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FINANCIAL SERVICES

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 FINANCIAL SERVICES

Dr. [Link] [Link]., [Link]., Ph.D

Assistant Professor
Department of Commerce
Nehru Arts and Science College, Coimbatore.

Ms. [Link] [Link]., [Link]., (Ph.D)

Assistant Professor
Department of Commerce
Nehru Arts and Science College, Coimbatore.

Ms. [Link] [Link]., [Link]., (Ph.D)

Assistant Professor
Department of Commerce
Nehru Arts and Science College, Coimbatore.

[Link] [Link]., (Ph.D)

Assistant Professor
Department of Commerce
Nehru Arts and Science College, Coimbatore.
.

[Link]
Edition: First

Year: June, 2024

ISBN: 978-81-973085-8-1

All Rights Reserved: No part of this publication can be stored in

any retrieval system or reproduced in any form or by any means
without the prior written permission of the publisher.

©Authors

© Publisher

Publisher

(International Publisher)
Kanyakumari,Tamilnadu,India.
Phone: +91 6384730258
E-Mail: editor@[Link]
[Link]
 SYLLABUS
FINANCIAL SERVICES
UNIT I
Financial services-concepts, objectives, functions, characteristics-
financial services market, concepts, constituents-Growth of
financial services in Indiafinancial services sector problems-
financial services environment-forcesplayers in financial markets-
Interest rate determinations-Macroeconomic aggregates in India.
Unit II
Merchant Banking - Meaning, Origin and Growth - Merchant
Banking in India - Scope of Merchant Banking Services -
Organization and management patterns of merchant banks,
Merchant bank and management of public issues - Role of
merchant bankers in maintaining health and creditability of the
capital market.
Unit III
Mutual Fund - Concept and Origin of mutual fund - Growth of
mutual fund in India- Mutual Fund Schemes- Money market-
Mutual Funds- Institution involved in mutual fund business. Unit
Trust of India, Life Insurance Corporation, Commercial banks -
Entry of private financing companies in mutual fund business -
Safety, Liquidity and Profitability of mutual funds - Need for
regulation
Unit IV
Lease Financing - Need for leasing - types of leasing - Fixation of
Lease Rentals - Factors influencing Lease Vs Buy Decision –
Accounting treatment for leasing - Growth and prospects of
leasing industry in India. Hire purchase , Meaning, concept,
growth of hire purchase companies in India - Source of finance -
RBI guidelines for hire purchase companies in India-Hire
purchase companies and transport industry - problems and
prospects of hire purchase - Hire purchase Vs. Leasing
Unit V
Factoring - concept of factoring - Types of factoring mechanism -
Factoring in India - Cost and benefits of factoring - Issues
involved in factoring business. Credit cards - concept - Evolution
of Credit Cards -Varieties of Credit Cards - operational procedure
- Acceptance of credit cards from the point of view of bankers,
customers, members – Establishments -Credit Rating - Objectives
- Institutions engaged in credit rating - purpose and procedure of
rating for debentures - Fixed deposits - Short-term instruments.
Role of CRISIL and ICRA -Venture Capital - Concept and
characteristics Origin Growth of Venture capital - Difference
between venture capital financing and conventional funding -
Venture capital schemes - Legal aspects - Agencies involved in
providing venture capital.
 TABLE OF CONTENTS

Chapter Content Page No

I Financial Services 1-14

II Merchant Banking 15-27

III Mutual Fund and Commercial 28-44

Banks

IV Leasing and Hire Purchasing 45-59

V Hire Purchase 60-67

VI Factoring 68-88

VII Forfaiting 89-96

VIII Credit Rating 97-98

IX Venture Capital 99-105

 CHAPTER I

FINANCIAL SERVICES

INTRODUCTION
Financial Service as a part of financial system provides different
types of finance through various credit instruments, financial products
and services. In financial instruments, we come across cheques, bills,
promissory notes, debt instruments, letter of credit, etc. In financial
products, we come across different types of mutual funds, extending
various types of investment opportunities. In addition, there are also
products such as credit cards, debit cards, etc.
In services we have leasing, factoring, hire purchase finance etc.,
through which various types of assets can be acquired either for
ownership (or) on lease. There are different types of leases as well as
factoring [Link], financial services enable the user to obtain any asset
on credit, according to his convenience and at a reasonable interest rate.
Objectives (or) Functions of Financial Services
Following are the objectives of Financial Services that are generally
offered by banking financial companies :-
1. Fund Raising
Financial services are essential in raising funds from investors,
individuals, institutions, and corporations. They use various finance
instruments to facilitate the flow of capital between those with excess
funds and those in need for investment or other purposes. Financial
institutions, through services like loans, investments, and insurance,
ensure efficient allocation of funds to support economic growth and
development.
2. Funds Deployment
Financial markets offer various financial services to ensure profitable
fund deployment. These services help in decision-making regarding
financing mix, such as bill discounting, factoring, money market
borrowing, credit rating, e-commerce, and debt securitization. They also

1
reduce risks associated with financial transactions and provide valuable
insights into market trends. By utilizing these services, businesses can
optimize their financial strategies, achieve long-term growth, and achieve
success.
3. Specialized Services
The financial services sector offers a range of specialized services
including credit rating, venture capital financing, lease financing,
factoring, mutual funds, merchant banking, stock lending, depository,
credit cards, housing finance, and book building, alongside banking and
insurance institutions, agencies, stock exchanges, and other financial
institutions.
4. Regulation
The financial services sector offers a range of specialized services
including credit rating, venture capital financing, lease financing,
factoring, mutual funds, merchant banking, stock lending, depository,
credit cards, housing finance, and book building. It includes banking and
insurance institutions, non-banking finance companies, subsidiaries,
banks, and insurance companies.
5. Economic Growth
Financial services contribute, in good measure, to speeding up the process
of economic growth and development. This takes place through the
mobilization of the savings of a cross section of people, for the purpose of
channeling them into productive investments.
Characteristics of Financial Services
1. Intangibility
Financial services are intangible and require institutions to have a
good image and client confidence for successful creation and marketing.
The quality of customer service is also crucial for the success of these
services.
2. Customer Orientation
Financial institutions meticulously analyze customer needs,
generating innovative strategies considering costs, liquidity, and maturity

2
for various financial products and services. This customer-oriented
approach ensures that financial services are tailored to meet the unique
requirements of each individual client, ensuring a tailored and efficient
financial experience.
3. Inseparability
The functions of production and supply of financial services have
to be carried out simultaneously. This cause for a project understanding
between the financial services firms and their clients.
4. Perishability
Financial services must be instantaneously created and delivered
to clients, ensuring a match between demand and supply. They cannot be
started, and must be supplied according to customer requirements.
Importance of Financial Services

Financial services enhance a country's economic condition,

promoting increased production across all sectors and leading to
economic growth. This growth benefits individuals through economic
prosperity, resulting in a higher standard of living for individuals.
1. Promoting Investment
Financial services increase product demand, leading producers to
seek investment. They assist investors like merchant bankers through new
issue markets and the stock market, enabling capital raising. Foreign
investments are also attracted. Factoring and leasing companies enable
producers to sell products and acquire modern machinery and technology,
leading to increased productivity and market competitiveness. This
process benefits both domestic and foreign producers.
2. Promoting Savings
Mutual funds offer various savings options for pensioners and
older individuals, ensuring reasonable returns without much risk. They
also provide reinvestment opportunities for those interested in growth of
their savings. These financial services cater to the convenience of
pensioners and older individuals.

3
3. Minimising the risks
The risk of both financial services as well as producers are
minimized by the presence of insurance companies. Various types of risks
are covered which not only offer protection from the fluctuating business
conditions but also from risks caused by natural calamities. Insurance is
not only a source of finance but also a source of a savings, besides
minimizing the risks.
4. Maximising the returns
The presence of financial services enables businessmen to
maximize their returns. This is possible due to the availability of credit at
a reasonable rate. Producers can avail various types of credit facilities for
acquiring assets. In certain cases, they can even go for leasing of certain
assets of very high value. Factoring companies enable the sources as well
as producer to increase their turn over which also increases the profit.
5. Ensures greater yield
Return and yield are key factors in attracting producers to enter
the market and meet consumer demands. Financial services help
producers earn more profits and maximize their wealth, enhancing their
goodwill and encouraging diversification. The stock market and
derivative markets offer opportunities for higher yields, leading to
increased financial security and stability in the long run. This subtle
difference between return and yield is crucial in attracting producers to
the market.
6. Economic growth
The development of all sectors is crucial for economic growth,
and financial services ensure equal distribution of funds across primary,
secondary, and tertiary sectors, ensuring balanced activity distribution
across all three sectors.
7. Economic development
Financial Services enable the consumers to obtain different types
of products and services by which they can improve their standard of
living. Purchase of car, house and other essential as well as luxurious

4
items are made possible through hire purchase, leasing and housing
finance companies.
8. Benefit to Government
The presence of financial services enables the government to raise
both short-term and long-term funds to meet both revenue and capital
expenditure through the money market, government raises short-term
funds by the issue of Treasury Bills. There are purchased by commercial
banks from out of their depositor‘s money. In addition to this, the
government is able to raise long-term funds by the sale of government
securities in the securities market which forms a part of financial market.
Even foreign exchange requirements of the government can be met in the
foreign exchange market.
9. Expands activities of financial institutions
The presence of financial services enables financial institutions to
not only raise finance but also get an opportunity to disburse their funds
in the most profitable manner. Mutual funds, factoring, credit cards, hire
purchase finance are some of the services which get financed by financial
institutions.
10. Capital Market
A vibrant capital market is a crucial indicator of an economy's
health, as it ensures companies can secure sufficient funds to boost
production and ultimately increase profits. The financial services
provided by financial services help companies achieve this..
11. Promotion of Domestic and Foreign Trade
Financial Services ensure promotion of domestic as well as
foreign trade. The presence of factoring and forfeiting companies ensures
increasing sale of goods in the domestic market and export of goods in
the foreign market. Banking and insurance services further contribute to
step up such promotional activities.
12. Balanced Regional Development
The government monitors the growth of economy and regions that
remain backward economically are given fiscal and monetary benefits

5
through tax and cheaper credit by which more investment is promoted.
This generates more production, employment, income, demand and
ultimately increase in prices.
Types of Finncial Services

[Link]
[Link]
[Link]
[Link] Purchase Finance
[Link] Card
[Link] Banking
7. Book Building
[Link] Liability Management (ALM)
9. Housing Finance
[Link] Finance
[Link]
12. Credit Rating
[Link] and Credit Swap xiv. Mutual Funds
1. Factoring
Factoring is a credit agreement between a financial institution and a
business, involving the sale of goods on credit. It involves three parties:
the supplier, the buyer, and the factor. The saver saves goods for the
buyer, prepares a bill for 3 or 6 months, and gives it to the factor, which
will provide up to 80% of the bill value. The factor collects the money
from the buyer, and the balance is handed over to the saver.
2. Leasing
To enable companies (or) small firms to acquire asset of a higher value,
leasing companies were setup. The leasing company will purchase the
asset and give it the manufacturer on a lease for a period of 10 (or) 12
years the company leasing the machine is called lessor and manufacturer
who is taking the asset for use is called leasing. The lease will be paying
rent to the lessor for the use of the asset. Basically there are 2 types of
lease agreement.

6
(i) Financial Lease
(ii) Operating Lease
Financial Lease
A financial lease is a contract involved payment over a fixed
period of a specific amount the capital outlay of a specific project.
Operating Lease
An equipment is purchased and production on lease to the Lessee
for use. The Lessee has the option to cancel the contract and at the same
time, the Lessee has the option to sell the asset to any other person to cost
of the equipment is not fully recovered by the lease amount and the lease
period is normally shorter that the economic life of the asset.
Forfeiting
Exporters can receive finance against their bills by forfeiting the bank,
while in domestic trade, foreign bills are discounted in favor of the
exporter. This arrangement allows for immediate financing after export,
eliminating the risk of bad debts and facilitating domestic trade.
Hire Purchase Finance
Hire-purchase finance companies offer financing for assets for 2 to 5
years, or even 10 years, when a buyer cannot afford to purchase an asset.
The finance is repayable on a monthly installment over 24 to 60 months,
with a portion going towards the principal and the remaining towards
interest. Interest is charged at a flat rate of 10% or 15% for the loan
period.
5. Credit Card
A credit card is a facility provided to customers of fixed income
or middle and higher income groups. It is a plastic card with the
customer's name embossed in block letters, the bank's name, date of issue,
and expiry mentioned on the front, and the customer's specimen signature
on the reverse side. The banker also provides a list of vendors or savers to
customers.

7
6. Merchant Banking
A merchant banker underwrites corporate securities and advises clients on
mergers, often acting as a bank, company firm, or proprietary concern.
This service banking involves providing non-financial services like
arranging funds, understanding business requirements, and utilizing
financial institutions, banks, stock exchanges, and the market to arrange
finances for a business.
7. Book Building
When a company instead of offering shares directly to the public,
invitesbids from the merchant bankers for the sale of shares it is called
book [Link] merchant bankers will take the full responsibility for
the issue of the [Link] entire procedure of allotment of listing of
shares will be undertaken by themerchant bankers. The share price
depends on the demand for the shares in themarket.
8. Asset Liability Management (ALM)
It is a method used by banks for adjusting their liability from
assets whichshould qualify the three conditions of safety, liquidity and
profitability. In otherwords, a bank which receives money from the
depositors will go for investment(or) grating of loans of different
[Link] bank will prefer such kind of assets (while investing (or)
lending)which will have safety, liquidity and profitability. There are
companies whichhelps banks is managing assets and liabilities in a
creditable manner.
9. Housing Finance :
Housing Finance has not only become popular. But the procedure
for obtaining loan has been simplified and housing loans for dwelling
houses are made easily available. This due to the change is the housing
policy of both the central and state governments. Commercial banks have
entered housing finance. In fact State Bank of India has setup a separate
subsidiary for housing finance. World bank is providing soft loan repay in
25 to 40 years for the purpose.

8
10. Portfolio Finance
Portfolio finance deals with the Management of Portfolio
Investment. A company involved in portfolio management undertakes to
manage the investment of an individual (or) company is such a manner
that a better return on investment is ensured, keeping in that the safety of
investment. Thus in portfolio finance the finance in various shares (or)
securities is managed by persons with special knowledge of the market
and different securities. The mutual fund companies and investment trust
companies are very good example of portfolio finance. They help
individuals, commercial banks and other finance companies is
distributing their investment in different portfolios. Portfolio management
consists of investment in shares debentures, government securities,
commercial paper, bonds, global depositreceipt and other investment
securities such as unit trust of India, Infra structurebonds etc.
11. Under Writing
Under Writing is an act of guarantee by an organisation for the
sale of certain minimum amount of shares and debentures issued by a
public limited company. According to the companies act, when a person
agrees to take up shares specified in the underwriting agreement, when
the public (or) others failed to subscribe for them, it is called underwriting
agreement. For this purpose the underwriter who guarantees for the sale
of shares is given a commission.
12. Credit Rating
It is a method of judging the credit worthiness of a borrower (or)
of a company in which investments are made the credit rating of a
borrowing company is done on the basis of its performance of the
company is previous years, liquidity position, market share of the
company repayment of deposits, profits earned, interest offered on
deposits & assets portfolio etc.
13. Interest and Credit Swap
There are two types of interest rate fixed interest rate and floating
interest rate. The fixed interest rate is applicable for the entire loan while

9
is floating interest rate the interest will be changing. Interest swap is a
method where by a person who has taken a loan with a higher rate of
interest, would like to take advantage of the lower rate of interest by
shifting his previous loan to the new floating rate which has a lower rate
of interest. When an old loan is replaced by a new loan at a lower rate of
interest it is called interest swap and also credit swap because of a new
creditors replacing the old creditor
14. Mutual Funds
A mutual fund is a company that brings together from many
people and invests it is stocks bonds (or) assets. The combined holdings
of stocks bonds (or) other assets the fund owns are known as its portfolio.
Each investor in the fund owns shares, which represent a part of these
holdings. The mutual fund offers open-ended and close-ended funds. The
open ended funds are kept open and the investors have the option to enter
at any time and option out as they like. But in closed-ended fund there is
a limit of time and amount and this ensures that mutual fund to get a
better return. Apart from this there is also
growth. Oriented fund which reinvest the return by the customers so that
on a future date they can get a higher return. In the case of tax benefit
funds there is a tax relief for the return they get on the investment.
FINANCIAL SERVICES MARKET

The market for the exchange of financial services products and

instruments through a wide variety of players, each one offerings a
unique type of service, may be designated as the ‗financial services
market‘. Constituent
The Financial Services Market comprises of four major constituents as
stated below :
1. Market Players
Financial Services are offered by a host of institutions and agencies that
understand and meet the requirements of a wide spectrum of customers.
The players include banks, financial institutions, mutual funds, merchant

10
bankers, stock brokers, consultants, underwriters, market makers,
corporate bodies, FIIS, custodians, vendute capital funds etc.
2. Instruments
Financial Instruments constitute an important part of the financial
servicesmarket. The instruments include equity instruments, debt
instruments, hybrid andexotic instruments. It is characteristic of a
financial services market that a numberof innovative instruments, such as
zero-coupons bonds, etc. are floated on acontinuous basis. The purpose is
to keep the financial markets vibrant.
3. Specialized Institutions
A financial services market is characterized by the dynamic
presence of specialized institutions. These include acceptance house,
discount houses, factors, depositories, credit rating agencies, venture
capital institutions, etc
4. Regulatory Bodies
The financial service market is regulated by a host of institutions
and agencies. The regulatory bodies include the department of banking
and insurance of the Central Government, Reserve Bank of India,
Securities and the exchange board of India, board of industrial and
financial reconstruction, etc.
Growth of Financial Sources in India
The growth of financial services in India has taken place under the
various stages. It is outlined below :
1. Merchant Banking Era :
The period between 1960 and 1980 may be called the ‗Merchant Banking
Era‘. During this period, financial queries such as merchant banking,
insurance and leasing services began to grow. During this period,
merchant bankers carried out the following functions.
(i) Identifying projects, preparing feasibility reports, and
developing detailed project reports.
(ii) Conducting marketing, managerial, financial and technical
analysis on behalf of their clients.

11
 (iii) Assist in designing an appropriate capital structure.
(iv) Acting as a bridge between the capital market and fund-
seeking institutions.
(v) Carrying out underwriting functions. (vi) Assisting enterprises
in getting their issues listed on the stock exchange.
(vi) Offering legal advice relating to mergers and acquisitions.
(vii) Providing technical advice on leverged buyouts and
takeovers.
(viii) Extending syndication facility as part of arranging project
finance. (x) Arranging working capital loans.
2. Investment Companies Era
This era marked the setting up of a variety of investment institutions and
banks. The investment companies include the Unit Trust of India, which
is the largest public sector mutual fund in the world, the life insurance
corporation of India that initiated the life insurance business and the
general insurance corporations.
3. Modern Services Era
This stage marked the launch of a variety financial products and services
during the eighties. These financial services included over-the-counter
services. Share transfers, pledging of shares, mutual funds, factoring,
discounting, venture capital & credit rating.
4. Depository Era
In order to integrate the Indian financial sector with the global
financial services industry, depositories were setup. The depository
system was introduced with a view to promoting the concept of paperless
trading through the dematerialization of shares and bonds. The
introduction and popularization of book-building was also another step
forward in the direction of building a strong financial services sector in
India. Similarly the ‗On-line Trading‘ interface introduced by the
Bombay Stock Exchange, the Delhi Stock Exchange and the
computerization of the National Stock Exchange, are all acting as the

12
fulcrum for the development of a strong financial services market in
India.
5. Legislative Era
Several legislations were introduced in order to allow for broad based
development in the financial services sector. The FERA has been
replaced by FEMA. Far-reaching amendments were made in the Indian
Companies Act, Income Tax Act, etc. to facilitate safe and orderly
trading, and settlement of transactions.
PART A
1. What are financial services? Name them
2. What is a financial services market?
3. List out the financial services environment?
4. Define interest rate?
5. Meaning of Forfeiting?
6. Mention any four players in financial services?
7. Mention any four problems in financial services sector?
8. What is mean by financial market?
9. Name any three components of financial services
10. list any four characteristics of financial services?
Part B

1. Bring out the important role played by financial services in developing

the economic
growth of a country
2. What kind of economic environment should prevail for the effective
functioning offinancial
services in a country
3. State the features of rate determination
4. State the financial Services Sector – Problems in Indian Financial
Services:
5. Describe the types of players in the financial services sector
6. Explain the Functions of Financial Services

13
7. Explain the types of financial services
8. Mention and explain the Characteristics of Financial Services
9. Explain the growth of financial services in India?
10. Explain the role played by the financial services in favorable
economic system

14
 CHAPTER II
Merchant Banking
Introduction
The term merchant banking is used different countries. In London,
merchant banker refers to those who are members of British Merchant
Banking and Securities House Association who carry on consultation,
leasing, portfolio services, assets management, euro credit, loan
syndication etc. In America, merchant banking is concerned with
mobilising savings of people and directing the funds to business
enterprise.
Definition
There is no universal definition of merchant banking. It assumes
diverse functions in different countries. So, merchant banking may be
defined as, ―an institution which covers a wide range of activities such as
management of customer service portfolio management, credit
syndication, acceptance credit, counselling, insurance etc.
The Notification of the Ministry of Finance defines a merchant banker
as,‖ any person who is engaged in the business of issue management
either by making arrangements regarding selling, buying or subscribing to
the securities as manager, consultant, advisor or rendering corporate
advisory service in relation to such issue management‖.
Origin and development of Merchant Banking

 London Merchants has first originated in merchant

banking.
 The main motive of London merchant banking is financing
foreign trade through acceptance of bill.
 Later, merchants assisted the governments of
underdeveloped countries in raising long term funds
through floatation of bonds in London money market.
 Over a period, they extended their activities to domestic
business of syndication of long term and short term

15
 finance, underwriting of new issues, acting as registrars
and share transfer agents, debenture trustees, portfolio
managers, negotiating agents for managers, take over etc
 In a post war-period witnessed the rapid growth of
merchant banking through the innovative instruments like
Euro, Dollar and the growth of various financial centres
like Singapore, Hong Kong, Bahrain, Kuwait, Dubai etc.
Merchant Banking in India
In India prior to the enactment of Indian Companies Act 1956, managing
agents acted as issue of houses for securities, evaluated project reports,
planned capital structure and to provide venture capital for new firms.
Share broking firms also functioned as merchant banks.
In India the specialised merchant banking services need with the rapid
growth in the number and sizes of the issues made in the primary market.
The merchant banking services was started by foreign banks namely, the
National Grindlays Bank in 1967 and the Citibank in 1970
In 1972, the banking commission report recommended the setting up of
merchant banking institutions by commercial banks and financial
institutions.
To begin with, merchant banking services were offered along with other
traditional banking services.
In the mid eighties, the Banking Regulation Act was amended permitting
commercial banks to offer a wide range of financial services through the
subsidiary route.
In 1972, the State Bank of India was the first Indian bank set up Merchant
Banking Division.
Later ICICI Bank, Bank of Baroda, Canara Bank, Punjab National Bank
and UCO bank were set up. The merchant banking gained prominence
during 1983-84 due to new issue boom.

16
 A set of activities undertaken to ensure the efficient running of a
corporate enterprise is known as corporate counseling. The
merchant banker is guiding in the following activities.
 Diversification based on the Government‘s economic and
licensing policies.
 Appraisal of product lines, analyzing their growth and profitability
and forecasting future trends.
 Arranging funds for rehabilitation through banks/financial
institutions
 Monitoring of rehabilitation schemes.
 Assisting takeover of sick units
 Diagnosing sick units, assessing revival prospects for
rehabilitation by way of modernization and diversification,
suggesting suitable strategy for improving their production
technology and financial structure.
Scope of Digital Banking Corporate Counselling

17
 Project Counselling
 Project counseling is the feasibility study of the project
with reference to various aspects such as financial,
economical, commercial technical etc. It includes the
following activities.
 Review of project idea, conducting feasibility study and
providing advice for implementation.
 Providing assistance in the preparation of project reports,
conducting market surveys and obtaining government
consents (approvals/licenses/permissions/grants) for
implementation of the project
 Providing guidance in making investment in Indian
projects in India and abroad.
 Arranging and negotiating foreign collaborations,
amalgamations, mergers, and takeovers
Pre Investment Studies
 It is a detailed feasibility study to evaluate alternative
avenues of capital investment in terms of growth and profit
prospects. Activities related to pre-investment studies are:
 Analyzing environment and regulatory factors
 Identification of raw material sources
 Estimation of demand
 Estimation of financial requirements
Capital Restructuring Services

Capital restructuring aims to reduce the cost of capital and

maximize the shareholders wealth. Merchant bankers provide the
following services related to capital restructuring:
 Determination of optimum capital structure
conforming to legal requirements.
 Getting consent of controller of Capital issues for
capitalization of reserves by way of issuing bonus shares.

18
Credit Syndication
Credit syndication refers to activities connected with credit
procurement and project financing, aimed at raising Indian and foreign
currency loans from banks and financial institutions, are collectively
known as ‗credit syndication‘. The activities are:
 Estimating the total cost of the project and drawing up a
financing plan for the total project cost.
 Preparing loan application for financial assistance from
term lenders/financial institutions/banks, and monitoring
their progress, including pre-sanction negotiations.
 Selecting institutions and banks for participation for
financing.
 Issue Management and Underwriting
 Issue management and underwriting is concerned with the
activities of management of the public issues of corporate
securities, viz. equity shares, preference shares, and
debentures of bonds to procure money from the capital
market. The activities and SEBI guidelines in this regard
are discussed later elaborately in this unit.
Portfolio Management

Portfolio management is making investment decisions in marketable

securities for maximizing returns with minimum risk.
These services are;
 Providing advice on selection of investments.
 Carrying out a critical evaluation of investment portfolio.
 Collecting and remitting interest and dividend on
investment.
 Undertaking investment in securities.
 Safe custody of securities in India and overseas.
 Undertaking review of Provident fund investment, Trust
investment, etc

19
Working Capital Finance
Working Capital finance is the fund required to meet the day-today
expenses of an enterprise. The related activities are:
 Assessment of working capital requirements.
 Facilitating sanction of credit facilities
speedy disbursements.
 Accepting Credit and Bill Discounting
 Acceptance credit and bill discounting‘ means activities
relating to acceptance and discounting of bills of exchange
and advancement of loans on the strength of such
instruments.
Merger and Acquisition
The merchant banker arranges for negotiating acquisitions and
mergers by offering expert valuation regarding the quantum and the
nature of considerations, and other related matters. The activities relating
to merger and acquisition are:
 Conducting SWOT analysis in order to help formulate
guidelines and directions for future growth.
 Conducting studies for locating overseas markets, foreign
collaborations and prospective joint venture associates.
 Obtaining approvals from shareholders and other
stakeholders
 Monitoring the implementation of merger and
amalgamation schemes
 Venture Capital Financing Venture capital is the seed
capital in the form of equity financing for high-risk and
high-reward projects.
Lease Financing
Leasing is one of the fund based financial services of merchant
banker. Leasing means ‗letting out assets on lease‘ for use by the lessee
for a particular period of time. Merchant banker provides the following
services:
 Providing advice on the viability of leasing .
20
  Providing advice on the choice of a favorable rental
structure.
 Foreign Currency Financing
 Foreign currency finance is the fund provided for foreign
trade transactions in the form of export import trade
finance, euro currency loans. The role of merchant bankers
in this regard is:
 Assisting the study of turnkey project and construction of
contract projects.
 Liaison with RBI, EXIM, ECGC and other institutions.
 Providing assistance in opening and operating banks
accounts abroad.
 Assisting in obtaining export credit facilities and letter or
credit.
 Providing guidance on forward cover for exchange risk.
 Arranging foreign currency guarantees.
 Arranging various types of foreign currency loans such as
Eurocurrency Loans, Syndication of Euroloans, Bank
guarantees etc
Fixed Deposit Brokering
 Working out the quantum of procurement of fund in the
form of deposits from the public
 Drafting of advertisement for inviting deposits and filing a
copy of it with the registrar of Companies for registration.
 Arranging payment of interest amounts.
 Advising on the terms and conditions of fixed deposits the
company
Mutual Funds
Mutual funds are institutions that mobilize the savings of
innumerable investors for the purpose of channeling them into
productive investments in a wide variety of corporate and other
securities. Investment of the fund is in a diversified portfolio of

21
 shares and debentures belonging to well managed and growing
companies.
Organization and Management patterns of Merchant Banks
Merchant Banker/Lead Managers
―In a syndicate, an underwriting firm immediately subordinate to
the managing underwriter. A syndicate is a group of underwriters
responsible for placing a new issue of a security with investors.
Every syndicate is a temporary arrangement. The lead manager is
assigned the second largest part of the new issue for placement. A
lead manager is also called an arranger‖.
As per the SEBI regulations all issues should be managed by at
least one authorized Merchant Banker functioning as Sole
manager or Lead manager. As such only Category1 Merchant
Bankers could act as
 Lead Managers to an issue
 Number of Lead Managers
 The SEBI guidelines stipulate the following:
 For an issue of size less than ` 50 crores, the number of
Lead Managers should not exceed 2.
 For an issue of size ` 50 crores but less than 100 crores, the
maximum number of Lead Managers should not exceed 3
 For an issue of size ` 100 crores but less than 200 crores,
the maximum number of Lead Managers should not
exceed 4.
 For an issue of size 200 crores but less than 400 crores, the
maximum number of Lead Managers should not exceed 5
 For an issue of size above ` 400 crore the number of Lead
Managers may be 5 or more as may be agreed by SEBI
Conditions/Registration/Renewal certificate of a Merchant Banker
The Registration/Renewal certificate of a Merchant Banker is
subject to the following conditions:
 Prior approval of SEBI is necessary to continue to act as a
Merchant Banker after change of its status/constitution –

22
 such as amalgamation, merger, and consolidation and any
other kind of corporate restructuring/ change in its
managing/whole time directors, change in control etc.
 A Merchant Banker should enter into a legally binding
contract with the issuer specifying their mutual duties and
responsibilities
 A Merchant Banker should pay the Registration/Renewal
in the prescribed manner.
 He should take adequate steps for redressal of grievances
of investors within one month of the complaint. He should
inform the SEBI the details of complains and the manner
of redressal.
 He should abide by the relevant regulations under the
SEBI act.
Restriction on Business
The Merchant Banker other than a bank/public finance institution
is not permitted to carry on business other than in the securities
market i.e., he is prohibited from carrying on fund/asset based
business such as leasing.
Responsibilities of Lead Managers
Every Lead Manager must sign an agreement with the issuing
companies. The agreement must contain the matters regarding
mutual rights, liabilities and obligations relating to issues which
must necessarily include disclosures, allotment and refund.
Merchant banker should furnish a statement specifying the details
in the agreement to SEBI. Such statement should be sent at least
one month before the opening of the issue for subscription. The
statements should also contain the details about all lead managers
and their respective responsibilities if there were more than one
Lead Manager/Merchant Banker.
 There should be no association between the lead manager
and the issuing company.

23
  There should be no association with other merchant
bankers who do not hold a certificate of registration
with SEBI
 The minimum undertaking obligation to be accepted by a
lead manager is 5% of the total underwriting commitment
or ` 25 lakhs whichever is less.
 Due diligence certificate: The lead manager should furnish
a certificate to SEBI 2 weeks before the opening of the
issue for subscription stating the following:
 The prospectus/letter of offer is in conformity with the
documents/materials and papers relevant to the issue.
 All legal requirements in connection with the issue have
been complied [Link] disclosures are true fair and
adequate to enable the investors to make a decision
regarding investment
The merchant banker must submit to the SEBI two weeks before
the date of filing with the registrar of companies/regional stock
exchanges or both, the following particulars of the issue:
 Draft prospectus/letter of offer,
 Other literature to be circulated to
the investors/shareholders.
The merchant banker should pay to the SEBI, the following fee
prescribed:
[Link] Issue Issue Size Fees
Flat rate
Up to Rs.10 crore
Rs.25,000
0.025% of the
Rs.10 to 5000 crore
Issue size
1 Public Issue Rs.1.25 crore
plus 0.00625%
Rs.5000 crore to
of the issue size
25000 Crore
excess of 5000
crore

24
 More thanRs.25000 Flat charge
Crore Rs.3crore
Flat rate Rs.
Up to Rs.10 crore
25000/-
2 Right Issue 0.005% of the
Rs.10 to 500 Crore
Issue
Flat rate Rs. 5
More than Rs.500
Lakh
Crore
Choose the correct Answer
1. Formal merchant banking activity in India was originated in
which of the following years?
a) 1978 b) 1969
c)1979 d) 1987
Answer: 1969
2. A merchant bank is a financial institution conducting money
market activities and which of the following?
a) Lending b)Underwriting and Financial services
c)Investment service d) All off the above
Answer: All of the above
3. In India, merchant-banking activity was originated with the
merchant banking division set up by which of the following?
a)Grind Lays Bank b)Barclays Bank
c)Yes Bank d) None of the above
Answer: Grind Lays Bank
4. State Bank of India started merchant banking in which of the
following years?
a) 1974 b) 1978

25
 c)1973 d) 1980
Answer: 1973
5. The early growth of merchant banking in the country is assigned
to the which of the following?
a) Foreign Exchange Regulation Act, 1973
b) b)Securities contract Act
c)Income Tax Act d) FEMA
Answer: Foreign Exchange Regulation Act, 1973
Short Questions
PART A
1. Define merchant bank
2. State four functions of merchant banks.
3. State four code of conduct of merchant bankers
[Link] - Meaning
5. What is pure underwriting?
6. What is firm underwriting?
7. Define underwriting commission
8. What is public issue of securities?
9. What do meant by IPO?
10. What do you meant by FPO?
Part B
1. Describe the functions of merchant banking function in India
2. Discuss code of conduct of merchant bankers
3. Describe the Functions of Public Issue Management
4. Explain mode of Public Issue of Securities
5. Discuss role of issue managers in public issue of securities.

26
6. Explain Mechanics of Public Issue Management.
7. Explain various types of underwriting?
8. Discuss the importance of underwriting.
9. Explain benefits of underwriting.
[Link] issue managers of issue of securities and SEBI

27
 CHAPTER III

Mutual Fund and Commercial Banks

Introduction
 Mutual fund is the ‗ safety of the principal‘ guaranteed
plus added advantage of capital appreciation together with
the income earned in the form of interest or dividend.
 Our people prefer mutual funds to bank deposits, life
insurance and even bonds. Because, with a little money
they can get into the investment game.
 Other can own a string of blue chips like TCS, TISCO,
Reliance etc. through mutual funds
 Thus mutual fund acts as a gateway to enter into big
companies higher to inaccessible to an ordinary investor
with its small investments.
Concept of Mutual Fund

 Mutual funds represent one of the most important

institutional forces in the market. They are institutional
investors. They play a major role in today‘s financial
market. The first mutual fund was established in Boston in
1924 (USA).
 A mutual fund pools the savings of investors who share a
common financial goal and he acts as a special type of
institution that acts as an investment agent.
 It invests thereafter careful research and analysis in
various types of securities.
 It offers the individual saver, the advantages of reasonable
dividend and capital appreciation coupled with safety and
liquidity..
 Corporation, which receives funds from investors and
deploy (invest) the same in equities, long term bonds and
money market instruments etc., is called mutual funds.

28
Meaning
 A mutual fund collects the savings from small investors,
invest them in government and other corporate securities
and earn income through internet and dividends besides
capital gains.
 The principle of mutual fund is ‗ Small drop of water
makes a big ocean‘.
 Large enough fund to invest a wide varieties of shares and
debentures on a large scale organisations.
 Hence, mutual fund is nothing but a form of collective
investment.
 It is formed by coming together of a number of investors
who transfers their surplus funds to a professionally
organisation to manage it.
 Each fund is divided into small fractions called ‗units‘ of
equal value.
 Each investors is allocated units in proportion to the size
of his investment.
 Thus, every investor big or small will have stake in to fund
and can enjoy the wide portfolio of investment held by the
funds.
Definition
1. The Securities Exchange Board of India (SEBI Mutual
Funds) Regulations, 1993 defines Mutual Funds as ―A
fund established in the form of a trust by a sponsor, to
raise monies by the trustees through the sale of units to the
public, under one or more schemes, for investing in
securities in accordance with these regulations‖.
2. According to Frank Reilly defines Mutual Funds as
―Financial intermediaries which bring a wide variety of
securities within the reach of most modest of investors‖.
3. According to [Link] and Brigham, Eugene.F., Unit
Trusts are ―Corporations which accept dollars from savers

29
 and then use these dollars to buy stocks, long term bonds,
short term debt instruments issued by business or
government unites; these corporation pool funds and thus
reduce risk by diversification‖.

Origin of Mutual Fund

The origin of the concept of mutual fund dates back to the
dawn of commercial history. It is said that Egyptians and
Phoenicians sold their shares in vessels and caravans with a view
of spreading the risk attached with these risky ventures. However,
the real credit of introducing the modern concept of mutual funds
goes to the Foreign and Colonial Government Trust of London
established in 1868. Therefore, a large number of close ended
mutual funds were formed in the USA in 1930s followed by
many countries in Europe, the Far East and Latin America. In
most of the countries, both open-ended and close ended types
were popular. In India, it gained momentum only in 1980, thought
it began in the year 1964 with the Unit Trust oof India launching
its first fund, the Unit Scheme 1964.
Types /Classification of Mutual Fund

30
 A. On the basis of Operation
1. Close Ended Funds
Under this type of fund, the size of the fund and its
duration are fixed in advance. Once the subscription reaches
the predetermined level, the entry of investors will be closed.
After the expiry of the fixed period, the entire corpus is
disinvested and the proceeds are distributed to the unit holders
in proportion to their holding.
Features
 The period and the target amount of the fund is fixed
beforehand.
 Once the period is over and/ or the target is reached, the
subscription will be closed ([Link] cannot purchase
any more units)
 The main objective is capital appreciation.
 At the time of redemption, the entire investment is
liquidated and the proceeds are liquidated and the proceeds
are distributed among the unit holders.
 Units are listed and traded in stock exchanges.
 Generally the prices of units are quoted at a discount of
upto 40% below their net asset value.
Open Ended Funds

This is the just reverse of close-ended funds. Under this scheme

the size of the fund and / or the period of the fund is not fixed in
advance. The investors are free to buy and sell any number of
units at any point of time.
Features

 The investors are free to buy and sell units.

 There is no time limit.
 These are not trade in stock exchanges.

31
  Units can be sold at any time.
 The main motive income generation (dividend etc.)
 The prices are linked to the net asset value because units
are not listed on the stock exchange
Difference between open ended and close ended schemes

 The close-ended schemes are open to the public for a

limited period, but the open –ended schemes are always
open to be subscribed all the time.
 Close-ended schemes will have a definite period of life.
But he open-ended schemes are transacted in the company.
 Close-ended schemes are transacted at stock exchanges,
where as open-ended schemes are transacted (bought and
sold) in the company.
 Close-ended schemes are terminated at the end of the
specified period. Open-ended schemes can be terminated
only if the total number of units outstanding after
repurchase fall below 50%of the original number of units.
B. On the basis of Return/Income
1. Income Fund
This scheme aims at generating regular and periodical
income to the members. Such funds are offered in two
forms. The first scheme earns a target constant income at
relatively low risk. The second scheme offers the
maximum possible income.
Features
 The investors get a regular income at periodic intervals.
 The main objective is to declare dividend and not capital
appreciation.
 The pattern of investment is oriented towards high and
fixed income yielding securities like bonds, debentures etc.
 It is best suited to the old and retired people.
It focuses on short run gains only.

32
Growth Funds
Growth fund offers the advantage of capital appreciation.
It means growth fund concentrates mainly on long run gains. It
does not offers regular income. In short, growth funds aim at
capital appreciation in the long run. Hence they have been
described as ―Nest Eggs‖ invest mentsor long haul investments.
Features
 It meets the investors‘ need for capital appreciation.
 Funds are invested in equities with high growth potentials
in order to get capital appreciation.
 It tries to get capital appreciation by taking much risk.
 It may declare dividend. But the main objective is capital
appreciation.
 This is best suited to salaried and business people.
Conservative Fund

This aims at providing a reasonable rate of return, protecting the

value of the investment and getting capital appreciation. Hence
the investment is made in growth oriented securities that are
capable of appreciating in the long run.
C. On the basis of Investment

[Link] Fund
It mainly consists of equity based investments. It carried a
high degree of risk. Such funds do well in periods of
favourable capital market trends.
2. Bond Fund
It mainly consists of fixed income securities like bonds,
debentures etc. It concentrates mostly on income rather than
capital gains. It carries lower risk. It offers secure and steady
income. But there is no chance of capital appreciation.
[Link] Fund

33
It has a mix of debt and equity in the portfolio of investments.
It aims at distributing regular income as well as capital
appreciation. This is achieved by balancing the investments
between the high growth equity shares and also the fixed
income earning securities.
4. Fund of fund scheme
In this case funds of one mutual fund are invested in the units
of other mutual funds
[Link] Fund
This is basically a growth oriented fund. It offers tax rebates
to the investors. It is suitable to salaried people.
6. Leverage Fund
In this case the funds are invested from the amounts
mobilized from small investors as well as money borrowed
from capital market. Thus it gives the benefit of leverage to
the mutual fund investors. The main aim is to increase the
size of the value of portfolio. This occurs when the gains
from the borrowed funds are more than the cost of the
borrowed funds.
[Link] Bond
These are linked to a specific index of share prices. This
means that the funds mobilized under such schemes are
invested principally in the securities of companies whose
securities are included in the index concerned and in the same
proportion. The value of these index linked funds will
automatically go up whenever the market index goes up and
vice versa.
8. Money market and Mutual Fund
These funds are basically open ended mutual funds. They
have all the features of open ended mutual funds. But the
investment is made is highly liquid and safe securities like

34
 commercial paper, certificates of deposits, treasury bills etc.
These are money market instruments.
9. Off shore Mutual Funds
The sources of investments for these funds are from abroad.
[Link] Funds
This is a type of mutual fund in which the funds are invested
in guilt edged securities like government securities. It means
funds are not invested in corporate securities like shares,
bonds etc.
Structure/Institutions Involved in Mutual Funds

1. Auditors
An auditor is required to be appointed by the AMC and must
undertake independent inspection and verification of its
accounting activities.
2. Registrars and Transfer Agents
The registrars and transfer agents who are appointed by the AMC
carry out the following functions.
 Receiving and processing the application form of
investors.

35
  Issuing unit certificates
 Sending refund orders
 Giving approval for all transfers of units and maintaining
all such records.
 Repurchasing the units and redemption of units.
 Issuing dividends or income warrants
[Link] Accountants
 Fund accountants are appointed by the AMC.
 They are in charge of maintaining proper books of
accounts relating to fund transactions and management.
 The functions performed by these agencies
4. Sponsor/Settler/Sponsoring Institution
 The Company which sets up the mutual fund is called the
sponsor.
 The SEBI has laid down certain criteria to be met by the
sponsor
 These criteria mainly deal with adequate experience, good
past track record, net worth etc.
[Link] Advisors
 Legal advisors are appointed to offer legal guidance about
planning and execution of different schemes.
 A group of advocates and solicitors may be appointed as
legal advisors.
 Their fees is in no way associated with the net assets of the
fund, but is paid to them as decided.
6. Custodian
A person carrying on the activity of safe keeping of the securities
by participating in clearing system on behalf of the clients to
effect deliveries of the securities are known as ―Custodians‖.
The jobs to be performed by custodians are:
 Settlements: Payments, receipts and deliveries.
 Safer custody of securities

36
  Registration of documents
 Collection of dividend, interest, bonus, right and other
benefits (Corporate action)
 Accounting scheme-wise, both for money handled and
scraps held.
 Comprehensive insurance coverage – minimizing the risks
involved in operations.
 Reporting about physical holding, bad delivers, pending
purchases, pending sales
[Link]
 Trustees are people with long experience and good
integrity in their respective fields.
 They carry the crucial responsibility of safeguarding the
interest of investors.
 For this purpose, they monitor the operations of the
different schemes.
 These have wide ranging powers and they can even
dismiss asset management companies with the approval of
the SEBI.
[Link] Advisors
 Carrying out the market and security analysis.
 Advising the AMC to design its investment strategies on a
continuous basis.
9. Underwriters
In recent times, mutual funds also undertake the activities of
underwriting issues; such activities generate an additional source
of income for mutual funds. Prior approval from SEBI is
necessary for underwriting the activity
10. Lead Managers
Lead managers carry out the following functions:

37
  Selecting and coordinating the activities of intermediaries
such as advertising agency, printers, collection centre‘s
and marketing the services.
 Carrying out extensive campaigns about the scheme and
acting as marketing associated to attract investors
 Assisting the AMC to approach potential investors through
meetings, exhibitions, contacts, advertising, publicity and
sales promotion.
Growth of Mutual Funds in India
 Recently, the SEBI has flagged off the entry mutual funds
from the ICICI 20th Century financial service, Tata Sons,
Credit Capital Financial services many others.
 Among all these the Unit Trust of India enjoys a very
special status being more than all other mutual funds put
together.
The following are the various growth of mutual fund schemes in
India
Unit Trust of India 1964
 The UTI was set up by the Government of India under the
Unit Trust of India Act 1963.
 The objective was ―to encourage savings and investments
and participation in the income, profit and gains accruing
from the acquisition, holding management and disposal of
securities‖.
 As of April, 1993 the UTI has launched 50 Schemes of
these 42 are close ended, 6 are open ended and 2 are off
shore mutual funds.
 Thirty four of these schemes are income funds, 3 are
income/ growths funds are 3 are tax saving funds
State Bank of India Mutual Funds 1987
 The State Bank of India entered the field in the year 1987.

38
  By the end of 1992: it has launched 13 schemes out of
these 13 schemes, 11 are close ended and 2 are off shore
funds.
 Initially the SBI Mutual Funds were mainly of Income and
Tax saving type.
Canara Bank Mutual Funds
 The first Canara Bank Mutual Fund was established in the
year 1987.
 Can Bank Mutual Funds played an aggressive role in the
mutual fund market until the securities scan of 1992.
However they Can Bank Mutual Funds were innovative
and aimed at the various segments of investors.
Indian Bank Mutual Fund
 It is a comparatively late entrant to the industry but has
remained a fore runner in the mutual fund market.
 It has 13 schemes and all are close ended.
 There of these is IndRatna, IndSagar and IndMoti is
growth schemes.
Bank of India Mutual Fund
 It is also a comparatively new comer.
 The initial success was marred by the 1992 scam. Seven
schemes are offered by BOI Mutual Fund.
 All are close ended.
Punjab National Bank Mutual Fund
 All the schemes are closed ended.
 The PNB RIPS in income oriented scheme and PNB
premium plus is an income and growth oriented scheme.
Life Insurance Corporation Mutual fund
The LIC Mutual Fund provides comprehensive packages
to its investors.
It has a total corpus of nearly Rs. 1,000 Crores with
investors numbering over five lakhs.

39
General Insurance Corporation Mutual Fund
The GIC Mutual Fund was set up in 1990 by the GIC and its four
subsidiaries National Insurance Company Ltd, the New India
Assurance Company Ltd, Oriental Insurance Company and the
United India Insurance Company.
Need and Role of Commercial Bank
There has been an urgent need for the banks to enter into the field
of mutual fund due to the following reasons.
 Banks are not able to provide better yields to the investing
public with their savings and fixed deposit interest rates.
 Hence there is a necessity to enter in to the field of mutual
fund.
 Mutual fund backed by a bank will be in a better position
to tap the savings effectively and vigorously for the capital
market.
 Indian investor‘s particularly small and medium ones may
hesitate to invest in a direct way through private financial
intermediaries.
 Thus banks have the advantage of public confidence which
is very essential for the success of mutual; funds.
 Earlier banks were not permitted to tap the capital market
for funds or to invest their funds in the market.
 Now a green signal has been given to them to enter into
this market and reap the maximum benefits.
 Banks can provide a wider range of products in mutual
funds by introducing innovative schemes and extend the
professionalism in the mutual funds industry.
 Banks as merchant banks have wide experience in the
capital market and hence managing a mutual fund may not
be a big problem for them.
 The entry of banks would provide much needed
competition in the mutual fund industry and his

40
 competition will improve customer service and widen
customer choice also.
 Investor servicing can be effectively done by banks
through their network branches spread throughout the
country.
 Hence the commercial banks have entered into the mutual
fund market without any hesitancy
 Banks are not able to provide better yields to the investing
public with their savings and fixed deposit rates whereas
many financial intermediaries, with innovative market
instruments offering very attractive returns, have entered
the financial market. So, banks are not able to compete
with them in tapping the savings. Hence, there is a
necessity to enter into the field of MFs.
 The gross domestic savings has raisen from 10 percent in
fifties to 20 percent in eighties, thanks to the massive
branch expansion programme of banks and growing their
deposit mobilisation. Since, the banks have branches in the
rural as well as urban sectors, they can reach out to
everyone in the country. Hence, a MFs backed by a bank
will be in a better position to tap the savings effectively
and vigorously for the capital market.
 Indian investors, particularly small and medium ones, are
not very keen in investing any substantial amount directly
in capital market instruments. They may hesitate to invest
in an indirect way through private financial intermediaries.
On the other hand, if such intermediary has the backing of
a bank, investors may have confidence and come forward
to invest. Thus, banks have the advantage of ‗public
confidence‘ which is very essential for the success of
mutual funds.
 Earlier, banks were not permitted to tap the capital market
for funds or to invest their funds in the market. Now, a

41
 green signal has been given to them to enter into this
market and reap the maximum benefits.
 Banks can provide a wider range of products/ services in
mutual funds by introducing innovative schemes and
extend their professionalism to the mutual funds industry.
 Banks, as merchant banks, have wide experience in the
capital market and hence managing a mutual fund may not
be a big problem for them.
 The entry of banks would provide much needed
competition in the mutual fund industry which has been
hitherto monopolised by the UTI. The competition will
improve customer service and widen customer choice also.
 Above all the , investor servicing can be effectively done
by banks through their network of branches spread
throughout the country . Hence, the commercial banks
have entered into the mutual fund market without any
hesitancy.
Objective type of Questions
The corpus of the fund and its duration areprofixed under
________ funds
a) Open ended b) Close ended
c) Index fund d) Dual Fund
Ans: Close ended
2. ___________ funds invests in highly liquid securities like
commercial paper.
a) Balanced fund b) Fiscal market
c) Money market –Mutual d) Taxation fund
Ans: Money Market –Mutual
3. The small investor‘s gateway to enter into big companies is
__________

42
Ans: Mutual
4. The __________ is nothing but the intrinsic value of each
unit of a mutual fund.
Ans: Net asset value.
5. The company which set up a mutual fund is called
_____________
Ans: Sponsor.
6. The best suited fund to the business people is :
a) Income fund b) Balanced Fund
c) Growth Fund d) Taxation Fund
Ans: Growth Fund
7. The facility offered to investors to shift from one scheme to
another under the same fund is called ___________
Ans : Lateral shifting facility
8. Mutual funds are very popular in ___________
a) USA b) UK
c) Japan d) India
And : USA
9. In india, the company which actually deals with the corpus
of the mutual fund is called ____________
a) Sponsor Company b) Trustee Company
c) Asset management Company d) Mutual fund Company
Ans: Asset management Company
10. The pattern of investment of a mutual fund is oriented
towards fixed income yielding securities under:
a) Growth fund scheme b) Income fund scheme

43
c) Balanced fund scheme d) Money market mutual
fund scheme
Ans: Income fund scheme.

44
 CHAPTER IV
Leasing and Hire Purchasing
Concept of Leasing
Leasing as a financing concept is an arrangement between
two parties, the leasing company or lessor and the user or lessee,
where by the former arranges to buy capital equipment for the use
of the latter for an agreed period of time in return for the payment
of rent. In other words, Firms can acquire the use of assets.
Leasing is a process by which a firm can obtain the use of
a certain fixed assets for which it must pay a series of contractual,
periodic, tax deductible payments. The lessee is the receiver of the
services or the assets under the lease contract and the lessor is the
owner of the assets. The relationship between the tenant and the
landlord is called a tenancy, and can be for a fixed or an indefinite
period of time (called the term of the lease). The consideration for
the lease is called rent.
Definition of Leasing
According to the Equipment Leasing Association of
UK.―Lease is a contract whereby the owner of an asset (lessor)
grants to another party (lessee) the exclusive party to use the asset
usually for an agreed period of time in return for the payment of
rent‖.
Lease can be defined as the following ways
 A contract by which one party (lessor) gives to another
(lessee) the use and possession of equipment for a
specified time and for fixed payments.
 The document in which the contract is written
 A great way companies can conserve capital.
 An easy way vendors can increase sales.
A lease transaction is a commercial arrangement whereby
an equipment owner or Manufacturer conveys to the equipment
user the right to use the equipment in return for a rental. In other

45
words, lease is a contract between the owner of an asset (the
lessor) and its user (the lessee) for the right to use the asset during
a specified period in return for a mutually agreed periodic
payment (the lease rentals). The important feature of a lease
contract is separation of the ownership of the asset from its usage.
Terms used in the Lease agreement
1. Lessor – The party who is the owner of the equipment and
who gives it for lease
2. Lessee- The party who obtains the equipment for use for
which he pays periodical rentals
3. Lease property – The subject of the lease, the asset, article
or equipment that is on lease
4. Term of lease – This refers to the period for which the
agreement will be in operation
5. Lease rentals – This refers to the consideration for lease
Importance of Lease Financing
Lease financing is based on the observation made by
Donald B. Grant: ―Why own a cow when the milk is so cheap?
All you really need is milk and not the cow.‖
Leasing industry plays an important role in the economic
development of a country by providing money incentives to
lessee. The lessee does not have to pay the cost of asset at the time
of signing the contract of leases. Leasing contracts are more
flexible so lessees can structure the leasing contracts according to
their needs for finance. The lessee can also pass on the risk of
obsolescence to the lessor by acquiring those appliances, which
have high technological obsolescence. Today, most of us are
familiar with leases of houses, apartments, offices, etc.
Types of Leasing
1. Financial lease
2. Operating lease.
3. Sale and lease back

46
 4. Leveraged leasing and
5. Direct leasing.
1. Financial Lease
Long – term, non – cancellable lease contracts are known as
financial leases. The essential point of financial lease
agreement is that it contains a condition whereby the lessor
agrees to transfer the title for the asset at the end of the lease
period at a nominal cost. At lease it must give an option to the
lessee to purchase the asset he has used at the expiry of the
lease. Under this lease the lessor recovers 90% of the fair value
of the asset as lease rentals and the lease period is 75% of the
economic life of the asset. The lease agreement is irrevocable.
Practically all the risks incidental to the asset ownership and all
the benefits arising there from are transferred to the lessee who
bears the cost of maintenance, insurance and repairs. Only title
deeds remain with the lessor. Financial lease is also known as
‗capital lease ‗. In India, financial leases are very popular with
high – cost and high technology equipment.
2. Operational Lease
An operating lease stands in contrast to the financial lease in
almost all aspects. This lease agreement gives to the lessee
only a limited right to use the asset. The lessor is responsible
for the upkeep and maintenance of the asset. The lessee is not
given any uplift to purchase the asset at the end of the lease
period. Normally the lease is for a short period and even
otherwise is revocable at a short notice. Mines, Computers
hardware, trucks and automobiles are found suitable for
operating lease because the rate of obsolescence is very high in
this kind of assets.
3. Sale and Lease back
It is a sub – part of finance lease. Under this, the owner of an
asset sells the asset to a party (the buyer), who in turn leases

47
 back the same asset to the owner in consideration of lease
rentals.
However, under this arrangement, the assets are not physically
exchanged but it all happens in records only. This is nothing
but a paper transaction. Sale and lease back transaction is
suitable for those assets, which are not subjected depreciation
but appreciation, say land. The advantage of this method is that
the lessee can satisfy himself completely regarding the quality
of the asset and after possession of the asset convert the sale
into a lease arrangement.
4. Leveraged Leasing
Under leveraged leasing arrangement, a third party is involved
beside lessor and lessee. The lessor borrows a part of the
purchase cost (say 80%) of the asset from the third party i.e.,
lender and the asset so purchased is held as security against the
loan. The lender is paid off from the lease rentals directly by
the lessee and the surplus after meeting the claims of the lender
goes to the lessor. The lessor, the owner of the asset is entitled
to depreciation allowance associated with the asset.
5. Direct Leasing
Under direct leasing, a firm acquires the right to use an asset
from the manufacture directly. The ownership of the asset
leased out remains with the manufacturer itself. The major
types of direct lessor include manufacturers, finance
companies, independent lease companies, special purpose
leasing companies etc
Other Types of Leasing
1. First Amentment Lease
The first amendment lease gives the lessee a purchase option at
one or more defined points with a requirement that the lessee
renew or continue the lease if the purchase option is not
exercised. The option price is usually either a fixed price

48
 intended to approximate fair market value or is defined as fair
market value determined by lessee appraisal and subject to a
floor to insure that the lessor‘s residual position will be covered
if the purchase option is exercised
2. Full Payment Lease
A lease in which the lessor recovers, through the lease
payments, all costs incurred in the lease plus an acceptable rate
of return, without any reliance upon the leased equipment‘s
future residual value.
3. Guideline Lease
A lease written under criteria established by the IRS to
determine the availability of tax benefits to the lessor
4. Net Lease
A lease wherein payments to the lessor do not include
insurance and maintenance, which are paid separately by the
lessee.
5. Open end Lease
A conditional sale lease in which the lessee guarantees that the
lessor will realize a minimum value from the sale of the asset at
the end of the lease.
6. Sales type Lease
A lease by a lessor who is the manufacturer or dealer, in which
the lease meets the definitional criteria of a capital lease or
direct financing lease
7. Synthetic lease
A synthetic lease is basically a financing structured to be
treated as a lease for accounting purposes, but as a loan for tax
purposes. The structure is used by corporations that are seeking
off- balance sheet reporting of their asset based financing, and
that can efficiently use the tax benefits of owning the financed
asset.

49
8. Tax Lease
A lease wherein the lessor recognizes the tax incentives
provided by the tax laws for investment and ownership of
equipment. Generally, the lease rate factor on tax leases is
reduced to reflect the lessor‘s recognition ‘of this tax incentive.
9. True Lease
A type of transaction that qualifies as a lease under the Internal
Revenue Code. It allows the lessor to claim ownership and the
lessee to claim rental payments as tax deductions.
Difference between Financial Lease and Operating Lease
i. While financial lease is a long term arrangement
between the lessee (user of the asset) and the owner of
the asset, whereas operating lease is a relatively short
term arrangement between the lessee and the owner of
asset.
ii. Under financial lease all expenses such as taxes,
insurance are paid by the lessee while under operating
lease all expenses are paid by the owner of the asset.
iii. The lease term under financial lease covers the entire
economic life of the asset which is not the case under
operating lease.
iv. Under financial lease the lessee cannot terminate or
end the lease unless otherwise provided in the contract
which is not the case with operating lease where lessee
can end the lease anytime before expiration date of
lease.
v. While the rent which is paid by the lessee under
financial lease is enough to fully amortize the asset,
which is not the case under operating lease.
History and Growth of Leasing
The history of leasing dates back to 200 B.C when
Sumerians leased goods. Romans had developed a full bod law

50
relating to lease for movable and immovable property. However,
the modern concept of leasing appeared for the first time in 1877.
When the Bell Telephone company began renting telephones in
the U.S.A. In 1832, Cottrell and Leonard leased academic caps,
gowns and hoods. Subsequently, during 1930s, the Railway
Industry used leasing services for its rolling stock needs. In post
war period, the American Airlines leased their jet engines for the
most of the new aircrafts.
The development of immediate popularity for the lease and
generated growth of leasing industry.
Since World War II, the use of leasing has been greatly
expanded and its constantly used for new products and new
industries. In May 1952, Henry Scholfield set up a separate
Corporations in the USA to handle lease transactions. He founded
the US leasing Corporating with a capital of $20,000. Since, 1963
commercial banks have been allowed to engage themselves in
direct leasing. In the early 1960s, leasing entered the United
Kingdom following in successful and rapid development in the
USA.
The concept of financial leasing was pioneered in India
during 1973. The first company was set up by the Chidambaram
Group in 1973 in Madras. The company undertook leasing of
industrial equipment as its main activity. The 20th century Leasing
Company Limited was established in 1979. By 1981, four finance
companies joined in the [Link] performance of first leasing
company lts and 20th century leasing company ltd motivated
others to enter leasing industry.
In 1980s, Financial Institutions made entry into leasing business.
Industrial Credit and Investment Corporation was the first of all
India financial institutions to offer leasing in 1983. Entry of
commercial banks into leasing was facilitated by an amendment of
Banking Regulation Act 1949. SBI was the first commercial bank
to set up a leasing subsidiary, SBI capital market in October 1986.

51
Can Bank Financial services ltd, BOB Financial services Ltd., and
PNB Financial Services Ltd followed suit. Industrial Financial
Corporation Merchant Banking division started financing leasing
companies as well as equipment leasing and financial services.
There was thus virtual explosion in the number of leasing
companies risingto about 400 companies in 1990.
In the subsequent years, the adverse trends in capital
market and other factors led to a situation where apart from the
institutional lessons, there were hardly 20 to 25 private leasing
companies who were active in the field. The total volume of
leasing business transacted by both private and public sector
leasing companies was Rs.5000 crore in 1993and it is expected to
cross rs.10,000 crore by March 1995.
Methods of Fixation of Lease Rentals
From the Lesse‘‘s Point of view he has to make an
important financial decision -whether to buy a capital equipment
or take it on a lease basis. Simlarly, from the lessor‘ss point of
view, he has to be very careful to computing the lease rentals so
that they may not suffer due to any loss at alater stage. Generally,
the following method is adopting for determining the lease rentals.
Determination of Lease rentals.
He following steps may be adopted for determining the lease
rentals:
Step 1. First, find out the total cost of the asset.
Total cost = Cost of the asset + Freight charges + Insurance +
Taxes +Installation charges, etc.
Step 2. Then, ascertain the cash flows to the lessor on account of
ownership of the asset. While ascertaining the cash flows, the tax
advantage on depreciation, investment allowance, if any, etc.,
should be taken into account. The cash flows should be computed
for each year separately as follows:

52
Cash flow = Amount of depreciation – Tax advantage on
depreciation
- Tax advantage on investment allowance + ―Salvage value
Note: It should be considered only in the last year of the life of the
asset.
* Step 3. The new step is to calculate the present value of already
computed tash flows s (as stated in Ste 2) year-wise with the help
of PV factor. Generally, Step the present value factor at a certain
percentage discount rate will be given. So, it is easy to calculate
the PV of cash flows as follows:
For example: PV factor @ 10 per cent discount
Year 1 = 0.813, Year II = 0.717, Year III = 0.697, Year IV =
0.606, Year V 0517
PV of cash flows – Cash flow for each year x PV factor at a given
discount rate
Step 4. The fourth step is to ascertain the minimum required net
recovery rough lease rentals with the help of the following
formula: rough Lease Rental (MRLR)
Minimum required net recovery = Cost of the asset (Step 1) of
cash flow (Step 3)The present value
Step 5. From this MRLR, it is easy to find out the post-tax lease
rentals the Se Fror the present value factor of annuity. This
annuity discount or at the specified discount rate for a specified
period will also be given. Eg. Annuity Discount factor at 10 per
cent. Discount for 5 years = 3.105.
Post Tax Lease Rental (PTLR) = MRLR/PV factor of Annuity
Step 6. Finally, the pre-tax lease rentals can be ascertained by
adjusting PTLR for the tax factor as follows:
Pre Tax Lease Rental (LR) = PTLR x 100/Tax rate.
From this, lease rental for each month can be computed. Usually,
this rent will be expressed in terms of per thousand and per month.
Therefore, the rate per month = Pre tax lease rental (CR)X
10000/Total cost of the asset X1/2.

53
Buy or Lease decision‘
Successful financial management requires taking sound financial
decisions at the appropriate time. One such decision is to decide
whether to buy a capital asset or to take it on a lease basis. These
two alternate proposals should be carefully studied before taking
any final decision. The financial viability of both the proposals
should be evaluated by adopting the normal technique of capital
budgeting. Generally, the NPV (Net Present Value technique is
used for this purpose. The present values of net cash outflows
after tax from these two options should be compared and the one
with lower present value of cash outflows is to be selected.
Decision Making process
For taking a final decision, the following factors should be taken
account:
As usual calculate depreciation on the capital asset to be bought
applying the formula:
Depreciation = Cost of Asset-Salvage Value/[Link] years of life.
(ⅱ) Then, ascertain savings in tax on depreciation with the help of
the tax rate.
Saving in tax on depreciation = Depreciation x Tax rate
(ⅲ) Similarly, find out savings in tax on interest paid with the he
the tax rate for the given period.
(iv) Then, calculate the Present Value of After-tax cash outflows
and purchase option with the help of the appropriate discount
rate(required rate of return).
Generally the present value of rupee one due for the given period
(any number of years) can be found with the help of following
formula:
PV = 1/(1+r)n
Where, PV means present value
R refers to rate of interest / discount
n-number of years
Factors Influencing Lease Vs Buy Decisions

54
 1. Capital adequacy
2. Liquidity consideration
3. Flexibility consideration
4. Nature of Asset
5. Availability of Finance
6. Debt capacity
7. Grants and Incentive consideration
8. Borrowing restrictions
9. Administrative consideration
Leasing and buying an asset, several factors need to be
considered to make an informed decision. These factors can be
broadly categorized into financial, operational, and strategic
considerations. Here are the key factors:
Financial Factors
Cost of Ownership vs. Leasing Costs:
Initial Cost:
Buying usually requires a larger upfront investment compared to
leasing.
Monthly Payments:
Lease payments are typically lower than loan payments.
Total Cost Over Time:
Calculate the total cost over the asset's useful life, including
interest, maintenance, and residual value.
Depreciation:
Owning an asset means bearing the cost of depreciation, which
can impact the overall value of the asset over time.
Tax Implications:
Leasing payments are often fully deductible as business expenses,
while buying may offer depreciation and interest deductions.
Cash Flow Impact:
Leasing can improve cash flow since it requires less initial capital
outlay and provides predictable monthly expenses.

55
Interest Rates:
The cost of financing an asset purchase is influenced by prevailing
interest rates, which can make leasing more attractive in high-
interest environments.
Residual Value Risk:
Leasing transfers the residual value risk to the lessor, whereas
buying leaves the owner with the risk of the asset‘s future value.
Operational Factors
Usage Requirements:
High-usage or high-mileage assets might be better purchased, as
lease agreements often come with usage limitations and penalties.
Maintenance and Repairs:
Ownership typically involves higher maintenance and repair costs,
whereas some leases include maintenance in the lease agreement.
Flexibility and Mobility:
Leasing offers more flexibility to upgrade or change equipment
frequently, which can be beneficial in rapidly changing industries.
Strategic Factors
Asset Control:
Buying provides complete control over the asset, including
modifications, usage, and disposal. Leasing may have restrictions
on how the asset is used or altered.
Long-term Business Strategy:
If the asset is critical to the core operations and expected to be
used for a long period, buying might be more advantageous. For
short-term needs or rapidly evolving technologies, leasing might
be preferred.
Balance Sheet Considerations:

56
Leasing can be off-balance-sheet financing (operating leases),
which can be beneficial for certain financial metrics. However,
with changes in accounting standards (like IFRS 16 and ASC
842), many leases are now recognized on the balance sheet.
Risk Management:
Leasing can help manage risk, particularly for assets that may
become obsolete quickly. It allows businesses to avoid the risk of
owning outdated or underutilized equipment.
Examples
Technology Equipment:
Given the rapid obsolescence, leasing is often preferred to ensure
access to the latest technology without the burden of disposal or
depreciation.
Vehicles:
Businesses that require a fleet of vehicles might lease to maintain
newer models and avoid the high depreciation costs associated
with ownership.
Real Estate:
Leasing commercial property provides flexibility and can be less
capital-intensive, but buying can be a good investment and
provide long-term stability.
Each factor carries different weights depending on the specific
circumstances of the business and the asset in question. A
comprehensive analysis considering all these aspects will guide
the best decision between leasing and buying.
Objective type of questions
1. Which of the following clearly define the Leasing
services?
a) One party agrees to rent property owned by another
property

57
 b) It guarantees the lessee, also known as the tenant, use of an
asset
c) It guarantees the lessor, regular payments from the lessee
d) All the above
Answer: a) All the above
2. The type of lease that includes a third party, a lender, is
called as which of the following?
a) Sale and Lease back b) Leveraged Lease
c)Direct leasing arrangements d) Operating Lease
Answer: Leveraged Lease
3. A Direct lease, a sale and leaseback, and a Leveraged lease
are all examples of which of the following?
a) Operating Lease b)Financial Leases
c)Full service leases d) Off Balance sheet method
of financing
Answer: Financial Leases
4. What are the benefits of leasing to other companies?
a) Interest Revenue b) High Residual values
c)Tax incentives d) All of the above
Answer: All of the above
5. Which of the following clearly defines Price Checking?
a) A prospects call on the phone and ask for your rental rates
b) A supervisor checks your knowledge rental rates
c) Both a and b
d) None of the above

58
 Answer: a) A prospects call on the phone and ask for your
rental rates
PART A
1. What are the terms used in a lease agreement? 2, list out the
legal aspects involved in leasing?
3. How does financial lease differ from operating lease?
4. What is hire purchase?
5. Who is hirer?
6. Who is Hire Vendor?
7. What is leveraged lease?
8. Who is Lessee?
9. Who is lessor?
10. What is consumer loan?
Part B
1. Discuss the various types of leasing?
2. What are the contents of hire purchase agreement?
3. Bring out the differences between hire purchase and lease?
4. Discuss the advantages of leasing?
5. What are the benefits available under leasing agreement in
india?
6. Explain features of hire purchase
7. Detail functions of the various participants in lease contract?
8. What are the limitations of lease financing ?
9. What are the characteristics and features of a leasing?
10. Discuss various consumer finance

59
 CHAPTER V
Hire Purchase

Meaning of Hire Purchase

Hire purchase is a method of selling goods. In a hire purchase
transaction, the goods are let out on hire by a finance company
(creditors) to the hire purchase customer (hirer). The buyer is
required to pay an agreed amount in periodical installments during
a given period. The ownership of the property remains with
creditors and passes on to hirer on the payment of last installment.
Concept of Hire Purchase
Hire purchase is a type of installment credit under which
the hire purchaser, called the hirer, agrees to take the goods on
hire at a stated rental, which is inclusive of the repayment of
principal as well as interest, with an option to purchase. Under this
transaction, the hire purchaser acquires the property (goods)
immediately on signing the hire purchase agreement but the
ownership or title of the same is transferred only when the last
installment is paid.
The hire purchase system is regulated by the Hire Purchase
Act 1972. This Act defines a hire purchase as ―An agreement
under which goods are let on hire and under which the hirer has an
option to purchase them in accordance with the terms of the
agreement and includes an agreement under which:
1. The owner delivers possession of goods thereof to a person
on condition that such person pays the agreed amount in
periodic installments.
2. The property in the goods is to pass to such person on the
payment of the last of such installments, and
3. Such person has a right to terminate the agreement at any
time before the property so passes‖.

60
Legal framework for Hire purchase transactions
The hire purchase system is regulated by the Hire Purchase
Act 1972. In a hire – purchase transaction, assets are let on hire,
the price is to be paid in installments and hirer is allowed an
option to purchase the goods by paying all the installments. A
Hire Purchase agreement usually requires the customer to pay an
initial deposit, with the remainder of the balance, plus interest,
paid over an agreed period of time.
Under Hire Purchase Agreement
 Purchase goods through installment payments
 Use the goods while paying for them
 Do not own the goods until you have paid the final
installment Rights of the hirer
The hirer rights
 To buy the goods at any time by giving notice to the owner
and paying the balance of the HP price less a rebate
 To return the goods to the owner -this is subject to the
payment of a penalty.
 With the consent of the owner, to assign both the benefit
and the burden of the contract to a third person.
 Where the owner wrongfully repossesses the goods, either
to recover the goods plus damages for loss of quiet
possession or to damages representing the value of the
goods lost.
Additional Rights
 Rights of protection
 Rights of notice
 Rights of repossession
 Rights of Statement
 Rights of excess amount
Obligation of hirer
The hirer usually has following obligations:

61
1. To pay hire installments,
2. To take reasonable care of the goods
3. To inform the owner where goods will be kept.
Owner’s Right
The owner usually has the right to terminate agreement where
hirer defaults in paying the installments or breaches any of the
other terms in agreement. This entitles the owner:
 To forfeit the deposit.
 To retain the installments already paid and recover the
balance due.
 To repossess the goods (which may have to be by
application to a Court depending on the nature of the
goods and the percentage of the total price paid.
 To claim damages for any loss suffered.
RBI guidelines for Hire Purchase Business
Under section 6(I) (0) of Banking Regulation Act - 1949, the
Govt. Of India has permitted banks to engage in HP business.
Following are some of the important guidelines of RBI for HB
business of banks;
1. Banks shall not themselves undertake directly
(departmentally) the business of hire purchases.
2. Banks desirous of undertaking HP business through an
existing companies or new subsidiaries will require prior
approval of RBI.
3. Banks investments in the shares of subsidiaries engaging
in leasing and HP business shall not exceed 10% of the
paid-up share capital and reserves of the banks.
4. Without prior approval of RBI, banks shall not act as
promoters of other hire purchase companies.
5. Prior clearance of RBI is required for the purpose of any
application to the Controller of Capital issue in case of
IPO of new subsidiary and FPO of existing subsidiaries of
Banks.

62
 6. Bank shall furnish necessary information regarding its HP
or equipment leasing subsidiaries, as and when RBI
demands.
Problems and prospects of Hire Purchase
Hire purchase transactions are very uncommon
transactions in India. Meaning there by the awareness of this
concept is very lesser in India. All segment of India‘s population
treats the hire purchase transaction as a hypothecation loan but
there is a slight differentiation among all processes related to hire
purchases. Almost for the population of India the hire purchase
transaction is very similar to the loans & hypothecation.
Person who wants to purchase any asset then the best
option & way for him or her would be loan or hypothecation.
Because the public is not aware with transaction named hire
purchases. Hire purchase transaction is of two types the cash
credit & asset hire purchases. People do not go for hire purchases
in India because in India business people are very less so they can
not hire the assets for a longer period of time. Finally, we would
like to end up over here that, lack of awareness leads to
occurrence of problem in dealing with hire purchase.
Other problems of HP are follows
1. Personal debt
A hire purchase agreement is yet another form of personal
debt it is monthly repayment commitment that needs to be
paid each month
2. Final Payment
A consumer doesn‘t have legitimate title to the goods until
the final monthly repayment has been made;
3. Bad credit
All hire purchase agreements will involve a credit check.
Consumers that have a bad credit rating will either be turned
down or will be asked to pay a high interest rate;
4. Creditor harassment

63
 Opting to buy on credit can create money problems should a
family experience a change of personal circumstances;
5. Repossession Rights
Seller is entitled to ‗snatch back‘ any goods when less than a
third of the amount has been paid back.
Difference between Lease and Hire Purchase
Leasing is a contractual agreement under which the owner
of an asset called lessor agrees to allow the use of the asset by
another party called lessee for a periodic payment as lease rent.
Hire purchase is a method of selling goods. In a hire
purchase transaction the goods are let out on hire by a finance
company to the hire purchase customer. The buyer is required to
pay an agreed amount in periodical installments during a given
period. The ownership of the property remains with the creditor
and passes on to hirer on the payment of last installment.
Hire Purchase and Leasing Similarities
 Economic substance of both of them is same.
 Both are instances of bailment with hire purchase having
an additional element of sale.
 Financial remains owner in both cases.
 Repossession rights are similar in both cases.
 In case of motor vehicles in both cases user is recognized
as owner.
 Documentation largely same in both cases.
 Requirements of bailment are applicable to both with
equal force.
[Link] Leasing Hire Purchase
Ownership is with Ownership passed at the option
1 financier forever of the hirer at end

2 No option to buy It contains option to buy

64
 Legal ownership is with Legal ownership with the
3 the lessor financier

Income tax recognizes Income tax recognizes hirer as

4 lessor as owner owner

Depreciation allowed to Depreciation allowed to hirer.

5 lessor

Lease rental taxed as Only the interest point of

6 lessor‘s income and installments taxed as financier
allowed as lessee‘s income and allowed as hirer‘s
expenses. expenses.
7 Accounted as a lessors Accounted as hirer‘s asset
asset
8 Sales tax laws treat as Sales tax laws treat as nominal
special sale sale
Leasing finance Hire purchase financing both
9 business assets business assets and consumer
articles
Lessee does not enjoy Hirer being owner of the asset,
10 the salvage value of the enjoy the salvage value of the
asset asset
11 No deposit in leasing 20% deposit is required in hire
purchase.

Objective type of questions

1. When examining for deficiencies of stock, a firm would
not make allowances for which of the following?
a) Changes in market conditions
b) b) stealing by customers
c)Theft by employees
d)Wastage of goods

65
 Answer: Changes in market conditions
2. Which of the following is the act of buying an asset
without having to make full payment in the immediate
future?
a) Operating Lease b) Hire Purchase
c)Sale and Leaseback d) Finance Lease
Answer: Hire Purchase
3. The rules for how to deal with leases and hire purchase
contracts is dealt with in which accounting standard?
a)FRS 16 b) FRS19
c)SSAP 21 d) SSAP 20
Answer: SSAP 21
4. Which of the following would not make a distinction
between a hire purchase and a ‗normal‘ purchase?
a) Purchaser pays for an item by instalments over a period of
time
b) Asset does not belong topurchaser when delivery is
received from supplier
c) Cost to buyer is likely to be higher than it would be for a
normal purchase
d) Trade discounts cannot be offered on hire purchase
Answer: Trade discounts cannot be offered on hire purchase
5. On the balance sheet of a company, the value of the asset
bought through hire purchase will appear as which of the
following?

66
a) Cost less depreciation to date less amount owing on
hire purchase less interest owing
b) Cost less amounts owing on hire purchase
c) Cost less depreciation to date
d) Cost less depreciation to date less owing on hire
purchase.
Answer: c) Cost less depreciation to date

67
 CHAPTER VI

Factoring
MEANING OF FACTORING
Factoring is a financial service in which the business entity
sells its bill receivables to a third party at a discount in order to
raise funds. It differs from invoice discounting. The concept of
invoice discounting involves, getting the invoice discounted at a
certain rate to get the funds, whereas the concept of factoring is
broader. Factoring involves the selling of all the accounts
receivable to an outside agency. Such an agency is called a factor.

CONCEPT OF FACTORING
The seller makes the sale of goods or services and
generates invoices for the same. The business then sells all its
invoices to a third party called the factor. The factor pays the
seller, after deducting some discount on the invoice value. The
rate of discount in factoring ranges from 2 to 6 percent. However,
the factor does not make the payment of all invoices immediately
to the seller. Rather, it pays only up to 75 to 80 percent of the
invoice value after deducting the discount. The remaining 20 to 25
percent of the invoice value is paid after the factor receives the
payments from the seller‘s customers. It is called factor reserve.
SALIENT FEATURES OF FACTORING
Credit Cover
The factor takes over the risk burden of the client and thereby the
client‘s credit is covered through advances.
Case advances
The factor makes cash advances to the client within 24 hours of
receiving the documents.
Sales ledgering
As many documents are exchanged, all details pertaining to the
transaction are automatically computerized and stored.

68
Collection Service
The factor, buys the receivables from the client, they become the
factor‘s debts and the collection of cheques and other follow-up
procedures are done by the factor in its own interest.

Provide Valuable advice

The factors also provide valuable advice on country-wise and
customer-wise risks. This is because the factor is in a position to
know the companies of its country better than the exporter clients.

MECHANISM OF FACTORING
The mechanism of factoring is summed tip as below:
(i) An agreement is entered into between the selling firm and
the factor firm. The agreement provides the basis and the scope of
the understanding reached between the two for rendering factor
services.
(ii) The sales documents should contain the instructions to
make payments directly to the factor who is assigned the job of
collection of receivables.

(iii) When the payment is received by the factor, the account of

the selling firm is credited by the factor after deducting its fees,
charges, interest etc. as agreed.
(iv) The factor may provide advance finance to the selling firm
if the conditions of the agreement so require.
PARTIES TO THE FACTORING
There are basically three parties involved in a factoring
transaction.
[Link] buyer of the goods.
[Link] seller of the goods

69
[Link] factor i.e. financial institution.
The three parties interact with each other during the purchase/ sale
of goods. The possible procedure that may be followed is
summarized below
The Buyer.

[Link] buyer enters into an agreement with the seller and

negotiates the terms and conditions for the purchase of goods on
credit.
[Link] takes the delivery of goods along with the invoice bill and
instructions from the seller to make payment to the factor on due
date.
[Link] will make the payment to the factor in time or ask for
extension of time. In case of default in payment on due date, he
faces legal action at the hands of factor.
The Seller
[Link] seller enters into contract for the sale of goods on credit as
per the purchase order sent by the buyer stating various terms and
conditions.

[Link] goods to the buyer as per the contract.

[Link] copies of invoice, delivery challan along with the goods
to the buyer and gives instructions to the buyer to make payment
on due date.
[Link] seller sells the receivables received from the buyer to a
factor and receives 80% or more payment in advance.

[Link] seller receives the balance payment from the factor after
paying the service charges.

The Factor
[Link] factor enters into an agreement with the seller for rendering
factor services i.e. collection of receivables/debts.

70
[Link] factor pays 80% or more of the amount of receivables
copies of sale documents.
[Link] factor receives payments from the buyer on due dates and
pays the balance money to the seller after deducting the service
charges.
Functions of Factor
A factor performs a number of functions for his client.

These functions are:

[Link] OF SALES LEDGER
A factor maintains sales ledger for his client firm. An
invoice is sent by the client to the customer, a copy of which is
marked to the factor. The client need not maintain individual sales
ledgers for his customers.
On the basis of the sales ledger, the factor reports to the
client about the current status of his receivables, as also receipt of
payments from the customers and as part of a package, may
generate other useful information. With the help of these reports,
the client firm can review its credit and collection policies more
effectively.
[Link] OF ACCOUNTS RECEIVABLES

Under factoring arrangement, a factor undertakes the

responsibility of collecting the receivables for his client. Thus, the
client firm is relieved of the rigours of collecting debts and is
thereby enabled to concentrate on improving the purchase,
production, marketing and other managerial aspects of the
business.

With the help of trained manpower backed by

infrastructural facilities a factor systematically undertakes follow
up measure and makes timely demand in the debtors to pay

71
amounts. Normally, debtors are more responsive to demands or
reminders from a factor as they would not like to go down in the
esteem of credit institution as a factor.

[Link] CONTROL AND CREDIT PROTECTION

Another useful service rendered by a factor is credit
control and protection. As a factor maintains extensive
information records (generally computerized) about the financial
standing and credit rating of individual customers and their track
record of payments, he is able to advise its client on whether to
extend credit to a buyer or not and if it is to be extended the
amount of the credit and the period there-for.
Further, the factor establishes credit limits for individual
customers indicating the extent to which he is prepared to accept
the client‘s receivables on such customers without recourse to the
client. This specialized service of a factor assists clients to handle
a far greater volume of business with confidence than would have
been possible otherwise.
In addition, factor provides credit protection to his client by
purchasing without recourse to him every debt of approved
customers (within the stipulated credit limit) and assumes the risk
of default in payment by customers only in case of customers‘
financial inability to pay.

[Link] FUNCTIONS
Times, factors render certain advisory services to their
clients. Thus, as a credit specialist a factor undertakes
comprehensive studies of economic conditions and trends and
thus is in a position to advise its clients of impending
developments in their respective industries. Many factors employ
individuals with extensive manufacturing experience who can
even advise on work load analysis, machinery replacement

72
programs and other technical aspects of a client‘s business.
Factors also help their clients in choosing suitable sales
agents/seasoned personnel because of their close relationship with
various individuals and non-factored organizations. Thus, as a
financial system combining all the related services, factoring
offers a distinct solution to the problems posed by working capital
tied in trade debts.

TYPES OF FACTORING

[Link] Factoring
Factoring can be both domestic and for exports. In domestic
Factoring, the client sells goods and services to the customer and
delivers the invoices, order, etc., to the Factor and informs the
customer of the same.

In return, the Factor makes a cash advance and forwards a

statement to the client. The Factor then sends a copy of all the
statements of accounts, remittances, receipts, etc., to the customer.
On receiving them the customer sends the payment to the Factor.

Different types of Domestic Factoring are as follows

[Link] Factoring
This is also known as ―Without Recourse Factoring ―. It is
the most comprehensive type of facility offering all types of
services namely finance sales ledger administration, collection,
debt protection and customer information.
[Link] Factoring
The Factoring provides all types of facilities except debt
protection. This type of service is offered in India. As discussed
earlier, under Recourse Factoring, the client‘s liability to Factor is
not discharged until the customer pays in full.

73
[Link] Factoring
It is also known as ―Collection Factoring ―. Under this
arrangement, except providing finance, all other basic
characteristics of Factoring are present. The payment is effected to
the client at the end of collection period or the day of collecting
accounts whichever is earlier.

[Link] Factoring
This could be with or without recourse. Under this
arrangement, the Factor provides advance at an agreed rate of
interest to the client on uncollected and non-due receivables. This
is only a pre- payment and not an advance. Under this method, the
customer is not notified about the arrangement between the client
and the Factor. Hence the buyer is unaware of factoring
arrangement. Debt collection is organized by the client who
makes payment of each invoice to the Factor, if advance payment
had been received earlier.

[Link] Discounting
In this arrangement, the only facility provided by the
Factor is finance. In this method the client is a reputed company
who would like to deal with its customers directly, including
collection, and keep this Factoring arrangement confidential. The
client collects payments from customer and hands it over to
Factor. The risk involved in invoice discounting is much higher
than in any other methods. The Factor has liberty to convert the
facility by notifying all the clients to protect his interest. This
service is becoming quite popular in Europe and nearly one third
of Factoring business comprises this facility.

[Link] Factoring
It is a modified version of Involve discounting wherein
notification of assignment of debts is given to the customers.

74
However, the client is subject to full recourse and he carries out
his own administration and collection.

[Link] Factoring
Under this arrangement, the facilities of finance and
protection against bad debts are provided by the Factor whereas
the sales ledger administration and collection of debts are carried
out by the client.

[Link] Guarantee Factoring

Supplier Guarantee Factoring is also known as ‗drop
shipment factoring‘. This happens when the client is a mediator
between supplier and customer. When the client is a distributor,
the factor guarantees the supplier against the invoices raised by
the supplier upon the client and the goods may be delivered to the
customer. The client thereafter raises bills on the customer and
assigns them to the factor. The factor thus enables the client to
make a gross profit with no financial involvement at all.

[Link] participation factoring

In bank participation factoring the bank takes a floating
charge on the client‘s equity i.e., the amount payable by the factor
to the client in .respect of his receivables. On this basis, the bank
lends to the client and enables him to have double financing.

[Link] and Undisclosed Factoring

The factoring in which the factor‘s name is indicated in the
invoice by the supplier of the goods or services asking the
purchaser to pay the factor, is called disclosed factoring.
Conversely, the form of factoring in which the name of the factor
is not mentioned in the invoice issued by the manufacturer. In
such a case, the factor maintains sales ledger of the client and the
debt is realized in the name of the firm. However, the control is in
the hands of the factor.

75
[Link]-Based Factoring
Buyer-based factoring involves factoring of all the buyer‘s
payables. Thus, the factor would maintain a list of ‗approved
buyers‘ and any claims on such buyers (by any seller) would be
factored without recourse to the seller.

[Link] Factoring
Traditionally international trade is based on Letters of
Credit. When the exporter knows the importer well with repetitive
transactions, he may be willing to export on ‗Open Account
‗basis. On open account the exporter ships the goods without letter
of credit or advance payment. Hence, it is credit risky for
exporter. If credit is extended (say 90 days since), the exporter
will be quite reluctant as he encounters a credit risk and hence
invariably insists on L/C.
In advanced countries bankers do not make much of a
distinction between fund-based and non- fund based facilities and
hence if they have to open L/C‘s it may be at the cost of a reduced
overdraft or bills limit for the importer.

The system of L/C‘s operates on the ―Doctrine of Strict

Compliance‖ which means the Letter of Credit opening bank will
pay money to the exporter only when all the conditions listed in
the Letter of Credit document are satisfied by the exporter/shipper
of goods.

In many cases, the documents fail to pass the grade which

means the exporter has simply lost the security available to him
under the L/C. Further, now-a-days, goods move very fast and
hence if documents are held up in banks for processing, it causes
delay and inconvenience to the importer.

In the light of the above, international trade has slowly

started moving from cash to credit, and from L/C‘s to open

76
account sales. International Factoring is a service which helps the
exporter and importer to trade on open account terms.

Types of International Factoring

The following are the important types of International
Factoring. The client can choose any type of international
factoring depending upon exporter – client needs and his price
bearing capacity.

Two Factor Systems

This is the most common system of international factoring
and involves four parties i.e., Exporter, Importer, Export Factor in
exporter‘s country and Import Factor in Importer‘s country.

The functions of the export Factor are

[Link] of the financial strength of the exporter

[Link] to the exporter

[Link]-up with the Import Factor

[Link] of commission with the import Factor The functions of

the Import Factor are:
[Link] the books of the exporter in respect of sales to the
debtors in his country

[Link] of debts from the importer and remitting the proceeds

to the exporter‘s Factor
[Link] credit protection in case of financial inability on the
part of any of the debtors

[Link] / Direct Factoring System

In this system, a special agreement is signed between two
Factoring companies for single Factoring. Whereas in Two Factor

77
System, credit is provided by import Factor and pre-payment,
book keeping and collection responsibilities remain with export
Factor. For this system to be effective there should be strong co-
ordination and co-operation between two Factoring companies.
Pricing is lower when compared to Two Factor System.

[Link] Export Factoring

Here only one Factoring company is involved, i.e., export
Factor, which provides all services including finance to the
exporter.

[Link] Import Factoring

Under this system, the seller chooses to work directly with
Factor of the importing country. The Factoring agreement is
executed between the exporter and the import Factor. The import
Factor is responsible for sales ledger administration, collection of
debts and providing bad debt protection up to the agreed level of
risk cover.

[Link] to Back Factoring

It is a very specialized form of International Factoring,
used when suppliers are selling large volumes to a few debtors for
which it is difficult to cover the credit risk in International
[Link] this case, International Factor can sign a domestic
Factoring agreement with the debtor whereby it will be getting the
receivables as security for the credit risk taken in favour of Export
Factor.

ADVANTAGES OF FACTORING IMMEDIATE CASH

INFLOW
This type of finance shortens the cash collection cycle. It
provides swift realization of cash by selling the receivables to a
factor. Availability of liquid cash sometimes becomes a deciding

78
factor for grabbing an opportunity or losing it. The cash boost
provided by factoring is readily available for capital expenditures,
securing a new order or meeting an unforeseen condition.

ATTENTION TOWARDS BUSINESS OPERATIONS AND

GROWTH
By selling off invoices, business managers can feel stress-
free of the task of collection from the customers. Resources
employed in the receivables department can be directed towards
business operations, financial planning, and future growth.

EVASION OF BAD DEBTS

Factoring is of two types – with recourse and without
recourse. Under without recourse factoring, in case of bad debts,
the loss is borne by the factor. Hence, the seller is under no
obligation to the factor once it sells off its receivables.

SPEEDY ARRANGEMENT OF FINANCE

Factors provide funds more rapidly than banking
companies. Factoring companies offer quicker application, lesser
documentation and swifter realization of funds as compared to
other financial institutions.

NO REQUIREMENT OF COLLATERAL
The advances are extended on the basis of the strength of
accounts receivables and their credit healthiness. Unlike cash
credit & overdraft, factors do not require any collateral security to
be pledged/hypothecated. New businesses, startups can easily
avail the advances provided they have strong receivables.

SALE NOT LOAN

Factoring transaction is a transaction of sale, not a loan.
Unlike other types of finances, factoring does not result in an

79
increase in liabilities of the business. Hence, there are no adverse
impacts on the financial ratios as well. It just involves the
conversion of book debts into liquid cash.

CUSTOMER ANALYSIS
Factors provide valuable advice and insights to the seller
regarding the credit strength of the party from whom receivables
are pending. It helps in negotiating better terms between the
parties in future contracts.

REDUCED CURRENT LIABILITIES

The amount received from the factoring is used to pay off
the bank borrowing and other current liabilities comprising trade
creditors. As a result, current liabilities are considerably reduced.
The liquidity position of the firm is strengthened further.

OFF-BALANCE SHEET FINANCE

When the factor purchases the clients‘ debts, the finance is
provided off the balance sheet. In recourse factoring, the finance
appears in the client‘s balance sheet only as a contingent liability.
In recourse factoring, if the customer defaults in payment, the
client has to make good the loss incurred by the factor. The factor
is entitled to recover from the client the amount paid in advance.
But in case of non-recourse factoring, the finance provided does
not appear anywhere in the financial statements of the borrower.
The factor does not have the right of recourse.

HIGHER CREDIT STANDING

With increased cash flows to the client, he is able to meet
his liabilities promptly as and when they arise. The factor‘s
acceptance of the client‘s receivables itself is the mark of high
quality of the receivables factored. The problem of bad debts does
not arise.

80
DISADVANTAGES OF FACTORING REDUCTION OF
PROFIT
The factor deducts a certain discount from the value of
accounts receivable as fees for the services offered. Moreover, in
certain cases, the factor also charges interest on the advance made.
Consequently, profit of an entity is reduced by a significant
margin.
RELIABILITY OF CUSTOMER’S CREDIT
The factor assesses and evaluates credit wellness of the
party who owes bills receivables. This is a critical factor which is
outside the control of the seller. A factor may refuse to extend
advances due to poor credit ratings of the concerned party.

EXHAUSTING OF COLLATERAL SECURITY

Factoring exhaust bills receivables of an entity as the
entity is no longer entitled to receive payments from them. The
seller is no longer holding any control over the book debts. Hence,
they can not be provided as collateral security while obtaining any
other type of finance.

PRESENCE OF CONTINGENT LIABILITY

The liability of the seller is not completely waived in case of with
recourse factoring. If a party fails to pay its debts to the factor, the
factor is legally entitled to recover it from the seller. Thus,
the seller is contingently liable to the factor for paying the debts in
future in case of default. This situation would impact business
operations and financial plans which are under execution.

HIGHER FINANCE CHARGES

Factors usually deduct 2% to 4% of the total amount
involved as their fees for the duration of 45- 60 days. Computing
it annually, the cost of finance turns out to be around 18% to 24%
p.a. which is very higher than other sources of finance.
81
LOSS OF PERSONAL TOUCH
The buyer may not be willing to deal with a factor because
of their professional nature and stringent methods. Factoring
agencies even send notices at regular intervals to the buyer as a
reminder of the debt. The buyer may develop a negative image of
the seller through factoring. Loss of personal touch may lead him
to consider switching vendors.

COMMON PROBLEMS WITH FACTORING INVOICES

[Link] customer is not creditworthy
This is the most common problem when trying to factor
receivables. If the customer is not creditworthy, the invoice isn‘t
factorable. Unfortunately, there is little that can be done about this
since the creditworthiness of the customers is the cornerstone of
factoring.

[Link] invoice exceeds the credit line

This common problem occurs when the total amount of the
invoices that the client want to factor exceeds the credit line that
the provider has assigned to the customer. It‘s always a good idea
to review and manage the status of the line proactively so that one
can anticipate this problem. The solution is to try to negotiate a
credit line increase.

3. The invoice can’t be verified

Most factoring companies will verify invoices prior to
funding. This step allows them to verify that the work has been
completed satisfactorily – or that the product has been delivered in
accordance with the purchase order. It also helps you ensure that
the clients are happy. However, customers can refuse to verify an
invoice at their discretion. And if they do, the provider may not
factor that invoice.

82
4. The customer refuses to submit payment to the factoring
company
As part of the financing process, the customer must submit
the invoice payment directly to the factoring company. This
process is usually outlined in the notice of assignment letter that is
sent to them. For whatever reason, the customer could refuse to
send the payment to the factor. This situation can be very
problematic and could prevent factor from financing the invoices
associated with that customer.

[Link] work is not complete / the product is not delivered

This is the most common problem when factoring
invoices. Usually the client tries to factor an invoice for which the
service has not been completed or the product has not been fully
delivered. This invoice will be un-factorable until the work is
completed or the product is delivered. Factoring companies can
only purchase invoice for completed services.

KEY DIFFERENCES BETWEEN BILL DISCOUNTING

AND FACTORING
The following are the major differences between bill discounting
and factoring:
 Selling of bills at a discount to the bank, before its maturity is
known as Bill Discounting. Selling of the debtors to a financial
institution at a discount is Factoring.
 The bill is discounted, and the whole amount is paid to the
borrower at the time of the transaction. Conversely, the
maximum part of the amount is provided as an advance, and
the rest of the amount is given as balance when the dues are
realized.
 The parties to bill discounting are a drawer, drawee, and payee
whereas the parties to factoring are the factor, debtor, and
borrower.

83
 The bill discounting is always recourse, i.e. if the customer
defaults in payment of debt, then the payment is made by the
borrower. On the other hand, the factoring can be recourse and
nonrecourse.
 The Negotiable Instrument Act, 1881 contains the rules
relating to bills discounting. In contrast to factoring which is
not covered under any act.
 In bill discounting the financier gets the discounting charges
for financial services, but in the case of factoring the factor gets
interest and commission.
 In factoring, the debts are assigned which is not done in bill
discounting.
FACTORING IN INDIA
Factoring service in India is of recent origin. It owes its
genesis to the recommendations of the Kalyanasundaram Study
Group appointed by the RBI in 1989. Pursuant to the acceptance
of these recommendations, the RBI issued guidelines for factoring
services in 1990. The first factoring company – SBI Factors and
Commercial Ltd (SBI FACS) started operation in April 1991. This
article highlights the important aspects of the factoring services in
India.
The business of factoring in India is regulated by the
Factoring Regulation Act, 2011. Section 2(j) of the Factoring
Regulation Act, 2011 defines factoring business as ―factoring
business‖ means the business of acquisition of receivables of
assignor by accepting assignment of such receivables or financing,
whether by way of making loans or advances or otherwise against
the security interest over any receivables but does not include—
1. credit facilities provided by a bank in its ordinary course
of business against security of receivables;

84
 2. any activity as commission agent or otherwise for sale of
agricultural produce or goods of any kind whatsoever or
any activity relating to the production, storage, supply,
distribution, acquisition or control of such produce or
goods or provision of any services.‖

3. At present, the factoring business can be carried out by

either banks or NBFCs. The Reserve Bank of India (RBI)
is the regulatory body supervising the factoring business.
Banks can undertake factoring business without the prior
approval of RBI. However, NBFCs intending to carry out
factoring business as their principal business are required
to obtain a prior approval from RBI.
4. Further, the Factoring Regulation Act, 2011, states that the
NBFCs which intend to engage itself in the factoring
business have to fulfill the principality test. To determine
whether the principal business of the NBFC is factoring, it
needs to fulfill the following conditions
a) if its financial assets in the factoring business are more
than fifty per cent of its total assets or such per cent as may
be stipulated by the Reserve Bank; and

b) if its income from factoring business is more than fifty per

cent of the gross income or such per cent as may be
stipulated by the Reserve Bank.‖

Market for factoring in India

SBI Factors and Commercials Limited was the first
factoring company to start its operation in India in April, 1991.
Since then a number of companies have started factoring business
in India. At present, there are only 7 NBFC factors registered with
RBI.

85
 Since its inception, factoring business has made a
significant progress in India. The total factoring volume has
increased in the past 7 years. The factoring volume was highest in
2013 and subsequently decreased till 2015. In the years 2016 and
2017, there was again a rise in the volume. The following graph
depicts this increase: In the year 2017, the total volume of
factoring was Rs. 361811 million[2] (4269 in million EUR[3]).
Out of this, the major contribution was from the domestic sector.
The domestic sector contributed Rs. 325622 million (3842 in
million EUR) and the international sector Rs. 36189.60 million
(427 in million EUR). The following pie chart shows the
percentage contributed by the domestic and international sectors
in the total factoring volume in the year [Link] factors such
as lack of awareness, a perception of high interest rates and
cumbersome documentation processes, have prevented the growth
of factoring services in India.

Global Scenario
Factoring business is becoming popular over the world on
account of various services offered by the factors. The world
factoring statistics indicate that the factoring industry volume
have shown a significant growth. The total volume estimated for
2017 amounts to Rs. 209510 billion (2,472 billion EUR).

Though the Asian market for factoring has declined by 4%

in 2017 but Indian market for factoring has increased by 10% in
2017 as compared to [Link], the contribution of India in
the global factoring market is way too less than the other Asian
countries. The factoring volume in India in 2017 is Rs. 361811
million (4269 in million EUR) as compared to other Asian
countries like Rs. 34370500 million (405537 in million EUR) in
China, Rs. 3978650 million (46944 in million EUR) in Hong
Kong, Rs. 3159940 million (37284 in million EUR) in Japan and
Rs. 3729140 million (44000 in million EUR) in Singapore. The

86
following chart shows a comparison of Indian factoring market
with other Asian countries factoring market.

EXPORT FACTORING
Export factoring services are offered to the exporters
(clients) who sell their products or services to the importers
(customers) in other countries on open account tern having a
credit period ranging from 60 to 180 days. Before the goods are
shipped to the customer, export factor is expected to investigate
the customer's creditworthiness and assume responsibility for
collecting all amounts owed as well as affording credit protection.
Export factor can offer benefits of export factoring both to the
exporters as well as to the importers. The mechanism of export
factoring is similar to that of domestic factoring, the exception
being the exporter and importer belong to two different countries.

Four different types of arrangements are possible for export

factoring:
1) Two Factor System
2) Single (Direct) Factoring System
3) Direct Export Factoring
4) Direct Import Factoring
The main function of the export factor relate to :
 Assessment of the financial strength of the exporter.
 Prepayment to the exporter after proper documentation,
regular audit and post sanction control.
 Follow-up with the import factor.
 Sharing of commission with the import factor.
The main functions of the import factor are as under:
Maintenance of books of the exporter in respect of sales to
the debtors of his country. Collection of book debts from
importers and remitting proceeds of the same to the export factor.

87
Providing credit protection under non-recourse factoring
arrangement in case of financial inability on part of any of the
debtors of his country.

Need for Export Factoring

Many exporters find it difficult to evaluate
creditworthiness of potential importers due to lack of' information
and data. Further, on account of various reasons, they also
experience difficulties to recover dues from import customers on
maturity dates. This poses the problem of credit risk. All these
problems in respect of export trade can be solved by offering
export factoring services to the exporters. Use of such services
will help exporters to sell goods or offer services in abroad on
open account terms and eliminate credit risk as well. Such
facilities will help exporters to expand the business with the
existing customers and search new markets for the business.

88
 CHAPTER VII
FORFAITING
Introduction
Forfaiting is a means of financing that enables exporters to
receive immediate cash by selling their medium and long-term
receivables—the amount an importer owes the exporter—at a
discount through an intermediary. The exporter eliminates risk by
making the sale without recourse. It has no liability regarding the
importer's possible default on the receivables. A forfaiter is
typically a bank or a financial firm that specializes in export
financing.

Definition of Forfaiting
Forfaiting is a mechanism, in which an exporter surrenders
his rights to receive payment against the goods delivered or
services rendered to the importer, in exchange for the instant cash
payment from a forfaiter. In this way, an exporter can easily turn a
credit sale into cash sale, without recourse to him or his forfaiter.

FEATURES OF A FORFAITING ARRANGEMENT

1) It is a specific form of export trade finance.
2) Export receivables are discounted at a specific but fixed
discount rate.
3) Debt instruments most commonly used in Forfaiting
arrangement are a bill of exchange and a promissory note.
4) Payment in respect of export receivables which is further
evidenced by bill of exchange or promissory notes, must
be guaranteed by the importers' bank. The most usual form
of guarantee attached to a Forfaiting agreement.
5) It is always without recourse to the seller (viz. Exporter).
6) Full value of export receivables i.e. 100 per cent of the
contract value is taken into account.

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 7) Normally the export receivables carrying medium to long
term maturities are considered.
COST OF FORFAITING SERVICES
A Forfaiting service is subjected to various costs such as
commitment fee, discount rate and documentation fee. Of these,
discount rate, which is fixed, forms a larger portion of cost of
Forfaiting service.

The discount rate charged by the forfaiter is based on the

following elements
1.A charge for the credit extended or finance provided. This is the
main element and is roughly equivalent to the forfaiter's own costs
of raising the money.

2.A charge based on the risk of interest rate and exchange rate
movements in the currency in which the credit is extended.
3.A charge based on the sovereign risk, political risk and transfer
risk e.g. the probability of a change of government and imposition
of exchange controls preventing the discharge of the debt.
4.A charge based on the credit risk attached to the importer as
well as avalor.

DIFFERENCE BETWEEN FORFAITING AND EXPORT

FACTORING
Forfaiting differs from export factoring in the following
three ways: Factors usually want access to all or a large
percentage of an exporter´s business, while forfaiters will work on
a transaction-by-transaction basis.
 Forfaiters usually work with medium and long term
receivables, while factors work with short term
receivables. Since payment terms usually reflect the types
of products involved.

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  Forfaiters usually work with sales of capital goods
(machinery), commodities and large projects, while factors
work mostly with sales of consumer goods.

 Most factors do not have strong capabilities with

developing countries where legal and financial
frameworks are inadequate and credit information is rarely
available through affiliate factor. However, most forfaiters
are willing to work with sales to such countries because
they usually required bank or sovereign guarantees.

KEY DIFFERENCES BETWEEN FACTORING AND

FORFAITING
The major differences between factoring and forfaiting are
described below:

[Link] refers to a financial arrangement whereby the business

sells its trade receivables to the factor (bank) and receives the cash
payment. Forfaiting is a form of export financing in which the
exporter sells the claim of trade receivables to the forfaiter and
gets an immediate cash payment.

[Link] deals in the receivable that falls due within 90 days.

On the other hand, Forfaiting deals in the accounts receivables
whose maturity ranges from medium to long term.

[Link] involves the sale of receivables on ordinary goods.

Conversely, the sale of receivables on capital goods are made in
forfaiting.
[Link] provides 80-90% finance while forfaiting provides
100% financing of the value of export.

[Link] can be recourse or non-recourse. On the other hand,

forfaiting is always non- recourse.

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[Link] cost is incurred by the seller or client. Forfaiting cost
is incurred by the overseas buyer.

[Link] involves dealing with negotiable instruments like bills

of exchange and promissory note which is not in the case of
Factoring.
[Link] factoring, there is no secondary market, whereas in the
forfaiting secondary market exists, which increases the liquidity in
forfaiting.

PROCESS OF FORFAITING
The forfaiter is a financial intermediary that provides
assistance in international trade. It is evidenced by negotiable
instruments i.e. bills of exchange and promissory notes. It is a
financial transaction, helps to finance contracts of medium to long
term for the sale of receivables on capital goods. However, at
present forfaiting involves receivables of short maturities and
large amounts.

[Link] resorting to forfaiting, the exporter approaches the

forfaiting company with the details of his export and the details of
the importer and the importing country.
[Link] approval by the forfaiter, along with the terms and
conditions, a sale contract is entered into between the exporter and
importer.
[Link] execution of the export, the exporter submits the bill to the
forfaiter and obtains payment. In this way, the three parties
involved in the forfaiting process are the exporter, the importer
and the forfaiter.

[Link] the exports are done against Document Acceptance Bill, it has
to be signed by the importer and since the importer‘s bank has

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guaranteed through the Letter of credit, it will be easy for the
forfaiter to collect payment.

[Link] the trade documents, connected with exports, are handed

over by the exporter to his bank which in turn hands over the
documents to the importer‘s bank.
[Link] proof of all these documents will be submitted by the
exporter to the forfaiter who will make payment for the export.

[Link] cost of forfaiting is included in the bill. The exporter may

not lose much as the interest will be included in the invoice and
recovered from the importer. However, the forfaiter is exposed to
the risk of fluctuations in the exchange rate, interest rate and
commercial risk, and to cover these risks, he charges suitably.

ADVANTAGES OF FORFAITING
The following are some of the advantages of forfaiting.

[Link] provides immediate funds to the exporter who is saved from

the risk of the defaulting importer.
[Link] is an earning to commercial banks who by taking the bills of
highly valued currencies can gain on the appreciation of
currencies.

[Link] forfaiter can also discount these bills in the foreign market
to meet more demands of the exporters.

[Link] is very little risk for the forfaiter as both importer‘s bank
and exporter‘s banks are involved.
[Link] of Credit plays a major role for the forfaiter. Moreover,
he enters into an agreement with the exporter on his terms and
conditions and covers his risks by separate charges.

[Link] forfaiting provides 100% finance to exporter against his

exports, he can concentrate on his other exports.

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DISADVANTAGES OR DRAWBACKS OF FORFAITING
The following are some of the disadvantages of forfaiting.

[Link] is not available for deferred payments especially

while exporting capital goods for which payment will be made on
a deferred basis by the importer.

[Link] is discrimination between Western countries and the

countries in the Southern Hemisphere which are mostly
underdeveloped (countries in South Asia, Africa and Latin
America).
3There is no International Credit Agency which can guarantee for
forfaiting companies which affects long-term forfaiting.
[Link] selected currencies are taken for forfaiting as they alone
enjoy international liquidity.

FORFAITING IN INDIA
Recognizing the utility of Forfaiting services to Indian
exporters, the RBI decided to make available such services to the
exporters. At the beginning the RBI authorized I EXIM Bank in
1992 to offer Forfaiting services. The role of the EXIM Bank has
been that of a facilitator between the Indian exporter and the
overseas Forfaiting agency. Scheduled commercial banks have
also been permitted to offer Forfaiting services by acting as an
agent or a facilitator between Indian exporter and the Forfaiting
agency operating in some other country. That means in other
words, scheduled commercial banks can undertake Forfaiting
services as a part of fee has &financial services. A subsidiary of
EXIM bank namely; Global Trade Financial Services Private Ltd.
has been engaged in prclviding Forfaiting services to the exporters
in India. As per the RBI's A D Circular No. 3 Dated February 13,
1992, discount fee, documentation fee and any other costs levied
by a forfaiter must be transferred to the overseas buyer.

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 In view of this, the exporter, who intends to avail
Forfaiting facility, should finalise the export contract in a manner
which ensures that the amount received in foreign exchange by
him after payment of Forfaiting discount and other fees is
equivalent to the price which he would obtain if goods were sold
on cash payment terns. If the banks are able to act as an agent to
structure Forfaith deals keeping in view the requirements of our
Indian exporters, then there will be demand for such product. For
this, commercial banks and others may have to introduce a lot of
flexibility while acting as an agent or a facilitator in this regard.
Fa example, the minimum value of the forfaiting transaction may
be required to be kept at a reasonable level. Instead of acting
simply as an agent, with the permission from the RBI, banks and
financial institutions in India must explore the possibility of taking
up Forfaiting activity as a fund based activity. With the
dissemination of knowledge about Forfaiting among Indian
exporters, it may be possible to create awareness about it and
subsequently demand for the same.
For a long time, Forfaiting was unknown to India. Export
Credit Guarantee Corporation was guaranteeing commercial
banks against their export finance. However, with the setting up of
export-import banks, since 1994 forfaiting is available on
liberalized basis.
The Exim bank undertakes forfaiting for a minimum value of Rs.
5 lakhs. For this purpose, the exporter has to execute a special
Pronote in favor of the Exim bank. The exporter will first enter
into an agreement with the importer as per the quotation given to
him by the Exim bank. The Exim bank on its part, gets quotation
from the forfaiting agency abroad. Thus, the entire forfaiting
process is completed by exporter agreeing to the terms of the
Exim bank and signing the Pronote. Forfaiting business in India
will pick up only when there is trading of foreign bills in

95
international currencies in India for which the value of domestic
currency has to be strengthened. This would be possible only with
increasing exports. At present, India‘s share stands at 1.7 percent
in the world exports.

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 CHAPTER VIII
Credit Rating
Meaning of Credit rating
To understand the meaning of credit rating, let us look at some
definitions effered by well-known rating agencies.
Moodys': 'Ratings are designed exclusively for the purpose of
grading bonds according to their investment qualities'.
Australian Ratings: 'A corporate credit rating provides lenders
with a simple system of gradation by which the relative capacities
of companies to make timely repayment of interest and principal
on a particular type of debt can be noted'.
According to CRISIL, 'Credit rating is an unbiased and
independent opinion as to issuer's apacity to meet its financial
obligations. It does not constitute a recommendation to buy/sell or
hold a particular security'.
According to ICRA, 'Ratings are opinions on the relative
capability of timely servicing of corporate debt and obligations.
These are not recommendations to buy or sell....neither the
accuracy nor the completeness tf the information is guaranteed.
From the above definitions, it is understood that:
(1) Credit rating is an assessment of the capacity of an
issuer of debt curity, by an independent agency, to pay interest
and repay the principal per the terms of issue of debt. A rating
agency collects the qualitative as well as quantitative data from a
company which has to be rated and assesses e relative strength
and capacity of company to honour its obligations intained in the
debt instrument throughout the duration of the instrument. The
rating given is based on an objective judgement of a team of
expert‘s om the rating agency.

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 (ii) The ratings are expressed in code number which can be
easily prehended even by the lay investors. The ratings are the
quickest way of understanding a company's financial standing
without going into the multiplicities financial reports. Credit
rating is only a guidance to the investors ad not a recommendation
to a particular debt instrument. The important element for
investment decision making in debt security are
1. Yield to maturity
2. Risk tolerance to investor
3. Credit risk of the security.
Purpose/Functions of Credit Rating
1. Superior Information
2. Low cost information
3. Basis for a proper risk return and trade off
4. Healthy discipline on corporate borrowers
5. Formulation of public policy guidelines on institutional
investment.

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 CHAPTER IX
Venture Capital
Introduction
There are some businesses that involve higher risks. In the
case of newly started business, the risk is more. The new
businesses may be promoted by qualified entrepreneurs. They
lack necessary experience and funds to give shape to their
ideas. Such high risk, high return ventures are unable to raise
funds from regular channels like banks and capital markets.
Generally, people would not like to invest in new high-risk
companies. Some people invest money in such new high-risk
companies. Even though the risk is high, there is a potential of
getting a return of ten times more in less than five years. The
investors making such investments are called venture
capitalists. The money investd in new, high risk and high
return firms is called venture capital. Venture capitalists not
only provide money but also help the entrepreneur with
guidance in formalizing his ideas into a viable business
venture. They get good return on their investment. The
percentage of the profits the venture capitalists get is called
the carry.
Origin/History of Venture Capital
In the 1920‘s and 1930‘s, the wealthy families of individual
investors provided the start-up money for companies that
would later become famous. Eastern Airlines and Xerox are
the more famous ventures they financed. Among the early VC
fund set-ups was the one by the Rockfeller family which
started a special fund called Venrock in 1950, to finance new
technology companies. General Georges Doriot (the father of
venture capital), a professor at Harvard Business School, in
1946 set up the American Research and Development
Corporation (ARD). ARD‘s approach was a classic VC in the

99
 sense that it used only equity, invested for long term. ARD‘s
investment in Digital Equipment Corporation (DEC) in 1957
was a watershed in the history of VC financing. While in its
early years VC may have been associated with high
technology, over the years, the concept has undergone a
change and, as it stands today, it implies pooled investment to
unlisted companies.
Meaning
The term venture capital comprises of two words, namely,
‗venture‘ and ‗capital‘. The term ‗venture‘ literally means a
‗course‘ or ‗proceeding‘, the outcome of which is uncertain (i.e.,
involving risk). The term capital refers to the resources to start the
enterprise. Thus, venture capital refers to capital investment in a
new and risky business enterprise. Money is invested in such
enterprises because these have high growth potential.
A young hi-tech company that is in the early stage of
financing and is not yet ready to make a public issue may seek
venture capital. Such a high-risk capital is provided by venture
capital funds in the form of long-term equity finance with the
hope of earning a high rate of return primarily in the form of
capital gain. In fact, the venture capitalist acts as a partner with
the entrepreneur.
Venture capital is the money and resources made available to
startup firms and small business with exceptional growth potential
(e.g., IT, infrastructure, real estate etc.). It is fundamentally a
long-term risk capital in the form of equity finance for the small
new ventures which involve risk. But at the same time, it a the
strong potential for the growth. It thrives on the concept of high
riskhigh return. It is a means of equity financing for rapidly
growing private companies.
Venture capital can be visualized as ‗your ideas and our
money‘ concept of developing business. It is ‗patient‘ capital that
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seeks a return through long term capital gain rather than
immediate and regular interest payments as in the case of debt
financing.
When venture capitalists invest in a business, they typically
require a seat on the company‘s board of directors. But
professional venture capitalists act as mentors and provide support
and advice on a number of issues relating to management, sales,
technology etc. They assist the company to develop its full
potential. They help the enterprise in the early stage until it
reaches the stage of profitability. When the business starts making
considerable profits and the market value of the shares go up to
considerable extent, venture capitalists sell their equity holdings at
a high value and thereby make capital gains.
In short, venture capital means the financial investment in a
highly risk project with the objective of earning a high rate of
return.
Characteristics of Venture Capital
The important characteristics of venture capital finance are
outlined as below:
1. It is basically equity finance.
2. It is a long-term investment in growth-oriented small or
medium firms.
3. Investment is made only in high risk projects with the
objective of earning a high rate of return.
4. In addition to providing capital, venture capital funds take
an active interest in the management of the assisted firm. It
is rightly said that, ―venture capital combines the qualities
of banker, stock market investor and entrepreneur in one‖.
5. The venture capital funds have a continuous involvement
in business after making the investment. 6. Once the
venture has reached the full potential, the venture capitalist
sells his holdings at a high premium. Thus, his main
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 objective of investment is not to earn profit but capital
gain.
Types of venture Capitalists
Generally, there are three types of venture capital funds. They
are as follows:
1. Venture capital funds set up by angel investors (angels):
They are individuals who invest their personal capital in
startup companies. They are about 50 years old. They have
high income and wealth. They are well educated. They have
succeeded as entrepreneurs. They are interested in the startup
process.
2. Venture capital subsidiaries of Corporations: These are
established by major corporations, commercial banks, holding
companies and other financial institutions.
3. Private capital firms/funds: The primary source of venture
capital is a venture capital firm. It takes high risks by investing
in an early stage company with high growth potential.
Methods or Modes of Venture Financing (Funding
Pattern)/Dimensions of Venture Capital
Venture capital is typically available in four forms in
India: equity, conditional loan, income note and conventional
loan.
Equity: All VCFs in India provide equity but generally their
contribution does not exceed 49 per cent of the total equity
capital. Thus, the effective control and majority ownership of
the firm remain with the entrepreneur. They buy shares of an
enterprise with an intention to ultimately sell them off to make
capital gains.
Conditional loan: It is repayable in the form of a royalty after
the venture is able to generate sales. No interest is paid on
such loans. In India, VCFs charge royalty ranging between 2

102
and 15 per cent; actual rate depends on the other factors of the
venture, such as gestation period, cost-flow patterns and
riskiness.
Income note: It is a hybrid security which combines the
features of both conventional loan and conditional loan. The
entrepreneur has to pay both interest and royalty on sales, but
at substantially low rates.
Conventional loan: Under this form of assistance, the
enterprise is assisted by way of loans. On the loans, a lower
fixed rate of interest is charged, till the unit becomes
commercially operational. When the company starts earning
profits, normal or higher rate of interest will be charged on the
loan. The loan has to be repaid as per the terms of loan
agreement.
Other financing methods: A few venture capitalists,
particularly in the private sector, have started introducing
innovative financial securities like participating debentures
introduced
Venture Capital in India
In India, the venture capital plays a vital role in the
development and growth of innovative entrepreneurships.
Venture capital activity in the past was possibly done by the
developmental financial institutions like IDBI, ICICI and state
financial corporations. These institutions promoted entities in
the private sector with debt as an instrument of funding. For a
long time, funds raised from public were used as a source of
venture capital. And with the minimum paid up capital
requirements being raised for listing at the stock exchanges, it
became difficult for smaller firms with viable projects to raise
funds from the public. In India, the need for venture capital
was recognised in the 7 five-year plan and long term fiscal
policy of the Government of India. In 1973, a committee on

103
 development of small and medium enterprises highlighted the
need to foster VC as a source of funding new entrepreneurs
and technology. VC financing really started in India in 1988
with the formation of Technology Development and
Information Company of India Ltd. (TDICI) – promoted by
ICICI and UTI.
The first private VC fund was sponsored by Credit Capital
Finance Corporation (CEF) and promoted by Bank of India,
Asian Development Bank and the Commonwealth
Development Corporation, namely, Credit Capital Venture
Fund. At the same time, Gujarat Venture Finance Ltd. and
AFIDC Venture Capital Ltd. were started by state-level
financial institutions. Sources of these funds were the financial
institutions, foreign institutional investors or pension funds
and high net worth individuals.
Part A
1. Define venture capital
2. Mention the two credit rating companies?
[Link] do you know of CRISIL
[Link] do you know of CARE?
[Link] do you know of CIBIL
6. What is ―Start-up financing?
[Link] is seed capital?
[Link] is startup business?
[Link] do you meant by credit rating?
[Link] do you know of credit score ‗ AAA‘?
Part B
1. Explain features of venture capital funds
2 Explain the procedure followed by venture capital for providing
vci to a borrowing concern
3. Discuss characteristics of venture capital funds
4. Explain the methodology adopted by CRISIL for rating a
company?

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5. What are the different types of loan available to a consumer?
[Link] the methodology adopted by CARE for rating a
company?
7. Explain the mechanism of consumer finance and sources
finance?
8. Explain various stages of venture capital.
9. Explain various sources of consumer finance.
10. What are the advantages of venture capital finance?

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