Mba 922

Self Learning Material
MANAGEMENT OF
FINANCIAL SERVICES
(MBA-922)
Course: Master Business Administration

Semester-III
Distance Education Programme

I.K. Gujral Punjab Technical University
Jalandhar
Syllabus
MANAGEMENT OF FINANCIAL SERVICES (MB 922)
Objectives: The objective of this paper is to acquaint the students with emerging trends in
financial services.
Unit – I
Financial Services - Meaning, types and their importance. Depository - Introduction, Concept,
depository participants, functioning of depository systems, process of switching over to
depository systems, benefits, depository systems in India, Dematerialization and
Rematerialization. Role, objectives and functions of SEBI and its guidelines relating to
depository system.
Unit – II
Mutual funds and AMCs - Concept, origin and growth of mutual funds, Constitution &
management of MFs - Sponsors, Trustees, AMCs, and custodians. Classification of mutual fund
schemes, advantages and disadvantages in mutual fund schemes, NAV and pricing of mutual
fund units. Recent trends in mutual funds in India. Credit rating - the concept and objective of
credit rating, various credit rating agencies in India and International credit rating agencies,
factors affecting credit rating & procedural aspects.
Unit – III
Leasing - concept and development of leasing, business, difference between leasing & hire
purchase, types of leasing business, advantages to lessor and lessee. Tax aspect of leasing.
Merchant Banking - Origin and development of merchant banking in India scope, organizational
aspects and importance of merchant bankers. Latest guidelines of SEBI w.r.t. Merchant bankers.
Venture capital - concepts and characteristics of venture capital, venture capital in India,
guidelines for venture capital.
Unit – IV
Debt Securitisation: Meaning, Features, Scope and process of securitisation. Factoring -

Development of factoring types & importance, procedural aspects in factoring, financial aspects,
prospects of factoring in India. Plastic Money - Concept and different forms of plastic money -
credit and debit cards, pros and cons. Credit process followed by credit card organisations.
Factors affecting utilisation of plastic money in India.
Note : Relevant Case Studies should be discussed in class.

Suggested Readings:
1. S Gurusamy ‘Financial Services & System’ Thomson Publications

2. M Y Khan ‘Financial Services’ Tata McGraw-Hill
3. L M Bhole ‘Financial Institutions & Markets’ Tata McGraw- Hill
4. Gordon & Natarajan ‘Financial Markets & Services’ Himalaya Publications
5. V. A. Avdhani ‘Financial Services in India’ Himalaya Publications
6. Vasant Desai ‘Financial Markets and Financial Services’ Himalaya Publications
Table of Contents
Lesson No. Title Page No.
1 1
Overview of Financial services
2 Depository 19
3 Mutual Funds 43
4A 67
Credit Rating Agencies
4B 78
5 102
Leasing
6 121
Venture Capital
7 Merchant Banking 138
8 Factoring 153
9 Debt Securitisation 170

10 Plastic Money 184
Written by:
Dr. Aparna Mohindru, Assistant Prof.
Dept. of Commerce, GNDU, Amritsar
Reviwed by:
Dr. Mahesh Chand Garg, Prof.
Guru Jambheshwar University of Science & Technology,
Hisar
© IK Gujral Punjab Technical University Jalandhar

All rights reserved with IK Gujral Punjab Technical University Jalandhar
LESSON - 1
Overview of Financial services
Structure
1.0. Learning Objectives
1.1. Introduction
1.2. Financial System
1.3. Financial Services: meaning
1.4. Financial Services: Objectives
1.5. Financial Services: Features
1.6. Financial Services: Types
1.7. Financial Service: Importance
1.8. Summary
1.9. Glossary
1.10. Answers to check your progress
1.11. References
1.12. Model questions
1.0. LEARNING OBJECTIVES
After studying this chapter you should be able to understand:
 The relationship between savings, investment and capital formation
 The financial system and its components.
 Meaning, Objectives, Features, Types and Importance of financial services
1.1. INTRODUCTION
Capital is a very vital factor of production. Capital formation is one of the most
important preliminaries of an economy’s ability to produce goods and services. Capital
formation is the result of savings and investment in the economy. Capital formation
takes place only when the savings are transferred from the savers to the investors who
can make productive use of the same. Capital formation refers to net annexation
of capital stock or infrastructural facilities such as plant and machinery, equipment, land
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and buildings and other intermediate goods which are not consumed directly. A nation
uses this capital investment along with labour to render services and manufacture
goods. An increase in this capital stock is known as capital formation. The higher the
rate of capital formation; higher would be the Gross Domestic Product (GDP) of a
country. GDP is the value of a country's overall output of goods and services , typically
during one fiscal year, at market prices. The process of production produces not only
goods and services but also generates income for those who are the participants in the
process. Hence, GDP is a prime indicator of aggregate real income in the country.
Thus, the circle of economic development begins from savings leading to investment;
thereby enhancing capital formation in the country and leading to economic
development of a nation.
Importance of Capital formation

Capital formation refers to increasing the capital stock of a country. It refers to the
excess of production over consumption. Capital formation is vital for economic
expansion of a country.
1. It helps in the development of those industries which require massive capital.
2. The availability of huge capital stock facilitates a country to make use of latest
techniques of production.
3. With the accelerated availability of infrastructural and capital facilities, a country
acquires the ability to change, innovate and adapt to new ideas and technological
advances, thus contributing to the GDP.
Process of capital formation

The process of capital formation involves three sub processes:
1. Savings: It is a process of setting aside the disposable income for some other
purpose which may include purchase of capital equipment; securities etc. the
portion of income which is not spent on current consumption is called savings. It
denotes the excess of income over consumption. A nation’s progress not only
depends upon its level of income, but also depends upon its level of savings. For
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mobilization of savings and its deployment into productive purposes, and
effective financial system is required.
2. Financing: It is a process of accumulating savings into a common pool to make
them available for purposes other than consumption of consumer goods. The
existence of a n efficient financial system in the country is a preliminary to the
process of financing.
3. Investment: It is the process of deploying pooled savings for the manufacturing
of goods and services in the economy. Investments are of two types: i. Financial
Investment and ii. Real Investment. Financial investment represents the claims
on the future stream of income and/or assets of an undertaking in the form of
equity shares, bonds and debentures. Real investment refers to investment in
real assets that can be used for further production. It is real investment that is
relevant for the purpose of capital formation.
Thus the more the savings, more would be the investment resulting into higher capital
formation and resultant economic growth of a country. But an efficient financial system
is a pre requisite to the success of this process as it would bridge the gap between the
savers and the investors.
Relationship between Savings and Investment
Savings is that portion of the total income that is not spent on consumption. It can be
written as:
Savings = Income – Consumption
S= Y – C
Investment refers to the net increment in the stock of capital. It is that portion of the
income which is spent to add to the real capital. It can be written as:
Investment = Income - Consumption
Hypothesizing that entire savings are invested.
I=Y–C
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When there is increase in income, resultantly there is increase in savings. With the
incremental savings the level of investment also increases though Savings and
investment usually do not increase proportionately.
Hence, more savings means more investment, which would lead to more production.
Increase in production would raise more demand for factor inputs. This results in
circulation of resources resulting in more income, which in turn implies more demand
that requires more investment, leading to rapid economic growth, this again leads to
increased savings. Hence the complete process of conversion of income to savings, to
capital stock, to production, to demand and increased income and so on is cyclical.
Check your Progress A
Answer in True/ False
1) Capital formation is the result of income (__________)

2) There are three sub-processes of capital formation (__________)
3) More savings would lead to more capital formation (__________)
4) There are five components of financial system (__________)
1.2. THE FINANCIAL SYSTEM

Financial system is the system that allows the transfer of money between savers
and investors. It is a system that aids at establishing and facilitating an evenly, orderly,
efficient and cost effective linkage between depositors/ savers and investors. It is a set
of closely integrated instructions, agents, practices, markets, transactions, claims and
liabilities relating to financial aspects of an economy.
It comprises of four major elements:
1. Financial Institutions
2. Financial Services
3. Financial Markets
4. Financial Instruments
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Financial Institutions
Institutions that provide credit and credit related services are called financial institutions.
 FIs act as saving mobilisers by transferring funds from surplus to deficit units.
 FIs are major participants of financial system.
 FIs deal in financial resources by accepting deposits from individuals and
institutions and lending them to trade and industry.
 FIs also deal in financial assets and investment in securities.
 FIs buy and sell financial instruments and generate these new instruments.
 FIs are regulated by SEBI, RBI etc.
 FIs include: 1. Banking Institutions and 2. Non Banking Institutions as LIC,
UTI etc.
 FIs also include specialized financial institutions as NABARD, EXIM etc.
Financial Services
The functions and services that are provided by the financial institutions in a
financial system are called financial services. Financial services rendered by the
financial intermediaries’ reduce the gap between unaware and amateur investors and
mounting sophistication of financial market and instruments.
 Financial Services aid in obtaining funds and finances as well as distribution
of the same.
 FS are rendered by Stock Exchanges, Financial Institutions, Banks,
Insurance Companies etc.
 FS are goverened by SEBI, RBI, Dept. of Banking and Insurance, GOI.
Financial Markets
Financial markets help in purchase and sale of financial claims, assets, services
and securities.
 FMs transfer funds from surplus to deficit units.
 Banking and NBFIs, dealers, borrowers, lenders, investors, depositors and
agents are the players of FMs.
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 Organised markets are governed by statutes and governing bodies as against
unorgainsed markets.
 Money market deal with short term instruments with maturity up to one year
as against capital markets.
Primary markets is the market for new issue of securities and secondary markets trades
in already issued securities.
Financial Instruments
Financial claims such s financial assets and securities dealt in the financial
market are called financial instruments.
 These allow faster conversion into cash
 These can be pledged for taking loans
 Easily tradable and marketable
 These are short term, medium term and long term.
 Buying and selling them involves transaction cost.
 These can be tax saving and tax deductible
 Allows earning of higher returns
 Attract risk
 Securities are subject to price fluctuations.
 These can be 1. Ownership and 2. Creditorship securities.
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Activity A
What is the role of the following components in the mechanism of financial system?
1. Financial Institutions:
_______________________________________________________________
2. Financial Services:
_______________________________________________________________
3. Financial Instruments:
______________________________________________________________
4. Financial Markets:
________________________________________________________________
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Figure 1: Components of Indian Financial System
Source: www.indiamba.com
Note: Money to be managed needs a system – hence the financial system. Financial
institutions operate in financial market rendering financial services and selling and
buying financial instruments.
1.3. FINANCIAL SERVICES: MEANING

Financial Services constitute one of the most significant components of the
Financial System. Services that are financial in nature are known as financial services.
These services are given by banks, FIs, Insurance companies and other intermediaries
in the financial market. These cater to the needs of individuals, companies as well as
institutions. The efficiency of financial system is determined to quite an extent on the
quality of financial services.
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1.4. FINANCIAL SERVICES: OBJECTIVES
1. Mobilization of funds: Financial services help to raise funds from the

individuals, companies and institutions. Various financial instruments help to pool
these funds as equities, bonds, mutual funds.
2. Deployment of funds: Large number of financial services is available in the
financial markets which help in utilization of funds. Funds may be used for the
purpose of rendering services as factoring, credit rating, securitization, bill
discounting etc. Financial services also help to decide the financial mix.
3. Providing specialized need based services: But for traditional services like
banking and insurance, financial services include credit ratings, factoring,
securitization, book building, merchant banking housing finance etc. Specific
institutions as banks, insurance companies, stock exchanges, Non Banking
Finance Companies etc. provide these services.
4. Regulation of services: These services are governed by the statutory bodies of
the country as Reserve Bank of India, Securities Exchange Board of India,
Department of Banking and Insurance of the Government of India with rules and
legislations.
5. Economic development: Financial Services help in the economic growth of the
country. These mobilize the savings of vast population and channelize the same
into proper productive avenues. This leads to capital formation and increased
GDP and growth of a country.
1.5. FINANCIAL SERVICES: FEATURES
1. Intangible: Financial services are invisible in nature. Unlike a tangible financial
product they do not bear a form. They are dependent on the innovativeness,
attractiveness and quality of the supplier.
2. Inseparable: Financial services cannot be separated from the supplier. Eg:
credit ratings have to be obtained from the credit rating agencies only.
3. Customer focused: Financial services are rendered as per the need of the
customer. These have to be tailor made to suit the requirements of individual
customer.
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4. Heterogeneous: Even if the financial product is the same, services have to be
provided keeping into mind the nature, type and geographical location of the
receiver. Same set of services would not serve the purpose of all.
5. Dynamic: The nature, quality and quantum of financial services change with the
change in the environment. For instance, services like factoring and
securitization are of recent origin.
6. Personalized in Nature: In spite of high degree of computerization, delivery of
financial services require personal guidance and advise. Hence these are highly
labor intensive.
7. Based on faith and trust: the credibility of suppliers is very important in financial
services. Client’s confidence and trust have to be won if mobilization of funds has
to be done.
8. Information based: Financial service industry as a whole deals with information
dissemination. Information is an essential component in the delivery of financial
services.
1.6. FINANCIAL SERVICES: TYPES
Financial Services can be categorized into two:
1. Asset/ Fund based services: Fund based income come mainly from interest,
lease rentals etc. because these involve provision of funds against assets, bank
deposits etc. The following are the fund based services:
i) Lease financing: Lease financing is one of the important sources of
medium- and long-term financing where the owner of an asset gives
another person, the right to use that asset against periodical payments.
The owner of the asset is known as lessor and the user is called lessee.
The periodical payment made by the lessee to the lessor is known as
lease rental. Under lease financing, lessee is given the right to use the
asset but the ownership lies with the lessor and at the end of the lease
contract, the asset is returned to the lessor or an option is given to the
lessee either to purchase the asset or to renew the lease agreement.
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ii) Hire purchase: Hire purchase is a method of providing finance for the
purchase of fixed asset to be acquired on future date. Under this method
of financing, the cost price is paid gradually in installments. Ownership of
the asset purchased is transferred only after the payment of the last
installment, though the right to use emerges immediately. The main
features of hire purchase finance are:
 The hire purchaser does not become the owner of the asset till he
pays the last installment.
 Each installment is deemed to be a hire charge for using the asset.
 Hire purchaser can use the asset when he makes an agreement
with the hire vendor.
 The hire vendor reserves the right to repossess and take back the
asset sold on hire purchase in case the purchaser makes a default
in the payment of the installments.
iii) Bill discounting: Discounting of bills is an attractive fund based financial
service provided by the finance companies. “Bill of Exchange is a written,
unconditional order by one party (the drawer) to another (the drawee)
to pay a certain sum, either immediately (a sight bill) or on a fixed date
(a term bill), for payment of goods and/or services received”. The drawee
accepts the bill by putting his signature on it. This way he rather converts it
into a post-dated cheque and enters into a binding contract. Discounting of
bill is a very convenient and prominent form of financing as the bank lends
advance money without asking for any collateral security. The
development of bill discounting as a source of finance is dependent upon
the availability of a developed bill market. In order to facilitate this source
of financing, the Central Bank of the country, RBI, has now permitted
banks to rediscount bill amongst themselves and with other financial
institutions. This would definitely expedite the process and make bill
discounting an even attractive tool of finance.
iv) Venture capital: Venture capital (VC) is the finance given to budding
entrepreneurs who are in early-stage or emerging stage of growth. The
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venture capital funds lend money against their investment in companies’
equity capital. It is perceived that these ventures have high potential for
future growth and that is the major reason as to why venture capitalist
undertakes the risk of providing money to the untried businessmen. The
entrepreneurs favor it as their startup proects do not have access to
capital markets. It engulfs high risk for the investor, but it has the ability of
earning above-average returns.
v) Housing finance: Housing finance is the financial access that provides
for the building and construction of housing facilities. It refers to the
finance that is used to make and maintain the nation’s housing stock. But
it also includes the money that is needed to pay for it, in the form of rents,
mortgage loans and repayments. Till late 1970s the responsibility to
provide for house building rested with the Government of India. But, with
the setting up of National Housing Bank (NHB) by RBI in 1988, it became
an important financial service. Till now a number of specialised financial
institutions in the public, private and joint sectors have entered in th field of
housing finance such as HDFC, LIC Housing Finance, Citi Home, Gujarat
Ambuja etc. these companies have designed suitable schemes for
individuals, corporate and builders.
vi) Insurance services: It is a financial service that involves a commitment
for compensation of covered specific and unforeseen future losses
in exchange for periodic payments called insurance premium.
It protects the financial health of an individual, a corporate or
other entity in the case of unanticipated losses. Some forms of insurance
are compulsory under the provision of law while others are optional.
The contract between the insured and the insurer is created after agreeing
to the terms of the insurance contract. In most cases, the policy
holder pays part of the loss (called the deductible), and the insurer pays
the rest. Motor insurance, Medical and Health insurance, Accidental
Insurance, Disability insurance, life insurance, marine insurance
and business insurance are some of the examples of insurance.
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vii) Factoring: Factoring is a financial service in which a firm transfers and
sells its accounts receivable and invoices to a third party which is usually a
financial institution or a financial company, known as a “factor.” This helps
business to have access to liquid resources in terms of cash more quickly.
The pre payment made by the factor can range from 80% to as much as
95% depending upon various factors as the nature of industry, customers’
creditworthiness record, reputation and goodwill in the market etc. The
factor also provides the allied services of collection of receivables,
maintenance of ledgers and cover for bad debts. The balance is paid by
the factor after collection from the customer. The factor also deducts his
associated costs, commission and service charges before settling the final
payment.
2. Non fund/ fee based services: these services are primarily advisory in nature
and the financial institution charges a fee for rendering them. These include the
following:
i) Merchant Banking: Merchant banking refers to giving financial advice and
services on the issues of portfolio construction and portfolio management to
the big corporations and rich individuals. The main activities included in
merchant banking service offered by the bank to its clients are: Issue
Management, Payment of Dividend Warrants and Interest Warrants, Refund
Orders; Debenture Trustee; Underwriting function and acting as a Monitoring
Agency etc. Grindlays Bank was the first one to set up Merchant Banking
Division in 1969 in India. Then many other foreign banks followed suit. State
Bank of India also started rendering this service in 1973.
ii) Credit Rating: Credit rating is an evaluation of the credit worthiness of a
customer either in general terms or with respect to a specific debt or financial
obligation. A credit rating can be assigned to an entity that intends to borrow
or raise finance/ money and largely includes an individual, corporate, state or
provincial authority, or sovereign government. There are many credit rating
agencies operating both at the national and international level in the country
In India there are three credit rating agencies namely: 1. CRISIL (Credit
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Rating Information Services Of India Ltd.) 2. ICRA (Investment Information
and Credit Rating Agency of India Ltd.) 3. CARE (Credit Analysis and
Research in Equities). At the international level prominent Credit Rating
Agencies include Standard & Poor’s, Moody’s or Fitch etc. Commission and
service charges are paid against the services rendered by these rating
agencies.
iii) Stock Broking: A stockbroker is a middleman who is a professional
individual and is attached with a brokerage firm or broker-dealer. His main
function is to buy and sell stocks and other securities for both his retail and
institutional clients. He performs this activity through a stock exchange as well
as over the counter. His remuneration includes a fee or commission. In order
to give a push to the resource mobilization process in the country stock
broking has emerged as a very important financial service. SEBI is the chief
governing body of this financial service.
Activity B
What do you understand from the following?

1. Intangibility of financial services:
_______________________________________________________
2. Financial service as a personalized service:
_______________________________________________________
3. Fund based Vs feed based services:
_______________________________________________________
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1.7. FINANCIAL SERVICES: IMPORTANCE
i) It serves as a bridge between saving-surplus and saving-deficits.
ii) Financial services help in pooling the resources of vast spread
population.
iii) Financial services help to put the pooled resources into productive use.
iv) Financial services have helped to improve the process of capital
formation thereby leading to economic development.
v) Financial services bring the other three components of the financial
system viz. financial institutions, financial markets and financial
instruments into action and use.
vi) Financial services cater to the specialized needs of specific customers
be they be individuals, corporate or institutions.
vii) Development of financial services has led to the growth of modern
services as securitization, factoring etc.
viii) Financial services help people to manage the money and investments
professionally.
ix) It has led to the replacement of informal financial system.
x) It offers clients the opportunity to understand their goals and better
plan for them.
xi) Financial services act as a catalyst to economic growth.
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Check your Progress B
Select the correct option.
1) Income is divided into:
a. Savings and consumption
b. Savings and investment
c. Consumption and investment
d. Investment and capital formation
2) Financial institution includes:
a. Banks
b. Insurance companies
c. Non bank finance companies
d. All of the above
3) Bank guarantee is an example of:
a. Fund based service
b. Fee based service
c. May be a or b
d. Neither a nor b
4) Financial services may be:
a. Tangible
b. Intangible
c. Physical
d. All of the above.
1.8. SUMMARY
Income is divided into savings and consumption. Financial services mobilize the
savings of people and deploy them into productive channels. This leads to higher capital
formation and economic growth. Financial services are one of the most important
components of the financial system. Others are Financial Institutions, Financial Markets,
Financial Services and Financial Instruments. These services are given by banks and
non banking financial institutions. There are two categories of financial services namely
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fund based services and fee based services. The growth in financial service sector
would lead to the development of the nation as a whole.
1.9. GLOSSARY
1. Capital formation: It is the process of adding capital stock in the country. It
means putting new machines, factories and infrastructure.
2. Financial system: A system that facilitates transfer of money from savers to
investors. It has four components namely Financial Institutions, Financial
Services, Financial Markets, Financial Services and Financial Instruments.
3. Financial Services: Functions and services performed by financial institutions.
4. Fund based services: Fund based income come mainly from interest, lease
rentals etc. because these involve provision of funds against assets, bank
deposits etc. These include hire purchase, venture capital, factoring etc.
5. Fee based services: These services are primarily advisory in nature and the
financial institution charges a fee for rendering them. These may include
merchant banking, stock broking, credit rating etc.
1.10. ANSWERS TO CHECK YOUR PROGRESS

1) false
2) true
3) true
4) false

1) a
2) d
3) b
4) b
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1.11. REFERENCES
1. M.Y. Khan, Financial Services, Tata McGraw Hills, New Delhi, 2007
2. Guruswamy, S. Indian Financial System, Tata McGraw Hills, New Delhi.
3. Bhole LM, Financial Institutions and Markets, Tata McGraw Hi1l, 2004, 4th
Edition.
1.12. MODEL QUESTIONS
1. What are financial services? Discuss main features of financial services.
2. Define financial services. What are different fund based and fee based financial
services?
3. Why are financial services important? Highlight the objectives of financial
services.
4. Efficient Financial Services are the backbone of economic growth. Discuss.
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LESSON - 2
Depository
Structure
2.1. Introduction
2.2. Concept: Depository system and its components
2.3. Features of Depository System
2.4. Functions of depository system
2.5. Comparison between bank and Depository
2.6. Benefits of Depository System
2.7. Depository Systems in India
2.8. Dematerialization and Rematerialization
2.9. Roles, Objectives and Functions of SEBI and its guidelines relating to Depository
System
2.10. Summary
2.11. Glossary
2.13. References
 The concept, benefits and functions of depository system

 The depository system in India
 The concept of dematerialization and rematerialization
 SEBI and depository system
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2.1. INTRODUCTION
In the globalised world, a developed and efficient capital market that guarantees
a systematic growth and provides measures for protection of the investor’s interest, is
the most vital parameter for analyzing the health of any economy. The system of
physical trading of shares restricted the trading practices both in terms of volume as
well as speed with which new piece of information was placed into price system. There
were multiple obstacles associated with handling physical documents, forged share
certificates and stealth of shares. Putting fake signatures was a common practice. Many
a times there was mismatch of signatures. Duplication and defacement of shares
hindered the system of secondary markets. There were issues related to transfer of
shares involving lot of time and resultant inefficiency. In fact, paper certificates were the
major cause of disputes and adjudication. The problems of traditional system of trading
can be listed in a summarized form as follows:
 Time consuming
 Poor deliveries because of differences in signatures
 Errors in completion of transfer deeds
 Tearing and mutilation of certificates
 Forged and false certificates
 Costs of transfers involved as stamp duty
 Postal delays
 Long settlement cycles
In 1994 NSE started its operations and introduced online electronic trading in
equities. Though the screen base trading system of NSE was efficient, the deliveries of
securities were causing problems because the securities remained in paper form. The
depository system was introduced in India to address the shortcomings of holding and
trading of securities in paper form. The Government of India endeavored to establish a
fully automated and high technology based stock exchanges, which provided screen
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based trading. Then the terminology and concept of depositories evolved as an ultimate
solution to all the problems related to traditional system of trading. The Government of
India publicised the Depository Ordinance in 1995 and both houses of Parliament
passed the Depositories Act in 1996. At present depository system has become
important an essential market infrastructure and has contributed greatly to the efficiency
of capital market.
2.2. CONCEPT
Depository System
It is a system in which the trading, exchange and settlement of shares take place
through a modernized system involving transfer of ownership of securities through the
medium of book entry on the ledgers or the depository and does not involve any
physical movement of securities. This updated system eliminates paper work. It
provides automatic buying and selling of scrips. The settlement period is shortened and
the liquidity is highly improved with the expedition in the trading system. This system of
trading through depository is also known as Scripless Trading System.
Constituents of Depository System:
There are four constituents of depository system:
1. The Depository
2. The Depository Participant
3. The Beneficial Owner/ Investor
4. The Issuer
1. Depository means a company, formed and registered under the Companies Act,
1956 and which has been granted a certificate of registration under sub-section (1A)
of section 12 of the SEBI Act, 1992. A depository is an organisation, which assists
in the allotment and transfer of securities, and securities lending. The shares in a
depository are held in the form of electronic accounts, i.e., in dematerialised form
and the depository system revolves around the concept of paper-less or scrip-less
trading. It is for keeping securities in electronic form in the organization/ central
location.
A depository is an organization like a central bank where the securities of a
shareholder are held in electronic form at the request of the shareholder through the
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medium of a Depository Participant. If an investor wants to utilize the services of a
Depository, the investor has to open an account with the depository through the
Depository Participant.
In India, the Depositories Act, 1996 defines a depository to mean “A Company
formed and registered under the Companies Act, 1956 and which has been granted
a certificate of registration under sub-section (1A) of section 12 of the Securities and
Exchanges Board of India Act, 1992”.
As per The Bank for International settlements (BIS), depository is “a facility for
holding securities which enables securities transactions to e processed by book
entry, physical securities may be immobilized by the depository or securities may be
dematerialized (so that they exist only as electronic records)”.
So a depository is just another form of a custodial service, the difference being that
the securities are held in an electronic form. At present there are two depositories in
India, National Securities Depository Limited (NSDL) and Central Depository
Services (CDS).
2. A Depository Participant (DP) is an agent of the depository through an association

is maintained with the investor. A Depository Participant has to first get registration
from SEBI in order to become eligible to offer depository services. He maintains the
investor’s ‘securities account’ with depository. He also has connected to a broker
who trades on behalf of the investor. A Depository account that is like a bank a/c-
demat a/c is opened with a DP. An investor chooses a DP. He can choose more
than one DP with multiple Demat accounts. According to Depository Act, 1996 a
financial institution, banks, including approved for banks, Custodian, Stock brokers,
Clearing Corporation, Non-banking financial company, a registrar to an issue or
share transfer agent can be a DP.
3. Owner is of two types: 1. Registered Owner and 2. Beneficial Owner.

1. Registered owner is the one whose name is recorded in the books of the
issuer. The depository (CDSL or NSDL) is the registered owner. It does not
enjoy any rights and liabilities attached with the securities.
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2. Beneficial owner is the investor, whose name is in the records of the
Depository. He enjoys all rights, duties and liabilities attached with the
securities. His rights include: Voting rights, Dividend rights, Right issue right,
Bonus share right.
4. Issuer means any person making an issue of securities.
2.3. Features of the Depository System in India

1. “Multi-Depository System”: The depository model practiced in India provides for a
viable multi-depository system. Thus, several entities can provide depository services
in the country, though currently there are two depositories registered with SEBI,
namely:
 “National Securities Depository Limited (NSDL), and
 Central Depository Service Limited (CDSL)”
2. “Depository services facilitated by Depository Participants”: Depository Participants
are the middlemen through whom the depositories provide their services to investors.
The appointment of these intermediaries acting as the agents of investors are subject
to the conditions prescribed under Securities and Exchange Board of India
(Depositories and Participants) Regulations, 1996 .
3. “Dematerialisation”: The system of depository practices in India provides for
conversion of paper securities into electronic scrips, that is, it facilitates
dematerialisation of securities. This results in accomplishment of an entirely a paper-
free securities market. Like the transactions in the bank these electronic securities
are credited to the account of the depository participant.
4. “Fungibility”: The securities that exist in the electronic form through dematerialization
do not bear any unique characteristic like a “distinctive number, folio number or
certificate number. Once shares are dematerialized, they are no longer identified with
any distinctive numbers and folio numbers. As a result all securities in the same class
become identical and interchangeable. For instance, all equity shares in the class of
fully paid up shares are transposable”.
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5. “Registered Owner/ Beneficial Owner”: In the depository system, a distinction is
made between a Registered Owner and Beneficial Owner. Registered owner is the
depository as its in the name of the depository that issuer issues the securities. The
beneficial owner is the actual investor with whom all benefits vest.
6. “Free Transferability of Shares”: There is no physical transfer of shares held in
dematerialized form. The transactions take place freely through the system of
electronic book entry.
Activity 1
Highlight the role of the following as a component of Depository System

1. Depository Participant
______________________________________________________________
______________________________________________________________
2. Depository
______________________________________________________________
______________________________________________________________
2.4. FUNCTIONS OF DEPOSITORY SYSTEM

1. Provide safe and convenient way of holding securities.
2. Facilitate immediate transfer of securities
3. Eliminate risks associated with physical certificates such as bad delivery, fake
securities, delays, thefts etc.
4. Reduce paperwork involved in transfer of securities;
5. Enhance nomination facility
6. Infuse liquidity into capital market
7. Expediting transactions in the market. Electronic trading provides for
automatic credit of shares obtained as bonus shares or through split, mergers
and consolidation mechanism
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8. Investments both in the form of equity and debt instruments can be held in a
single account.
2.5. COMPARISON BETWEEN A BANK AND A DEPOSITORY
Bank Depository
Account is opened with a depository

Account is opened with a bank
participant.
Holds funds in account on behalf Holds securities in account on behalf
of customers. of investors.
Facilitates safe keeping of money. Facilitates safe keeping of securities.
Funds are transferred between Securities are transferred between
accounts on the order of the accounts on the order by the account
account holder. holder.
Physical handling of funds is Physical handling of money is
avoided avoided
Interest rate is applicable on No interest rate is given on securities

holdings held in demat form
I. Fill in the blanks

1. For getting the shares dematerialized an investor has to open an account with
a ________.
2. Depository Act was passed in the year___________.
3. There are _________Depositories in India.
4. Depository facilitates conversion of paper securities into __________ form.
5. When securities in demat form do not bear a distinct number, they are said to
have _________
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2.6. BENEFITS OF DEPOSITORY SYSTEM
i. Exclusion of all risks connected with physical certificates: There is no longer
any risk of loss, disfigurement or stealth of physical shares.
ii. Removal of bad deliveries: In the depository system, shares cannot be given
back “under objection” for any reason. As a result the scope of bad delivery is
completely eliminated. The investor has not to deal with any uncertainty on
the gentility of securities bought by him.
iii. Expedited transfer and registration of shares: Once a payout is made, the
shares are credited immediately to the investor’s demat account. The investor
becomes the owner of the securities. He is not to bother himself with the
formalities of seeking registration from the company or its registrar.
iv. Faster settlement cycles: Earlier the settlement system used to follow T+7
day pattern but presently the settlement cycles have been reduced to T+2
rolling settlement cycle i.e. settlement of trades is done on the 2nd working
day from the trade day. This reduction in the settlement cycles has been
made possible only because of demat, facility that expedites transfer of
securities.
v. Faster receipt of securities in case of bonus/split/merger etc.: The securities
that are issued in the form of bonus shares are directly credited to the
investor’s account. Similarly in case of allotment of IPO/rights, split and
merger demat ensures faster receipt of securities and there is no fear of loss
of certificates in transit.
vi. Abolition of stamp duty: Payment of stamp duty by the investors for transfer of
any kind of securities in demat form is not applicable.
vii. Facilitates ease in recording change of address, transmission, etc.: One
single instruction has to be given to DP for all investments held in the BO’s
a/c. in case of change in address, bank account details, nomination. Informing
each company separately about the change is not required.
viii. Ease of portfolio management: Demat has facilitated management and
monitoring of portfolio very convenient for the investor. A periodical statement
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of accounts is sent by the DP to the investor. This updates the investor with
respect to consolidated position of all his investments in the demat account.
2.7. DEPOSITORY SYSTEMS IN INDIA
Depository services are offered by two depository institutions namely National

Securities Depository Ltd. (NSDL) and Central Depository Services (India) Ltd. (CDSL).
National Securities Depository Limited (NSDL) is based in Mumbai. It is the

Indian Central Securities Depository . It was established on 8 November 1996. It is
India’s first electronic securities depository. It has a nationwide coverage. NSDL was
set up after the recommendation of “national institution responsible for the economic
development of India. It operates with infrastructure based on international standards. It
handles most of the securities held and settled in de-materialised form in the Indian
capital markets”.
The prime objective of NSDL is to “ensuring the safety and efficiency of Indian
marketplaces”. It is responsible for “developing settlement solutions that enhances
market efficiency, reduces risk and minimizes costs”. NSDL performs a significant role
in “developing products and services that ensure to fulfill the increasing requirements of
the financial services industry”. NSDL is promoted by the “largest bank of India, the
largest Mutual Fund and the largest stock exchange of India namely, Industrial
Development Bank of India Limited (IDBI) , Unit Trust of India (UTI) and National Stock
Exchange of India Limited (NSE). Some other forestanding banks in the country that
have taken a stake in NSDL include Axis Bank Limited, State Bank of India, Oriental
Bank of Commerce, Citibank NA, Standard Chartered Bank, HDFC Bank Limited, The
Hongkong and Shanghai Banking Corporation Limited, Deutsche Bank, Dena Bank,
Canara Bank, Union Bank of India. NSDL has 1.39 crores Demat A/c as on 30-06-
2015”.
Central Depository Services Limited (CDSL) is also based in Mumbai. It is “the

second Indian central securities depository of India. Its main function is the holding
securities either in certificated or uncertificated (dematerialized) form, to enable book
entry transfer of securities. CDSL is promoted by Bombay Stock Exchange Limited
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(BSE) jointly with State Bank of India, Bank of India, Bank of Baroda, HDFC
Bank, Standard Chartered Bank, Axis Bank and Union Bank of India. The main purpose
of CDSL is to provide easy, reliable, safe and secure depository services at an
affordable cost to investors. CDSL has 9800000 Demat A/c as on 30-06-2015”.
2.8. DEMATERIALISATION AND REMATERIALISATION
Dematerialisation is the process that “facilitates conversion of physical shares into

electronic format”. For this conversion an investor is required to “open a demat account
with Depository Participant. Investor gives up his physical shares and in exchange gets
electronic shares in his demat account”.
Procedure for dematerialization of shares of company
 “A company should amend its Articles of Association by passing a special

resolution in the general meeting of the company, thereby allowing the company
to issue shares in dematerialized form”.
 “Private companies should register with both the central depositories i.e.,
National Securities Depository Limited (NSDL) and Central Securities Depository
Limited (CDSL). These depositories have their own terms of registration, so it is
necessary for a company to meet those criteria”.
 “If registration is successful depositories will be providing companies with an
International Securities Identification Number (ISIN) for each of the shares. ISIN
is a unique 12 digit alphanumeric code given to a security, shares, Debentures,
Bonds etc. when the security is admitted in the depository system. First two digits
of the ISIN code tell about the country of registration for the security. For all
scrips that are registered on depository in India, the first two digits of the ISIN
code are IN”.
 “If the private company wants to transfer its dematerialized shares it may arrange
demat connectivity from depositories like NSDL or CDSL along with a Registrar
and Transfer Agent (RTA) by entering into a tripartite agreement between the
company, the depositories and the transfer agent. An RTA i.e. Registrar and
Transfer Agent is an agent of the issuer. RTA act as a middleman between the
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issuer and depository for providing services such as Dematerialization,
Rematerialisation, Initial Public Offers and Corporate actions”.
 “After establishment of electronic connectivity, Depositories inform the name and
ISIN of the company, which has joined the depository System, to the
Participant”.
“The company should inform the Stock Exchanges, where its shares are listed
that the company's shares are eligible for dematerialisation. The shareholders
should also be intimated that the company's shares can be held in dematerialised
form. The same can be communicated by issuing an advertisement in
newspapers. The information can also be disseminated through its disclosure in
the Annual Report of the company”.
Procedure to be followed by DP on receiving request from the investor
 In order to dematerialize the physical share certificates, an investor will have

to first open account know a Demat account with the DP of his choice.
 Obtain the account number from DP.
 Obtain the Dematerialised Request Form (DRF) from his DP.
 This DRF, together with the Share Certificates desired to be dematerialised is

to be submitted to DP.
 The DP once receives the shares and the DRF, will issue an
acknowledgement and will send an electronic request to the
Company/Registrars and Transfer Agents of the Company through the
Depository for confirmation of demat.
 DP, then issues an “acknowledgement to the investor” and afterwards follows

the following procedure:
a. “Defaces the Share Certificates by putting a rubber stamp "Surrendered

for Dematerialisation" and by punching two holes on the name of the
company on the Share Certificate”.
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b. “Generates a Demat Request Number (DRN) through his Depository
Participant Module (DPM) and fills the same in DRF at the appropriate
place”.
c. “Sends an electronic communication to Depository viz. NSDL or CDSL,

as the case may be, to the effect that so many shares of this company
(Identified by ISIN) have been received for dematerialization”.
d. “Sends the DRF and Share Certificates to the company by courier. The
role of DP comes to an end with this but he must send a reminder in
case credit of shares is not received in demat account of investors within
a month”.
 “The depository electronically downloads the particulars of demat request,

received from DP and sends to the electronic Registrar of the company so that
these shares could be dematerialized”. Ultimately, the company or its RTA, as
the case may be, receives two kinds of communications:
a. DRF and Physical Share Certificates from DP.
b. Electronic Download of Demat Request from depository through

electronic Registrar.
Benefits of Demat
1. Elimination of Risk: Facilitates paperless trading. Risks associated with bad

deliveries, theft, forgery, delays in transfer are completely eliminated.
2. Convenient: There is immediate transfer of securities. Even “odd lot shares can
be traded, as small as even one share”.
3. Lesser formalities: No formal registration required
4. Safety: Reduction of risks involved in physical certificates such as bad delivery,

fake securities etc.
5. Economical: Charges applicable to an investor are lower for each demat

transaction as compared to physical holdings. There is reduction in
holding/transaction cost. No stamp duty on transfer of securities
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6. Quick settlements: Securities are transferred immediately on receipt of
instructions. The settlement is done on T+2 basis.
7. Liquidity: The expedited procedures enhance the liquidity of the stock market.
8. Mandatory requirements are fulfilled: in the present electronic era it is

preliminary for Investors to demat the shares if he/she wants to sell the same
through the Stock Exchanges.
9. Lesser formal procedures: No requirement for approval of Board of Directors

of the Company for transfers.
10. Incorporation of changes: Correspondence with each company separately is

not needed as the change in address recorded with DP gets registered
automatically through the electronic channel with all companies in which investor
holds securities.
11. Crediting of shares: Shares received as “bonus, split, consolidation, merger etc.
are electronically credited into the demat account of the investor”. Demat system
is “automatic”. Similarly, “shares allotted in public issues are directly credited into
the demat account of the applicants immediately”.
12. Pledge of Securities: when the securities are held in “electronic form pledge of
securities to raise loans at short notice is possible”.
Rematerialization of shares
Remat is the process by which shares in the demat form can be reconverted into the
physical form with the reissue of a share certificate.
The procedure for rematerializing shares is as under: ·
 “Shareholder has to deposit duly filled in Rematerialisation Request Form (RRF)

to the associated DP.
 “DP informs the particular Depository of the request through the system
electronically. DP submits RRF to the Company’s R&TA”.
 “Company’s RTA assures rematerialisation request to the Company’s R&TA”.
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 “The RTA clears the remat request in the physical master, prints certificate(s)
and sends it to the company for its sanction”.
 “After the sanction and return of the printed certificates duly signed, the share
certificate is sent to the shareholder(s)”.
 “After dispatch RTA assures the remat request in the Depository system”.
 “Depository updates the Beneficiary”.
Rematerialisation process can be explained as follows:
Source:www.sbismart.com
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What is the difference between dematerialisaton and rematerialisation of shares?
2.9. ROLES, OBJECTIVES AND FUNCTIONS OF SEBI AND ITS GUIDELINES

RELATING TO DEPOSITORY SYSTEM
Securities Exchange Board of India (SEBI) was established in 1988. Its main function is
to “regulate the functions of securities market. SEBI promotes systematic and efficient
growth of the stock market”.
Reasons for Establishment of SEBI:
There is abundance increase in the transaction taking place in the stock markets. Many
scams have taken place with respect to trading. Similarly many unethical practices were
seen in stock markets including “price rigging, deferred delivery of shares, and
desecration of rules and regulations of stock exchange and listing requirements”. Due to
these malpractices the faith and confidence of investors was lost in the stock exchange.
As a remedy to the ever growing unrest among investors and shareholders, the
“Government of India decided to set up an agency or regulatory body known as
Securities Exchange Board of India (SEBI)”.
Purpose and Role of SEBI:

SEBI was set up with the main purpose of controlling the malpractices prevalent in the
stock market thereby protecting the “interest of investors”. It was set up to meet the
needs of the following stakeholders.
1. Issuers: To facilitate a market place in where the finances could be raised

easily and openly in a fair manner.
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2. Investors: To provide a safeguard against illegal and unethical practices and
provide faster dissemination of correct and accurate disclosure.
3. Intermediaries: To provides a marketplace with competitiveness and
professionalism.
Objectives of SEBI:
The overall objectives of SEBI are to “protect the interest of investors and to promote
healthy and orderly development of stock exchange and to regulate the activities of
stock market”. The objectives of SEBI can be enlisted as follows:
1. To “standardise the activities of stock exchanges”.
2. To “defend the rights of investors and ensure protection of their investment”.
3. To “prevent fraudulent and malpractices by having balance between self
regulation of business and its statutory regulations”.
4. To “generate a code of conduct for middlemen such as brokers, underwriters,
etc”.
Functions of SEBI:
The SEBI performs functions to meet its objectives. To meet these objectives SEBI has
three important functions. These are:
1. Protective Functions:
In order to guard the interest of the investor, Protective functions are performed by
SEBI. These include:
(i) Checks on Price Rigging: Price rigging is a practice in which the “prices of
securities are manipulated with the main aim of inflating or depressing the market
price of securities. SEBI restricts such practice as leads to defrauding and cheating
the investors”.
(ii) Prohibits Insider trading: This practice facilitates the use of inside information by
the people associated with the company to their advantage. This kind of piece of
information is accessible only to the person who is an Insider. Insider may include
“any person linked with the company such as directors, promoters etc. These
insiders have reach to even the secretive information which may affect the prices of
the securities. This information is not available to the public at large or the outsiders.
It become the privilege of people working inside the company. When they use this
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information to make profit, then it is known as insider trading, e.g., the directors of a
company may know that company will issue Bonus shares to its shareholders at the
end of year and they purchase shares from market to make profit with bonus issue.
This is known as insider trading. SEBI endeavors to keeps a strict check when
insiders are buying securities of the company and takes strict action on insider
trading in order to ensure fair trading practices”.
(iii) Prohibit fraudulent and Unfair Trade Practices: SEBI disallows any “publicity in
the form of misleading statements by the companies that are meant to induce the
sale or purchase of securities by any other person”.
(iv) SEBI also takes “initiative to make investors aware by educating them so that they
are able to analyse the securities of various companies”. SEBI tries to “generate the
capability in investors of selecting the most profitable of the available securities”.
(v) SEBI “promotes fair practices and code of conduct in security market” by taking
following steps:
(a) SEBI has “issued guidelines to look after the interest of debenture”.
(b)SEBI has “the power to investigate cases of insider trading and can impose
fine, penalties and even recommend imprisonment”.
(c)SEBI has “stopped the practice of making preferential allotment of shares
unrelated to market prices”.
2. Developmental Functions:
These are the functions that “encourage and widen activities in stock exchange and
augment the business in stock exchange”. Under developmental categories following
functions are included:
(i) “SEBI undertakes training of middlemen and intermediaries of the securities
market”.
(ii) “It promotes activities of stock exchange by following flexible and easy
approach” in following way:
(a) “Internet trading has been allowed by SEBI through registered stock
brokers”.
(b) “Underwriting has been made optional by SEBI in order to reduce the cost
of issue”.
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(c) “Launching of initial public offer in the primary market has been allowed
through stock exchange”.
3. Regulatory Functions:
These functions are performed by SEBI to regulate the business in stock exchange. To
regulate the activities of stock exchange following are included:
(i) In order to regulate the intermediaries such as merchant bankers, brokers,
underwriters, etc. SEBI has framed rules and regulations and a code of conduct.
(ii) These middlemen are now under the regulatory purview of SEBI. Even,
private placement has become more limiting
(iii) The functioning and the working of intermediaries as stock brokers, sub-
brokers, share transfer agents, trustees, merchant bankers and others who are
connected and related with stock exchange in any manner is registered and
regulated under SEBI.
(iv)The working, registration and regulation of mutual funds etc. is seen by SEBI.
(v) The takeover of the companies is regulated by SEBI.
(vi) The audit of stock exchanges is regulated by SEBI.
SEBI (Depositories and Participants) Regulations, 1996
“In accordance with the Depositories Act, 1996 there are certain regulations governing
the registration of a depository, the certificate of commencement of business,
registration of a participant, rights and obligations of various constituents of the
depository system and inspection”. The salient features of these regulations are as
follows:
1. Registration of Depository:
“Every Depository has to take a certificate of registration as well as certificate of
commencement of business form SEBI by fulfilling certain conditions. The
sponsor must belong to one of the following categories:
 A scheduled bank
 A public financial institution
 A foreign bank operating in India with the approval of RBI
 A recognized Stock exchange
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 A body corporate engaged in providing financial services where not less
than 75 percent of the equity capital is held by any of the institutions
mentioned earlier, jointly or severally
 A body corporate constituted or recognized under any law in force in a
foreign country at that time for providing custodial, clearing or settlement
services in the securities market and approved by the Government of India
 An institution engaged in providing financial services established outside
India and approved by the Government of India
 An applicant is a fit and proper person
This sponsor shall, at all times, hold at least 51 percent of the equity capital of the
depository and the balance of the equity capital of the depository shall be held by its
participants. No participants shall at any time hold more than 5 percent of the equity
capital of the depository. However, no foreign entity individually or collectively, either as
a sponsor or as a participant or as both sponsor and participant, shall hold more than 20
percent of the equity capital of a depository. A foreign entity shall mean a body
corporate or an entity where more than 51 percent of its equity is held by persons who
are not citizens of India.”
2. Conditions for registration
“A depository shall have a net worth of not less than INR 1,000 million and it shall get its
by-laws approved by the depository. It shall have automatic data processing system,
which are protected against unauthorized access, alteration, destruction, disclosure or
dissemination of records and data. The network through which continuous electronic
means of communications is established between the depository, participants, issuers
and issuers’ agent must be secure against unauthorized entry or access. The
depository shall make adequate arrangements, including insurance, for indemnifying the
beneficial owners for any loss that may be caused to such owners by a wrongful act,
negligence or default of the depository or its participants or of any employee of the
depository or participant”.
3. Registration of the DP
As per the SEBI regulations, “the registration of a depository participant with SEBI is
also required. An application for the grant of a certificate of registration as a participant
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shall be made to SEBI in the prescribed form through each depository in which the
applicant proposes to act as a participant. The applicant shall belong to one of the
following categories.
 A public financial institution
 A scheduled commercial bank
 A foreign bank operating in India with the approval of the RBI
 A state financial corporation
 An institution engaged in providing financial services, promoted by any of the
institutions mentioned in Section 10.8.1, jointly or severally
 A custodian of securities who has been granted a certificate of registration by
SEBI
 A clearing corporation or a clearing house of a stock exchange.
 A stockbroker who has been granted a certificate of registration by SEBI,
provided that the stockbroker has a minimum net worth of INR 5 million and the
aggregate value of the portfolio of securities of the beneficiary owners held in
dematerialized form in a depository through him does not exceed 100 times the
net worth of the stockbroker. If the stockbroker seeks to act as a participant in
more than one depository, he shall comply with the specified criteria separately
for each such depository. Further, when the stockbroker has a minimum net
worth of INR 100 million, the limits on the aggregate value of the portfolio of
securities of the beneficial owners held in dematerialized form in a depository
through him shall not be applicable.
 Non-banking finance company with net worth of not less than IND 5 million,
provided that such a company shall act as a participant only on behalf of itself
and not on behalf of any other person. Further, a non-banking finance company
may act as a participant on behalf of any other person if it has a net worth of INR
500 million in addition to the net worth specified by any other authority.
 A registrar to an issue or share transfer agent who has a minimum net worth of
INR 100 million and who has been granted or certificate of registration by SEBI”.
4. Eligible Securities for Dematerialization
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“The following securities shall be eligible for being held in dematerialized form in a
depositary.
 Shares, scripts, stocks, bonds, debentures, debenture stock or other marketable
securities of similar nature in or of any incorporated company or other body
corporate.
 Units of mutual funds, right under collective investment schemes and venture
capital funds, commercial paper, certificates of deposit, securitized debt, money
market instruments, government securities and unlisted securities.
 Any other security as may be specified by SEBI from time to time.”
5. Other Conditions
“Separate accounts shall be opened by every participant in the name of each of the
beneficial owners and the securities of each beneficial owner shall be segregated and
shall not be mixed up with the securities of other beneficial owners or with the
participant’s own securities. A participant shall register the transfer of securities to or
from a beneficial owner’s account only on receipt of instructions from the beneficial
owner and thereafter confirm this to the beneficial owner in a manner specified by the
depository in its by-laws. Every entry in the beneficial owner’s account shall be
supported by electronic instructions or any other mode of instruction received from the
beneficial owner in accordance with the agreement with the beneficial owner.
Every issuer whose securities have been declared eligible for dematerialization in a
depository shall give information to the depository about book closures, record dates,
dates for the payment of interest or dividend, dates for annual general meetings and
other meetings, dates of redemption of debentures, dates of conversion of debentures
and warrants, call money dates and other such information at the time and in the
manner specified by the depositary in its by-laws or agreement. However, no such
information would be required to be given to the depositary where the state or the
central government is the issuer of government securities”.
“SEBI has made it mandatory for all newly issued securities to be compulsorily traded in
dematerialized form. The admission to a depository for dematerialization of securities
has been made a prerequisite for making a public or rights issue or an offer for sale. It
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has also been made compulsory for public limited companies going for an IPO of any
security for INR 100 million or more only in dematerialized form”.

II. True/ False
1. All stock exchanges follow T+7 settlement cycle. (_____)
2. CDSL was the first depository established in India. (_____)
3. NSDL has been promoted by State Bank of India. (_____)
4. An issuer must register itself with a depository for the purpose of
dematerialization. (_____)
5. Rematerialisation of shares is not allowed by SEBI. (_____)
2.10. SUMMARY
Depository Act was passed in the year 1996. It replaced the traditional system of trading
in physical securities into an electronic mode also called scripless trading. Depository
system has four constituents namely, depository, depository participant, owner and
issuer. Depository is an “organization that holds securities in the electronic form.
Depository Participant is an agent of the depository who serves as a link between the
investor (owner) and the depository”. Transactions are conducted in the name of the
“Registered Owner but all the actual benefits belong to the Beneficial Owner”. In India
there are two depositories namely, “NSDL and CDSL”. SEBI is the governing body of
Depository system in India. It has issued many guidelines and amendments for
depositories in India.
2.11. GLOSSARY
1. Depository: A depository is an “organisation, which assists in the allotment and
transfer of securities, and securities lending. The shares in a depository are held in the
form of electronic accounts, i.e., in dematerialised form and the depository system
revolve around the concept of paper-less or scrip-less trading”.
2. Depository Participant (DP): is an “agent of the depository through an
association is maintained with the investor”. According to Depository Act, 1996 a
“financial institution, banks, including approved for banks, Custodian, Stock
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brokers, Clearing Corporation, Non-banking financial company, a registrar to an
issue or share transfer agent” can be a DP.
3. Issuer: “Issuer means any entity such as a corporate / state or central
government organizations issuing securities which can be held by depository in
electronic form”.
4. Dematerialisation (demat): Dematerialisation is the “process by which physical
certificates of an investor are converted in the electronic/ paperless form”.
5. Rematerialization (remat): Rematerialization is the “process of re-converting
securities held in electronic form into physical certificate form”.
6. Registered owner of Securities: This refers to the Depository whose “name in
the books of the company”. In case of demat shares, and “investor’s name is
replaced with the name of the depository and the depository becomes
‘Registered owner” in the books of the company.
7. Beneficial Owner (BO): Though the depository is “the registered owner, yet the
benefits of the dematerialized shares belong to the actual investor only. The
depository holds the securities in a fiduciary capacity on behalf of the investors.
Hence, the actual investor is the “Beneficial Owner” (BO) of the securities”.

1. Depository Participant
2. 1996
3. two
4. fungibility
1. False
2. False
3. False
4. True
5. False
2.13. REFERENCES
Page 41 of 200
1. http://web.sebi.gov.in
2. Shanmugham R, Financial Services, Wiley India, New Delhi, 2010.
3. Rama Gopal C, Management of Financial Services, Vikas Publications, Noida
(UP), 2014.
1. What is depository? Discuss major depositories in India.
2. Differentiate between dematerialization and rematerialization. Discuss the
process of dematerialisaiton.
3. Explain the provisions of SEBI with respect to depository system in India.
4. Explain the following:
a. Depository participant
b. Owner
c. Benefits of dematerialization
d. Functions of depository
Page 42 of 200
LESSON - 3
Mutual Funds
Structure
3.1. Mutual Fund: Concepts
3.2. Origin and growth of mutual funds
3.3. Constitution and Management of Mutual Funds
3.4. Classification of Mutual Fund Schemes
3.5. Difference between closed-ended and open-ended mutual funds
3.6. NAV and pricing of mutual fund units
3.7. Recent trends in mutual funds in India
3.8. Summary
3.9. Glossary
3.11. References
 Concept of mutual funds

 Advantages and disadvantages of mutual funds
 Constitution of mutual funds.
 Origin of mutual funds in India
 Mutual fund schemes
 NAV and Pricing of Mutual Funds
 Recent trends in mutual funds
Page 43 of 200
3.1. MUTUAL FUNDS: CONCEPT
In the modern era there are multiple options available with an investor to invest
his scarce resources to earn a reasonable rate of return. Investors investing for long
term tend to opt for real estate investment, shares, debentures, bonds etc. investors
who have safety as the prime motive put their money in bank deposits schemes and ,
post office deposits. But for these traditional channels mutual fund is one more type of
investment avenues available to investors.
“A mutual fund is a financial service organization that receives money from
shareholders, invests it, earns returns on it, attempts to make it grow and agrees to pay
the shareholder cash on demand for the current value of his investment”. SEBI (Mutual
Funds) Regulations, 1996 defines mutual funds as a “fund established in the form of a
trust to raise moneys through the sale of units to the public or a section of the public
under one or more schemes for investing in securities, including money market
instruments”.
A mutual fund is a “professionally managed type of collective investment scheme
that pools money from many investors and invests it in stocks, bonds, short-term money
market instruments and other securities. Mutual funds have a fund manager who
invests the money on behalf of the investors by buying / selling stocks, bonds etc”. So, a
mutual fund is a “special type of institution, a trust or an investment company which acts
as an investment intermediary and channelizes the savings of large number of people to
the corporate securities in such a way that investigators get steady returns, capital
appreciation and a low risk”.
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Concept of mutual funds can be summarized as follows:
Source:www.moneywizardfin.com
Why Mutual Funds?
The most common way of making investment in the share market is the direct purchase
of shares directly from the market. But this requires that investors should be familiar
with the “performance of the company whose share is being purchased”. He must also
know the future business prospects of the company. He ought to find out the track
record of the promoters. Financial parameters of performance as the dividend declared
by a company or the bonus issue made by the company in the previous years too
should be known. In gist, investors must know the history as well as the future
prospects of the company. For being an informed investor he needs to do research
before investing. For conducting this elaborative fundamental analysis with respect to a
particular company an investor needs to spend lot of time and resources. Still he would
act as an amateur only and not a professional. As a result majority of investors find it
“cumbersome and time consuming” to have access to so much of information and
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obtain such details about every company before investing in the shares. “In order to
save their valuable time, energy resources and get professional opinion, Investors
prefer the mutual fund route. They invest in a mutual fund scheme which in turn takes
the task of investing in stocks and shares after due analysis and research. The investor
need not trouble himself with evaluating thousands of stocks. He leaves it to the mutual
fund and its professional fund management team. Mutual funds provide the benefit of
diversification of investment. An investor’s money is invested by the mutual fund in a
variety of shares, bonds and other securities thus diversifying the investor’s portfolio
across different companies and sectors. This diversification helps in minimizing the
overall risk of the portfolio. It is also cheaper to invest in a mutual fund since the
minimum investment amount in mutual fund units is fairly low (Rs. 500 or so)”. The
advantages of mutual funds can be enlisted as follows:
1. Portfolio diversification: “Each investor is a part owner of a total fund’s assets,
thus enabling him to hold a diversified portfolio even with a small investment
which otherwise would not have been possible without a big capital investment”.
2. Professional management: Since the fund is managed professionally under a
formal legal structure, investors get professional expertise at all stages of
investment.
3. Diversification of risk: In any investment like buying a share or a debenture the
risk belongs to the investor. But in case of mutual funds since the investor hold
only a part of the total funds, risk is reduced.
4. Reduction in transaction cost: The professional aid available invests in large
securities at one go, thereby reducing the transaction cost.
5. Liquidity: An investor gets benefits of scale. He pays lesser costs due to
increased volumes. In other individual investments total cost has to be solely
borne by the investor alone.
6. Other facilities: Mutual funds offer many other services due to availability of
professional expertise as “easy transfer of funds from one scheme to another,
access to updated market information etc”.
7. Multiple Schemes: Many alternative schemes suitable to the objective of an
investor are available to an investor.
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8. Well regulated: Mutual funds are governed by SEBI and work under the strict
provisions of investor protection.
9. Transparency: Regular information on investment is readily available.
Why not Mutual Funds?

1. No control over costs: An investor has any control over costs. He pays
management fees as long as he holds the fund. He is liable to pay the fee
even if the value of his investment is declining. He pays cost of fund
distribution also which is not present in case of individual investments.
2. No tailor made portfolios: Investing at a personal level facilitates construction
of a portfolio of one’s own choice. Here the investor has to delegate this
decision to fund managers.
3. Dilution of benefits: Mutual funds tend to invest into a portfolio of small
holdings. The benefit of big investment in blue chip companies cannot be
achieved by this kind of broken investment.
4. Ambiguity about cost: Many salesmen do not make their costs clear to the
investor.
3.2. ORIGIN AND GROWTH OF MUTUAL FUNDS IN INDIA
“The mutual fund industry in India started in 1963 with the formation of Unit Trust of
India, at the initiative of the Government of India and Reserve Bank of India. The history
of mutual funds in India can be broadly divided into four distinct phases”.
 First Phase - 1964-1987
The first endeavor was the “establishment of Unit Trust of India (UTI) in 1963 by an Act
of Parliament”. . UTI is India’s first mutual fund organisation .There was an economic
tumult in 1960s. The then Finance Minister, “T.T. Krishnamachari set up the idea of Unit
Trust of India”. The aim was “to help to mobilise small savings of people and invest the
same in capital market. It was established by the Reserve Bank of India. UTI functioned
under the Regulatory and administrative control of the Reserve Bank of India. But, in
1978 UTI got de-linked from the RBI. Thereafter, Industrial Development Bank of India
(IDBI) took over the regulatory and administrative control of UTI instead of RBI. Unit
Scheme 1964 was the first scheme launched by UTI”.
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 Second Phase - 1987-1993 (Entry of Public Sector Funds)
In the second phase of “development of Mutual Fund industry the public sector banks
showed their participation”. As a result “the year 1987 witnessed the entry of non-UTI,
public sector mutual funds set up by public sector banks and Life Insurance Corporation
of India (LIC) and General Insurance Corporation of India (GIC). SBI Mutual Fund was
the first non-UTI Mutual Fund established in June 1987 followed by Canbank Mutual
Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund
(Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established
its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990”.
 Third Phase - 1993-2003 (Entry of Private Sector Funds)
In the third phase “private sector funds were started in 1993. This led to the inception of
a new era in the Indian mutual fund industry. It gave the Indian investors a wider choice
of deploying their funds. In the year 1993 only the first Mutual Fund Regulations came
into being, and all mutual funds, except UTI were to be registered and governed under
it. The Kothari Pioneer (now merged with Franklin Templeton) was the first private
sector mutual fund registered in July 1993. The 1993 SEBI (Mutual Fund) Regulations
were substituted by a more comprehensive and revised Mutual Fund Regulations in
1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996. The
number of mutual fund organizations increased drastically over a period of time and
even foreign mutual funds started setting up funds in India. The mutual fund industry
also experienced many mergers and acquisitions during this phase”.
 Fourth Phase - since February 2003
“UTI was split into two separate entities in February 2003. The two entities thus formed
were: 1.Specified Undertaking of the Unit Trust of India and 2. UTI Mutual Fund.
Specified Undertaking of the Unit Trust of India consisted of the assets of US 64
scheme. It promised assured return and certain other schemes. The Specified
Undertaking of Unit Trust of India was functioning under an administrator. It was
covered under the rules framed by Government of India and did not come under the
scope of the Mutual Fund Regulations. The UTI Mutual Fund was sponsored by State
Bbank of India, Punjab National Bank, Bank of Baroda and LIC. It is registered with
SEBI. It comes under the purview of the Mutual Fund Regulations”.
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Check Your Progress A
Fills in the blanks:
1. Mutual fund is managed by a ______________.
2. Mutual fund investment provides the benefit of a ____________portfolio.
3. ________was the first Mutual Fund launched in India.
4. ____________was the first non- UTI mutual fund set up in the country.
3.3. CONSTITUTION AND MANAGEMENT OF MUTUAL FUNDS IN INDIA

Mutual Funds in India follow a 4-tier structure.
1. Sponsor: “This is the first tier of the mutual fund structure. He is the
entrepreneur who thinks of establishing and intiating a mutual fund. The Sponsor
contacts the Securities & Exchange Board of India (SEBI), which is the market
regulator and also the regulator for mutual funds. Not everyone can start a
mutual fund. SEBI checks whether the person is of integrity, whether he has
enough experience in the financial sector, his Net worth etc”.
2. Public Trust: “This is the second tier of the mutual fund structure. After SEBI is
convinced, the sponsor creates a Public Trust as per the Indian Trusts Act, 1882.
In India Trusts do not have any legal identity. Thus these cannot enter into
contracts, hence the Trustees are the people authorized to act on behalf of the
Trust. Contracts are entered into in the name of the Trustees. After the Trust is
made, it is registered with SEBI. After this process the trust is known as the
mutual fund. The Trustees role is not exactly to manage the money. Rather, their
task is primarily to see that the money of investors is being managed as per
given objectives. Trustees are infact the internal regulators of a mutual fund”.
3. Asset Management Company: “This is the third tier of the mutual fund
structure. Its primarily role is to manage money. Trustees appoint the Asset
Management Company (AMC). The AMC works in lie of a fee for the services
provided by it. This charge of fee is borne by the investors as it is deducted from
the money collected from them. The AMC’s Board of Directors must have at
least 50% of Directors who are independent directors. The AMC has to be
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approved by SEBI. The AMC functions under the supervision of its Board of
Directors, and also under the direction of the Trustees and SEBI. It is the AMC,
which in the name of the Trust, floats new schemes and manages these
schemes by buying and selling securities. In order to do this the AMC needs to
follow all rules and regulations prescribed by SEBI and as per the Investment
Management Agreement it signs with the Trustees”.
4. Custodian: “The main role of the custodian is that he keeps physical securities
safe with him. He also keeps a track of the various activities of the corporate in
terms of rights, bonus and dividends declared by the companies in which the
fund have been invested. The Custodian is appointed by the Board of Trustees.
The custodian also participates in a clearing and settlement system through
approved depository companies on behalf of mutual funds, in case of
dematerialized securities. In India today, securities (and units of mutual funds)
are no longer held in physical form but mostly in dematerialized form with the
Depositories. The holdings are held in the Depository through Depository
Participants (DPs). Only the physical securities are held by the Custodian. The
deliveries and receipt of units of a mutual fund are done by the custodian or a
depository participant at the instruction of the AMC and under the overall
direction and responsibility of the Trustees. Regulations provide that the Sponsor
and the Custodian must be separate entities”.
Activity 1
Highlight the role of the following in the management of Mutual funds
1. Sponsor
________________________________________________________________
____________________________________________________________
2. Custodian
________________________________________________________________
____________________________________________________________
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3.4. CLASSIFICATION OF MUTUAL FUND SCHEMES
Source:www.slideshare.net
Classification of Mutual Funds Schemes can be done in the following manner:

1. By structure
2. By investment objectives
3. By geographical location
4. Other Schemes
1. By structure:
i. Open ended scheme: an open ended scheme is one that is always open to
new investors and existing investors can redeem their units at any time. Entry
and exit of investors into and out of the scheme can be made at any time. This
scheme does not have a fixed maturity period. “The units can be purchased and
sold even after the initial offering (NFO) period (in case of new funds)”.
Investors can buy and sell at NAV related prices that are available on daily
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basis. Open ended schemes continue to operate indefinitely and allow investors
to plan for a longer time period. Liquidity is the major advantage of open ended
schemes.
The number of outstanding units “keeps on changing every time the fund house
sells or repurchases the existing units”. This is the “major cause of variation in
the unit capital of an open-ended mutual fund”. The fund “enlarges in dimension
when the fund house sells more units than it repurchases as more money is
coming in”. “On the other hand, the fund's size diminishes when the fund house
repurchases more units than it sells. However, an open-ended fund is not under
any obligation to keep selling new units all the time. For example, if the
management feels that manage a massive-sized fund judiciously is difficult; it
can discontinue accepting new subscription requests from investors. However,
it cannot refuse to repurchase the units at all times because this is the essence
of an open ended fund”.
ii. Closed ended scheme: “A closed-end fund functions much more like an
exchange traded fund than a mutual fund.” They are issued through an IPO in
order to raise money. These are then traded in the open market. Only specifc
number of units can be sold under closed ended scheme as the unit capital of
the fund is fixed. “Investors cease the right to buy the units of a closed-ended
fund after its NFO period is over. This prohibits new investors to enter and
existing investors to exit till the term of the scheme ends. However, to facilitate
and grant a platform for investors to leave before the expiry of the term, the fund
houses list their closed-ended schemes on a stock exchange. Trading on a
stock exchange enables investors to buy and sell units through a broker or an
intermediary in the same way as transacting the shares of a company. The
performance of the fund depends upon many factors including investor’s
expectation from the future pattern and prospects of the company and as a
result the units may trade at a premium or discount to the NAV. The price of the
units of fund is also affected by the demand and supply of fund units and other
market factors. The number of outstanding units of a closed-ended fund
remains same because of trading on the stock exchange. Apart from listing on
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an exchange, these funds sometimes offer to buy back the units. This offeris
another source of liquidity to the investor. SEBI regulations make sure that
closed-ended funds offer at least one of the two options to investors for entering
or exiting. The closed-ended funds do not result into abrupt redemption which
relieves the investor from any anxiety. Also, the fund managers are not anxious
about the size of the fund”.
iii. Interval Scheme: Interval Schemes are those “that combine the features of
open-ended and close-ended schemes”. The units may be traded on the stock
exchange or may be open for sale or redemption during pre-determined
intervals at NAV related prices.
2. By investment objectives: These schemes include growth scheme, income

scheme, balanced scheme and money market scheme. These may be open-
ended or closed- ended schemes.
i. Growth schemes: These schemes usually “make an investment of majority of

their funds (70%-80%) in equities”. These are ready to put up with short term
decline in value for possible future appreciation. The main purpose of growth
schemes is to “offer capital appreciation over the medium to long term”.
“However, these schemes are not meant for investors who wish to have regular
income or need their money back in the short term. This scheme is most
suitable for investors who are in their prime earning years and investors wishing
for growth over the long term”. These schemes are also known as “equity
schemes”.
ii. Income Schemes: “These schemes aim to provide periodic and stable income
to investors. These schemes generally invest in fixed income securities such as
bonds, government securities, money market instruments and corporate
debentures”. A greater portion is invested in debt securities (as high as 80%).
Capital appreciation in such schemes may be limited. These are also called
debt schemes. These are ideal for retired people who need regular income and
capital protection.
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iii. Balanced Schemes: As the name suggests “these schemes invest in both
shares and fixed income. The main aim to provide both growth and income by
periodically distributing a part of the income and capital gains they earn”. The
offer documents mention the proportion of securities (either 50:50 or 40:60
proportions). These schemes are safe though a prosperous and booming stock
market does not hike the NAV of these schemes but at the same time a
regressive and depressive market may not lead to an equal fall of NAV of these
securities. These are most suitable for Investors looking for a combination of
both income and moderate growth.
iv. Money Market/Liquid Schemes: These schemes accompany multiple
benefits as their major purpose is to ensure liquidity along with maintenance of
capital. The scheme also generates a reasonable income. “These schemes
believe in investing in safer instruments with, short term maturity periods and
may include instruments like treasury bills, certificates of deposit, commercial
paper and interbank call money. Return on these schemes is volatile and it is
affected by the interest rates available in the market. These are most suitable
for corporate and individual investors who wish to invest their surplus funds for
a short duration only”.
3. By Geographical Location:
i. Domestic fund: Those mutual funds that are registered in India are called
domestic funds.
ii. Off shore fund: The mutual fund that is registered outside India and is set up
by an institution that is based outside India is called off shore fund. These funds
have non- resident investors and are subject to rules and regulations of a
foreign country where they are registered.
4. Other Schemes: The other schemes include the following:
i. Tax Saving Scheme: These schemes are the ones that provide tax incentives
to the investors which are given under tax laws of the country from time to time.
The investment in these schemes is made in equities which has a long term
orientation. These are suitable for investors who need tax benefits along with
investment for a longer period of time.. For instance, under Section 88 of the
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Income Tax Act, investments made in Equity Linked Saving Schemes (ELSS)
and pension schemes are eligible for deduction in computing the total taxable
income of the investor. Basically, the scheme is a growth scheme and funds are
invested in equity.
ii. Special Schemes: This category includes
 Index schemes: These are the “schemes which are similar in
performance of a particular index such as the BSE SENSEX, the NSE 50
(NIFTY)”. In case of index schemes the investment is made only in those stocks
that are included in the index number. Also, the amount of investment in each
scrip will be in the same proportion as that of the particular scrip in the index
number. The NAV or schemes would increase or fall in accordance with the rise
and fall of the specific index number.
 Sector specific schemes: These are the schemes that invest
investor’s fund in specific sectors or industries such as Information
&Technology, Textiles, Drugs and Pharmaceuticals, Infrastructure, Banking,
etc. “The returns to be generated in these funds are associated with the
performance of the respective sectors or industries. These funds are
comparatively riskier than the diversified ones as these tend to invest total
amount in one industry or sector only”. Putting all eggs in one basket generates
more risk. But, simultaneously the riskiness involved brings higher return as
well.
“Besides, there are also schemes which invest exclusively in certain segments
of the capital market, such as Large Caps, Mid Caps, Small Caps, Micro
Caps, 'A' group shares, shares issued through Initial Public Offerings (IPOs),
etc”.
iii. Fixed Maturity Plans (FMPs): These schemes primarily make investment in
debt instruments though a meager proportion may be put in the equity shares.
These are closed ended schemes. These investment schemes have fixed
tenure. “These funds range from a short period investment to a medium term
investment as the maturity period varies from one month to three/five years.
The main purpose of this type of scheme is to ensure stable returns over a
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fixed-maturity period and shield the investor against market fluctuations. FMPs
are typically passively managed fixed income schemes and the endeavor of the
fund manager is to put money into investments with maturities corresponding
with the maturity of the plan. FMPs are not guaranteed schemes”.
iv. Exchange Traded Funds: “These are essentially index funds that are listed
and traded on exchanges”. These funds may be Index fund schemes or sector
specific schemes or a commodity fund. For instance, a gold exchange traded
fund scheme means a mutual fund scheme that makes investment mainly in
gold or gold related instruments. These are suitable for “investors who want to
earn a return nearly equal to that of an index”. At the international level as well,
“ETFs have offered a whole new vista of investment opportunities to retail as
well as institutional investors. ETFs aid investors to have immense exposure to
entire stock markets as well as in specific sectors. These also offer ease, on a
real-time basis and at a lesser cost than many other forms of investment”.
v. Fund of Funds (FOFs): “A mutual fund scheme that invests mainly in other
schemes of the same mutual fund or other mutual funds”. Just as a mutual fund
that holds securities in different companies, fund of funds holds units in different
mutual fund schemes. It offers advantage of greater diversification. But, the
returns from this scheme are comparatively lower than other schemes.
vi. Load fund/ no load fund: Load refers to a fee charged by the mutual fund from
the investor. So, load fund means a scheme that charges fees as a percentage
of the NAV for entry and exit. Each time when an investor buys or sells the fund,
a charge is payable by him. This charge is used by the mutual fund to bear the
marketing expenses. When no such additional fees or charges are taken it is
called a no load fund.
3.5. “Difference between open ended and closed ended mutual fund”
Features “Open ended” “Closed ended”

Open for subscription through- Open for subscription only for
Subscription
out the period of the scheme a limited period of time.
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The funds raised remain fixed
Variation Funds raised keeps on varying
for all time to come.
Anytime exit can be made from Exit takes place only on the
Exit
the scheme closure of the scheme
Liquidation is possible only on
Liquidation High liquidation
the closure of the scheme
Trading on
These are not traded on stock These are traded on stock
stock
exchange exchange
exchange
Maturity Any time maturity Fixed maturity period
3.6. NAV AND PRICING OF MUTUAL FUND UNITS

“The Net Asset Value (NAV) per unit of a particular mutual fund scheme is the
sum total of the market value of all the assets held in the portfolio including cash minus
expenses divided by the total number of units held by the investors. That is, Net asset
value (NAV) is the value of a fund's asset less the value of its liabilities per unit”. It can
be put as:
“NAV = (Value of Assets-Value of Liabilities)/number of units outstanding”
The investments based on mutual funds are marked to market on daily basis. In
other words, it can be said that current market value of such investments is calculated
on daily basis. Therefore NAV on a particular day reflects the realizable value that the
investor will get for each unit if the scheme is liquidated on that day. This NAV keeps on
changing with the changes in market rates of equity and bond market. Therefore, the
investment in mutual funds is not risk free. It is the good managed funds that can give
high returns. NAV helps an investor verify the valuation of the fund and assess if the
fund is overvalued or undervalued. NAV is especially important in case of open-end
funds. NAV represent that value of the fund's that an investor will be entitled to receive
at the time of withdrawal of investment. In case of a close-end fund, which is a mutual
fund with fixed number of units, price per unit is determined by market and is either
below or above NAV
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NAV is a measure of the market value of fund’s units. It helps to track the
performance of the mutual fund where the investment has been made. The percentage
increase in the NAV of the fund is the true increase in the value of investment over a
period of time. Therefore, an investor can have precise and correct information about
his investment by evaluating NAV movements of a fund over a longer period of time.
Assume that the market value of the portfolio of a mutual fund scheme is Rs. 100
lakh and the scheme issued 5 lakh units. The NAV per unit of this particular scheme is
100lakh/ 5 lakh= Rs. 20.
Importance of NAV
1. The NAV helps the investor in calculating the number of units an investor can
buy in a certain scheme. For eg if NAV of a particular scheme is Rs. 25 at one
point of time and the investor wants to invest Rs. 25000 in the scheme. He can
purchase 25000/25= 1000 units.
2. NAV helps the investor in calculating redemption amount and profit of an
invested amount. For instance, if NAV in above example in point 1 is Rs. 50 at
some point of time and the investor sells his holding of 1000 units. The profit per
unit to the investor would be Rs. 25.
3. NAV helps in assessing the general performance of a particular scheme over
time. The NAV of a mutual fund scheme can be compared at two different time
points to see the performance of a fund. For instance if NAV was Rs. 15 and it
rose to Rs. 25 in two years, there is a return of 66.67% in two years. The
annualized growth of this investment is 29.10
Activity 2
Highlight the benefits of the following types of Mutual Fund Scheme
1. Growth Scheme
___________________________________________________________
___________________________________________________________
2. Balanced Scheme
___________________________________________________________
___________________________________________________________
3. Exchange Traded Funds
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___________________________________________________________
___________________________________________________________
3.7. RECENT TRENDS IN MUTUAL FUNDS IN INDIA

Mutual fund industry was started in 1963 with the formation of UTI by the
Government of India and Reserve Bank of India. “Thereafter in 1987 permission was
given to Public Sector Banks, Life Insurance Corporation and General Insurance
Corporation to set up Mutual Funds”. SBI Mutual Fund was launched as the first non
UTI Mutual fund. From 1993 onwards, Private sector funds also entered the market.
Since years Mutual Fund Industry is mobilizing huge savings of people and investing
the same in the capital market and money market instruments. The net resource
mobilization done by mutual fund industry from 1974-75 till 2013-14 is shown an follows:
Table 1
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Table 1 shows the net resources mobilized by mutual funds from 1974-75 till 2013-14.
The resource mobilization has shown an increasing trend especially for two decades till
1994-95. Thereafter it showed declining trend, especially in the years 1994-95 till 1999-
2000. In 2000s an intermittent declining trend is observed though the resource
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mobilization showed a suppressive behavior in the years after the global financial crisis
that is, 2008-09 and thereafter.
The number of schemes offered by Mutual Fund Industry in the recent years is shown
as follows in Table 2.
Table 2
Source: SEBI
The same can be evaluated graphically
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It is observed that the number of schemes have largely been increasing in the
recent years, though there seems to be some fall in 2012-13 perhaps on account
of the aftermath of recession.
Table 3 gives the funds mobilized through mutual funds under different schemes
in the recent year of 2010-11 till 2013-14.
Table 3
Debt schemes seem to be most preferred ones by the investors, followed by

Income schemes. The total mobilization declined in the year 2011-12 and 2012-
13. The same can be shown graphically.
Source: SEBI
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Table 4 shows the Net assets under Mutual Funds during the recent time from
2010-11 till 2013-14.
Table 4
There is a sharp increase in the Net Assets under Mutual Funds. The same can
be shown graphically.
Source: SEBI
Thus, mutual funds have become a very favored channel of investment. With its multiple
advantages in terms of diversified portfolio and professional management, the industry
seems to have a radiant future.

Answer in True/ False.
1. Sponsor is the one who thinks of starting a mutual fund (______)
2. Close ended mutual funds remain open indefinitely for investment. (______)
3. Greater portion of income funds is invested in equity shares. (______)
4. NAV calculates the per unit value of a mutual fund scheme. (______)
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3.8. SUMMARY
Mutual fund is one of the most upcoming channels of investment. “A mutual fund is a
professionally managed type of collective investment scheme that pools money from
many investors and invests it in stocks, bonds, short-term money market instruments
and other securities.” It is managed through a four tier structure including the Sponsor, a
Public Trustee, an Asset Management Company and a Custodian. Mutual funds provide
the benefit of a diversified portfolio, risk reduction, professional expertise and a choice
of multiplicity of schemes. Performance of mutual funds is determined with the help of
“Net Asset Value (NAV). NAV per unit of a particular mutual fund scheme is the sum
total of the market value of all the assets held in the portfolio including cash minus
expenses divided by the total number of units held by the investors. That is, Net asset
value (NAV) is the value of a fund's asset less the value of its liabilities per unit”. UTI
was the first mutual fund started in 1963 and thereafter there has been tremendous
growth in the mutual fund industry.
3.9. GLOSSARY
1. Mutual Funds: “A mutual fund is a mediator that brings together a group of
people and invests their money in stocks, bonds and other securities. Each
investor owns shares, which represent a portion of the holdings of the fund. Thus,
a mutual fund is one of the most viable investment options for the common man as
it offers an opportunity to invest in a diversified, professionally managed basket of
securities at a relatively low cost”.
2. AMC: “is a company that manages a mutual fund. For all practical purposes, it is
an organized form of a money portfolio manager which has several mutual fund
schemes with similar or varied investment objectives. The AMC hires a
professional money manager, who buys and sells securities in line with the fund's
stated objective”.
3. Net Asset Value (NAV): “NAV is the actual value of one unit of a given scheme on
any given business day. The NAV reflects the liquidation value of the fund's
investments on that particular day after accounting for all expenses. It is calculated
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by deducting all liabilities (except unit capital) of the fund from the realisable value
of all assets and dividing it by number of units outstanding”.
4. Open ended funds Vs Close ended funds: “An open ended scheme allows the
investor to enter and exit at his convenience, anytime (except under certain
conditions) whereas a close ended scheme restricts the freedom of entry and exit”.

1. Fund manager
2. Diversified
3. UTI
4. SBI Mutual Fund
1. True
2. False
3. False
4. True
3.11. REFERENCES
1. www.nseindia.com
2. www.rbi.org.in
3. www.sebi.gov.in
5. Gupta, S.K. and Aggarwal N, Financial Services, Kalyani Publishers, New
Delhi, 2007
6. Bhole LM, Financia1 Services, Tata McGraw Hi1l, 2008, 4th Edition.

1. What are mutual funds? Discuss merits and demerits of investment in mutual
funds.
Page 65 of 200
2. Discuss schemes of mutual funds along with their advantages and
disadvantages.
3. How are mutual funds managed? Explain.
4. What are the recent trends in the mutual fund industry in India?
Page 66 of 200
LESSON – 4 A
Structure
4.1. The Concept of Credit Rating
4.2. Objectives of Credit Rating
4.3. Factors affecting credit ratings
4.4. Procedural aspects of credit ratings
4.5. Limitations of Credit Ratings
4.6. Summary
4.7. Glossary
4.9. References
 The concept of Credit Rating

 Objectives of Credit Rating
 Factors affecting credit ratings
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4.1. THE CONCEPT OF CREDIT RATING
There is immense development of Financial System in the country. This has

offered multiple instruments and channels of investment to the investors. Right
investment decisions require right information with respect to both the companies as
well as their instruments. There is a problem of information asymmetry between the
issuers of securities and lender of funds. The investors cannot be certain about the
credentials of a company because of the non availability of true and accurate public
disclosures. Credit Ratings render investors with information that aids them in making
better investment decision. Credit ratings suggest whether the issuer would be able to
honor its obligations with respect to securities in terms of payment of interest and
dividend and repayment of the principle as per the terms and conditions of the contract.
Credit ratings tend to bridge the gap between the lenders and borrowers of funds by
informing about the credit worthiness of the borrower to the lender.
A credit rating is assigned to an entity that intends to borrow money from any of
the stakeholders including individuals, corporate, state authority etc. Thus, it involves
evaluation of credit risk of companies and government that issue financial securities. It
determines the likelihood that the borrower would pay back the loan without default. A
high credit rating suggests a high probability of the borrower to return loan while a low
credit rating suggest a low probability of the borrower in honoring the commitments.
Definitions:
1. “Credit rating is an analysis of the credit risks associated with a financial

instrument or a financial entity. It is a rating given to a particular entity based
on the credentials and the extent to which the financial statements of the
entity are sound, in terms of borrowing and lending that has been done in the
past.” (The Economic Times) .
2. Credit Rating is grading of a borrower’s ability to meet financial obligations in

a timely manner. Credit ratings are set by lenders and by independent agents
for companies, individuals and specific debt issues. (The Financial Dictionary)
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3. Ratings are designed exclusively for the purpose of grading bonds according
to their investment qualities. (Moody’s Investor Service, 1984)
4. Corporate of Municipal debt rating is a current assessment of the

creditworthiness of an obligor with respect to specific obligation.(Standard
and Poor, 1984)
Thus, credit ratings evaluate the credit worthiness of the issuer in terms of alpha or
alphanumeric ratings; aiding the investor in his investment decisions. It is the opinion on
the credit quality of a debt instrument given by a credit rating company. It is a symbolic
expression regarding the capability and intention of the issuer of debt to service his debt
obligations as per the terms of the agreement.
Features of Credit Ratings
1. It is an opinion on the credit risk associated with an investment

2. Credit ratings are done with the help of symbols as AAA, AA etc.
3. It involves rating of the instruments. Different instruments of a same corporate
can have different rating.
4. Different rating agencies can give different ratings to the same instrument.
Hence there is a certain degree of subjectivity involved in the ratings.
5. Credit rating is just an indicator of risk associated with default. It does not
guarantee yield nor does it rates as per customer preferences and nature.
6. The assignment of ratings is subject to change with passage of time and
change in environment.
4.2 Objectives of Credit Rating
I. Objectives of companies:
1. Determination of Rate of Interest: Good credit ratings enable companies to
offer low rate of interest to the investor. Safety is a very important
parameter for most of the investors. Even if a little low rate of interest if
offered by a company with guaranteed creditworthiness, investors are
ready to invest their money into such companies.
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2. Determination of Cost of Capital: Credit ratings help companies to reduce
their cost of capital. Hence, companies with higher grades assigned by
credit ratings would offer less return while those with low ratings would
have to offer high rate of return to the investors.
3. Maximum Resource Mobilisaiton: Since credit ratings serve as a tool to
rate the credibility of a company, therefore, company with good ratings
find it easy to attract customers and raise finances from the market.
4. Establishment of Goodwill: Credit ratings help to establish reputation and
goodwill of a company in the market. It is a tool of indirect advertising.
5. Easy Financing: Higher ratings provide easy access to finances.
6. Reaction in the Financial Market: The immediate reaction if the financial
market comes from the grades given by credit rating agencies. Hence,
credit ratings can either improve or deteriorate these reactions.
II. Objectives of investors
1. Safety of Investment: Good credit ratings reduce the probability of default and
hence bring an element of safety in investment.
2. Risk Evaluation: The credit symbols given to financial instruments help the
investors to evaluate risk attached with the particular instrument.
3. Risk Reduction: It reduces the probability of credit risk to the investor as it is a
yardstick for the creditworthiness of the company.
4. Investment Decisions: Credit ratings facilitate investment decisions. Investors
can base their decisions of financial investment on the grades given by credit
rating agencies to the fund raising instruments of various companies.
5. Yardstick of Performance: The credit ratings are based on the past track
records of the issuer company. Hence an investor can estimate the
performance of company on the basis of its ratings assigned by the credit
rating agencies.
6. Professional Guidance: Credit rating agencies that are operating nationally
and internationally are formal institutions comprising of professional from
related fields. So, the investors are able to base their investment decisions by
on the basis of the professional guidance.
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7. Others: Credit rating act as a guide for new investors as well as for unaware
investors. It also motivates the investor to make investment in trade and
industry.
1) The higher the rating, the more is the chance of default (__________)
2) Credit rating is used extensively for evaluating all debt instruments.
(__________)
3) Credit rating is a communicative tool to the investor (__________)
4) Credit Ratings help the borrowers to avail loans at a competitive rate
(__________)
4.3. FACTORS AFFECTING CREDIT RATINGS

1. Volume and composition of outstanding debt: it refers to the quantum of debt
outstanding against the company as well as the sectors in which the same is
deployed. If the areas where the finances are deployed are productive, then it
would ensure the financial viability of the company.
2. Earning capacity of a company: higher earning capacity is a favorable factor
attracting good credit ratings.
3. Future cash flows: the probability of earning higher future cash flows brings
added advantage to the company.
4. Interest coverage ratio: this refers to the number of times a company’s profits are
sufficient to cover its compulsory debt obligations. The more, the better.
5. Current ratio: it is the ratio of a firm’s current assets to its current liabilities. The
ratio suggests a company’s ability to meet its short term obligations.
6. The value of assets pledged as collateral security:
7. Market position of a company: it is judged by the demand for company’s
products, its market share, distribution channels etc.
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8. Operational efficiency of a company: This is judged by the capacity utilization,
prospects of expansion, availability of raw material, technological upgradation
etc. it a company aim at increasing operational efficiency, its other performance
parameters too would improve.
9. Track record of a company: This helps in looking into the history of debt
payments of a company. It checks if the company had been a defaulter in the
past. This also reviews the non-payment issues as well as delay in payment
issues.
10. Quality of management: The track record of company’s promoters, directors and
expertise of staff also affects the credit ratings of a company.
Activity 1
How do Credit Ratings help in achieving:

1. Lower cost of capital for companies:
___________________________________________________________
___________________________________________________________
2. Evaluate risk for investors:
___________________________________________________________
___________________________________________________________
4.4. PROCEDURAL ASPECTS OF CREDIT RATINGS
The procedure followed to rate the issuers can be described in the following steps:
Step 1: Rating request from the issuer:
A company desirous of getting rated submits an application in the prescribed format and
pays the fees for obtaining the credit rating service.
A written agreement is made with the issuer by the credit rating. The agreement
contains the following clauses:
 Rights and liabilities of both parties
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 Fee for credit rating
 Periodic review by the credit rating agency during the tenure of the
instrument.
 Submission of true and sufficient and timely information by the
company to the credit rating agency.
 Disclosure of the ratings assigned to the firm through a procedural
methodology of dissemination
 Clients duty to disclose in the prospectus the rating assigned by the
credit rating agency during the last three year and the rating given by
some other agency which was not acceptable to it.
 Rating from two credit rating agencies in case of debt securities if the
size of issue is equal to or exceeds hundred crore.
Step 2: Rating procedure
Every credit rating agency specifies the rating process it is going to follow. It has also to
file a copy of it with SEBI. The rating agency shall specify the board with respect to any
modifications made in the ratings over the tenure of the instrument.
In following the formal process of ratings every rating agency shall form professional
rating committees. They shall appoint analytical team consisting of two or more
analysts. One of these two analysts would act as the lead analyst and serve as the
primary contact. The analytical team is supposed to submit its report to the professional
rating committee which finalized the ratings. The ratings are communicated to the client
with a rationale and explanation.
The credit rating agencies has to fulfill certain responsibilities while following this
procedure. Every agency has to:
 Exercise due diligence while and ensure that rating is fair and appropriate
 It shall never rate securities issued by it.
 Without prior permission of SEBI it shall not change the rating definition and
rating structure of any instrument being rated.
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 The credit rating agency shall communicate the ratings as well as the
periodic reviews to the stock exchanges.
Step 3: Rating Methodology
The instruments are rated on the basis of following parameters:
 Business analysis: It includes operational efficiency, market position and

industry risk
 Financial Analysis: It includes accounting ratios, debt service capacity, cash
flow projections, and future earnings.
 Managerial Analysis: It includes quality and education of promoter, directors
and staff. It also includes their experience and expertise.
Step 4: Communication and dissemination to the public
When the client accepts the ratings, the credit rating agency will disseminate it to the
investors through a print media as well as notification through the company’s website.
Step 5: Rating Review
Whenever there is some new information received, the CRA has to incorporate the new
piece of information and modify and revise the ratings. It has to continuously monitor its
clients. If the credit rating agency feels that there the rating needs to be revised it fixes a
meeting with the management of the issuer company.
Step 6: Acceptance/ Rejection of Rating
The client reserves the right of either accepting or rejecting the rating given by the CRA.
It may opt for a second credit rating agency. However in this case it has to disclose both
the ratings to the public. If two rating agencies give different ratings for the same
security it is called split rating.
4.5. LIMITATIONS OF CREDIT RATINGS

 It only addresses credit risk.
 Ratings do not guarantee the increase in the market prices or market
liquidity.
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 There is no answer to split ratings, i.e different rating by two CRAs for the
same instrument.
 Ratings are simply opinions and not facts
 Ratings may be subjective and biased
 Ratings are generated from the information supplied by the one’s to be
rated. Hence, it may not be fully true.
 Ratings are subject to change.
Activity 2
How do Credit Ratings help in achieving:

1. Lower cost of capital for companies:
_____________________________________________________
_____________________________________________________
2. Evaluate risk for investors:
_____________________________________________________
_____________________________________________________

1) Credit rating is an
a. Estimate
b. Opinion
c. Anticipation
d. Guarantee
2) Credit ratings affect a firm’s:
a. Cost of Capital
b. Goodwill
c. Availability of resources
d. All of these
3) When two different ratings are given by two agencies of the same
instrument it is called
a. Dual Ratings
b. Split Ratings
c. Multiple Ratings
d. Dissimilar ratings
4) Which factor does not influence the credit rating?
a. Repayment history
b. Total outstanding debt
c. Quality of management
d. Future connections
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4.6. SUMMARY
Credit rating is an analysis of the credit risks associated with a financial instrument or a
financial entity. It is a rating given to a particular entity based on the credentials and the
extent to which the financial statements of the entity are sound, in terms of borrowing
and lending that has been done in the past. Credit ratings satisfy multiple objectives of
companies and investors. It helps companies in determination of cost of capital,
resource mobilization, creation of goodwill etc. it is helps investors in risk reduction,
investment decision making and provides them with professional guidance. There are
many factors that affect a company’s credit ratings. These factors include volume and
composition of outstanding debt, earning capacity of a company, Interest coverage
ratio, Current ratio, market position of a company etc. A step-wise procedure is followed
for obtaining the credit ratings. Two different ratings may also be assigned by different
credit rating agencies. The firm reserves the choice on not accepting the ratings given
by the agencies
4.7. GLOSSARY
1. Credit Rating: Credit rating is an analysis of the credit risks associated with a
financial instrument or a financial entity.
2. Current Ratio: It refers to the ratio of company’s current assets to its current
liabilities. The ratio tells about the liquidity position of a company.
3. Credit Risk: It refers to the risk of default by the company.
4. Split rating: Two different ratings given by two different credit rating agencies on
the same security.
1. false
2. true
3. true
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4. true
1. b
2. d
3. b
4. d
4.9. REFERENCES
1. Gupta, Shashi. K and Aggarwal , Nisha, Financial Servies, Kalyani

Publishers, New Delhi, 2007
3. Bhole LM, Financia1 Institutions and Markets, Tata McGraw Hi1l, 2004,
4th Edition.
4. 3. websites:
i. www.crisilratings.com
ii. www.icra.com
iii. www.careratings.com
1. What do you mean by credit ratings? Give their features.

2. Explain the concept of credit rating. What factors affect credit ratings? What are
its advantages?
3. Why do companies go in for credit ratings? Does it satisfy any of the objectives of
investors? Discuss.
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LESSON – 4 B
Structure
4.1. Credit Rating Agencies in India
4.2 International Credit Rating Agencies
4.3 Summary
4.4. Glossary
4.6. References
 Different Credit Rating Agencies at the national level

 Different Credit Rating Agencies at the international level
 Procedural aspects of credit ratings.
4.1. CREDIT RATING AGENCIES IN INDIA

The following are the major Credit Rating Agencies in India.
1. Credit Rating Information and Services India Ltd. (CRISIL)
2. Credit Analysis and Research (CARE)
3. ICRA Ltd.
4. Fitch Ratings
5. Onida Individual Credit Rating Agency (ONICRA)
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A detailed explanation of these national Credit Rating Agencies is given below:
1. Credit Rating Information and Services India Ltd. (CRISIL)

Credit Rating Information and Services India Ltd. (CRISIL) was jointly promoted by
ICICI and UTI in the year 1987. CRISIL’s majority shareholder is Standard & Poor’s,
S&P is a division of McGraw Hill Financial. CRISIL business is divided into three broad
categories: 1. Ratings, 2. Research, and 3. Risk and Policy Advisory Services. “CRISIL
rates the entire range of debt instruments: bank loans, certificates of deposit,
commercial paper, non-convertible debentures, bank hybrid capital instruments, asset-
backed securities, mortgage-backed securities, perpetual bonds, and partial
guarantees. CRISIL Ratings help lenders, investors, issuers, market intermediaries and
regulators. Most of India's largest companies and several of the smallest are being rated
by CRISIL. Its ratings cover manufacturing companies, banks, non-banking finance
companies, public sector undertakings, financial institutions, state governments, urban
local bodies, mutual funds across 190 industry sectors”. As per the information given by
CRISIL, it is known as the pioneer in the following:
“First corporate sector entity rating” 1988
“First financial sector entity rating” 1989
“First ABS rating with a separate symbol” 1991
“First bank rating” 1993
“First public finance rating” 1993
“First credit quality rating on a mutual fund's debt scheme” 1996
“First financial strength rating” 1998
“First municipal bond rating (first in Asia)” 1998
“First bond fund rating” 1998
“First MBS rating” 2000
“First Ratings Round-Up” 2000
“First rating based on partial guarantee (a global first)” 2001
“First hospital grading” 2002
“First governance and value creation rating” 2004
“First default study” 2005
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“First fund governance rating” 2005
“First capital protected fund rating” 2006
“First bank loan rating” 2007
“Assignment of complexity levels, a pro bono service, for classifying 2008
capital market instruments into three categories based on the ease of
understanding of the risk elements inherent in these instruments”
“Sectoral Credit Alerts” 2009
“First multi asset MFI securitization” 2010
“First education grading” 2011
“First criteria on corporate sector perpetual instruments” 2011
“First 50-year rupee bond rating” 2013
“First inflation-indexed debentures' rating” 2013
“First Basel III compliant issues' rating” 2013
“First NBFC IDF rating” 2013
“CRISIL rates India's first CMBS issue” 2014
Source: crisil.com
A brief year wise description of CRISIL’s growth is discussed as follows:
 “January 29: CRISIL, India's first credit rating agency, is

incorporated, promoted by the erstwhile ICICI Ltd, along with UTI
1987 and other financial institutions”.
 “Mr. N Vaghul and Mr. Pradip Shah are CRISIL's first Chairman
and Managing Director, respectively”.
 “January 1: CRISIL commences operations within a year of its

incorporation. The business environment is far from promising for
1988 the one-year old - the lending rates are fixed, and India has no
such thing as a corporate bond market as yet. And, what's more,
credit rating is an idea that's far ahead of its times”.
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 “The CRISILCARD Service - providing comprehensive information
1990
and analytical opinion on India's corporate entities - is launched”.
 “Despite the odds, and the initial lack of market acceptance of

credit ratings, CRISIL's operations are now well established. It
1991
begins to acquire brand identity, with a reputation for analytical
rigour and independence”.
 “CRISIL offers technical assistance and training to help set up

1992 Rating Agency Malaysia Berhad, and MAALOT, the Israeli
securities rating company”.
 “CRISIL's IPO is a whopping success - its 20, 00,000 shares, sold

1993 at a premium of Rs.40 per share, are oversubscribed by 2.47
times.”
 “Mr. R Ravimohan takes over as CRISIL's Managing Director”.

 “CRISIL diversifies business portfolio with a strategic entry into
1994
advisory services, and wins its first major mandate in the
infrastructure policy advisory domain”.
 “In partnership with the National Stock Exchange of India Ltd

1995 (NSEIL), CRISIL develops and launches the CRISIL500 Equity
Index, helping investors clue in on stock price movements”.
 “CRISIL forges a strategic business alliance with Standard &

1996 Poor's (S&P) Ratings Group. The tie-up is part of CRISIL's
strategy to develop its skills and processes”.
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 “S&P acquires a 9.68 per cent stake in CRISIL. The alliance with
the world's leading rating agency adds a new dimension to
1997
CRISIL's methodologies. It provides CRISIL with exposure to the
international rating markets and to S&P's rating processes”.
 “CRISIL sets up India Index Services Ltd (IISL), a joint venture

1998 with NSEIL, to provide a variety of indices and index-related
services and products to India's capital markets.”
 “CRISIL's proprietary Risk Assessment Model (RAM) becomes

the banking industry standard: given the heightened regulatory
1999
focus on the banks' risk management practices, RAM serves as a
customised credit rating model for the banks”.
 “CRISIL acquires the business, and brand, INFAC, of Information

Products and Research Services (India) Pvt Ltd. INFAC is a
leading provider of research to India's financial sector. The
acquisition strengthens CRISIL's research business, and makes it
2000 India's leading provider of integrated research.”
 “CRISIL launches the CRISIL Composite Performance Ranking
(CRISIL~CPR) to provide performance evaluation standards and
investment decision support to mutual fund houses, distributors,
and investors.”
 “CRISIL sets up subsidiary, Global Data Services of India Ltd, to

standardise published financial data for analysis”.
2001  “CRISIL launches Mutual Fund Awards in association with CNBC-

TV18 - a benchmark award for India's best performing mutual
funds”.
 “CRISIL launches the CRISIL Young Thought Leader (CYTL)
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Award - to attract outstanding talent and provide a platform to
India's future business leaders to showcase their views.”
CRISIL sets up:
 “The Centre for Economic Research - to apply economic

2002 principles to live business situations”
 “CRISIL MarketWire - to provide real-time financial news services
to help clients make pricing- and investment-related decisions”.
 “CRISIL sets up its investment and risk management services

group to offer integrated risk management solutions and advice to
banks and corporate”.
2003  “CRISIL follows it up with its first overseas acquisition -
EconoMatters Ltd (later the Gas Strategies Group), a London-
based company providing natural gas related consulting,
information and training, and conference-organising services”.
 “CRISIL expands its global reach further with an equity

investment in the world's first regional rating agency, the
Caribbean Information and Credit Rating Services Limited
2004 (CariCRIS), which CRISIL also helps set up.”
 “The CRISIL Awards for Excellence in Municipal Initiatives are
instituted, to recognise outstanding programmes in urban
development.”
 “The strategic alliance with S&P since 1996 culminates in S&P's
2005 acquiring majority control of CRISIL”.

 “CRISIL makes its second overseas acquisition, of Irevna, thus
adding equity research to its wide canvas of work. Irevna is a
Page 83 of 200
leading global equity research and analytics company.”
 “CRISIL launches Small and Medium Enterprise (SME) Ratings to
serve the specialised needs of the SME sector”.
 “CRISIL partners CNBC-TV18 for Emerging India Awards - the
first platform to recognize and reward the achievements of India's
Small & Medium Enterprises”.
 “CRISIL launches IPO grading services to provide investors with

independent, reliable, and consistent assessments of the
2006 fundamental strengths of new public issues”.
 “Irevna is ranked globally as the top Investment Research
Outsourcing Firm by The Black Book of Outsourcing”.
 “Ms. Roopa Kudva takes over as Managing Director and CEO of

CRISIL, following Mr. Ravimohan's appointment as Managing
Director and Region Head of S&P, South Asia”.
 “CRISIL assigns India's first Bank Loan Rating under the Reserve
Bank of India's Basel-II related regulations”.
 “The Pension Fund Regulatory and Development Authority
2007
awards CRISIL with a prestigious mandate to assist in the
selection of Fund Managers under the New Pension Scheme”.
 “The Black Book of Outsourcing ranks Irevna the No. 1 Financial
Services Industry Analytics Outsourcing Firm”.
 “CRISIL launches Real Estate Awards with CNBC AWAAZ. The
award honors India's exemplary developers and builders”.
 “CRISIL launches Complexity Levels, an initiative to strengthen

2008 India's capital markets by providing greater transparency to
investors”.
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 “CRISIL's revenues cross Rs.5 billion in 2008”.
 “CRISIL's SME Ratings group assigns its 5000th SME rating”.

 “CRISIL captures about half of India's bank loan rating marke”t.
2009  “Irevna is ranked globally by The Black Book of Outsourcing as
the No. 1 Investment Research and Analytics Outsourcing Firm”.
 “CRISIL Research launches Independent Equity Research (IER)”.
 “CRISIL moves into a new, corporate head office - the new

CRISIL House, at Powai, Mumbai, is a state-of-the-art, green
building”.
2010  “CRISIL SME Ratings crosses its 15,000th SME rating”.
 CRISIL launches Real Estate Star Ratings.”
 “CRISIL acquires Pipal Research, further strengthening its
leadership in the KPO industry.”
 “CRISIL launches Education Grading, beginning with business

schools”
 “CRISIL Rating enhances access to funding for SMEs;
Announces 20,000th SME Rating”
2011
 “CRISIL Ratings launches Solar grading”
 “CRISIL Research launches Gold and Gilt Index”
 “CRISIL Global Research & Analytics receives NASSCOM
Exemplary Talent Practices Award”
 “CRISIL acquires UK-based Coalition, a company providing high-

end analytics to global investment banks”
2012  “CRISIL assigns its 10,000th Bank Loan Rating”
 “CRISIL announces its 25,000th SME rating”
 “CRISIL transforms the lives of 1000 rural citizens through
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'Pragati', a series of financial awareness workshops.”
 “CRISIL launches 'Doing what is right: The CRISIL Story', a book
on the company's 25-year evolution, on December 19”.
 “CRISIL launches four fixed income indices to measure the
performance of government securities in the Sri Lankan capital
markets in association with NDB Capital Holdings PLC”
 “CRISIL launches CRISIL Foundation, a platform for achieving its

twin goals of increasing financial awareness and conservation of
the environment”
 “CRISIL launches CRISIL Inclusix, India's most comprehensive
financial inclusion index which accurately measures the extent of
2013
financial inclusion in the country, right down to each of the 632
districts.”
 “CRISIL releases its first 'State of the Nation' report, a unique top-
down-meets-bottom-up analysis that offers a holistic perspective
on the economic state of India”.
 “CRISIL rates India's first Commercial Mortgage Backed

Securities”
 “CRISIL introduces Fund Management Capability Ratings for the
2014 mutual fund”
 “CRISIL signs an MoU with the Indian Institute of Management,
Ahmedabad (IIM-A) to set up a 'CRISIL Chair of Financial
Markets' at the institute”.
 “CRISIL RE launched - a programme focusing on environment

2015 conservation through employee volunteering”
 “Ms Ashu Suyash takes over as Managing Director and CEO of
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CRISIL”
Source: crisil.com
2. Credit Analysis and Research (CARE)
CARE Ratings commenced operations in April 1993. “It was promoted by Industrial
Development Bank of India (IDBI) jointly with investment institutions, banks and finance
companies. Over nearly two decades, it has established itself as the second-largest
credit rating agency in India, with the rating volume of debt as Rs. 68.08 lakh crore (as
of March 31st, 2015, (careratings.com). CARE’s registered office and head office, is
located in Mumbai. It provides independent and unbiased credit rating opinions. CARE
Ratings has the unique advantage in the form an External Rating Committee to decide
on the ratings. Eminent and experienced professionals constitute CARE’s Rating
Committee”.
The growth of CARE as a credit rating agency can be seen as follows:
1997-2000
 “Launched ‘CARE Loan Ratings’ for rating term loans”

 “Ventured into Advisory business and bagged 13 assignments”
 “Initially started rating for Debt Mutual Funds”
 “Obtained registration with SEBI when rating agencies came under its
purview”
2001-2004
 “Founding member of Association of Credit Rating Agency in Asia

(ACRAA)”
 “Launched Corporate Governance and Value Creation Rating”
 “Signed MOU with NSIC for empanelment as an approach rating
agency for small scale industries”
2005-2008
 “IPO grading launched”
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 “Received ECAI recognition”
 “Signed MOU with 19 banks to provide rating facilities under BASE II”
 “Received mandate from Ministry of Urban Development for rating 13
ULBs under JNNURM”
 “Completed 5,000 assignments”
2009-2012
 “Made an IPO in 2012. Subscribed 34.05 times”.

 “Listed on BSE and NSE.”
 “Rated debt volume crossed Rs. 10 trillion”
 “Foray in Maldives”
 “Acquired Kalypto Risk Technologies Pvt. Ltd”
 “Obtained 9001:2008 certification”
2013 onwards
 “Obtained a license for doing business in Mauritius and will operate

under the banner of CARE Ratings (Africa) Private Limited (CRAF).
CRAF was launched on 3rd August 2015”.
 “Empanelled by Government of Karnataka for rating of Tourism sector
in the state”
 “Rated the first Green Infrastructure bond”
 “Launched rating of Real Estate Investment Trusts (REITs)”
 “Developed and launched a Debt Quality Index called CDQI. The Index
denotes the quality of debt in the country that can be interpreted over
time and juxtaposed with other developments in the financial sector”.
 “In terms of rating business penetration attained highest share in BS
top 1000 companies (45%), ET top 500 companies (54%) and FE top
500 companies (52%).”
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 “Partnered with four other domestic credit rating agencies in Brazil,
Malaysia, Portugal and South Africa, to form an international credit
rating agency called ARC Ratings.ARC Ratings was launched on
January 2014 in London”.
 “Assigned rating to India’s first Alternate Investment Fund (AIF)”
 “Rated India’s First Securitization Transaction backed by Mortgage
Guarantee”
3. ICRA Ltd.
“ICRA Limited (formerly Investment Information and Credit Rating Agency of India
Limited) was set up in 1991 by leading financial/investment institutions, commercial
banks and financial services companies as an independent and professional investment
Information and Credit Rating Agency”.
Today,” ICRA and its subsidiaries together form the ICRA Group of Companies (Group
ICRA). ICRA is a Public Limited Company, with its shares listed on the Bombay Stock
Exchange and the National Stock Exchange.”
Alliance with Moody’s Investors Service

“The international Credit Rating Agency Moody’s Investors Service is ICRA’s largest
shareholder”. It has entered into an agreement with Moody’s Investors Services
supported by a Technical Services Agreement, according to which:
 “Moody would provide certain high-value technical services to ICRA”.
 “Moody would conduct regular training and business seminars for ICRA analysts
on various subjects to help them better understand and manage concepts and
issues relating to the development of the capital markets in India”.
 “Moody would also advise ICRA on Rating-products strategy, and the Ratings
business in general.”
Objectives of ICRA
 “Provide information and guidance to institutional and individual
investors/creditors”.
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 “Enhance the ability of borrowers/issuers to access the money market and the
capital market for tapping a larger volume of resources from a wider range of the
investing public”
 “Assist the regulators in promoting transparency in the financial markets; and
 Provide intermediaries with a tool to improve efficiency in the funds raising
process”.
Range of Services offered by ICRA
I. “Rating Services”
 “ICRA rates rupee-denominated debt instruments issued by manufacturing
companies, commercial banks, non-banking finance companies, financial
institutions, public sector undertakings and municipalities, among others.”
 “ICRA also rates structured obligations and sector-specific debt obligations such
as instruments issued by Power, Telecom and Infrastructure companies”.
 “The other services offered include Corporate Governance Rating, Stakeholder
Value and Governance Rating, Credit Risk Rating of Debt Mutual Funds, Rating
of Claims Paying Ability of Insurance Companies, Project Finance Rating, Line of
Credit Rating and Valuation of Principal Protected-Market Linked Debentures
(PP-MLD). “
 “ICRA, along with National Small Industries Corporation Limited (NSIC), has
launched a Performance and Credit Rating Scheme for Small-Scale Enterprises
in India. The service is aimed at enabling Small and Medium Enterprises (SMEs)
improve their access to institutional credit, increase their competitiveness, and
raise their market standing”.
II. “Grading Services”
“The Grading Services offered by ICRA employ pioneering concepts and
methodologies, and include Grading of: Microfinance Institutions (MFIs); Construction
Entities; Real Estate Developers and Projects; and Maritime Training Institutes”.
III. “Industry Research”
“ICRA’s industry research service covers over 30 segments in the corporate and
financial services sectors. Given ICRA’s strong analytical capabilities across industries,
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the research reports provide in-depth analysis of industry-specific issues, trends in
demand-supply factors, the competitive landscape, and medium-to-long-term outlook”.
IV. “Consulting Services”
“ICRA Management Consulting Services Limited (IMaCS), a wholly-owned subsidiary of
ICRA Limited, is a multi-line management consulting firm with a global operating
footprint. IMaCS’ consulting services span Public Policy, Strategy, Risk Management,
and Transaction Advisory services.”
V. “Software Development, Analytics & Business Intelligence and Engineering
Services”
“ICRA Techno Analytics Limited (ICTEAS), a wholly-owned subsidiary of ICRA Limited,
offers a complete portfolio of Information Technology (IT) solutions to meet the dynamic
needs of present-day businesses. The services range from the development of
traditional web-centric and mobile applications to the new generation of cutting-edge
analytics and business intelligence solutions. ICTEAS offers analytics solutions in
multiple functional domains such as procurement, sales, supply chain, logistics, and
resource planning. The Engineering Division of ICTEAS offers multidisciplinary
computer aided engineering design services”.
VI. “Knowledge Process Outsourcing and Online Software”
“ICRA Online Limited (ICRON) is a wholly-owned subsidiary of ICRA Limited.
Encouraged by the emerging dynamics of the outsourcing business, ICRA diversified
into the Knowledge Process Outsourcing business in April 2004, with focus on the
Banking, Financial Services and Insurance (BFSI) vertical. Presently, ICRON has three
lines of business (LoBs) offering data services, research and analytics to regional and
global clients. ICRON works with banks, insurance companies, asset management
companies and other financial institutions. Timely, accurate, and affordable solutions
help partners achieve their business goals”.
Activity 1
Enlist ONE major contribution each of the following credit rating agencies :
1. CRISIL:
____________________________________________________
Page 91 of 200
2. ICRA
____________________________________________________
3. CARE
____________________________________________________
Rating Symbols of CRISIL, ICRA and CARE

Rating Symbols of CRAs
CRISIL ICRA CARE
Rating Definitions
CRISIL AAA ICRA AAA CARE AAA
Highest Safety
CRISIL AA ICRA AA CARE AA
High Safety
CRISIL A ICRA A CARE A
Adequate Safety
Moderate Credit CRISIL BBB ICRA BBB CARE BBB
Risk
Moderate default CRISIL BB ICRA BB CARE BB
Risk
CRISIL B ICRA B CARE B
High Default Risk
Very High Default CRISIL C ICRA C CARE C
Risk
CRISIL D ICRA D CARE D
Default
Source: indiaratings.co.in
4. Fitch Ratings
“Fitch Ratings is a global rating agency committed to providing the world's credit
markets with independent and prospective credit opinions, research, and data. Fitch
Ratings is headquartered in New York and London and is part of the Fitch Group.
Formerly it was known as Duff and Phelps Credit Rating, India. It has four rating offices
in India located at Mumbai, Delhi, Chennai and Kolkata”.
Credit Rating Symbols of FITCH

Symbol Rating
AAA “reliable and stable”
AA “quality with a bit higher risk”
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A “economic situation could affect finance”
BBB “middle class-an acceptable risk”
BB “more prone to economic changes”
CCC “vulnerable, dependent on current economic situation”
D “has defaulted before, high risk to again “
Source: fitchratings.com
5. Onida Individual Credit Rating Agency (ONICRA)
“ONICRA Credit Rating Agency is one of the leading Credit and Performance Rating
agencies in India. It provides ratings, risk assessment and analytical solutions to
Individuals, MSMEs and Corporate. ONICRA scrutinizes a variety of financial,
operational, industry and market information, synthesizing that information, and
providing autonomous, reliable assessments of the entity, thereby providing
stakeholders with an important input into their decision making process.
It has underlying objectives of providing timely, independent and forward-looking credit
and performance opinions. Its core principles include — objectivity, quality,
independence, integrity and transparency”.
Some important “milestones” of ONIRCA include:
2013  “Empanelled by Ministry of New and Renewable Energy for grading of

Renewable Energy Service Companies (RESCOs) & System Integrators
 Empanelled with SIDBI (Small Industries Development Bank of India) to
provide loan syndication services for facilitating flow of timely and adequate
credit to the micro, small and medium enterprises (MSMEs)”
2012  “Empanelled with Agriculture Finance Corporation for providing rating and
consulting services to their customers”
 “Conducted first of its kind study in agriculture sector”
 “Leadership achieved in the MSME Rating Business”
 “Completed 10000 MSME Ratings”
2009-11
 “Launched Education Rating Business - Conducted Strength, weakness
opportunity and threat analysis (SWOT) and Training Need Analysis (TNA)
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for engineering colleges under the Technical Education Quality Improvement
Program (TEQIP)”
 “Launched Vendor Rating Business”
 “Tied with State Government for Rating Business”
 “Launched Associate Rating Business”
 “Singed Memorandum of understanding with 20 Banks/Financial Institutions”
2006  “Launched Rating Business”
2005  “Registration with National Small Industries Corporation (Ministry of Micro,

Small and Medium Enterprises, Government of India ) to undertake Micro,
Small and Medium Enterprises Ratings”
2002  “Nationwide Infrastructure set up”
Source: www.onicra.com
Credit Rating Symbols of Onicra
www.onicra.com
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1) The first credit rating agency to be set up in India was:

a. CRISIL
b. CARE
c. ICRA
d. FITCH
2) CRISIL is a subsidiary of:
a. FITCH ratings
b. Standard and Poors
c. Moodys
d. None of the above
3) Former name of Fitch was:
a. Duff and Phelps Credit Rating
b. Moody
c. ICICI
d. HDFC
4) Which Credit Rating Agency made an alliance with Moody’s
Investors :
a. CARE
b. CRISIL
c. ICRA
d. All of the above
4.2. International Credit Rating Agencies
International Credit Rating Agencies include:
1. Standard and Poor’s (USA)

2. Moody’s (USA)
3. Fitch
Page 95 of 200
1. Standard and Poor’s (USA)
“Standard and Poor’s is a US based company. It is a 150 year old company. They are
the world's leading providers of independent credit risk research and benchmarks
across industries, asset classes and geographies. Its main aim is to help our clients,
investors and other market participants to make more informed business and
investment decisions. Their operations are extending in 26 countries of the world with
approximately 1.2 million credit ratings outstanding on government, corporate, financial
sector and structured finance entities and securities. They have around 1400 credit
analysts attached with them. In 2014 alone, S&P rated more than $4.3 trillion in new
debt. Of all corporate sector investment-grade ratings issued, just 1% had defaulted
over the most recent five-year period.”
“On September 24, 2007, the U.S. Securities and Exchange Commission granted the
registration of Standard & Poor's Ratings Services as a nationally recognized statistical
rating organization ("NRSRO") under the U.S. Credit Rating Agency Reform Act of 2006
(the "Act").”
Services offered by S&P include:
 Providing independent credit ratings, research, and analytics in bringing

transparency and comparability to the financial markets on the basis of clearly
defined methodology and transparent data
 Helps investors in managing credit risk
 Assisting businesses and governments in securing financing
2. Moody’s (USA)
“Moody's Investors Service, often referred to as Moody's, is the bond credit

rating business of Moody's Corporation. It is a subsidiary of Moody's Corporation
(NYSE: MCO), which reported revenue of $3.3 billion in 2014, employs approximately
10,200 people worldwide and maintains a presence in 35 countries.”
“Moody's Investors Service provides international financial research on bonds issued by

commercial and government entities. It was established in the year 1909. It has its
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headquarters in New York, USA. Moody's was founded by John Moody in 1909 to
produce manuals of statistics related to stocks and bonds and bond ratings. In 1975, the
company was identified as a Nationally Recognized Statistical Rating
Organization (NRSRO) by the U.S. Securities and Exchange Commission. Following
several decades of ownership by Dun & Bradstreet, Moody's Investors Service became
a separate company in 2000; Moody's Corporation was established as a holding
company”. According to Moody's, the purpose of its ratings is to "provide investors with
a simple system of gradation by which future relative creditworthiness of securities may
be gauged". To each of its ratings from Aa through Caa, Moody's appends numerical
modifiers 1, 2 and 3; the lower the number, the higher-end the rating. “The firm's ratings
and analysis track debt covering more than 120 sovereign nations, approximately
11,000 corporate issuers, 21,000 public finance issuers, and 72,000 structured finance
obligations”. (www.moody.com)
3. Fitch (USA)
Fitch is an “international credit rating agency and is dual headquartered in New York
and London. It is controlled by the France-based FIMALAC. As of 2013 they hold a
collective global market share of "roughly 95 percent"[1] with Moody's and Standard &
Poor's having approximately 40% each, and Fitch around 15%”.
Activity 2
Enlist ONE major contribution each of the following credit rating agencies :
1. CRISIL
____________________________________________________
2. ICRA
____________________________________________________
3. CARE
___________________________________________________
Page 97 of 200
Credit Rating symbols of international agencies
Source: www.grin.com
Page 98 of 200
1) Credit Rating Agency rating bonds exclusively is __________.

2) Standard and Poor’s is a _________ based company.
3) AAA is the rank given for __________credit rating.
4) The oldest international Credit Rating Agency is __________.
4.3. SUMMARY
“Credit rating is an analysis of the credit risks associated with a financial instrument or a
financial entity. It is a rating given to a particular entity based on the credentials and the
extent to which the financial statements of the entity are sound, in terms of borrowing
and lending that has been done in the past”. Credit ratings satisfy multiple objectives of
companies and investors. It helps companies in determination of cost of capital,
resource mobilization, creation of goodwill etc. it is helps investors in risk reduction,
investment decision making and provides them with professional guidance. The major
Credit Rating Agencies operating in India include ICRA, CARE, CRISIL, FITCH and
ONICRA. CRISIL was the first credit rating agency of India. The major credit rating
agencies at the international level include S&P, Moody and Fitch. Credit Rating
Agencies have to follow the procedural aspects of assigning credit ratings. The clients
have a choice of accepting/ not accepting these ratings, though they are under an
obligation to publish both. Credit ratings also suffer from certain limitations as
subjectivity, biasness etc.
4.4. GLOSSARY
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1. ICRA: “ICRA limited is a joint venture between Moody’s Investors and various
financial services companies is a part of ICRA group which was founded in 1991.
It is a Credit rating agency listed on the National Stock Exchange and Bombay
Stock Exchange. ICRA has four subsidiaries ICRA Management Consulting
Services Ltd, ICRA Techno Analytics Ltd, ICRA Online Ltd, PT. ICRA Indonesia
and ICRA Lanka Ltd”.
2. CARE: “CARE Ratings is second-largest among the credit rating agencies in
India as far as Indian Origin Company is concerned. CARE’s rating businesses
can be divided into various segments like for banks, IPO grading and sub-
sovereigns. Company’s shareholders include leading domestic banks and
financial institutions in India.”
3. CRISIL: “CRISIL headquartered at Mumbai is India’s largest and first credit rating
agency; and a global leader in research, ratings and risk & policy advisory
services. It is one of the top credit rating agency in India which has won many
prestigious awards in the credit rating category and had assessed more than
61000 entities”.
4. Fitch: “Fitch Ratings, a Fitch Group company is among the top credit rating
agencies in India incorporated in 1913 in New York, USA. Fitch Ratings provides
financial information services in more than 30 countries and has over 2000
employees working at 50+ offices worldwide.”
5. ONICRA: “Onicra Credit Rating Agency is a Credit and Performance Rating
company based in Gurgaon and founded in 1993. Onicra is among the top 10
credit rating agencies in India offering smart and innovative solutions like risk
assessment, analytical solutions and ratings to MSMEs, corporate and
individuals.”
1. a
2. b
3. a
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4. c
1. Moody
2. USA
3. Highest
4. Standard and Poor’s
4.6. REFERENCES
1. Gupta, Shashi. K and Aggarwal , Nisha, Financial Servies, Kalyani

Publishers, New Delhi, 2007
3. Bhole LM, Financia1 Institutions and Markets, Tata McGraw Hi1l, 2004,
4th Edition.
4. 3. Websites:
i. www.crisilratings.com
ii. www.icra.com
iii. www.careratings.com
1. Which Credit Rating Agencies are operating in India? Briefly explain.

2. Discuss international credit rating agencies operating at the global level.
3. How were different Credit Rating Agencies formed? Explain their objectives and
growth.
Page 101 of 200

LESSON - 5
Leasing
Structure
5.1. Introduction
5.2. Concept of Leasing
5.3. Development of Leasing
5.4. Difference between Leasing and Hire Purchase
5.5. Types of Leasing
5.6. Advantage of Leasing
5.7. Disadvantages of Leasing
5.8. Tax Aspects of Leasing
5.9. Summary
5.10. Glossary
5.12. References

 Concept and Development of Leasing

 Difference between Leasing and Hire Purchase
 Types of Leasing
 Advantage of Leasing
 Tax aspects of Leasing
Page 102 of 200

5.1. INTRODUCTION
Business runs on credit, loans and borrowings. Availing these facilities from banks
and financial institutions through the traditional channels is both expensive and
cumbersome. Leasing is a new tool of financing which is of recent emergence in India. It
is a fund based service provided by the financial institutions to the corporate as well as
the individuals. Leasing has tremendously boosted the process of capital formation in
the country as it is a very popular mode of financing heavy machinery and equipment,
computers, aircrafts, ships and vehicles etc. First Leasing Company of India Limited
pioneered this service in 1973 in India. Thereafter, many other financial institutions like
ICICI, GIC etc. have entered into this business.
5.2. CONCEPT OF LEASING

Leasing is a contract between the two parties, namely the lessor and the lessee that
provides lessee the right to use the asset for an agreed period of time, without buying or
owning the asset in return of rental payments called lease rentals. Lessor is the owner
of the asset while the lessee is the user of the asset. It is a form of renting the assets.
The consideration that is paid for the use of the asset is called lease rentals. Lease
rentals are periodical and regular fixed payments paid over the period of lease. The
lease contract is governed by the terms and conditions of the lease agreement. At the
end of the lease period the asset generally reverts back to the legal owner of the asset,
that is, the lessor.
Definitions
International Accounting Standard 17 defines “lease an agreement whereby the
lessor conveys to the lessee, in return for a payment or a series of payments, the right
to use an asset for an agreed period of time. Leasing allows the use of assets without
passing the ownership, implying the parting of possession of an asset for a temporary
period”.
Miller, M.H. and C.W. Uptron define that “leasing separates ownership and use as two
economic activities and facilitates asset use without ownership”.
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The European Leasing Association defines leasing as “a contract between a lessor
and a lessee, for the hire of a specific asset selected from a manufacturer or vendor of
such asset by the lessee. The lessee can have possession and use of the asset on
payment of specific rental over a period”.
Institute of Chartered Accountants of India define “lease as an agreement whereby
the lessor conveys to the lessee, in return for rent, the right to use an asset for an
agreed period of time. Lessor is a person who conveys to another person (lessee) the
right to use an asset in consideration of a payment of periodical rental, under a lease
agreement. Lessee is a person who obtains from the lessor, the right to use the asset
for a periodical rental payment for an agreed period of time.”
Thus, to summarize it can be said that leasing is a financing arrangement that
gives the right to use the asset without making lump sum capital investment in the
asset.
Features of leasing
1. Lease financing is a tool of money lending.
2. There are two parties in lease agreement: lessor who is the owner of the
asset and lessee who is the user of the asset.
3. Lease provides an alternative to purchase of an asset.
4. During the lease period ownership rests with the lessor though the use is
transferred to the lessee.
5. Leasing is not without consideration. The lessee pay regular and fixed
payments to the lessor called the lease rentals. Lease rentals are determined
so that they cover such costs as interest on lessor’s investment, cost of
repairs, maintenance, depreciation and profit to the lessor.
6. The assets involved are usually fixed assets high in value like machinery,
automobiles etc. Though assets with high obsolescence rate as computers
too could be leased.
7. Lease agreement must have a specific time period. It is illegal to have a lease
agreement without mentioning the time.
8. Leasing is not sale as the asset is usually returned to the lessor after the
expiry of the lease period.
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5.3. DEVELOPMENT OF LEASING
The first leasing company was established in India by Farouk Irani, with industrialist A C
Muthia in 1973 in Chennai. The name of the company was First Leasing Company of
India Ltd. Until 20th century it remained the only company providing leasing services in
the country.
Around 1980, Century Finance Corporation was set up .By 1981, many others as Shetty
Investment and Finance, Jaybharat Credit and Investment, Motor and General Finance,
and Sundaram Finance etc. joined the leasing game. The last three institutions had
been functioning in the hire-purchase business dealing with commercial vehicles. They
wanted to expand their activities in order to take the benefit of the available tax break
and leasing was a good choice for them
In late 1982, many financial institutions and commercial banks entered into leasing.
ICICI came in the industry in 1983. This encouraged the idea and concept of leasing
business in India.
Thereafter, International Finance Corporation also made an announcement and took a
decision to open and set up four leasing joint ventures in India.
In order to maintain and encourage the leasing business in the country, the Finance
Ministry gave very stringent measures and recommended enlistment of investment
companies on stock-exchanges. This boosted many investment companies to turn into
leasing companies immediately.
As per RBI's records by, “31st March, 1986, there were 339 equipment leasing
companies in India whose assets leased totaled Rs. 2395.5 million. One can notice the
sharp increase in number - from merely 2 in 1980 to 339 in 6 years”.
Subsequent increase in the growth of leasing companies is related with the capital
market, that is, whenever the capital markets were more booming, leasing companies
flooded the market.
Dahotre Committee's recommendations were another important landmark in the
development of Indian leasing. After their recommendations RBI gave instructions and
guidelines on commercial banks giving funds to leasing companies. The provision of
funding from banks and other financial institutions has strongly assisted the growth of
leasing business in India.
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Then later in 1994, Banks themselves diversified into non-core activities and were
allowed to offer leasing services. But, even till date, the leasing services provided by
commercial banks form a very small proportion of the total leasing business and has
notbeen able to contribute significantly in the development of this business in the
country.
In the post-liberalisation era foreign investment is also seen into Indian leasing
business. Though the endeavor is sluggish yet it is sure to pick up significant
momentum in the coming years. GE Capital was the first to venture in India. In the
present day, an increasing number of foreign-owned financial firms and banks have
become interested in leasing in India.
The key highlights from the performance review of the leasing entities for the year 2013
– 2014 are presented below:
 New Business Volumes declined by 21.75% in 2013 – 2014, as compared to
that of a decline of 6.42% in 2012 – 2013.
 The penetration of leasing in gross capital of the company reduced to 0.563% in
2013 – 2014 from 0.626% in 2012 – 2013.
 The year has witnessed emergence of new asset classes like medical
equipments and solar equipments. Car/ vehicle leasing continuous to be the
most favorite asset class.
 Of new the business volumes, 48% is constituted by operating leases and the
rest 52% by financial leases. This is similar to that of 2012 – 2013.
(Source: Vinod Kothari Consultants, Indian Leasing Report, 2014)
5.4. LEASING AND HIRE PURCHASE

Leasing is a contract between the two parties, namely the lessor and the lessee that
provides lessee the right to use the asset for an agreed period of time, without buying or
owning the asset in return of rental payments called lease rentals.
Hire Purchase is a transaction whereby goods are bought and sold on payment of
periodic installments by the hirer/ hire purchaser to the hire vendor. The hire purchaser
gets immediate right to the possession of the asset though he becomes the owner of
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the same on the payment of last installment only. The vendor reserves the right of
repossession in case of default by the hire purchaser.
Following points of distinction can be made between Leasing and Hire Purchase.
Sr. Nature of Lease financing Hire Purchase Financing
No. difference
1. Meaning A financing arrangement A financing arrangement
where the lessor/owner grants where the asset is
the right to use the asset in purchased on payment of
lieu of periodical payments periodical installments
called lease rentals
2. Parties Lessor is the owner of the Hire vendor is the seller
involved asset and lessee is the user and hire purchaser/ hirer is
of the asset the buyer.
3. Capitalization Capitalization of asset is done Capitalization of asset is
of asset in the books of lessor done in the books of hirer.
4. Depreciation Lessor is entitled to claim The hirer (owner) is entitled
benefit depreciation as he is the to claim depreciation.
owner of the asset
5. Payments Entire lease payments are Only the hire interest is
and tax eligible for tax computation in eligible for tax computation
computation the books of the lessee in the books of the hirer.
6. Salvage The lessor has the right to The hirer can claim benefit
value claim the benefit of salvage of salvage value as he ends
value as he remains the up to become the owner of
owner after the expiry of the the asset.
lease period
7. Assets Usually high cost assets are Usually low cost assets are
involved leased as machinery, involved as automobiles,
equipment, ships, etc. office equipments,
generators etc.
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8. Down No down payment is involved Down payment is made in
payment in leasing case of hire purchasing
9. Disclosure The leased asset is not shown The asset purchased under
as asset in the books of the hire purchase is shown as
lessee an ‘asset’ in the books of
the hirer and the
installments payable is
shown as a liability.
10. Maintenance In case of financial lease, Hirer has the responsibility
of the asset lessee is to maintain the asset of maintaining the asset as
while in case of operating he is the prospective
lease lessor has the owner.
responsibility of maintenance
1) Leasing is a source of finance. (__________)

2) Lessee is the owner of the asset (__________)
3) Claiming the benefit of depreciation is the right of the lessee. (__________)
4) Hire purchase is synonymous to leasing (__________)
5.5. TYPES OF LEASING

1. Operating Lease: Operating lease is a short term lease on a period to period
basis. The lease period is less than the estimated useful life of the asset such
that the lessor is not able to recover the cost of the asset in a single lease. The
lessor therefore has the option of renewing the lease after the expiry of the lease
period. Operating lease is cancellable at short notice at the option of the lessee.
This makes it risky for the lessor. However, this also allows him to charge higher
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lease rentals from the lessee. The responsibility of servicing, maintenance,
repairs and insurance is of the lessor since the lease is for a short period of time
as well as cancellable. Operating lease is common to the equipment which is
exposed to obsolescence due to technological developments. Eg: computers,
data processing equipments, vehicles etc.
2. Financial Lease: The lease which is of such a long period that the lessor is able
to recover his cost of investment along with reasonable return on capital during
the term of lease. The lease is non-cancellable and hence less risky. Since the
lease period is usually long, lessee incurs the cost of maintenance and servicing
of the asset. Title may or may not be transferred to him at the end of the lease
period. Financial lease is also called capital lease. The assets involved in
financial lease include land, building, machinery and other fixed equipments.
3. Conveyance-type lease: Such lease is for a very long period of time extending
from 99 to 999 years as well. This lease usually involves immovable properties.
The title is conveyed at the expiry of the lease period.
4. Leveraged Lease: In this type of lease the lessor purchases the asset with the
help of financing from a third party because the cost of the asset to be leased is
very high. As a result, the financer has a charge over the leased asset as well as
a claim on the part of lease rentals.
5. Sales and Lease Back: In this type of lease, the owner of the asset sells his
asset to the other party and then takes it back on lease from him. As a result of
this lease, the original owner becomes the lessee whereas the new owner
becomes the lessor. This lease helps the original owner to release his funds tied
up in the asset and also enjoy the use of the asset though as a lessee.
6. Consumer Leasing: It involves leasing of consumer durables as Televisions,
Refrigerators etc. The growth of consumer credited has popularized this type of
lease.
7. Balloon Lease: The lease under which the lease rentals are low at the beginning
of the lease, then high during the middle tenure of the lease and then again low
towards the end of the lease is called balloon lease.
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8. Closed-end Leasing: Under this lease the leased asset is reverted to the lessor,
that is, the owner of the asset at the end of the lease period.
9. Swap Leasing: Under this lease the lessee is given a substitute for the leased
asset in case the same is sent for repairs and maintenance to the lessor.
10. Wrap Leasing: When the lessee further sub leases the asset to the next person
and retains a fee and share of the salvage value it is called wrap lease.
11. Domestic and International Leasing: When the lessor, lessee and equipment
supplier are resident in the same country, it is called domestic leasing but when
the parties to the lease contract are resident in different countries it becomes
international leasing.
12. Cross Border Leasing: It is an international lease where the lessor and lessee
fall in different jurisdictions. The domicile of equipment supplier is not material in
this lease.
13. Import Leasing: It is a lease agreement where lessor and lessee are resident of
the same country but equipment supplier belongs to a different country. The
lessor has to first import the asset and then lease it out.
Key notes on:

I. Difference between Operating Lease and Financial Lease
Sr. Basis of Operating Lease Financial Lease
No. Difference
1. Nature of lease The useful life of the asset The useful life of the asset is
is not amortized during the amortized during the term of the
term of the lease period. lease period.
2. Tenure It is usually a short period It is usually a long period lease.
lease
3. Cancellability The lease is cancelable at The lease is non-cancelable.
the option of the lessee
after a short notice
4. Maintenance The cost of maintenance The cost of maintenance and
and servicing is borne by servicing is borne by the lessee
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the lessor
5. Transfer of Ownership remains vested Ownership is usually transfered
ownership with the lessor at the expiry to the lessee at the expiry of the
of the lease period lease period
6. Risk It is more risky as it is It is less risky as it is non-
cancelable cancelable
7. Re-leasing The lessor needs to renew The lessor does not need to
the lease in order to renew the lease again.
recover his investment
Activity 1
When are the following leases beneficial?
1. International leasing
_____________________________________________________________
2. Balloon leasing
_____________________________________________________________
3. Operating leasing
_____________________________________________________________
5.6. ADVANTAGES OF LEASING

Both the lessee and the lessor have advantages from the contract of leasing. These are
discussed as follows:
1. Advantages to the lessee:
i) Less finance required: The use of the asset can be made by the lessee
without the purchase of the asset. The finances thus saved can be
deployed either to some other productive purpose or can be invested to
earn a rate higher than the cost of leasing. More funds are available even
for the working capital requirements. This also improves the cash position
of the business.
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ii) Cheaper source of finance: In comparison to the traditional sources of
finance leasing arrangement is comparatively economical to the lessee.
iii) Flexibility and convenience: The leasing agreement can be tailor-made
to suit the needs of the lessee. Even the lease rentals can be adjusted by
adopting various methods and types of leasing.
iv) Enhancement in borrowing capacity: Since liquidity of business is
maintained and the cash flow position remains intact, the lessee is in a
position to borrow more funds from diversified sources.
v) Off balance sheet financing: The asset acquired through leasing and
the corresponding liability does not appear in the Balance Sheet of the
firm. This improves the debt-equity ratio of the firm.
vi) Tax benefits: Lease rentals are fully tax deductible. The lessee is thus
able to save on taxes through leasing.
vii) Reduced risk of obsolescence: The leased asset reverts back to the
owner of the asset, that is, the lessor at the expiry of the lease period
especially in case of an operating lease. Thus, the burden of capital
investment due to technological developments lies with the lessor and not
the lessee. The risk is further reduced as operating lease is cancelable at
the choice of the lessee.
2. Advantages to the lessor:
i) Good Return: The lease rentals are sufficient to cover the cost of the
asset, services charges and a reasonable return on capital invested.
ii) Benefits from different lease types: Different types of leases as
leveraged lease can be entered into to get the benefit of adding a financer
to the lease agreement. This helps the lessor to avoid making huge
investment from one’s own finances immediately. The interest payable and
lease rentals received can be adjusted to the benefit of the lessor.
iii) Avoiding obsolescence risk: In case of financial lease, the asset may
not be reverted to the lessor and hence the loss due to technological
developments and the associated obsolescence has to be borne by the
lessee only.
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iv) Tax Benefit: The sale tax payable on lease rentals is less than the direct
tax payable on the revenue receipts from the sale of an asset. Also
depreciation also provides tax shield to the lessor.
5.7. Disadvantage of Leasing to the lessor and the lessee:
Disadvantages to the Lessor Disadvantages to the Lessee

Risk of obsolescence is of the owner The lease rentals cover various costs as
only cost of investment, servicing, maintaining
and profit margin of the lessor as well
Even in increase in prices due to The lease rentals are fixed and do not
inflation, lessor gets fixed lease rentals take care of the gestation period.
only.
There is growing competition, squeezing The lessee does not become the owner
the profitability of leasing business. of the asset and is deprived of owner’s
advantages as depreciation
It involves huge initial capital investment No alteration or changes can be made in
the asset by the lessee
Loss of user benefits as sales tax, duties The salvage value belongs to the owner
etc. and not the user of the asset
It is a long term investment which may The lessee cannot resell the leased
take years to recover itself asset
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5.8. TAX ASPECTS OF LEASING
Leasing has tax implications under both for the lessor and the lessee. The implications
for both the parties can be discussed as follows:
I. Implications for the Lessor
A. Depreciation as a Tax Shield:
The lessor has claim on the ownership rights of the assets and hence the lessor can
use depreciation as a tax shield. The lessor can deduct the amount of depreciation on
leased assets from his taxable income. This results in reduction in tax liability of the
lessor. Resultantly there is availability of more funds for distribution to the shareholders.
The provisions of depreciation are explained as follows:
The person who wants to claim the benefit of depreciation for the purpose of taxation
should own the asset. The lessor must not establish only legal ownership, he must also
be the beneficial owner as well. The lessor must prove that he has a substantive right
and not merely a notional or a technical claim in the reversion of the asset. Thus, the
lessor's beneficial ownership of the leased asset is proved by his right of reversion of
the asset at the end of the lease period.
It is not necessary that the lessor is always a single owner of the leased asset. The
asset may be held even jointly by the lessor. Though till 1996 claim of depreciation was
not allowed in case of joint ownerships, but then a special amendment was made to
make syndicated leases possible. But, there is still lot of confusion as to when the asset
is leased out jointly by two or more lessors; whether both of them or all of them shall be
considered as separate assessable entities for tax purposes or not. (Vinod Kothari
consultants India Ltd.)
However in case of movable property given on lease the rule says that when this kind of
movable property becomes a permanent fixture to land and the land is not of the lessor,
the lessor no longer is consideres as the legal owner of such fixture. The recent ruling
by the Supreme Court in case of First Leasing Company of India also highlights this
issue. Here, the Supreme Court distinguished “a lease from hire-purchase on the
ground whether the transfer of right to use in a lease resulted into a permanent effective
right of use being transferred, preparatory to a sale”. (Vinod Kothari Consultants India
Ltd.)
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There is one more condition for claiming depreciation. According to it the tax payer
should be the user of the asset. It clearly implies that the tax payer should be using the
asset in the business of leasing. Thus, it is the usage of the lessor that determines his
tax shield and not that of the lessee's use. The provision also suggests that the non-use
of the asset by the lessee should not involve any implication on the lessor's depreciation
claim.
Depreciation is allowed in India on a pooling basis. This means that all assets on which
the same rate of depreciation is applicable under a particular class of assets will be
treated as one pool, or block of assets. When new assets are acquired the same are
treated as addition to the block. similarly, the sales or transfers, at whatever is their
transfer consideration, are netted off from the block. Therefore, no regard is given to the
profit or loss on sale of an individual asset.
Rates of depreciation are listed in the Schedule to the Income-tax Rules. “The
applicable depreciation rates of some assets generally used in leasing are given below:
Motor cars 20%

General plant or machinery (residuary rate) 25%
Lorries, buses or taxies plying on hire, aeroplanes, 40%
moulds used in plastic or rubber factories
Bottles and crates 50%
Computers (proposed) 60%
Pollution control devices, energy saving devices, 100%
renewable energy devices, rollers in flour mills, gas
cylinders, etc.
Source: www.india-financing.com
The Income-tax law was amended and revised to incorporate a specific provision for
Sale and leaseback transactions. This provision states the amount of depreciation that
can be claimed. It restricts the same to the written down value in the hands of the seller-
lessee. As per this provision the actual cost of the asset to the lessor will not be
considered rather depreciation will be allowed on the seller's depreciated value. This
provision is applicable only where the seller is the lessee; in other words, not applicable
for every lease of second-hand assets.
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B. Lessor’s Income
Lease rental income is taxable under the head ‘Profits and Gains of Business and
Profession’ where leasing constitutes the lessor’s main activity. In all other cases lease
rental income will be taxable under the head ‘Income from Other Sources’. The
following expenses are allowed for deduction for the purpose of determining the taxable
income of the leasing company:
 Depreciation, rents, rates, taxes, repairs and insurance of the leased asset
where such expenditure is borne by the lessor.
 Amortization of some preliminary expenses.
 Legal charges for drafting and printing of memorandum of association, articles of
association, registration expenses subject to a maximum of 2.5% of the cost of
the project allowable in 10 equal installments.
 Interest on borrowed capital
 Bad debts
 Expenses incurred for improving business
 Entertainment expenses
 Travel expenses on the basis of approved norms
II. Implications for the Lessee

Deduction of rentals by the Lessee:
In general, in a lease, the lessee will be allowed to claim the rentals as an expense. The
lease rentals should b e in the nature of revenue and these should not be a personal
expense and should wholly and exclusively related to business purposes of the lessee.
Also if the expenses such as, repairs, maintenance, insurance etc. are borne by the
lessee, then these are allowed for deduction from taxable income of the lessee. Also
expenses related to installation of equipment can also be claimed and should not be
capitalized as the lessee is not the owner of the asset.
Thus, for the purpose of tax planning the lessor can claim depreciation as the major
source of tax saving and lessee can claim lease rentals for the same.
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Activity 2
Would it always be beneficial to go for leasing services? Answer from the view point of:
1. Purchase of Computer
_______________________________________________________________
2. Purchase of automobile
_______________________________________________________________
3. Purchase of Machinery
_______________________________________________________________

1) The other name for financial lease is:
a. Operating lease
b. Capital lease
c. Hire purchase
d. Installment system
2) Which lease is helpful in improving liquidity of the business
a. Operating lease
b. Leveraged lease
c. Sales and leaseback
d. All of the above
3) The relationship between lessor and lessee is that of
a. Buyer and seller
b. Debtor and creditor
c. Owner and tenant
d. Bailor and bailee
4) Depreciation as a tax shield is available to:
a. lessor
b. lessee
c. hirer
d. any of these
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5.9. SUMMARY
Leasing is developing as a significant and important tool of financing in India. It is
a contract between the two parties, namely the lessor and the lessee that provides
lessee the right to use the asset for an agreed period of time, without buying or owning
the asset in return of rental payments called lease rentals. Lessor is the owner of the
asset while the lessee is the user of the asset. Lessee is expected to return the asset
after the lease period. Lease financing was introduced in India in 1973 by the opening of
First Leasing Company of India Ltd. in Chennai. Thereafter, many banking and non
banking financial institutions came into the market with their leasing service. Leasing is
different from Hire Purchase as latter is a commercial agreement where the hirer buys
the asset from the hire vendor in lieu of periodical payments in installments. The
possession is transferred immediately to the hirer but the ownership is reserved with the
vendor till the payment of last installment. Leasing is of different types. Financial lease
amortizes the asset during the lease period while in case of operating lease the asset
has to be leased time and again to cover its cost. This usually makes duration of
financial lease longer than the operating lease. Leasing has many advantages to the
lessee in terms of savings on making huge investment, improved liquidity position,
improved ratios as debt-equity ratio etc. Similarly, leasing provides a good rate of return
and tax advantages to the lessor as well. The lessor can claim benefit of depreciation
under the provision of income tax while the lessee can claim the benefit of lease rentals.
Similarly, lease rentals become the income of the lessor under the income tax
provisions.
5.10. GLOSSARY
1. Leasing: It is a commercial agreement between the lessor and the lessee which
grants the right to use the asset without the transfer of title, in lieu of periodical
payments called lease rentals.
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2. Lessor: The owner of the asset who purchases the asset for the purpose of
leasing the same.
3. Lessee: The user of the asset who pays consideration in terms of periodical
payments to the lessor.
4. Lease Rentals: This is the consideration payable by the lessee to the lessor for
the use of the asset and includes interest on lessor’s investment, cost of repairs,
maintenance, insurance, depreciation and service charges.
5. Hire Purchase: A commercial agreement where the hirer buys the asset from
the hire vendor in lieu of periodical payments in installments. The possession is
transferred immediately to the hirer but the ownership is reserved with the vendor
till the payment of last installment.
6. Operating lease: Operating lease is a short term cancellable lease on a period
to period basis. The lease period is less than the estimated useful life of the
asset such that the lessor is not able to recover the cost of the asset in a single
lease and thus reserves the option of renewing the lease after the expiry of the
lease period.
7. Financial Lease: It is a long period non-cancelable lease where the lease period
covers the estimated useful life of the asset and recovers the investment made
by the lessor along with a reasonable return on his capital investment.

1) true
2) false
3) false
4) false

1) b
2) c
3) d
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4) a
5.12. REFERENCES
3. Pandian Punithavathy, Financial Services and Markets, Vikas Publishing
House Pvt. Ltd. Nodia (U.P.) 2009.

1. What is leasing? Explain its types.
2. Differentiate leasing from Hire Purchase. Discuss the merits of a acquiring an
asset on leasing.
3. Write a note on evolution and development of leasing in India.
4. What are various implications of leasing for the lessor and the lessee under
Income Tax provisions?
Page 120 of 200

LESSON - 6
Venture Capital
Structure
6.1. Introduction
6.2. Concept of Venture Capital
6.3. Modes of Finance of Venture Capital
6.4 Characteristics of Venture Capital
6.5. Venture Capital in India
6.6. Difficulties of Venture Capital
6.7. Guidelines for Venture Capital
6.8. Summary
6.9. Glossary
6.11. References
6.12 Model questions
 Concept of Venture capital and its characteristics

 Venture Capital Financing in India
 Guidelines for Venture Capital
6.1. INTRODUCTION
Capital is the backbone of the business. The first preliminary required to establish a
business is in fact availability of sufficient capital. The more attractive a project is the
more is the probability of risk in the project. Traditional financial houses were reluctant
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to give loans against such projects. This made it difficult for the new entrepreneurs to
start new projects which were risky. As a result the concept of venture capital financing
developed. Today Venture Capital has developed as a new method of financing
budding entrepreneurs and risky and innovative projects.
6.2. CONCEPT OF VENTURE CAPITAL

“Venture capital is a form of equity financing especially designed for funding high
risk and high reward projects. It is a long term investment made in ventures promoted
by technically or professionally qualified but unproven entrepreneurs or ventures
depending upon the use of unproven technology or ventures involving high risk.” A
young entrepreneur or a company in its early stages may not be able to raise finances
from the public; venture capital financing provides this seed capital for unproven ideas,
products, and technology oriented start up firms. It provides finance to such firms that
are not able to raise finance from the traditional sources. Such a high risk capital is
provided by venture capital funds in the long term equity finance with a hope to earn
with a high rate of return in the form of capital gain.
Definitions
International Finance Corporation (IFC) defines venture capital as “equity or equity
featured capital seeking investment in new ideas, new companies, new products, new
processes or new services that offer the potential of high returns on investment”
Koloski Morris define that venture capital as “providing seed, start-up and first stage
financing and also funding to the public securities market or to credit oriented
institutional funding sources”.
The European Venture Capital Association defines venture capital as “risk finance for
entrepreneurial, growth oriented companies”.
Neil Cross defines venture capital investment as “the provision of risk bearing capital,
usually in the form of a participation in equity, to companies with high growth potential.
In addition, the venture company provides some value added in the form of
management advice and contribution to overall strategy. The relatively high risks for the
venture capitalists are compensated by the possibility of high return, usually through
substantial capital gains in the medium term.”
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Bank of England Quarterly Bulletin (1984) defines “venture capital investment as an
activity by which investors support entrepreneurial talent with finance and business
skills to exploit market opportunities and thus obtain long term capital gains”.
Thus, to summarize it can be said that venture capital financing is an
arrangement of mutual gain both to the budding entrepreneur and the financer. The
entrepreneur gets convenient financing in the form of seed capital to start his business
and the financer gets equity ownership in a upcoming firm with bright future prospects.
The risk involved is high, but the gains are also attractive and lucrative.
6.3. MODES OF FINANCE BY VENTURE CAPITAL

Venture Capitalist provides long term finance in any of the following modes:
1. Equity: The venture capital finances equity up to 49% of the total equity. The
ownership and control remains in the hands of the entrepreneur only. This is a
good mode of financing as in the initial years when business has not picked up
momentum; dividend payment is not a compulsory to be made, unlike debt that
requires mandatory interest payments.
2. Conditional loan: A conditional loan is unlike the traditional loan as it involves
either no interest at all or a coupon payment at a very meager rate. Also, a
royalty is payable by the entrepreneur on the basis of his sales turnover.
Gradually when the business picks up momentum and the sales begin to
increase, the royalty is reduced and the interest payments are increased.
3. Convertible loan: This involves conversion of loan into equity over the time
business picks up.
6.4. CHARACTERISTICS OF VENTURE CAPITAL

1. Risky Ventures: Venture Capital involves financing for risky projects with the
aim of earning a high rate of return.
2. New Ventures: Financing is generally made in new businesses with unproven
entrepreneurs and unproven ideas. However, venture capital may also be
provided to businessmen in the second round of financing where the initial
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project has been a success but sufficient cash is yet to be generated and new
investment is required for the second round of financing.
3. Equity financing: The venture capitalist invests in the equity of the new
company. The entrepreneur get seed capital, which otherwise is difficult for a
new company to raise from the capital market. The financer in return is able to
get capital gains once the business establishes itself. The risk involved is
definitely high.
4. Objective: The main objective of the financer is to get good returns by making
investment in promising projects. The aim of the entrepreneur is to get access to
capital.
5. Long term investment: Venture Capital is a long term investment as it takes
long time for the venture capitalist to get back his investment.
6. Hands on Approach: But for making investment in the equity of the firm, venture
capitalist also gives advice, managerial and business skills to the entrepreneur
by participating in its business affairs. Though the venture capitalist does not
acquire a controlling interest in the company still he provides value added
services and has continuous interest in the welfare of the company.
7. Illiquid: The investment is comparatively less liquid. The capitalist can recover
his investment either when the company is highly successful or gets a stock
market listing.
8. Distinct and Social orientation: Venture capital financing is different from the
traditional mode of financing. The orientation is more social in nature as it
supports the budding entrepreneurs. Earning of profits is not the prime motive.
1) Venture capital is provided only to the new entrepreneurs.

(__________)
2) Venture Capital is another form of debt (__________)
3) The objective of venture capitalist is to earn high return on his
investment. (__________)
4) Venture capital is for new and risky projects. (__________)
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Activity 1
How is venture capital a better mode of financing when compared to:
1. Loan from banks:
________________________________________________________________
________________________________________________________________
2. Raising shares capital in the market
________________________________________________________________
________________________________________________________________
6.5. VENTURE CAPITAL IN INDIA

VC started in 1975 in India; when Industrial Finance Corporation of India set up Risk
Capital Foundation (RCF). Then in 1976, GOI set up Technical Development Fund
(TDF) in the Ministry of Industry with the assistance of World Bank. Its major aim was to
finance modernization programmes. In 1986 GOI set up Venture Capital Fund (VCF) to
encourage the use of indigenous technology. Grindlays Bank of Australia set up Indian
Technology Fund Ltd (ITFL) for early stage financing. The funds were provided to the
budding and new entrepreneurs who were in the early stage of financing. State Bank
opened SBI Caps- a subsidiary. Bangalore Genei Pvt. Ltd. opened VCF for financing
bio technology projects for the first time. These projects required substantial amount of
Research and Development and were based on innovative products and ideas. The
Investment Credit and Investment Corporation of India (ICICI) also came up with
venture capital services to the small and medium firms who were established with a
major purpose to use domestic technology
VC Financing is done in the following categories:
1. Specialised Financial Institutions and their finance schemes
2. Funds promoted by State Level Institutions
3. Funds promoted by Public Sector Banks
4. Private Agencies
5. Overseas Venture Capital Funds
1. Specialized Financial Institutions and their finance schemes
 Industrial Finance Corporation of India (IFCI):
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• In 1975, IFCI started Risk Capital Foundation (RCF).
• This provides capital assistance to first generation entrepreneurs.
• It provides equity financing.
• In 1988, IFCI had set up Risk Capital and Technology Finance Corporation Ltd.
(RCTFC) as its wholly owned subsidiary.
• RCTFC provides finance for innovative technology, energy conservation and
environmental pollution.
• RCTC also manages a separate VCF scheme named Venture Capital Unit
Scheme (VECAUS)-III (started in 1991) with resource base of Rs. 30 crores. It is
a collaborative effort of UTI, IFCI and World Bank.
 The Industrial Credit and Investment Corporation of India (ICICI):
• In 1988 ICICI formed Technology Development and Information Company of
India (TDICI).
• Financing is provided for marketing, business management, exports etc.
• Equity financing is a popular mode followed by conditional loans.
• Eg 1:In Mastek; a Bombay based software firm , TDICI invested Ts. 42 lakhs
equity in 1989 which went public in 1992.
• Eg 2: In temptation Foods (a frozen food export co.) TDICI invested Rs. 50 lakhs
which went public in 1992.
 Industrial Development Bank of India (IDBI):
• IDBI started “Seed Capital Scheme”.
• This provides financing for chemical, software electronics, bio technology, food
product and medical equipment.
• Financing is done from 5 lakhs to 250 lakhs.
• Mode is equity financing or unsecured loans at concessional rates.
2. Funds promoted by State Level Institutions
 APIDC- Venture Capital Ltd (AVCL):
• This is wholly owned by Andhra Pradesh Industrial Development Corporation Ltd.
• It is set up with a capital of 13.5 crores contributed by APIDC, IDBI and Andhra
Bank.
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• It provides capital for technological innovations, energy conservation projects,
exports etc.
 Gujarat Venture Finance Ltd (GVFL):
• This is wholly owned Gujarat Industries Investment Corporation Ltd.
• It provides capital for technological innovations, energy conservation projects,
exports etc.
3. Funds promoted by Public Sector Banks
 Canara Bank Venture Capital Fund (CVCF)
• This fund is promoted . By Canara Bank and its subsidiary Can Bank Financial
Services Ltd.
• It was set up in 1989.
• It provides equity financing, conditional loans and convertible loans.
• It has a capital base of 24 crores.
It supports technological up gradation.
4. Funds promoted by Private Agencies
 Credit Capital Venture Fund (CCVF)
• It was set up in 1986.
• It provides financing upto Rs. 50 lakhs.
• It is popularly known as Lazard Credit Capital Fund.
 20th Century Venture Capital Fund
• It was set up by 20th Century Finance Ltd.
• It provides financing to sick industries
 India Investment Fund
• It is India’s first private venture fund.
• It is mainly subscribed by NRIs.
• It was started in 1987.
• Maximum funding is up to Rs one crore.
• It gives finances to young as well as established Indian companies.
 Indus Venture Capital Fund
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• It was promoted by Shri T. Thomas, the former director of Unilever.
• It has a capital base of 21 crores, contributed by IVML, IDBI, IFCI , Deutsche
Bank, International Finance Corporation (Washington).
 SBI Venture Capital Fund (Singapore based firm)
• It was set up by SBI Capital Market Ltd.
• It finances ventures through bought out deals.
5. Overseas Venture Capital Funds
This financing is usually in the areas having promising returns as tourism,
communication, pharmaceutical, consumer durables, food processing industry,
machinery, components and textiles.
Eg:
1. The global insurance company, AIG has a tie up with IL and SF for 150mln
venture fund.
2. IL and SF has a tie up with ADB $100mln.
3. George Sors has floated Indocean Fund.
6.6. DIFFICULTIES OF VENTURE CAPITAL IN INDIA

 There is no legal framework for VCF.
 VC firms are running as captive firms of financial institutions.
 Small companies are not able to go public, hence cannot avail VCF.
 VCF is a risky investment, hence not very attractive.
 Venture Capitalists do not have any incentives even tax incentives.
6.7. GUIDELINES ON VENTURE CAPITAL

REGISTRATION OF VENTURE CAPITAL FUNDS
Application for Grant of Certificate
As per provisions of SEBI the guidelines include
(1) “Any company or trust [or a body corporate] proposing to carry on any activity as a
venture capital fund on or after the commencement of these regulations shall make an
application to the Board for grant of a certificate”.
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(2) “Any company or trust [or a body corporate], who on the date of commencement of
these regulations is carrying any activity as a venture capital fund without a certificate
shall make an application to the Board for grant of a certificate within a period of three
months from the date of such commencement: Provided that the Board, in special
cases, may extend the said period upto a maximum of six months from the date of such
commencement”.
(3) “An application for grant of certificate shall be made to the Board in Form A and
shall be accompanied by a nonrefundable application fee as specified in Part A of the
Second Schedule to be paid in the manner specified in Part B thereof”.
(4) “Any company or trust 3 [or a body corporate] that fails to make an application for
grant of a certificate within the period specified therein shall cease to carry on any
activity as a venture capital fund”.
(5) “The Board may in the interest of the investors issue directions with regard to the
transfer of records, documents or securities or disposal of investments relating to its
activities as a venture capital fund”.
(6) “The Board may in order to protect the interests of investors appoint any person to
take charge of records, documents, securities and for this purpose also determine the
terms and conditions of such an appointment”.
Eligibility Criteria
For the purpose of the grant of a certificate by the Board the applicant shall have to
fulfill in particular the following conditions, namely:—
(a) if the application is made by a company :—
(i) “Memorandum of association as has its main objective, the carrying on of the activity
of a venture capital fund;”
(ii) “it is prohibited by its memorandum and articles of association from making an
invitation to the public to subscribe to its securities;”
(iii) “its director or principal officer or employee is not involved in any litigation
connected with the securities market which may have an adverse bearing on the
business of the applicant;”
(iv): its director, principal officer or employee has not at any time been convicted of any
offence involving moral turpitude or any economic offence;”
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(v) “it is a fit and proper person;”
(b) if the application is made by a trust—
(i) “the instrument of trust is in the form of a deed and has been duly registered under
the provisions of the Indian Registration Act, 1908 (16 of 1908); “
(ii) “the main object of the trust is to carry on the activity of a venture capital fund; “
(iii) “the directors of its trustee company, if any or any trustee is not involved in any
litigation connected with the securities market which may have an adverse bearing on
the business of the applicant; “
Procedure for grant of certificate
(1) “If the Board is satisfied that the applicant is eligible for the grant of certificate, it
shall send intimation to the applicant“.
(2) “On receipt of intimation, the applicant shall pay to the Board, the registration fee
specified in Part A of the Second Schedule in the manner specified in Part B thereof. “
(3) “The Board shall on receipt of the registration fee grant a certificate of registration in
Form B. “
INVESTMENT CONDITIONS AND RESTRICTIONS
Minimum investment in a Venture Capital Fund.
(1) “ A venture capital fund may raise monies from any investor whether Indian, Foreign
or non-resident Indian. “
(2) “No venture capital fund set up as a company or any scheme of a venture capital
fund set up as a trust shall accept any investment from any investor which is less than
five lakh rupees: “
Investment conditions and restrictions
“All investment made or to be made by a venture capital fund shall be subject to the
following conditions”, namely:—
(a) “venture capital fund shall disclose the investment strategy at the time of application
for registration“;
(b) “venture capital fund shall not invest more than 25% corpus of the fund in one
venture capital undertaking “
(c) “shall not invest in the associated companies“; and
(d) “venture capital fund shall make investment as enumerated below:
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(i) “at least 66.67% of the investible funds shall be invested in unlisted equity shares or
equity linked instruments”
(ii) “Not more than 33.33% of the investible funds may be invested by way of”:
(a) “subscription to initial public offer of a venture capital undertaking whose shares are
proposed to be listed”;
(b) “debt or debt instrument of a venture capital undertaking in which the venture capital
fund has already made an investment by way of equity”.
(c) “preferential allotment of equity shares of a listed company subject to lock in period
of one year;”
(d) “the equity shares or equity linked instruments of a financially weak company or a
sick industrial company whose shares are listed”
(e) “Special Purpose Vehicles which are created by a venture capital fund for the
purpose of facilitating or promoting investment in accordance with these Regulations.”
Prohibition on listing
“No venture capital fund shall be entitled to get its units listed on any recognised stock
exchange till the expiry of three years from the date of the issuance of units by the
venture capital fund”.
GENERAL OBLIGATIONS AND RESPONSIBILITIES
Prohibition on inviting subscription from the public
“No venture capital fund shall issue any document or advertisement inviting offers from
the public for the subscription or purchase of any of its units”.
Private placement
“A venture capital fund may receive monies for investment in the venture capital fund
through private placement of its units”.
Placement memorandum or subscription agreement
(1) The venture capital fund shall—
(a)”issue a placement memorandum which shall contain details of the terms and
conditions subject to which monies are proposed to be raised from investors”; or
(b) “enter into contribution or subscription agreement with the investors which shall
specify the terms and conditions subject to which monies are proposed to be raised.”
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(2) “The Venture Capital Fund shall file with the Board for information, the copy of the
placement memorandum or the copy of the contribution or subscription agreement
entered with the investors along with a report of money actually collected from the
investor.”
Contents of placement memorandum
(1) The placement memorandum shall contain the following, namely:—
(a)”details of the trustees or trustee company [and the directors or chief executives] of
the venture capital fund;”
(b) (i) “the proposed corpus of the fund and the minimum amount to be raised for the
fund to be operational;”
(ii) “ the minimum amount to be raised for each scheme and the provision for refund of
monies to investor in the event of non-receipt of minimum amount”;
(c) “details of entitlements on the units of venture capital fund for which subscription is
being sought;”
(d)” tax implications that are likely to apply to investors”;
(e)” manner of subscription to the units of the venture capital fund”;
(f) “the period of maturity, if any, of the fund (g) the manner, if any, in which the fund
shall be wound up”;
(h) “the manner in which the benefits accruing to investors in the units of the trust are to
be distributed”;
(i) “details of the fund manager or asset management company if any, and the fees to
be paid to such manager”;
(j) “the details about performance of the fund, if any, managed by the Fund Manager;
(k) investment strategy of the fund”;
(l) “any other information specified by the Board”.
Maintenance of books and records
(1) “Every venture capital fund shall maintain for a period of 3 years books of account,
records and documents which shall give a true and fair picture of the state of affairs of
the venture capital fund”.
(2) “Every venture capital fund shall intimate the Board, in writing, the place where the
books, records and documents are being maintained”.
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Power to call for information
(1) “The Board may at any time call for any information from a venture capital fund with
respect to any matter relating to its activity as a venture capital fund.”
(2) “Where any information is called for it shall be furnished within the time specified by
the Board”.
Submission of reports to the Board.
“The Board may at any time call upon the venture capital fund to file such reports as
the Board may desire with regard to the activities carried on by the venture capital fund.”
Winding-up
(1) “A scheme of a venture capital fund set up as a trust shall be wound up,
(a) when the period of the scheme, if any, mentioned in the placement memorandum is
over”;
(b) “if it is the opinion of the trustees or the trustee company, as the case may be, that
the scheme shall be wound up in the interests of investors in the unit”;
(c) “if seventy-five per cent of the investors in the scheme pass a resolution at a
meeting of unit holders that the scheme be wound up”; or
(d) “if the Board so directs in the interests of investors”.
(2) “A venture capital fund set up as a company shall be wound up in accordance with
the provisions of the Companies Act, 1956”
(2A) “A venture capital fund set up as a body corporate shall be wound up in
accordance with the provisions of the statute under which it is constituted”
(3) “The trustees or trustee company of the venture capital fund set up as a trust or the
Board of Directors in the case of the venture capital fund is set up as a company shall
intimate the board and investors of the circumstances leading to the winding up of the
scheme.”
Effect of winding-up.
(1) “On and from the date of intimation, no further investments shall be made on behalf
of the scheme so wound up”.
(2) “Within three months from the date of intimation, the assets of the scheme shall be
liquidated, and the proceeds accruing to investors in the scheme distributed to them
after satisfying all liabilities”.
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(3) “Distribution of assets of the scheme, shall be made by the venture capital fund at
any time, including on winding up of the scheme, as per the preference of investors,
after obtaining approval of at least 75% of the investors of the scheme”.
INSPECTION AND INVESTIGATION
Board’s right to inspect or investigate
(1) “The Board may 2 suo motu or upon receipt of information or complaint] appoint one
or more persons as inspecting or investigating officer to undertake inspection or
investigation of the books of account, records and documents relating to a venture
capital fund for any of the following reasons”, namely:—
(a) “to ensure that the books of account, records and documents are being
maintained by the venture capital fund in the manner specified in these regulations”;
(b) “to inspect or investigate into complaints received from investors, clients or any
other person, on any matter having a bearing on the activities of the venture capital
fund”;
(c) “to ascertain whether the provisions of the Act and these regulations are being
complied with by the venture capital fund”; and
(d) “to inspect or investigate suo motu into the affairs of a venture capital fund, in
the interest of the securities market or in the interest of investors”.
Liability for action in case of default.
“Without prejudice to the issue of directions or measure under regulation , a venture
capital fund which”—
(a) “contravenes any of the provisions of the Act or these regulations”;
(b) “fails to furnish any information relating to its activity as a venture capital fund as
required by the Board”;
(c) “furnishes to the Board information which is false or misleading in any material
particular”;
(d) “does not submit periodic returns or reports as required by the Board”;
(e) “does not co-operate in any enquiry, inspection or investigation conducted by
the Board”;
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(f) “fails to resolve the complaints of investors or fails to give a satisfactory reply to
the Board in this behalf shall be dealt with in the manner provided in 2 [Chapter V of
the Securities and Exchange Board of India (Intermediaries) Regulations, 2008.]”
Source: www.sebi.gov.in
Activity 2
Comment on the:
1. Eligibility and investment criteria of venture capitalist in India:
_____________________________________________________________
_____________________________________________________________
2. Requirement for more Venture Capitalists in India
_____________________________________________________________
_____________________________________________________________

1) The pioneer of Venture Capital in India was:
a. SIDBI
b. IDBI
c. IFCI
d. ICICI
2) Which venture capital scheme was started by IDBI
a. SBI Cap
b. RCF
c. TDICI
d. Seed capital
3) Venture Capital in India is governed by:
a. SEBI
b. RBI
c. Companies Act
d. All of these
4) Credit Capita Venture Fund is set up by:
a. Public Sector Bank
b. Private Sector agency
c. Development bank
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6.8. SUMMARY
Venture Capital is developing as a new source of financing risky, innovative and
entrepreneurial projects. It is primarily an equity mode of financing. The financer earn
return in the form of capital gains and the entrepreneur gets access to capital without
entering into the formalities of raising money through capital market. Major
characteristics of venture capital are that it is risky, long term, equity oriented, Illiquid
and a lucrative channel of investment that has a social motive as well. IFCI was the first
one to start up venture capital in India by establishing Risk Capital Foundation (RCF).
The rules and regulations of VC are governed by SEBI in India.
6.9. GLOSSARY
1. Venture Capital: The financial investment in highly risky projects usually in the
early stages with the objective of earning a high rate of return.
2. Venture Capitalist: Venture Capitalist is the financer or the venture investor who
provides financing either as equity or loan to the firm or entrepreneur requiring
capital.
3. Seed Capital: It is the capital provided to start up a new project by the budding
and unproven entrepreneurs.

1) false
2) false
3) true
4) true

1) c
2) d
3) a
4) b
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6.11. REFERENCES
1. Gupta, S.K. and Aggarwal, N , Financial Services, Kalayani Publishers,
Ludhiana
4. www.sebi.gov.in

1. What do you understand by the term Venture Capital? What are its major
features?
2. Write a note on Venture Capital financing in India.
3. What are various provisions given by SEBI for Venture Capital in India?
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Lesson- 7
Merchant Banking
Structure
7.1. Introduction
7.2. Concept of Merchant Banking
7.3. Difference between Commercial Banking and Merchant Banking
7.4. Origin and development of Merchant Banking in India
7.5 Scope of Merchant Banking
7.6. Importance of Merchant Banking
7.7. Problems of Merchant Banking in India
7.8. Guidelines of SEBI on Merchant Banking
7.9. Summary
7.10. Glossary
7.12. References

 The concept of Merchant Banking
 Origin and development of merchant banking in India
 Scope of Merchant Banking
 Organizational aspects and importance of merchant bankers.
 Guidelines of SEBI for Merchant bankers.
7.1. INTRODUCTION
Economic development requires introduction of specialized services in the economy.
Banks are needed to mobilize savings of people; finance companies are required for
providing credit and credit related services; insurance companies have to be
established for security of life and property, agricultural banks are required for rural
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development and so on. Thus in order to bring greater sophistication in financial
services, Merchant Banking was originated.
7.2. CONCEPT OF MERCHANT BANKING
“A merchant bank is a financial institution providing capital to companies in the
form of share ownership instead of loans. A merchant bank also provides advisory
services on corporate matters to the firms in which they invest. It is an institution or an
organization which provides a number of services including management of securities
issues, portfolio services, underwriting of capital issues, insurance, credit syndication,
financial advices, project counseling etc”.
“Merchant banking is a combination of banking and consultancy services.” It
helps businessmen to start a business and help to raise finance. It provides consultancy
to its clients for financial, marketing, managerial and legal matter. It helps to register,
buy and sell shares at the stock exchange.
Source: kalian-city.blogspot.com
Definitions
Securities Exchange Board of India (Merchant Bankers) Rules, 1992 defines
Merchant Banker as “any person who is engaged in the business of issue management
either by making arrangements regarding selling, buying, or subscribing to securities as
manager, consultant, advisor or rendering corporate advisory service in relation to such
issue management.”
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Gupta and Chopra define a merchant banker as “an organization that acts as an
intermediary between the issuers and the ultimate purchasers of securities in the
primary security market”.
As per Coax, Merchant banks are “the financial institutions providing specialist services
which generally include acceptance of bills of exchange, corporate finance, portfolio
management and other banking services”.
Thus, to summarize it can be said that Merchant Banking is often defined in term
of what a merchant banker does. It is a specialized financial service that is identified by
the functions of a merchant banker, such as organizing and extending finance for
investment in projects, assistance in financial management, portfolio management,
underwriting of shares and overall corporate counseling.
7.3. DIFFERENCE BETWEEN COMMERCIAL BANKING AND MERCHANT

BANKING
There is a lot of difference in the purpose and services of commercial banking and
merchant banking.
BASIS COMMERCIAL BANKING MERCHANT BANKING
Primary Accepting deposits and granting Acting as financial consultants to
Function loans the corporate
Nature Fund based service Non Fund based service
Target Individuals and corporate who Large corporations and high net
Customers require basic banking services worth individuals
Scope Narrow scope of providing credit Broad in scope as they provide
and credit related services only. financial advisory services in
facilitating corporate restructuring,
mergers and acquisitions, private
equity placements etc.
Clientele Wide customer base Limited customer base
Risk of Risk from non-performing assets No such risk
default
Governing Ministry of Finance and Reserve Governed by SEBI
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body Bank of India
7.4. ORIGIN AND DEVELOPMENT OF MERCHANT BANKING IN INDIA

The formal merchant banking service in Indian capital market was initiated in
1967, when Reserve Bank of India (RBI) granted license to ‘The National Grindlays
Bank’ to perform the services relating to issue management. The Bank started merchant
banking services by opening merchant banking Division within the bank in 1969. The
First National City Bank followed the Grindlays Bank by opening a ‘Management
Consultant Division in 1970. Both these banks acted as ‘managers to the issues’. On
the recommendations of Banking Commission, State Bank of India (SBI) became the
first Indian commercial bank to start with the merchant banking activities in 1972-73 by
opening ‘Merchant Banking Division’ with its head office in Bombay and sub offices as ‘
management banking bureau’ at the other major cities. The other commercial banks
that followed the SBI were Central Bank of India, Bank of India and Syndicate Bank who
started merchant banking services in 1977; Bank of Baroda, Chartered Bank and
Mercantile Bank in 1978; Union Bank of India, UCO Bank, Punjab National Bank,
Canara Bank and Indian Overseas Bank undertook merchant banking activities in late
1970s and the early 1980s. Among the development banks, ICICI started merchant
banking activities in 1973, followed by IFCI (1986) and IDBI (1991).
Merchant banking divisions of commercial banks were offering narrow and
traditional range of merchant banking services that included issue management,
underwriting and syndication of loans and provision of advisory services to corporate
clients on fund raising and other financial aspects.
Merchant banking activities to a large extent are affected by the development
and growth of capital market in the country. Following the notification under section 6(1)
(o) of the Banking Regulation Act, 1949, commercial banks were permitted during 1984
to set up subsidiaries for undertaking equipment leasing or investments in shares within
the limits specified in section 19(2) of the above Act. The notification provided the real
impetus to commercial banks and consequently a number of subsidiaries were
established by them to undertake merchant banking activities. On August 1, 1986, State
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Bank of India set up a wholly owned subsidiary namely, SBI Capital Market Ltd. to
undertake the merchant banking activities of the bank. This pioneering step of SBI in
launching a subsidiary exclusively for performing the merchant banking services
attracted many other leading commercial banks in India. At the end of June 1992, there
were nine merchant banking subsidiaries set up by commercial banks with prior
approval of RBI.
The current players in Merchant Banking in India are shown as follows:
Source: Economy and Finance, 2013
1) Merchant banking is another name for commercial banking. (__________)

2) Merchant banking is wider than commercial banking (__________)
3) Merchant bankers provide advisory and financial consultancy services.
(__________)
4) State Bank of India was the first commercial bank to undertake merchant
banking services in India. (__________)
7.5. SCOPE OF MERCHANT BANKING

Merchant banking is a service oriented industry with a wide scope of operations.
It includes the following functions and services in its scope:
1. Issue Management:
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Issue management is the primary function of a merchant banker. Merchant
banker act as a manager, consultant and an advisor to the issue and helps
companies in raising finance. They assist firm in drafting prospectus,
preparing application form and completing formalities under Companies Act
and seeking permissions from SEBI. They are liable to make the issue
successful. Their major activities under issue management include:
i. Preparing prospectus
ii. Registration of prospectus
iii. Pricing of issue
iv. Publicity of the issue
v. Assisting in appointment of registrar for dealing with application of
shares
vi. Underwriting function
vii. Clearing and Listing on stock exchanges
2. Corporate Counseling
It refers to set of activities undertaken to ensure efficient running of a
company. It includes effective management of the financial affairs of a
company. Corporate counseling may include the following activities:
i. Analyzing product lines, their growth and profitability.
ii. Reviving old line companies and ailing sick units y appraising their
technology and process.
iii. Rehabilitation through modernization and diversification
iv. Providing assistance in getting loans from financial institutions for
capital expenditure.
3. Underwriting of public issue
It refers to a guarantee given by a merchant banker that in the event of the
issue being under subscribed the amount underwritten would be subscribed
by them.
4. Portfolio Management
It refers to maintaining proper combination of securities so that the customer
earns maximum rate of return on the investment. Many a times customers do
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not have expertise in the area of investment inspite of having huge resources.
Merchant bankers provide expert services in the buying and selling of
securities and timely re-arrangement of the same.
5. Promotional Activities
Merchant bankers help firms to identify a business proposal, prepare
feasibility reports and obtain approvals from the government. It also helps
firms to have access to technical and financial collaborations.
6. Loan syndication
It refers to a loan arranged by a bank for a borrower who is likely to be a large
company, a local authority or a government department. The merchant
banker finalizes the cost of the project and then approaches financial
institutions for term loans.
7. Mergers and Acquisitions:
Merchant banker acts as a middleman in the exercise of mergers and
acquisitions. He advises on the feasibility of mergers and acquisitions. He
also seeks permissions from RBI and other statutory bodies.
8. Lease Financing:
Many merchant bankers provide leasing and finance facilities to their
customers. Some of them aid the budding entrepreneurs by rendering
services of maintaining venture capital funds for them. They also help
companies in raising finance by way of public deposits.
9. Other Specialized Services:
In addition to the basic activities involving marketing of securities, merchant
banks also provide corporate advisory services on issues like tax matters,
recruitment of executives and cost and management audit, etc. Many
merchant bankers have also started making of bought out deals of shares
and debentures.
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Activity 1
How have Merchant Banking Services :
1. Introduced specialization in the area of financial services:
________________________________________________________________
________________________________________________________________
2. Enlarged the scope of banking services:
________________________________________________________________
________________________________________________________________
7.6. IMPORTANCE OF MERCHANT BANKING

1. Bridging supply and demand of funds: Merchant banking is a financial
service that brings the savers and investors together. Many people have huge
resources but lack expertise and seek the advice of Merchant Bankers.
Similarly, entrepreneurs need expertise in raising money from the market
through them.
2. Multiplicity of Services: Merchant banker not only helps to raise capital from
the market but follows the customer through all stages of corporate growth
and development. It provides multiple services as portfolio management, loan
syndication, advice on mergers, taxation, leasing etc.
3. Professional expertise: With ever increasing sophistication and
professionalism in the stock market, Merchant banking services helps firms
an access to professional advice and support. It helps clients in meeting
4. Growing complexity in rules and procedures: The hurdles in fulfilling the
varied formalities of stock exchanges and other financial institutions and
statutory bodies can be tackled by the merchant bankers.
5. Encouragement to budding entrepreneurs: The new entrants in the market
get help from the merchant banking services. These entrepreneurs do not
lack talent but definitely wish to seek advice on many cumbersome matters.
Merchant Banking services add to their convenience.
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6. Development of Backward areas: The services of Merchant Banking
provide encouragement and motivation to entrepreneurs to open business in
the backward areas as well. They help them to avail the facilities required for
opening businesses in such areas. The entrepreneurs are able to avail many
subsidies and tax incentives as well as exploit the untapped areas. These
areas tend to grow and develop leading to growth of the economy as a whole.
7. Development of Capital Market: Merchant banking provides finance to the
firms and channelizes savings of lenders in the best possible portfolios. This
definitely leads to the development of capital market.
7.7. Problems of Merchant Banking in India

1. There is lack of cooperation from issuing houses in timely allotment of
securities and refund of funds. This brings inefficiency in the operations of
merchant bankers.
2. The guidelines given by SEBI with respect to capital adequacy and net
worth for merchant bankers are arduous to achieve.
3. Issue related services are the major domain of Merchant Bankers. Other
activities are in lesser demand in the market.
7.8.SEBI GUIDELINES ON MERCHANT BANKING

1. REGISTRATION OF MERCHANT BANKERS
Application for grant of certificate
The application shall be made for any one of the following categories of the merchant
banker namely:—
“Category I”,
(i) “to carry on any activity of the issue management, which will, inter alia, consist of
preparation of prospectus and other information relating to the issue,
determining financial structure, tie up of financiers and final allotment and refund
of the subscriptions”; and
(ii) “to act as adviser, consultant, manager, underwriter, portfolio manager”;
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“Category II”
(i) “to act as adviser, consultant, co-manager, underwriter, portfolio manager”;
“Category III”,
(i) “to act as underwriter, adviser, and consultant to an issue”;
“Category IV”,
(i) “to act only as adviser or consultant to an issue”.
2. CAPITAL ADEQUACY REQUIREMENT.

“The capital adequacy requirement referred shall be a net worth of not less than five
crore rupees. The net worth shall be as follows”:
“The Minimum Amount in the categories required is”:
“Category I : Rs. 5, 00, 00, 000”
“Category II: Rs. 50, 00, 000”
“Category III: Rs. 20, 00, 000”
“Category IV: Nil
3. GENERAL OBLIGATIONS AND RESPONSIBILITIES
“Merchant banker is not to associate with any business other than that of the securities
market”.
4. MAINTENANCE OF BOOKS OF ACCOUNT, RECORDS ETC.
(1) “Every merchant banker shall keep and maintain the following books of account,
records and documents” namely:—
(a)” a copy of balance sheet as at the end of the each accounting period”;
(b) “a copy of profit and loss account for that period”;
(c) “a copy of the auditor’s report on the accounts for that period
(d) “a statement of financial position”.
(e) “Records and documents pertaining to due diligence exercised in pre-issue and post
–issue activities of issue management and in case of takeover, buyback and delisting of
securities”.
(2) “Every merchant banker shall intimate to the Board the place where the books of
account, records and documents are maintained”.
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(3) “Every merchant banker shall, after the end of each accounting period furnish to the
Board copies of the balance sheet, profit and loss account and such other documents
for any other preceding five accounting years when required by the Board”.
5. SUBMISSION OF HALF-YEARLY RESULTS.
“Every merchant banker shall furnish to the Board half-yearly unaudited financial results
when required by the Board with a view to monitor the capital adequacy of the merchant
banker”.
6. REPORT ON STEPS TAKEN ON AUDITOR’S REPORT
“Every merchant banker shall, within two months from the date of the auditor’s report,
take steps to rectify the deficiencies made out in the auditor’s report”.
7. LEAD MANAGERS
“The number of lead merchant bankers may not, exceed in case of any issue of Size of
issue No. of Merchant Bankers
(a) “Less than rupees fifty crores “ (b) “Rupees fifty crores but less than rupees one
hundred crores”
(c) “Rupees one hundred crores but less than rupees two hundred crores”
(d) “Rupees two hundred crores but less than rupees four hundred crores”
(e) “Above Rupees four hundred crores five or more as may be agreed by the board”
Responsibilities of lead managers.
(1) “No lead manager shall agree to manage or be associated with any issue unless his
responsibilities relating to issue mainly, those of disclosures, allotment and refund are
clearly defined, allocated and determined and a statement specifying such
responsibilities is furnished to the Board at least one month before the opening of the
issue for subscription”
8. UNDERWRITING OBLIGATIONS.
“In respect of every issue to be managed, the lead merchant banker holding a certificate
under Category I shall accept a minimum underwriting obligation of five per cent of the
total underwriting commitment or rupees twenty-five lacs, whichever is less”
9. ACQUISITION OF SHARES PROHIBITED
“No merchant banker or any of its directors, partner or manager or principal officer shall
either on their respective accounts or through their associates or relatives, enter into
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any transaction in securities of bodies corporate on the basis of unpublished price
sensitive information obtained by them during the course of any professional
assignment either from the clients or otherwise”.
10. DISCLOSURES TO THE BOARD.
“A merchant banker shall disclose to the Board, as and when required, the following
information”, namely:—
(i) “his responsibilities with regard to the management of the issue”;
(ii) “any change in the information or particulars previously furnished, which have a
bearing on the certificate granted to it”;
(iii) “the names of the body corporate whose issues he has managed or has been
associated with”;
(iv) “the particulars relating to the breach of the capital adequacy requirement as
specified in regulation”
(v) “relating to his activities as a manager, underwriter, consultant or adviser to an
issue, as the case may be”.
11. FEES
“Every merchant banker shall pay a sum of twenty lakh rupees as registration fee at the
time of grant of certificate of initial registration”.
Activity 2
How are following SEBI regulations with respect to Merchant Banking cumbersome to
achieve? Justify your answer.
1. Capital Adequacy Requirement:
________________________________________________________________
________________________________________________________________
________________________________________________________________
2. Fees:
________________________________________________________________
________________________________________________________________
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1) Which of the following is a function of Merchant Banker?
a. Assisting mergers
b. Underwriting of shares
c. Issue of prospectus
d. All of the above
2) Which of the following is not a function of a Merchant Banker
a. Accepting deposits
b. Issue management
c. Loan syndication
d. Lease financing
3) The minimum net worth required for merchant banker in Category I is:
a. 1 crore
b. 2 crore
c. 3 crore
d. 5 crore
4) The broadest scope of functions can be offered by Merchant Bankers falling
in which category:
a. Category IV
b. Category III
c. Category II
d. Category I
7.9. SUMMARY
Merchant Banking is a specialized fee based service developing in the Indian
economy. It is better understood by the functions performed by the merchant banker
and includes issue management, portfolio management, underwriting of shares,
corporate counseling and advisory services. Merchant Banking was started in India with
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the establishment of Grindlays Bank in 1967. State Bank of India was the first
commercial bank to start with Merchant Banking in India in 1972. Thereafter many other
banks and financial institutions joined the race. Merchant banking engulfs many
functions and services in its scope. It provides corporate counseling, portfolio
management, underwriting of shares, issue management, facilitates mergers and
acquisitions, provides lease financing and other related services as tax management,
audits etc. Merchant Banking services hold great importance for the budding
entrepreneurs, capital market functioning, development of backward areas as these
extend professional advice and expertise. Merchant Banking services are governed by
SEBI that has issued many guidelines with respect to registration, fees and disclosure
requirements with respect to Merchant Bankers.
7.10. GLOSSARY
1. Merchant Banker: “A merchant bank is a financial institution that provides
advisory services on corporate matters to the firms in which they invest. The services
including management of securities issues, portfolio services, underwriting of capital
issues, insurance, credit syndication, financial advices, project counseling etc”.
2. Merchant Banking: “It is a specialized financial service that is identified by the
functions of a merchant banker, such as organizing and extending finance for
investment in projects, assistance in financial management, portfolio management,
underwriting of shares and overall corporate counseling”.
3. Issue Management: It is a major function of a merchant banker. Merchant
Banker helps a firm in drafting prospectus, seeking approvals and permissions and
publicizing the issue in such a way that the issue becomes a success and its client is
able to raise money from the market. Else it performs the function of underwriting the
unsubscribed shares.

1) false
2) true
3) true
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4) true

1) d
2) a
3) d
4) d
7.12. REFERENCES
Ludhiana
2. Gopal C. Rama, Management of Financial Services, Vikas Publishing
4. Tripathi, N.P, Financial Services, PHI Learning Private Ltd., New Delhi,
2010.
5. www.sebi.gov.in

1. What do you understand by the term Merchant Banking? Discuss its scope.
2. Explain the origin and development of Merchant Banking in India.
3. What are various provisions given by SEBI for Merchant Banking?
Page 152 of 200

LESSON - 8
Factoring
Structure
8.1. Introduction
8.2. Concept of Factoring
8.3. Development of Factoring
8.4. Types of Factoring
8.5. Importance of Factoring
8.6 Procedural aspects in Factoring
8.7. Difference between factoring and bill discounting
8.8. Financial aspects in factoring
8.9. Prospects of Factoring in India
8.10. Summary
8.11. Glossary
8.13. References
 Concept of Factoring
 Development of factoring
 Types & importance of Factoring
 Procedural aspects in factoring,
 Financial aspects of Factoring
 Prospects of factoring in India.
8.1. INTRODUCTION
Business is run on credit. As a result receivables form a very important asset in the
Balance Sheet of a business. Receivables are also very vulnerable asset as there is
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always an apprehension of their recovery. Receivables management is a very tedious
and time consuming activity of any business. Factoring is a financial service that
facilitates receivable management. Receivables attract two types of costs: 1. cost of
financing receivables and 2. cost of collection of receivables. Hence to manage
receivables, firms may procure services of specialized institutions dealing in receivable
management called factoring firms. In India the concept of factoring was launched by
RBI by a committee headed by Shri. C.S. Kalyan Sundaram. Then in 1991 State Bank
of India opened SBI Factor Ltd to undertake factoring services in India.
8.2. CONCEPT OF FACTORING

Factoring is defined as “the relationship created by an agreement between the seller of
good/services and a financial institution called the factor, whereby the latter purchases
the receivable of the former and also controls and administers these receivables”. It is in
fact a continuous relationship between the selling firm and the factor on open account
basis, where the factor purchases the debts of the seller and also manages the
collection, record keeping and administration of the credit sales. It is a “fund based
financial service” that provides resources to “finance receivables” and also facilitates the
“collection of receivables”.
Definitions
CS Kalyan Sundram (RBI Report, 1988) defines factoring as a “continuing
arrangement under which a financing institution assumes the credit and collection
functions for its clients, purchases receivables as they arise (with or without recourse for
credit losses, that is, the customer’s financial inability to pay), maintains the sales
ledger, attends to other book-keeping duties relating to such accounts, and performs
other auxiliary functions.”
Biscose defines factoring as “a continuing legal relationship between a financial
institution (factor) and a business concern (client) selling goods or providing services to
trade customers, whereby the factor purchases the clients’ book debts, either with or
without recourse to the client and in relation thereto, controls the credit extended to
customers and administers the sales ledger clients ”.
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Study Group appointed by International Institute for the Unification of Private Law,
Rome state that “factoring means an arrangement between a factor and his client which
includes at least two of the following services to be provide by the factor:
 Finance
 Maintenance of accounts
 Collection of debts
 Protection against credit risk”
Thus, factoring is an “agreement in which receivables arising out of sale of goods are
sold by the firm to the Factor, as a result of which the title to the goods represented by
the said receivables passes on to the factor. Thereafter, factor becomes responsible for
all credit control, sales accounting and debt collection from the customers”.
Features of Factoring
1. Credit realization: Factoring helps to realize proceeds of credit sales and
increases cash availability to the business.
2. Parties to factoring: There are three parties in factoring, namely the seller (client),
the Buyer (customer) and the factor (financial Institution)
3. Receivables management: But for collection function against the credit sales,
factor also performs functions of providing finance, maintaining accounts, ledgers
and bears risk of default.
4. With or without recourse: A factoring arrangement which bears risk of bad debts
is called without recourse while the one which does not bear the risk of bad debts
is called with recourse.
5. Open account sales: When credit sales are made without raising any bill of
exchange of promissory note it is known as open account sales.
6. Reduced dependence on banks: Since factor finance a portion of receivables
immediately, there is less dependence on banks for the financing of working
capital needs.
7. Fund based service: Factoring is a fund based service where the factor makes
prepayment of the eligible debt after retaining a specific margin.
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8. Off balance sheet financing: Under factoring arrangements while making credit
sales the invoice is made in the name of the factor. Hence, factoring becomes an
off balance sheet item and does not comes in the books of the client.
9. Compensation: A factor takes a serviced charge on the turnover.
Activity 1
How is factoring:
1. An off balance sheet activity:
________________________________________________________________
________________________________________________________________
2. A fund based service:
________________________________________________________________
________________________________________________________________
8.3. DEVELOPMENT OF FACTORING

Factoring originated in France and England in the 15th and 16 century. These countries
were exporting goods to their colonies and required an intermediary to distribute the
goods, provide finance as well as collect the proceeds. Initially, in the 19 th and 20th
century, agents use to provide finance and collect receivables. Other functions included
under factoring services were not known. Factoring took a new shape when developed
countries as USA and UK made endeavors to shape up the structure of factoring. Today
USA and European countries account for nearly 80% of global factoring turnover.
Factoring service in India has originated recently only. The credit of the same belongs to
the recommendations of the Kalyanasundaram Study Group appointed by the RBI in
1989. When the recommendations of this study group were accepted, the RBI issued
guidelines for factoring services in 1989. The committee directed that factoring services
could be undertaken by banks through the medium of separate subsidiaries. The first
factoring company – SBI Factors and Commercial Ltd (SBI FACS) started operation in
April 1991.
Some of the institutions providing factoring services in India are explained as follows:
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1. SBI Factor and Commercial Services (SBI FACS)
 Floated as subsidiary of SBI in 1991 with a paid up capital of 25 crores.
 It follows both domestic as well as international factoring.
 Service fee levied varies from 0.5 to 2%.
 Prepayment of 80% is made.
 Maintains sales ledgers also.
2. Canara Bank Factors
 Floated as subsidiary of Canara Bank in 1991 with a paid up capital of 10 crores.
 It is sponsored by Canara Bank, Andhra Bank and SIDBI in the proportion of
60:20:20.
 It is more popular in South of India.
3. Fairgrowth Factors:
 It is the first company to be set up in Private Sector
 Started in 1992
 Paid up capital is 5 crores.
4. Foremost Factors Ltd. (FFL)
 First private sector Company to set up export factoring services in 1997.
 It is a joint venture between Mohan Exports and National Bank Overseas
Corporation (USA) and 20th century Finance Corporation.
 Provides advance payment to exporters up to 80%.
 FFL is a member of Factors Chain International, a group that includes nearly 120
of the world’s leading financial institutions in 50 countries.
 It uses the standard International Electronic Data Interchange Factoring Network,
and hence provides Speedy reporting services on the overseas accounts as well.
8.4. TYPES OF FACTORING

1. Recourse and Non Recourse Factoring:
In recourse factoring the factor can come back to the client in case of default by the
customer. Risk of bad debts is not borne by the factor. He assumes the responsibility of
collection of debt and maintenance of sales ledger only.
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In case of non recourse the factor bears the risk of bad debts. The commission charged
is higher in case of non recourse factoring.
2. Advance and Maturity Factoring:
In advance factoring, “the factor pays only a certain percentage (between 75-90%) of
receivable to the client, the balance being repaid on the guaranteed payment date. As
soon as the receivables are approved, the factor pays the advance amount to the client.
The interest is charged from the date advance is paid till the receivables are actually
received”.
In maturity factoring no advance payment is made to the client. The factor helps only in
collecting receivables and guarantees the same.
3. Bank Participation factoring:
Sometimes part of finance, which is in fact the retained amount, is arranged by the
factor through the bank, it is called Bank Participation factoring. It is a modified form of
advance and maturity factoring.
Eg: Accounts Receivable = Rs.100
Pre -payment by factor= 70%= Rs.70
Balance =Rs. 30
Bank participation= 50%
Amount paid by bank = Rs. 15
Total amount factored= Rs. 85
4. Conventional and Full Factoring:
When a factor performs almost all services covered under factoring as, “collection of
receivables, maintenance of sale ledger, credit collection, credit control and credit
insurance”, it is also conventional or full factoring. However, factor put up a limit on the
total bills outstanding and also covers the risk of default with respect to them. Eg: SBI
Factor is doing full factoring.
5. Disclosed and undisclosed factoring:
“In disclosed factoring name of factor is mentioned in the invoice”. Payment is made by
buyer directly to the factor. When the name of factor is not mentioned and all payments
take place in the name of the seller it is called undisclosed factoring.
6. Domestic or Export Factoring:
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“In domestic factoring three parties are involved: buyer, seller and factor. All three
parties reside in the same country. There is only one agreement i.e between the factor
and the seller”.
In export factoring four parties are involved: buyer, seller, export factor and import
factor. There are two agreements: one between the export factor and exporter (seller)
and second between the export factor and the import factor. The import factor acts as a
link between the export factor and the importer. Export factoring is always non -recourse
factoring, hence the exporter has 100% surety against bad debts.
7. Limited Factoring:
When factor discounts only certain bills on selective basis it is called limited factoring.
It can be :
 Selected seller factoring: when factor selects only few clients with whom he
would act as factor.
 Selected buyer factoring: when factor selects buyers on the basis of their credit
worthiness and goodwill and discount the bills of only those customers.
1) Factoring services always cover bad debts. (__________)

2) The factor gets claim on the proceeds to be received from debtors.
(__________)
3) There are three parties in domestic factoring while four in export factoring.
(__________)
4) In mature factoring the factor makes full payment in advance to the client.
(__________)
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8.5. IMPORTANCE OF FACTORING
1. Specialized services: it is more than just financing. It includes many other
services as collection of receivables, ledger maintenance, bad debts cover etc.
2. Increases client’s liquidity and improves his credit worthiness: Factoring induces
liquidity into the business. It pays money in advance almost to the extent of 80%
which can be deployed to meet working capital needs.
3. Reduces risk of bad debts: One if the most important services included in
factoring is the cover of risk of default. The non-recourse factoring allows the
client to transfer the risk of bad debts to the factor.
4. Improved cash flows: The recovery of debt usually takes long, but the factor
immediately releases the advance payment to the client.
5. Better purchase planning: The cycle of inventory management is not interrupted
as the business always have sufficient fund for providing for the next purchase
planning.
6. Expansion of business: The client feels secured and confident and can always
think of expansion of business due to sufficient availability of finances.
7. Off balance sheet item: Factor takes away the bills receivables and hence these
do not appear in the Balance Sheet of the firm. These become off Balance Sheet
items and hence improve financial ratios of a company.
8. Saves management time and effort: Management is relieved of the burden of
pursuing receivable management. It is able to utilize its time, energy and efforts
in other areas.
9. Better management of receivables: The burden of receivable management which
is a very major asset of a business is shifted to the factor who render
professional expertise in managing the same.
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Activity 2
When are following types of factoring useful:
1. Undisclosed factoring:
________________________________________________________________
________________________________________________________________
2. Export factoring:
________________________________________________________________
________________________________________________________________
3. Bank participating factoring:
________________________________________________________________
________________________________________________________________
8.6. PROCEDURAL ASPECTS IN FACTORING

The procedure of factoring is step wise. It can be explained as follows:
There are three parties in a factoring agreement:
1. Client: He is the seller and needs receivables management.
2. Customer: He is the buyer to whom goods have been sold on credit
3. Factor: it is the financial institution that renders services of receivables
management.
Step 1: An agreement is entered between the seller/client and the factor firm. The
buyer/customer places an order with the client. The delivery of goods and invoice bil
is given to the buyer. Instructions are given to him to make payment to the factor
directly. An invoice copy is sent to the factor as well.
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Mechanism of Factoring
Source: www.kkhsou.in
Step 2: The factor makes an advance payment to the client as per the terms and
conditions of the contract between them. The payment may be made upto 80% of
the bill amount. The remaining 20% is the retention money paid by the factor after
the proceeds are received from the customer.
Step 3: The factor takes follow up from the customer. He performs various functions
as maintaining of the sales ledger, sending reminders to the customer and
expediting the collection of the receivables.
Step 4: The customer makes the payment to the factor on due date. In case of
default the factor bears the risk of bad debts if the factoring agreement is non-
recourse.
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Step 5: The factor pays the balance amount to the Client after deducting interest
charges, servicing charges and fees.
8.7. DIFFERENCE BETWEEN FACTORING AND BILL DISCOUNTING

Bill discounting is an old and traditional system available for taking short term credit
from the bank where the bank discounts the bill of the customer prior to the due date
and collects the same from the customer on the due date. The bank deducts its
commission in the process. However the risk of bad debts is borne by the client only.
The major points of difference between the two can be shown as follows:
Sr. Bill discounting Factoring
No.
1 It provides finance against bills. It is on open account basis.
2 Bill discounting involves only It renders other services like sales ledger
financing maintenance etc.
3 Advances are made against Advances are made by purchasing bills.

promissory notes.
4 Bills discounted may be rediscounted These cannot be rediscounted

before maturity
5 The drawer undertakes to collect bills The factor collects the dues
and return to bank.
6 Bill discounting is always recourse Factoring can be without recourse

7 It is bill based, i.e, individual bill is It covers entire quantum of credit/
taken over each time. receivables for the whole accounting
period under one category.
8.8. FINANCIAL ASPECTS IN FACTORING

Factoring improves the financial aspects of a firm. The impact of factoring is positive on
the Balance Sheet of a company. It can be explained with the help of following example.
Abstract of Balance Sheet of a Company (before Factoring)
Current Liabilities Rs Current Assets Rs
Bank borrowing against Inventory 100
1. Inventory 70
2. Receivables 50
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120 Receivables 80
Other current liabilities 30 Other current assets 20
Total current liabilities 150 Total current assets 200
The financial analysis of the company can be made through the following parameters:
1. Working capital position = Current Assets – Current Liabilities
=200 – 150
= 50
2. Current Ratio = Current Assets/ Current Liabilities
= 200/150
= 1.33: 1
The factoring firm makes an advance payment of 80% against the receivables. The
Balance Sheet after factoring is presented as follows:
Balance Sheet of a Company (after Factoring)
Liabilities Rs Assets Rs
Bank borrowing against Inventory 100
1. Inventory 70
2. Receivables NIL
70 Receivables (80-64) 16
Other current liabilities(30-14) 16 Other current assets 20
Total current liabilities 86 Total current assets 136
The financial analysis of the company can be made through the following parameters:
1. Working capital position = Current Assets – Current Liabilities
=136-86
= 50
2. Current Ratio = Current Assets/ Current Liabilities
= 136/86
= 1.58:1
Thus, the financial aspect of factoring can be explained as follows:
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1. Current Ratio: The new current ratio is better than the previous current ratio. This
suggests an improved liquidity position of the company.
2. Current Liabilities: There is reduction in current liabilities as the payment of Rs.
64 has been utilized in paying off the bank borrowings.
3. Effect of Off- balance sheet financing: Factor purchases the receivables. These
no longer appear on the asset side of the balance sheet. These appear only in
the footnotes as a contingent liability which becomes due in the event of default
by the customer in case of recourse factoring only.
4. Working capital position: The working capital position of the firm remains
unchanged. Factoring simply changes the composition of current assets and the
receivables are converted into cash.
8.9. PROSPECTS OF FACTORING IN INDIA

Factoring has developed and grown in India at a very sluggish pace. According to a
World Bank report, “India's factoring activity grew by over 800% between 1998 and
2003”. According to the latest report from Factors Chain International (FCI), “the Indian
factoring market has grown from Euro 1290 million to Euro 3560 million (a growth of
176%) between 2002 and 2006. There are signs that show that the Indian factoring
market is maturing fast. In fact, GTF is the founding member of Factors Association of
India (FAI), a grouping of factoring companies operating in India. FAI is a strategic
conglomeration that will ensure wider dissemination of knowledge of factoring in India”.
“The overall worldwide growth in factoring is estimated at 12%. Europe has the largest
market representing 64% of the world volumes with a growth of 18% during the year.
America's growth was 10%, whereas Australia recorded impressive growth of 40%. Asia
saw a fall in volume. The growth trends mentioned above support the fact that there is
enormous scope for expansion worldwide and India is no exception to this. The
potential in India is estimated at an annual turnover of Rs. 15000 to Rs. 20000 cr”. But
large portion is untapped because of the following reasons
 India lacks a proper legal framework to safeguard factoring services. Factoring
companies need some legal protection.
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 Factoring is confused with Bill discounting only. The shift from Banking industry
to Non banking is also not acceptable to the customer.
 Non-Recourse factoring is almost absent: Recourse factoring only gives the
facility of financing but does not generate credit covers, whereas in case of non-
recourse factoring, in case of default of a customer, the factor will bear the risk of
bad debt. However, the facility, which is lucrative for the clients and enhance the
business of factoring in the country, is almost missing,
 Network of branches is poor for factoring.
 No database provides information on credit worthiness of customers.
 High stamp duty on assignment of debt to factors.
 High cost of operations leading to lesser profitability of factors.
 Lack of funding avenues available to factor as compared to other financing
institutions.
 Factoring may lead to overtrading by the traders.
 Malpractices and fraudulent acts mar the objective of factoring as duplicate
invoicing, non- existent goods, pre invoicing etc.
 Lack of professionalism and competence in the area.
 There are some companies which are relatively small with respect to turnover.
Similarly, such companies may have large concentration on few debtors only.
These companies find it difficult to avail factoring services.
 Also, companies with speculative business or companies selling large number of
products may find it tedious to enter into factoring business.
Still India is making rapid strides and moving towards economic growth. Modern
financial services are breaking the reluctance of people. The awareness levels are
growing amongst people and factoring definitely has a vast scope in the years to come.
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1) Which of the following benefit is offered by factoring:
a. Financing
b. Collection
c. Risk cover
d. All of the above
2) Factoring is based on:
a. Bills receivable
b. Promissory note
c. Open account sales
d. Post dated cheque
3) Retention money is paid:
a. After 10 days of advance payment
b. After recovering the proceeds from the customer
c. Along with the advance payment
d. No time is fixed
4) The biggest hurdle in growth of factoring is:
a. Malpractices in financial system
b. Lack of legal framework of factoring
c. Economy in other services
d. Any of the above
8.10. SUMMARY
Factoring is a new fund-based financial service which is of recent origin in India.
Kalyansundram Committee (RBI Report, 1989) recommended the inception of this
service in India. Presently many banks, government agencies as well as NBFCs are
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performing this service in the country. It is a sophisticated substitute of bill discounting
wherein open account sales are made by the seller to the buyer. The factor pays 80% of
money in advance to the client and also bears the risk of bad debts in case of non-
recourse factoring. The factor charges his fee and commission in lieu of this service. it
saves the selling firm from the hassles of receivable management. Factoring is an off-
balance sheet activity that improves the financial parameters of the firm. It has lot of
scope of growth in a developing country as India.
8.11. GLOSSARY
1. Factor: A factor is an institution that offers credit against receivables and
provides managerial services relating to management of debts arising from credit
sales.
2. Factoring: Factoring is a financial service in which the factor buys the debts of a
firm and pays advance money for the credit sales and takes charge of collection
and management of receivables.
3. Non-Recourse: When the factor agrees to bear the risk of bad debts, it is called
non-recourse factoring.
4. Retention Money: Out of the total eligible debt the factor gives approximately
80% of the payment in advance and retains the balance to be paid after receiving
the proceeds. The money thus retained is called retention money.
5. Open account sales: When goods are sold on credit by the seller/ client to the
buyer/customer without raising a bill of exchange or a promissory note.

1) false
2) true
3) true
4) false
Page 168 of 200

1) d
2) c
3) b
4) b
8.13. REFERENCES
Ludhiana
3. Avdhani, V.A., Financial Services in India, Himalaya Publishers, Mumbai,
2010.
4. Khan, M.Y., Financial Services, Tata McGraw Hills, New Delhi, 7th Edition,
2012.

1. What do you understand by Factoring? Explain some institutions providing
factoring services in India.
2. Explain different types of factoring? How is factoring important in receivables
management?
3. What is factoring? Explain in detail the procedure of factoring.
4. What is the impact of factoring on the financial aspects of a company? What are
the future prospects of factoring in India?
Page 169 of 200

LESSON - 9
Debt Securitisation
Structure
9.1. Introduction
9.2. Meaning of Debt Securitisation
9.3. Features of Securitisation
9.4. Process of Securitisation
9.5. Scope of Securitisation
9.6 Bottlenecks of Securitisation
9.7. Summary
9.8. Glossary
9.10. References

 Concept of Debt Securitisation
 Features of Debt Securitisation
 Scope of Debt Securitisation
 Process of Debt Securitisation
9.1. INTRODUCTION
One of the most prominent developments of modern finance is the development of
Securitisation. Banks and financial institutions make loans and advances for the
purchase of assets such as vehicles, houses, machinery etc. Therefore, these loans
make a pool of receivables. Securities are created against these loans; these are rated
and then sold to the investors. In factoring the receivables are taken up by the factor
Page 170 of 200

against the advance payment and future receipt of the same from the debtor. But, in
Securitisation these taken up debts are pooled and converted into securities.
9.2. CONCEPT OF SECURITISATION

Securitisation is a “process of pooling and repackaging of homogeneous illiquid financial
assets into marketable securities that can be sold to investors”. It is a systematic
process where loans and other receivables are pooled, packaged, rated and sold in the
market in the form of securities. The pooled financial assets and underlying cash flows
are used to create guarantees for securities that are offered on retail to institutional/
individual investors. The principal and interest rate payments are met on the securitised
instruments with a fixed return based on the maturity profile of the loan. Securitisation
can be backed by a variety of assets such as vehicles, construction equipment, real
estate, consumer loan, personal loans, lease receivables, hire purchase receivables,
credit card receivables, trade debtors etc.
Securitisation: Parties Involved
The following parties are involved in Securitisation:
1. The originator: the bank, financial institution or entity which had decided to
adopt Securitisation of assets. It is the prime mover of the deal. The originator
sells the assets on its books and receives the funds generated from such sale.
2. Special Purpose Vehicle (SPV): it is an entity which buys pools of assets from
the originator and covert the receivables into securities. It issues them to the
investors in the capital market.SPV is usually constituted as a trust under the
Indian Trust Act or as a company under the Companies Act. The originator may
also float a subsidiary in the form of a limited company.
3. Obligors/ Debtors: the original borrower is the obligor. The amount due from the
obligor is the securitised debt. He must meet his commitments on the due date
otherwise the cash flows would be affected. The whole process greatly depends
on the integrity of the obligors.
4. The investor: the ones who buy securities from the SPV. They receive the
interest and the principal. These may be individuals/ institutional investors like
financial institutions, provident funds, pension funds, insurance companies etc.
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5. Credit rating agency: since the asset pool has its own inherent risk. The
securities pooled have to be rated. The credit rating agencies rate these
securities on the basis of strength of the underlying assets, the likely cash flow
etc. The rating agencies keep reviewing the originators continuously.
6. Servicer: it collects payments due from the original debtor and passes them on
to the SPV. It also takes follows up of the obligors and pursues legal remedies
when required against defaulting borrowers. It is also called receiving and paying
agent.
7. Credit Enhancer: this refers to the additional security provided to the investors.
The investors have direct exposure to the performance of the underlying asset or
mortgage and have limited or no recourse to the originator. The loss to the
investors may vary infrequency, severity and timings depending on the assets
characteristics, origination and administration. An another institution like an
insurance company or a bank that provides credit support through a letter of
credit, guarantee or another assurance is called credit enhancer.
Features of asset to be securitized
 The asset should have similar features in terms of the payment pattern,
documentation and nature of loan.
 Asset should have consistent cash flows.
 Default rate should be low.
 Principal should be totally amortized at maturity.
 Underlying collateral should be liquid.
 There should be diverse obligors so that risk is minimized.
 Underlying assets should have standard documentation.
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Activity 1
Justify the following:
1. The servicing of debt by the obligor is the backbone of process of
Securitisation:
______________________________________________________________
______________________________________________________________
____________________________________________________________
2. The role of credit enhancer is very significant in the process of Securitisation:
______________________________________________________________
______________________________________________________________
______________________________________________________________
9.3. FEATURES OF SECURITISATION

Marketability:
Securitization facilitates marketability of financial claims. Marketability involves two
concepts: (1) “the legal possibility of marketing the instrument”; (2) “the existence of a
market for the instrument”. The mercantile law aids and gives the legal back up to it.
Liquidity is enhanced by floating it in to an organized market (such as securities
exchanges) at either pre-determined or market-determined prices.
Merchantable Quality:
The securitized product should be capable of being sold. This means that the financial
commitments which are a part of the instrument are honored to the investors’
satisfaction.
Wide Distribution:
The product to be securitized should be distributed widely in order to bring cost
efficiency. The issuer would be able to market the product with lesser financial cost to
him. But a wide investor base involves the huge cost of distribution and servicing.
Commoditization:
Securitization is the process of commoditization. It refers to “taking the outcome of the
process into the capital market”. Thus, securitization process should be able to take the
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instruments to the market for the purpose of trading and ensuring returns and
marketability.
Integration and Differentiation
The originator first integrates the assets into a homogenous pool. Then this integrated
pool is split into instruments of fixed denomination to be offered in the market.
1) If a finance company securitizes assets its liquidity is improved and

assets exist on its Balance Sheet. (__________)
2) Commoditization refers to taking over securities by bank. (__________)
3) The securitized instruments ar not traded in the stock market.
(__________)
4) SPV is responsible for the financial engineering of cash flows and sale of
securities. (__________)
9.4. PROCESS OF SECURITISATION

The process of Securitisation involves the following steps:
1. The originator or the lending institution identifies the assets out of its total
portfolio of loans and advances for Securitisation. A homogenous pool of assets
is created in terms of assets having almost the same maturity portfolios.
2. This homogenous pool of assets is passed through to another institution called
the Special Purpose Vehicle (SPV) usually by way of a trust.
3. SPV which is usually an investment banker issues the securities to the investors.
These assets when transferred cease to exist in the books of the originator.
4. SPV splits this pool of assets into individual shares. It recovers the payment
made by selling these to the investors. These securities are called pass through
certificates. These securities are non-recourse as the SPV cannot claim their
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dues from the originator in case of default. The obligor pays interest to the SPV
directly which is paid as dividend to the investors.
5. For the purpose of safety, SPV arranges for credit enhancement by obtaining an
insurance policy to cover the credit losses if any. These are also got rated by a
credit rating agency. This increases the credibility of the securities an gives a
boost to their liquidity and marketability.
The process is further explained in a simplified manner as follows:
The lender institution creates loan assets in its books.
As per credit standing of the borrowers loans are segregated for selling to the issuer of securities.
The issuer pays the loan amount to the lender institution.
The issuer converts these loans into securities.
Securities are issued to investors.
The original lending institution receives payments
The lending institution gives pro rata amount of installment to the issuer.
The issuer passes the recovery amount to the investors
Source: www.dnb.co.in
9.5. Scope of Securitisation
I. Types of Securitisation
II. Instruments of Securitisation
III. Indian scenario of Securitisation
I. Types of Securitisation
1. Asset backed Securitisation:
Securitisation against current/ movable fixed assets is known as ABS. The
securities issued by SPV in ABS rely on the performance of the asset that collateralizes
the securities. Eg: securities against vehicles, machinery, personal loans etc.
2. Mortgage backed securities:
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Securitisation on the basis of immovable fixed assets is known as MBS. This is
usually backed by real estate property, where the lender has the right to sell the
property if the borrower defaults.
Difference between Asset Backed Securitisation and Mortgage Backed

Securitisation
Asset Backed Securitisation Mortgage Backed Securitisation
Backed by movable property, which is Backed by immovable property which

difficult to trace is easily traceable
Asset need not exist at the time of Mortgage has to exist necessarily at the
securitization such as future cash flows time of Securitisation
can also be Securitised
Process takes into consideration the Process takes into consideration the
depreciation in the value of assets. (Eg appreciation in the value of assets. (eg
raw material) real estate).
Legal hassles are relatively easy. Legal hassles are complicated as the
mortgage property cannot be sold
without the intervention of the court
Stamp duty varies as the assets may Stamp duty is levied on the basis of the
not be based at one place. rates specified in the state where the
deal is struck.
II. Instruments of Securitisation

1. Pass through certificates:
Pass through certificate is of single security structure with similarity in risk
with the associated asset. The holders of the pass through certificates are the
owners of the trust. In pass through certificates there is no obligation of the
originator to pay. Obligation to pay continues to be that of original borrower.
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The ‘pass through’ promises that the cash flows from the underlying
mortgages would be passed through to the holders of the securities in the
form of monthly payments of interest, principals and prepayments. In case of
pass through certificates payments to investors depend upon the cash flow
from the assets backing such certificates. As and when cash is received from
the obligor it is passed on to the investor at regular intervals and the entire
principal is reimbursed with the retirement of the assets packed in the pool
Thus, the tenure of these certificates is matched with the life of the securitised
assets.
2. Pay through certificates
In Pay through certificates, interest received from the receivables is not
passed to the holder of the securities. Instead, SPV issues new securities to
them. Pay through securities has a multiple security structure. Under this two
or three different types of securities are issued with different patterns of
maturity. As a result cash flows are different for the securities issued. Investors
have only a charge against the securitized assets. The assets are owned by
the SPV. The SPV issues regular securitized debt instruments. The SPV pays
investors on fixed dates, not matching with the dates on which the transferred
receivables are collected by it. In order to ensure smooth payment to the
investor, SPV used the credit enhancements.
III. Indian Scenario of Securitisation
ABS is preferred in India, though residential mortgage Securitisation is gaining
momentum. The biggest beneficiaries of Securitisation are FIs, banks and NBFCs.
Truck/ automobile pool is a popular one. Mutual funds are the dominant investors.
Now, banks, insurance companies are participating too. Retail investors do not
participate as investors. There is charge of stamp duty on Securitisation. The
immovable property has to be registered for MBS. The general laws as Transfer of
Property Act, Indian Contract Act and Indian Trust Act are applicable to
Securitisation. From 2000, Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Ordinance 2002 (SARFAESI) is implemented.
Some highlights of India in Securitisation deal are as follows:
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1. “In 1990 Citibank (originator) securitised a deal with GIC mutual fund (SPV), for
auto loans, for 160 mln. Citibank was the pioneer of Securitisation in India.”
2. “In 1991, a deal was struck between ICICI and Citibank and the underlying asset
was the bills in respect of credit granted to manufacturers and suppliers. Pass
through certificates were issued by Citibank.”
3. “In 1991, Ind-bank house Ltd securitised its debts with Ind Merchant Banking Ltd,
creating paper to be traded in secondary market.”
4. “Citibank securitised its own car loan portfolio under the auto loan scheme in
1992.”
5. “SBI Cap securitised cash flows of high value customers of Rajasthan State
Industrial Development Corporation in 1995.”
6. “Larsen and Toubro securitised the lease receivables in 1995 for Rs. 4090 mln..
7. “L&T raised Rs 4,090 mn through the securitisation of future lease rentals to
raise capital for its power plant in 1999.”
8. “India’s first securitisation of personal loan by Citibank in 1999 for Rs 2,841 mn”.
9. “India’s first mortgage backed securities issue (MBS) of Rs 597 mn by NHB and
HDFC in 2001.”
10. “Securitisation of aircraft receivables by Jet Airways for Rs 16,000 mn in 2001
through offshore SPV”.
11. “India’s first sales tax deferrals securitisation by Govt of Maharashtra in 2001 for
Rs 1,500 mn.”
12. “India’s first deal in the power sector by Karnataka Electricity Board for
receivables worth Rs 1,940 mn and placed them with HUDCO”.
13. “India’s first Collateralised Debt Obligation (CDO) deal by ICICI bank in 2002”.
14. “India’s first floating rate securitisation issuance by Citigroup of Rs 2,810 mn in
2003. The fixed rate auto loan receivables of Citibank and Citicorp Finance India
included in the securitisation”
15. “India’s first securitisation of sovereign lease receivables by Indian Railway
Finance Corporation (IRFC) of Rs 1,960 mn in 2005. The receivables consist of
lease amounts payable by the ministry of railways to IRFC”
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16. “India’s largest securitisation deal by ICICI bank of Rs 19,299 mn in 2007. The
underlying asset pool was auto loan receivables.”
Activity 2
Bring out the differences between:
1. Pay through certificates and Pass through certificates:
________________________________________________________________
________________________________________________________________
________________________________________________________________
2. Securitisation and Factoring:
________________________________________________________________
________________________________________________________________
________________________________________________________________
9.6. BOTTLENECKS OF SECURITISATION IN INDIA

 Stamp Duty: The structure of stamp duty in India is one of the gross obstacles
hindering the development of the securitisation market. In India, whichever
instrument is concerned with transfer rights or receivables, stamp duty is le vied
on such an instrument. As a result, the mechanism of transfer of the receivables
from the originator to the SPV leads to implementation of stamp duty. This tends
to make the process of securitisation commercially unfeasible in states that still
have a high stamp duty. There is need to rationalize stamp duty and SEBI has
recommended to the Government of India to make an endeavor in this direction.
Only the can the growth of securitisation can be expected in the country.
Another recommendation given by the Patil Committee states the uniform
implementation of stamp duty in all the states across India.
 Foreclosure Laws: There are not much effective foreclosure laws available in the
country. This restricts the growth of securitisation in India. The present
foreclosure laws are not lender friendly. Rather, these enhance the risks of MBS
and make it cumbersome to transfer property in cases of default.
 Taxation related issues: There is vagueness in the tax treatment of mortgage-
based securities, SPV trusts, and NPL trusts.
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 Issues under the SARFAESI Act: The right of title or interest in the financial
assets is guaranteed by the security receipt (SR) which is given to the holder in
the process of securitisation. This definition holds good for “Securitisation
structures where the securities issued are referred to as pass through
certificates”. However, the rationale flops in the case of pay through certificates.
 Legal Issues: “Investments in PTCs are typically held-to-maturity. As there is no
trading activity in these instruments, the yield on PTCs and the demand for
longer tenures especially from mutual funds is dampened”.

1) Which category of asset is not suitable for Securitisation
a. Mortgage backed Securitisation
b. Credit Rating
c. Risk cover
d. Collateralized Debt Obligations
2) Credit Enhancement helps in:
a. Acceleration of cash flows
b. Improvement in credit rating
c. Prevention of default in cash flows
d. Enhancement of credit risk
3) The first institution to pioneer Securitisation in India is:
a. CitiBank
b. ICICI
c. HDFC
d. SBI
4) Mortgage back Securitisaiton is based on:
a. Single security structure
b. Multiple security structure
c. Either a or b
d. Neither a or b
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9.7. SUMMARY
Securitisation is a very important development of the financial service sector in India. It
refers to the process of “converting loan into securities”. The originator is “the institution
on whose books the loan exists”. The obligor is the “borrower of the loan”. SPV is an
“investment banker who takes over the loan and financially engineers the process of
Securitization”. The success of the process depends upon the credibility of the obligor to
a large extend in terms of meeting his debt obligations. The process of Securitisation
should facilitate marketability, merchantable quality, wider distribution and
commoditization. The mechanism of Securitisation is sequential. The originator
identifies the assets to be securitized. A homogenous pool of assets is created on the
basis of maturity portfolio of assets. SPV buys these assets and converts them into
securities namely Pass through certificates and Pay through certificates. These are sold
to investors who trade these in the market. Citibank was the pioneer of Securitisation in
India. The prospects of Securitisation are very bright provided some bottlenecks need to
be overcome.
9.8. GLOSSARY
1. Securitisation: It refers to the conversion of existing or future cash flows into
tradable securities which can be sold to the investors. It is the process by which
financial assets such as loan receivables, mortgage backed receivables, credit
card balances, hire purchase debtors, lease receivables, trade debtors etc, are
converted into securities.
2. The originator: the bank, financial institution or entity which had decided to
adopt Securitisation of assets. It is the prime mover of the deal. The originator
sells the assets on its books and receives the funds generated from such sale.
3. Special Purpose Vehicle (SPV): it is an entity which buys pools of assets from
the originator and covert the receivables into securities. It issues them to the
investors in the capital market.SPV is usually constituted as a trust under the
Indian Trust Act or as a company under the Companies Act. The originator may
also float a subsidiary in the form of a limited company.
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4. Obligors/ Debtors: the original borrower is the obligor. The amount due from the
obligor is the securitised debt. He must meet his commitments on the due date
otherwise the cash flows would be affected. The whole process greatly depends
on the integrity of the obligors.
5. Asset backed Securitisation: Securitisation against current/ movable fixed assets
is known as ABS. The securities issued by SPV in ABS rely on the performance of
the asset that collateralizes the securities. Eg: securities against vehicles,
machinery, personal loans etc.
6. Mortgage backed securities: Securitisation on the basis of immovable fixed assets
is known as MBS. This is usually backed by real estate property, where the lender
has the right to sell the property if the borrower defaults.

1) false
2) false
3) false
4) true

1) c
2) b
3) a
4) a
9.10. REFERENCES
Ludhiana
3. Avdhani, V.A., Financial Services in India, Himalaya Publishers, Mumbai,
2010.
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4. Khan, M.Y., Financial Services, Tata McGraw Hills, New Delhi, 7th Edition,
2012.

1. What do you understand by Securitisation? Explain its features.
2. What are the major parties involved in the process of Securitization? Also explain
the mechanism of Securitisation.
3. What is Securitisation? What are its kinds? Which types of securities are involved
in Securitisation?
4. Highlight the scope of Securitisation and its progress in India?
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Lesson- 10
Plastic Money
Structure
10.1. Introduction
10.2. Concept of Plastic Money
10.3. Different forms of Plastic Money
10.4. Debit Card- Pros and cons
10.5. Credit Card- Pros and cons
10.6. Difference between a Debit Card and a Credit Card
10.7. Credit Card Process followed by Credit Card Organizations
10.8. Factors affecting utilization of Plastic Money in India
10.9. Summary
10.10. Glossary
10.12. References
 The concept and forms of Plastic Money

 Debit Card and Credit card- pros and cons
 Credit Card Process followed by Credit Card Organizations
 Factors affecting utilization of Plastic Money in India
10.1. INTRODUCTION
Paper money is a medium of exchange for goods or services within an economy. It
is the country's “official paper currency that is circulated for transaction-related
purposes”. The country's central bank/treasury has the responsibility and authority of
regulating the printing of paper money in order to keep the flow of money in
synchronization with monetary policy. Paper money was first used in China around the
seventh century AD. The biggest problem with the paper money is its rapid wear and
tear. The paper note has very small life due to shifting of ownership by time to time and
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their usage. Due to these problems, plastic cards are introduced. These have replaced
not only cash/ currency but also substituted cheques, drafts, traveler’s cheques etc. The
plastic cards are same as paper but the only difference is that they are made of plastic
and more secured.
10.2. CONCEPT OF PLASTIC MONEY
A plastic card is a “term that is used predominantly in reference to the hard plastic
money we use every day in place of actual bank notes. They can come in many
different forms such as cash cards, credit cards, debit cards, pre-paid cash cards and
store cards”. Plastic money is a new and easier way of paying for goods and services. It
was introduced in the 1950s. New York based bank named as Franklin National Bank
started providing cards (Plastic Money) in the year 1951. The “plastic” portion of this
term refers to the plastic construction of cards, as opposed to paper and metal of
currency. Plastic Money has longer life but after wore they are recycled for further
utilizing. The plastic notes also secure the government for copying because paper note
easily copied but plastic note cannot be copied. They can be easily used to carry huge
cash in traveling and shopping which are much unsecured in this increasing crime rate.
Holders of the card have the authorization to purchase goods and services up to a
predetermined amount called a credit limit. It includes Debit cards, credit cards, ATMs,
smart cards, cash cards, pre-paid cash cards and store cards etc.
Advantages of Plastic Money
1. It reduces the risk of handlings a huge amount of cash.
2. It is also a very safe mode of carrying purchasing power (money) while travelling.
Even if the plastic card is stolen or lost the respective bank can be consulted
immediately and the card can be blocked.
3. It makes it too easy for us to buy things we normally could not afford, which
makes it easier to get into debt. Bill can be paid easily via using cards.
4. It is durable in nature. As the loss due to wear and tear in paper notes is
minimized in case of plastic money.
5. It gives you incentive such as reward points that can be redeemed.
Disadvantages of Plastic Money
1. Complicated terms and Conditions
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2. Allow you to build up more debt than you can handle
3. Damage your credit rating if your payment is late.
4. Cost much more than other forms of credit, such as a line of credit or a personal
load, if you don’t pay on time.
10.3. DIFFERENT FORMS OF PLASTIC MONEY
1. Cash Cards - A card that “will allow you to withdraw money directly from your
bank via an Authorized Teller Machine (ATM) but it will not allow the holder to
purchase anything directly with it”.
2. Credit Cards – The card that permits the card holder to “withdraw cash from an
ATM”, and a credit card will “allow the user to purchase goods and services
directly” is the credit card. But unlike a Cash Card the withdrawal of money
involves a “high interest loan” to the card holder. However the card holder can
avoid any interest charges by paying off the balance in full each month only.
3. Debit Cards - This type of card directly debits money from the bank account of
the holder. It can also be directly used to purchase goods and services.
However, there is no credit facility available in the debit cards. This card is linked
with the balance of the card holder in the bank account. As a result of this the
limit of the card automatically gets restricted to the balance available in the
account of the card holder. But, if an overdraft facility is available then the limit
will be extended up to the overdraft.
4. Pre-paid Cash Cards – The pre-paid card is one in which the user will “add credit
to the card” themselves, and will not exceed the amount held in by the card.
These are usually “re-useable: in that they can be “topped up.” However some
cards, which are given as “Gift Cards” are “not re-useable”. These are of no utility
once the credit has been spent. It is better to dispose them off then.
5. Store Cards - These are similar in concept to the “Credit Card model”. In these
cards the card holder has the “right to purchase something in store and be billed
for it at the end of the month”. These cards carry a very high interest rate. These
are also usable in limited locations and places only. Also, the store and the store
brand must exist in order that the card becomes usable.
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6. Gift Cards - It is pre wrapped and ready for gifting. It is used for making
purchases. It works at thousands of merchant establishments. It is used in
denominations of Rs. 500 till Rs. 20,000. The validity period of the card is one
year only. The date of issue and validity period is marked on the face of the card.
It can be used any number of times in one year till the amount remains in the
card.
1) Paper Money is the only official currency approved through RBI.

(__________)
2) Plastic Money is convenient for long travels. (__________)
3) Bank account is a pre-requisite for obtaining a debit card.
(__________)
4) There is no limit to the use of gift card. (__________)
10.4. DEBIT CARD

Debit card is an instrument of plastic money. It has substituted not only cash but
also cheques. It is magnetically encoded plastic card issued by banks. It eliminates the
requirement of carrying cash and permits the customers to pay for goods and services
via this card. These days debit card is issued free of cost. This provision is available
only to the accountholders who may hold a savings or even a current account with the
bank. Debit card serves many purposes. But, for making instant payments while
shopping it is also used in ATMs to avail services available through ATMs as
withdrawing cash, making balance enquiry and even making payment against the credit
card from the holder’s account. Debit card is very convenient while doing shopping
online. The e-payment can be made directly with the help of debit card wherein the
amount is deducted from the customer’s account and credited to the merchant’s
account. There is neither delay in making payments nor any fear of loss as in case of
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traditional instruments like draft, cheque etc. Usage of debit card is very convenient.
The debit card has to be swiped in the terminal with magnetic code reader. It reads and
records customer's bank and account number. Every customer is given a PIN code. He
is required to enter the PIN code in the terminal and then perform the transaction. The
information is carried to electronic network linked to the merchant's bank with the bank
that issued debit card to the customer. If the transaction is correct and approved then
the customer account is debited and merchant account is credited with that amount.
Though multiple parties are involved including the customer, the merchant, customer’s
bank, the merchant’s bank yet the entire process takes place very fast and instantly.
Thus, debit cards are considered very convenient for customers and it also increases
the sales of the merchants. Banks also tend to increase their transactions and business
because of the usage of debit cards.
Pros of a Debit Card
1. Budget. The debit card is ideal for those who have a tight budget and want to
keep within it.
2. Safety. There is no need to carry cheque book and satisfy identification
requirements every time a payment has to be made. It is safe for both the holder
and the dealer. The PIN code is known only to the holder of the card.
3. Easy to obtain. These days as soon as a person opens an account with the
bank, debit card is automatically given to the client. There is no extra fee or
charge for the same.
4. Convenience. The card eliminates the need of carrying huge cash. It is very
easy to use. It just needs to be swiped at the terminal and the respective
transaction can be made in minutes.
5. Readily accepted. Debit cards have international recognition and usage. These
work even in other cities, states and countries. Now –a-days there is interbank
usage of cards also. One can withdraw money, make balance enquiry etc. from
the card issued by one bank by using in the terminal of some other bank. But,
such transactions attract extra charge. Thus, uninterrupted services are available
with the plastic money.
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Cons of a Debit Card
1. Less Users. In order to have a debit card, opening an account with the bank is a
preliminary. In a developing country like Indian there are many unbanked people.
Also, one can have only debit card of a particular bank only as the card is
dependent on the balance available in the account. Hence, the usage of debit
card is limited to the accountholder only.
2. Payment is instant. The terminal does not give any time for corrective action in
case of error and the payment in immediately debited from the account of the
holder.
3. No right to withhold payment. The payment cannot be stopped or postponed in
case of a debit card. The transaction would be completed in any case and the
amount would be debited from the account of the holder. Any bargain or dispute
would fall under a separate legal jurisdiction.
4. Transaction fees. Though extra fees is not charged at the time of issuing the
debit card. But certain banks used to charge a small transaction cost in case of
debit card usage.
5. High risks of stealth. The risk prevails in case the card is stolen or lost. These
days the hackers are even able to have access to the PIN/ password. Hence
high level risk is attached with it.
6. No grace period. The transaction is immediate. Availability of cash in the
account is a prerequisite to the use of debit card. No grace time is allowed in the
usage of a debit card.
7. Check book balancing. The traditional method of balancing the pass book used
to generate a written statement with the accountholder for future reference. A
mini statement can be generated even in the terminal but that is not a permanent
record for a long period.
8. Less protection. No protection is given to the account holder by the bank in
case of occurrence of fraud related to debit cards.
9. Charges. Using debit card for ATM transactions becomes costly if the ATM is not
affiliated with your institution, as now there is an inter-bank charge.
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10.5. CREDIT CARD
The "credit card" is a plastic card issued to a cardholder and contains a credit limit. This
is a form of plastic money that provides credit facility to the holder. When goods and
services are purchased through a credit card no immediate payment is deducted or
advanced. It is issued by banks having the logo of one of the bank card association
private and foreign banks. Unlike debit cards, there is availability of overdraft facility in
the credit cards. The amount in the customer’s account is not related with his purchase
of goods and services. The customer can purchase any amount of goods upto the credit
limit available in the credit card. The merchant banker gets his dues and payment via
the credit card issuer within few hours only. Thus, credit card is a very popular and
authentic tool of payment. However, almost after 45 days from the date of the
transaction, Interest charges are levied on the unpaid balance. It is advisable for
cardholders to pay the entire amount and save on the interest that is otherwise quite
exorbitant. The benefit of Equated Monthly installments (EMI) scheme is also made
available by some banks to the customers. This facilitates making purchases of huge
amount and paying back gradually through easy installments. Banks also give the
benefit of accumulation of point system in order to encourage usage of credit card and
make it lucrative for the customer.
Pros of Credit Card

1. No immediate payment. The best part of using credit card is the facility of credit
period available. No immediate payment is debited from the account of the
accountholder and a credit period of almost a month or more is enjoyed by the
user.
2. Grace Period. That transaction amount is paid by Credit Card Company to
merchant. The customer need not hurry to make the payment and enjoy his
grace period till the next month or during the billing period. The dues can be paid
even in installments.
3. Convenience. There is no need to carry cash. There is also no need to have a
balance in the account. Thus it is very convenient for the cardholder.
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4. Record keeping. The record keeping is done by the banks only. Holder of credit
card gets an instant mobile message of the update of the total outstanding
balance. The companies also send monthly and yearly statements wherein the
balance and account summaries can be tracked. Low-cost loans. Due to
revolving credit to save today (e.g., at a one-day sale), when available cash is a
week away.
5. Instant cash--Cash withdrawal facility is also available via credit cards. One can
withdraw up to the credit limit sanctioned. In case of emergency need of money it
is a good option.
6. Perks— Many credit card companies make their card lucrative by giving certain
incentives on the card. For instance, HDFC gives instant cash back of 10% on
credit card usage on the petrol filling stations. Similar, practice is followed by
Multiplex Theatres on their movie tickets. There is also accumulation of points
which can be reimbursed at a future date on every purchase made through credit
cards.
7. Build positive credit— The user has to exercise wisdom and enjoy the credit
terms free of cost facilitated by the credit card. But, in case of delays payment
the charge is levied.
8. Protection against deficiencies—Disputes are settled between the customer
and the merchant by some credit card companies as the payment is not
immediate.
9. Balance surfing-- Low introductory interest rates are given by many credit card
companies. These offers motivate cardholders to move balances to lower-rate
cards.
Cons of Credit Card
1. Going beyond means. Since immediate cash has not to be paid, there is a
tendency of overspending and going beyond ones means and resources. In fact
credit card usage has also become a matter of status symbol especially in
developing countries.
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2. Paperwork. It is advisable to keep a track of all transactions and keep a record
so that one is able to match one’s outstanding balances against those generated
by the credit card company. This involves alertness and huge paperwork as well.
3. High-cost fees. In case the payment is not made within the free credit period
allowed, the cost of fees thereafter is quite high.
4. Hidden fees. Many cardholders are not aware of the exact time when the charge
of credit would begin. Also, there is immediate charge on cash withdrawal. Such
information needs to be communicated repeatedly to the cardholder.
5. Disguise instrument. Nothing is free of charge. It is only a disguise to the card
holder especially if the accuracy of the payment cycle is not maintained. The
benefit received may lag behind than the associated cost.
6. Debt crisis. The customer with the excessive usage of credit card or usage
beyond his means may find himself entrapped in a debt laden situation. The
recovery from this is very difficult as the trap is like a spider’s web with less
chances of exit.
7. Updating knowledge The card holder must read all the provisions with respect
to the facilities as well as charges involved lest he may find himself in turmoil.
8. Teaser rates. Low introductory rates are offered initially to attract the customers.
Such rates are for a limited time period only. It is because once the teaser rate
expires, the interest rate charged on the balance rises drastically.
10.6. DIFFERENCE BETWEEN DEBIT CARD AND CREDIT CARD

Following are the points of differences between a Debit Card and a Credit Card.
Basis Debit Card Credit Card
Bank account holding It is a must It is optional
Nature of financing Own resources Loaned resources
Chances of default Nil Substantial
Nature of banking product Liability product Asset product
Lines of credit and usage Debit cards can be used Credit cards are lines of
anywhere as the money is credit. This is a loan to the
deducted from the customer that is expected
to pay back in full
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customers’ account.
Limit on the card No limit is connected to the The credit limit set by the
debit card. credit card issuer
organization. Limits of
credit may increase or stay
the same over time as a
borrower’s creditworthiness
changes.
Charge of interest No interest is charged If a credit card bill is not
because no money is paid in full, interest is
borrowed charged on outstanding
balance.
Activity 1
Bring out some similarities between:
1. Debit card and a credit card
________________________________________________________________
________________________________________________________________
________________________________________________________________
2. Credit cards and store cards
________________________________________________________________
________________________________________________________________
________________________________________________________________
10.7. CREDIT PROCESS FOLLOWED BY CREDIT CARD ORGANIZATIONS

Credit cards is not only a form of plastic money that lessens the burden of carrying
cash, but it has become a very significant financial tool these days. These cards render
convenience and are also systematically and automatically connected to the entire
network. This networking facilitates payment of bill of transactions immediately
anywhere and everywhere. There are least chances of fraud or cheating. A simple
rectangular piece of plastic or a metallic material identifies the user’s accounts and is
considered a wonderful instrument in the current era of credit and credit based
transactions. The cardholder’s name and account number are printed on its face.
There are number of parties that contribute to the process of credit card. These may
include the following:
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 Credit Card Provider: there are many credit card providers as VISA,
MasterCard, JCB and American Express etc. The “logos” of these service
providers are often displayed on the shops, which are suggestive of the fact that
those store accepts the type of card a particular cardholder possesses.
 Card issuers: Like many card providers, there are significant numbers of card
issuers as well. These are primarily banks and companies that issue credit cards.
These cards mention “the logos of the issuer and the supplier”.
 Acquirer of card: These refer to the owners or the holders of credit cards. The
Credit Card holder uses credit card for many purposes as making payments to
merchants, buying through online shopping, payment of bills and even
withdrawal of money on credit. This service is known as a treatment by credit
card.
Applying for credit card
 Verification of documents
This is the first stage. The credit card organization checks the various documents
given by the customer who has put in his request for the issue of the credit card.
Documents are checked for their correctness. False documents render the
cancellation of the credit card. Income and address are the prime parameters
that are checked the issuing organizations.
 Verification of credit points
This is the second step of the process. Credit card issuer makes an effort to find
the right person who deserves the credit card. Here, the credit worthiness and
credit history of the applicant is verified. Information of the applicant is also
sought from the agency business information who provide updated information to
the institution for a subsequent transformation. After the income verification and
check of the credit worthiness of the applicant, the credit limit is also decided by
the issuers of the card.
 Security Audit
The credit card should not be issued to people with poor credit histories. Safety
needs to be assured by the credit issuers. Thus, the official is required to submit
the data relating to safety issues of the applicant. This data is related to an
Page 194 of 200

applicant’s sources of income, value of property, confirmation of the ownership of
property as well as the responsibility attached with the owned property. These
details in relation to the applicant also determine the overdraft limit that would be
sanctioned on the card in case of withdrawal of money on credit.
 Submission of the credit card applicant
This is the last step. Here the credit card is delivered to the applicant. This step is
pursued after completion of the audit.
Processing Of Credit Cards
Issue of credit cards is a complex process. It involves many parties in terms of vendors
and entities. The step-wise procedure is explained as follows:
1. Collect and enter credit card information

The first and foremost is that the Credit Card Organization collects the credit card
information. Then only the order to process the payment is given. This
information is taken from the person who makes the payment of the credit card.
The information has to be taken in both cases when the money is transferred
electronically or manually. This first step involves writing down the card
information and sending it to the bank of the applicant. This is done by typing it
into an online system or swiping the card through a specific kind of hardware or
terminal.
2. Authorize and commit the charge
In the second step, the payment information thus collected is entered and the
same is transferred to a payment processor electronically. The processor
authorizes it after scrutinizing that whether the credit card account exists and
also checks that it has enough money to cover the charge. Then, the processor
makes a charge from the card. There are several ways through which the credit
card organization manages the electronic flow of money for credit card
transactions. It requires processing time as well as the services of processing
specialist.
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3. Deposit money into the bank account
When the card has been charged, the most crucial step in the processing of
credit card is getting the money. The payment processor always deposits the
money in a bank account which is known as “merchant account.” Money is then
automatically transferred from the merchant account into a bank account from
which the withdrawal can be made. There are many ways to open a merchant
account through the bank. The same can be suggested by the payment
processor. These accounts define the minimum base amount that the applicant is
required to pay for each transaction.
10.8. FACTORS AFFECTING UTILIZATION OF PLASTIC MONEY IN INDIA

The adoption of recent plastic money has shown spectacular performance and many
adopters of plastic money are expected in future. The volumes and the number of card
transactions will witness an exponential growth aided largely by the factors such as the
annual growth in credit and debit cards in India which is approximately 30 per cent to 40
per cent. This adoption has some antecedents which usually called for some strong
point to boost the adopter’s decision of adopting plastic money.
The various factors that affect utilization of plastic money in India include:
1. Convenience is the foremost features. Plastic money is easy to carry and
attracts lesser wear and tear.
2. Status Symbol is attached in the use of plastic money especially in a
developing country like India.
3. Brand of plastic money have increased the reliability of the users.
4. Acceptability of plastic money nationally and internationally has increased its
growth.
5. Interest Rate on the use of plastic money is negligible.
6. Education of the masses too has been a contributory factor in the growth in
the usage of plastic money.
7. Distribution of network both of the card issuers as well as card acceptors has
increase the use of plastic money.
Page 196 of 200

8. Electronic development in the country is in fact a pre-requisite to the use of
plastic money.
9. Costs involved are less as compared to the benefits derived.
The other factors that influence the utilization of plastic money include the amount of
annual spending on cards, wider acceptance of plastic money by merchants, aggressive
marketing campaigns by new generation banks and foreign banks, prompt payment by
cardholders, growth of co-branded cards, innovative schemes and privileges offered by
cards, retail boom, changes in consumer behaviour, increased level of socio-economic
environment of people, explosive rise in corporate citizens, and emergence of e-
commerce as a main stream business channel. Plastic money usage is affected by
unethical practices of the fraudsters or other parties without the consent of users. The
desire on the part of the middle class and upper middle class to enhance the lifestyles
by accessing more products and undertaking too encourages its growth. It is a primary
mode of payment promoting ecommerce and m-commerce. They are rapidly gaining a
foothold in the financial service industry. The convenience and reliability of plastic
money confer to the customers and the merchants have already made the plastic
money as an irreplaceable mode of payment instrument in the present cashless society.
Plastic money also has become a part of the modern life style of people today. All these
highlight the scope and potential for plastic money as a payment instrument in India.
Factors that discourage the usage of plastic money should be controlled. These factors
include:
1. Loss of card
2. Documentation and processing formalities
3. Transaction charges
4. Processing fees
5. Electronic failures
Activity 2
Highlight the factors that:
Page 197 of 200

1. Encourage the use of plastic money
________________________________________________________________
________________________________________________________________
________________________________________________________________
2. Discourage the use of plastic money
________________________________________________________________
________________________________________________________________
________________________________________________________________

1) Which of the following is not a form of plastic money :
a. Credit card
b. Debit card
c. Identity card
d. Master card
2) Interest charges exist in the following form of plastic money:
a. Credit card
b. Debit card
c. Both a and b
d. Neither a norPage
b 198 of 200
10.9. SUMMARY
Plastic money is a new and easier way of paying for goods and services. The
different forms of plastic money are cash card, credit card, debit card, pre paid card and
store card. Each card has its own advantages and disadvantages. The most popular
form amongst the cards is debit cards and credit cards. The debit card is issued to a
person having a bank account. The amount is immediately debited from the account of
the debit card holder. But in case of credit card, the amount is paid after few days. The
various factors like convenience, status symbol, brand, acceptability, interest rate and
others are seen as the important factors for effective utilization of the plastic money in
India. Plastic money has become an important part for the modern society and has
immense scope for development in India.
10.10. GLOSSARY
1. Plastic Money: Plastic money is the name given to all types of plastic bank
cards. Plastic Money is in the form of hard plastic cards which we use every
day instead of actual bank notes.
Page 199 of 200

2. Debit Card: Debit card is a magnetically encoded plastic card issued by
banks which has replaced cash and cheques. It allows the customers to pay
for goods and services without carrying cash with them.
3. Credit Card: The term "credit card" generally refers to a plastic card issued to
a cardholder, with a credit limit, that can be used to purchase goods and
services on credit or obtain cash advances.

Check your progress A
1) False
2) True
3) True
4) False
1) c
2) a
3) c
4) d
10.12. REFERENCES
1. Kaptan, S. S. Indian Banking in Electronic Era, Sarup & Sons, 2003.
2. Sethi, J., & Bhatia, N., Elements of Banking and Insurance. PHI Learning Pvt.
Ltd., 2012.

1. Discuss the concept of plastic money? Explain its various forms.
2. What are the pros and cons of debit card and a credit card? Differentiate
between the two forms of plastic money.
3. What are the factors affecting the utilization of the plastic money in India?
4. Explain the process of followed by credit card organizations in the issuance of
credit cards.
Page 200 of 200

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Self Learning Material

Course: Master Business Administration

Distance Education Programme

Debt Securitisation: Meaning, Features, Scope and process of securitisation. Factoring -

Note : Relevant Case Studies should be discussed in class.

1. S Gurusamy ‘Financial Services & System’ Thomson Publications

9 Debt Securitisation 170

© IK Gujral Punjab Technical University Jalandhar

Importance of Capital formation

Process of capital formation

Relationship between Savings and Investment

Check your Progress A

Answer in True/ False

1) Capital formation is the result of income (__________)

1.2. THE FINANCIAL SYSTEM

1.3. FINANCIAL SERVICES: MEANING

1. Mobilization of funds: Financial services help to raise funds from the

What do you understand from the following?

1.10. ANSWERS TO CHECK YOUR PROGRESS

Check your Progress B

2.0. Learning Objectives

2.2. Concept: Depository system and its components

2.3. Features of Depository System

2.4. Functions of depository system

2.5. Comparison between bank and Depository

2.6. Benefits of Depository System

2.7. Depository Systems in India

2.8. Dematerialization and Rematerialization

2.12. Answers to check your progress

2.14. Model questions

2.0. LEARNING OBJECTIVES

After studying this chapter you should be able to understand:

 The concept, benefits and functions of depository system

2. A Depository Participant (DP) is an agent of the depository through an association

3. Owner is of two types: 1. Registered Owner and 2. Beneficial Owner.

4. Issuer means any person making an issue of securities.

2.3. Features of the Depository System in India

Highlight the role of the following as a component of Depository System

2.4. FUNCTIONS OF DEPOSITORY SYSTEM

2.5. COMPARISON BETWEEN A BANK AND A DEPOSITORY

Account is opened with a depository

Interest rate is applicable on No interest rate is given on securities

Check your Progress A

I. Fill in the blanks

2.7. DEPOSITORY SYSTEMS IN INDIA

Depository services are offered by two depository institutions namely National

National Securities Depository Limited (NSDL) is based in Mumbai. It is the

Central Depository Services Limited (CDSL) is also based in Mumbai. It is “the

2.8. DEMATERIALISATION AND REMATERIALISATION

Dematerialisation is the process that “facilitates conversion of physical shares into

Procedure for dematerialization of shares of company

 “A company should amend its Articles of Association by passing a special

Procedure to be followed by DP on receiving request from the investor

 In order to dematerialize the physical share certificates, an investor will have

 Obtain the account number from DP.

 Obtain the Dematerialised Request Form (DRF) from his DP.

 This DRF, together with the Share Certificates desired to be dematerialised is

 DP, then issues an “acknowledgement to the investor” and afterwards follows

a. “Defaces the Share Certificates by putting a rubber stamp "Surrendered

c. “Sends an electronic communication to Depository viz. NSDL or CDSL,

 “The depository electronically downloads the particulars of demat request,

a. DRF and Physical Share Certificates from DP.

b. Electronic Download of Demat Request from depository through