivative is a financial instrument whose value is derived from the
value of anunderlying asset. The underlying asset can be equity shares or
index, precious metals,commodities, currencies, interest rates etc. A
derivative instrument does not have anyindependent value. Its value is
always dependent on the underlying assets.

6.7.1 Types of Derivatives

The most common types of derivatives are:
(a) Forwards: A forward is a contract between two parties to buy or sell an
underlying asset at a future date for a predetermined price on the date of
contract. Both contracting parties are committed and obligated to honour
the transaction regardless of the underlying asset's price at the time of
delivery. Contract terms and conditions are customised because forwards
are negotiated between two parties. Forwards contracts are negotiated
bilaterally between two parties in OTC (Over the Counter) markets and
are not traded on the Stock Exchange.
(b) Futures: A futures contract is a legally binding agreement to buy or sell
an asset on a publicly traded exchange. The contract specifies when the
seller must deliver the asset and how much it will cost. A futures contract's
underlying asset is typically a commodity, stock, bond, or currency. In
terms of fundamental economics, futures markets are identical to forward
markets. Contracts, on the other hand, are standardised, and trading is
centralised (on a stock exchange). There isn't a counterparty. Increasing
the time to expiration in futures markets, unlike forward markets, does not
increase counter party risk. Futures markets are much more liquid than
forward markets.

75
Innovative Financial Services (c) Options: An option is a contract that grants the right, but not the
obligation, to buy or sell the underlying at a specified price and on or
before a specified date. While the buyer of an option pays the premium
and acquires the right to cancel the contract at any time, the writer/seller of
an option receives the premium along with the obligation to sell/purchase
the underlying asset if the buyer exercises his right.

Types of Options:
(i) Call Options:A call option grants the holder the right to purchase a
predetermined amount of the underlying asset at the strike price on a
predetermined date.
(ii) Put Options:A put option, on the other hand, grants the holder the right
to purchase a predetermined amount of the underlying asset at the strike
price on a predetermined date.
(d) Swaps: A swap is a two-party derivative contract that involves the
exchange of pre-agreed-upon cash flows from two financial instruments.
The notional principal amount is commonly used to calculate cash flows
(a predetermined nominal value). Each cash flow stream is referred to as a
"leg."

Types of Swaps:
(i) Interest rate swap: Two parties agree to exchange one stream of future
interest payments for another based on a fixed notional principal amount.
Interest rate swaps, in general, involve the exchange of a fixed interest rate
for a floating interest rate.
(ii) Currency swap: Parties swap principal and interest payments
denominated in different currencies. Swap contracts are frequently used to
protect another investment position from currency exchange rate
fluctuations.
(iii) Credit default swap: It protects against the default of a debt
instrument. The premium payments are transferred to the seller by the
buyer of a swap. If the asset fails, the seller will reimburse the buyer for
the asset's face value, and the asset will be transferred from the buyer to
the seller.
(iv) Commodity swap: These derivatives are designed to exchange
floating cash flows based on a commodity's spot price for fixed cash flows
based on a commodity's pre-agreed price. Contrary to popular belief,
commodity swaps do not involve the exchange of actual commodities.

6.7.2 Participants of Derivatives Market:

Participant in the derivative market can be divide them into the following
categories based on their trading motives:
(i) Hedgers: Hedgers are stock market traders who are risk-averse. They
intend to use derivative markets to protect their investment portfolio from
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 Stock Broking
market risk and price fluctuations. They accomplish this by taking an
opposing position in the derivatives market. In this way, they transfer the
risk of loss to those who are willing to accept it. They must pay a premium
to the risk-taker in exchange for the available hedging.
(ii) Speculators: They are risk-seekers in the derivative market . They want
to take risks in order to profit. In comparison to the hedgers, they have a
completely opposing viewpoint. This difference of opinion allows them to
profit handsomely if their bets are correct. The speculator retains the
premium and profits.
(iii) Margin traders: A margin is the minimum amount you must deposit
with your broker in order to participate in the derivative market. It is used
to reflect your daily losses and gains based on market movements. It
allows you to gain leverage in derivative trades while maintaining a large
outstanding position. In the derivative market, however, you can own a
three times larger position, i.e. if you have Rs. 2 lakhs, you can enter into
contracts worth Rs 6 lakh with the same amount. In the derivative market,
even minor price changes result in larger gains/losses than in the stock
market.
(iv) Arbitrageurs: These are people who profit from low-risk market
imperfections. They buy low-priced securities in one market while selling
them at a higher price in another. Only when the same security is quoted at
different prices in different markets can this occur.

6.7.3 Advantages and Disadvantages of Derivatives:

Advantages

 Risk diversification: As the value of the derivatives is linked to the

underlying asset's value, the contracts are primarily used to hedge risks.
For example, an investor may buy a derivative contract whose value
moves in the opposite direction of an asset owned by the investor. Profits
from the derivative contract may thus offset losses from the underlying
asset.
 Underlying Asset pricing:Derivatives are frequently used to
determine the underlying asset's price. For example, futures spot prices
can be used to approximate commodity prices.

 Market efficiency: Derivatives are thought to improve the efficiency

of financial markets. The payoff of assets can be replicated using
derivative contracts. As a result, in order to avoid arbitrage opportunities,
the prices of the underlying asset and the associated derivative tend to be
in equilibrium.

 Access to previously unavailable assets or markets: Derivatives can

assist organisations in gaining access to previously unavailable assets or
markets. By using interest rate swaps, a company can obtain a lower
interest rate than would be available through direct borrowing.

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Innovative Financial Services Disadvantages

 High risk: Derivatives' high volatility exposes them to potentially

massive losses. The complex design of the contracts makes valuation
extremely difficult, if not impossible. As a result, they have a high
inherent risk.

 Speculative characteristics: Derivatives are widely regarded as a

speculative tool. Unreasonable speculation may result in massive losses
due to the extremely risky nature of derivatives and their unpredictable
behaviour.

 Counter-party risk: While derivatives traded on exchanges generally

undergo extensive due diligence, some contracts traded over-the-counter
do not include a due diligence benchmark. As a result, there is a risk of
counter-party default.

 Market sensitivity and volatility: Due to the high volatility of the

derivatives market, many investors and traders avoid it. Most financial
instruments are extremely sensitive to small changes, such as changes in
the expiration period, interest rates, and so on, making the market
extremely volatile.

 Complexity: Because of the derivatives market's high risk and

sensitivity, it is frequently a very complex subject. Because derivatives
trading is so difficult to understand, the general public avoids it, and they
frequently use brokers and trading agents to invest in financial
instruments.

6.8 GENERAL OBLIGATIONS AND

RESPONSIBILITIES APPLICABLE TO BROKER/SUB-
BROKER/CLEARING MEMBER/SELF-CLEARING
MEMBER
6.8.1 GENERAL OBLIGATIONS AND RESPONSIBILITIES
(Chapter IV)
(1) Every Stock Broker must keep and maintain the following books of
account, records, and documents: (a) Transaction Register (Sauda Book);
(b) Clients ledger; (c) General ledger; (d) Journals; (e) Cash book; (f)
Bank pass book; (h) Member's contract books showing details of all
contracts entered into by him with other members of the same exchange or
counterfoils or duplicates of memos of confirmation issued to such other
members; (j) Written consent of clients in respect of contracts entered into
as principals; (k) Margin deposit book;
Every stock broker is required to keep books of account and other records
for a minimum of five [Link] stock broker must appoint a
compliance officer who is in charge of monitoring compliance with the
Act, rules and regulations, notifications, guidelines, instructions, and so on
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 Stock Broking
issued by the Board or the Central Government, as well as resolving
investor complaints. Any noncompliance observed by the compliance
officer must be reported to the Board immediately and independently.

6.8.2 PROCEDURE FOR INSPECTION (CHAPTER V)

(a) Board’s right to inspect: Where the Board believes it is necessary, it
may appoint one or more persons as inspecting authority to conduct
inspections of the stock brokers' books of account, other records, and
documents to ensure that the books of account and other books are
maintained in the required manner and that the provisions of the Act,
rules, and regulations are followed.
(b) Procedure for inspection: Before conducting any inspection under
regulation 19, the Board shall provide reasonable notice to the stock
broker. However, if the Board is satisfied that such notice is not in the best
interests of the investors or the public, it may, by written order, direct that
the inspection of the stock broker's affairs be conducted without such
notice. Upon being authorized by the Board, the inspecting authority shall
conduct the inspection, and the stockbroker being inspected shall be bound
to discharge his obligations.
(c) Obligations of stock-broker on inspection by the Board: Every director,
proprietor, partner, officer, and employee of a stockbroker who is being
inspected shall assist the authority in inspection and produce such books,
accounts, and other documents in his custody, as well as to provide him
with such statements and information relating to the transactions as the
said officer may require. The stock-broker shall allow the inspecting
authority reasonable access to the premises occupied by such stock-broker
or any other person on his behalf, as well as reasonable facilities for
examining any books, records, documents, and computer data in the stock-
or broker's any other person's possession, and shall provide copies of
documents or other materials which, in the inspecting authority's opinion,
are relevant.
(d) Submission of report to the Board: The inspecting authority must
submit an inspection report to the Board as soon as possible. Following
consideration of the inspection or investigation report, the Board shall take
whatever action it deems fit and appropriate.
(e) Appointment of an Auditor: Board may appoint a qualified auditor to
investigate into the books of account or the affairs of the stock-broker

6.8.3 PROCEDURE FOR ACTION IN CASE OF DEFAULT

(CHAPTER VI)
A stock broker who violates any of the provisions of the Act, rules, or
regulations may faceone or more of the following penalties:
(i) Monetary penalty under Section VIA of the Act for the violations
such as:Failure to file any return or report with the Board, or to furnish
any information, books, or other documents within 15 days of the Board's

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Innovative Financial Services issue of notice, or to keep books of account or records in accordance with
the Act, rules, or regulations framed thereunder or to address investor
grievances within 30 days of receiving notice from the Board or to issue
contract notes in the form and manner prescribed by the Stock Exchange
or to deliver any security or make payment to the investor within 48 hours
of trade settlement.
(ii) Penalties as specified, including suspension or cancellation of a
stock broker's certificate of registration for violations such as: (i) ceases
to be a member of a stock exchange; or (ii) is declared a defaulter by a
stock exchange and is not re-admitted as a member within six months; or
(iii) surrenders his certificate of registration to the Board; or (iv) is found
by the Board to be not a fit and proper person under these or any other
regulations; or (v) has been declared insolvent or an order for winding up
has been passed. (vi) Any of the partners or any full-time director has been
convicted by a court of competent jurisdiction of a moral turpitude-related
offense; or (vii) fails to pay the fee specified in Schedule III of these
regulations. (viii) fails to comply with the rules, regulations and bye-laws
of the stock exchange of which he is a member
(iii) Prosecution in accordance with Section 24 of the Act in case
of:(i) Dealing in securities without first obtaining a certificate of
registration as a stock broker from the Board.
(ii) Trading in securities, providing trading floor, or assisting in trading
outside of a recognized stock exchange in violation of the Securities
Contracts (Regulation) Act of 1956.
(iii) Securities or index market manipulation.
(iv) Participating in insider trading.
(v) Engaging in fraudulent and unfair business practices.
(vi) Failure without reasonable cause—(a) to produce to the investigating
authority or any person authorized by him in this regard any books,
registers, (b) to appear personally before the investigating authority or to
answer any question posed to him by the investigating authority; or (c) to
sign the notes of any examination taken down by the investigating
authority.
(vii) Failure to pay penalty imposed by the authority.
These provisions of Chapters IV, V and VI of shall mutatis mutandis
apply to sub-broker or a clearing member and self-clearing member or
clearingmember or self-clearing member.

6.9 SUMMARY
A stock broker must be a member of a stock exchange and hold the
necessary SEBI certificate before dealing with securities on behalf of
investors. He must provide excellent service to investors, the stock
exchange, and the SEBI. He is responsible for keeping the necessary
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 Stock Broking
books of accounts and records. He must fulfil general obligations, such as
paying SEBI fees, and follow the code of conduct, as well as allow the
SEBI or stock exchange authorities to inspect his records and transactions.
He is responsible for ensuring fair play. The investor, on the other hand,
should not be swayed by the broker's advice and should use his or her own
discretion.
A sub-broker is defined as "any person who is not a member of a stock
exchange who acts on behalf of a stock broker as an agent or otherwise for
assisting investors in buying, selling, or dealing in securities through such
stock brokers." A sub-broker is an agent who works for a stock exchange
trading member. A sub-broker must be registered with both the Securities
and Exchange Board of India (SEBI) and a local stock [Link]
Members: are members of SEBI-registered stock exchanges who are
authorized to trade on their clients' or their own behalf (proprietary
trades). Each trading member is assigned a unique TM-ID under SEBI
[Link] cum Clearing Members (TCM): A Trading Member
(TM) who is also a Clearing Member (CM) of the exchange (TM). TCMs
account for the vast majority of large brokers. This type of TCM can clear
and settle their own proprietary trades, client trades, trades of other TMs,
and even trades of Custodial Participants.

6.10 EXERCISE
A. Choose the correct alternative:
1. ________ is not a member of stock exchange but acts on behalf of stock
Broker as an agent.
(a) Sub-Broker (b) Clearing Member (c) Jobbers (d) Trading Member
2. ________ is the oldest stock exchange in India.
(a) Calcutta Stock Exchange (b) National Stock Exchange
(c) Bombay Stock Exchange (d) Metropolitan Stock Exchange
3. ______ act as agent to the investors.
(a) Stock Broker (b) Registrar (c) Proprietor (d) Lessor
4. Which type of derivative instrument is unregulated.
(a) Swap (b) Futures (c) Options (d) Forward

Answers:
6. A _________ grants the holder the right to purchase a predetermined
amount of the underlying asset at the strike price on a predetermined date
(a) put option (b) call Option (c) swap option (d) forward option
1 – (a); 2 – (c); 3 – (a); 4 – (d); 5 – (b)
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Innovative Financial Services B. Answer the following
1. List down the code of conduct for the Stock broker.
2. State the obligation of Stock Broker towards Investor.
3. Write a short note on Foreign Broker.
4. State the code of conduct laid down for the trading member / clearing
member or self-clearing member.
6. Write a note on different types of derivatives instruments.

References:
[Link]
[Link]
[Link]
exchange-board-of-india-stock-brokers-regulations-1992-last-amended-
on-february-23-2022-_56447.html

Rules and Regulations laid down by the SEBI



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 7
SECURITIZATION
Unit Structure
7.0 Learning objectives
7.1 Definition
7.2 Meaning of Securitization
7.2.1 Participants in the Securitization
7.2.2 Securitization mechanism
7.3 Securitization v/s Factoring
7.4 Features of securitization
7.5 Pass through certificates
7.5.1 Meaning
7.5.2 Parties involved in the pass-through certificate transaction
7.5.3 Benefits of pass-through certificate
7.6 Special purpose vehicle
7.7.1 Meaning
7.7.2 Purpose of special purpose vehicle
7.7.3 Advantages of special purpose vehicle
7.7.4 Limitations of special purpose vehicle
7.7 Securitisable Assets
7.8 Benefits of Securitization
7.8.1 Benefits to the originators
7.8.2 Benefits to the investor
7.8.3 Benefits to the financial system
7.9 New guidelines on securitization
7.10 Summary
7.11 Exercise

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Innovative Financial Services 7.0 LEARNING OBJECTIVES
After learning this chapter, learners will be able to:

 understand the meaning of asset securitisation;

 describe various benefits of securitisation;
 Understand the difference between securitization and factoring
 appreciate the various instruments of securitisation;
 explain various steps involved in the securitisation process; and
 analyse securitisation developments in the Indian market.

7.1 DEFINITION
“Securitisation” means acquisition of financial assets by any [asset
reconstruction company] from any originator, whether by raising of funds
by such [asset reconstruction company] from [qualified buyers] by issue of
security receipts representing undivided interest in such financial assets or
otherwise;

7.2 MEANING OF SECURITIZATION

The process of converting illiquid loans into marketable securities is
known as securitization. The lender sells to a third party his or her right to
receive future payments from the borrowers and is compensated for it. As
a result, the lender is repaid at the time of securitization. These borrowers'
future cash flows are sold to investors in the form of marketable securities.
In India, securitization is mostly done through trust structures, in which
the underlying assets are sold to a trustee company, which holds the
security in trust for investors. In this case, the trustee company is a
special-purpose vehicle (SPV) that issues securities in the form of pass-
through or pay-through certificates (PTCs). The underlying assets are
legally owned by the trustee. Investors who hold PTCs have a beneficial
interest in the underlying assets held by the trustee.

Fig 7.1 Securitization Process

7.2.1 PARTICIPANTS IN THE SECURITIZATION

(i) Originator: They are original lender and seller of receivables. This is
typically a bank, or an NBFC, or a housing finance company in India.
(ii) Seller: One who pools assets in order to securitize them. In India, the
seller and the originator are frequently the same person or entity.
84
(iii) Borrower: The counterparty to whom a loan is made by the originator. Securitization
Borrower payments (typically in the form of equated monthly
instalments) fund investor payouts.
(iv) The Issuer (SPV). They are the entity who issues marketable securities
(to which investors subscribe) and ensures that transactions are carried
out on specific terms. In India, the SPV is usually established as a
trust.
(v) Arranger: The securities are structured by investment banks. They
work with other parties (such as investors, rating agencies, and legal
counsel) to ensure that the transaction goes smoothly.
(vi) Investor: The person who buys securities. Banks, insurance funds, and
mutual funds are the most common types of investors in India.
(vii) Credit Rating Agency: These agencies assess the risks associated
with each transaction, impose credit enhancements commensurate with
the PTCs' ratings, monitor transaction performance until maturity, and
take appropriate rating actions.
(viii) Provider of credit enhancement. The originator is typically used as a
facility to cover any shortfall in pool collections in relation to investor
payouts. A third party can also provide the enhancement for a fee.
(ix) Servicer: The entity that collects periodic instalments due from
individual borrowers, pays out to investors, follows up on delinquent
borrowers, and provides the rating agency with periodic information
about pool performance. In India, the originator is usually the servicer.

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Innovative Financial Services 7.2.2 SECURITIZATION MECHANISM
Stage 1:The Identification Stage
The first stage of securitization occurs when a financial institution or
banker, known as the ORIGINATOR, pools his lending such as mortgages
or account receivables into a homogeneous type based on interest rate,
maturity period, and so on. As a result, the first stage is known as the
Identification process stage.
Stage 2: Transfer of Assets to SPV
The originator will transfer all of his assets to another institution, which
will aid in the securitization process. SPECIAL PURPOSE VEHICLE
(S.P.V) or Trust converts the assets into securities. The Trustees could be
retired high court judges with experience in asset valuation and finance.
There are also merchant bankers who act as SPVs and issuers. The
reputation of merchant bankers will aid in the issuance of debt
instruments, which will be oversubscribed.
Stage 3:Issue stage
The SPV categorises various assets into various types of securities based
on their maturity date and interest rate.
The SPV offers the following securities to investors:

 Pass through certificates: Pass through certificates receive payments

from assets such as housing loans, from which payments for
certificates of deposits are met as and when they are due.
 Pay Through certificates: In this case, multiple maturity structure
certificates will be issued based on the maturing pattern of various
assets, so that the respective certificates will be paid as and when the
assets mature.
 Interest-only certificates: These certificates will pay interest based on
the earnings from the assets securitized.
 Principal-only certificates: From asset realisation, only the principal
amount will be paid on the certificates.
Stage 4: Redemption stage
Payments received from various assets are used to redeem various credit
instruments issued during the redemption stage of securitization. This is
accomplished by the creator himself. In some cases, a separate servicing
agent may be appointed to handle collection work in exchange for a
commission. The servicing agent's job will be to discharge the assets by
collecting principal and interest and settling the debt instruments.
For example, a housing loan may be collected with principal and interest,
and debt instruments such as certificates of deposit may be satisfied as a
result.

86
A pass through certificate, as previously mentioned, can be either with or Securitization
without recourse. In the case of a recourse certificate, if payment is not
made on time, the SPV will hold the originator liable. As a result, SPVs
play an important role in resolving investor claims.
Stage 5: Credit rating stage
As debt instruments issued to the public, the pass through certificate
issued by SPV must be credit rated. The financial institutions issuing these
debt instruments will be subjected to credit rating, which is legally
required in some countries. Debt instruments are traded in the secondary
market, particularly for interest swaps.
The following are the various assets which can be used for Securitization
by financial institutions.

 Housing loan granted to individuals or institutions

 Hypothecation of vehicle loan
 Leasing finance, especially financial lease
 Supply bills belonging to government departments
 Outstanding on credit cards
 Long-term loans granted to reputed parties.

7.3 SECURITIZATION V/S FACTORING

While both factoring and securitization involve capitalising the company's
receivables, there are significant differences between the two. Let us have
a clear understanding about the same

Securitization Factoring

1. Meaning

Securitization is the process of Factoring is an agreement between

converting illiquid assets into liquid a bank and a company in which the
assets by converting longer duration financial institution purchases a
cash flows into shorter duration company's book debts and pays the
cash flows is known as money to the company in exchange
securitization. for receivables.

2. Parties to the Process

In the case of securitization, there In the case of factoring, there are

are many investors who invest in the two parties involved viz. the bank
securitized asset. and the company.

3. Credit Rating

Since securitization involves many Since factoring only involves two

investors, it is necessary to obtain a parties i.e. the bank and the
credit rating before proceeding with company; no credit rating is
receivables securitization. required.

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Innovative Financial Services 4. Duration of the securities involved in transactions

Securitization is done for medium Factoring is used for short-term

term or long term receivables of the receivables ranging from one
company. month to six months.

5. Credit Risk

Securitization is done without Factoring can be with or without

recourse i.e.; Originator will take recourse.
portion of credit risk.

6. Related

Securitization is generally related to Factoring is related to receivables

loans

7.4 FEATURES OF SECURITIZATION

a. Marketability: The very purpose of securitization is to ensure that
financial claims are marketable. As a result, the instrument is designed to
be marketable. This is one of the most important characteristics of a
securitized instrument, and the others that follow are mostly imported to
ensure it. Marketability is comprised of two concepts:
(1) the legal and systematic possibility of marketing the instrument, and
(2) the existence of a market for the instrument.
Traditional mercantile law took a contemporaneous view of marketable
documents in terms of the legal possibility of marketing the instrument. In
most jurisdictions around the world, laws dealing with marketable
instruments (also known as negotiable instruments) were mostly limited to
what was in circulation at the time. If the instrument is loaded on to a few
professional investors with no possibility of a liquid market, the purpose
of securitization is defeated. A securitized instrument is given liquidity by
either introducing it into an organised market (such as securities
exchanges) or by one or more agencies acting as market makers, i.e.;
agreeing to buy and sell the instrument at either pre-determined or market-
determined prices.
b. Merchantable Quality: For a securitized product to be marketable, it
must be of saleable quality. This concept is acceptable to merchants in
normal trade in the case of physical goods. When applied to financial
products, it means that the financial commitments embodied in the
instruments are secure to the satisfaction of the investors. Because investor
satisfaction is a relative term, the originator of the securitized instrument
secures the instrument based on the investors' needs. Evaluation of quality
and certification by an independent expert, i.e., rating, is common for
widely distributed securitized instruments. The rating is intended to assist
the lay investor, who is unlikely to be able to assess the level of risk
88
involved. In the case of receivables securitization, the concept of quality Securitization
changes dramatically, making rating a universal requirement for
securitization. As previously stated, securitization is the purchase by
investors of a claim on the debtors of the originator. As a result, the
quality of the debtors' claim becomes important, allowing investors to
respond purely on the credit rating of the debtors (or a portfolio of
debtors) and thus make the instrument completely independent of the
originators' own rating.
c. The primary goal of securitization is to distribute the product widely.
The extent of distribution desired by the originator is based on a cost-
benefit analysis of the costs and benefits that can be realised. Wider
distribution has a cost benefit in that the issuer can market the product
with a lower return, resulting in a lower financial cost to him. However, a
large investor base entails high distribution and servicing costs.
In practise, retail investors still struggle to understand securitization
issues. As a result, the majority of securitizations are privately placed with
professional investors. However, retail investors are likely to be drawn
into purchasing securitized products in the future.
d. Commoditization: Securitization is a commoditization process in which
the basic idea is to take the outcome of this process and place it in the
capital market. Thus, the end result of any securitization process,
regardless of its application, is the creation of certain instruments that can
be traded on the market.
e. Homogeneity: The product must be in homogenous lots in order to be
marketable.

7.5 PASS THROUGH CERTIFICATES

7.5.1 MEANING
A Pass-Through Certificate (PTC) is a financial instrument that allows the
certificate's holder or investor to earn a fixed income from the certificate's
proceeds. It is issued to the investor in exchange for the asset or mortgage-
backed securities that have been pooled together in a single securitized
loan package held by the [Link] certificates are typically issued by
financial institutions such as banks, asset management firms, and
insurance companies. Customers of such institutions can obtain a large
number of mortgages. These mortgages are bundled into a large
investment and sold to other financial institutions such as asset
management companies (AMC) or insurance companies. AMCs or
Insurance Companies then create a debt instrument and sell it to the
investor as a Pass-Through Certificate that delivers fixed income to the
investor. To better understand Pass-Through Certificates, one must first
understand the concept of Securitization. Banks offer a variety of loans,
such as home loans, commercial loans, and auto loans. These loans
generate revenue or receivables for lending institutions. As previously
stated, securitization is the process of converting these receivables or
income into debt instruments that are then sold to individual investors. As
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Innovative Financial Services previously explained, a Special Purpose Vehicle is established to issue
these debt instruments to investors. When an investor purchases these debt
instruments, the Special Purpose Vehicle issues them a Pass-Through
Certificate.
7.5.2 PARTIES INVOLVED IN THE PASS-THROUGH
CERTIFICATE TRANSACTION
a. The Originator: The transaction's creator is known as the originator. The
originator creates the structures required to complete the transaction. The
proceeds from the sale of the assets on Originator's books are received by
the company.
b. The Special Purpose Vehicle: The Pass-Through Certificates are
distributed to investors by the Special Purpose Vehicle. The SPV is
typically governed by independent trustees/directors who act in their own
best interests as a low-capitalized entity with narrowly defined purposes
and activities.
c. The Investor: Individuals and institutional investors, such as Mutual
Funds, Insurance Companies, Pension Funds, and other financial
institutions, are examples of investors. They buy the certificates from the
total pool of receivables and are paid in interest according to the pattern
agreed upon by the parties.

7.5.3 BENEFITS OF PASS-THROUGH CERTIFICATE

Pass-Through Certificates provide numerous advantages to both lenders
and issuers

 Lenders can use Pass-Through Certificates to convert illiquid assets

into cash-generating liquid assets.
 Securitization allows funds to be transferred from the inefficient debt
market to the more efficient capital market.
 Securitization can help a company's debt-equity ratio.
 The underlying assets of Pass-Through Certificates are typically
tangible. In the event of a default/failure to repay the loan associated
with the object, the lender has the right to seize the item as payment.
 Because banks or other financial institutions package these loans into a
securitized investment, such as a Pass-Through Certificate, potential
investors may consider the investment to be more stable than other
types of investments.
 Originators/Banks: Pass-Through Certificates are issued by originators
or banks to protect themselves from risk by transferring their
receivables to the government or other financial institutions that buy
debt securities. The originators can write off these assets from their
books, allowing them to make more loans to borrowers and increase
their liquidity.
 Investors: Investing in Pass-Through Certificates can provide a steady
stream of fixed income.

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 Securitization
7.6 SPECIAL PURPOSE VEHICLE
7.6.1 MEANING
A Special Purpose Vehicle (SPV), also known as a Special Purpose Entity
(SPE) or a Special Purpose Corporation (SPC), is a legal entity formed for
a single, well-defined, specific, and narrow purpose. An SPV can only be
formed for lawful purposes and cannot be formed for activities that are
prejudicial or contrary to public policy. It is primarily a business
organisation of individuals or entities who are eligible to join the
association. SPVs are primarily used to raise capital by collateralizing
future [Link] are primarily formed to raise capital from the
market. SPVs are formed as Companies only and are subject to the
provisions, rules, and regulations of the Companies Act, 2013. They are an
artificial juridical person. A SPV has the same rights and benefits as a
company formed under the Companies Act of 2013. Members of an SPV
are typically the companies and individuals who sponsor the entity. SPVs
have a limited scope of operation, whereas other companies can carry out
all of the activities permitted by the Memorandum of Association (MoA).
In the case of an SPV, the MoA is quite narrow. This is done primarily to
reassure lenders who are concerned about their investment.

7.6.2 PURPOSE OF SPECIAL PURPOSE VEHICLE

a. Risk Mitigation
Any company's regular operations involve a significant amount of risk.
The establishment of SPVs assists the parent company in legally isolating
the risks involved in projects or operations.

b. Securitization of Loans/Receivables
One of the most common reasons for forming an SPV is to securitize loans
and other receivables. In the case of mortgage-backed securities, the bank
can simply create an SPV to separate the loans from the other obligations
it has. As a result, this special purpose vehicle allows its investors to
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Innovative Financial Services receive any monetary benefits before the company's other debtors or
stakeholders.

c. Easily Transfer Non Transferable Assets

For the purpose of easily transferring non-transferable assets, an SPV is
formed to own such assets. If the parent company wishes to transfer the
assets, it sells the SPV as a whole rather than splitting them up or
obtaining multiple permits. Such situations arise during mergers and
acquisitions processes.

d. Hold Company’s Key Properties

An SPV is sometimes formed to hold the property of a company. When
property sales outnumber capital gains for the company, it will choose to
sell the SPV rather than the properties. It will assist the parent company in
paying taxes on capital gains rather than the proceeds of the property's
sale.

7.6.3 ADVANTAGES OF SPECIAL PURPOSE VEHICLE

a. By forming SPVs, private companies and institutions can gain easier
access to capital markets.
b. The most common reason for forming an SPV is to securitize loans;
generally, the interest rates payable on securitized bonds are lower
than those offered on the parent company's corporate bonds.
c. Since the assets of the company can be held by the SPV, they are safe
and secure. When a company experiences financial difficulties, it
reduces the credit risk for investors and stakeholders.
d. The SPV's credit rating remains good, so investors are confident in
purchasing the bonds.
The company is owned entirely by its shareholders and investors.

7.6.4 LIMITATIONS OF SPECIAL PURPOSE VEHICLE

a. The company would have to take back the assets if the SPV was closed,
which would incur significant costs.
b. The establishment of a special purpose vehicle may limit the parent
company's ability to raise funds.
c. Direct control over some of the parent's assets may be diluted, which
may reduce the company's ownership at the time of dilution.
d. There is a high risk of severe complications for the companies that
created these special vehicles if the regulations change.
e. If the SPV sells an asset, the parent company's balance sheet will suffer.

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f. Because it lacks the same market credibility as the sponsor or parent Securitization
company, the special purpose vehicle may have less access to capital
and raise capital from the public.

7.7 SECURITISABLE ASSETS

All financial assets can be securitized by definition, but most loans and
other assets that generate receivables (such as commercial or consumer
debt) can be converted into a tradeable item with monetary value.
Scrutinization assists businesses in raising funds and generating additional
income from financial debts or assets, allowing banks to lend out more
money while investors diversify their portfolios and earn higher returns.
All of these instruments fall into one of two categories of securities:
Asset-backed securities
Commercial debt, student loans, Bank loans to businesses, Automobile
loans and other non-mortgage loans are examples of asset-backed
securities. These are recorded as assets in the books of the financial
institution providing the credit. The government has authorised these
organisations to pursue the personal assets of defaulters who fail to make
timely payments.

Mortgage-backed securities
Mortgage-backed securities are bonds that are backed by real estate or
loans with collateral in the form of a vehicle, for example. Investors who
purchase these securities receive interest payments on the underlying
debts, as banks frequently request that borrowers send the interest amount
directly to these investors.

7.8 BENEFITS OF SECURITIZATION

7.8.1 BENEFITS TO THE ORIGINATORS
a. Risk Management: Capital can be better used by reconfiguring
portfolios to better meet risk-weighted capital adequacy norms.
b. Unblocks Capital: Properly structured securitisation transactions allow
originators to focus on the expansion of their franchise rather than the
expansion of their capital base. Originators' competitive advantage will be
built on efficient marketing, tighter credit management, and lower cost of
servicing rather than the ability to raise capital. Competitors' costs and
capabilities are no longer muted; rather, they are highlighted and
magnified.
c. Overcomes Uncertainty of Profit and increases Profitability:
Securitisation directly rewards better credit quality by lowering the costs
of credit enhancement and funding. This provides a clear incentive for
institutions to improve loan origination quality. In short, originators who
ensure higher credit quality are compensated.

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Innovative Financial Services d. Better Financial Position: Securitisation allows weaker firms to exit
without triggering a downward spiral. Consider the recent performance of
the NBFC sector. The emphasis on limiting access to public deposits by
NBFCs, regulators, and rating agencies has forced even established
NBFCs out of businesses that they have successfully run for decades. If
the emphasis had been on assisting these institutions in securitizing their
assets, their financials would have improved and fewer risks would have
been retained on their balance sheets.

7.8.2 BENEFITS TO THE INVESTOR

a. Quality Investment: Securitization provides wise investment options
that provide investors with dependability by providing mortgaged and
asset-backed securities.
b. Better Returns: Through the securitization process, investors gain
access to superior returns. It provides securities of companies with a
stronger market position.
c. Diversified portfolio: Securitized bonds offer investors a well-
diversified portfolio created by pooling the assets of a company. These
instruments differ from other types of investments.
d. Less Credit Risk: Because the assets offered through the securitization
process are rated by good credit rating agencies, they carry a lower degree
of credit risk. In the market, such assets have a higher creditworthiness.
7.8.3 BENEFITS TO THE FINANCIAL SYSTEM
a. Securitisation divides the lending and funding process into discrete
steps, allowing for specialisation and economies of scale. As a result, the
system's overall costs are reduced, and consumers pay lower borrowing
costs in the end.
b. The economy's asset turnover rate is increasing. Housing Finance
Companies, for example, may have insufficient balance sheet size to
absorb the entire risk but can securitize loans in excess of what they are
comfortable with.
c. As a result of the preceding, the volume of resources available increases
significantly. This is significant given that our economy as a whole, and
specific sectors like housing and infrastructure in particular, are capital-
strapped. Eg: Mortgage securitisation allows a breakaway from the
"specialist circuit" of housing finance into a larger pool of resources.
Furthermore, securitisation facilitates the flow of funds from capital-rich
to capital-poor regions.
d. Risk is redistributed from high default to low default regions in unison
with the flow of funds across regions. Securitised instruments reach a
broader market, provide more appropriate instruments, and are more
resilient to market cycles than conventional debt.

94
e. Credit, liquidity, interest rate, forex, and catastrophe risks are separated Securitization
and distributed to market intermediaries best suited to absorb them. As a
result, the financial system becomes more stable.
f. The debt market as a whole grows in depth. Other countries' experiences
have confirmed this fact. Capital markets can play a more direct role in
infrastructure and other long-term projects.

7.9 NEW GUIDELINES ON SECURITIZATION

The Reserve Bank of India (RBI) has issued separate master directions on
loan exposure transfer and standard asset securitization. These master
directives were issued after taking into account public comments on
draft rules issued on June 8, 2020. Based on the examination of the
comments received, the Reserve Bank has issued the Master Direction –
Reserve Bank of India (Securitisation of Standard Assets) Directions,
2021.
Unless otherwise specified, the provisions of these directions apply to the
following entities (collectively referred to as lenders in these directions):
Scheduled Commercial Banks (excluding Regional Rural Banks); All
India Term Financial Institutions (NABARD, NHB, EXIM Bank, and
SIDBI); Small Finance Banks (as permitted under Operating Guidelines
for Small Finance Banks dated October 6, 2016 and as amended from time
to time); and All Non-Banking Financial Companies (NBFCs) including
Housing Finance Companies (HFCs). These directions will be applicable
to securitisation transactions undertaken subsequent to the issue of these
directions.
General requirements for securitisation:
A. Assets eligible for securitisation
Lenders, including Indian bank overseas branches, shall not engage in
securitisation activities or assume securitisation exposures as described
below:
a. Re-securitisation exposures;
b. Structures in which short-term instruments, such as commercial paper,
are issued against long-term assets held by
a. Re-securitisation exposures;
b. Synthetic securitisation; and
c. Securitisation with the underlying assets listed below:
i. revolving credit facilities
ii. restructured loans and advances in the specified period;
iii. exposures to other lending institutions;
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Innovative Financial Services iv. refinance exposures of AIFIs; and
v. Loans with bullet payments of both principal and interest.
B. Minimum Retention Requirement (MRR)
The MRR is primarily intended to ensure that originators continue to have
a vested interest in the performance of securitised assets, allowing them to
conduct proper due diligence on loans to be securitised.
a. The MRR for underlying loans with original maturities of 24 months or
less shall be 5% of the book value of the loans being securitized.
b. The MRR for underlying loans with original maturities of more than 24
months, as well as loans with bullet repayments, as specified in Clause 6
proviso, shall be 10% of the book value of the loans being securitised.
C. Standards of Origin
Underwriting standards for securitised exposures should not be less
stringent than those applied to exposures retained on the originator's
balance sheet.
D. Priorities for payment and observability
To avoid unexpected repayment profiles during the life of a securitisation,
the priorities of payments for all liabilities in all circumstances should be
clearly defined at the time of securitisation, and appropriate legal comfort
regarding their enforceability should be provided.
E. Maximum Retained Exposures by Originators
An originator's total exposure to securitisation exposures belonging to a
specific securitisation structure or scheme should not exceed 20% of the
total securitisation exposures created by such structure or scheme.
F. Issuance and Listing:
The minimum ticket size for securitisation notes issuance shall be Rs.1
crore. Listing of securitisation notes, particularly in relation to specific
product classes, such as RMBS, and/or generally above a certain
threshold, is recommended but not required. In any case, any offer of
securitisation notes to fifty or more people in an issuance would be
required to be listed in accordance with Securities and Exchange Board of
India regulations.
G. Conditions to be satisfied by the special purpose entity
The SPE must meet the following requirements:
a. Any transaction between the originator and the SPE must be conducted
at arm's length.
b. In its title or name, the SPE and the trustee should not resemble or
imply any connection or relationship with the originator of the assets.
96
c. Except as expressly permitted by these guidelines, the originator should Securitization
have no ownership, proprietary, or beneficial interest in the SPE. The
originator should not own any stock in the SPE.
d. The originator should not have more than one non-veto representative
on the SPE board, provided the board has at least four members and
independent directors are in majority.
e. If the SPE is established as a trust, the originator shall not exercise
control over the SPE and the trustees, either directly or indirectly, and
shall not settle the trust deed, if any. The originator is not permitted to
have any ownership, proprietary, or beneficial interest in the trustees. The
trust deed, if any, should detail the functions to be performed by the
trustee, their rights and obligations, as well as the investors' rights and
obligations in relation to the securitised assets. The trustee should only
perform trusteeship functions with respect to the SPE and should not
conduct any other business with the SPE.
These are some of the highlight features of the new guidelines on
securitization.

7.10 SUMMARY
Asset securitisation is the process of packaging, underwriting, and selling
loan assets and future receivables arising from trade and business activities
as securities. The originator (seller of loan assets), trust or company
(special purpose vehicle), merchant bankers, rating agencies, and
institutional investors, among others, are all involved in the securitisation
process. Loan assets and receivables can be securitized either with or
without recourse. In the securitisation process, three instruments are used:
pass through certificates, pay through certificates, and stripped
[Link] first securitisation transaction in India occurred in 1991,
when ICICI Ltd. and Citi Bank agreed to securitize ICICI Ltd.'s loan
assets. Since then, the securitisation market has grown slowly but steadily.
Many commercial banks and mortgage lenders have securitized their loan
portfolios. In the near future, India's securitisation market is expected to
grow significantly.

7.11 EXERCISE
A. Choose the correct alternative
1. The process of selling trade debts of a client to a financial intermediary
is called _________.
(a) Sale (b) Securitisation (c) Factoring (d) Bill
Discounting
2. The term _____ is defined as a central location for keeping securities on
deposit.
(a) Depository (b) Instrument (c) Institutions (d) Broker
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Innovative Financial Services

3. The Certificate of Initial Registration for an underwriter with Securities

and Exchange Board of India remains valid for how many years?
(a) 3 (b) 4 (c) 5 (d) 7
4. There are ________ categories of Merchant bankers.
(a) two (b) three (c) four (d) five
5. For the assets with original maturity of more than 24 months, the
minimum retention requirement is __________ of the cash flows.
(a) 5% (b) 10% (c) 12% (d) 15%
Answer: 1 – (b);2 – (a); 3 – (c); 4 – (c); 5 – (b)

Answer in Brief:
1) What exactly do you mean by "securitisation"?
2) Explain to originators and investors the various benefits of
securitisation.
3) Describe the securitisation process.
4) Define the roles of the various parties involved in the securitisation
process.
5) What are the various securitisation instruments?
6) Describe the characteristics of asset securitization as a structured
financial product in the Indian market.

References:
[Link]
[Link]
[Link]
[Link]
[Link]
[Link]



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 8
FINANCIAL SERVICES AND ITS
MECHANISM
Unit Structure
8.0 Objectives
8.1 Introduction & Meaning
8.2 Types of Leases
8.3 Advantages and Disadvantages of Leasing
8.4 Leasing in India
8.5 Legal Aspects of Leasing in India
8.6 Hire Purchase: An Introduction
8.7 The Difference between Hire Purchase and Installment Sale
8.8 Summary Questions

8.0 OBJECTIVES:

i) Learners will learn in details about leasing and hire purchase system.
ii) Learners will understand the regulatory aspects of leasing and hire
purchase system.
iii) Learners will be capable of distinguishing between leasing and hire
purchase system.
Financial Services is a broad consortium that includes an array of services
right from insurance, real estate, investments, digital payment systems and
money management at corporates and individual levels. The scope of
financial services has been evolving for decades now and presently turns
out to be the second-fastest-growing sector in the global markets. The
financing services in the form of leasing finance, hire-purchase and
venture capital have provided a great push to start-ups and innovative
tech-ups in a big way to meet the long-term financial needs. This unit
deals with the theoretical framework of leasing, hire purchase and venture
capital in India.

8.1 LEASE FINANCE: INTRODUCTION AND

MEANING:
Lease is defined as a contractual agreement between two parties wherein
one party who owns the asset/ equipment (known as the lessor) lends the
asset/ equipment for use to another party (known as lessee) for periodical
rental payments for a pre-defined period. The agreement however can be
renewed over a period of time. At the end of the agreement, the lessee
returns the asset/ equipment to the lessor. It is a temporary transfer of the
asset/equipment. In other words, the ownership remains intact only the
right to use is temporarily transferred.

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Innovative Financial Services A lease is a contractual procedure calling for the lessee (user) to pay the
lessor (owner) for use of an asset. The lease usually involves two parties
which include the lessor (owner) and the lessee (user). In this
arrangement, the lessor transfers the right to use to the lessee in return for
the lease rentals agreed upon. The lease agreement can be made flexible
enough to meet the financial necessities of both parties (Maheshwari,
1997).

The components of the lease agreement are as follows:

1. Parties to the agreement: There are a minimum of two parties to this
agreement i.e lessor and lessee. But with growing complexities and
demand broker forms part of the agreement.
a. Lessor: The party that owns the asset/ equipment is known as the
lessor.
b. Lessee: The party that uses the asset/equipment for periodic
payments.
c. Lease Broker: The party that acts as a liaison between the lessor and
lessee in closing the deals. They are generally merchant bankers
who act as lease brokers.
2. Lease Assets: The assets that can be leased are vehicles, equipment,
machinery, land, factory building etc.
3. Term of Lease: The agreement vividly specifies the lease period and
clause for its renewal.
4. Payment Terms: The amount and the terms of payment are well
specified in the lease agreements.
5. Mode of Termination: The contractual agreement may be terminated at
the discretion of the lessor or lessee as defined in the agreement.
Generally, on the following terms the agreement is terminated:
a. The lessor sells the asset/ equipment to the third party
b. The lessee/ lessor terminates the agreement
c. The period of the agreement comes to an end.
6. Other Terms and Conditions: The agreement explicitly mentions the
other terms and conditions such as restrictive use, insurance coverage,
repairs and maintenance, tax responsibility etc.

8.2 TYPES OF LEASES

The Indian Accounting Standard 17 deals with types of leases in India,
however, from 1st Jan 2019 IFRS 16 superseded it. The IFRS 16 provides
for a single accounting model for recording lease transactions wherein the
term of the lease exceeds 12 months. The variation in terms of leasing
leads to the classification of leases in the following groups
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A. Terms of Lease Financial Services and Its
Mechanism
1. Finance Lease V/s Operating Lease
The lease is classified as a finance lease when the lessor transfers
substantial risks and awards associated with the leased equipment to the
lessor and the lease term exceeds 75% of the economic life of the asset.
The periodic payments are charged in such a way that amortize the asset
value over the given period and add profit to the lessor. The title of the
asset may or may not be transferred at the end of the lease depending upon
the arrangements between the two parties. Generally, with the balloon
payment, the lessee takes over the ownership of the asset at the end of the
lease term. The primary object of the lessor is to recover the capital
investment and make a profit out of the leased asset. This type of lease is
therefore known as Full Payout Leases. The assets acquired under the
financial lease are recorded in the Balance sheet of the lessee. The assets
leased under this arrangement is railway wagons, heavy machinery, ships,
aircraft, land and building etc. To cite MIDC (Maharashtra Industrial
Development Corporation) lands are leased to the industries that fall under
this category.
On other hand operating lease is one that is for a shorter period of time
wherein the lessee doesn’t enjoy full rights and rewards attached to the
asset/ equipment. The typical period lease ranges from 1- 3 years. Under
this type of lease, the lessor apparently rents out the support services
involving a fixed payment. This type of lease is also known as a service
lease. It is often treated as an offshore balance sheet item with rental
payments charged under the Profit and Loss Account of the lessee. The
assets leased under this arrangement are computers, telephones, furniture,
music systems etc.

B. Method of Lease
2. Sale and Leaseback V/s Direct Lease
Sale and Leaseback is also known as Indirect Lease wherein, the lessee
sells his asset/ equipment to the lessor with a pre-agreement that it would
be leased back to the lessee for a fixed rental payment and tenure. Thus,
the lessee can now receive the capital invested and the lessor on other
hand earns fixed income and ownership of the asset.
Direct Lease on other hand generally involves three parties, the equipment
supplier, the lessor and the lessee. The lessor either owns the asset or
acquires it from the supplier and then leases it out to the lessee on pre-
defined terms and conditions. In the case where equipment supplier and
lessor are the same, it is known as bipartite lease and when different it is
known as Tripartite Lease.

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Innovative Financial Services C. Parties to Lease
3. Single Investor V/s Leveraged Lease
Under a Single investor lease, there are two parties to the contract i.e. the
lessor and lessee. The lessor purchases the asset through a debt-equity mix
and rents out it to the lessee for periodic payments. The debt so raised for
the equipment is at the liability of the lessor alone and in case of default,
the lessee cannot be held i.e without recourse from the lessee.
In the case of the leveraged lease, there are three parties to the agreement
the lessor who contributes through equity, the financier also known as
lender (debt financier) and the lessee. The lender here has full recourse to
the lessee in case of default payments. Such a transaction is routed through
the trustee who is entitled to look after the interests of the lessor and
lessee. The sum paid towards rental are distributed first towards the loan
payment i.e. lender and then to the lessor.

D. Geographical Area.
4. Domestic V/s International Lease
When all the parties to the contractual lease agreement reside in the same
country it is known as a domestic lease.
The international lease agreements are further classified into import lease
and cross border lease. When lessor and lessee reside in the same country
but the asset/ equipment supplier belongs to a foreign land it is known as
import lease. This is because the lessor imports the asset/ equipment to the
native land of the lessor and lessee in order to execute the transaction.
On another hand, if the lessor or lessee belong to different countries such a
contractual agreement is known as cross border lease. The country of
asset/equipment supplier remains immaterial here. In the case of cross
border lease, the terms of the contract are complex and involve substantial
risks.

8.3 ADVANTAGES AND DISADVANTAGES OF

LEASING
A. Advantages to the Lessee:
1. Balanced Cash Flow out: The lessee can acquire the full rights to the
use of asset without involving a huge one-time immediate payout. On
other hand the capital so saved can be invested to meet the other
business requirements. This can help the lessee to meet its working
capital requirements effectively and efficiently.
2. Cheaper and Quick Source of Financing. :Considering the time value of
money and huge capital outlay required leasing option acts as cheaper
source of finance for the equipment. Also, the formalities involved are
eased out in comparison to purchase of asset thereby reducing both the
time and efforts involved.
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3. Use and Control of Assets: The lessee in case of financial lease has a Financial Services and Its
complete access to the full use of the equipment without dilution and Mechanism
invasion of the financier. This leads to non-restrictive use of asset as
against where institutional finance is involved.
4. Tax Benefits: Periodical Leasing payments are classified as revenue
payments and hence receive a tax benefit.
5. No Risk of Obsolescence: Since the ownership rests with the lessor, the
risk of obsolescence is also with him.

B. Advantages to the Lessor

1. Security: Since the ownership rests with the lessor, in case of any
default payments by the lessee, the asset/ equipment can be reinstated.

2. Tax Benefits: The lessor can claim the depreciation for the asset leased
thereby incentivizing through tax benefits without an actual cash
payout.

3. Trading on Equity: The lessor enjoys the benefits of trading on equity

thereby earning higher returns. The returns are generally higher than
the cost of borrowings.

Disadvantages of Leasing to the lessee.

A. Disadvantages to the Lessee:
1. The lessee though makes a substantial payment towards the assets, the
benefits of capital appreciation vests with the lessor alone.
2. In case of lock in period involved the lessee is at obligated to make the
payments even if the asset/ equipment has become obsolete or renders
minimal value addition.
3. The lessee though cannot claim for the depreciation of the asset is
responsible for maintenance and wear and tear of the asset/ equipment.

B. Disadvantages to the Lessor:

1. High Payback Period: The capital investment involved in the buying
out the asset/ equipment is huge, whereas the returns in form of rental
payments involve a high payback period.
2. High Risk of Obsolescence: With constant changes in the
technological environment the risk of obsolescence confronted is high.
3. Changes in Price Level: With the lessee receiving fixed amount of
payments, the changes in price level are not accounted for accurately
and cost of replacement of the asset/ equipment is also high.

8.4 LEASING IN INDIA

The concept of lease finance was pioneered in 1973 in Chennai (formerly
known as Madras) by “First Leasing Company of India Pvt ltd”. It was
jointly started by Farouk Irani and A.C Muthia and enjoyed monopoly for
over 7 years until 1980’s and promoted by professionals from Citibank.
Witnessing the phenomenal growth prospects of the leasing finance, in
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Innovative Financial Services 1980’s 20th Century Finance Corporation was floated. This attracted the
other players to step into the shoes of lease finance, thereby gearing the
industry in the Indian economy. The next five-year period witnessed a
rapid growth of leasing finance companies in India jumping from mere 2
companies in 1981 to 339 companies by the end of 1986 with leased value
of assets amounting to Rs 2395.5 million. (Annual RBI report 1987).
With New Economic Policy in 1991 coupled with Dahotre Commission
Recommendations, RBI widened the scope of banking functions in 1994
wherein banks themselves turned out to act as leasing companies.
The leading categories of leasing companies existing in India presently
can be classified as below-
1. Banking Sector: Both the public and private banking sectors do
provide industrial leasing services in India. The major players here as
below-
• Industrial Credit & Investment Corporation of India (ICICI)
• Industrial Finance Corporation of India (IFCI)
• Industrial Investment Bank of India (IIBI)
• Small Industries Development Corporation (SIDC)
• State Industrial Investment Corporation (SIIC)

2. Non-Banking Financial Companies: The popularity of NBFC’s

has grown immensely during the lastdecade due to reduced processing
time, quick disbursement of funds,limited documentation and close
informal relations with customers. This has helped them gain a cutting
edge over other financial institutions in indulging into ancillary activities
of leasing, hire purchasing, insurance. The specialized arm of NBFC
categorized as Asset Finance Company primarily provide leasing and
finance of assets. Eg Sundaram Finance Ltd, Anagram Finance Ltd and
DCL finance Limited specialize in leasing services.

3. Non-Banking Non-Financial Companies (NBNFC): The

companies that don’t indulge in banking or financing activities are
categorized as NBNFC. They deal into providing operating lease services
such as IT equipment’s, furniture, elevators etc for a shorter period of time
for rental payments. EgOriga Leasing Solutions Ltd, OPC Assets
Solutions Pvt Ltd, Fujitsu India etc.

4. Specialised entities
a. Car finance companies
b. Captive financing arms of Vendors and Original Equipment
Manufacturers.
c. Cab aggregators
d. Indian Railway Finance Corporation
Note: Uber Model operates under leasing agreement. Car leasing is one
of most popular models of leasing in India.

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 Financial Services and Its
8.5 LEGAL ASPECTS OF LEASING IN INDIA Mechanism
There exists no umbrella act for leasing in India however they are
governed by the Indian Contract Act 1872 and The Transfer of Property
Act 1881. The four characteristics features of lease of a movable asset are
1. The subject matter of lease is goods.
2. The ownership vests with lessor
3. The possession and rights to use goods is transferred to lessee.
4. On termination of contract, the goods are redelivered to the lessor by
the lessee.
Registration with RBI: Any company dealing with financial lease and
whose 50% or more assets are financial assets and its 50% or more gross
income is derived from these financial assets needs to mandatorily get
itself registered with RBI apart from its registration under Indian
Companies Act 1956 as amended in 2013.
Accounting Aspects: The IAS 17 and AS19 deals with leasing in India
however with convergence of IFRS, the IFRS 16 superseded the IAS 17.
Taxation Aspect: The lease transactions are subject to GST tax in India.
The provision of Input Tax credit too is applicable.
Stamp Duty: The lease agreements are subject to state law prevailing to
stamp duty. In states where no separate provisions are laid down, it is
governed by Indian Stamp Act 1899.

8.6 HIRE PURCHASE SYSTEM: AN INTRODUCTION

The demand for luxurious consumer goods has recorded an upsurge in the
last decade, but the real increase in the purchasing power has failed to
grow parallelly. This gap between demand and actual purchasing power
has given rise to hire purchase system.
Under hire purchase system the hire purchaser can get the full possession
of goods immediately on payment of the installment over the stipulated
time specified in the agreement. This enables the hire purchaser to fulfill
his demand without making the full payment at once. However, the
ownership is transferred from the hire vendor to the hire purchaser only
after the payment of the last installment. In this case even if the last
installment is defaulted the hire vendor possess the right to repossess the
goods without compensating the hire purchaser.
The thin line of difference between the hire purchaser and installment sale
is the right of ownership. In case of installment sale, the right to ownership
is transferred immediately whereas in case of hire purchase agreement it is
paid only at after the last installment is paid.
The hire purchase transaction too is governed by IAS 17, AS 19 and IFRS
16.

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Innovative Financial Services 8.7 THE DIFFERENCE BETWEEN HIRE PURCHASE
AND INSTALLMENT SALE
Sr. Point of Hire Purchase Installment Sale
no Difference
1. Governing Act Hire Purchase Act Sale of Goods Act 1930
1972
2. Ownership Transferred on Transferred
payment of last immediately as in case
installment of normal sale
transaction
3. Return of Goods The hire-purchaser The goods are not
can return the goods returnable.
before the ownership
is transferred
4. Recourse to the The hire vendor can The seller can file a suit
Seller in case of take the re-possession against the buyer but re-
Default of the goods in case of possession of goods
even single default cannot be taken unless
ordered by court.
5. Parties Involved Hire Purchaser and Buyer and Seller
Hire Vendor
6. Total Amount Down-payment + Hire Down-payment +
Includes charges Interest.

Difference between Lease and Hire Purchase

Sr. Point of Hire Purchase Leasing Period

no Difference
1. Governing Act Hire Purchase Indian Contract Act
Act,1972 1872 and Transfer of
Property Act, 1881
2. Ownership Transferred on The ownership may or
payment of last may not be transferred
installment depending upon type of
lease.
3. Depreciation Claimed by the Hire Claimed by the Lessor
Purchaser
4. Duration Shorter Period of time Longer Period of time
5. Parties Involved Hire Purchaser and Lessor and Lessee
Hire Vendor
6. Total Amount Down-payment + Hire Rental Payments only.
Includes charges No down payment is
required.

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 Financial Services and Its
8.8 SUMMARY QUESTIONS Mechanism

1. Explain the concept of Leasing. Discuss its advantages and

disadvantages.
2. Discuss in brief the regulatory aspects of leasing in India.
3. State the various types of leases.
4. Write short note on: i) Financial Lease ii) Operating Lease iii) Hire-
purchase system.
5. Distinguish between Leasing and Hire purchase system.



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 9
HOUSING FINANCE
Unit Structure
9.0 Objectives
9.1 Introduction & Meaning
9.2 Statutory Regulatory Framework of Housing Finance Companies in
India
9.3 Challenges confronted by Housing Sector Finance
9.4 Housing Industry in India: SWOC Analysis
9.5 National Housing Bank: Introduction
9.6 Disbursement of Funds under Refinance Schemes of NHB.
9.7 Summary Questions

9.0 OBJECTIVES:

i) Learners will learn in conceptual and theoretical framework of housing

finance in India
ii) Learners will understand the role of National Housing Bank.
iii) Learners will be exposed to facts and data as adapted from RBI.

9.1 HOUSING FINANCE: INTRODUCTION &

MEANING
With improved penetration of housing finance during the last decade, the
Real Estate Industry in India has turned out to be the second largest
growing sector with providing employment to millions. Increasing
demand due to nuclearization of families, High Disposable Income,
Incentives from government and increased verticals of housing finance
availability has led tothe growth of thehousing finance industry in its
length and breadth. Pradhan Mantri Awas Yojana–Urban (PMAY-U)
further gave an impetus to the this sector. The home loan market recorded
a CAGR of 18% during the fiscal period of 2014-19 with low priced
housing segment contributing to 80% market share of housing finance
market. This rising trend is witnessed not only in top 50 districts of the
country but also smaller districts of the country with nuclearization of
families acting as major growth driver.

Institutional Framework of Housing Finance in India

National Housing Bank is the apex institution that acts as refinancing
agency, the regulatory body in terms of housing finance and at the same
time acts as an ancillary body to state and public authorities aligned
towards housing and development project. The entire ecosystem is broadly
categorized into Commercial Banks, Housing Finance companies and co-
operative institutions that directly acts as financial agents to direct

108
consumers and project finance intermediaries. The entire housing finance Housing Finance
ecosystem can be glanced with the help of below tree diagram:
Institutional Framework of Housing Finance in India.

Source: Lalita Mutreja, CC BY-SA 4.0, via Wikimedia Common

9.2 STATUTORY REGULATORY FRAMEWORK OF

HOUSING FINANCE COMPANIES IN INDIA (AS
ADAPTED FROM RBI)
Principal business and housing finance
1. “Housing finance company” shall mean a company incorporated under
the Companies Act, 2013 that fulfils the following conditions:
a. It is an NBFC1 whose financial assets, in the business of providing
finance for housing, constitute at least 60% of its total assets (netted
off by intangible assets). Housing finance for this purpose shall mean
providing finance as stated at clauses (a) to (k) of Para 2 below.
b. Out of the total assets (netted off by intangible assets), not less than
50% should be by way of housing financing for individuals as stated at
clauses (a) to (e) of Para 2 below.
2. “Housing Finance” shall mean financing, for purchase/ construction/
reconstruction/ renovation/ repairs of residential dwelling units, which
includes:
a. Loans to individuals or group of individuals including co-operative
societies for construction/ purchase of new dwelling units.
b. Loans to individuals or group of individuals for purchase of old
dwelling units.

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Innovative Financial Services c. Loans to individuals or group of individuals for purchasing old/ new
dwelling units by mortgaging existing dwelling units.
d. Loans to individuals for purchase of plots for construction of
residential dwelling units provided a declaration is obtained from the
borrower that he intends to construct a house on the plot within a
period of three years from the date of availing of the loan.
e. Loans to individuals or group of individuals for renovation/
reconstruction of existing dwelling units.
f. Lending to public agencies including state housing boards for
construction of residential dwelling units.
g. Loans to corporates/ Government agencies for employee housing.
h. Loans for construction of educational, health, social, cultural or other
institutions/ centres, which are part of housing projects and which are
necessary for the development of settlements or townships (see note
below).
i. Loans for construction meant for improving the conditions in slum
areas, for which credit may be extended directly to the slum-dwellers
on the guarantee of the Central Government, or indirectly to them
through the State Governments.
j. Loans given for slum improvement schemes to be implemented by
Slum Clearance Boards and other public agencies.
k. Lending to builders for construction of residential dwelling units.
All other loans including those given for furnishing dwelling units,
loans given against mortgage of property for any purpose other than
buying/ construction of a new dwelling unit/s or renovation of the
existing dwelling unit/s as mentioned above, will be treated as non-
housing loans and will not be falling under the definition of “Housing
Finance”.
Note: Integrated housing project comprising some commercial spaces
(e.g. shopping complex, school, etc.) can be treated as residential housing,
provided that the commercial area in the residential housing project does
not exceed 10 per cent of the total Floor Space Index (FSI) of the project.
3. The above criteria will be applicable from the date of this circular.
Registered HFCs which do not currently fulfil the criteria as specified in
Para 1, but wish to continue as HFCs, shall be provided with the following
timeline for transition:

110
 Minimum Housing Finance
Minimum
percentage of
percentage of
total assets
Timeline total assets
towards housing
towards housing
finance for
finance
individuals

March 31, 2022 50% 40%

March 31, 2023 55% 45%

March 31, 2024 60% 50%

Such HFCs shall be required to submit to the Reserve Bank, a Board

approved plan within three months including a roadmap to fulfil the
above-mentioned criteria and timeline for transition. HFCs unable to fulfil
the above criteria as per the timeline shall be treated as NBFC –
Investment and Credit Companies (NBFC-ICC) and they will be required
to approach the Reserve Bank for conversion of their Certificate of
Registration from HFC to NBFC-ICC. Application for such conversion
should be submitted with all supporting documents meant for new
registration together with an auditor’s certificate on principal business
criteria and necessary Board resolution approving the conversion.

Net Owned Fund (NOF) Requirement

4. In exercise of the powers conferred by clause (b) of sub-section (1) of
Section 29A of the National Housing Bank Act, 1987, and all powers
enabling it in that behalf, the Reserve Bank hereby specifies Rupees
twenty crore as the minimum net owned funds required for a company to
commence housing finance as its principal business or carry on the
business of housing finance as its principal business.
Provided that a housing finance company holding a Certificate of
Registration (CoR) and having net owned fund of less than Rupees twenty
crore, may continue to carry on the business of housing finance, if such
company achieves net owned fund of Rupees fifteen crore by March 31,
2022 and Rupees twenty crore by March 31 2023.
5. It will be incumbent upon such HFCs whose NOF currently stands
below Rupees twenty crore, to submit a statutory auditor's certificate to
Reserve Bank within a period of one month evidencing compliance with
the prescribed levels as at the end of the period indicated above. HFCs
failing to achieve the prescribed level within the stipulated period shall not
be eligible to hold the Certificate of Registration (CoR) as HFCs and
registration for such HFCs shall be liable to be cancelled. Such companies,
who wish to be treated as NBFC – Investment and Credit Companies
(NBFC-ICCs), will be required to approach RBI for conversion of their
CoR from HFC to NBFC-ICC. Application for such conversion should be
submitted with all supporting documents meant for new registration
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Innovative Financial Services together with an auditor’s certificate on principal business criteria (PBC)
and necessary Board resolution approving the conversion.

Applicability of directions issued by Reserve Bank

6. The following master directions, as amended from time to time, shall
apply mutatis mutandis to all HFCs:
a. Master Direction – Monitoring of Frauds in NBFCs (Reserve Bank)
Directions, 2016.
b. Master Direction – Information Technology Framework for the NBFC
Sector dated June 08, 2017.
7. The following instructions, as further detailed in the Appendix shall
apply mutatis mutandis to all HFCs:
a. Definition of public deposits as contained in Master Direction – Non-
Banking Financial Companies Acceptance of Public Deposits (Reserve
Bank) Directions, 2016. Additionally, any amount received from NHB or
any public housing agency shall also be exempted from the definition of
public deposit.
b. Implementation of Indian Accounting Standards: HFCs shall
maintain a prudential floor in respect of impairment allowances and follow
instructions on regulatory capital.
c. Loans against security of shares: HFCs lending against the collateral
of listed shares shall maintain a Loan to Value (LTV) ratio of 50% for
loans granted against the collateral of shares. Any shortfall in the
maintenance of the 50% LTV occurring on account of movement in the
share prices shall be made good within seven working days.
d. Loans against security of single product – gold jewellery: HFCs
shall maintain a Loan-to-Value (LTV) Ratio not exceeding 75 per cent for
loans granted against the collateral of gold jewellery, and shall put in place
a Board approved policy for lending against gold.
e. Levy of foreclosure charges: HFCs shall not impose foreclosure
charges/ pre-payment penalties on any floating rate term loan sanctioned
for purposes other than business to individual borrowers, with or without
co-obligant(s).
f. Guidelines on Securitization Transactions and reset of Credit
Enhancement: HFCs shall carry out securitization of standard assets and
transfer of assets through direct assignment of cash flows and the
underlying securities. In doing so, HFCs, among other things, shall
conform to the minimum holding period (MHP) and minimum retention
requirement (MRR) standards.
g. Managing Risks and Code of Conduct in Outsourcing of Financial
Services: It is imperative for HFCs outsourcing their activities that they
ensure sound and responsive risk management practices for effective
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oversight, due diligence and management of risks arising from such Housing Finance
outsourced activities.
h. Guidelines on Liquidity Risk Management Framework: All non-
deposit taking HFCs with asset size of 100 crore and above and all
deposit taking HFCs (irrespective of asset size) shall pursue liquidity risk
management, which inter alia should cover adherence to gap limits,
making use of liquidity risk monitoring tools and adoption of stock
approach to liquidity risk. It will be the responsibility of the Board of each
HFC to ensure that the guidelines are adhered to. The internal controls
required to be put in place by HFCs as per these guidelines shall be subject
to supervisory review.
i. Guidelines on Liquidity Coverage Ratio (LCR): HFCs shall maintain
a liquidity buffer in terms of LCR, which will promote resilience of HFCs
to potential liquidity disruptions by ensuring that they have sufficient High
Quality Liquid Asset (HQLA) to survive any acute liquidity stress
scenario lasting for 30 days. Guidelines on LCR will be applicable to
HFCs as per the following timeline:
i) All non-deposit taking HFCs with asset size of 10,000 crore & above,
and all deposit taking HFCs irrespective of their asset size:

December December December December December

From
01, 2021 01, 2022 01, 2023 01, 2024 01, 2025

Minimum
50% 60% 70% 85% 100%
LCR

ii) All non-deposit taking HFCs with asset size of 5,000 crore & above,
but less than 10,000 crore with the timeline as:

December December December December December

From
01, 2021 01, 2022 01, 2023 01, 2024 01, 2025

Minimum
30% 50% 60% 85% 100%
LCR

8. Exposure of HFCs to group companies engaged in real estate

business: In case of companies in a group engaged in real estate business,
HFCs may undertake exposure either to the group company engaged in
real estate business or lend to retail individual home buyers in the projects
of such group companies. In case HFC prefers to undertake exposure in
group companies, such exposure by way of lending and investing, directly
or indirectly, cannot be more than 15% of owned fund for a single entity
in the group and 25% of owned fund for all such group entities. The HFC
would in all such cases follow arm’s length principles in letter and spirit.

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Innovative Financial Services 9.3 CHALLENGES CONFRONTED BY HOUSING
SECTOR FINANCE IN INDIA
Every Rs one lakh home loan adds Rs 2.9 lakhs to the economy, such is
the importance of housing finance both at the demand and supply side.
However, in midst of COVID 19 the challenges of Housing Finance
Sector have been wide and deeper. The turbulence experienced in both the
real estate construction sector as well as consumer’s affordability have led
to declined in the housing sector finance. Following are few challenges
confronted by the Housing Sector Finance in India
1. Credit Growth: The credit growth is expected to slower down in the
coming period of 2-3 years due to slip off of cashflows of the
consumers due to reduction in pays, job loss, adding safety cushion
etc. On other hand due to increase in steel prices and delays in existing
construction the real sector too has been patchy. This has led to delay
in loan disbursements and addition in credit growth has received a
severe blow.
2. Lower Profitability: With increased in non-performing assets and
restructuring plans, the over profitability margins have witnessed a
downfall.
3. Fiscal Liquidity crunch: With the collapse of DHFL, the fiscal
liquidity crunches the risk aversion has been high leading to
deceleration of housing sector credit.
4. Increased Costs: The increased costs of the HFC’s have further led to
decline in the loan borrowings further widening the income and
revenue gaps.
5. Decline in Asset Quality: The asset quality has witnessed a weak
credit appraisal and decline in credit backing due to erratic macro-
economic parameters coupled with absence of stern bankruptcy laws.
The COVID wave has further impacted the asset quality.

9.4 HOUSING INDUSTRY IN INDIA: SWOC ANALYSIS

Strengths:
1. Huge Finance Market: The housing finance industry holds total
outstanding loan amount of Rs 20.4 trillion (RBI Report 2020) out of
which housing finance companies occupy the dominant position.
2. Strong Institutional Framework: Indian housing finance ecosystem is
well carved serving right at grassroot levels by housing finance
companies, co-operative banks, NBFC’s and commercial banks who
serve the customers while at the other end, NHB provides refinance to
these financing institutes.
3. Favorable Regulatory Framework: Recent reforms in tax wherein two
residential properties are now allowed by an individual as well refund
in stamp duty and GST for the purchase of the first residential property
have further boosted this sector.

114
Weakness: Housing Finance

1. Huge NPA: With present scenario wherein income levels have

shrinked, the existence of NPA’s have increased pressurizing the credit
growth of the lending institutes.
2. Stability in Interest Rates: Frequent fluctuations in repo rate and reverse
repo rate lead to changes in home loan interest rates.

Opportunities
1. Nuclear Family Systems: With increasing nuclear family system being
practiced, there is an upsurge in the demand of home loans.
2. Increased in Disposable Income: Increased income of the individuals
and existence of more working members in the family have led to
increased capacity of families to buy home.
3. Increased Penetration: Increased penetration of housing finance with
availability of wide consortium of banks, NBFC’s, housing finance
companies that at the same time empower customers with improved
bargaining power.

Challenges
1. High Inflation: The inflation rates have been ever rising impacting the
entire ecosystem of fiscal and public finances.
2. Uncertainty: Due to presence of COVID -19 the element of uncertainty
and fear amongst the individual has increased. This has led to keep
increased in demand for liquidity and has also impacted loan paying
capacity of an individuals.

9.5 NATIONAL HOUSING BANK: INTRODUCTION

With a vision to promote in stability in housing finance sector, the
Government Of India enacted the National Housing Bank Act, 1987 which
led to the formation of National Housing Bank on July 8, 1988 as an apex
institute with entire paid up capital subscribed by the Reserve Bank of
India. It’s head office is located in New Delhi.
The Preamble of the National Housing Bank Act, 1987 describes the basic
functions of the NHB

“… to operate as a principal agency to promote housing finance

institutions both at local and regional levels and to provide financial and
other support to such institutions and for matters connected therewith or
incidental thereto …”
Source: National Housing Bank Act, 1987
The broad objectives of the NHB are as below-
1. To act as facilitator and refinance to promote housing.
2. To provide a robust, healthy, cost-effective housing finance system in
the country.
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Innovative Financial Services 3. To integrate and align the housing finance into the mainstream of
financial system of the country.
4. To make available housing finance at affordable rates.
5. To penetrate deeper across the regions and income groups for assuring
availability of housing finance services.

The major milestones achieved are stated as below –

1. In 1990-91: NHB was recognized as Public Financial Institution
2. In 1992-93: With an aim to reach out to the large population, it
launched the refinance schemes for Slum Development Projects.
3. In 1994-95: Launched Unsecured Bonds and established prudential
norms with Housing Finance Companies.
4. In 2002-03: Defined Liberalized Refinance Scheme for Housing
Loans.
5. In 2006-07: Established the first housing index of India i.e NHB
Residex.
6. In 2007-08 Established finance to Rural Housing Fund with NHB.
7. In 2009-10: Formed Asia Pacific Union for Housing Finance
8. In 2012 NHB was awarded with Skoch Financial Inclusion Awards for
its project, “Energy Efficient New Residential Housing in India.
9. In 2014-15 : It was appointed as Nodal agency under Pradhan Mantri
Awaz Yojana
10. In 2017-18: The National Housing Bank Act, 1987 was amended
under the Finance Act, 2018 wherein the share capital was transferred
from RBI to Central Government.

9.6 DISBURSEMENT OF FUNDS UNDER REFINANCE

SCHEMES OF NHB.
DISBURSEMENTS BY NATIONAL HOUSING BANK UNDER ITS REFINANCE SCHEMES
(Rs. Crore)
Year Housing Finance Banks Others Total
(July- Companies
June)
Disburse Outsta Disburse Outstan Disburse Outsta Disburs Outstan
ments nding ments ding ments nding ements ding
1 2 3 4 5 6 7 8 9
2000-01 762 3344 106 150 141 830 1008 4325
2001-02 719 3750 85 211 219 984 1024 4946
2002-03 1772 4629 798 935 140 1044 2710 6607
2003-04 1851 4736 1284 2259 118 1056 3253 8052
2004-05 2623 4928 5404 6720 35 819 8062 12467
2005-06 1840 4888 3791 10428 2 952 5633 16268
2006-07 1210 4915 4280 14011 10 348 5500 19274
2007-08 1189 4750 7398 11758 0 268 8587 16776
2008-09 7055 10324 3799 5972 0 166 10854 16461
2009-10 3544 11146 4335 8153 229 505 8108 19804

116
2010-11 3309 10891 8414 11037 312 653 12035 22581 Housing Finance
2011-12 5302 13288 8994 14799 93 477 14390 28564
2012-13 7693 16402 9848 17268 0 328 17541 33998
2013-14 9633 22086 8223 17137 0 215 17856 39438
2014-15 7390 24300 14367 19555 90 176 21847 44031
2015-16 10852 29735 10678 23172 60 157 21590 53064
2016-17 16779 40277 5855 14335 50 193 22684 54804
2017-18 11508 38116 13363 20416 50 193 24921 58725
2018-19 21736 50145 3391 18786 50 163 25177 69094
2019-20 27551 64653 3707 17951 0 149 31258 82753
2020-21 26905 71389 7325 13135 0 149 34230 84673
Notes : 1. Data for 2020-21 are provisional.
2. Banks include Private Sector, Public Sector, Foreign Banks and Regional Rural Banks (RRBs).
3. Others include Urban Co-operative Banks (UCBs), Agriculture and Rural Development Banks
(ARDBs) and Apex Co-operative Housing Finance Societies (ACHFs).
4. NHB follows July-June financial year.
Source: National Housing Bank.

9.7 SUMMARY QUESTIONS

1. Write a SWOC analysis of Housing Finance sector in India

2. Write in brief about National Housing Bank of India
3. Critically evaluate the housing finance sector in India in light with its
growth prospects and challenges.
4. Discuss in brief the regulatory and statutory norms of Housing Finance
in India as laid down by RBI.



117
 10
VENTURE CAPITAL FINANCING
Unit Structure
10.0 Objectives
10.1 Introduction & Meaning
10.2 Features of Venture Capital Financing
10.3 Stages of Venture Capital Financing
10.4 Facts and Figures
10.5 Summary Questions

10.0 OBJECTIVES:

i) Learners will learn in details about venture capital financing and its
growth in India.
ii) Learners will be acquainted with various facts and figures pertaining to
venture capital funding in India.

10.1 INTRODUCTION & MEANING

The dearth of Capital financing remains one of the largest barriers for the
businesses and start-ups in our country even today. The impact is even
higher in cases where the entrepreneur is unknown, lacks previous
experience or a brand, i.e an unknown technocrat. The Indian Information
Technology sector and young lads have the huge unexplored potential for
start-ups involving creativity and innovation but what pulls the strings
back is the availability of initial capital investments. Due to limited credit
score (CIBIL Score) and the non-existence of required documentation, the
availability of loans from commercial banks and NBFC’s is difficult.
Raising public finance remains outside the gamut. Thus, the need for
financing these ventures who involved substantial risk but at the same
time have high potentialities was felt. This gave birth to the concept of
venture capital financing. Venture capital refers to long term investment
in form of equity and/ or conditional loans into these high-risk high
potential business ventures.
The concept of venture capital is no new term in India but was first coined
in 1986. However, it was at the infancy stage where adoption of asset class
was carried upon by public financial institutions in consent with the
government only. The initiation of the New Economic Policy in 1991 led
to transformation with stakes now involving private venture capitalists
from India and abroad. The growth remained underpinned until 2010, then
scaling up the venture capital financing both in terms of numbers and
capital.

118
A Venture Capital Fund may be registered in form of trust or company Venture Capital Financing
and has been defined to mean a fund established in the form of a trust or a
company including a body corporate and registered with SEBI which –
i) has a dedicated pool of capital, raised in a specified manner, and
ii) invests in venture capital undertakings in accordance with these
regulations.

10.2 FEATURES OF VENTURE CAPITAL FINANCE

1. Equity Capital: The investments here are in form of equity capital,

therefore they not only provide finance but also bear the risk in the
business.
2. Returns to the investor: The investor here being the shareholder, the
returns are in form of profits and not interests through participation in
sale holdings. The conditional loans if provided earn royalties on sales
in most cases.
3. Limited Participation in Management: Though the venture capitalist is
technically the owner of the company their participation in managing
the day-to-day affairs of the company is limited. They act as advisors,
mentors and counsellors in the company.
4. High Degree of Risk: Venture capitalists invest in ventures that are
floated by unknown technocrats and hence the element of risk and
uncertainties are high.

10.3 STAGES OF VENTURE CAPITAL FINANCING

The business needs have always been evolving and need capital injections
at various stages of its life cycle. The broad classification can be
illustrated with help of below tree -diagram:

Source: Lalita Mutreja, CC BY-SA 4.0, via Wikimedia Commons

A) Early-Stage Financing: It can be further classified into Seed capital,
Start-up Stage and Second Round Financing.

119
Innovative Financial Services i) Seed Capital: This stage can also be referred to as pre-natal capital
that is associated with the research and development of the venture. At this
stage, the funds are required for laboratory testing or testing the waters of
the product before initializing commercialization. At this stage, the
decision as to whether the product is to be launched and/or with
modifications is taken by the innovator. Being a high-risk proposition, the
capital requirements at this stage are contributed by the developer.
Venture Capitalists do provide this capital but in form of loans and not
equity.
ii) Start- up Stage: Once the venture has been approved in its research
and development, the need for financing the commercial launch is felt.
The venture capitalists in most cases start their funding from this stage
onwards. At this stage, venture capitalists screen the entrepreneurial
capabilities along with the proposal before investing in the venture in form
of equity and/ or conditional loans. The funds so invested herein have a
wider time horizon.
iii) Second Round Financing: Liquidity injections or need for mid-term
financing is met through venture capitalists financing in form of debt
rather than equity. At this stage, the venture capitalists don’t deliberate
many discussions, as the ventures are more or less stable.
B) Later Stage Financing: Financial requirements of a business vary
with its life cycle, once the business reaches its growth stage, huge
financial requirements are once again required either to diversify or branch
out in various directions. This financing is available in the following
modes:
i) Expansion: As the business reaches to its peak, innovation and
expansion are the key drivers for its sustenance in the long run. Where the
venture cannot raise public finance directly, it may acquire or take over an
existing venture. In the second scenario where the entrepreneur reaches its
maximum equity, venture capitalists pump in debt funds in form of
conditional loans.
ii) Replacement: When the promoters of the company intend to exit the
investee company however the equity is not floated in the market but at
the same time growth potential curves for 3-5 years, the venture capitalists
now replace the promoter’s equity with its funds.
iii) Turn Around: Ventures after a certain level reach maturity or need
change at various levels i.e in form of product, organization or
transformation that once again requires inflow of funds. Being risk in
nature, in-depth scrutiny is conducted, consultancy too may be appointed.
A substantial investment is done at this stage by the venture capitalists.
iv) Buyout: Set of passive shareholders that desire to exit from the
venture are taken over by the active shareholders before offering it to the
public or outsiders. This set of arrangements is known as buyout deals.
These active shareholders need additional finance that can be met through
venture capitalists.
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 Venture Capital Financing

10.4 VENTURE CAPITAL: INDIAN SCENARIO: FACTS

AND FIGURES:

Source: Statista 2020.

The above graph displays the inflow of venture capital funds in Indian
companies during the period 2013-2020. As visualized above, spectacular
growth was achieved that jumped off from USD 4.8 billion to USD 6.1
billion during the period 2016-17 and continued to remain constant in
2018. Though it dipped off in 2019 and 2020 but the investments still
continue to substantial in midst of COVID -19 foreseeing a huge potential.

Source: Bain VC deals database; Crunchbase; IVCA; Bain analysis

The number of active venture capitalists have witnessed a substantial
increase even during the pandemic. The major venture capitalists are
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Innovative Financial Services Tiger, Softbank, Inflection Point Ventures, Avataar Venture Partners,
Coatue Management, Beyond Next Ventures, Titan Capital and Arkam
Ventures.

Top start-ups that received more than $100M funding in 2020

Stage of
Asset Key investors funding
Tiger Global, Alkeon, BlackRock,
Byju's" General Atlantic, Late
Bond Capital, Silver Lake, Sands
Capital, Owl Ventures
Fidelity, Kora Management, Luxor
Zomato Capital, Mirae Asset, Late
Tiger Global, Steadview, Temasek, D1
Capital
FirstCry SoftBank Late
SoftBank, Nexus, Sequoia, General
Unacademy* Atlantic Late
Tiger Global, TPG, ChrysCapital,
Dreamil Footpath Ventures Late

Google, Microsoft, Falcon Edge, Sofina

DailyHunt* Group Late
Advent International, Tiger Global,
Zenoti Steadview Capital Late
Samsung Ventures, Korea Investment
Swiggy* Partners, Late
Naspers, Tencent, Mirae Asset,
Meituan-Dianping
Postman Charles River, Insight, Nexus Late
GGV Capital, Coatue Management,
Vedantu* WestBridge, Late
Omidyar Network, Tiger Global
Glance Google, Mithril Capital Late
Iron Pillar, Investment Corporation of
FreshToHome Dubai Late
PolicyBazaar SoftBank Late
Capital One Growth Ventures, General
Eightfold Catalyst, Late
Lightspeed
Citi Ventures, ICONIQ Capital,
HighRadius Susquehanna Growth Late

122
 Sequoia, Prosus Ventures, Chan Venture Capital Financing
Eruditus Zuckerberg Initiative, Late
Ved Capital, Leeds Illuminate
Temasek, Accel, Epiq Capital Fund,
CureFit Satyadharma Late
Investments, Ascent, PraTithi, Chiratae
Gaja Capital Partners, Investcorp India,
Xpressbees NVP India Late
B Capital, Falcon Edge, Omidyar
Bounce* Network, Maverick, Late
Qualcomm, Accel, Chiratae, Sequoia
Accel, Founder Fund, ICONIQ Capital,
MindTickle Qualcomm, Late
SoftBank
Tiger Global, Sequoia, Matrix, Ribbit
Razorpay Capital, Late
Y Combinator
Sequoia, SoftBank, MassMutual,
Biofourmis Openspace Late
Source: Bain VC deals database; Crunchbase; IVCA; Bain analysis

10.5 SUMMARY QUESTIONS:

1. Explain the need and importance of Venture Capital financing.

2. Discuss in brief the various stages of Venture Capital financing.
3. Write a short note on:i) Seed Capital ii) Features of Venture Capital.
4. Carve out Indian scenario with respect to Venture Capital Finance in
India.

References
1. Master Direction – Non-Banking Financial Company – Housing
Finance Company (Reserve Bank) Directions, 2021; Retrieved from
[Link]
[Link]\

2. [Link]

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Innovative Financial Services Additional Reading:
1. IFC Report: Evaluation of Leasing in India: March 2019:or Scan the
below QR code

2. India Venture Capital Report 2021: IVCA: Bain and Company or

Scan the below QR code



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 11
CONSUMER FINANCE AND CREDIT
RATING
Unit Structure
11.0 Introduction
11.1 Consumer Finance
11.1.1 Sources of consumer finance
11.1.2 Types of consumer finance
11.1.3 Types of Products
11.1.4 Consumer Finance Practice in India
11.1.5 Mechanics of Consumer Finance
11.1.6 Consumer Credit Scoring
11.1.7 Case for and against consumer credit
11.2 Plastic Money
11.2.1 Introduction
11.2.2 Growth of Plastic Money Services in India
11.2.3 Types of Plastic Card
11.2.4 Benefits of Credit Cards
11.2.5 Danger of Debit Cards
11.2.6 Prevention of Frauds and Misuse
11.2.7 Consumer Protection
11.2.8 Indian Scenario
11.3 Credit Rating
11.3.1 Meaning
11.3.2 Origin
11.3.3 Features
11.3.4 Advantage of Rating
11.3.5 Regulatory Framework

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Innovative Financial Services 11.3.5 Credit Rating Agency
11.3.6 Credit Rating Process
11.3.7 Credit Rating Symbol
11.3.8 Credit Rating Agencies in India

11.0 INTRODUCTION:

“When business offers finance to the customers with the help of

professional financing companies it is known as consumer finance” the
main motive of this process is to provide the consumer to pay for goods or
services that they couldn't pay directly in cash or credit card. This helps to
bridge the gap between the buyer and seller enabling them with easy cash
availability. Consumer finance is helpful for both consumer financing
company as well as consumers. In other words,Consumer finance is a
type of lending that provides credit to a customer for personal or
domestic use.
When a business or retailer offers customer financing choices to its
consumers, the term "consumer financing" refers to the use of either the
customer's own funds or the funds of a lending firm or bank. This enables
the consumer to purchase an item that they would otherwise be unable to
afford or would prefer not to pay for with cash. Typically, the term refers
to debt for common goods and services.

11.1 SOURCES OF CONSUMER FINANCE

1. Commercial banks:

Commercial banks give loans to people who can afford to pay them back.
Loans are the sale of money's use by those who have it (banks) to those
who want it (borrowers) and are willing to pay a price for it (interest).
Consumer loans, home loans, and credit card loans are all forms of loans
that banks [Link] loans are for monthly instalment purchases
that are repaid with interest. Cars, yachts, furnishings, and other expensive
durable goods account for the majority of consumer [Link]
mortgages, home construction, and home upgrades are all possible uses for
housing [Link] prearrangement, credit card loans may be accessible
in the form of cash advances.

2. Savings and Loan Associations (S&Ls):

Personal instalment loans, home renovation loans, second mortgages,

education loans, and savings account loans are all available through
savings and loan associations. Savings and loan associations lend to
creditworthy individuals, and collateral is often required. Savings and loan
associations loan rates vary depending on the amount borrowed, the term
of the loan, and the collateral.
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Because S&Ls lend depositors' money, which is a relatively affordable Consumer Finance and Credit
source of capital, their interest rates are often lower than those of other Rating
types of lenders.

3. Credit Unions (CUs):

Credit unions are non-profit cooperatives that serve members who share a
common interest. Credit unions are typically able to offer better loan and
savings terms than commercial institutions due to their non-profit status
and cheaper costs. Because sponsoring firms offer employees and office
space, and because some corporations agree to collect loan payments and
savings instalments from members' salaries and apply them to credit union
accounts, the credit union's costs may be reduced.

Personal loans and savings accounts are frequently offered at a good rate
by credit unions. CUs typically have fewer prerequisites and offer speedier
loan service than banks or savings and loans.

4. Consumer Finance Companies (CFCs):

Personal instalment loans and second mortgages are the specialty of

consumer finance companies. Consumers with no credit history can
frequently borrow from CFCs without putting up any collateral. CFCs are
generally eager to lend money to clients who are having trouble obtaining
credit elsewhere, but the interest rate is greater because the risk is more.

The interest rate is determined by the loan balance as well as the

repayment plan. CFCs handle loan applications fast, frequently the same
day they are submitted, and tailor repayment plans to the borrower's
financial situation.

5. Sales Finance Companies (SFCs):

If you've ever purchased a car, you've probably come across the option of
financing the purchase through the manufacturer's financing business.
These SFCs allow you to pay for large-ticket things over a longer length
of time, such as a car, major appliances, furniture, computers, and stereo
equipment.

You don't deal with the SFC directly, but the dealer will usually advise
you that your instalment note has been sold to a sales financing firm. You
then make your monthly payments to the SFC rather than the dealer from
whom you purchased the goods.

6. Life Insurance Companies:

You can normally borrow up to 80% of the accrued cash value of a whole
life (or straight life) insurance policy from an insurance company. Loans
against some policies are not required to be repaid, but the remaining loan
sum is deducted from the amount your beneficiaries receive after you die.
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Innovative Financial Services
Compounding interest works against you, therefore it's critical to repay at
least the interest component. Because they assume no risks and incur no
collection fees, life insurance companies charge lower interest rates than
other lenders. The cash value of the policy serves as collateral for the
loans.

7. Pawnbroker:

Pawnbrokers, who have recently become popular, are an unusual but

widespread source of secured loans. They take possession of your home
and lend you a piece of its value. You receive your property back if you
repay the loan and interest on schedule. If you don't, the pawnbroker will
sell it, though you can ask for an extension. The interest rates charged by
pawnbrokers are greater than those charged by other lenders, but you don't
have to apply or wait for approval. What is the main attractiveness of
pawnbrokers? They don't ask many questions.

8. Loan Sharks:

These predatory lenders do not have a state-issued licence to operate in the

lending industry. They demand exorbitant interest rates for refinancing,
repossession, and late payments, and they only give you a limited amount
of time to repay. They're well-known for adopting violent or criminally
motivated collection practises. Stay away from them. They are, after all,
unlawful.

9. Family and Friends:

Your relatives may be your finest source of credit at times. All such
transactions, however, should be handled professionally; otherwise,
misunderstandings may arise, jeopardising family relationships and
friendships.

If the IRS learns about an intra-family "loan," it can "impute interest" on

it, which is revenue for the lender but not deductible for the borrower. An
IRS audit can also have a negative impact on family relationships.

10. Traders:

Traders are the most common companies that deal with consumer credit.
Sales finance firms, hire buy companies, and other financial institutions
fall under this category.

11.1.2 Types of Consumer Finance

The term “consumer loan” refers to the type of loan extended to

consumers to fund specific items or purposes. Typically, consumers avail
of loans for financing home purchases, debt consolidation, education,
general living expenses, etc. On the other hand, growing small businesses
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take on loans to fund working capital requirements, equipment purchase Consumer Finance and Credit
and real estate, inventory purposes, etc. In short, there is a wide variety of Rating
consumer loan products available in the market, and thus it is important
for consumers to understand their own needs before availing of any of the
products. This article will provide a brief understanding of consumer loans
and their different types.

Types of Consumer Loan

1. Mortgage
A mortgage is a secured loan given by a bank to a consumer for buying a
house, which usually costs much more than what an average person earns
in a year. This type of loan is stretched over a longer period of time to ease
out monthly installments, the most common mortgage being a 30-year
fixed-rate loan.

2. Auto Loan
An auto loan is either extended by a bank or the car dealer itself to finance
the purchase of a vehicle. The term of a typical auto loan ranges from 2
years to 7 years. The tenure is shorter, and the down payment is larger for
an auto loan due to the rapid car value depreciation. It is typically secured
in nature.

3. Education Loan
The objective of an education loan is to fulfill the education needs of a
student by paying the college/tuition fees. In this way, students are able to
pursue their life goals through proper education. This is an unsecured type
of loan, and the repayment only starts few months after the student’s
graduation from college.

4. Personal Loan
A personal loan caters to various day-to-day needs of the borrower. It is
the most versatile type of loan in the consumer loan market due to its wide
range of end-use purposes, including debt consolidation, vacations, etc.
This type of loan usually has a long tenure and can be either secured or
unsecured in nature.

5. Refinance Loan
As the name suggests, this type of loan is used to refinance an existing
loan. In fact, a refinance loan can be used to refinance any of the
abovementioned loans. Typically, it has a fixed payment with a lower
interest rate, which primarily attracts consumers.
11.1.3 Types of Products:
1. Revolving Credit:
Revolving credit is a type of credit that allows an account holder to
borrow money indefinitely up to a defined monetary limit while returning
a portion of the current balance due in monthly instalments. Each payment
replaces the account holder's available funds, minus the interest and fees
[Link]: credit card
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Innovative Financial Services 2. Fixed Credit:

The interest rate on a fixed rate loan does not fluctuates. When a loan is
taken, a fixed rate of interest is locked and the rate and monthly payments
remain the same throughout the payback period. It's easier to arrange
budget and prevent skipping payments if a steady monthly payment is
known.
eg; Term loan

3. Cash Loan:

A cash loan is one in which the borrower receives the funds in cash. A
personal loan can be granted to a private individual, and a business loan
can be issued to a company. A consumer takes loan from a bank or a
financial institution for the purchase of product for personal use.
eg: Personal loan
4. Secured Finance:

Secured loans are commercial or personal loans that require some form of
collateral to be repaid. A bank or lender can ask for collateral for
significant loans that are being used to buy a specific asset or when your
credit ratings aren't good enough to qualify for an unsecured loan. Because
secured loans provide a reduced risk to lenders, they may offer cheaper
interest rates to borrowers. Certain secured loans, such as negative credit
personal loans and short-term instalment loans, can, nevertheless, have
higher interest rates.

5. Unsecured Loans:

An unsecured debt or obligation is one that is not supported by any kind of

[Link], which is found in secured debt, is property or other
valuable assets that a borrower delivers as a way to secure the loan. In an
unsecured loan, the lender will give money based on other parameters that
the borrower meets. Credit history, income, employment position, and any
outstanding debts are among the qualifying considerations.

6. Credit Card
It is the most commonly used and popular among the various types of
consumer loans. A borrower usually uses it to buy daily need items, such
as groceries, apparel, etc., on credit. The rate of interest charged on this
type of loan is a bit on the higher side, and thus failure to pay on time can
attract a very high penalty.

1.1.4 Consumer Finance Practice in India:

Consumer finance has enormous potential and is a highly profitable and
bankable activity, especially in a low-interest environment. However,
there are concerns about credit bureaus, supplier alliances, product
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innovation, and consumer [Link] is regarded as the world's Consumer Finance and Credit
second-fastest-growing country, after China. India has recently developed Rating
as a primarily industrialised and service-oriented economy. This fact is
supported by the consistent growth rate over the last few years. The
combination of economic liberalisation and a young population has
resulted in an increase in income and purchasing power. Young people's
thoughts have been caught by international companies and trends.
Aspiring for higher-quality items, a fast-changing lifestyle, and larger
expectations for personal growth have all become the norm.

An ordinary man who previously disliked credit is now in favour of it for

shopping convenience, financing housing, autos, consumer durables, and
even vacations. The traditional cautious mindset has shifted, and
borrowing against future earnings is now a common occurrence in India.

The Indian customer can choose from a variety of financing options

provided by a variety of banks and other financial institutions.
Commercial banks have now reached an agreement with non-banking
finance companies to address the rising demand for consumer finance as a
result of increased consumer goods product offerings. Consumer finance
has grown at a rate that is commensurate with the country's supply of
goods. The disadvantage is that the retail loan boom will increase
household indebtedness.

Although financial systems change from country to country, there are

numerous similarities among financial service providers. Below are few
mentioned common service providers:
a) Central bank
b) Banks
c) Financial institutions
d) Money and capital markets and
e) Informal financial enterprises.

1. Demand for credit-fuelled consumption:

With India's financial industry evolving at an unparalleled rate, the

country's credit demand has been steadily increasing over the years. The
emergence of India's "affluent middle class" and rural economic growth
are shifting consumer spending habits and driving the majority of the
country's consumption growth. From March 2000 to March 2021, India's
domestic credit growth averaged 15.1%, fueled mostly by retail loans and
increased credit card use. With 22 million Indian customers seeking for
new credit every month, the Indian consumer credit market continues to
grow at a faster rate than most other major economies across the world.

2. Increase in the purchasing power of an average Indian:

India spends more than twice as much as countries like Brazil on

consumer goods. Over the last five years, private final consumption
expenditure has risen steadily, reaching INR 123.1 Mn (USD 1.70 Mn) in
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Innovative Financial Services 2020. In the last five years, India's household debt has increased at an
annualised rate of almost 13%.

3. A shift in the demographic profile of the consumer:

India is one of the world's newest countries, with more people of working
age joining the workforce every day. Millennials and Gen-Z, the next
generation, have better access to education, jobs, and higher earnings,
causing them to abandon frugality in favour of increased consumer
expenditure. Consumers are spending more on aspirational categories
including lifestyle products, consumer durables, and jewellery as their
income levels improve. Domestic consumption in India has expanded 3.5
times in the last decade, from INR 31 trillion (USD 0.42 trillion) to INR
110 trillion (USD 0.42 trillion) (USD 1.50 Tn).

4. Changing customer landscape – the rising role of fintech:

Fintech, the fastest-growing industry that serves both consumers and
corporations, has been dubbed the "invention of the decade." When banks
dominated India's financial services business, fintechs carved out their
own niche by focusing on customers from urban and rural areas who were
turned down by banks owing to a lack of credit history or collateral. The
fintech industry has introduced the notion of'sachet packaging' for simple
access to financial products — available anytime, anywhere, and in any
number. With increased client demands, the introduction of e-commerce,
and the widespread use of smartphones the Indian fintech ecosystem has
grown manifold in the last few years.

5. Growth Trends:
a. In comparison to Secured Products, which increased at a CAGR of
17% from 2017 to 2020, Unsecured Products had a 38 percent increase
in loan books.
b. With the rise of consumerism and financial institutions, new loans
were sanctioned at a 39 percent annual growth rate between FY18 and
FY20. Unsecured loans accounted for the majority of the growth, with
a CAGR of 49%.
c. There has been a rise in credit growth to tier 3 and tier 4 markets for
lending. Low-ticket, high-volume lending goods like as two-wheelers,
entry-level vehicles, and inexpensive homes have seen a strong
increase in these markets. Given the skew of the working population,
metros remain the largest lending markets.
d. With a contraction of 7.5 percent in the second quarter of 2020 to 21,
the Indian economy recovered faster than projected. After April 2020,
a V-shaped recovery began, and the current fiscal year is predicted to
be one of high economic growth.
e. Legacy banking systems are preparing the way for technology-driven
new-age lending systems that will provide mass-market tailored
financial products and services.
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f. The rise in rural India's income has resulted in increased demand for Consumer Finance and Credit
micro insurance. Rating

Source : A review of India’s Credit Ecosystem by Experian

1.1.5 Mechanics of Consumer Finance:

As a small company owner, you have a number of payment alternatives to
offer your consumers to make purchasing your products and services more
convenient. The following are by far the most prevalent methods of
payment:
1. Debit cards
2. Cheques
3. Credit Card
4. Cash
5. Online transfer
6. E-wallets etc

Need:
When it comes to unbanked and underbanked clients, many businesses
with high average prices on their products or services face circumstances
where customers put off important purchases due to their financial status.
Many of these consumers simply do not have sufficient credit lines or
funds in their checking accounts to cover the transaction. As a result, these
organisations either lose the customer or develop their own in-house
financing scheme, which can be a risky endeavour if the consumer does
not pay in full on time.

Requirement:
Fortunately, there is a new payment option in the form of consumer
finance that can be used in these circumstances. Consumer financing,
often known as "customer financing" or "retail financing," allows you (the
merchant) to provide customers an affordable monthly payment plan for
financing transactions, with loan approvals occurring in seconds at the
point of sale.

Way of receiving consumer finance:

This niche form of financing, known as consumer retail financing, allows
you as a merchant to instantly provide a way for your customers to finance
their purchase by allowing them to apply for a 6 – 24 month instalment
loan within minutes at checkout to finance the purchase of your products
or services. The merchant is charged an upfront fee and/or a monthly
service fee for this type of financing.

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Innovative Financial Services Platform:
Typically, the platform will create partnerships with a variety of financial
services businesses in order to provide diverse solutions through a single
platform. They might, for example, partner with traditional banks, credit
unions, alternative loan firms, leasing companies, rent-to-own companies,
and others.

Approval:
The customer will fill out one brief application at the point of sale, and the
system will decide the optimal package to recommend based on their risk
profile. Once the "approved" signal is displayed, the specifics are
displayed, allowing the consumer to decide whether or not to join the
programme.

Interest:
Some retail finance platforms allow your business to make money on the
loans provided as well, by marking up the interest rates and costs that are
being provided to your customer.

Loan sanction:
When a consumer accepts a loan option and electronically signs the
papers, they typically receive a receipt, and you are then permitted to
provide the customer with the items or services they require. The sum of
the purchase is deposited into your bank account within 24 to 72 hours.
The financing business will subsequently begin deducting the agreed-upon
payments for the loan transaction from your customer's bank account.

1.1.6 Consumer Credit Scoring:

A credit score is a numerical representation of a consumer's
creditworthiness based on the consumer's credit record, and it measures
the likelihood of the consumer defaulting on a credit obligation.
Consumers' credit scores also influence the marketing offers they get, such
as credit card offers.
Each element that helps forecast who is most likely to repay a debt is
given points in a credit scoring system. A credit score is a total number of
points that helps estimate how creditworthy a customer is, or how likely
he or she is to repay a loan and make payments on time.
The use of scoring models in credit operations is becoming increasingly
prevalent as a result of their multiple advantages:
1. application processing time is reduced, resulting in cheaper
expenses.
2. credit risk assessment that is objective.
3. improved employee productivity
4. Use of adequate financial collateral is a possibility.
5. Keeping tabs on the credit portfolio for any bad debts
134
6. projections and credit methods that are more accurate Consumer Finance and Credit
Rating
Factors influencing credit scoring:
When deciding whether or not to give a loan, many variables are
considered. These include the borrower's attributes (who they are), their
financial status, the amount of the loan requested, the loan's purpose (what
it will be used for), and the type of collateral. Because of the complexity
of these factors, the risk is calculated using both quantitative and
qualitative methods.
The quantitative analysis begins with an assessment of the customer's
financial situation based on their monthly income and expenses. It may
also include a cash flow analysis of the customer's accounts as well as a
review of the customer's credit history. While the qualitative assessment
considers factors such as marital status, education, or work status - for
natural individuals - and legal form, industry in which they operate, or
accounting method - for businesses.
Past customer activities that have a negative impact on credit scores are
also important:
1. late instalment payments and other obligations,
2. overspending on credit cards
3. exceeding credit card limitations, making a massive number of
commitments
4. There isn't any credit history.
Before providing money, the financier should always analyse the
customer's ability to repay. Several measures are used to analyse a
customer's believability and repayment capacity. Consumer credit scoring
systems, often known as credit rating methods, are used to determine a
customer's credit worthiness and repayment potential.
These strategies provide criteria for admitting or rejecting a customer, as
well as determining a customer's creditworthiness. Dunham Greenberg
Formula, Specific Fixed Formula, and Machinery Risk Formula are three
of the most widely utilised techniques. Credit Bureau of Information India
Ltd is India's largest credit rating agency for personal consumer finance
(CBIL)

A. Dunham Greenberg Formula:

This technique is based on the following factors:
i) the customer's employment history,
ii) income level,
iii) financial situation,

135
Innovative Financial Services iv) type of security offered,
v) payment history.
It emphasises the customer's income level and previous records. The
customer's numerous aspects/parameters are assigned points using this
procedure. It is ranked out of a possible 100 points. An applicant with a
credit score of greater than 70 is regarded to have strong credit.

B. Specific Fixed Formula:

Another credit rating formula is this one. It emphasises
i) Age,
ii) Gender,
iii) Residence Stability,
iv) Occupation,
v) Type of Industry,
vi) Employment Stability, and
vii) Customer Assets in determining a customer's credit worthiness.
Each of these criteria has a specific score assigned to it. Borrowers with a
score of more than 3.5 are classified as "great borrowers," while those
with a score of more than 2.5 but less than 3.5 are classified as "marginal
borrowers."

136
 Consumer Finance and Credit
Rating

C. Machinery Risk Formula:

The amount of the down payment, monthly salary, and length of service
are all factors in this strategy. Essentially, this strategy is based on the
customer's current financial situation and projected income earning
capacity. Generally, government departments use this strategy to advance
loans to their personnel. The following formula is used to compute the
loan amount to be approved.
Loan amount = Down payment + (0.124 x monthly income) + (6.45 x
length of service in months)

1.1.7 Case for and against consumer credit:

Consumer loans, in all of their forms, have benefits and drawbacks, and
must be utilised prudently for maximum benefit. Many of us can use credit
to buy a car or a house with a mortgage and financial loans, or to pay for
education or furnishings with a credit card, or even to buy clothes when
we don't have cash but need to extend our wardrobe. Many people profit
from good consumer credit use, yet reckless consumer credit use results in
massive debt and distress.

Case for Consumer Credit:

Flexibility and convenience:
Credit can be used to make online purchases or to avoid carrying
significant quantities of cash when shopping, renting a car, dining out, or
doing other forms of entertainment. Many people's only option in an
emergency, such as when their roof has to be fixed or their car requires a
new gearbox, is to use credit.

Rewards:
Consumers can benefit significantly from utilising credit cards if they are
used responsibly. Many department stores and car dealerships provide
clients with favourable financing options, such as late payments and cheap
interest rates. Credit cards frequently offer cashback, frequent flyer miles,
and reward points to cardholders. These advantages and awards are free

137
Innovative Financial Services money for consumers who resist the impulse to overspend and remove
money from their credit cards each month.
Building credit history: If oneestablishes a good payment history for
consumer credit accounts, such as credit cards and personal loans, and
otherwise manage your credit responsibly, consumer credit can be a useful
tool for improving credit score.
Increasing credit score: Your credit score can be boosted by a track record
of timely payments on credit cards, loans, and other forms of consumer
credit.

Protecting against fraud:

Contactless cards, virtual card numbers, card-locking capabilities, and
little to no cardholder liability for unauthorised purchases are just a few
ways to protect yourself against fraud with credit cards.

Reimbursing certain purchases:

When a consumer is not satisfied with an item bought, but the merchant
won't accept a return, certain credit card companies will refund you for
your purchase.

Case Against Consumer Credit:

Costs of financing: Taking out a loan involves borrowing money that you
don't have. Financing costs, or the fee charged to the consumer for the
privilege of borrowing money, are included in such loans. When a person
makes a payment on a line of credit, finance or interest costs must be paid
first, and the leftover amount of the payment is utilised to cover the whole
amount. Financing charges can swallow up to three-quarters of a payment,
causing the borrower to wait longer for payment. Interest rates are
calculated using the card's annual percentage rate and the borrower's credit
or payment history. The higher your credit score, the more likely you are
to receive a cheaper interest rate.
Debt: Borrowing, unfortunately, encourages people to spend more than
they earn, resulting in debt. The level of a consumer's debt is determined
by his vigilance in using credit and his ability to repay it, which can
quickly grow from hundreds to thousands of dollars.

Temptation:
Since credit cards are so easy to use, they also make it easy to overspend.
Interest charges:
If one buys something and don't pay it off right away, they’ll be
responsible for not only the purchase price but also the interest charges.
To put it another way, if one wants to balance on card, everything he/she
buys will cost a bit more.

138
Fees: Consumer Finance and Credit
Rating
Cash advances may come with costs as well as hefty interest rates.
Furthermore, you could wind up paying more in interest and fees than you
save in discounts or cash back. Make sure the advantages outweigh the
disadvantages.

Monthly review:
One should check bills every month to be sure it accurately reflects
purchases and that there are no indicators of fraudulent usage of cards.
Scammers are particularly interested in credit cards.
Tricky Short-term teaser rates:
A low interest rate may appear to be a wonderful deal, but many people
are surprised to learn that it was only for a limited time. You may end up
paying significantly more in interest than you anticipated if you don't read
the fine print.

11.2 PLASTIC MONEY:

1) Growth of plastic Money Services in India
2) Types of Plastic Cards – Credit Card – Debit Card – Smart Card – Add
– on Cards, Performance of Credit Cards and Debit Cards, Benefits of
credit Cards, Dangers of Debit Cards, Prevention of Frauds and
Misuse, Consumer Protection, Indian Scenario.
3) Smart cards – Features, Types, Security Features and Financial
Applications.

Plastic Money:
1.2.1 Introduction:
Customers of many Indian and international banks now have credit cards.
The issuing bank will have a tie-up with a number of companies that will
honour the credit cards, ranging from 10 to 12 lakh, including hotels,
hospitals, and department stores. Credit cards will be issued by this issuing
bank to persons with a regular monthly income in excess of a certain
amount, creditworthiness as measured by wealth and income, and
corporate executives and their top brass. The bank is willing to take a
chance on that particular cardholder is provided a loan facility with a 30-
45-day repayment period, and there is a risk of default.
Since the early 1980s, commercial banks in India, beginning with
numerous foreign institutions, have been issuing those cards. The usage of
a credit card replaces and replaces the use of cash. It raises the amount of
money on hand and accelerates the velocity of money to the point where
idle money is used to buy goods and services. Because credit cards
provide overdrafts and additional borrowing capability, they can

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Innovative Financial Services supplement the existing money supply while also reducing the use of cash,
which is subject to wear and tear.

1.2.2 Growth of Plastic Money Services in India:

Edward Bellamy proposed the concept of utilising plastic money to make
purchases in 1887. He published a book called "Looking Backward," in
which he portrays his ideal society. He coined the phrase "credit card" in
this work. Since then, technological improvements have allowed this
concept to become a reality.
All of this began with a few rupees saved in his local bank and progressed
to billions of rupee loans raised by syndicate banks and financial
organisations capable of financing projects in any country on the planet.
Nonetheless, these banking majorities were strongly reliant on their retail
base of borrowers and savers. As worldwide competition strengthened in
the late 1970s and early 1980s, almost all bankers began to focus on the
retail market segment.
The debit card was created out of the remains of its older sibling, the
credit card. Plastic money has surged in popularity in recent decades, from
274 million transactions in 1990 to 8.15 billion transactions in 2002,
challenging credit cards as the favoured payment card. As it stands, the
debit card industry has always been a multibillion-dollar engine that drives
bank profits and point-of-sale consumer purchases - but it is also starting
to alter traditional payment options in the corporate and other sectors.
Credit cards are one of the banking products that serve to the needs of the
retail segment, which has experienced a recent increase in its number in
GP. This evolution had been aided greatly by technological advancements,
and it would not have been conceivable without these advancements.
Modern customers and clients can no longer imagine banking without the
use of plastic cards. As a cash substitute, credit and debit cards have
largely replaced cheques. Both provide a higher level of security than cash
and are commonly accepted.
Plastic money's major characteristics of user friendliness and feasibility
have made it popular not only in India but around the world.

 Credit cards usage for travel bookings:

Consumers began to make reservations with credit cards, and it has since
become a lifestyle choice for the majority of city dwellers.

 Electronic transactions grew strongly with the help of Reserve

Bank of India (RBI)
Consumers who had been doing their shopping online for a long time
turned to net banking instead of cash on delivery since it was more
convenient and faster. This included grocery shopping online, particularly
in major cities like Bangalore, Hyderabad, Mumbai, Delhi, Chennai, and
Kolkata.
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 Mobile banking applications become common for all banks Consumer Finance and Credit
Rating
Smart phones have become one of the most popular methods of banking.
To provide customers with a convenient and safe banking experience,
nearly every major bank in the country, whether private or public, has
created mobile applications for all major smartphone operating system
platforms, including Android, iOS, and Windows.

Security
Anyone can make use of money that has been misplaced. If you lose a
credit or debit card, you can phone the 24.7 hotline and report it to the
bank, ensuring that your card is safeguarded from unlawful usage. Various
banks may have different liability policies, so check with your bank to see
if they have any liability waivers.

Popularity:
The popularity of online purchasing has resulted in a higher use of plastic
cards than in past years. The urban population and the greater adoption of
cards by organised shops were the primary drivers. Both grocery and non-
grocery retailing saw significant usage.

Baseline growth
The number of people who have a credit card has increased by 9.8% in the
last year. Alternative payment methods including mobile wallets and
prepaid debit cards accounted for 3% of all digital transactions. In FY15,
the debit card base increased by 40%. However, the number of PoS
terminals increased little. On a year-over-year basis, the number of PoS
terminals increased by only 6%.

Number of transactions
Over the years from 2011 to 2015 debit card transactions have expanded at
a CAGR of 36.5 percent, while credit card transactions have climbed at a
CAGR of 21 percent. Debit cards have grown 30% year over year, while
credit cards have grown 23%. At point-of-sale terminals, debit card
transactions account for 57% of total card transactions.

The Currency of Modern India

The Indian card market is competitive with the world's best. Here are
several indicators to consider. Profitable application: To prevent fraud,
credit cards can be used online with a separate security number.
Profitability has improved as a result. Even school tuition and healthcare
expenditures are increasingly being paid with credit cards.
Players' safety requirements for preventing abuse are among the best in the
world. For example, each transaction over a certain amount is instantly
referred to the issuing bank, which phones the cardholder on their mobile
phone to confirm the purchase in a matter of seconds.

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Innovative Financial Services The product features are also among the greatest in the globe. Almost all
credit cards come with normal perks like free accident insurance, heavily
discounted medical insurance, and more. The cardholder is given the
option of converting a large credit card transaction into a loan with a
cheaper interest rate spread over a longer term.

1.2.3 Types of Plastic cards:

Credit Card:
A credit card is a tiny rectangular piece of plastic or metal issued by
financial institutions that allows you to borrow money from a pre-
approved limit to make purchases. The credit limit is set by the issuing
institution based on your credit score and history. A higher credit score
and a longer credit history will usually result in a greater credit limit.
When you swipe a debit card, the money is removed from your bank
account, however when you swipe a credit card, the money is deducted
from your pre-approved limit.
Users can pay with their credit cards or utilise them for online purchases
by swiping them. To prevent penalty charges, make sure that the borrowed
amount is repaid within the specified time frame when you apply for a
credit card. The card issuer keeps your credit card information safe at all
times. To avoid fraud, you should never give out your credit card
information to anyone.

Types of Credit card:

• Travel credit card:
Flight, bus, and rail tickets, cab bookings, and other travel expenses can all
be reduced with the use of a travel credit card. Every purchase earns you
reward points. These points can be converted to earn air miles, which may
be used to gain discounts on future reservations. With travel credit, you
may also get free access to VIP airport lounges, book discounted tickets,
and more.

Fuel credit card:

Fuel surcharge waivers can help save money on transportation
expenditures when one use a fuel credit card. Purchases of fuels made
with these credit cards might also help earn bonus points. Also significant
fuel savings throughout the course of the year can be made.

Reward credit card:

On particular purchases and transactions, this sort of credit card offers
expedited reward points. You can use the bonus points you earn to get
discounts on future purchases or to pay off your credit card bills on a
monthly basis.

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Shopping credit Card: Consumer Finance and Credit
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Shopping credit cards can be used at linked stores both online and offline
to get discounts on purchases and transactions. Year-round, get cashbacks,
discount coupons, and more.

Secured credit card

Take advantage of a secured credit card to complement your fixed deposit
investment and take advantage of excellent interest rates. This type of
credit card, when used correctly, can help customers improve their credit
scores.

Advantages of Credit Card:

Purchase protection
Credit cards provide additional security in the form of insurance for
purchases made with the card that may be lost, damaged, or stolen. If you
want to file a claim, you can use the credit card statement to vouch for its
validity.

Record of expenses
Each purchase made with a credit card is recorded, and a complete list is
delivered with your monthly credit card statement. This can be used to
track and determine your spending and purchases, which can be helpful
when creating a budget or filing taxes. Lenders also send you fast alerts
every time you swipe your card, letting you know how much credit you
have left as well as how much you owe.

Flexible credit:
Credit cards have an interest-free period, which is a period of time during
which you will not be charged interest on your outstanding credit. If you
pay off the entire balance owing by your credit card bill payment date, you
can get free, short-term credit for 45-60 days. As a result, you can get a
credit advance without having to pay the fees that come with carrying a
balance on your credit card.

Incentives and offers:

Many credit cards come with several offers and incentives to encourage
you for using your card. These could range from cash back to
accumulating rewards points each time you swipe your card, which can
then be redeemed for air miles or used to pay off your outstanding card
balance. Lenders may also give discounts on credit card purchases, such as
aeroplane tickets, vacations, or significant purchases, allowing you to save
money.

EMI facility:
You can choose to put a major purchase on your credit card as a way to
defer payment if you don't want to spend all of your savings on it.
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Innovative Financial Services Furthermore, you have the option of paying for your item in equal
monthly instalments, guaranteeing that you do not pay a large sum for it
and depleting your bank account. Paying through EMI is less expensive
than taking out a personal loan to pay for a large purchase like a television
or a refrigerator.

Building a line of credit

Credit cards give you the ability to build up a credit line. This is critical
because it allows banks to see your active credit history, which is based on
your credit card repayments and usage. Credit card usage is frequently
used by banks and financial institutions to assess a potential loan
applicant's creditworthiness, making your credit card vital for future loans
or rental applications.

Easy access to credit:

The most significant benefit of a credit card is the ease with which it may
be used to obtain credit. Credit cards work on the principle of deferred
payment, which means you can use your card now and pay for your
purchases later. The money used does not leave your account, so you don't
have to worry about depleting your bank account every time you swipe.

Disadvantages of Credit Card:

Credit card fraud:
There's a chance you've been a victim of credit card fraud, though it's not
particularly prevalent. With technological advancements, it is now
possible to clone a card and obtain access to personal information,
allowing another person or entity to make purchases on your card. Check
your statements for any strange purchases and notify your bank right once
if you suspect card fraud. If the fraud is established, banks will normally
waive charges, so you won't have to pay for purchases made by the thief.

High interest rate:

If you do not pay your bills by the due date, the balance will be carried
forward and interest will be applied. This interest accumulates over time
on purchases made after the interest-free period has ended. Credit card
interest rates are relatively high, with an average of 3% each month, or 36
percent per year.

Ease of overuse:
Although your bank balance remains the same with revolving credit, it
may be tempting to charge all of your purchases to your card, leaving you
uninformed of how much you owe. This could lead to you overspending
and owing more than you can repay, starting a debt cycle with high
interest rates on future payments.

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Hidden costs: Consumer Finance and Credit
Rating
Credit cards appear to be simple and uncomplicated at first glance, but
they have a lot of hidden fees that can quickly add up. Late payment costs,
joining fees, renewal fees, and processing fees are just a few of the taxes
and fees that come with credit cards. Missing a card payment can result in
a penalty, and making many late payments can result in your credit limit
being reduced, which can hurt your credit score and future credit
prospects.

Minimum due trap:

The most significant disadvantage of a credit card is the minimum due
amount displayed at the top of a bill statement. Many credit card holders
are misled into believing that the minimum amount is the total amount
owed, when in fact it is the minimum amount that the company expects
you to pay in order to continue receiving credit facilities. As a result,
customers assume their bill is low and spend even more, accruing interest
on their outstanding balance, which can quickly add up to a large and
unmanageable sum.

Debit Card:
If a debit card is used, money is deducted directly from the consumer's
checking account. They are sometimes known as "check cards" or "bank
cards," and can be used to purchase products or services, as well as to
obtain cash from an automated teller machine or a merchant who will
allow you to add an additional amount to a purchase.
A debit card (also known as a bank card or check card) is a type of plastic
payment card that allows the cardholder to access his or her bank
account(s) at a financial institution electronically. Some cards feature a
stored value that can be used to make a payment, although most send a
message to the cardholder's bank to withdraw funds from a payee's
designated bank account. When making purchases, the card can be used
instead of cash where it is accepted. In some circumstances, the primary
account number is assigned solely for usage on the Internet, and no
physical card is issued.

Advantages of Debit Card:

Debit card can be easily obtained:
Most banks provide a free debit card when you open a savings or current
account. Make sure you fill out all of the appropriate paperwork in order
to acquire your debit card.

Free insurance coverage

Debit cardholders are also entitled to free insurance coverage. Bankers
offer such insurance options in order to attract new consumers and retain
existing ones. They offer free insurance to their cardholders in the
following categories:
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Innovative Financial Services a) Insurance for debit card loss,
b) purchase insurance,
c) personal insurance,
d) accident insurance,
e) travel insurance, and so on.
However, depending on the type of debit card used, different types of
insurance are provided at no cost to [Link] who give debit
cards to their customers bear the cost of insurance premiums.

Gifts on redeeming points

As previously stated, a debit card can be used to earn bonus points through
a reward programme. These points can be redeemed by the cardholder at
any merchant website and/or outlet that the bank has already authorised
(within the card's expiration period). While redeeming accrued points, the
cardholder has an understanding of its merit in terms of monetary value,
and then proceeds to claim presents virtually equal to that amount.

Earns Bonus Points:

Nowadays, competition among debit card suppliers (banks) is fierce. Most
banks now provide bonus points to encourage their cardholders
(customers) to use their debit cards to make purchases. Banks can provide
such points to their cardholders since merchants, not banks, manage the
incentive scheme. As a commission, a merchant gives the bank a modest
cut-off or percentage of each successful sale. This commission is then split
or divided by the bank with the original purchase's holder (as a reward).
As a result, it finally assists the cardholder in earning bonus points on
chosen financial transactions made with a debit card.

Easy to Manage:
When going to outstations or overseas, a debit card is incredibly
convenient to carry, handle, and maintain. It readily fits in any pocket
because it is tiny, thin, flat, and light. Even with only two fingers, it is
incredibly easy to manipulate. It is also not difficult to manage. A
cardholder just needs to take the necessary precautions to ensure that:To
avoid damaging the sensitive surface of a debit card, it is usually covered
with a thick plastic cover.
It is not subjected to tainted water or heat.
It is not folded by mistake, which helps to keep it from breaking.
It is carefully put in a handy spot that one recalls.

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Instant Withdrawal of Cash: Consumer Finance and Credit
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The debit card allows for immediate cash withdrawals from any nearby
ATM. This saves the holder the time and effort of going to the bank's
office and waiting in a large line. In other words, it can be used as an
ATM card to meet the cash needs of its owner at any time and in any
location.

Immediate Transfer of Funds:

The quick transfer of funds into the merchant's or dealer's bank account is
ensured by using a debit card. At the time of purchases of goods and
receptions of services, such a transfer of funds occurs almost instantly. Its
use eliminates the need to go to a bank's office and make a manual cash
transfer into the merchant's or dealer's bank account. As a result, it saves
time and provides ease, safety, and comfort to its owner in his or her
financial tasks.

Alternative to Cash :
A debit card is a type of payment that can be used to complete a variety of
cash-related financial transactions. It can be used to make purchases and to
get services. There is no need to carry a huge sum of money when it is
present. As a result, it helps travellers avoid carrying large amounts of
cash and reduces the chance of loss due to theft, damage, and other
factors.
Nominal Fee:
An annual fee is charged by the bank that issues the debit card for the
issuance and maintenance of the card. This is a very small cost to be
charged. The fee is usually charged once a year or once a year by the
bank. The debit cardholder's bank account is automatically debited
(deducted) for such a fee.

Prepaid Card:
A debit card is similar to a prepaid card. It is, because the holder's bank
account already has a significant amount of cash in it. It allows the value
of the transaction (i.e. purchases) to be carried forward to the extent of the
available balance in the holder's bank account.

Disadvantages of Debit Card:

Identity theft:
Debit cards are only safeguarded by a personal identification number
(PIN), which is an encrypted number. This PIN will not keep you safe
from identity theft. Anyone having the card can access the account if the
PIN is known.

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Innovative Financial Services Transaction limit:
In most circumstances, the issuing bank restricts the maximum amount
that a customer can withdraw or transfer. This impedes business
transactions where the volume and value of the amount involved are
significant.

Terminal Dependent
Debit card transactions can only be processed by merchants who have an
electronic terminal. Furthermore, a consumer can only access his or her
account from a location where the issuing bank has an outlet terminal.

Smart Card:
A smart card, also known as a chip card or an integrated circuit card (ICC
or IC card), is a physical electronic identification device that regulates
resource sharing. It's usually a plastic card the size of a credit card with an
integrated circuit (IC) chip embedded in it. To connect to the inner chip,
many smart cards feature a grid of metal contacts. Others are contactless,
while others are a combination of the two. Smart cards can be used for
personal identification, authentication, data storage, and application
processing.
Identification, banking, mobile phones (SIM), public transportation,
computer security, schools, and healthcare are some of the applications.
Smart cards have the potential to provide effective security authentication
for single sign-on (SSO) within businesses. A number of countries have
used smart cards to provide their residents with.

Advantages of a smart card:-

1. More secure:-
Smart cards offer the most security and anonymity of any financial or
transaction card on the market. They employ more secure encryption and
authentication technology than previous payment card systems.

2. Safe to transport:-
Another advantage of having a smart card is its use in the banking
industry. These cards enable the bearer to carry large sums of stolen
money. They are also secure because the cards are easily changeable and
the individual would need to know the pin number to access the store
value.

3. Offer a variety of benefits:

Cards with embedded intelligence Offer retailers, financial institutions,
and other card issuers with a number of benefits such as speedier
transactions, more sales, lower expenses, easier bookkeeping, and fewer
losses.

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4. Time-saving:- Consumer Finance and Credit
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Making a payment using a smart card saves time because its microchip
carries non-encrypted data about the owner and the user does not have to
directly supply information for authentication.

Disadvantages of smart card:-

1. Easily Lost:-

Smart cards are thin and compact, and they can be easily misplaced if the
user is careless. Because smart cards have various functions, their loss
could be quite [Link] would be extremely inconvenienced for
several days if you lost a card that serves as a debit card, transit pass, and
workplace key.

2. Security:-

The disadvantage from using smart cards is the lack of protection they
provide. Swipe cards are less secure than these.
They are not, however, as safe as some members of the public believe.
This gives people a false sense of security, and they may not be as careful
about securing their card and the information it contains.

3. Slow Adoption:

Not every store or restaurant will have the hardware required to utilise
these cards as a payment card. One reason for this is that as technology
becomes more secure, it becomes more expensive to develop and operate.
As a result, some establishments may levy a basic minimum cost for
paying using smart cards rather than cash.
4. Possible Risk of Identify Theft:-
Hardware hacking can cause data on smart cards to be altered or
corrupted. Based on the quantity of information they can contain on an
individual, they are like treasure to crooks seeking a new identity.

Add-on Cards:
Add-on cards, also known as supplemental cards, are cards given to other
cardholders at the request of the primary cardholder, such as a spouse or
child. Even if the Add-On card holder has the same credit limit as the
primary card user, he or she cannot be held legally accountable for credit
card payments. All expenses incurred on an Add-On card are billed to the
principal card [Link] application can be used by the primary
cardholder to apply for Add-On cards online. The user can apply for an
Add-On card by selecting the supplied option. The user can customise the
Add-On card by selecting the name that will be imprinted on it, as well as
the credit and cash limits.

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Innovative Financial Services To apply for an Add-On card:

1. From the Relationship list, select the relation of the person for whom
the Add-On card is required.
2. In the Name on Card field, enter the name of the Add-On card holder.
3. In the Required credit limit field, enter the desired credit limit for the
Add-On card.
4. In the Required cash limit field, enter the desired cash limit for the
Add-On card.
5. In the Delivery Location field, select the appropriate delivery address.
a. If you select the My Address option;
a. From the Select Address list, select the appropriate option.
Based on the option selected, the complete home/ work address of the
user as maintained by the bank is displayed.
b. If you select the Branch Near Me option;
i. From the City list, select the desired city.
ii. From the Branch Near Me list, select the desired branch.

The complete address of selected branch appears.

6. Click Apply .
OR
Click Cancel to cancel the transaction.

7. The Review screen appears. Verify the details, and

click Confirm .
OR
Click Cancel to cancel the transaction.

8. The success message appears, along with the service request

number.

9. Click Go to Dashboard to go to Dashboard.

OR
Click Go To Account Details to go to the accounts page.

1.2.5 Benefits of Credit Card:

Purchase protection
Credit cards provide additional security in the form of insurance for
purchases made with the card that may be lost, damaged, or stolen. If you
want to file a claim, you can use the credit card statement to vouch for its
validity.

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Record of expenses Consumer Finance and Credit
Rating
Each purchase made with a credit card is recorded, and a complete list is
delivered with your monthly credit card statement. This can be used to
track and determine your spending and purchases, which can be helpful
when creating a budget or filing taxes. Lenders also send you fast alerts
every time you swipe your card, letting you know how much credit you
have left as well as how much you owe.
Flexible credit:
Credit cards have an interest-free period, which is a period of time during
which you will not be charged interest on your outstanding credit. If you
pay off the entire balance owing by your credit card bill payment date, you
can get free, short-term credit for 45-60 days. As a result, you can get a
credit advance without having to pay the fees that come with carrying a
balance on your credit card.
Incentives and offers:
Many credit cards come with several offers and incentives to encourage
you for using your card. These could range from cash back to
accumulating rewards points each time you swipe your card, which can
then be redeemed for air miles or used to pay off your outstanding card
balance. Lenders may also give discounts on credit card purchases, such as
aeroplane tickets, vacations, or significant purchases, allowing you to save
money.
EMI facility:
You can choose to put a major purchase on your credit card as a way to
defer payment if you don't want to spend all of your savings on it.
Furthermore, you have the option of paying for your item in equal
monthly instalments, guaranteeing that you do not pay a large sum for it
and depleting your bank account. Paying through EMI is less expensive
than taking out a personal loan to pay for a large purchase like a television
or a refrigerator.
Building a line of credit
Credit cards give you the ability to build up a credit line. This is critical
because it allows banks to see your active credit history, which is based on
your credit card repayments and usage. Credit card usage is frequently
used by banks and financial institutions to assess a potential loan
applicant's creditworthiness, making your credit card vital for future loans
or rental applications.
Easy access to credit:
The most significant benefit of a credit card is the ease with which it may
be used to obtain credit. Credit cards work on the principle of deferred
payment, which means you can use your card now and pay for your
purchases later. The money used does not leave your account, so you don't
have to worry about depleting your bank account every time you swipe.

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Innovative Financial Services 1.2.6 Dangers of Debit Card:
1. Fraud protection:
If a wallet is stolen, the fraud protection on debit card isn't as robust as it is
on a credit card. When using a credit card, the liability for fraudulent
payments is usually limited. With a debit card, you might be held liable
for unauthorised access charges. Furthermore, some banks will hold the
customer entirely responsible if debit card is used fraudulently for pin-
based purchases. Furthermore, if a thief uses credit card, one can refuse
payment while the credit card company investigates the suspected fraud. If
a burglar uses the stolen debit card, they can drain bank account in
moments and then probably wouldn't be able to get your money back until
your bank investigates.
2. Building credit:
A debit card will not benefit you if you do not yet have a credit history or
if you are attempting to restore your credit [Link] the other hand, if you
routinely neglect to make credit card payments, using a debit card may
prevent you from further harming an already blemished credit report.
3. Merchant disputes
If one goes to restaurant for lunch or dinner and deny receipt, and the
waiter does some error in charging you are unaware of the error until you
use your debit card again and it is declined. When you arrive home, you
check with your bank and discover the problem. Obviously, the merchant
would most likely restore your money (preferably with a strong apology),
but it will take several days for the money to be returned to your account.
In the interim, you must contact your bank to get any overdraft fees
reversed.

4. Fees:
If you make the majority of your transactions with a debit card, you must
be especially conscientious about keeping track of your account balance.
Your card may not be denied if you overcharge by a few dollars (or even a
few hundred). The bank may allow your charge to go through but then
charge you up to $34 in overdraft fees. These costs quickly build up to
more than the interest charged by a credit card if you carried a minor
balance from one month to the next. Debit cards have spending limits as
well. Credit cards have spending limits, but that is your credit limit.

1.2.7 Prevention of Frauds and Misuse

1. Prevention of frauds of Debit Card:
a. Use a Secured Network:
Do not perform financial transactions online if you are using your mobile
device or computer in a public area or on an unprotected network.

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b. Protect Your Computer and Mobile Devices: Consumer Finance and Credit
Rating
Install firewall, anti-virus, and anti-spyware software on your computer
and mobile devices, and keep it up to date.

c. Beware of Phishing Scams:

When you check your email or conduct business online, make sure you
know who you're dealing with. A phishing website set up by an identity
thief may look to be from your bank or another company with which you
have an account. In reality, the scammer is seeking to obtain your personal
information, as well as your bank account.

d. Don't Keep All Your Money in One Place:

If your bank account is hacked, you'll need to be able to get cash from
somewhere else to pay for basics and keep up with your bills.

[Link] Old Debit Cards:

Some shredders will handle this for you; otherwise, having an outdated
card around puts your information at risk.

f. Stick to Bank ATM:

Bank ATMs are more secure (with video cameras) than automated teller
machines found in convenience stores, restaurants, and other locations.
[Link]'t Make Purchases With Your Debit Card:
Instead of using a debit card, use a credit card, which provides better fraud
protection.

h. Go Paperless:
You may avoid having your bank account information stolen from your
inbox by opting for paperless bank statements. When you're finished with
your bank statements and debit card receipts, shred them with a paper
shredder to significantly reduce the danger of bank account information
being stolen from your trash.

i. Get Banking Alerts:

You may sign up for banking alerts in order to check your balance and
recent transactions online every day. When certain activity occurs on your
accounts, such as a withdrawal in excess of the amount you select or a
change of address, your bank will notify you through email or text
message.

2. Prevention of frauds of Credit Card:

1. Choosing secured websites for credit cards:
While credit cards are convenient, it is critical that you only use them on
secure websites. The website's address solely utilises 'https' rather than
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Innovative Financial Services 'http'. In addition, the website should display the secured lock in the
bottom right corner or, in some browsers, at the top. Use a website with
strong encryption software. To avoid being taken advantage of, never shop
online using public computers.

2. Signing card:
Another thing to remember is to sign the back of your credit card as soon
as you get it. This will prevent someone else from using your credit card if
it is stolen.

3. Checking credit card statements:

Reviewing credit card statements on a regular basis is another way to keep
credit cards safe. Any unexpected purchases or small-dollar debits could
be a sign of fraud. Furthermore, ensure that credit card bill is received on
time. A late delivery could indicate identity theft, and it should be notified
to the credit card provider as soon as possible.

4. Being careful at an ATM:

At an ATM machine, one must exercise caution. One must ensure there
isn't anything attached to the ATM slot that could be used to steal credit
card information when it is swiped. If onefind anything similar, contact
the bank right once.

5. Keeping an eye at the time of transaction:

If a cashier takes too long to finish a transaction, card may be checked for
information utilising skimming machines. Keeping a tight eye on who is
using your card and ask for returning it as soon as possible.

6. Buying identity theft insurance and card protection plans:

Theft of identity is becoming more common these days. It comprises
taking someone's identity and using it to acquire credit in their name.
Identity theft and false charges insurance has been created by some
insurers, such as Tata AIG. It safeguards you against unauthorised charges
made to your credit card by someone posing as you. ICICI bank, HDFC
bank, and Axis bank offer card protection programmes as well. You'll be
able to block all of your lost cards with a single phone call if you join up
with them. One can also be able to replace any cards that were missing.
There are several membership options to choose from.

1.2.8 Consumer Protection:

The Consumer Protection Bill, 1986 seeks to provide for better protection
of the interests of consumers and for the purpose, to make provision for
the establishment of Consumer councils and other authorities for the
settlement of consumer disputes and for matter connected therewith.

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It seeks, inter alia, to promote and protect the rights of consumers such as- Consumer Finance and Credit
Rating
(a) the right to be protected against marketing of goods which are
hazardous to life and property;
(b) the right to be informed about the quality, quantity, potency, purity,
standard and price of goods to protect the consumer against unfair
trade practices;
(c) the right to be assured, wherever possible, access to an authority of
goods at competitive prices;
(d) the right to be heard and to be assured that consumers interests will
receive due consideration at appropriate forums;
(e) the right to seek redressal against unfair trade practices or
unscrupulous exploitation of consumers; and
(f) right to consumer education.

1.2.9 Indian Scenario:

Debit and credit cards have provided relief to those who have struggled to
withdraw cash through banks and ATMs in the post-demonetisation
[Link] the fact that plastic money has been here for decades, rate
of adoption in India tend to be low.
In March 2016, there were 24.51 million credit cards and 661.8 million
debit cards in India, according to RBI statistics. However, between March
2015 and March 2016, the number of transactions was only 72.22 million
and 112.87 million, respectively.
These figures would, without a doubt, have improved from
demonetisation. However, for those who remain cautious of plastic money
and are hesitant in cheques and demand draft, there are a few additional
options that can be quickly exercised from their cell phones.

E-Wallets
In the absence of cash in the market, e-wallets such as Paytm are growing.
An e-wallet is a mobile application that may be downloaded from the
Internet and installed on a mobile device such as a smartphone.

UPI
The Unified Payment Interface is a key differentiator in Indian banking.
The UPI, which was introduced in 2016, is currently available through
most of the banks.
It was established by the National Payments Corporation of India, which is
backed by the Reserve Bank of India. It enables you to transfer money in
actual time for free utilizing your bank account linked to its net banking
application or any third-party UPI app.

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Innovative Financial Services If you live in a linked, urban location, you can meet the majority of your
transactional needs with plastic money or Internet money. There is a
worldwide movement to digitise the economy by reducing reliance on
paper currency. You can contribute to this gradual transformation by
becoming acquainted with electronic transfers and assisting those around
you in adopting technology. It is safe, secure, and provides numerous
benefits.
Although UPI 2.0 includes numerous improvements that will improve
collection points more convenient and secure during transactions, the
addition of certain new features may increase adoption. Several potential
aspects are depicted below:

Smart Cards:
The smart card is all about converting a tiny rectangular piece of card into
a' smart' piece of card. These cards are extremely comfortable to take in
our wallets or back pockets. This is where the primary benefit of smart
cards may be observed. Banks, stores, educational institutions, and offices,
among others, are using these cards for a variety of transactions. Though
these cards come in a variety of sizes and shapes, they all serve that
purpose: the technology that powers them. Any transaction may now be
made more secure and convenient thanks to smart cards. The technology
employed allows users to save unique personal information. Smart cards
have increased the ease and protection of any transaction. The technology
used allows users to save unique personal information.
A smart card cannot function on its own. To work, it requires a smart card
reader. The card includes an embedded memory chip in the form of a
contact pad. When the touch pad is removed from the card, it no longer
functions as a smart [Link] contact pad in the card reader makes touch
with the reader and performs the processing. As a result, it aids you in
transactions via POS (point of sale) or another [Link] are,
however, two types of cards: contact and contactless. Because of their ease
of use, contactless cards are becoming increasingly popular.

Features :
1) Authentication:
For those that choose to acquire them, these cards provide authentication
techniques that can be used to validate individuals, devices, or applications
that want to use the data on the card chip. This feature can preserve the
cardholder's privacy while also lowering the chance of loss or loss and the
problems that can arise as a result of it.
2) Secure data storage
These cards provide protection for their carrier data and can only be
handled by individuals with suitable access privileges by the smart card
operating system. This is possible by storing personal user data on the card
rather than the central database.

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3) Encryption: Consumer Finance and Credit
Rating
They offer cryptographic services such as key generation, safe key
storage, retail, and digital signing. Which can be used to safeguard one's
privacy. A smart card system, for example, can generate a digital signature
for an e-mail message, allowing e-mail to be validated. This prevents
tampering with the communication and gives the receiver confirmation of
its creation. The fact that the signature key came from a smart card lends
confidence to the site's origin and destination.
4) Strong device security:
Smart cards are difficult to tag because they have a built-in resistance to
tampering. Smart card chips include a variety of hardware and software
features for detecting, interacting with, and assisting in the tampering of
potential attacks.

5) Secure communications:
They act as a barrier between both the card and its user. Smart card
security allows the user to send and collect information in a secure and
private manner.
6) Biometrics:
They propose a dynamic template storage system that can be used to
improve privacy in biometric systems, store dynamic templates, and
conduct biometric matching activities. One of the most notable examples
is the use of smart cards to store fingerprints rather than databases.
7) Personal device:
The smart card is, without a doubt, linked to its holder. Smart-card plastic
is frequently personalised, resulting in an even greater bond with the
cardholder. This attribute can be utilised to increase physical privacy in
the health care system, such as patient data storage and medical care.

Types of Smart Cards

Classification based on mechanism.
Based on the working mechanism of the cards, they are being classified
into three:
 Contact Smart Cards
 Contactless Smart Cards
 Hybrid Cards

1. Contact Smart Cards:

This is the most prevalent type of smart card. ATM cards, major credit
cards, SIM cards, and other similar items come under this group. Cards are

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Innovative Financial Services put into card readers, which read the stored information on the contact pad
and perform transactions as needed.

2. Contactless Smart Cards

These cards, as the name says, do not require a reader. It uses Near Field
Communication technology or radio frequencies to establish wireless
communication between the smart card and the device you wish to use.

3. Hybrid Cards:
Hybrid cards are dual-capacity cards. These cards are compatible with
both contact and contactless card readers. These cards are quite
uncommon in use.

Classification based on configuration

1. Memory cards:
These cards are only used for short periods of time. It only has the ability
to read, write, and save data. The memory capacity of these cards is rather
limited, and they are frequently destroyed after use. Once stored, data on
this type of card cannot be updated or changed.

2. Microprocessors:
Microprocessors function similarly to minicomputers and feature volatile
memory. These are small enough to fit in our [Link] feature a large
amount of memory, allowing you to write, read, rewrite, edit, and change
data as needed.

Security Features:
Smart Cards' self-contained nature makes them immune to assault because
they do not rely on potentially exposed external resources. As a result,
Smart Cards are frequently employed in applications that demand high
security and authentication.
Technology and security are inextricably linked. Crackers develop clever
methods of accessing ostensibly encrypted information on cards => Card
producers must develop more sophisticated locks and keys => Crackers
devise better methods to circumvent these... generating an unending
improvement loop in which both sides drive each other to use and build
better technology.
There are four different aspects of the Smart Card security:
 Communication
 Hardware
 Operating System (OS)
 Software

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Communication with the outside world Consumer Finance and Credit
Rating
Small data packets known as APDUs are used to interact between a Smart
Card and a Card Accepting Device (CAD) (Application Protocol Data
Units). The following qualities of this interaction make it more difficult
for third parties to successfully attack the system:
a) For sending information, a serial bi-directional transmission line (ISO
standard 7816/3),
b) In half duplex mode, at a low bit rate (9600 bits per second), is used
(data only travels in one direction at a time)
c) The communication follows a complex protocol, which is detailed
below.
Every external device that communicates with the card, on the other hand,
makes it more vulnerable to assault via the communication link.

To identify each other, the Smart Card and the CAD employ a mutual
active authentication mechanism. The card creates a random number and
transmits it to the CAD, which encrypts it with a shared encryption key
before returning it to the card. The resulting result is then compared
against the card's own encryption. The operation can then be reversed by
the pair.
Once communication has been established, each message sent and
received between the pair is authenticated with a message authentication
code. This is a combination of data, an encryption key, and a random
number. If the data is changed (for any reason, including transmission
issues), the message must be reissued. The data can also be authenticated
using a digital signature if the chip has enough memory and computing
power.

Hardware Security:
The EEPROM stores all data and passwords on a card and can be deleted
or updated by an odd voltage supply. As a result, certain security
processors include sensors that detect environmental changes. This
technology, however, is not frequently utilised since it is difficult to
establish the proper amount of sensitivity and there is a voltage fluctuation
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Innovative Financial Services when power is delivered to the card. Other successful attacks include
heating the controller to a high temperature or focussing UV light on the
EEPROM, so destroying the security lock. When the card is cut and the
processor is removed, the most damaging physical attacks occur. The
chip's layout can then be reverse engineered.

Operating System Security

Smart Card data is arranged in a tree hierarchy. This has one master file
(MF or root) and multiple elementary files (EF) as well as several
dedicated files (DF). DFs and MFs represent directories, while EFs
represent files, analogous to the structure in any conventional PC
operating system. These two hierarchies differ, however, in that DFs can
also include data. The headers of DF, EF, and MF contain security aspects
similar to user privileges associated with a file/directory in a common
operating system. Any application can navigate the file tree, but it can
only move to a node if it has the necessary permissions.

Software Security:
Software developers also help to Smart Card security by providing
adequately encrypted data and transfers in their products. To assist them in
achieving this aim, hardware-based or operating-system-based instructions
and libraries enabling advanced cryptographic algorithms have been
developed.
Most modern attacks are designated as class 3 attacks, which means that
either the costs of breaking the system are significantly greater than the
cost of the system itself, or the cracker must expend several or hundreds of
years of computer power to break into a single transaction. Technology
advances quicker than cracker approaches. As a result, each new
generation of technology usually protects against threats that the preceding
generation was vulnerable to.

Financial Applications
Banking & Retail
ATM cards, credit cards, and debit cards are some of the most frequent
applications for smart cards. Many of these cards are "chip and PIN"
cards, which need the consumer to provide a four- to six-digit PIN
number, while some are "chip and signature" cards, which just require a
signature for verification.
Fuel cards and public transit/public phone payment cards are two further
financial and retail applications for smart cards. When the chip is filled
with monies, they can also be used as "electronic wallets" or "purses" to
pay for modest items such as groceries, laundry services, cafeteria food,
and taxi rides. Because cryptographic methods safeguard the transaction of
money between the smart card and the machine, there is no need for a
bank link.

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 Consumer Finance and Credit
11.3 CREDIT RATING: Rating
Meaning, Origin, Features, Advantages of Rating , Regulatory
Framework, Credit rating Agencies , Credit Rating Process, Credit Rating
Symbols, Credit Rating Agencies in India, Limitations of Rating

11.3.1 Meaning
A credit rating is a specific credit agency's assessment of an entity's
(government, business, or individual's) ability and desire to meet its
financial obligations completely and on time. A credit rating also indicates
the likelihood of a debtor defaulting. It also represents the credit risk borne
by a debt instrument, whether it is a loan or a bond issuance.
A credit agency assesses a debtor's credit rating by examining the
qualitative and quantitative characteristics of the organisation in question.
Internal information provided by the organisation, such as audited
financial statements and annual reports, as well as external data, such as
analyst reports, published news stories, general industry analysis, and
estimates, may be used to source the information.
A credit agency is not engaged in the transaction and is thus expected to
provide an independent and unbiased evaluation of the credit risk
represented by a specific organisation seeking to raise funds through loans
or bond issuance. At the moment, three major credit rating agencies
dominate 85 percent of the global ratings market: Moody's Investor
Services, Standard and Poor's (S&P), and Fitch Group. To express credit
ratings, each agency use a distinct but strikingly comparable rating style.

Objectives of Credit Rating

Credit rating aims to:
1) Provide great information to investors at a reasonable cost;
2) Establish a solid foundation for optimum risk-return framework;
3) Borrowers should be subjected to appropriate discipline.
4) Contribute to the development of public policy guidelines on
institutional investment.

11.3.2 Origin
In 1841, the first mercantile credit agency was created in New York to
assess merchants' ability to meet their financial obligations; later, it was
taken over by Robert Dunn. This agency produced its first rating guide in
1859. The second agency was founded by John Bradstreet in 1849, which
later merged with the first agency to become Dunn and Bradstreet in 1933,
which eventually became the owner of Moody's Investor Service in 1962.
Moody's has been around since roughly 100 years. These ratings did not
have a substantial impact on the market until 1936, when a new rule
prohibiting banks from utilising Moody's ratings was adopted.
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Innovative Financial Services Investing in speculative bonds or bonds with a poor credit rating to reduce
the danger of default and financial loss This technique was swiftly
replicated by other businesses and financial institutions, and reliance on
credit agencies soon became the standard.
The first Indian CRAs appeared in the late 1980s, with credit Rating
Information Services of India Limited ("CRISIL") being created in 1987.
CRISIL, Fitch Ratings India Private Ltd., Investment Information and
Credit Rating Agency ("ICRA"), Credit Analysis & Research Ltd
("CARE"), Brickwork Rating India Pvt Ltd., Infomerics Valuation and
Rating Pvt Ltd, and SME Rating Agency of India Ltd, ("SMERA") are the
seven CRAs currently registered with SEBI.

Major growth factors of rating in India

The key driver of Credit Rating Agency growth in India is higher average
national income growth of 5.8 percent from 1981 to 1990 and industrial
expansion of 10.5 percent from 1989 to 1990. Following 1991, there was a
general increase in per capita spending capacity in India due to a large
inflow of capital in numerous areas such as the banking sector, industrial
sector, infrastructure sector, insurance industry, and several others. As the
number of body corporates and individual investors increased, so did the
value and volume of total investments.
The country's political instability exacerbated the financial crisis, to the
point where the only way to handle the acute fiscal deposit was to conform
to the dramatic restructuring of the Indian economy advocated by the IMF
and World Bank in exchange for the credit given. Foreign investment in
the domestic market rose as a result of the deregulation, particularly in
underdeveloped sectors such as the corporate bond market. The markets
were exceedingly volatile, with stock exchange turnover increasing from
Rs. 6364 crores in 1984 to Rs. 194000 crores in 1986.
Another reason for the growth of Credit Rating Agency’s is the witnessing
of massive capital market scams such as the Harshad Mehta Scam and the
Ketan Parekh Scam, which led market participants and regulators to
recognise the need for transparency and investor education to mitigate the
risks associated with the market. Regulators implemented criteria for
banks or the general public to obtain a credit rating in order to obtain
credit facilities above a certain threshold, such as the RBI's Basel II
Norms.

11.3.3 Features of Credit Rating

The following are the features of Credit Rating
1. Rating is Based on Information
Any rating based solely on publicly available information has major
limitations, and the success of a rating agency will be heavily reliant on its
ability to gain access to privileged information. Cooperation from the
issues, as well as their willingness to give even sensitive material, are

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critical prerequisites. The rating agency must keep confidential Consumer Finance and Credit
information obtained throughout the rating procedure private. Rating

2. Many Factors Affect Rating:

The rating is not established by a fixed mathematical method. The final
ranking is based on the management quality, corporate strategy, economic
forecast, and international environment. A number of certified
professionals are involved in the rating process to assure uniformity and
reliability.

3. Rating by More than One Agency

Debt issues are frequently rated by more than one agency in well-
developed capital markets. And it is natural for ratings given by two or
more agencies to differ, such as when a debt issuance is rated AA+ by one
agency and AA or AA- by [Link] will be exceptional if one agency
awards an AA rating while another assigns a BBB grade.

4. Monitoring the Already Rated Issues:

A rating is an opinion formed on the basis of available information. Many
factors can have an impact on the issuer's ability to service its debt. As a
result, it is critical that rating agencies closely monitor issues and upgrade
or lower ratings based on the conditions following extensive interaction
with the issuers.

5. Publication of Ratings:
In India, ratings are only conducted at the request of issuers, and only
ratings that are re-accepted by issuers are released. Thus, if a rating is
accepted, it is published, and any later adjustments resulting from the
agency's monitoring will be published, although such changes are not
agreeable to the issuers.
6. Right of Appeal Against Assigned Rating:
If an issuer is dissatisfied with the rating issued, he may seek a review and
provide any additional information deemed [Link] rating agency
will conduct a review and then make its final [Link] the rating
agency ignored important evidence during the initial assessment, the
chances of the rating being revised on appealing are slim.
7. Rating of Rating Agencies

Informed public thought will be the standard against which credit ratings
will be judged, and the success of a rating agency is defined by the quality
of services provided, reliability, and honesty.

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Innovative Financial Services 8. Rating is for Instrument and not for the Issuer Company:
The crucial thing to remember is that ratings are always done for a specific
issue, not for a firm or an [Link] instruments issued by the same
company may have different ratings, especially if their maturities are
significantly different or one of the instruments is backed by additional
credit reinforcements such as guarantees.

9. Credit Rating not Applicable to Equity Shares:

Credit rating is, by definition, an opinion on the issuer's ability to service
debt. Because equity is in the nature of venture financing, there is no pre-
determined service obligation. As a result, credit ratings do not apply to
stock options. Entrepreneur's Obligation to Suppliers, Creditors, and
Depositors.

10. Time Taken in Credit Rating Process

The rating procedure is quite extensive. It entails, among other things,
analysing published financial information, visiting the issuer's offices and
workings, intensive meetings with the issuer's senior managers,
discussions with auditors, bankers, creditors, and so on. It also entails an
in-depth examination of the sector as a whole, as well as some
environmental scanning. All of this takes time; it may take a rating agency
6 to 8 weeks or more to make a conclusion.
11.3.4 Advantages of Credit Rating:

1. Information:

Credit rating information conveys the relative ranking of the default loss
likelihood for a certain fixed-income investment in comparison to other
relevant [Link] credit rating system enables the common
investor to recognise risk perception in relation to debt instruments and
familiarises investors with the risk profile of debt products.

2. Systematic Risk Evaluation:

A systematic risk assessment is required for the efficient deployment of

resources. Credit rating enables the corporate issuer of a financial
instrument to provide every prospective investor with the chance to
conduct a complete risk assessment.
It enables a diverse group of investors to get a meaningful and consistent
judgement about the relative credit quality of the instrument, especially
when they lack the necessary credit rating abilities.

3. Professional Competency:
A credit rating agency that possesses the necessary abilities, abilities, and
authority provides a professional service that allows for the use of well-
researched and scientifically assessed opinions regarding the relative
ranking of various debt instruments based on their credit quality.
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 Consumer Finance and Credit
Rating
4. Easy to Understand:

Credit ratings are symbolic and thus simple to comprehend. The rating
attempts to establish a correlation between risk and [Link] use
the rating to analyse the overall risk of the product by comparing the
provided rate of interest to the rate of return (for the specific degree of
risk), with the goal of selecting the risk-return preferences.

5. Low Cost:
A professional credit agency's credit rating is important not just for
individuals/small investors, but also for organised institutional [Link]
serves as a low-cost addition to the house appraisal [Link] serves as a
low-cost addition to the house appraisal system.

6. Efficient Portfolio Management:

Large investors can utilise credit ratings to diversify their portfolios by
selecting appropriate instruments from a wide range of investment
[Link] investors could make use of the information offered by
rating agencies by closely monitoring upgrades and downgrades and
adjusting their portfolio mix through secondary market trading.

7. Index of Faith:
Credit rating serves as an ideal indicator of the market's confidence in the
[Link] will eventually serve as a guide for investing selections.

8. Wider Investor Base:

When compared to unrated securities, credit ratings have a larger investor
base. Rating provides a broad group of investors with specific capabilities
for analysing every investment opportunity and assisting them in making
well-informed decisions about their investment.

9. Benchmark:
A credit rating agency's view is widely trusted by investors. This could
allow issuers of highly rated products to enter the market even in difficult
market situations. Furthermore, a credit rating serves as a foundation for
estimating the additional return (above and beyond a risk-free return) that
investors seek as compensation for the increased risk they bear. When
compared to unrated securities, credit ratings have a larger investor base.
10. Effective Monitoring:
Ratings could be used as input by stock market intermediates such as
brokers and dealer to manage their risk exposure.

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Innovative Financial Services 11.3.5 Regulatory Framework:

The Securities Exchange Board of India SEBI regulates CRAs in

India. Through the SEBI (Credit Rating Agencies) Regulations, 1999
('CRA Regulations,' SEBI was one of the first regulators in the world to
provide a complete framework for the regulation of CRAs.

The CRA Regulations cover the following areas-

1. Registration: In general, the CRA Regulations require that CRAs be

companies sponsored by people with credit rating experience, such as
financial institutions or individuals with a net worth of more than 100
crore rupees. To carry out the operation of generating credit ratings,
CRAs must have a minimum net value of 5 crore rupees, as well as
suitable facilities, professionals, and personnel. Furthermore,
registration would be granted only if the applicant's registration is in
the best interests of investors and the securities market.

2. Obligations: The CRA Regulations require CRAs to carry out their

duties in line with the agreement of their involvement with the
issuer, as well as the Regulations' baseline principles. CRAs must
follow SEBI's Code of Conduct, which requires them to carry out their
duties with honesty, ’s professionalism, independence, and secrecy.
Furthermore, CRAs are obligated to monitor their rating throughout
the life of the securities evaluated and to conduct periodic assessments
of their rating.

3. Disclosure: According to the CRA Regulations, CRAs must keep and

disclose their ratings in a specific manner. They require CRAs to keep
a copy of their ratings notes, ratings issued, terms of engagement,
records of rating committee decisions, and fees charged for ratings for
at least five years.

4. Conflicts of interest: The Regulations make an initiatives to minimize

potential conflicts. They provide that CRAs may not rate securities by
themselves promoter or [Link], CRAs must maintain an
arm's length link between credit rating and other activities.\

5. Accountability and Enforcement: The Regulations require CRAs to

conduct an internal audit, transmit information to SEBI as needed,43
and be open to inspection and inquiry by SEBI. 44 They further state
that CRAs may be held accountable for any violation of the SEBI Act
or any of the Rules or Regulations enacted under it. They may also be
held responsible under Chapter V of the Securities and Exchange
Board of India (Intermediaries) Regulations, 2008.

Until 2008, there were no significant modifications to the regulatory

framework for CRAs. However, following the global financial crisis, in
which CRAs were deemed complicit, a 'Committee on Comprehensive
Regulation for Credit Rating Agencies' was formed to review the
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regulatory system. The Committee stated that "at first glance, there Consumer Finance and Credit
appears to be no immediate cause for worry concerning the operations and Rating
activities of CRAs in India, even in light of the recent financial crisis."
However, existing rules must be strengthened by drawing relevant lessons
from the current crisis." Following that, SEBI made various adjustments to
the regulatory framework for CRAs.

SEBI published circulars revising its regulatory framework in 2010,

recognising the critical role of CRAs in financial markets and the need of
CRA transparency. SEBI published circulars outlining the standards for
CRA internal audits and requiring CRAs to provide greater disclosures.
SEBI mandated CRAs to provide default matrices of securities and to keep
explanatory notes for each rating or surveillance they performed.

So far, SEBI has exclusively controlled the rating of debt instruments.

CRAs, on the other hand, evaluated a wide range of products, including
bank loans, overdraft facilities, and letters of credit. All of these rating
operations went unchecked. However, SEBI issued a circular in 2012
stating that CRAs would "follow the applicable requirements pertaining to
rating process and procedures and its records, accountability and disclose,
evasion of potential conflicts of interest, code of conduct, and so on, as
recommended in the Regulations and circulars issued by SEBI from time
to time" for rating of other instruments as well.

SEBI released a circular in 2016 outlining instructions for improving CRA

standards and increasing openness in their operations. This circular
mandates CRAs to publicly publish their rating criteria and rating
processes, to standardise press releases for rating actions, to report rating
both in cases of non-acceptance and non-cooperation by issuers, and to
disclose a delay in rating Ratings are reviewed on a regular basis.
Furthermore, the circular mandates CRAs to hold rating analysts
accountable and to improve the functioning and evaluation of rating
committees.

Despite ongoing development of the regulatory environment in India,

several worries about CRA regulation remain. These will be discussed in
the following chapter.

11.3.5 Credit Rating Agencies:

Credit Rating Agencies in India
Credit Rating Agencies (CRA) evaluate the creditworthiness of businesses
and other entities. In layman's terms, these agencies assess a debtor's
ability to repay the loan as well as their credit risk. SEBI (Credit Rating
Agencies) Regulations, 1999 of the Securities and Exchange Board of
India Act, 1992 govern all credit rating agencies in India. CRISIL, CARE,
ICRA, SMREA, Brickwork Rating, India Rating and Research Pvt. Ltd,
and Infomerics Valuation and Rating Private Limited are the seven credit
agencies in India.

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Innovative Financial Services How Credit Rating Agencies Work
Ratings are assigned to organisations or entities by credit rating agencies.
Companies, state governments, non-profit organisations, countries,
securities, special purpose entities, and local governmental bodies are
among the entities rated by credit rating agencies. Before assessing an
entity's credit, credit rating companies analyse numerous variables such as
its financial statements, level and kind of debt, lending and borrowing
history, ability to repay the loan, and past debts. Once a credit rating
agency rates the entities, it offers further information to the investor, who
then analyses and makes an informed investment decision. A low credit
rating suggests that the entity is likely to default. The credit ratings
assigned to entities serve as a standard for financial market regulations.
Credit ratings are issued by organisations such as Moody's Investors
Service and Standard and Poor's (S&P) based on extensive research.

Some of the Top Credit Rating Agencies in India are:

[Link] Rating Information Services of India Limited (CRISIL)
CRISIL is one of India's oldest credit rating firms. It was first introduced
in the country in 1987, and the company went public in 1993. CRISIL,
headquartered in Mumbai, began grading infrastructure in 2016 and
celebrated its 30th anniversary in 2017. In 2017, CRISIL purchased an 8.9
percent share in the CARE credit rating agency. In 2018, it created India's
first index to benchmark the performance of foreign portfolio investors'
(FPI) fixed-income assets in the rupee and dollar markets. The portfolio of
the organisation comprises mutual fund rankings, ULIP rankings, CRISIL
coalition index, and so on.

2. ICRA Limited
ICRA Limited is a public limited corporation based in Gurugram that was
founded in 1991. Previously, the organisation was known as Investment
Information and Credit Rating Agency of India Limited. ICRA was a joint
venture between Moody's and many Indian financial and banking service
organisations before going public in April 2007. Currently, the ICRA
Group includes four subsidiaries: Consulting and Analytics, Data Services
and KPO, ICRA Lanka, and ICRA Nepal. Moody's Investors Service, the
multinational credit rating agency, is currently ICRA's largest stakeholder.
Corporate debt, financial rating, structured finance, infrastructure,
insurance, mutual funds, project and public finance, SME, market linked
debentures, and other products are all part of ICRA's product offering.

3. Credit Analysis and Research limited (CARE)

CARE, which was founded in 1993, provides credit ratings in areas such
as corporate governance, debt ratings, financial sector, bank loan ratings,
issuer ratings, recovery ratings, and infrastructure ratings. CARE,
headquartered in Mumbai, provides two types of bank loan ratings: long-
term debt instruments and short-term debt instruments. The organisation
also provides ratings for Initial Public Offerings (IPOs), real estate,
168
renewable energy service companies (RESCO), financial assessments of Consumer Finance and Credit
shipyards, Energy service companies (ESCO), and numerous educational Rating
institution courses. CARE Ratings has recently expanded its services to
include valuation of stock, debt instruments, and market related
debentures. Furthermore, the company has formed a new worldwide credit
rating agency called ARC Ratings in collaboration with four partners from
South Africa, Brazil, Portugal, and Malaysia. ARC Ratings has begun
operations and has completed sovereign ratings of countries such as India.

4. Brickwork Ratings (BWR):

Canara Bank promotes Brickwork Rating, which was founded in 2007. It
provides ratings for bank loans, small and medium-sized enterprises
(SMEs), corporate governance ratings, municipal corporations, capital
market instruments, and financial institutions. It also evaluates NGOs,
tourism, IPOs, real estate investments, hospitals, IREDA, educational
institutions, MFI, and MNRE. Brickwork Ratings has been designated by
the Reserve Bank of India (RBI) as an external credit assessment agency
(ECAI) to conduct credit ratings in India.

5. India Rating and Research Pvt. Ltd:

Fitch Group's wholly owned subsidiary in India is India Ratings. It
provides credit ratings to insurance companies, banks, corporate issuers,
project finance, financial institutions, finance and leasing firms, managed
funds, and municipal governments. The company is also recognised by the
Reserve Bank of India and the National Housing Bank, in addition to
SEBI.

6. Acuite Ratings & Research Limited:

Acuité Ratings & Research Limited is a full-service credit rating firm that
is registered with the Securities and Exchange Board of India (SEBI). In
2012, the company was accredited by the RBI as an External Credit
Assessment Institution (ECAI) for Bank Loan Ratings under BASEL-II
guidelines. Since then, it has assigned over 8,300 credit ratings to various
securities, debt instruments, and bank facilities of companies from all over
the country and across all industries. It is registered and has its
headquarters in BKC, Mumbai.

7. Infomerics Valuation and Rating Private Limited:

Infomerics Valuation and Rating Private Limited, an RBI-accredited and
SEBI-registered credit agency, was founded by top financial professionals
and is now led by Mr. Vipin Mallik. The credit bureau attempts to provide
unbiased and extensive credit worthiness analysis and evaluation to
NBFCs, banks, corporations, and small and medium-sized businesses.
They determine an organization's creditworthiness through their rating and
grading system. Infomerics aids in the reduction of information
asymmetry between investors and lenders. Keeping transparency as a core
objective, the credit bureau ensures that all of their clients receive full and
accurate reports and data.
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Innovative Financial Services

11.3.6 Credit Rating Process:

1. Issuing formal request:

The credit rating process begins when the issuer (the person or entity
seeking a credit rating) submits a formal credit rating request to credit
rating agencies. Specifically, CRISIL. When a credit rating agency
approves the application. The issuer company and the rating agency reach
an agreement.
The following are the terms of the agreement:
1. It requires the CRA (Credit Rating Agency) to maintain the
confidentiality of the Company's information.
2. The issuer company has the option to accept or reject the rating.
3. The issuer company must provide accurate material and information to
the CRA in order for it to be rated.
2. Assigning Analytical Team:
In the second step, the Credit Rating Agency (CRA) assigns the job and
responsibilities of credit rating to an analytical team. The analytical team
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is in charge of project and assignment evaluation. The team is typically Consumer Finance and Credit
made up of two members/analysts with relevant business experience. Rating

3. Obtaining Financial Information

The analytical team will gather all of the necessary information from the
client or issuer company in this case. The analytical team gives the issuer
firm with a list of the required information as well as strategies for
negotiations.

The analytical team examines information pertaining to the company's

financial statements, cash flow estimates, and other pertinent data.

4. Research and Meeting with management:

To obtain a deeper understanding of the client's operations, the analytical
team visits the company's plant or factory and speaks with executives.
This includes recognising and documenting the major elements that
determine production level, quality, and cost.

Direct meetings with the issuing firm's management are maintained since
this enables the CRA (Credit Rating Agency) to incorporate or disclose
non-public material in a rating determination and permits the rating to be
forward-looking.

5. Discussion Meeting
When all of the study is completed, the team will meet with an internal
committee comprised of top analysts from credit rating agencies to analyse
the findings in depth. All of the issues affecting the company have been
identified. An opinion about the ranking is created as well. The team's
analysis results are finally delivered to the rating committee's senior
authority.

5. Final Rating Meeting:

This is the final authority meeting for assigning ratings, and the analytical
team's job concludes. The only phase in which the issuer does not
participate directly is the rating committee [Link], the final
authority will scrutinise facts, findings, and factors such as political,
social, and other considerations. The credit rating agency will assign the
actual Credit Rating after considering all of the results, facts, and other
information.

6. Informing Assigned Rating:

After assigning the rating grade, CRA will notify the issuer company of
the rating as well as the reasons for the credit rating. The issuer
corporation can now accept, refuse, or give additional information to be
reviewed again. The credit rating rejected by the issuer corporation should
be kept private and not made public.

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Innovative Financial Services 7. Announcing to the Public:
Once the issuer accepts the rating, credit rating organisations distribute
ratings to the public via printed reports, newspapers, and other media.

8. Monitoring the company:

Once the company has opted to accept the rating, CRAs are required to
monitor the accepted ratings for the duration of the instrument or
according to the time specified in the contract. The CRA must regularly
examine all ratings in light of new political, economic, and financial
developments, as well as industry trends.
All of this data is evaluated on a regular basis to identify significant
changes. If a credit rating changes, the CRA will make the modified rating
public via media and printed publications.

11.3.7 Credit Rating Symbols in India

The ratings scale in India is divided into ratings for :
1) Long term debt instruments.
2) Short term debt instruments
3) Long term structured finance instruments
4) Short term structured finance instruments
5) Credit Ratings - Fixed Deposit Scale
6) Credit Ratings - Corporate Credit Scale

Rating symbols should have CRA’s first name as prefix. Like in the
below table:
1) Long term debt instruments:
1) AAA :Instruments with this rating are considered to have the highest
level of safety in terms of timely payment of financial obligations. These
instruments have the lowest credit risk.
2) AA: Instruments having this rating are considered to offer a adequate
level of safety in terms of prompt servicing of financial obligations. These
instruments have a very low credit risk.
3) A: Instruments with this rating are considered to offer a moderate level
of safety in terms of timely servicing of financial obligations. These
instruments have a low credit risk.
4) BBB: Instruments with this rating are considered to have moderate risk
of default regarding timely servicing of financial obligations.

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5) B : Instruments with this rating are considered to have high risk of Consumer Finance and Credit
default regarding timely servicing of financial obligations. Rating

6) C: Instruments with this rating are considered to have very high risk of
default regarding timely servicing of financial obligations.
7) D: Instruments with this rating are in default or are expected to be in
default soon.
(“+”)may apply '+' (plus) or '-' (minus) signs for ratings from ‘AA' to 'C' to
reflect comparative standing within the category.
b) Short term Debt Instruments:
1) A1: Instruments with this rating are considered to have very strong
degree of safety regarding timely payment of financial obligations. Such
instruments carry lowest credit risk.
2) A2: Instruments with this rating are considered to have strong degree of
safety regarding timely payment of financial obligations. Such instruments
carry low credit risk.
3) A3: Instruments with this rating are considered to have moderate degree
of safety regarding timely payment of financial obligations. Such
instruments carry higher credit risk as compared to instruments rated in
the two higher categories.
4) A4: Instruments with this rating are considered to have minimal degree
of safety regarding timely payment of financial obligations. Such
instruments carry very high credit risk and are susceptible to default.
5) D: Instruments with this rating are in default or expected to be in
default on maturity.
'+' (plus) sign for ratings from 'A1' to 'A4' to reflect comparative standing
within the category.
C) Long term structured Finance Instruments:
1) AAA (SO) - Instruments with this rating are considered to have the
highest degree of safety regarding timely servicing of financial
obligations. Such instruments carry lowest credit risk.
2) AA (SO)- Instruments with this rating are considered to have high
degree of safety regarding timely servicing of financial obligations. Such
instruments carry very low credit risk.
3) A (SO) - Instruments with this rating are considered to have adequate
degree of safety regarding timely servicing of financial obligations. Such
instruments carry low credit risk.
4) BBB (SO) - Instruments with this rating are considered to have
moderate degree of safety regarding timely servicing of financial
obligations. Such instruments carry moderate credit risk.
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Innovative Financial Services 5) BB (SO) - Instruments with this rating are considered to have moderate
risk of default regarding timely servicing of financial obligations.
6) B (SO) - Instruments with this rating are considered to have high risk of
default regarding timely servicing of financial obligations.
7) C (SO) - Instruments with this rating are considered to have very high
likelihood of default regarding timely payment of financial obligations.
8) D (SO)- Instruments with this rating are in default or are expected to be
in default soon.
* '+' (plus) or '-' (minus) signs for ratings from 'AA' to ‘C’.
D) Credit Ratings - Short Term Structured Finance Scale
1) A1(SO) - Instruments with this rating are considered to have very
strong degree of safety regarding timely payment of financial obligation.
Such instruments carry the lowest credit risk.
2) A2(SO) - Instruments with this rating are considered to have strong
degree of safety regarding timely payment of financial obligation. Such
instruments carry low credit risk.
3) A3(SO) - Instruments with this rating are considered to have moderate
degree of safety regarding timely payment of financial obligation. Such
instruments carry higher credit risk as compared to instruments rated in
the two higher categories.
4) A4(SO) - Instruments with this rating are considered to have minimal
degree of safety regarding timely payment of financial obligation. Such
instruments carry very high credit risk and are susceptible to default.
5) D(SO) - Instruments with this rating are in default or expected to be in
default on maturity.
* '+' (plus) sign for ratings from 'A1(SO)' to 'A4 (SO)' to reflect
comparative standing within the category.
E) Credit Ratings - Long Term Credit Enhancement (CE)
1) AAA(CE) - Instruments with this rating are considered to have the
highest degree of safety regarding timely servicing of financial
obligations. Such instruments carry lowest credit risk.
2) AA(CE) - Instruments with this rating are considered to have high
degree of safety regarding timely servicing of financial obligations. Such
instruments carry very low credit risk.
3) A(CE) - Instruments with this rating are considered to have adequate
degree of safety regarding timely servicing of financial obligations. Such
instruments carry low credit risk.

174
4) BBB(CE) - Instruments with this rating are considered to have Consumer Finance and Credit
moderate degree of safety regarding timely servicing of financial Rating
obligations. Such instruments carry moderate credit risk.
5) BB(CE) - Instruments with this rating are considered to have moderate
risk of default regarding timely servicing of financial obligations.
6) B(CE) - Instruments with this rating are considered to have high risk of
default regarding timely servicing of financial obligations.
7) C(CE) - Instruments with this rating are considered to have very high
likelihood of default regarding timely payment of financial obligations.
8) D(CE) - Instruments with this rating are in default or are expected to be
in default soon.
*Modifiers {“+” (plus) or “-“ (minus)} will be used with the rating
symbols for the categories AA (CE) to C (CE). The modifiers reflect the
comparative standing within the category.
F) Credit Ratings - Short Term Credit Enhancement (CE)
1)A1(CE) - Instruments with this rating are considered to have very strong
degree of safety regarding timely payment of financial obligation. Such
instruments carry the lowest credit risk.
2) A2(CE) - Instruments with this rating are considered to have strong
degree of safety regarding timely payment of financial obligation. Such
instruments carry low credit risk.
3) A3(CE) -Instruments with this rating are considered to have moderate
degree of safety regarding timely payment of financial obligation. Such
instruments carry higher credit risk as compared to instruments rated in
the two higher categories.
4) A4(CE) - Instruments with this rating are considered to have minimal
degree of safety regarding timely payment of financial obligation. Such
instruments carry very high credit risk and are susceptible to default.
5) D(CE) - Instruments with this rating are in default or expected to be in
default on maturity.
*Modifier {“+” (plus)} will be used with the rating symbols for the
categories A1 (CE) to A4 (CE). The modifier reflects the comparative
standing within the category.
G) Credit Ratings - Fixed Deposit Scale
1) FAAA ("F Triple A") Highest Safety: This rating indicates that the
degree of safety regarding timely payment of interest and principal is very
strong.

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Innovative Financial Services 2) FAA ("F Double A") High Safety : This rating indicates that the degree
of safety regarding timely payment of interest and principal is strong.
However, the relative degree of safety is not as high as for fixed deposits
with 'FAAA' ratings.
3) FA Adequate Safety: This rating indicates that the degree of safety
regarding timely payment of interest and principal is satisfactory. Changes
in circumstances can affect such issues more than those in the higher rated
categories.
4)FB Inadequate Safety: This rating indicates inadequate safety of timely
payment of interest and principal. Such issues are less susceptible to
default than fixed deposits rated below this category, but the uncertainties
that the issuer faces could lead to inadequate capacity to make timely
interest and principal payments.
5) FC High Risk: This rating indicates that the degree of safety regarding
timely payment of interest and principal is doubtful. Such issues have
factors present that make them vulnerable to default; adverse business or
economic conditions would lead to lack of ability or willingness to pay
interest or principal.
6) FD Default: This rating indicates that the fixed deposits are either in
default or are expected to be in default upon maturity.
7) NM Not Meaningful:Instruments rated 'NM' have factors present in
them, which render the outstanding rating meaningless. These include
reorganisation or liquidation of ,the issuer, and the obligation being under
dispute in a court of law or before a statutory authority.
‘+' (plus) or '-' (minus) signs for ratings from FAA to FC to indicate the
relative position within the rating category

Credit Ratings - Corporate Credit Scale

1) CCR AAA ("CCR Triple A") : A 'CCR AAA' rating indicates Highest
degree of strength with regard to honoring debt obligations.
2) CCR AA("CCR Double A") : A 'CCR AA' rating indicates High degree
of strength with regard to honoring debt obligations.
3) CCR A: A 'CCR A' rating indicates Adequate degree of strength with
regard to honoring debt obligations.
4) CCR BBB: A 'CCR BBB' rating indicates Moderate degree of strength
with regard to honoring debt obligations
5) CCR BB: A 'CCR BB' rating indicates Inadequate degree of strength
with regard to honoring debt obligations.
6) CCR B: A 'CCR B' rating indicates High Risk and greater susceptibility
with regard to honoring debt obligations.

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7) CCR C : A 'CCR C' rating indicates Substantial Risk with regard to Consumer Finance and Credit
honoring debt obligations. Rating

8)CCR D: A 'CCR D' rating indicates that the entity is in Default of some
or all of its debt obligations.
9) CCR SD: A 'CCR SD' rating indicates that the entity has Selectively
Defaulted on a specific issue or class of debt obligations, but will continue
to meet its payment obligations on other issues or classes of debt
obligations.
'+' (plus) or '-' (minus) modifiers for ratings from 'CCR AA' to 'CCR C' to
reflect comparative standing within the category.

113.8 Credit Rating Agencies in India

[Link] Rating Information Services of India Limited (CRISIL)
CRISIL is one of India's oldest credit rating firms. It was first introduced
in the country in 1987, and the company went public in 1993. CRISIL,
headquartered in Mumbai, began grading infrastructure in 2016 and
celebrated its 30th anniversary in 2017. In 2017, CRISIL purchased an 8.9
percent share in the CARE credit rating agency. In 2018, it created India's
first index to benchmark the performance of foreign portfolio investors'
(FPI) fixed-income assets in the rupee and dollar markets. The portfolio of
the organisation comprises mutual fund rankings, ULIP rankings, CRISIL
coalition index, and so on.

2. ICRA Limited
ICRA Limited is a public limited corporation based in Gurugram that was
founded in 1991. Previously, the organisation was known as Investment
Information and Credit Rating Agency of India Limited. ICRA was a joint
venture between Moody's and many Indian financial and banking service
organisations before going public in April 2007. Currently, the ICRA
Group includes four subsidiaries: Consulting and Analytics, Data Services
and KPO, ICRA Lanka, and ICRA Nepal. Moody's Investors Service, the
multinational credit rating agency, is currently ICRA's largest stakeholder.
Corporate debt, financial rating, structured finance, infrastructure,
insurance, mutual funds, project and public finance, SME, market linked
debentures, and other products are all part of ICRA's product offering.

3. Credit Analysis and Research limited (CARE)

CARE, which was founded in 1993, provides credit ratings in areas such
as corporate governance, debt ratings, financial sector, bank loan ratings,
issuer ratings, recovery ratings, and infrastructure ratings. CARE,
headquartered in Mumbai, provides two types of bank loan ratings: long-
term debt instruments and short-term debt instruments. The organisation
also provides ratings for Initial Public Offerings (IPOs), real estate,
renewable energy service companies (RESCO), financial assessments of
shipyards, Energy service companies (ESCO), and numerous educational
institution courses. CARE Ratings has recently expanded its services to
177
Innovative Financial Services include valuation of stock, debt instruments, and market related
debentures. Furthermore, the company has formed a new worldwide credit
rating agency called ARC Ratings in collaboration with four partners from
South Africa, Brazil, Portugal, and Malaysia. ARC Ratings has begun
operations and has completed sovereign ratings of countries such as India.

[Link] Ratings (BWR):

Canara Bank promotes Brickwork Rating, which was founded in 2007. It
provides ratings for bank loans, small and medium-sized enterprises
(SMEs), corporate governance ratings, municipal corporations, capital
market instruments, and financial institutions. It also evaluates NGOs,
tourism, IPOs, real estate investments, hospitals, IREDA, educational
institutions, MFI, and MNRE. Brickwork Ratings has been designated by
the Reserve Bank of India (RBI) as an external credit assessment agency
(ECAI) to conduct credit ratings in India.

5. India Rating and Research Pvt. Ltd:

Fitch Group's wholly owned subsidiary in India is India Ratings. It
provides credit ratings to insurance companies, banks, corporate issuers,
project finance, financial institutions, finance and leasing firms, managed
funds, and municipal governments. The company is also recognised by the
Reserve Bank of India and the National Housing Bank, in addition to
SEBI.

6. Acuite Ratings & Research Limited:

Acuité Ratings & Research Limited is a full-service credit rating firm that
is registered with the Securities and Exchange Board of India (SEBI). In
2012, the company was accredited by the RBI as an External Credit
Assessment Institution (ECAI) for Bank Loan Ratings under BASEL-II
guidelines. Since then, it has assigned over 8,300 credit ratings to various
securities, debt instruments, and bank facilities of companies from all over
the country and across all industries. It is registered and has its
headquarters in BKC, Mumbai.

[Link] Valuation and Rating Private Limited:

Infomerics Valuation and Rating Private Limited, an RBI-accredited and
SEBI-registered credit agency, was founded by top financial professionals
and is now led by Mr. Vipin Mallik. The credit bureau attempts to provide
unbiased and extensive credit worthiness analysis and evaluation to
NBFCs, banks, corporations, and small and medium-sized businesses.
They determine an organization's creditworthiness through their rating and
grading system. Infomerics aids in the reduction of information
asymmetry between investors and lenders. Keeping transparency as a core
objective, the credit bureau ensures that all of their clients receive full and
accurate reports and data.

178
11.3.9 Limitations of Credit Rating: Consumer Finance and Credit
Rating
1) Biased rating and misrepresentation:
Credit rating is a burden for the capital market business in the absence of
quality rating. To avoid a biassed rating, a rating agency expert doing a
detailed analysis of a firm should have no ties to the company or any of its
stakeholders, so that their assessment is impartial and prudent in its
recommendation to the rating committee.

2) Static study:
The rating is based on the company's current and historical data, and it is a
static analysis. Predicting the health of a firm through rating is imprecise,
and anything can happen after the assignment of rating symbols to the
company. Reliance on the rating for future results defeats the many
purposes of the risk indicator of the rating.

3) Concealment of material information:

Rating companies may withhold key facts from the credit rating
company's investigation team; in such circumstances, the rating's quality
suffers and the rating becomes unreliable.

4) Rating is no guarantee for soundness of the company:

Ratings are done for a specific instrument to measure credit risk, but they
should not be viewed as a certification of the company's or management's
matching quality.

5) Human bias:
The findings of the investigation team may be influenced by human
prejudice due to unavoidable personal weaknesses on the part of the
employees, which could affect the rating.
6) Down grade:
Once a firm has been rated, if it fails to maintain its working results and
performance, the credit rating agency will evaluate the grade or decrease
the rating, harming the company's reputation.

7) Validity of rating:
The rating's validity expires when a debt instrument matures, and it no
longer benefits the issuing company because the rating is only valid for the
duration of the debt instrument being rated.

8) Difference in rating of two agencies:

In many circumstances, the ratings assigned by two different credit rating
agencies to the same instrument by the same issuing company will not be
equal. Such discrepancies are likely to arise as a result of value judgement
disparities in the qualitative element of the analysis between two rating
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Innovative Financial Services agencies, despite the fact that the quantitative analysis may be the same
and identical.

Q1 Fill in the blanks

1) ________________ is a type of lending that provides credit to a
customer for personal or domestic use.

2) The interest rate on a fixed rate loan does not ______________

3) A _____________ is a numerical representation of a consumer's

creditworthiness based on the consumer's credit record, and it
measures the likelihood of the consumer defaulting on a credit
obligation.

4) Edward Bellamy proposed the concept of utilising

________________ to make purchases in 1887.

5) In the absence of cash in the market, ____________ such as Paytm

are growing

Q2 Answer briefly
1) What are the sources of consumer finance?
2) What are the benefits of credit card and danger of credit card?
3) What is the prevention of fraud and misuse of Plastic money?
4) Explain briefly Consumer Finance Practice in India?
5) What are the types of consumer finance?

Q3 Short note
1) Explain consumer credit scoring
2) What are the types of plastic cards?
3) Explain credit rating agencies?
4) Explain Growth of Plastic Money Services in India?
5) Explain Credit Rating Symbol?



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