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UNIT-I Introduction to Indian Financial System-Financial Markets and Types-Financial Institutions in India-Reserve Bank of India-Commercial Banks-State Bank of IndiaDevelopment Financial Institutions NABARD, SIDBI, EXIMBank and IFCI. UNIT-II Asset/Fund Based Financial Services-Leasing-Types and its Evaluation. Hire purchase Finance and Consumer Credit-Factoring and Forfaiting. UNIT-III Other Services-Bills Discounting-Housing Finance-National Housing BankOther housing financing Institutions-Insurance Services-Insurance Regulatory and Development Authority (IRDA)- Venture Capital Financing. UNIT-IV Merchant Banking Services-Issue Management-Pre Issue and Post Issue Management. UNIT-V Merger/Amalgamation-Stock Broking-Types, Credit Rating Agencies.Process and Methodology.

The growth of output in any economy depends on the increase in the proportion of savings/ investment to a nations output of goods and services. The financial system and financial institutions help in the diversion of rising current income into savings/investments. A financial system may be defined as a set of institutions, instruments and markets which foster savings and channels them to their most efficient use. The system consists of individuals (savers), intermediaries, markets and users of savings. Economic activity and growth are greatly facilitated by the existence of a financial system developed in terms of the efficiency of the market in mobilizing savings and allocating them among competing users. Well developed financial markets are required for creating a balanced financial system in which both financial markets and financial institutions play important roles. Deep and liquid markets provide liquidity to meet any surge in demand for liquidity in times of financial crisis. Such markets are also necessary to derive appropriate reference rates for pricing financial assets. II. FINANCIAL MARKET Marketing require institutions that impartially enforce contract and property rights. The state must create the right kind of institutional environment and must be strong enough to enforce institutional rights. Economic growth depends on the existence of a well-functioning financial market. Market efficiency would be reflected in wide dissemination of information, reduction of transaction costs and allocation of capital to the most productive uses. II.a)FUNCTIONS OF FINANCIAL MARKET:

The primary function of the financial markets is to facilitate the transfer of funds from surplus sectors (lenders) to deficit sectors (borrowers). Normally, households have excess of funds or savings which hey lend to borrowers in the corporate and public sectors whose requirements of funds exceed their savings. A financial market consists of investors or buyers, sellers, dealers and brokers and does not refer to a physical location. The participants in the market are linked by formal trading rules and communication networks for originating and trading financial securities. Financial markets trade in money and their price is the rate of return the buyer expects the financial asset to yield. The value of financial assets change with the investors expectations on earning or interest rates. Investors seek the highest return for a given level of risk (by paying the lowest price) and users of funds attempt to borrow at the lowest rate possible. To sum up, the three important functions of financial markets are: Price discovery process which results from the interaction of buyers and sellers in the market when they trade assets Provision of liquidity by providing a mechanism for an investor to sell financial assets and Low cost of transactions and information. The financial markets also promote financial product innovation. Our primary markets have seen a big explosion of financial product innovation. First, we have convertible debentures which attracted large subscriptions. Later, especially in the last five years, our merchant bankers and financial institutions have introduced
Participating debentures

Convertible debentures with options

Partly convertible debentures Convertible debentures redeemable at a premium Debt equity swaps Zero coupon convertible notes Secured premium notes with detachable warrants Zero interest fully convertible debentures Zero interest partly convertible debentures with detachable warrants and Floating rate bonds and warrants All-India Financial Institutions have issued zero coupon bonds, easy exit regular income and retirement bonds, step-up liquid bonds, growth bonds, lakhpati bonds, encash bonds, index bonds, deep discount bonds and capital gain bonds. The financial markets abroad have seen a wide variety of asset-backed securities, junk bonds and indexed bonds. II.b)TYPES OF MARKETS: Money Market The financial system consists of the money market and capital market as found elsewhere in the world. The money or credit market is the centre for dealings in monetary assets of short-term nature generally below one year. The money market has organized players are the Reserve Bank of India, Life Insurance Corporation, General Insurance Corporation, Unit Trust of India, Securities Trading Corporation of India Ltd and Discount and Finance House of India. The role of the unorganized sector in providing finance for trade has considerably diminished with the geographical coverage of the organized banking sector and increase in the flow of bank finance to small borrowers.

Self-help Groups In this connection, the novel scheme of self-help groups (SHGs) of the National Bank for Agriculture and Rural Development (NABARD) may be noted, which is likely to reduce the dependence on money lenders in the unorganized sector, especially in the rural areas. NABARD found that lending to the poor through SHGs is a viable proposition. SHGs are voluntary associations of people formed to attain some common goal. The groups have a similar identity, heritage, caste or traditional occupations and come together for a common cause and manage resources for the benefit of the group members. These groups generally deal with thrift and credit as an important component of their activities. Capital Market: The capital market consists of primary and secondary markets. The primary market deals with the issue of new instruments by the corporate sector such as equity shares, preference shares and debentures. The public sector consisting of Central and State governments, various public sector industrial units (PSU), statutory and other authorities such as state electricity boards and port trusts also issue bonds and shares especially as a part of disinvestment of government holdings. Foreign exchange market In view of the contemplated convertibility of the rupee, the foreign exchange market would be intimately linked to the interbank or call money market since the players in the two markets are the same, commercial banks. Further the link between foreign exchange markets is being fostered by permitting banks to borrow and deposit funds abroad. The exchange rate instead of being determined by supply and demand would be governed in future by interest differentials.

Foreign exchange markets provide the mechanism for exchanging different monetary units for each other. If the currency is widely accepted as in the case of US $ it can pay in its own currency. Actually, dollars remain in circulation among international traders. III. COMMERCIAL BANKS III.a)CHARACTERISTICS OF BANKS: Among the financial institutions the role of commercial banks is unique. Firstly, bank demand deposit liabilities that constitute a large proportion. Secondly, commercial banks are the primary vehicle through which credit and monetary policies are transmitted to the economy. Credit and monetary policies are implemented through action on bank reserves, margin requirements and the rate at which scheduled banks can borrow from the RBI. These affect the supply, availability and cost of credit at banks. Thirdly, the nature of lending and investing by commercial banks is multifunctional. They deal in a wide variety of assets and accommodate different types of borrowers. They facilitate the spread of the impact of monetary policy to non-bank lenders and to other sections of the economy. Further, the operations of commercial banks are highly flexible since they provide facilities for financing different types of borrowers which enables them to channel funds according to specified priorities and purposes. III.b)DEFINITION OF BANKING The Banking Regulation Act, 1949, defines banking as accepting for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise and with-drawable on demand by cheque, draft or-order otherwise.

III.c)FUNCTIONS OF COMMERCIAL BANK The functions of a commercial bank are:

1. To change cash for bank deposits and bank deposits for cash.

2. To transfer bank deposits between individuals and/or companies. 3. To exchange deposits for bills of exchange, government bonds, the secured and unsecured promises of trade and industrial units. 4. To underwrite capital issues. They are also allowed to invest 5% of three incremental deposit liabilities in shares and debentures in the primary and secondary markets. 5. They also offer their constituents services to pay insurances, advise on tax problems and undertake executive and trustee services. III.d) Payment Systems

Commercial banks are institutions which combine various types of transactions services with financial intermediation. Bank provides three types of transactions to convert deposits into notes and coins to enable holders of deposits to undertake transactions in cash.

2. 3.

Secondly, bank deposits are used as a means of settling debts. Thirdly, where exchange control do not exist, banks exchange cash and deposits from one currency

Commercial banks earlier had a monopoly on transaction services. Other financial intermediaries such as savings and loans, saving banks and credit unions in the United States have been authorized to offer transaction accounts. Money market mutual funds, another type of financial service organizations have developed financial product against which checks may be written.

Commercial banks are at the very centre of the payment systems. Bank money constitutes 38 per cent of the money supply of the Indian economy. An efficient payment system is vital to a stable and growing economy and the banks role is important. In advanced economics commercial banks are also at the heart of the electronic payment system which is replacing paper based payment methods. Finally, Swift (the Society for Worldwide Interbank Financial

Telecommunication) based in Brussels is operated by 2000 banks, brokerage firms and non-banking financial institutions worldwide. Intermediation Commercial banks undertake the important process of financial intermediation whereby the funds or savings of the surplus sectors are channeled to deficit sectors. Commercial banks along with other financial institutions channel the funds of surplus economic units to those wanting to spend on real capital investments. Financial intermediaries including banks buy and sell the right to future payments. Banks collect deposits from savers by offering interest. Through their intermediary activities banks provide a package of information and risk sharing services to their customers. While doing so they take on part of their risk. Banks have to manage the risks through appropriate structuring of their activities and hedge risks through derivative contracts to maximize their profitability. Transformation Services Banks combine various types of transformation services with financial intermediation. They provide three transformation services when they undertake intermediation process. Firstly, liability, asset and size transformation consisting of mobilization funds and their allocation (provision of large loans on the basis of numerous small deposits). Secondly, maturity transformation by offering the savers,

the relatively short-term claim on liquid derposits they prefer and providing borrowers long-term loans which are better matched to the cash flows generated by their investment. Finally, risk transformation by transforming and reducing the risk involved in direct lending by acquiring more diversified portfolios than individual savers can. Transformation Services and Risks: Banks incur while undertaking transformation services. In the past three decades banks abroad assumed new roles and accepted new forms of financial intermediation by undertaking currency and interest rate swaps and of dealing in financial futures, options and forward agreements. These new instruments reflect considerable flexibility in responding to market situations and adjusting continually assets and liabilities both on and off balance sheet, while enhancing profitability. III.e) Analysis of Assets and Liabilities of scheduled Commercial Banks: Number: As at the end of March 2000 there was 101 scheduled commercial banks (SCBs) comprising 27 public sector banks (PSBs), 32 private sector banks and 42 foreign banks. The public sector banks (PSBs) dominate the banking system with more than 80% share in the total assets of SCBs. Size: Assets of Rs.11,10,368 crores consist of cash in hand and balances with RBI of Rs. 85,371 crores(7.69% of total assets), assets with banking system of Rs. 81,019 crores(7.30%) investments of Rs.4,13,871 crores(37.27%) bank credit of Rs.4,43,469 crores(39.94%). Liabilities of all scheduled commercial banks, Rs.11,10,368 crores consist of capital of Rs.18,447 crores(1.66%) reserves and surplus of Rs.43,834 crores(3.95%) and deposits from public of Rs. 9,00,307 crores(81.1%).

Liabilities Paid-up Capital and Reserves Paid-up capital of Rs.18, 447 crores and reserves of Rs.43, 834 crores in 19992000 together constituted 5.61% of liabilities of scheduled commercial banks.


The Reserve Bank of India was established on April 1, 1935, under the Reserve Bank of India Act, 1934. The Banks share capital was Rs.5 crores. In the terms o the Reserve bank (Transfer to Public Ownership) Act, 1948, the entire share capital was deemed to be transferred to the Central Government. The Reserve Bank entered upon its career as a state-owned institution from January 1, 1949. The Act of 1948 empowered the Central Government to issue such directions to the Bank as it might, after consultation with the Governor of the Bank, consider necessary in the public interest. b)Functions of the Bank: The main functions of the Bank are to act as the note-issuing authority, Bankers Bank, Banker to the government and to promote the growth of the economy within the framework of the general economic policy of the government, consistent with the need to maintain price stability. The Bank also performs a wide range of promotional functions to support the pace of economic development. The Reserve Bank is the controller of foreign exchange. It is the watchdog of the entire financial system. The Bank is the sponsor bank of a wide variety of top-ranking banks and institutions such as SBI, IDBI, NABARD and NHB. The Bank sits on the board of all banks and it counsels the Central and State governments and public sector institutions

on monetary and money matters. No central bank, even in the developed world, is saddled with such onerous responsibilities and functions. c)Issue of Currency: The Reserve Bank is the sole authority for the issue of currency in India. Rupee coins/notes and subsidiary coins are issued by the government of India but they are put into circulation only through the Reserve Bank. Currency notes are legal tender in payment or on account, without limit. One rupee notes and coins are legal tender for unlimited amounts, fifty paise coins for a sum not exceeding ten rupees and smaller coins for any sum not exceeding one rupee. The Act permits the issue of notes in the denominations of rupees two, ten, twenty, fifty, hundred, five hundred, one thousand, five thousand and ten thousand. At present denominations up to Rs.1000 are being used. The affairs of the bank relating to note issue and its general banking business are conducted through two separate departments, the Issue and Banking Department. The Issue Department deals directly with the public in exchange of currency for coins and vice versa and exchange of notes of one denomination for another. The assets which form the backing for the note issue are kept wholly distinct from those of the Banking Department. The expansion and contraction of currency in circulation is effected through the Banking Department. Cash deposits and withdrawals by scheduled banks are handled by the Banking Department. d)Public Debt: Public debt management policy determines the composition of debt while the size of the debt is determined by budgetary requirement. The introduction of the auction system for treasury bills and securities has let the interest rate to be market-

determined. The Reserve Bank manages the public debt and issues new loans on behalf of the Central Government and state governments. SECONDARY DEBT MARKET Debt management policy can be effective if there is a secondary market with depth. The move to market related rates of interest is likely to strengthen the development of the secondary market. The system of primary dealers would enable the development of an orderly market. They are not final investors but should have the financial capacity and skills to bid in the primary auctions and hold the securities till they are able to access them in the secondary market. Primary dealers are approved by the RBI and help in the placement of government securities in primary issues by committed participation in auctions. e) RESERVE REQUIREMENTS Cash Reserve Ratio The variation of reserve requirement changes the amount of cash reserves of banks and affects their credit-creating capacity. The requirements may e stipulated as a proportion of aggregate outstanding deposits or on the increment after a base date. Reserve Bank regulates the liquidity of the banking system through two complementary methods: cash reserve ratio(CRR) involving deposit of cash by the bank with the Reserve Bank of a proportion of deposits; and statutory liquidity ratio involving the maintenance by the bank, of a proportion of its deposit liabilities in the form of specified liquid assets. The cash reserve ratio could be varied between 3 per cent and 15 per cent of their total demand and time liabilities.


NABARD is apex rural credit institution which plays an active role in implementation of various Rural Development Programmes. The NABARD came into existence in July 1982. It took over the function of providing rural credit from the Reserve Bank of India and also the refinancing and development function of Agricultural Refinance and Development Corporation (ARDC). NABARD provides refinance for promoting agricultural activities as well as non-farm sectors particularly programme covered under poverty alleviation. NABARD plays the key role of a leader in rural credit management. NABARD has to ensure that there is adequate flow of credit for seasonal agricultural operation to maintain agriculture production. Similarly, NABARD has to accelerate the flow of credit for long term investment in agricultural sector. NABARD provides support through formulation of some innovative non-farm schemes, which are very helpful in raising the income level of rural people and bring them above the poverty line. NABARD has two funds to finance agricultural operations. They are, a) National Rural Credit(Long-term Operation) Fund b) National Rural Credit(Stabilisation) Fund The contributions to these funds are received mostly from the Reserve Bank of India. Apart from these funds, NABARD has general lines of credit from the Reserve Bank of India for meeting the credit requirements of seasonal and other than agricultural operations. Some important promotional activities supported by NABARD are discussed below:

b) Nabard strategies
For enlarging the scope for catalyzing credit follow, NABARD has formulated the following strategies: a) Involving state level functional and financial-cum-developmental corporations, voluntary agencies, Khadi and village commission under automatic refinance facility as also under group/bulk lendings. b) c) d) Supporting units jointly with Small Industries Development Bank Increasing the limits under composite and integrated loans Removal of certain constraints under agro-industries and service of India and formulating credit linked area development plans.

sector units. Remember, like a commercial bank, NABARD does not extend direct credit facilities to production units/individual borrowers. A major portion of the money (usually between 70 and 90 percent) lent by commercial, co-operative and regional rural banks for agricultural and other approved activities will be refinanced by NABARD at certain interest rate. It also extends refinance facilities to Land Development Banks. The total quantum of agricultural credit provided by commercial banks, co-operative banks and regional rural banks with or without assistance from NABARD amounted to Rs. 31,698 crore during 1997-98. This credit is expected to increase further to Rs. 38,054 crore in 1998-99 as per NABARD Annual Report for 1998-99. c)PROMOTIONAL ROLES BY NABARD Besides the above, NABARD plays the following promotional roles for the development of Indian Rural Economy:

1. Training and skill up gradation through Training-cum-Production Centres, rural entrepreneurship development, training by and of master craftsmen, market oriented training for rural artisans and training for rural artisans and training the beneficiaries of development credit 2. Development and dissemination of technology, employment oriented production technology, area planning for rural industrialization. The Reserve Bank of India set up the Committee to Review Arrangements for Institutional Credit for Agriculture and Rural Development (CRAFICARD) in March 1979. This Committee submitted its final report in March 1981 making far reaching recommendations. The main recommendation being the setting up of a new apex bank called the NATIONAL BANK FOR AGRICULTURE AND RURAL DEVELOPMENT (NABARD)as an organizational device for providing undivided attention, forceful direction and pointed focus to the credit problems arising out of integrated approach to rural development. The Committee has recommended that this new apex bank should take over from the Reserve Bank the overseeing of the entire rural credit system. Accordingly, the Government of India set up the National Bank for Agriculture and Rural Development on 12 July, 1982 with an authorized share capital of Rs.500 crores and paid-up capital of Rs.100 crores to be contributed equally by the Reserve Bank of India and the Government of India. In 1996, the capital was increased from Rs.500 crores to Rs. 2000 crores to give a thrust to the flow of credit to the agricultural sector. The Bank has been assigned the task of serving as a refinance institution for short term credit to agriculture, rural small scale industries. Cottage and village industries, handicrafts and rural crafts and other allied economic activities integrating rural development. It will also provide refinance to various banks for their term lending operations in agriculture.

Further, the CRAFICARD has recommended the reorganization of the cooperative credit structure. It has advocated a speedy reorganization of primary agricultural credit societies into multipurpose service institutions. They should provide all types of credit including long term credit for agriculture covering all types of population in the rural areas within a period of three years. The Committee has further recommended that preference should be given to Regional Rural Banks with regard to licensing of branches in rural areas and the Commercial banks should be encouraged to transfer the eligible business of their rural branches to RRBs.

d)Functions of National Bank for Agriculture and Rural Development (NABARD) With the establishment of National Bank for Agriculture and Rural Development (NABARD) in July 1982 on the basis of the recommendations of CRAFICARD, all the functions of the Reserve Bank of India relating to Rural Credit have been handed over to this apex bank NABARD. The assets and Liabilities of the RBI relating to rural credit were also transferred to this Bank. The two Funds, namely, The National Agricultural Credit(Stabilization) Fund, and National Agricultural Credit( Long-term Operations) Fund held by the Reserve Bank of India was renamed as National Rural Credit(Stabilization) Fund and National Rural Credit(Long-term Operations) Fund and handed over to NABARD. The Agriculture Refinance Development Corporation (ARDC) was merged with NABARD. The NABARD being the apex bank for rural credit, sanctions credit limits and refinances co-operative Banks, State Land Development Banks and the Regional Rural Banks for supplementing their resources for short-term and medium term loans of various agricultural and non agricultural purposes, including the investment credit provided by them under various schemes. In the case of commercial banks, NABARD

provides refinance against the term loans issued by them under schematic lending for agricultural and certain non-agricultural purposes, as the commercial banks are expected to meet the short-term requirements out of their own resources. The NABARD can provide refinance facilities to any financial institution approved by the Reserve Bank of India and the refinancing assistance is given for the following activities: a) Any agricultural operation or marketing of crops; b) Distribution and marketing of agricultural inputs for the purpose of rural development;
c) Bonafide commercial transactions or trade transactions;

d) Production and marketing activities of village artisans, small-scale industries etc. Besides short-term and medium-term loans, NABARD can provide ling-term loans by way of refinancing through financial institutions like Land Development Banks, Regional Rural Banks, Scheduled Banks, and State Co-operative Banks. Besides NABARD is also authorized to advance loans to State Governments for periods not exceeding 20 years to enable them to subscribe directly or indirectly, the share capital of co-operative societies. It can also contribute or invest in the securities of any institutions connected with agricultural or rural development. During drought and famine conditions, the NABARD can convert short-term loans into medium-term loans granted to State Co-operative Banks and Regional Rural Banks. e)Performance of NABARD As studied already, with the establishment of NABARD, all assets and liabilities relating to Rural Credit of the Reserve Bank of India were transferred and taken over by NABARD. On the date of establishment of NABARD, loans and advances issued by the Reserve Bank and outstanding against State Cooperative Banks and RRBs aggregating to Rs.759 crores were transferred to NABARD. As

indicated already, this apex institution NABARD does not deal directly with the farmers and other rural people; but grants assistance to them through the cooperative banks, commercial banks, RRBs etc. In the year 2003 - 2004, towards short-term assistance to institutions operating in the field of rural credit, NABARD sanctioned Rs.6,948 crores for financing seasonal agricultural operations and also a sum of Rs.927 crores for purposes other than seasonal agricultural operations. During the years 2006 - 2007 and 2007 - 2008 the amount sanctioned was Rs.12,708 crores and 12,989 crores respectively. Further, it sanctioned medium term credit limits amounting to Rs. 8 crores in the calendar year 2006 for approved agricultural purposes. A sum of Rs.59 crores was sanctioned in 2006 - 2007, in order to enable State Cooperative Banks and District Cooperative Central Banks to convert short-term agricultural loans into medium-term loans when the farmers were affected by droughts, floods and other natural calamities. In the year 2006 - 2007 it sanctioned Rs. 59 crores. Regarding long-term loans, by way of refinance, under various schemes, NABARD sanctioned Rs. 3232 crores in the year 2006 - 2007, covering nearly 12,814 schemes. NABARD has also provided financial assistance to non-farm sector as well, with a view to promoting integrated rural development and also securing prosperity for the rural areas. Financial assistance has been provided to small-scale and cottage industries, industrial cooperative societies for meeting their working capital and block capital requirements. NABARD has also initiated a rehabilitation programme in respect of State Cooperative Banks and District Cooperative Central Banks in the country which are financially weak, such as high level of overdue, inadequate internal resources, inefficient management and untrained staff.

Finally, this institution has set up a Research and Development Fund for granting assistance to Land Development Banks, State Cooperative Banks and Regional Rural Banks. The three main functions of NABARD are refinancing, institutional development and inspection of client banks. Of these, the first function, viz, refinancing has attracted larger attention of this apex institution. f)PARTICIPATION IN THRUST AREAS


SGSY scheme

Inspection for co operative BK & RRB

Women children development NABARD participation

Training centres

External aid project SHG


Monitoring and evaluation research activities

1. Integrated Rural Development Programme IRDP is a scheme devised by Government of India for generating selfemployment opportunities in the rural sector and for the economic development of rural areas. Banks are advised to extend cheap credit facilities to the people/group selected under this programme. NABARD then provide refinance to banks. Swaranjayanthi Gram Swarozgar Yojana(SGSY) Scheme: In the past years there were many self employment schemes were in operation for the upliftment of rural poor. Effective from April, 1999 Government of India have merged all such Self Employment Schemes into one and launched the new SGSY scheme. 2. Development of Women and Children in Rural Areas NABARD prepared guidelines for promoting group activities under the programme and provided 100% refinance support. 3. Training-cum-production centre for Women NABARD provides grants to voluntary/development agencies for setting up of centres which aim at providing vocational/entrepreneurship training centres for women exclusively. 4. Self-Help Group NABARD has been making efforts to establish linkages between SelfHelp Group organized by some voluntary agencies for poor people in rural areas and official credit agencies. This would augment the flow of credit for production purposes and reduce their dependence on informal credit sources. 5. Scheme of Monitoring Evaluation and Research Activities

NABARD conducts studies of on-going schemes and completed studies to obtain feedback on performance of those projects. The NABARD has system of District Oriented Monitoring studies in which a cross section of schemes sanctioned in a district to various banks is studied. 6. Vikas Volunteer Vahini Programe NABARD has been organizing farmers club in association with voluntary agencies in rural areas particularly in tribal areas, which have proved very helpful for credit institutions in extending credit to poor farmers. 7. External Aid Project NABARD has been implementing various foreign aided projects. The projects are assisted by World Bank Group, Organisation of Petroleum Exporting Countries Fund for International Development etc. 8. Inspection and Supervision of Co-operative Banks and Regional Rural Banks NABARD has been entrusted with the responsibility of supervision of Co-operative and Regional Rural Banks. For this purpose, it conducts inspections of Co-operative Banks and Regional Rural Banks. These banks are also to submit periodical information to NABARD for monitoring purposes. NABARD gives its recommendations to RBI with the matter relating to licensing of Co-operative Banks and Regional Rural Banks. 9. Human Resource Development(HRD) NABARD provides assistance and support or the training of staff of other credit institutions engaged in credit dispensation for agriculture and rural development. Training facilities are extended at its two training institutions-Bankers Institute for Rural Development (BIRD) and Regional Training Centres (RTCs)

g)RESOURCES OF NABARD NABARD has been providing financial assistance to various financial institutions engaged in Rural Credit Delivery System. These agencies include Co-operative Credit Institutions, Regional Rural Banks and Commercial Banks. The demand for funds for rural development has come up considerably in recent times. To meet the increasing demand of rural credit, NABARD raises funds from the following sources: a) Capital It went up from Rs.100 crore in March 1992 to Rs. 1500 crore in March 1998 and Rs. 2000 crore RBI. b) Deposits The deposit mainly come from Rural Infrastructural Development Fund (RIDF) introduced in Central Government Budget from the year 1995-96. c) Borrowings NABARD raises funds through market borrowings, Loans from Union Government and borrowings in Foreign Currency from abroad. Apart from these they also borrow funds from RBI. d) Reserves and Surplus The excess of income over expenditures is further in 1999. The total Capital of

NABARD is contributed by Government of India and

generally accumulated as Reserves and surplus.

e) Nation Rural CreditThese funds were earlier provided by RBI Funds (Long term to NABARD in connection with Operation Fund & were assistance under Agriculture sector. These Stabilisation Fund) given out of profits earned by RBI. f) Rural Infrastructural Development Fund (RIDF) The setting up of RIDF was announced in the Union Budget for 1995-96. The RIDF was set up with a contribution of Rs. 2000 crore mainly to provide assistance to State Governments to take up infrastructure projects pertaining to irrigation, rural roads, bridges and flood control measures. Contributions to this Fund came from Indian Scheduled Commercial Banks (other than RRBs) which failed to achieve the minimum agricultural lending target of 18 percent of net bank credit. VI.STATE BANK OF INDIA The State Bank of India is a statutory institution like the RBI and is governed by the SBI Act in 1955. a)Evolution of State Bank OF India: The evaluation of the State Bank of India can be divided into four periods. Such classification is given below:

1 2 3 4 Establishment of SBI

Before 1921 From 1921 to 1934 From 1934 to 1955

After 1955

Before 1921, there were three Presidency Banks of Bombay, Calcutta and Madras. In 1921, by the amalgamation of these three banks the Imperial Bank was established. It was governed by the Imperial Bank of India Act of 1920. The Imperial Bank was mainly a commercial bank owned by private shareholders. But it was simultaneously performing some of the functions of Central Bank such as the banker to the government, bankers bank and national clearing house. The Imperial Bank was functioning on this line till 1934 when a separate central bank i.e., RBI was established. Then the Imperial Bank of India Act was amended by the Imperial Bank (amendment) Act of 1934. Besides its regular functions, the Imperial Bank acted as the agent of the Reserve Bank of India in all places where the later had no branches of its own. b)NATIONALISATION OF THE IMPERIAL BANK Proposals for the nationalization of the Imperial Bank were under consideration ever since the attainment of independence in 1947. It was nationalized in 1955 according to the recommendations of Rural Credit Survey Committee. The committee recommended that the government should establish a strong government owned commercial bank, which would undertake rapid expansion of banking facilities in rural areas. For this purpose, it suggested the government to nationalize the Imperial Bank and other state associated banks.

c)MANAGEMENT OF THE BANK The bank is administered by a central board of directors consisting of: Members (a) Chairman (appointed by the Central Government in consultation with RBI) (b) Vice-Chairman (appointed by the Central Government in consultation with RBI) (c) Managing Directors (appointed by the Central board with the approval of the central Government) (d) Directors (Elected) (elected by the shareholders other than RBI (e) Directors (Nominated)(nominated by the central government in consultation with RBI to represent territorial and economic interest having commerce, industry, banking or finance) (f) Director (Nominated)(nominated by the central government) (g) Director (Nominated)(nominated by RBI) Total members 20 1 1 8 6 2 1 Number 1

d)FUNCTIONS OF STATE BANK OF INDIA The functions of SBI can be grouped under two categories, viz., the Central Banking functions and ordinary banking functions. i)Central Banking Functions: The SBI as agent of the RBI at the places where the RBI has no branch. Accordingly, it renders the following functions: a) Banker to the government b) Banker to banks in a limited way c) Maintenance of currency chest d) Acts as clearing house e) Renders promotional functions
(1) Banker to the Government: The SBI functions as the banker to the central

and state governments. It receives and pays money on behalf of the governments. (a) collection of charges on behalf of the government e.g. collection of tax and other payments (b) grants loans and advances to the governments (c) provides advises to the government regarding economic conditions etc.
(2) Bankers Bank: Commercial Banks have accounts with SBI. When the

banks face financial shortage, the SBI provides assistance to them as it is considered a big brother in the banking industry. It discounts the bills of the other commercial banks.
(3) Currency Chest: The RBI maintains currency chests at its own offices. But

RBI Offices are situated only in big cities. SBI, buy its wide network of branches operate in urban as well as rural areas.

(4) Acts as Clearing House: In all the places, where RBI has no branch, the SBI

renders the functions of clearing house.

(5) Renders Promotional Functions: State Bank of India also renders various

promotional functions. It provides various facilities to the following priority sectors: (i) Agriculture (ii)Small-Scale Industries (iii) (iv) (vi) Weaker sections of the society Co-operative sectors Unemployed youth

(v) Small-traders (vii) Others In this respect SBI is like any other commercial bank. ii)General Banking Functions Besides the above specialized functions, the SBI renders the following functions under Section 33 of the Act. 1. 2. 3. 4. 5. 6. Accepting deposits from the public under current, savings, Advancing and lending money and opening cash credits Drawing, accepting, discounting, buying and selling of bills Investing funds, in specified kinds of securities Advancing and lending money to court of wards with the Issuing and circulating letters of credit.

fixed and recurring deposit accounts. upon the security of stocks, securities etc. of exchange and other negotiable instruments.

previous approval of State Government.

7. 8. 9. stocks. 10. 11. public. 12. 13. 14. 15. 16. 17. 18. Ltd. 19. 20. 21.

Offering remittance facilities such as demand drafts, mail Acting as administrator, executor, trustee or otherwise. Transacting pecuniary agency business on commission Buying and selling of gold and silver It operates Public Provident Fund Accounts for the general It operates Non-Resident External Accounts and Foreign Providing Factoring service(through subsidiaries) Provides shipping finance Promotes Export through Export Credit. Provides Project Provides Merchant Banking Facilities. Provides specialized services like Global Link Services. Promotes housing finance through SBI Home Finance Provides Leasing Finance and Project Finance Facilities Participates in Lead Bank Scheme The State Bank may with the sanction of the Central

transfers telegraphic transfers etc.

Currency Accounts.

Export Finance.

Government, enter into negotiations for acquiring the business of any other Banking Institutions. e)STATE BANK OF INDIA AND AGRICULTURAL AND RURAL FINANCE One of the basic objectives with which the SBI established is to provide banking facilities to rural areas. The Rural Credit Survey Committee envisaged a

dominant part for the State Bank in rural finance. The SBI provides agricultural and rural finance in the following ways: 1. Expansion of Rural Branches. Direct finance to farmers 2. Loans and advances to co-operative banks 3. Loans and advances to co-operative marketing and processing societies 4. Financial assistance to Central Land Development Banks 5. Small Farmers Scheme 6. Farm Graduates Schemes 7. Agricultural Development Branches 8. Village Adoption Scheme and Service Area Approach 9. Sponsoring Regional Rural Banks 10.Ware Housing Finance 11.Integrated Rural Development Programme(now merged with SGSY scheme) f)STATE BANK OF INDIA AND SMALL SCALE INDUSTRIES Development of small scale industry and small business is another important aim of the State Bank of India. In small scale industry the following categories of business units are included. Small Scale Industry Industrial units, engaged in manufacturing, processing, preservation, repairing or service operations with original investments in plant and machinery not exceeding Rs.300 crore are classified as Small Scale Industries. (b) Tiny Sector Small scale industrial units with investment in plant and machinery up to Rs.25 lakh are classified as TinySector Industries. (c) Small Business (i) Any business established mainly for the purpose of providing any service other than professional services.

(viii) (ix) (x)

Original cost price of the equipment used for the purpose of Working capital limits granted to such an enterprise should The aggregate of term loan and working capital limits should

business should not exceed Rs. 10 lakh. not exceed Rs. 5 lakh. not exceed Rs.10 lakh. g)SBI ASSISTANCE TO SMALL UNITS The SBI helps the small units in the following ways: 1. Offers working capital 2. Medium-term Loans and Installment Credit 3. Discounting of bills 4. Entrepreneur Development Programmes 5. Encouraging Women Entrepreneur 6. Promotion of village and cottage industry 7. Encouraging self-employment schemes 8. Provides technical and financial consultancy services 9. Special Village Industries Division 10.Project uptech.

VII. Industrial Finance Corporation of India (IFCI)

This was first in the chain of establishment of financial corporations to provide financial assistance for industrial development. This was established on July 1, 1948 under the Act of the Parliament. IFCI provides assistance to the industrial concerns in the following ways: (i)

Long-term loans; both in rupees and foreign currencies, Underwriting of equity, preference and debenture issues. Subscribing to equity, preference and debenture issues.

Guaranteeing the deferred payments in respect of machinery imported from abroad or purchased in India; and Guaranteeing of loans raised in foreign currency from foreign institutions. financial

a)Role of IFCI
Financial assistance of IFCI can be availed by any Limited Company in the public, private or joint sector, or by a co-operative society incorporated in India, which is engaged or proposes to be engaged in the specified industrial activities. Such financial assistance will be available for the setting up of new industrial projects and also for the expansion, diversification, renovation or modernization of existing ones. The IFCI also provides financial assistance on concessional terms for setting up industrial projects in industrially less developed districts in the States or Union Territories notified by the Central Government. The paid-up Capital of IFCI as on 31st March 2007 was Rs. 380- crores subscribed by the Industrial Development Bank of India (50%) and by scheduled banks, cooperative banks, insurance concerns and investment trusts. The IFCI raises its resources by way of (a) issue of bonds in the market; (b) borrowing from Industrial Development Bank of India and the Central Government; (c) foreign credit secured from foreign financial institutions and borrowings in the international capital markets. In recent years, the range of activities undertaken by the IFCI has widened. It now undertakes Merchant Banking and other financial services, equipment financing, promotional services in the form of Technical Consultancy Support, Risk Capital Assistance, Up gradation of Managerial skills, Entrepreneurship development, etc.

Since its inception up to March 2007 the financial assistance sanctioned by IFCI aggregated to Rs.44,900 corers against which total disbursements amounted to rs 15,380 corers fertilizers , cement industries industrial machinery , and power generation industries were beneficiary .

VIII.EXIM BANK OF INDIA a)Introduction Export-Import Bank of India was created by an Act of Parliament, the ExportImport Bank of India Act, 1981. The Bank came into existence in 1982, for he purpose of financing, facilitating and promoting foreign trade of India. It is the principal financial institution in the country for coordinating and working of institutions engaged in financing exports and imports.

The Export-Import Bank of India is f u l l y owned by the Government of India and is managed by a Board of Directors with representation from the government, financial institutions, banks, and the business community The Board of Directors of the EXIM Bank consists of: a) chairman and a managing, director appointed by the Central Government: provided that the same person may be appointed to function both as chairman and as managing director. b) One director is nominated by the RBI. c) One director nominated by the Development Bank. d)One e) whom: director is nominated by the Export Credit and Guarantee Corporation Limited. Not more than twelve directors nominated by the central government of

(i) Five directors are nominated by the central government (ii) Not more than three directors are from the schedule banks, (iii) Not more than four directors are persons who have special knowledge of, or professional experience in, export or import or both.

The Board may constitute such committees whether consisting wholly of directors or wholly of other persons or partly of directors and partly of other persons for such purpose or purposes as it may think fit.

b)Resources of the EXIM Bank

The resources of the EXIM Bank are: 1. Loans by central government. 2. Borrowings and Acceptance of Deposits by EXIM Bank 3. Loans in foreign currency 4. Grants, donations etc., to EXIM Bank. 5. Export development fund.

c)Functions of the EXIM Bank

The export finance is the main function of EXIM Bank, and also involves a significant extent in other kinds of export promotional activities. Another salient feature is the extensive involvement of developing Indian economy. The EXIM Bank facilitates the following functions: 1. It provides loans and advances by itself or along with any bank or financial institution whether in or outside India for the purpose of export or import. 2. It also carries on and transacts all or any of the following functions relating to export and import business, namely:

(a) Granting loans and advances to a scheduled bank or any other banks or financial institution by way of refinance of loans and advances granted by it for purposes of export or import. (b) Underwriting the issue of stocks, shares, bonds or debentures of any company engaged in export or import. (c) Issuing bid bonds or guarantees in or outside India by itself or in participation with any government, bank or financial institution in or outside India. (d) Accepting, collecting, discounting, re-discounting, purchasing, selling or negotiating in or outside India, Bills of exchange or promissory notes arising out of transactions relating to export or import and granting of loans and advances in or outside India against such / bills or promissory notes. (e) Granting, opening, issuing, confirming or endorsing letters of credit and negotiating or collecting bills and other documents drawn there under. (f) Undertaking any transactions involving a combination of government to government and commercial credit for the purposes of export or import. (g) Granting loans and advances outside India for any Indian joint venture, 3. It renders services mentioned in the act for consideration like commission , brokerage , interest and remuneration or fees as may be agreed upon 4. it grants any loan or advance or other financial accommodation on the security of its own bonds or debentures


Leasing, like long-term debt, is a process by which a firm can obtain the use of certain fixed assets for which it must make a series of contractual, periodic, taxdeductible payments. b)The Concept of Leasing: Leasing is an alternative to purchase an asset in order to acquire the services of that asset. By leasing an asset the lessee essentially acquires its use value from the lessor, who actually purchased and owns (retains title to) the asset. Simply stated, ownership of a productive asset conveys two types of property rights to the owner (i) (ii) to use the asset throughout its productive life and to sell or dispose of it for its salvage value.

In this context, the lessee acquires all or a portion of the use value of the asset in return for making a set of rental payments to the lessor. The lessor retains title to the asset and hence the right to sell or dispose of it for its salvage value. Thus, leasing

distributes the rights of ownership by separating the assets use value from its salvage value. c)Types of Leasing: The ever growing complexity of the law and the various diverse circumstances of the lessees and lessors lead to a number of variations in the standard financial and operating leases. Financial Lease: A financial lease is a contract that is non-cancelable and the lease period is usually shorter than the useful life of the asset being leased. During the life of the contract all of the cost of the property plus financing and servicing charges should be recovered through periodic payments. In this kind of lease agreement the leasing company will act simply as a financial institution. The lessee will specify the equipment needed and act as the lessors agent in the matters of ordering it, inspecting it and maintaining it. The lessor is simply interested in the equipment as its legally owned asset. The lessor will raise the money, accept the invoice from the supplier and pay accordingly.

Floating rental rate lease contracts:

This kind of lease permits a lessee to undertake the risk and awards of interest rate variations.

Non-tax base leasing:

Lessor, in general, enjoys the benefits of tax deductions and various grants extended by governments to the new capital investment in the industry. (iii) Net Lease:

In a net lease, the lessee pays the costs associated with partnership. These costs include property taxes, insurance premiums and capital and maintenance expenses. USE VS. OWNERSHIP Financial leasing is a means of financing the use rather than the ownership of an asset.

Operating Lease: Operating leasing is a service available for which there is an established leasing and second-hand market. Computers and television sets are the items most widely leased on an operating basis in the commercial and consumer fields, respectively. Different kinds of operating lease writing: (a) Service lease A service lease resembles to Contract Hire but has a different legislative outlook. In this kind of lease, the lessor renders the services of the equipment, generally automobiles, office and domestic equipment, for a relatively short period. The rentals do not have any direct correlation towards the recovery of capital costs, interest and lessors profit in the lease period. Lessors primary objective while offering the lease rentals is to have a regular income and the interest on the capital. Moreover these rentals are fixed keeping in view the useful working life of the equipment. (b)Captive lease This kind of leasing was introduced by certain manufacturers who wanted to contest the second-hand market of the equipment which they are manufacturing to

maintain the monopoly of their products in the market. This type of leasing is significantly popular in computers, machine tools etc. Sale and Lease Back: Sale and lease back leasing was designed as an alternative to the hypothecation of fixed assets to raise funds by an organization in the traditional financial circles. Under this type a sole and leaseback arrangement consists of the sale of machinery, equipment, or building by a firm to a financial institution that in turn leases the assets back to the firm . New assets are frequently sold and leased back. For example, a firm may be building a new plant. During the construction period, the firm takes construction loans from a bank to handle the financing. LEVERAGE LEASE Under leverage lease the lessee assigns his interest in a purchase order to lessor who agrees to advance only a portion of the total equipment cost, and arranges to borrow the remaining portion from institutional lenders. There are number of participants in a leverage lease and the role of each is described below: (a) Broker: A leverage lease is organized and managed by a broker. Once the

broker has found a company interested in acquiring an asset by means of a leverage lease, he has to find two other parties to participate in the financing of the asset: a lender prepared to lend long-term debt funds to a lessor which then adds sufficient of its own funds to the borrowed funds in order to purchase the required asset. (b) Lender: This role is performed by one or more institutional lenders which lend a majority proportion of the cost of the asset to the lessor. The lender will receive interest and principal repayments paid out of the lease payments.

(c) Lessor (equity participants): The lessor comprises one or more banks or finance companies with sufficient profits to take the full tax advantage, of the depreciation charges and investment allowances allowable on the asset. The lessor provides the additional funds not provided by the lender and purchases the asset. The lesser receives only a very small cash flow from the lease payments as the major proportion of the lease payments is paid out as interest and principal repayments to the lender. (d) Lessee: The lessee enters into a normal lease agreement agreeing to lease the asset for a specified period of time and to make specified lease payments. Usually, the period of the lease is shorter than the economic life of the asset. SALE-AID LEASING: By the advent of intensive competition in product marketing, a number of companies adopted this technique as a marketing tool because under this scheme, a manufacturer directly extends facility of leasing either by one of his own subsidiaries or through a third party, a leasing company. TAX BENEFIT TRANSFER LEASE: The objective of these kinds of leases is to make the economically distressed companies to encash the benefits of investment tax credits and other various fiscal incentives which they were not in a position to enjoy because of the non-tax paying conditions of the company. In this kind of leasing, the lessor pays a down payment on the capital cost of the equipment and executes a note exactly identical to the lease rentals to be received from lessee. CROSS BORDER LEASE: When a lessor leases equipment to a lessee who is not falling in the jurisdiction of the lessors territory then the lease written is known as Cross Border leasing. Equipment financed by cross border leasing displays one or more of the following characteristics:

Undisputed title( giving rise to registration); Used in an economically essential sector with strong and lasting profitability; Long life and a good second hand value in many different countries; and, Relative mobility.

d)ADVANTAGES AND DISADVANTAGES: The merits of leasing from a potential lessees point of view are stated below: 1. Equipment procurement 2. Additional source of finance 3. Debt capacity 4. Certainty 5. Availability 6. Taxation 7. Flexibility 8. Limited claims in the event of bankruptcy or re-organisation 9. Hedging risks 10.Convenience 11.Avoiding of the risk of obsolescence 12.Increase in liquidity 13.Step-by-step financing 14.Flotation costs 15.Disposal problem 16.Higher incomes

17.A well-defined cost 18.Maintenance is cheap and certain The disadvantages are: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Ownership flexibility Residual value Taxation Early disposal Security value Understatement of assets Prestige High cost of leasing Prohibited property improvements Obsolescence considerations e) FINANCIAL EVALUATION OF LEASING: The process of financial appraisal in a lease transaction generally involves three steps: (i) (ii) (iii) appraisal of the client in terms of financial strength and credit worthiness evaluation of the security/collateral security offered and financial evaluation of the proposal.

LESSEES PERSPECTIVE Finance lease effectively transfers the risks and rewards associated with the ownership of an equipment from the lessor to the lessee. A lease can be evaluated either as an investment decision or as a financing alternative. The lease evaluation from the lessees point of view, thus, essentially involves a choice between debts

financing versus lease financing. Evaluation of lease financing from the view point of lessee is presented. The decision-criterion used is the Net Present Value of Leasing [NPV (l)]/Net Advantage of Leasing (NAL). The discount rate used is the marginal cost of capital for all cashflows other than lease payments and the tax cost of debt for lease payments. The value of the interest tax shield id included as a foregone cash flow in the computation of NPV (L)/NAL.

NPV (L)/NAL = Investment cost Less: Present value of lease payment (discounted by Kd), Plus: Present value of tax shield on lease payment Kc) Less: Management fee Plus: Present value of tax shield on management fee K) Minus: Present value of depreciation shield (discounted by Kc) Minus: Present value of interest shield (discounted by Kc) Minus: Present value of residual/salvage value (discounted by Kc) Where Kc = Post-tax marginal cost of capital Kd = Pre-tax cost of long-term debt If the NAL/NPV (L) is positive, the leasing alternative should be used, otherwise the borrowing alternative would be preferable. (discounted by (discounted by

An alternative approach is to determine the present values of the cash outflows after taxes under the leasing and the borrowing alternatives. The decision-criterion is to select the alternative with the lower present value of cash outflows. BREAK-EVEN LEASE RENTAL: The break-even lease rental (BELR) is the rental at which the lessee is indifferent between lease financing and borrowing and buying. Alternatively, BELR has NAL as zero. It reflects the maximum level of rental which the lessee would be willing to pay. If the BELR exceeds the actual lease rental, the lease proposal would be accepted, otherwise rejected. i)LESSORS VIEWPOINT: The lease evaluation from the point of view of the lessor aims at ascertaining whether to accept a lease proposal or to choose from alternative proposals. As in the case of the evaluation by a lessee, the appraisal method used is the discounted cash flow technique based on the lessors cash flows. The lease-related cash flow from his angle consist of a) outflows in terms of the initial investment/acquisition cost of the asset at the inception of the lease; income-tax on lease payments, sales-tax on lease transaction, if any; lease administration expenses such as rental collection charges, expenses on suits for recovery and other direct cost and so on. b) Inflows such as lease rentals, management fee, tax shield on depreciation, residual value and security deposit, if any and so on. Break-Even Lease Rental:

From the viewpoint of a lessor, the break-even lease rental represents the minimum (floor) lease rental which he can accept. The NAL/NPV (L) at this level of rental is zero. The discount rate to compute the NAL is the marginal over-all cost of funds to the lessor. Negotiation of Lease Rentals: The break-even rentals of the lessor and the lessee represent the range of acceptable level of rentals. The break-even lease rental of the lessor sets the lower limit, while the break-even rental of the lessee sets the upper limit of the range. The actual rental has to be negotiated within the range. A rental within the range implies a positive NAL/NPV (L) both for the lessor and the lessee. In a way, the difference between the break-even lease rental for the lessor and the lessee (i.e., the spread) represents the bargaining area for the negotiation of the actual lease rental for a lease proposal. II. HIRE-PURCHASE FINANCE AND CONSUMER CREDIT: a)Introduction: Historically, hire-purchase finance has been associated with financing of commercial vehicles for road transport operators. It has emerged as a source of equipment financing in recent years as an alternative to lease financing. b)Meaning and Characteristics: Hire-purchase is a mode of financing the price of the goods to be sold on a future date. In a hire-purchase transaction, the goods are let on hire, the purchase price is to be paid in installments and the hirer is allowed an option to purchase the goods by paying all the installments. A hire-purchase agreement is defined as peculiar kind of transaction in which the goods are let on hire with an option to the hirer to purchase them with the following stipulations:

(a) (b) (c) (d)

Payment to be made in installments over a specified period; The possession is delivered to the hirer at the time of The property in the goods passes to the hirer on payment of Each installment is treated as hire charges so that of default

entering into the contract; the last installment; is made in payment of any installment, the seller becomes entitles to take away the goods; and (e) The hirer/purchaser is free to return the goods without being required to pay any further installments falling due after the return. Thus a hire-purchase agreement has two aspects, firstly, an aspect of bailment of goods subject to the hire-purchase agreement, and secondly, an element of sale which fructifies when the option to purchase is exercised by the intending purchaser. Though the option to purchase is allowed in the very beginning, it can be exercised only at the end of the agreement. The interest component of each hire-purchase installment is computed on the basis of a flat rate of interest and the effective rate of interest is applied to the declining balance of the original loan amount to determine the interest component of each installment. c)Parties to Hire-Purchase Contract: Basically, there are two parties in a hire-purchase contract, namely, the intending seller and the intending purchaser or the hirer. Now a days, however, hirepurchase contracts generally involve three parties, namely, the seller, the financier and the hirer.

1. The dealer contracts a finance company to finance hire-purchase deals submitted by him. 2. The customer selects the goods and expresses his desire to acquire them on hire-purchase. 3. The customer then makes cash down payment on completing the proposal form. 4. The dealer then sent the documents to the finance company requesting them to purchase the goods and accept the hire-purchase transactions 5. The finance company, if it decides to accept the transactions, signs the agreement and sends a copy to the hirer along with the instructions as to the payment of the installments. 6. The dealer delivers the goods to the hirer against acknowledgments and the property in the goods passes on to the finance company. 7. The hirer makes payment of the hire installment periodically. 8. On completion of the hire-term, the hirer pays the last installment and the property in the goods passes to him on issue of a completion certificate by the finance company. Sales of Goods Act: In a contract of hire-purchase, the element of sale is inherent as the hirer always has the option to purchase the movable asset by making regular payment of hire charges and the property in the goods passes to him on payment of the lase installment. d)Contract of Sales of Goods: A contract of sales of goods is a contract whereby the seller transfers or agrees to transfer the property in goods to the buyer for a price. It includes both an actual sale and an agreement to sell which vastly differ from each other. A contract in which the property in the goods is transferred from the seller to the buyer, the contract

is called a sale, but where the transfer of property in the goods is to take place at a future time, or subject to some conditions to be fulfilled later, it is called an agreement to sell. An agreement to sell becomes a sale when the time elapses or the conditions are fulfilled subject to which the property in the goods is to be transferred. Sales Vs Bailment: In case of bailment (or leasing), there is a mere transfer of possession of the goods from the bailor to the bailee with no conveyance intended. The goods are delivered for a certain purpose, on the condition that when that purpose is over the goods will be returned in specie.

Sale Vs Hire-purchase: A hire-purchase agreement is a kind of bailment whereby the owner of the goods lets them on hire to another person called hirer, on payment of certain stipulated periodical payments as hire charges or rent. If the hirer makes the payment regularly, he gets an option to purchase the goods on making the full payment. Before this option is exercised, the hirer may return the goods without any obligation to pay the balance rent. The hirer is, however, under no compulsion to exercise the option and purchase the goods at the end of the agreement period. Goods: The subject-matter of a contract of sale is the goods. Goods means every kind of movable property excluding money and actionable claims. Besides, growing crops, grass, standing trees and other things attached to, or forming part of the land, also fall in the meaning of goods, provided these are agreed to be severed from land before sale or under the contract of sale. e)Nature of Hire-purchase Agreement:

The Act defines a hire-purchase agreement as a peculiar kind of transaction in which the goods are sold with the following stipulations: 1. Payment is to be made in installments over a specified period; 2. The possession is delivered to the purchaser at the time of entering into the contract; 3. The property in the goods passes to the purchaser on payment of the last installment; 4. Each installment is treated as hire charges so that if default is made in payment of any one installment, the seller becomes entitled to take away the goods; and 5. The hirer/purchaser is free to return the goods without being required to pay any further installments falling due after the return. Thus, a hire-purchase agreement has two aspects: (a)An aspect of bailment of goods subjected to the hire-purchase agreement, and (b) An element of sale which fructifies when the option to purchase is exercised by the intending purchaser/hirer. The essence of the agreement is that the property in the goods does not pass at the time me of the agreement but remains in the intending seller, and only passes later when the option is exercised by the intending purchaser. f)Form and Contents of a Hire-Purchase Agreement: There is no prescribed form for a hire-purchase agreement, but it has to be in writing and signed by both the parties to it. Where a hire-purchase agreement involves a guarantee, the agreement must be signed by the surety also, otherwise the agreement shall be avoidable at the option of the owner.

A hire-purchase agreement must contain the following particulars: (a) The hire-purchase price of the goods; (b) The cash price of the goods i.e., the price at which the goods may be purchased by the hirer for cash; (c) The date of commencement of the agreement; (d) The number of installments in which the hire-purchase price is to be paid, the amount, due date, the person to whom and the place where each of the installments is to be paid; and (e) The description of the goods, in a manner sufficient to identify them.

Implied Warranties: A hire-purchase agreement has the following implied warranties Quiet Possession: The owner undertakes a warranty that the hirer shall have and enjoy quiet possession of the goods. Free of Encumbrances: The goods are warranted as free from any charge or encumbrance in favour of any third party, at the time the property in the goods is to pass. Thus, where the goods are already pledged or hypothecated, and the owner enters into a hire-purchase agreement, it amounts to a breach of warranty. Implied Conditions: The following conditions are implied in hire-purchase agreement: Perfect Title: That the owner has the right to sell the goods at the time the property is to pass to the hirer. Merchantable Quality: That the goods are of merchantable quality, that is reasonably fit for the purpose for which they have been produced and marketed. However, no such conditions are implied:

(a) As regards any latent or hidden defects in the goods, which would not have been revealed on a reasonable examination; (b) As regards defects specified in the agreement; (c) As regards defects which ought to have been revealed when the hirer examined the goods or a sample; (d) As regards second-hand goods, when there is a statement to that effect in the contract. Fitness for Hirers Purpose: That the goods are fit for the hirers purpose, where the hirer expressly or implicitly informs the owner, or any other person through whom the negotiations were conducted, the purpose for which he requires the goods. As per Sample: That the goods correspond with the sample and the hirer has a reasonable opportunity to compare the bulk with the sample. As per Description: That the goods correspond with the description, where the goods are delivered under description. Hire-Purchase Charges A restriction on hire-purchase charges is imposed in order to prevent exploitation of hirers by the dealers and finance companies. Under this provision, the net hire-purchase charges must not exceed the statutory charges. Statutory charges, for this purpose, are calculated as: Net hire-purchase charges represents the difference between the net hire-purchase price and the net cash price. Passing of Property: Property in the goods under a hire-purchase agreement passes to the hirer only on the completion of the purchase, in the manner laid down in the agreement.

g) Rights of Hirer: To purchase with Rebate: The hirer has a right to purchase the goods under the agreement, at any time during the continuance of the agreement, by giving to the owner at least 14 days notice of his intention to do so. For making the purchase, the hirer has to pay to the owner, the balance of hire-purchase price after deducting a rebate, calculated in the following manner: Balance of hire-purchase Rebate = 2/3 price not yet due (Hire-purchase price-cash price) Hire-purchase price The right of the hirer cannot be taken away by an agreement to the contrary. However, where the agreement provides for a higher rebate, the hirer is entitled to it. To Terminate Agreement: The hirer has a right to terminate the agreement at any time before the final hire purchase installment falls due. For this purpose, the hire has to give to the owner at least 14 days notice of this intention to terminate the agreement. The hirer is required to return the goods to the owner and pay the installments which have fallen due but have not been paid, up to the date of termination. To Appropriate Payments: Where the hirer is required to pay several hire-purchase installments under two or more agreements to the same owner, and he makes a payment which is not sufficient to discharge the total amount when due under all the agreements, he may appropriate the payment to such agreement(s) as he likes. If the hirer does not exercise his right of appropriation, the owner gets the right to apply the payment to the agreements in the order of their time.

To Assign and Transmit: The hirer has right to assign his right, title and interest under the agreement, with the consent of the owner. If the owner unreasonably withholds his consent, the hirer may make assignment without his consent. The owners consent is deemed to be unreasonably withheld of he demands any consideration thereof. When the owner refuses to give his consent on a request by the hirer, the hirer may apply to the court for a declaration that the consent has been unreasonably withheld. If the court makes such an order, consent is deemed to have been reasonably withheld. To Refund on seizure of Goods: Where the owner seizes the goods in exercise of his right, the hirer has a right claim refund of an amount equal to: Total amount paid to the date of seizure plus value of the goods on the date of seizure less hire-purchase price. If the owner fails to refund the amount within 30 days after receiving notice from the hirer, he is liable to pay interest @ 12 percent on that amount, after the expiry of the notice period. h)Obligations of Hirer: To Comply with Agreement: The hirer must pay the hire installment in accordance with the agreement and also comply with the terms of the agreement. To take Care of Goods: The hirer is required to take as much care of the goods as a person of ordinary prudence would take of his own goods of the same bulk, quality and value under similar circumstances. If the hirer exercises so much care, he is not liable for any loss, destruction or deterioration of the goods.

Not to Make Unauthorised Use: The hirer must not use the goods for any purpose not authorized in the agreement, otherwise he is liable for any loss or damage to the goods. To Give Information: If the owner asks the hirer about the where house abouts of the goods, the hirer must inform the owner where the goods are at he is giving or posting the information. The hirer must inform the owner within 14 days; if he fails to do so without reasonable cause, he is punishable with fine upto Rs. 200.

Rights of Owner: Rights to Terminate Agreement: The owner has the right to terminate the agreement in the following cases: (a) When the hirer fails to make payment of more than one hire installments, the owner may terminate the agreement after giving the hirer a notice of writing. (b) When the hirer makes any unauthorized use of the goods or breaks an express condition of the agreement, on breach of which the owner becomes entitled to terminate the agreement. Rights on Termination: To Retain Hire: The owner has the right to retain the hire which has already been paid and to recover the arrears due up to the date of termination. This is, however, subject to the hirers right to refund in case of seizure of goods. To Forfeit Initial Deposit: The owner has the right to forfeit the initial deposit of the agreement so permits. To enter Premises and seize goods: The owner has the right to enter the premises of the hirer and seize the goods, unless there is a contract to the country. To Recover Possession: The owner has the right to recover possession of the goods either by an application to the court for recovery of protected goods or by means of a suit. To Recover Damages: Where the hirer delays the return of goods, the owner has the right to recover damages for non-delivery of the goods, for the period between the date of termination of agreement and the date of delivery.

Obligations of Owner: The owner has the following obligations: 1. To supply, free of cost, a true copy of the agreement, signed by him, to the hirer immediately after execution of the agreement. 2. To supply on demand, a copy of the agreement to the surety. 3. To supply on demand by the hirer, the following information, via: (a) The amount paid by or on behalf of the hirer; (b) The amount due and unpaid, the date on which each unpaid installment becomes due and the amount of each such installment: (c) The amount which is to e payable, the dates on which such installments are to become due and the amount of each such installment. III.FACTORING AND FORFAITING a)INTRODUCTION: Factoring, as a fund-based financial service, provides resources to finance receivables as well as facilitates the collection of receivables. b)CONCEPT AND MECHANISM: Concept: In the absence of any uniform codified law, the term factoring has been defined in various countries in different ways. International Institute for the Unification of Private Law (UNIDROIT), Rome during 1988, recommended, in general terms the definition of factoring as: Factoring means an arrangement between a factor and his client which includes at least two of the following services to be provided by the factor: (i) Finance (ii) Maintenance of accounts (iii) Collection of debts (iv) Protection against credit risk

(v) across national boundaries (vi) to trade or professional debtors (vii) when notice of assignment has been given to the debtors. Mechanism: Credit sales generate the factoring business in ordinary course of business dealings. Realisation of credit sales is the main function of factoring services. Once sale transaction is completed, the factor steps in to realize the sales. Thus, factor works between the seller and the buyer and sometimes with sellers banks together. The Buyer: (a) Buyer negotiates terms of purchasing the material with the seller; (b) Buyer receives delivery of goods with invoice and instructions by the seller to make payment to the factor on due date; (c) Buyer makes payment to factor in time or gets extension of time or in the case of default is subject to legal process at the hands of factor. The Seller: (a) Memorandum of understanding (MOU) with the buyer in the form of letter exchanged between them or agreement entered into between them (b) Sells goods to the buyer as per MOU; (c) Delivers copies of invoice, delivery challan, MOU instructions to make payment to factor given to buyer; (d) Seller receives 80 per cent or more payment in advance from factor on selling the receivables from the buyer to him; (e) Seller receives balance payment from factor after deduction of factors service charges, etc.

c)The Factor: (a) The factor enters into agreement with seller for rendering factor services to it; (b) On receipt of copies of sale documents as referred to above makes payment to the seller of the 80 per cent of the price of the debt; (c) The factor receives payment from the buyer on due dates and remits the money to seller after usual deductions; (d) The invoice, bills or other documents drawn by the seller should contain a clause that these payments arising out of the transaction as referred to or mentioned in might be factored; (e) The seller should confirm in writing to the factor that all payments arising out of these bills are free from any encumbrances, charge, lien, pledge, hypothecation or mortgage or right of set-off or counter-claim from another etc; (f) The seller should execute a deed of assignment in favour of the factor to enable him to recover the payment at the time or after default; (g) The seller should confirm( by a letter of confirmation) that all conditions to sell-buy contract between him and the buyer have been complied with and the transactions complete; and (h) The seller should procure a letter of waiver from a bank in favour of factor in case the bank has charge over the assets sold out to buyer and the sale proceeds are to be deposited in the account of the bank. d)FUNCTIONS OF A FACTOR: Depending on the type/form of factoring, the main functions of a factor, in general terms, can be classified into five categories: Maintenance/administration of sales ledger; Collection facility/of accounts receivable;

Financing facility/trade debts; Assumption of credit risk/ credit control and credit protection; and Provision of advisory services. Administration of Sales Ledger: The factor maintains the clients sales ledgers. On transacting a sales deal, an invoice is sent by the client to the customer and a copy of the same is sent to the factor. The ledger is generally maintained under the open-item method in which each receipt is matched against the specific invoice. The customers account clearly reflects the various open invoices outstanding on any given date. The factor also gives periodic (fortnightly/ weekly depending on the volume of transaction) reports to the client on the current status of his receivables, receipts of payments from the customers and other useful information. Provision of Collection Facility: The factor undertakes to collect the receivables on behalf of the client relieving him of the problems involved in collection and enables him to concentrate on other important functional areas of the business. This also enables the client to reduce the cost of collection by way of savings in manpower, time and efforts. Financial Trade Debts: The unique feature of factoring is that a factor purchases the book debts of his client at a price and the debts are assigned in favour of the factor that is usually willing to grant advances to the extent of 80-85 per cent of the assigned debts. The balance 15-20 per cent is retained as a factor reserve. Credit Control and Credit Protection: Assumption of credit risk is one of the important functions of a factor. This service is provided where debts are factored without recourse. The factor in consultation with the clients fixes credit limits for approved customers. Within these limits, the factor undertakes to purchase all trade

debts of the customer without recourse. In other words, the factor assumes the risk of default in payment by customers. Advisory Services: These services are spin-offs of the close relationship between a factor and a client. By virtue of their specialized knowledge and experience in finance and credit dealings and access to extensive credit information, factors can provide a variety of incidental advisory services to their clients such as: Customers perception of the clients products, changes in marketing strategies, emerging trends and so on; Audit of the procedures followed for invoicing, delivery and dealing with sales returns; Introduction to the credit department of a bank/subsidiaries of banks engaged in leasing, hire-purchase, merchant banking and so on. Cost of Services: The factors provide the various services at a charge. The charge for collection and sales ledger administration is in the form of a commission expressed as a per cent of the value of debt purchased. It is collected up-front/in advance. The charge for short-term financing in the form of advance part-payment is in the form of interest charge for the period between the date of advance payment and the date of collection/guaranteed payment date. It is also known discount charge. Types/ Forms of Factoring: Depending upon the features built into the factoring arrangement to cater to the varying needs of trade/clients, there can be different types of factoring. The collection of receivables and sales-ledger administration is a common feature of practically all factoring transactions. Recourse and Non-recourse Factoring: Under a recourse factoring arrangement, the factor has recourse to the client (firm) if the debt purchased/receivables factored turns

out to be irrecoverable. In other words, the factor does not assume credit risks associated with the receivables. If the customer defaults in payment, the client has to make good the loss incurred by the factor. The factor is entitled to recover from the client the amount paid in advance in case the customer does not pay on maturity. The factor does not have the right of recourse in the case of non-recourse factoring. The loss arising out of irrecoverable receivables is borne by him, as a compensation for which he charges a higher commission. Advance and Maturity Factoring: The factor pays a pre-specified portion, ranging between three-fourths to nine-tenths, of the factored receivables in advance, the balance being paid upon collection/ on the guaranteed payment date. A drawing limit, as a pre-payment, is made available by the factor to the client as soon as the factored debts are approved/the invoices are accounted for. An extension of advance factoring is Bank Participation Factoring, under which a bank provides an advance to the client to finance a part, say 50 per cent, of the factor reserve, that is, the factored debt less advance given by the factor. The maturing factoring is also known as Collection Factoring. Under such arrangements, the factor does not make a pre-payment to the client. The payment is made either on the guaranteed payment date or on the date of collection. Full Factoring: This is the most comprehensive form of factoring combining the features of almost all the factoring services specially those of non-recourse and advance factoring. It is also known as Old Line Factoring. Disclosed and undisclosed Factoring: In disclosed factoring, the name of the factor is disclosed in the invoice by the supplier-manufacturer of the goods asking the buyer to make payment to the factor. The name of the factor is not disclosed in the

invoice in undisclosed factoring although the factor maintains the sales ledger of the supplier-manufacturer. Domestic and Export/Cross-Border/International Factoring: In the domestic factoring, the three parties involved, namely, customer (buyer), client (seller-supplier) and factor. The process of export factoring is almost similar to domestic factoring except in respect of the parties involved. While in domestic factoring three parties are involved, there are usually four parties to a cross-border factoring transaction. They are:
(i) Exporter (client) (ii) importer(customer),(iii) export factor and (iv) import

factor. Since two factors are involved in the deal, international factoring is also called Two-Factor System of Factoring. The two-factor system results in two separate but inter-linked agreements. (a) Between the exporter (client) and the export factor and (b) Between the export factor and import factor. International factoring provides a non-recourse factoring deal. The clients (exporters) have cent per cent protection against bad debt loss on credit-approved sales. The factors take requisite assistance and avail facilities provided in the exporting country for export promotion. They handle exporters overseas sales on credit terms. f) LEGAL ASPECTS OF FACTORING: FACTORING CONTRACT: There is no codified legal framework/code to regulate factoring services in India. Factoring contract is like any other sale-purchase agreement regulated under the law of contract. The legal relationship between a factor and a client is largely

determined by the terms of the factoring contract entered into before the factoring process starts. Some of the contents of a factoring agreement and legal obligations of the parties: a) The client gives an undertaking to sell and the factor agrees to purchase receivables subject to terms and conditions mentioned in the agreement. b) The client warrants that the receivables are valid, enforceable, undisputed and recoverable. He also undertakes to settle disputes, damages and deductions relating to the bills assigned to the factor. c) The client agrees that the bills purchased by the factor on a non-recourse basis(i/e., approved bills) will arise only from transactions specifically approved by the factor or those falling within the credit limits authorized by the factor. d) The client agrees to serve notices of assignments in the prescribed form to all those customers whose receivables have been factored. e) The client agrees to provide copies of all invoices, credit notes, etc., relating to the factored accounts, to the factor and the factor in turn would remit the amount received against the factored invoices to the client. f) The factor acquires the power of attorney to assign the debts further and to draw negotiable instruments in respect of such debts. g) The timeframe for the agreement and the mode of termination are specified in the agreement. h) The legal status of a factor is that of an assignee. The customer has the same defence against the factor as he would have against the client.

i) The customer whose account has been factored and has been notified of the assignment is under legal obligation to remit the amount directly to the factor failing which he will not be discharged from his obligations to pay the factor even if he pays directly to the client unless the client remits the amount to the factor. IV.FORFAITING: a) Introduction: Forfeiting is a form of financing of receivables pertaining to international trade. It denotes the purchase of trade bills/promissory notes by a bank/financial institution without recourse to the seller. The purchase is in the form of discounting the documents covering the entire risk of non-payment in collection. All risks and collection problems are fully the responsibility of the purchaser (forfeiter) who pays cash to seller after discounting the bills/notes. The salient features of forfeiting: b)Salient Features: (a) In pursuance of a commercial contract between an exporter and importer, the exporter sells and delivers the goods to the importer on a deferred payment basis. (b) The importer draws a series of promissory motes in favour of the exporter for payment including interest charge. Alternatively, the exporter draws a series of bill which are accepted by the importer. The bills/notes are sent to the exporter. The promissory notes/bills are guaranteed by a bank which may not necessarily be the importers bank. The guarantee by the bank is referred to as an Aval, defined as an endorsement by a bank guaranteeing payment by the buyer (importer).

(c) The exporter enters into a forfeiting arrangement with a forfeiter which is usually a reputed bank including exporters bank. The exporter sells the avalled notes/bills to the bank (forfeiter) at a discount without recourse. The agreement provides for the basic terms of the arrangement such as cost of forfeiting, margin to cover risk, commitment charges, days of grace, fee to compensate the forfeiter for loss of interest due to transfer and payment delays, period of forfeiting contract, installment of repayment, usually bi-annual installment, rate of interest and so on. (d) Payment to forfeiter to the exporter of the face value of the bill/note less discount. (e) The forfeiter may hold these notes/bills till maturity for payment by the importers bank. Alternatively, he can securitize them and sell the short-term paper in the secondary market as high-yielding unsecured paper. c)FORFAITING Vs EXPORT FACTORING: Forfeiting is similar to cross-border factoring to the extent both have common features of non-recourse and advance payment. But they differ in several important respects:
a) A forfeiter discounts the entire value of the note/bill. The implication is

that forfeiting is hundred percent financing arrangement of receivables finance.

b) The availing bank which provides an unconditional and irrevocable

guarantee is a critical element in the forfeiting arrangement. The forfeiters decision to provide financing depends upon the financial standing of the availing bank.

c) Forfeiting is a pure financing arrangement while factoring also includes

ledger-administration, collection and so on.

d) Factoring is essentially a short-term financing deal. Forfeiting finances

notes/bills arising out of deferred credit transaction spread over 3-5 years. e) A factor does not guard against exchange rate fluctuations; a forfeiter charges a premium for such risk. d)ADVANTAGES AND EVALUATION: Factoring is to improve the financial discipline of the firm. Higher credit standing Improved efficiency More time for planning, production, planning Reduction of cost and expenses Additional source Evaluation framework Costs associated with In-house Management 1. Cash discount 2. Cost of funds invested in receivables 3. Bad debts 4. Lost contribution on foregone sales and 5. Avoidable costs of sales ledger administration and credit monitoring. Costs associated with Recourse and Non-recourse Factoring 1. Factoring commission

2. Discount charges 3. Cost of long-term funds invested in receivables Benefits associated with recourse Factoring They are in the terms of the costs associated with the in-house management alternative with the exception of item (3), namely, bad debt loss. Benefit associated with Non-recourse Factoring e)Operational Problems: The factoring service in India is still at a nascent stage. Its quantitative growth is relatively limited. Its future depends on the removal of a number of genuine operational obstacles. Credit Information: The factors do not have access to any authentic common source of information. They have to depend on their own data-base for credit evaluation of clients. Stamp Duty: The assignment of debt attracts stamp duty charged by the States which is as high as 15 per cent on the amount exceeding Rs 2 lakh. It inflates the cost of operations of service and erodes the profitability of the factors. Legal Framework: Changes are also called for in other components of the present legal framework to ensure success of factoring in India.

Funding: The factors in India are not allowed access to wider funding sources on scales available to other finance companies. Virtual dependence on equity funds does not permit them to have optimal funding. Disclaimer Certificate: To purchase a book debt of its clients, a factor needs a disclaimer certificate from banks. Limited Coverage: At present only domestic factoring of the advance with recourse is permitted and offered in India. It is high time to provide export factoring to Indian exporters.

Unit III I.Bill discounting a)INTRODUCTION

Bill discounting as a fund-based activity, emerged as a profitable business in the early nineties for finance Companies and represented a diversification in their activities in (Line with the emerging financial scene in India. In the post-1992 (scam) period its importance has substantially declined primarily due to restrictions imposed by the Reserve Bank of India-concept According to the Indian Negotiable Instruments Act, 1881: "The bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of that instrument." The bill of exchange (B/E) is used for financing a transaction in good which means that it is essentially a trade-related instrument.

b) Creation of a B/E
Suppose a seller sells goods or merchandise to a buyer. In most cases, the seller would like to be paid immediately but the buyer would like to pay only after some time, that is, the buyer would wish to purchase on credit. To solve this problem, the seller draws a B/E of a given maturity on the buyer. The seller has now assumed the role of a creditor; and is called the drawer of the bill. The buyer, who is the debtor, is called the drawee. The seller then sends the bill to the buyer who acknowledges his responsibility for the payment of the amount on the terms mentioned on the bill by writing his acceptance on the bill. The acceptor could be the buyer himself or any third party willing to take on the credit risk of the buyer Discounting of a B/E

The seller, who is the holder of an accepted B/E has two options: 1. Hold on to the B/E till maturity and then take the payment from the buyer. 2. Discount the B/E with a discounting agency. Option (2) is by far more attractive to the seller. The seller can take over the accepted B/E to a discounting agency [bank. NBFC, company, high net worth individual] and obtain ready cash. The act of handing over an endorsed B/E for ready money is called Financial Services , discounting the B/E. The margin between the ready money paid and the face value of the bill is called discount and is calculated at a rate percentage per annum on the maturity value. The maturity a B/E is defined as the date on which payment will fall due. Normal maturity periods 30, 60, 90 or 120 days but bills maturing within 90 days seem to be the most popular.

c)Types of Bills


Usance bill



D/a bills

D/p bills

There are various types of bills. They can be classified on the basis of when they are due for payment whether the documents of title of goods accompany such bills or not, the type of activity they finance, i so on. Some of these bills are: Demand Bill this is payable immediately "at sight" or "on presentment" to the drawee. A bill which no time of payment or "due date" is specified is also termed as a demand bill. Usance Bill this is also called time bill. The term usance refers to the lime period recognised custom or usage for payment of bills. Documentary Bills These are the B/Es that are accompanied by documents that confirm that a tri has taken place between the buyer and the seller of goods. These documents include the invoices and oil documents of title such as railway receipts, lorry receipts and bills of lading issued by custom officials Documentary bills can be

further classified as: (i) Documents against acceptance (D/A) bills i (ii) Documents against payment (D/P) bills. D/A Bills In this case, the documentary evidence accompanying the bill of exchange is deliverable against acceptance by the drawee. This means the documentary bill becomes a clean bill after delivery the documents. D/P Bllls In case a bill is a "documents against payment" bill and has been accepted by the drawee, documents of title will be held by the bank or the finance company till the maturity of the B/E. Clean BillS These bills are not accompanied by any documents that show that a trade has taken between the buyer and the seller. Because of this, the interest rate charged on such bills is higher than rate charged on documentary bills.

The advantages of bill discounting to investors and banks and finance companies are as follows: Investors 1. Short-term sources of finance; 2. Bills discounting being in the nature of a transaction is outside the purview of Section 370 of Indian Companies Act 1956. that restricts the amount of loans that can be given by group companies; 3. Since it is not a lending, no tax at source is deducted while making the payment charges which is v convenient, not only from cash flow point of view, but also from the point of view of companies that do envisage tax liabilities; 4. Rates of discount are better than those available on ICDs; and


5. Flexibility, not only in the quantum of investments but also in the duration of investments. Banks: Safety of Funds The greatest security for a banker is that a B/E is a negotiable instrument bearing signatures of two parties considered good for the amount of bill; so he can enforce his claim easilyCertainty of Payment A B/E is a self-liquidating asset with the banker knowing in advance the date of its maturity. Thus, bill finance obviates the maintaining large, un utilised, ideal cash balances as under the cash It also provides banks greater control over their drawls. Profitability Since the discount on a bill is front-ended, the yield is much higher than in other loans and advances, where interest is paid quarterly or half yearly. Evens out Inter-Bank Liquidity Problems The development of healthy parallel bill discounting market would have stabilized the violent fluctuations in money market as banks could buy and sell bills to even out their mismatches. Discount Rate and Effective Rate of Interest Banks and finance companies discounting bills prefer to discount L/C (letter of credit)-backed bills compared to clean bills. The rate of discount applicable to clean hills is usually higher than the rate applicable to L/C-based bills. The bills are generally discounted up-front, that is, the discount is payable in advance. As a consequence, the effective rate of interest is higher than the quoted rate (discount). The discount rate varies from time to time depending upon the short-term interest rate the call liquidity need credit for system.



The development of bill discounting as a financial service depends upon the existence of a full-fledged bill market. The Reserve Bank of India (RBI) has constantly endeavoured to develop the commercial bills market. Several committees set-up to examine the system of bank financing and money market had strongly recommended a gradual shift to hills finance and phase-out of the cash credit system. The most notable of these were; (i) Dehejia Committee, 1969, (ii) Tandon Committee, 1974, (iii) (iii) Chore Committee, 19SO and (iv)(iv) Vaghul Committee, 1985. This Section briefly outlines the efforts made by the RBI in the direction of the development of a full-fledged bill market.) e.(i).Bill Market Scheme, 1952 The salient features of the scheme were as follows: (i) The scheme was announced under Section 17(4)(c) of RBI Act which enables it to make advances to scheduled hanks against the security of issuance of promissory notes or bills drawn on and payable in India and arising out of bonafide commercial or trade transaction bearing two or more good signatures one of which should be that of scheduled bank and maturing within 90 days from the date of advances; (ii) The scheduled banks were required to convert a portion of the demand promissory notes obtained by them from their constituents in respect of loans/overdrafts and cash credits granted to them into usance promissory notes maturing within 90 days to be able to avail of refinance under the scheme; (iii) The existing loan, cash credit or overdraft accounts were, therefore, required to be split up into two parts, that is:

(a) one part was to remain covered by the demand promissory notes, in this account further withdrawals or repayments were as usual being permitted; (b) the other part, which would represent the minimum requirement of the borrower during the next three months would be converted into usance promissory notes maturing within ninety days (iv) This procedure did not bring any change in offering same facilities as before by banks to their constituents. Banks could lodge the usance promissory notes with RBI for advances as eligible security for borrowing so as to replenish their loanable funds. (y) The amount advanced by the RBI was not to exceed the amount lent by the scheduled banks to the respective borrowers. (vil The scheduled bank applying for accommodation had to certify that the paper presented by it as collateral arose out of bonafide commercial transactions and that the party was creditworthy. (vii)The RBI could also make such appropriate enquiries as it deemed fit, in connection with eligibilityof bills and call for any further information from the scheduled banks concerned (viil) Advances to hanks under the scheme, in the initial stages, were made at one-half of one per cent below the bank rate. The concessional rate of interest was withdrawn in two stages of one quarter of one per cent each and ceased to be operative from November 1956, (ix) As a further inducement to banks, the RBI agreed to bear half the cost of the stamp duty incurred converting demand bills into time bills. e.(ii)Bill Market Scheme, 1970 In pursuance of the recommendations of the Dehejia Committee, the RBI constituted a working group (Narsimham Study Group) to evolve a scheme to enlarge the use of bills. Based on the scheme suggested by the study group, the RBI

introduced with effect from November 1, 1970, the new bill market scheme in order to facilitate the re-discounting of eligible bills of exchange by banks with it. Eligible Institutions All licensed scheduled banks and those which do not require a licence (i.e. the State Bank of India, its associate banks and natioanlised banks) are eligible to offer bills of exchange to the RBI for rediscount. Eligibility of Bills The eligibility of bills offered under the scheme to the RBI is determined by the statutory provisions embodied in section 17(2)(a) of the Reserve Bank of India Act, which authorise the purchase, sale and rediscount of bills of exchange and promissory notes, drawn on and payable in India Procedure for Rediscounting Eligible banks are required to apply to the RBI in the prescribed form giving their estimated requirements for the 12 month ending October of each year and limits are sanctioned/renewed for a period of one year running from November 1 to October 31 of the following year. The RBI presents for payment bills of exchange rediscounted by it and such bills have to be taken delivery of by the rediscounting banks against payment, not less than three working days before the dates of maturity of the hills concerned. In case bills are retired before the dates, pro-rata refund of discount is allowed by the RBI. For rediscounting purposes, bills already rediscounted with RBI may be lodged with it. The unexpired period of the usance of the hills so offered should not he less than 30 days and the bills should not bear the endorsement of the discounting hank in favour of a party other than the RBI. Credit Assessment Banks and NBCFs (the main discounting agencies) undertake a detailed appraisal of a customer and thoroughly assess his creditworthiness before providing the bills discounting (BD facility. Regular credit limits arc fixed by banks and NBFCs for individual parties for purchase and discounting of clean bills and documentary bills separately. These limits are renewed annually and are based on the following considerations:

(i) Quantum of business undertaken by the party, that is, turnover of inventory; (ii) Credit worthiness of drawer (client); (Hi) Credit worthiness of drawee and details of dishonour, if any; (iv) Nature of customer's industry The earlier sanctioned limits are fully utilised by the client', The bills were promptly paid on maturity date; (iii) In case of unpaid bills, funds were paid by the drawer. Once the party is granted a bill discounting limit, the party approaches the finance company for each and every bill for discounting. The following documents are submitted alongwith the letter of request: (a) Invoice; (b) Challan; (c) Receipt of goods acknowledged by buyer; (d) Hundi/Promissory note; (e) Truck receipt/Railway receipt; (f) Post dated cheque for the interest amount. While fixing the limit for bill discounting the balance sheet and profit and loss account are properly analysed and various ratios are calculated to arrive at a sound business decision. Precautions The finance companies take following precautions while discounting bills: (i)The bills are not accommodation bills but are genuine trade bills. (ii) Bills are drawn on the places where the finance company is operating or has a branch office as itwould facilitate contact with drawee in case of exigencies. (iii)The goods covered by the documents are those in which they party deals.

(iv)The amount of the bills commensurate with the volume of business turnover of the party.Bills are drawn on a place where the goods have been consigned, (v)The credit report on the drawee is satisfactory. (vi) The description of goods mentioned in the invoice and railway receipt/truck receipt are same. (vii) The goods are not consigned directly to the buyer. (viii) The goods are properly insured. (ix) The usance bill is properly stamped. (x) Bills offered for discount do not cover goods whose prices fluctuate too much. (xi) The goods covered under the bill are not of perishable nature. (xii) The bills are not stale. (xiii) The truck receipt is in the form of prescribed by the Indian Banks Association. (xiv) The bills are drawn in favour of the finance company and have been accepted by the drawee.

Dealing with Default

The cycle of liabilities in a bill discounting transaction is as follows: The "drawee is liable to the drawer; and the drawer to the discounting agency. However, the bank/NBFC looks mainly to its customer (drawer or drawee) for recovery of its dues. In case of default, the discounting agency can resort to noting and protesting as laid down by the negotiable instrument act

II. Housing Finance


The responsibility to provide housing finance largely rested with the Government of India till the mid-eighties. The setting up of the National Housing Bank (NHB), a fully owned subsidiary of the Reserve Bank of India (RBI) in 1988, as the apex institution, marked the beginning of the emergence of housing finance as a fund-based financial service in the country. It has grown in volume and depth with the entry of a number of specialised financial institutions/companies in the public, private and joint sectors, although it is at an early stage of development.\Section I of the Chapter profiles the NHB. The NHB housing finance companies (HFCs) directions and guidelines relating to (i) acceptance of deposits, (ii) prudential norms, (Hi) directions to auditors, (iv) miscellaneous matters are comprehensively covered in Section 2. Sections 3-4 describe respectively the NHB's equity and refinance supports to the HFCs. While Section 5 sketches the housing finance systems in the country, mortgage-based securitisation by the NHB is illustrated in Section 6. A brief account of securitisation is given in Appendix 8-A. The main points are summarised in the last Section. b)NATIONAL HOUSING BANK (NHB) The NHB was established in 1988 under the NHB Act, 1987, to operate as a principal agency to promote housing finance institutions (HFIs), at both local and regional levels, and to provide financial and other support to them. The HFIs include institutions, whether incorporated or not, that primarily transact or have as one of their principal objects the transacting of the business of providing finance for housing, either directly or indirectly The general superintendence, direction and management of the affairs and business of the NHB is vested in its Board of Directors, which exercises all powers and executes all acts and things on its behalf. Subject to the provisions of the NHB Act. the Board, while discharging its functions, has to act on business principles, with due regard to public interest. In general,

(a) the Chairman, if he is a whole-time Director or if he is holding offices both as a Chairman and a Managing Director (CMD) or (b) the MD. if the Chairman is not whole-time director or is absent, can also exercise these powers of the Board. The MD has to follow, in the discharge of his powers and functions, all directions given by the Chairman, In the discharge of its functions. the NHB is to be guided by the directions given in Government in consultation with the RBI,/or by the RBI in involving public interest. The Board of Directors of the NHB consists of A Chairman and a Managing Director (CMD), two Directors from amongst experts in the field of housing, architecture, engineering, sociology, finance, law, management and corporate planning, or in any other field, special knowledge of which is considered useful to Ihe NHB, two Directors who are persons with experience in the working of institutions involved in providing finance for housing or engaged in housing development or have experience in the working of financial institutions/hanks, two Directors elected by shareholders other than the RBl Business NHB is authorised to transact all/any of the following kinds of business: (a) Promoting, establishing, supporting/aiding in the promotion/establishment/ support of housing financing institutions (HPIs); (b) Making of loans and advances or rendering any other form of financial assistance, whatsoever, for housing activities to HHs. banks, slate cooperative, agricultural and rural development banks or any other institution/class of institutions notified by the Government; (c) Subscribing to/purchasing stocks, shares, bonds, debentures and securities of every other description; writing matters by of the policy

(d) Guaranteeing the financial obligations of HPIs and underwriting the issue of stocks/shares/bonds/ debentures/other securities of HFIs (e) Drawing, accepting, discounting/rediscounting, buying/selling and dealing in bills of exchange/ promissory notes, bonds/debentures, hundies. coupons/other instruments (f) Promoting/forming/conducting or associating in promotion/formation/conduct of companies/moit-1 gage banks/riubsidiaries/soeicties/trusta/olher associations of persons it may deem fit for carrying, out all/any of its functions under the NHB Act; (g) Undertaking research and surveys on construction techniques and other studies relating to/connected with shelter/housing and human settlement; (h)Formulating schcme(s) for purposes of mobilisation of resources and extension of credit for housing; (i) Formulating scheme(s) for the economically weaker sections of society, which may be subsidised by the Government or any other source (j) Organising training progninimes/.seminars/symposia on matters relating to housing; (k)Providing guidelines to HFIs to ensure their growth on sound lines' (l)Providing technical/administrative assistance to HFI.s ' (m) Generally, doing of all such matters and things as may be incidental to orconsequential upon the exercise of its powers or the discharge of its duties under the NHB ActT Borrowing and Acceptance of Deposits For purposes of carrying out its functions, the NHBmay: (a) issue and sell bonds and debentures with or without the guarantee of the Central Government, such manner and on such terms as may be prescribed borrow money from the Central Government, banks, financial institutions, mutual funds and from any other authority or organisation or institution approved by the Government on such terms and conditions as may be agreed upon;

(c) accepting deposits repayable after such period and. such terms -as may generally or specially be approved by the RBI; (d) borrow money from the RBI fi) by way of loans and advances and, generally, obtain financial assistance in a manner specified by the RBI; (ii) out of the National Housing Credit (long-term . operations) Fund established under Section 46-D of the RBt Act; (e) receive, for services rendered, remuneration, commission, commitment charges, consultancy charges. service charges, royalties, premia, licence fees and other considerations of any description; (f) receive gifts, grants, donations or benefactions from the Government or any other source. Loans in Foreign Currency The NHB may borrow in foreign currency from any bank/financial institution in India/abroad in such manner and on such conditions as may be prescribed in consultation with the RBI and with the prior approval of Government. The NHB may also provide guarantee as to payment of interest and other incidental charges, as well as repayment of the principal. Assistance to Borrow Where any person/institution seeks any financial assistance from the NHB on the security of any (i) movable property belonging to him/institution or (ii) the property of some other person offered as collateral for such assistance, a written declaration would have to be executed in the prescribed form stating the particulars of the security/collateral security and agreeing that the dues relating to the assistance would be a charge on such property.. With the prior approval of the NHB, the above declaration may be varied/revoked at any time by the concerned person/institution Amount/Security to be Held in Trust Any sum received by a borrowing institution in repayment/ realisation of loans/advances financed/refinanced wholly/partly by the NHB, to the extent of the accommodation granted by it and

remaining outstanding, would be deemed to have been received by it in trust and should accordingly be paid by the institution to the NHB. Power to Transfer Rights The rights and interests of the NHB in relation to any loan/advance made or any amount recoverable may be transferred by it wholly or partly in any form. Not with standing such transfer, the NHB may act as a trustee for the transferee in terms of Section 3 of the Indian TrustsAct. 1882 Power to Acquire Rights The NHB has the right to acquire, by transfer/assignment, the rights and interests of any institution in relation to any loan/advance made/amount recoverable wholly or partly by the execution/issue of any instrument or by the transfer of any instrument or in any other manner in which the rights and interests in relation to such loan/advance may be lawfully transferred. / Exemption from Registration Subject to Section 17(1) of the Registration Act, 1908, (a) any instrument in the form of debt obligations/trust certificates of beneficial interest/other instruments, by whatever name called, issued by the NHB to securities loans granted by HFIs/banks and not creating/ declaring/assigning/limiting /extinguishing any right/title or interest to or in immovable property, except in so far as it entitles the holder to an undivided interest offered by a registered instrument, whereby the NHB has acquired the rights/interests in relation to such loans and in securities there form or (b) any transfer of the above instruments would not require compulsory registration Recovery of Dues as Arrears on Land Revenue Where any amount is due under an agreement to it acting as a trustee, or otherwise, in respect of the securitisation of loans of HFIs/banks, in addition to any other mode of recovery NHB may approach a state government for its recovery in the same manner as arrears of land revenue Power to Impose Conditions To protect its interests, the NHB may impose such conditions as it may think necessary/expedient in respect of any transaction entered into with any borrowing institution

Access to Records The NHB would have free access to all such records of the institution/persons) availing of any credit facilities from it/the institution, the perusal of which may be necessary in connection with the provision of finance or other assistance to the institution Validity of Loans/Advances The validity of any loan/advance by the NHB cannot be questioned merely on grounds of non-compliance with the requirements of any other law/resolution/contract or any instrument relating to the constitution of the borrowing institution Prohibition on Loans Against Own Bonds/Debentures Loans/advances against the security of its own bonds/debentures, by the NHB, is totally prohibited. Power to Inspect The NHB has the power to inspect the books/accounts/other documents of any institution to which it has made any loan/advance or granted any other financial assistance on its own or on direction from the RBI Power to collect and Publish Credit Information To discharge its functions efficiently, the NHB may direct an institution at any time. to submit to its credit information in the specified form and within the time specified by it from time to time. Credit information refers to any information relating to (i) the amount of loans/advances/other credit facilities granted for housing purposes, (ii) the nature of security taken for them, (iii) the guarantees furnished and (iv) any information that which has a bearing on the borrowers' credit worthiness. Advisory Services The NHB is authorised to provide advisory services to the Goverment(s), local authorities/other agencies connected with housing in respect of (a) formulation of overall polices aimed at promoting the growth of housing and HPI, and (b) legislation relating to matters having a bearing on shelter, housing and settlement. e)Deposits with Housing Finance Institutions Registration and Net Owned Funds to commence/carry on business, every HFI set-up as a company should (a) obtain a certificate of registration from the NHB and

(b) have net owned funds of Rs 25 lakhs or other such higher amounts as may be specified by the NHB from time to time. Net owned funds (NOFs) refer to (a) the aggregate of the paid-up equity capital and free reserves as disclosed in the latest balance sheet of the HFI, minus accumulated balance of loss, deferred revenue expenditure and other intangible assets and (b) further reduced by the amount representing (1) investments in shares of subsidiaries/group companies/all other HFIs that are companies and (2) book value of debenture s/bonds/outstanding loans/advances (including hire purchase and lease finance) made to, and deposits with, subsidiaries and group companies to the extent such amount exceeds 10 per f)cancellation of Registration The registration of a HFI can be cancelled by the NHB if it (a) ceases to carry on business, (b) has failed to comply with any condition, subject to which the registration was issued, (c) at any time fails to fulfil any of the conditions laid down for grant of registration, discussed above, (d) fails (i) to comply with any direction issued by the NHB (ii) to maintain accounts in accordance with the requirement of any law/any order/direction issued by the NHB and (iii) to submit/offer for inspection its books of accounts/other relevant documents when so demanded by an inspecting authority of the NHB and (e) has been prohibited from accepting deposits by an order made by the NHB, which has been in force for at least three months Furnishing of Statements All HFIs are required to furnish the statements/information/particulars called for in the form,-prescribed by the NHB and comply with any direction given to them in relation to | acceptance of deposits g)Powers and Duties of Auditors of HFIs The auditors should enquire whether HFIs have i furnished the NHB with the statements, information, or particulars relating to, or connected, with deposits ' received by them, as required under the provisions of the NHB Act. Except where satisfied on such enquiry about compliance, they should submit a report to the NHB giving the aggregate amount of deposits held by them

Power of the NHB to Prohibit Acceptance of Deposits The


may prohibit any


from accepting any deposit on violation of provisions or failure to comply with any direction/order given by it in relation to the acceptance of deposits. In addition, it may, if necessary in public/depositors' interest, direct such a HFI not to sell, transfer, create charge/mortgage or deal in any manner with its property and assets without the NHB's prior written permission, for a period not exceeding six months from the date of the order Filing of Winding-Up Petition On being satisfied that a HFI (i) is unable to pay its debt, (ii) ha^ become disqualified in terms of registration and net owned funds requirements to carry on business, (iii) has been prohibited by the NHB from receiving deposits, by an order in force for a period of at least three months, (iv) continuing in business is detrimental to the public interest/interest of depositors, NHB may file an application for its winding-up under the Companies Act. Inspection To verify the correctness/completeness of any statements/ information/particulars furnished to the NHB or to obtain any information/particulars which the HFI has failed to furnish, on being called up, the NHB may conduct an inspection by its officers) (inspecting authority). Every Director/member of any committee or other body/any person for the time being vested with the management of the whole/part of the affairs of the HFI and accepting deposits and other officers/employees would be duty bound to produce to the inspecting all books, accounts and other documents in custody / power to furnish any statement / information related to the business of the HFI, required within the specified time

NHB S HOUSING FINANCE COMPANIES DIRECTIONS The NHB had issued the Housing Finance Companies (HFCs) Directions in 1989 in public interest. It had also issued guidelines to them on prudential norms on

income recognition, accounting standards, asset classification, provisioning for bad and doubtful debts, capital adequacy and concentration of credit/investments. The NHB Act was amended comprehensively in 3000 to enable the NHB to safeguard the interest of depositories and promote healthy and universal growth of HFCs in the country

h)Acceptance of Public Deposits

Any HFC having NOFs of less than Rs 25 lakh cannot accept public deposits. NOFs mean Net Owned Fund (NOF) defined under Section 29-A of the NHB, including paid-up preference shares compulsorily convertible into equity capital A public deposit means a deposit but does not include the following; ' (a) Amount received from (i) the Central government and state government, (ii) any other source whose repayment is guaranteed by the Central Government or a slate government, (iii) a local authority (b) Amount received from the NHB, Industrial Development Bank of India, Life Insurance Corporation of India, General Insurance Corporation of India and its subsidiaries Amount received from another company (d)Amount received by way of subscription to any shares, stock, bonds, (e) Amount received from a person who at the time of receipt of the amount was a Director of the HFC (f)Amount raised by the issue of bonds debentures secured by the mortgage of any immovable property of the HFC (g)Amount brought in by the promoters by way of unsecured loan, subject to the conditions that (I) the loan is brought in pursuance of the stipulations imposed by the lending public financial institution)* ie a public financial institution in terms of Section 4-A of the Companies Act/a State Financial or Industrial Corporation/bank/General Insurance Corporation/any other institution notified by the

NHB) in fulfillment of the obligation of the promoters to contribute such finance, (ii) the loan is provided by the promoters themselves and/or by their relatives, but not from their friends and business associates and (iii) the exemption would be available only till the loan of the lending public financial institution is repaid (h)Any amount received from mutual funds (i) Amount received as hybrid/subordinated debt with a maturity period of at least five years (j)Amount received from a relative of a director of a HFC

i)Prudential Norms
The NHB guidelines to HFCs on prudential norms for income recognition, income from investments, accounting standards, accounting for investments, asset classification, provisioning requirements, capital adequacy and concentration of credit/investments are discussed below Income Recognition Income recognition should be based on recognised accounting principles. Income including interest/discount or any other charges on NPAs should be recognised only when it is actually realised.)Any such income recognised before the asset became NPA should be reversed. Where hire purchase instalments/lease rentals ar overdue for more than twelve months, income should be recognised only when they are actually received. Income from Investments Income from dividend on shares of corporate bodies and units of 'natural funds should be taken into account on cash basis. But when such dividend has been declared in the annual general meeting and .the HFC's right to receive payment is established, such income may be taken into account on accrual basis.

Income from bonds/debentures of corporate bodies and from Government securities/bonds may be taken into account on accrual basis if the interest on these instruments is predetermined, is serviced regularly and in not in arrear

j)Accounting Standards
Accounting Standards and Guidance Notes issued by the Institute of Chartered Accountants of India (ICAI) should be followed in so far as they are not inconsistent with any of these directions. Accounting for Investments All investments in securities should be classified as current and long-term investments. A current investment is an investment that is by nature readily realisable and is intended to be held for not more than one year from the date on which such investment is made Quoted Current Investment Quoted current investments should, for the purposes of valuation, he grouped into the following categories: (a) equity shares: (b) preference shares; (c) debentures and bonds; (d) Government securities, including treasury bills; (e) units of mutual funds and (f) others. Quoted current investments for each category should be valued at cost or market value, whichever is Unquoted Equity Shares This, in the nature of current investments should be valued at cost or break-up value, whichever is lower. However, MFCs may substitute fair value for break-up value of the shares, if considered necessary. Where the balance sheet of the investce company is not available for two years, such shares should be valued at one rupee only. While "fair value" refers to the mean of the earning value and the break-up value, the "earning value" means the value of an equity share

computed by taking the average of profits after tax as reduced by the preference dividend and adjusted for extraordinary and non-recurring items, for the immediately preceding three years, and further divided by the number of equity shares of the investee company and capitalised at 8 per cent, 10 per cent and 12 percent in the case of predominantly (i) manufacturing company, (ii) trading company and (iii) any other. III.Insurance services INTRODUCTION Insurance is pooling of risks. In a contract of insurance, the insurer (insurance company) agrees/undertakes, in consideration of a sum of money (premium), to make good the loss suffered by the insured against a specified risk such as fire and any other similar contingency or compensate the insured/beneficiaries on the happening of a specified event such as accident or death. Thus, there are two parties to an insurance contract: insurer/assurer/underwriter and (ii) insured/ass ured/beneficiary. The document laying down the terms of the contract is called (insurance) policy. The property which is insured is the subject-matter of insurance. It may be insured against loss arising from uncertain events/casualties/perils in the form of destruction of, or damage to, the property or death/disablement of a person. The interest which the insured has in the subject-matter of insurance is known as insurable interest Life insurance, under which a specified amount becomes payable on the death of the insured or upon the expiry of a specified period of time, whichever is earlier.A General insurance, which covers losses caused by fire, accident and marine adventures and so on b ) INSURANCE ACT. 1938 The Insurance Act provides the broad framework for the insurance sector/industry/services in the country Eligibility

Any class of insurance business in India can be carried out only by a public company, a cooperative society, an insurance cooperative society, having paid-up capital of Rs 100 crore, a body corporate other than a private company incorporated in any country outside India) However, only Indian insurance companies arc permitted to carry out any class of insurance business after the enactment of the IRDA Act. 1999 An Indian insurance company is defined as a company formed/registered under the Companies Act in which the aggregate holding of equity shares by a foreign company, cither by itself or through subsidiaries/nominees, docs not exceed 26 per cent paid-up equity capital and whose sole purpose is to carry on life/general/insurance business Life business means the business of effecting contracts of insurance upon human life, including any contract whereby the payment of money is assured on death except death by accident only) or the happening of any contingency dependent on human life- and any contract which is subject to payment of premiums for a term dependent on human We, and should be deemed to include (a) grant of disability (b) grant of annuities upon human life and (c) grant of superannuation allowance/annuities payable out of "any fund applicable solely to the relief and maintenance of persons engagedGeneral insurance business is defined to mean fire, marine/miscellaneous insurance business whether carried on singly or in combination with one/more of them. tire insurance business means the business of effecting, other than incidental, to some other class of insurance business, contracts of insurance against loss by or incidental to fire other occurrence customarily included among the risks insured against in fire insurance policies Marine insurance business means the business of effecting contracts of insurance upon vessels of any description including cargos, freights and other interests which may be legally insured in or in relation to such vessels, cargos and freights,


disc/ properly of whatever description insured for any transit

by land or water or both and whether or noi including warehouse risks or similar risks in addition or as incidental to such transit, and includes any other risks customarily included among the risks insured in marine insurance policies C )INSURANCE REGULARITY AND DEVEVELOPEMENT AUTORITY (IRDA) Following the recommendations of the Malhotra Committee, pending the enactment of a comprehensive legislation, on January 23, 1996, the Government of India to regulate the insurance sector approved the setting up of the interim Insurance Regulatory Authority (IRA) that would replace the controller of Insurance (COI) and be under the overall control of the Ministry of Finance. It had been entrusted with the task of preparing a comprehensive legislation to establish a statutory, autonomous IRA on the pattern of the Securities and Exchange Board of India (SEBI).\ c. (i).Salient Features of Interim IRA The chairman of the IRA was the ex-officio COI under the Insurance Act, 1938, and exercised all powers vested with the COI. The interim IRA was authorised to examine the powers withdrawn from the COI or modified through government notifications issued from time to time or delegated to the LIC/GIC under nationalising enactments of the insurance business that needed to be restored to the COI. While undertaking this exercise, the IRA had to bear in mind the possibility of privatisation of the insurance industry, wholly/ partially and make appropriate recommendations regarding the role and powers which it would need in such a scenario. It could also examine the powers of the government under the Insurance Act, 1938, which could be transferred to the IRA as and when it would be set upc.(ii)Insurance Regulator/ and Development Authority (IRDA) Act, 1999 In order to provide better insurance cover to citizens and also to augment the flow of long-term sources of financing infrastructure, the government reiterated its announcement of 1996 in its budget speech, 1998. to open up the insurance sector and also set up a statutory IRDA- The IRDA Act was enacted in 1999 to provide for the

establishment of the IRDA to protect the interests of policy holders, to regulate, promote and ensure orderly growth of the industry and for matters connected therewith/incidental thereto and also to amend the. Insurance Act, 1938, the LIC Act, 1956, and the General Insurance Business (Nationalisation) Act, 1972. Composition of IRDA The IRDA would consist of a chairperson and not more than nine members of whom not more than five would be full-time members, to be appointed by the government from amongst persons of ability, integrity and standing who have knowledge/experience of life insurance/general insurance/actuarial service, finance/economics/law/accountancy/administration/any other discipline which in the opinion of the government would be useful to itDuties/Powers/Functions of IROA: Duties The duty of the IRDA is to regulate, promote and ensure orderly growth of the insurance and reinsurance businesses. c.(iii)Powers and Functions The powers and functions of the IRDA, inier-alia, are stated below: a) Issue to the applicant a certificate of registration: to renew, modify, withdraw, suspend or cancel such registration; preference in registration to be given to companies providing with health insurance (b) Protection of the interests ofpolicyholders in matters concerning assigning of policy, nomination by y policy-holders, insurable interest, settlement of insurance claim, surrender value of policy, and other terms and conditions of contracts of insurance (C)Specifying requisite qualifications and practical training for insurance intennediaries (d)Specifying the code of conduct for surveyors and loss assessors (e) Promoting efficiency in the conduct of insurance business ,

(f) Promoting and regulating professional organisations connected with the insurance and reinsurance business; levying fees and other charges for carrying out the purposes of the IRDA Act (g) Calling for information from, undertaking inspection of, conducting enquiries and investigations. including audit of insurers, insurance, intermediaries and other organisations connected with the insurance business h) Control and regulation of the rates, terras and conditions that may be offered by insurers in respect of general insurance business not $o controlled and regulated by the Tariff Advisory Committee under Section 64U of the Insurance Act. 1938 (i) Specifying the form and manner in which books of account would be maintained and statement of accounts rendered by insurers and insurance intermediaries j) Regulating investment of funds by insurance companies; regulating maintenance of margin of solvency k)Adjudication of disputes between insurers and intermediaries or insurance intermediaries (L). --Supervising the functioning of the Tariff Advisory Committee (m)- Specifying the percentage of premium income of the insurer to finance schemes for promoting and (n) regulating professional organisations referred to above Specifying the percentage of life insurance and general insurance business' by me insurer in the rural or social sector (o) Exercising such other powers as may be prescribed Power to Make Regulations The IRDA may make regulations consistent with the Insurance Act/rules/regu) aliens to carry out its provisions to provide, in particular, for ail or any of the following Matters relating to registration of insurers The manner of suspension or cancellation of registration

Such fee, not exceeding Rs 5,000, as may be determined by the issue of a .1 duplicate certificate of registration Matters relating to renewal of registration (y-) The manner and procedure for divesting excess share capital (vi)Preparation of the balance sheet, profit and loss account and a separate account of receipt said payments and revenue account The manner in which an abstract of the report of the actuary is to be specified The form and the manner in which the statement of business in force .should be appended The time, manner and the other conditions of investment of assets held by an insurer. The minimum information to be maintained by an insurer in their books, the manner in which such information should be maintained, the checks and other verifications to be adopted by insurers in that connection and alt other matters incidental thereto The manner of making an application, the manner asd the fee for issuing a licence to act as an insurance agent (xii) The fee and the additional fee to be determined for renewal of licence of an insurance agent . The requisite qualifications and practical training to act as an insurance agent (xiv) he passing of examination to act as an insurance agent (xv)- The code of conduct of an insurance agent " (xvi)The fee not exceeding Rs 50 for the issue of a duplicate licence (xvii) The manner and the fees for the issue of a licence to aRyinlermerttaryor an insurance intermedi(xviii) The fee and the additional fee be determined for the renewal of licence of intermediaries or insurance intermediaries

(xix)The requisite qualifications and practical training of intermediaries or insurance intermediaries The examination to be passed to act as an intermediary or insurance intermediary , The code of conduct for an intermediary/insurance intermediary (xx) The fee for the issue of a duplicate licence Such matters as relating to the Tariff Advisory Committee (xxi) Matters relating to the licensing of surveyors and loss assessors, their duties, responsibilities and other professional requirements asset or assets as may be specified for evaluating the purposes of ascertaining sufficiency of assets The valuation of assets and liabilities (xxii)Matters relating to the sufficiency of assets (xxiii)'Matters relating to reinsurance IV. VENTURE CAPITAL FINANCING Introduction Venture capital institutions which emerged the world over to fill gaps in the conventional financial mechanism focused on new entrepreneurs, commercialisation of new technologies and support to small and medium enterprises in the manufacturing and the service sectors. Over the years, the concept of venture capital has undergone significant changes. The modus operand! has shifted from technologyoriented manufacturing organisations to being very close to "private equity class" for unlisted new companies in all sectors of the economy, irrespective of the nature of their projects. They also maintain a close rapport and a 'hands-on' approach in nurturing investments during their association with the assis led/in vestee companies as active partners rather than as passive investors. The initial steps for the institutionalisation of venture capital in India were taken by the Government in November, 1988. when guidelines were issued for setting up of

venture capital funds/companies (VCFs/VCCs) for investing in unlisted companies and to avail of a concessional facility of capital gains tax. b)Features Venture capital has, somehow, come to acquire various connotations. It is defined as an equity/equity-related investment in a growth-oriented small/medium business to enable investees to accomplish corporate objectives, in return for minority shareholding in the business or the irrevocable right to acquire it. Venture capital is a way in which investors support entrepreneurial talent with finance and business skills to exploit market opportunities and, thus, to obtain long-term capital gains let is the provision of risk-bearing capital, usually in the form of participation in equity, to companies with high-growth potential. In addition, it provides some value addition in the form of management advice and contribution to overall strategy. The relatively high risks are compensated by the possibility of high return, usually through substantial capital gains in the medium term. According to a very widely-accepted definition, venture capital is described as a separate asset class, often labelled as private equity Venture capital is basically equity finance in relatively new companies when it is too early to go ta\ the capital market to raise funds It is a long-term investment in growth-oriented small/medium firms. The acquisition of outstanding shares from other shareholders cannot be considered venture capital investment''^ is new, long-term /capital that is injected to enable the business to grow rapidly. There is a substantial degree of active involvement of the venture capital institutions with the promoters of the venture capital A venture capital financing involves high risk-return spectrum Some of the ventures yield very high returns to more than compensate for heavy losses on others which also may have had potential of profitable

returns. The returns in such financing are essentially through capital gains at the time of -exits from disinvestments in the capital market. Venture capital is not technology finance though technology finance may form a subset of venture capital financing c)The Stages of Financing The selection of investment by a VCI is closely related to the stages and type of investment. From analytical angle, the different stages of investments are recognised and vary as regards the time-scale, risk perceptions and other related characteristics of the investment decision process of the VCIs c.(i)Earty Stage Financing Seed Capital This stage is essentially an 'applied research' phase where the concepts and ideas of the promoters constitute the basis of a pre-commercialisation research project usually expected to end in a prototype which may or may not lead to a business launch The main risk at this stage is marketing related. The commercial acumen of the promoter to take advantage of the market opportunity, awareness of competition, the timing of launching the product and so on, are important elements of the appraisal. The risk perception of investment at this stage is extremely high. However, very few VCIs invest in this pre-commercialisalion/seed stage of product development. c.(ii)Start-Up This is the stage when commercial manufacturing has to commence. Venture capital financing here is provided for product development and initial marketing. The essence of this stage is that the product/ service is being commercialised for the first time in association with the VCIs c.(iii).Second Round Financing This represents the stage at which the product has already been launched in the market but the business has not, yet, become profitable enough for public offering to attract new investors. The promoter has invested his own funds but further infusion of funds by the VCIs is necessary

Stages of Financing The selection of investment by a VCI is closely related to the stages and type of investment. From analytical angle, the different stages of investments are recognised and vary as regards the time-scale, risk perceptions and other related characteristics of the investment decision process of the VCIs c.(iv).laterStage Financing This stage of venture capital financing involves established businesses which require additional financial support but cannot take recourse to public issues of capital. It includes mezzanine/development capital, bridge/expansion, buyouts and turnarounds. Mezzanine/Development Capital This is financing of established businesses which have overcome the extremely high-risk early stage, have recorded profits for a few years but are yet to reach a stage when they can go public and raise money from the capital market/conventional sources Bridge/Expansion This finance by VCIs involves low risk perception and a timeframe of one to three years. Venture capital undertakings use such finance to expand business by way of growth of their own productive asset or by the acquisition of other firms/assets of other BuyOuts These refer to the transfer of management .control. They fall into two categories: management buyouts (MBOs) and management buyins 'anagement BuyOuts In MBOs, VCIs provide funds to enable the current operating management/ investors to acquire an existing product line/business. Management Buyins MBIs are funds provided to enable an outside group [of manager(s)] to buy an Ongoing company. They usually bring three elements together: a management team, a target company and an investor Buyouts involve a time-frame from investment to public offering of one to three years with low risk perception. Turnarounds These are a sub-set of buyouts and involve buying the control of a sick company. Two Kinds of inputs are required in a turnaround namely, money and

management. The VCIs have to identify good management and operations leadership. Such form of venture capital financing involves medium to high risk and a time-frame of three to .five years. It is gaining widespread acceptance and increasingly becoming the focus of attention of VCIs Stages of Investments As pointed out earlier, the methods of portfolio valuation of shares depend on the stage of venture capital investments. Unquoted Venture Investments Unquoted venture investments are defined as investments in immature companies, namely, seed, start-up and early stage, until the companies stabilise and grow. They should generally be valued at cost as their market value is not available Unquoted Development Investments Unquoted development in vestments, are investments in mature companies with a profit record and where an exit can be reasonably foreseen, quoted Investments Quoted investments in companies which have achieved a possible exit by floatation of issues. They are valued at market quotations. In case of restrictions/limitations on the sale of shares, a suitable discount should be applied to the market value of the shares d) Debt Instruments VCIs provide, in addition to equity capital, debt finance. From the point of view of their valuation as a part of the overall portfolio (fund), they are divided into convertible, non-convertible and leveraged Convertible Debt Debt instruments are generally valued at cost. But convertible debts are converted into equity at a specified price and time.; Market Value Method This is appropriate for quoted convertible debt investments on the basis of the -same principles as are applicable to quoted investments.

Value Method This is appropriate, as in the case of unquoted equity investments, for unquoted convertible debt investments. As pointed out earlier, the valuation according to this method is based on the price agreed upon in an open and unrestricted market Non-convertible Debt This debt supplied by VCIs can be of two types: fixed interest bearing such as bonds/debentures and mortgages and non-interest bearing such as zero interest bonds and secured premium notes. Fixed Interest Non-convertible Debt This should be valued by relating the nominal yield of the investment to an appropriate current yield which depends upon a number of factors such as interest yield on the date of valuation, maturity date of the issue, safety of the principal, debt-service coverage, stability and growth of the earnings of the venture and so on. Non-interest Non-convertible Debt A factor of critical importance in this case is the solvency of the venture. If it is doubtful, an appropriate discount rate may be used to the value computed according to the method used for valuating fixed interest nonconvertible debt EXIT The last stage in venture capital financing is the exit to realise the investment so as to make a profit/ minimise losses. In fact, the potential exit in terms of the realisation horizon (exit timing) has to be planned at the time of the initial investment itself. The precise timing of exit depends on several factors such as nature of the venture, the extent and type of financial stake, the state of actual and potential competition, market conditions, the style of functioning as well as perception of VCIs and so on. For example, early stage financing typically takes a long-term view of eventual realisation/exit from five to seven years. In case of later stage financing, the realisation horizon could be shorter in the range of three to fives e) VENTURE CAPITAL FUNDS

Nodal Agency for VCFs To simplify procedure, the Finance Act, 2000 has made SEBI the single-point nodal agency for registration and regulation of both domestic and overseas Venture Capital funds (VCFs). No approval of VCFs by tax authorities is required. VCFs shall enjoy a complete pass-through status. There will be no tax on distributed or undistributed income of such funds. The income distributed by the funds will only be taxed in the hands of investors at the rates applicable to the nature of income. e.(i) Investment Restrictions The following restrictions apply to investments by VCFs: (a) VCF has to disclose the investment strategy at the time of application for registration, (b) A VCF cannot invest more than 25% corpus of the fund in one venture capital undertaking (VCU)/ (c) VCF cannot invest in the associated companies, and (d) VCF have to make investment in the VCU as per following: (i) At least 75% of the investible fund has to be invested ' (ii) Not more than 25% of the investible funds may be invested by way of subscription to IPO E(ii).Regulations of VCFs SEBI amended regulations for VCFs. The salient amendments are: (i) VCF is a fund established in he form of a trust/a company including a body corporate and registered with SEBI. It has a dedicated pool of capital, raised in the specified manner and invested in VCUs in accordance with the regulations (ii)The minimum investment in a VCF from any investor would not be less than Rs. 5 lakh and the minimum corpus of the fund before it could start activities should be at least Rs. 5 crore.

(iii) The norms of investment were modified. A VCF seeking to avail benefit under the relevant provisions of the Income Tax Act will be required to divest from the investment within a period of one year from the listing of the VCU (iv)The VCF will be eligible to participate in the IPO through book building route as'Qualified Institutional Buyer. (v) The mandatory exit requirement by VCF from the investment within -one year of the listing of the shares of VCUs to seek tax pass-through was removed under the SEBI ' (vi)The VCFs were directed to provide with the information pertaining '-to their venture capital activity for every quarter starting form the quarter ending December 31, 2000. (viii) Automatic exemption was granted from applicability of open offer requirements in case of transfer of shares form VCFs in Foreign Venture Capital Investors (FVCIs) to promoters of a VCU There were 35 VCFs registered with SEBI as at end June 2001. During the year 2000-01, 13 new domestic VCFs and only 1 FVCI were registered. All VCFs are now required to provide information pertaining to their venture capital activity for every quarter starting from the quarter ending December 2000 SBI ASSISANCE TO SMALL UNITS The SBI helps the small units in the following ways: 1.offers working capital 2.Medium term loans and installment credit . 3.Discounting of bills. 4.Entrepreneur development programmes. 5.Encouraging women entrepreneur. 6. Promotion of village and cottage industry. 7.Encouraging self employment schemes . (VCF) Regulation to provide for flexibility in exit to VCFs.

8.Provides technical and financial consultancy services. 9.Special village industrial division. 10.Project uptech.


a)INTRODUCTION: Merchant banking which is synonymous with financial services has been identified in India with just issue management in academic and popular parlance. It is quite common to come across references to merchant banking and financial services as thought they are distinct categories. Actually, merchant banking includes the entire range of financial services. The services provided by a merchant bank outfit, however, are subject to their inclination and resources, technical and financial. Merchant bankers (Category I) however are mandated by SEBI to manage public issues (as lead managers). Issue management activity has a big fall out on the integrity of the market. It affects inventors interest and hence transparency has to be ensured. There are also areas where compliance can be monitored and enforced. b)BANKING COMMISSION REPORT, 1972 The banking commission in its report in 1972 has indicated the necessity of merchant banking service in view of wide industrial base of the Indian economy. The Commission was in favour of a separate institution (distinct from commercial banks

and term leading institutions) to render merchant banking services. The commission suggested that they should offer investment management and advisory services particularly to the medium and small savers. The commission also suggested that they should be able to manage provident funds, pension funds and trusts of various types.

c)MERCHANT BANKING IN INDIA Merchant banking activity was formally initiated into the Indian capital markets when Grindlays Bank received the license from Reserve Bank in 1967. Grindlays which started with management of capital issues recognized the needs of an emerging class of entrepreneurs for diverse financial services ranging from production planning and systems design to market research. Apart from meeting specially, the needs of small scale units, it provided management consultancy services to large and medium sized companies. d)SERVICES RENDERED BY MERCHANT BANKS The working of merchant banking agencies and subsequent units formed to offer merchant banking services has shown that merchant banks are rendering diverse services and functions such as organizing and extending finance for investment in projects, assistance in financial management, acceptance of house business, raising Eurodollar loans and issue of foreign currency bonds, financing local authorities, financing export of capital goods, ships, hydropower installation, railways, financing of hire-purchase transactions, equipment leasing, mergers and takeovers, valuation of assets, investment management and promotion of investment trusts. e) REGULATION Merchant banking activities are regulated by (1) Guidelines of SEBI and Ministry of Finance, (2) Companies Act, 1956 and (3) Listing guidelines of Stock Exchanges and (4) Securities Contracts (Regulation) Act, 1956. Merchant banking activities especially those covering issue and underwriting of shares and debentures are regulated by the Merchant Bankers Regulations of Securities and Exchange Board of India (SEBI). Merchant banking activities are of course, organized and undertaken in several forms. Commercial banks, Indian and

foreign Development Finance Institutions (DFIs) have organized them through formation of divisions; nationalized banks have formed subsidiary companies; and share brokers and consultancies constituted themselves as private limited companies or firms, partnerships or proprietary concerns. f)NATURE OF MERCHANT BANKING Merchant banking is a skill-based activity and involves servicing any financial need of the client. It requires a focused skill base to provide for the requirements of a client. SEBI has made the quality of manpower as one of the criteria for renewal of merchant banking registration. These skills should not be concentrated in issue management and underwriting alone, which may cause an adverse impact on business as witnessed in 1995. Merchant bankers can turn to any of the activities mentioned above, depending on resources, such as capital, foreign tie-ups for overseas activities and skills. g)ORIGIN OF MERCHANT BANKING-ABROAD The origin of merchant banking is to be traced to Italy in late medieval times and France during the seventeenth and eighteenth centuries. The Italian merchant bankers introduced in England not only the bill of exchange but also all the institutions and techniques connected with an organized money market. In France, during seventeenth and eighteenth centuries a merchant banker ( Merchant Banquer) was not merely a trader but an entrepreneur par excellence. He invested his accumulated profits in all kinds of promising activities. He added banking business to his merchant activities and became a merchant banker.

II.REGULATIONS OF MERCHANT BANKING a)NOTIFICATIONS OF THE MINISTRY OF FINANCE AND SEBI Merchant bankers have to be organized as body corporate. They are governed by the Merchant Bankers Rules (MB Rules) issued by the Ministry of Finance and Merchant Bankers Regulations (M B Regulations) issued by SEBI (22.12.1992) RATIONALE OF NOTIFICATIONS Investors confidence is a prerequisite for an orderly growth and development of the securities market. In the primary market, investors confidence depends in a large measure on the efficiency of the issue management function which covers drafting and issue of prospectus or letter of offer after submitting it to SEBI and timely dispatch of share certificates or refund orders. III.OBJECTIVES OF THE MERCHANT BANKERS REGULATIONS M B regulations which seek to regulate the raising of funds in the primary market would assure the issuer a market for raising resources effectively and easily, at a low cost, to ensure a high degree of protection of the interests of the investors and provide for the merchant banker a degree of protection of interests of the investors and provide for the merchant banker a dynamic and competitive market with high standard of professional competence, honesty, integrity and solvency. The regulations would promote a primary market which is fair, efficient, flexible and inspires confidence. IV.DEFINITION OF MERCHANT BANKER The notification of the Ministry of Finance defines a merchant banker as, any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory service in relation to such issue management.

AUTHORISED ACTIVITIES The authorized activities would include issue management which consists of preparation of prospectus and other information relating to the issue, determining financing structure, tie-up of finances and final allotment and/or refund of subscription, corporate advisors to the issue, managers, consultants or advisors to issue and underwriting. Other authorized activities would be portfolio management services. CRITERIA FOR AUTHORISATION The criteria for authorization takes into account (a) professional qualification in finance, law or business management (b) infrastructure like adequate office apace, equipment and manpower, (c) employment of two persons who have the experience to conduct the business of merchant bankers (d) capital adequacy and (e) past track record, experience, general reputation and fairness in all their transactions. V.PROSPECTUS (FILING AND REGISTRATION) The Registrar of Companies (ROC) has also been advised that prospectus for public issue can only be filed by merchant bankers who are authorized by SEBI and given a code number. Further, the Registrar of Companies is required not to register a prospectus where he has been informed by SEBI that the contents of the prospectus are in contravention of the provisions of any law or statutory rules and regulations. Registration of Merchant Bankers SEBI abolished on 5-9-1997 all categories of merchant bankers below category I, Merchant bankers operating in the categories below I have to apply for category I status or take up some other activity. Portfolio management requires separate registration. Underwriting could be done without any additional registration. Merchant bankers can carry on any activity of issue management, which will inter alia consist

of preparation of prospectus and other information relating to the issue determining financial structure, tie-up of financiers and final allotment and refund of the subscription and act in the capacity of managers, advisor or consultant to an issue, portfolio manager and underwriter. Networth Minimum networth is Rs.5 crores. Registration fee is Rs. 2.5 lakhs annually in the first two years and Rs. 1 lakh in third year and Rs. 1 lakh to pay annually. Number of lead managers: The number of lead managers depends on the size of the public issue. The guidelines stipulate that for an issue of upto Rs.50 crores, the number of lead managers should not exceed two, for issues between Rs.50-100 crores maximum of three, for issues between Rs.100-200 crores,four,for issues above Rs.200 crores but less than Rs.400 crores, five, and for issues above Rs. 400 crores, five or as may be agreed by SEBI. Code of Conduct The code of conduct stipulates that in the performance of duties, merchant bankers should act in an ethical manner, inform the client that he is obliged to comply with the code of conduct, render high standard of service and exercise due diligence, not to indulge in unfair practices, not to make misrepresentations, give best advice, not to divulge confidential information about the clients, endeavor to ensure that true and adequate information is provided to investors and to abide by all rules, regulations, guidelines, resolutions issued by the Government of India and SEBI from time to time.

VI.GENERAL OBLIGATIONS AND RESPONSBILITIES Merchant bankers have to furnish annually to SEBI copies of balance sheet, profit and loss account and such other documents for preceding five accounting years as required. Merchant bankers are required to submit to SEBI half-yearly working results with a view to monitor the capital adequacy. Books, records and documents should be preserved for five years. Auditors report should be acted upon within two months. Merchant bankers should execute an agreement with the issuing company setting out their mutual rights, liabilities and obligations, relating to such issue and in particular to disclosures, allotment and refund. VII.PROCEDURES FOR INSPECTION SEBI may inspect books of accounts, records and documents of merchant bankers to ensure that the books of account are maintained in the required manner, that the provisions of the act, rules, and regulations are being complied with, to investigate complaints against the merchant bankers and to investigate suo moto in the interest of securities business or investors interest into the affairs of the merchant bankers. SEBI may either give reasonable notice or undertake inspection without notice in the interest of the investor. The findings of inspection report are communicated to the merchant banker. SEBI may appoint a qualified auditor to investigate into the books of account or the affairs of merchant banker. Penalties for compliance of conditions: for registration and contravention of the provisions of MB regulations include suspension or cancellation of registration. SEBI categorized defaults and the penalty points they attract. The details regarding defaults of merchant bankers and penalty points are as follows:

Defaults 1. General default 2. Minor default 3. Major default 4. Serious default VIII.defaults a)General Defaults:

Penalty points 1 2 3 4

For the purpose of penalty point, the following activities fall under general default and attract one penalty point (a) Non-receipt of draft prospectus/letter of offer from the lead manager by SEBI, before filing with Registrar of Companies/Stock Exchange. (b) Non-receipt of inter se allocation of responsibilities of lead managers in an issue by SEBI prior to the opening of issue. (c) Non-receipt of due diligence certificate in the prescribed manner by SEBI, before opening of the issue.
(d) Failure to ensure submission of certificate of minimum 90 per cent subscription

to the issue as required under Government of India, press note No. F2/14/cci$90 dated 6th April, 1990.
(e) Failure to ensure publicing of dispatch of refund orders, shares/debentures

certificates, filing of listing application by the issuer as required under Government of India press notification No.2/6/cci/89 dated 10-1-1990.

b)Minor Defaults: The following activities are categorized under minor defaults and attract two penalty points. (a) Advertisement, circular, brochure, press release and other issue related materials not being in conformity with contents of the prospects. (b) Exaggerated information or information extraneous to the prospectus is given by the issuer or associated merchant banker in any press conference, investor conference, brokers conference or other such conference/meet prior to the issue for marketing of the issue arranged/participated by the merchant banker. (c) Failure to substantiate matters contained in highlights to the issue in the prospectus.
(d) Violation of the Government of India letter number F 1/2/SE/86 dated 24th

March 1986 and/or Government of India letter number F 1/23/SE/86 dated 24th June 1987 regarding advertisement on new capital issues. (e) Failure to exercise due diligence in verifying contents of prospectus/letter of offer. (f) Failure to provide adequate and fair disclosure to investors and objective information about risk factors in the prospectus and other issue literature. (g) Delay in refund/allotment of securities. (h) Non handling of investor grievances promptly.

c)Major Defaults: The following activities are categorized under major defaults and attract three penalty points: a) Mandatory underwriting not taken by lead managers.
b) Excess number of lead managers than permissible under SEBI press

release of 28th February, 1991. c) Association of unauthorized merchant banker in an issue. d)Serious Defaults: The following activities are categorized under serious defaults and attract four penalty points: a) Unethical practice by merchant banker and/or violation of code of conduct. b) Non cooperation with SEBI in furnishing desired information, documents, evidence as may be called for. A merchant banker on reaching cumulative penalty points of eight (8) attracts action from SEBI in terms of suspension/cancellation of authorization. To enable a merchant banker to take corrective action, maximum penalty points awarded in a single issue managed by a merchant banker are restricted to four. In the event of joint responsibility, same penalty point is awarded to all lead managers jointly responsible for the activity. In the absence of receipt of inter se allocation of responsibilities, all lead managers to the issue are awarded the penalty points.

Defaults in Prospectus: If highlights are provided, the following deficiencies will attract negative points: i) ii) Absence of risk factors in highlights. Absence of listing in highlights

iii) Extraneous contents to prospectus, if stated in highlights. The maximum grading points of prospectus will be 10 and prospectuses scoring greater than or equal to 8 points are categorized as A+, those with 6 or less than 8 points as A, with 4 or less than 6 points as B and with score of less than 4 points, the prospectus falls into Category C. > > < < 8 8 6 4 6 4 A+ A B C

Merchant bankers are advised to take note of the above system of prospectus grading and should endeavour to give fair and adequate disclosures in prospectus for the benefit of investors. General Negative Marks: If at all Highlights are provided in the issue, i) Risk factors should form part of Highlights, otherwise it will attract negative point of -1 ii) Listing details, should form a part of Highlights, otherwise it will attract negative point of -0.5 iii) Any matter extraneous to the contents of the prospectus if stated in highlights, will attract negative point of -0.5.







REQUIREMENTS PRE-ISSUE OBLIGATIONS: Due Diligence: The lead merchant banker should exercise due diligence. The standard of due diligence should be such that he should satisfy himself on all the aspects of offering, veracity and adequacy of disclosure in the offer documents. Such a liability on his part would continue even after the completion of the issue process. Memorandum of Understanding (MOU) To make an issue of a security through a public or right issue, an MOU must be entered into between the lead manager (merchant banker) and the issuing company, specifying their mutual rights, liabilities and obligations relating to the issue. Due Diligence Certificate The lead merchant banker should furnish to the SEBI a due diligence certificate along with the draft prospectus. In case of debenture issues, he should also furnish to the SEBI a due diligence certificate given by the debenture trustees as specified in along with the offer document. Undertaking: The issuer should submit an undertaking to the SEBI to the effect that transactions in securities, by the promoter/promoter group and their immediate relatives, during the period between the date of filing the offer document with the Registrar of Companies (ROCs/stock exchange(s) and date of the closure of the issue would be reported to the stock exchange concerned, within 24 hours of the transaction(s).

Merchant Bankers: A merchant banker who is associated with the issuer company as a promoter/director/associate should not lead/manage its issue. However, a merchant banker holding securities of a company can lead/manage its issue. Co-managers: The lead merchant bankers must ensure that the number of co-managers does not exceed the number of merchant bankers to an issue, and there is only one advisor to the issue. Other Intermediaries: It is the responsibility of the lead merchant bankers to ensure that other intermediaries being appointed are duly registered with the SEBI, wherever applicable. They should independently assess their capability/capacity to carry out the assignment. They should further ensure that (i) issuer companies would enter into an MOU with intermediary/intermediaries concerned, whenever required and (ii) bankers to the issue are appointed in all the mandatory collection centres. Underwriting: The lead merchant banker(s) should: Satisfy themselves about the ability of the underwriters to discharge their underwriting obligations; Incorporate a statement in the offer document to the effect that in their opinion the underwriters assets are adequate to meet their underwriting obligations; Obtain written consent of the underwriters before including their names in the offer document;

Undertake in respect of every underwritten issue a minimum underwriting obligation of five per cent of the total underwriting commitment or Rs.25 lakh, whichever is less; the outstanding underwriting commitments of a merchant banker should nor exceed 20 times of its networth at any point of time; Ensure that the relevant details of underwriters are included in the offer document. Agreement with Depositories: The lead managers should ensure that (i) the issuer company has entered into an agreement with depository(ies) for dematerialization (demat) of securities, (ii) an option be given to the investors to receive allotment of securities in demat format. X.POST-ISSUE OBLIGATIONS/REQUIREMENTS Post-Issue Monitoring Reports: Irrespective of the level of subscription, the post-issue lead merchant banker must ensure the submission of the post-issue monitoring reports. (a) 3-day monitoring report for book-built portion, in case of issue through book building; the due date of the report would be the third day from the date of allocation in the book-built portion (b) 3-day monitoring report in other cases, including fixed price portion of bookbuilt issue (c) final post-issue monitoring report for all issues

Redressal of Investors Grievances The post-issue lead merchant banker should actively associate himself with post-issue activities namely, allotment, refund and dispatch and regularly monitor the redressal of investors grievances arising there-from.

Stockinvest: The lead merchant banker should ensure compliance with the instructions issued by the RBI on the handling of stockinvest by any person, including registrars to an issue. Underwriters: If the issue is proposed to be closed at the earliest closing date, the lead merchant banker must satisfy himself that the issue is fully subscribed before announcing closure of the issue. In case there is no definite information about subscription figures, the issue should be kept open for the required number of days to take care of the underwriters interests and avoid any dispute, at a later date, by the underwriters, with respect to their liability. Bankers to an Issue: The post-issue lead merchant banker should ensure that money (es) received pursuant to the issue and kept in separate bank (i.e. bankers to an issue), as per the provisions of Section 73(3) of the Companies Act, 1956, is released by the bank only after the listing permission has been obtained from all the stock exchanges where the security was proposed to be listed as per the offer document.


a)Introduction Following the economic reforms in India in the post-1991 period, there is a discernible trends among promoters and established corporate groups towards consolidation of market share and diversification into new areas through acquisition/takeover of companies but in a more pronounced manner through mergers/ amalgamations The acquisition/takeover bids fall under the purview of SEBI. The terms mergers and amalgamations on the one hand and acquisitions and takeovers on the other are treated here synonymously/interchangeably The terms merger and amalgamation are used interchangeably as a form of business organisation to seek external growth of business- A merger is a combination of two or more firms in which only one firm would survive and the other would cease to exist, its assets/liabilities being taken over by the surviving firm. An amalgamation is an arrangement in which the assets/liabilities of two or more firms become vested in another firm. As a legal process, it involves joining of two or more firms to form a new entity or absorption of one/more firms with another. The outcome of this arrangement is that the amalgamating firm is dissolved/wound-up and loses its identity and its shareholders become shareholders of the amalgamated firm b)Scheme of Merger/Amalgamation Whenever two/more companies agree to merge with each other, they have to prepare a scheme of amalgamation. The acquiring company should prepare the

scheme in consultation with its merchant banker financial consultants. The main contents of a model scheme, inter-aUa, are as listed below. Description of the transfer and the transfree company and the business of the transferor.

Their authorised, issued and subscribed/paid-up capital.

Change of name, object clause and accounting year. Protection of employment. Dividend position and prospects. Management: Board of directors, their number and participation of transfree companys' directors on the board. Application under sections 391 and 394 of the Companies Act, 1956, to obtain High Court's approval. c)Expenses of amalgamation. Conditions of the scheme to become effective and operative, effective date of amalgamation Essential Features of Scheme of Amalgamation The essential features or prerequisites ror any scheme of amalgamation are as enumerated below Determination of Transfer Date (Appointed Date) This involves fixing of the cut-off date from which all properties, movable us well as immovable and rights attached thereto are sought to be transferred from amalgamating company to the amalgamated company.. Determination of Effective Date by when all the required approvals under various statutes, viz, the Companies Act 1956. The Companies (Court) Rules 1959, Income Tax Act, 1961. Sick Industrial Companies (Special Provisions) Act, 1985, would be obtained and the transfer and vesting of the undertaking of amalgamating

company with the amalgamated company would take effect. This date is called effective date. A scheme of amalgamation normally should also contain conditions to be satisfied for the scheme to become effective Approve from Shareholders In terms of Section 391, shareholders of both the amalgamating and the amalgamated companies should hold their respective meetings under the directions of the respective high courts and consider the scheme of amalgamation. A separate meeting of both preference and equity shareholders should be convened for this purpose Approval from Creditors/Financial Institutions/Banks Approvals are required from the creditors, banks and financial institutions to the scheme of amalgamation in terms of their respective agreements/arrangements with each of the amalgamating and the amalgamated companies as also under Approvals from Respective High Court(s) Approvals of the respective high court(s) in terms of Sections 391-394, confirming the scheme of amalgamation are required. The courts issue orders for dissolving the amalgamating company without winding-up on receipt of the reports from the official liquidator and the regional director. Company Law Board, that the affairs of the amalgamating company have not been conducted in a manner prejudicial to the interests of its members or to public interests Step-wise Procedure for amalgamation is detailed below. Object Clause The first step is to examine the objects clauses of the memorandum of association of the transferor and the transferee companies so as to ascertain whether the power of amalgamation exists or not. The objects clause of Transferee Company should allow for carrying on the business of the transferor company. If it is not so, it is necessary to amend the objects clause. Similarly, it should be ascertained whether the authorised capital of the transferee company would be sufficient after the merger/ amalgamation.

Preparation of a scheme of amalgamation on the lines explained earlier. Meetings/Information (i) Holding of meetings of the board of directors of both the transferor and the transferee companies (a) To decide the appointed date and the effective date, (b) To approve the scheme of amalgamation and exchange ratio and (c) To authorise directors/officers to make applications to the appropriate high court for necessary action. (i) Inform the stock exchanges concerned about the proposed amalgamation immediately after the board meetings. ii) The shareholders and other members of the companies should also be informed through press release. (iii) The transfer or the and transferee companies should inform the financial institutions, bankers/ debenturetrustees at least 45 days before the board meeting so that their approval is available to the proposed amalgamation at the time of board meeting.

d)Application for Amalgamation An application for amalgamation can be submitted by the company,Members or even any of the creditors. A member, In this context means any person who has agreed to be a member and whose name appears on the register of members. A creditor includes all persons having pecuniary claims against the company for some amount whether present or future, definite or contingent. Even one member or one such creditor can make an application for amalgamation. Where the application is

proposed to be made by the company, only a person authorised by the company in this behalf can make an application for amalgamation. It is, therefore, essential that the company should authorise the director(s) or other officer(s) to make an applicalion to the appropriate high courts and take necessary action as may be required from time to time Procedure for Application to the High Court The procedure for making application to the high court has been laid down under the Companies (Court) Rules, 1959. An application under section 391(1) for an order convening a meeting of creditors and/or members or any class of them should be by a judge's summons supported by an affidavit. A copy of the proposed compromise or arrangement should be annexed to the affidavit On receipt of" the application by the high court, hearing takes place in the judge's chamber, and after the hearing the judge may cither dismiss the summons or order a meeting of the members or may give such directions as he may think necessary On being not satisfied with the scheme, the court may not even order the calling of meeting of creditors and/or members. Holding of Meeting The next step is to hold separate meetings of the shareholders and creditors of me company to seek approval to the scheme. The resolution approving the scheme may be passed by voting in person or by proxy as per the directions of the high court. At least three-fourth in value of the members or claims of members or creditors must vote in favour of the resolution approving the scheme of amalgamation, The members and the creditors are require to be classified into different classes for the purpose of convening meetings. This process has to be followed immediately on receipt of application under section 391(1). If meetings of incorrect classification are convened and objection is taken with regard to any particular creditor of having interest competing with others, the company runs the risk of the scheme being dismissed

For the purpose of convening meetings the court may give directions as it may deem fit regarding the following:

Determining the class or classes of creditors and/or members whose meeting(s) have to be held for considering the proposed compromise or arrangement;

(ii) (iii)

Fixing the time and place of such meeting(s); Appointing a chairman or chairmen for the meeting(s) to be held, as the case may be;

(iv) Fixing the quortum and the procedure to be followed at the Meeting (s) including voting by proxy; (v) Determining the values of creditors and/or the members of any Class, as the case may be, whose meetings have to be held; (vi) Notice to be given of the meeting(s) and the advertisement of such notice; (vii) The time within which the chairman of the meeting is to report to the court the results of the meeting; and such other matters as the court may deem necessary. The notice of the meetings of members and/or creditors, should be: (a) Sent to the members/creditors; (b) sent to them individually by the chairman appointed for the meeting or if the court so directs, by the company or any other person as the court may direct, by post under certificate of posting to the last known address at least 21 clear days before the date of the meeting; (c) Accompanied by a copy of the proposed scheme of compromise or arrangement and of the statement required to be furnished under section 393 and also a form of proxy

e) REPORT of Chairman to the Court The chairman of the meeting must within the time fixed byThe court or where no time is fixed within 7 days of the date of the meeting, report the result of the meeting to the court. The report should state accurately the number of creditors or class of creditors or the numbers of members or class of members, as the case may be, who were present who voted at the meeting either in person or by proxy, their individual values and the way the voted. Presenting Petition Before the Court After the proposed scheme is agreed to with or without modification in terms of section 391(2), the company must within seven days of the filing of the report by the chairman, present a petition to the court for confirmation of the compromise or arrangement. A copy of the petition should also be submitted to the regional director, company law board and others as directed by the court. The court would not sanction a scheme simply because it is recommended by the board of directors and approved by a statutory majority of the company. The court would have to see itself whether the scheme is reasonable and fair to all parties. A scheme which is proper on the face of it and in respect of which no fraud is alleged would not be rejected unless the objector shows any valid ground against Application for Direction If necessary, an application for direction of the court to provide for all or any matters indicated in Section 394(1) These are

The transfer to the transfree company of the whole or any part of the undertaking, property or liabilities of any transferor company; The allotment or appropriation by the transfree company of any shares, debentures, policies, or other like interests in that company which, under the


compromise or agreement, are to be allotted or appropriated by that company to or for any person;

The continuation by or against the transfree company of any legal proceedings pending by or against any transferor company; The dissolution, without winding-up, of any transferor company; The provision to be made for any persons who, within such time and in such manner as the court directs, dissents from the arrangement; and compromise or

(iv) (v)


Such incidental, consequential and supplemental matters as are necessary to secure that the reconstruction or amalgamation would be fully and effectively carried out.

The court would pass an order. Alternatively, by adding a suitable above

prayer in

the main application, the court could be requested to give direction in regard to the Certificate A certified copy of the order of the court dissolving the amalgamating company or giving approval to the scheme of merger, should be filed with the Registrar of Companies concerned within 30 days of the date of the court's order. Court order A copy of the order of the court should be to attached to the memorandum and articles of association of the transfree company f)Financing Techniques in Mergers After the value of firm has been determined on the basis of the preceding analysis, the next step is the choice of the method of payment of the acquired firm Ordinary Share Financing When a company is considering the use of common (ordinary) shares to finance a merge. the relative price-earnings (P/E) ratios of two firms are an important consideration. For instance, for;. firm having a high P/E ratio, ordinary shares represent an ideal method for financing mergers and acquisitions/

Debt and Preference Shares Financing . financing of mergers and acquisitions with equity shares is advantageous both to the acquiring firm and the acquired firm when the P/E ratio is high. However, since some firms may have a relatively lower P/E ratio as also the requirement of some investors might be different, other types of securities, in conjunction with/in lieu of equity shares, may be used for the purpose Deferred Payment Plan Under this method, the acquiring firm, besides making an initial payment, also undertakes to make additional payments in future years to the target firm in the event of the former being able to increase earnings consequent to the merger. Since the future payment is linked to the firm's earnings, this plan is also known as earn-out plan base-period earn-out. Under this plan, the shareholders of the target firm are to receive additional shares for a specified number of future years, if the firm is able to improve its earnings vis-a-vis the earnings of the base period (the earnings in the previous year before the acquisition firm Tender Offer A tender offer, as a method of acquiring a firm, involves a bid by the acquiring firm for controlling interest in the acquired firm. The essence of this approach is that the purchaser approaches the shareholders of the firm rather than the management to encourage them to sell their shares generally at a premium over the current market Merger as a Capital Budgeting Decision the merger should be evaluated as a capital budgeting decision. The target firm should be valued in terms of its potential to generate incremental future cash inflows Like the capital budgeting decision, the present value of the expected benefits from the merger are to be compared with the cost of the acquisition of the target firm. Acquisition costs include the payment made to the largel firm's shareholders and debenture-holders, the payment made to discharge the external liabilities. estimated value of the obligations assumed, liquidation expenses to be met by the acquiring firm and so on less cash proceeds expected to be realised by the acquiring firm from the sale of certain asset(s) of the target firm

Adjusted Present Value (APV) Approach The APV approach is a variant of the DCF approach used to value the target firm. This approach is very appropriate for valuing companies with changing capital structures (such as leveraged buyout targets) and for valuing target companies which are having capital structures substantially different from those of acquiring companies The APV based valuation has its genesis in the Modigliani-Millcr (MM) propositions on capital structure can affect the valuation only through taxes and other market imperfection ions and distortions Tax Aspects Related to Amalgamation/Mergers . According to Section 2 (1 B) 'amalgamation', in relation to companies, means the merger of one or more companies with another company or the merger of two or more companies to form one company (the company or companies that so merge are referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger is the amalgamated company in such a manner that: (i) All the property/liabilities of the amalgamating company(ie) immediately before the amalgamation, becomes the property/liabilities of the amalgamated company by virtue of the amalgamation (ii) Shareholders holding not less than three-fourths (in value) of the shares in the amalgamating company(ies) (other than shares already held therein immediately before the amalgamation by the amalgamated company, its subsidiary or by a nominee of the said company) become shareholders of the amalgamated company by virtue of the amalgamation. g)Tax Concessions to Amalgamated Company The following are the major benefits available to the amalgamation i. Carry Forward and Set off of Business Losses and Unabsorbed Depreciation/ According to section 72 A, the amalgamated company is entitled to carry forward accumulated losses as well as unabsorbed

depreciation of the amalgamating company, provided the following conditions are fulfilled: (i) The amalgamated company continuously holds, for a minimum period of 5 years, from the date of amalgamation at least three-fourths of the above value of fixed assets of the amalgamating company, acquired in the scheme of amalgamation. (ii) The amalgamated company continues the business of the amalgamating company for a minimum period of 5 years from the date of amalgamation. (iii) The amalgamated company fulfils such other conditions as may be prescribed to ensure the revival of the business of the amalgamating company or to ensure that the amalgamation is for genuine business purposes. (iv) The amalgamation should be of a company owning an industrial undertaking or ship 2, Expenditure on Scientific Research 3. Expenditure on Acquisition of Patent Rights or Copy Rights 4. Expenditure on Know-how 5. Expenditure for Obtaining License to Operate Telecommunication Services 6. Preliminary Expenses 7. Expenditure on Prospecting of Certain 8. Capital Expenditure on Family Planning 9. Bad Debts Tax Concessions to Amalgamating Company The tax concessions to the amalgamating are summarised below. (i) Free of Capital Gains Tax According to Section 47 where there is a transfer of any capital asset by an amalgamating company to any Indian amalgamated

company, such transfer will not be considered as a transfer for the purpose of capital gain. (ii) Free of Gift-Tax According to Section 45 (b) of the Gift Tax Act, where there is a transfer of any asset by an Indian amalgamating company, gift tax will not be attracted II.STOCK-BROKERS a) introduction Stockbroker is a member of a recognised stock exchange who buys, sells or deals in securities. A certificate Registration from SEBI is mandatory to act as a broker. SEBI is empowered to impose conditions while granting the certificate. As a member of a stock exchange, he will have to abide by its rules, regulations and bylaws, pay the prescribed fee and take adequate steps for redressal of investors' grievances within one month of the receipt of the complaint and keep SEBI informed about the number, nature and other particulars of such complaints. b)Registration A broker, seeking registration with SEBI, has to apply through the stock exchange of which he is a member. The application must be forwarded by the exchange to SEBI within 30 days from the date of receipt. While forwarding the application, the exchange should also include a statement to the effect that no complaints/ arbitration cases are pending against the applicant for granting registration to the broker, SEBI checks whether or not he is eligible to be a member of a stock' exchange, has the necessary infrastructure including manpower to effectively discharge his activities, has past experience in the business of buying, selling or dealing in securities and is subject to disciplinary proceedings under the rules, regulations and by-laws of the stock exchange with respect to his business and is a lit and proper person.

Payment of Fee Every registered broker has to pay the SEBI a specified registration fee based on the annual turnover, that is. the aggregate of the sale and purchase prices of securities received and receivable by the stockbroker during any financial year, on his own account as well as on account of his clients. For an annual turnover up to Rs 1 crore, a sum of Rs 5,000 is to be paid as fee to the SEBI. For an annual turnover in excess of Rs 1 crore, the registration fee is Rs 5,000 plus one hundreth of one per cent of the turnover in excess of Rs I crore, for each financial year. Code of Conduct Registered stockbrokers have to abide by a code of conduct specified as follows: General First, a stockbroker has to maintain high standards of integrity, promptness and fairness with due skills, care and diligence in the conduct of all his business. He should not indulge in manipulative, fraudulent or deceptive transactions or schemes or spread rumours with a view to distorting the market equilibrium or making personal gains c)Duty to the Investor 1) To his dealings with clients and the general investing public, he should faithfully execute the orders for buying and selling of securities at the best available market price and not refuse to deal with a small investor merely on the grounds of the volume of business involved He should promptly inform his client about the execution or non-execution of an order, make prompt payment in respect of securities sold and arrange for prompt delivery of securities purchased by clients; 2. He should issue his clients, or clients of the broker, without delay, a contract note for all transactions in the form specified by the stock exchanged 3 to avoid breach of trust, he should not disclose or discuss with any other person or make improper use of the details uf personal investments and other

informationfif a confidential nature regarding his clients, which he comes to know in the course of his business 4 Merely for generating business, with the sole objective of earning commission and brokerage, he should riot encourage sales or purchases of securities and/or furnish false or misleading quotations or give any other false or misleading advice or information to the clients 5) He should avoid dealing or transacting business knowingly, directly or indirectly with a client who Has faned to carry out his commitments in relation to securities with another stockbrokey (6) When dealing with a client, he is required to disclose whether he is acting as a principal or as an agent and should ensure. at ihe same time, that no conflict of interest arises between him and the client in the even of such a conflict, he must inform the client accordingly and not seek to gain a direct or direct personal advantage from the situation, and not consider the client's interest inferior to his own (7) He should not give investment advice to any client who might be expected to rely thereon to acquire, depose of, retain any securities unless he has reasonable grounds for believing that the recommendation suitable for such a client upon the basis of the facts, if disclosed by such a client as to his own security holdings, financial situation and objectives of such investment. The stockbroker should seek such information from clients whenever he feels is appropriate to do so: (7-A) A stockbroker or any of his employees should render investment advice directly or indirectly, about any security in the publicly accessible media, whether real-time or non-real-time, only after disclosing his interest/interest of his independent family members and the employer, including their short long position in the security, while rendering such advice. The employee should also

disclose the interest of his dependent family members and the employer including their short/long position; and 8A stockbroker should have adequately trained staff and arrangements to render fair, prompt and competent services to his clients Stockbrokers vis-a-vis Other Stockbrokers The code of conduct of stockbrokers in relation to other brokers are related to/covers the following aspects N Conduct of Dealings A broker should cooperate with other brokers in comparing unmatched transactions delivery Protection of Clients' Interests He should extend full cooperation to other brokers in protecting the interests of his clients regarding their rights to dividends, bonus shares, rights issues and any other I rights related to such securities. . Transactions With Stockbrokers While carrying out his transactions with other brokers, he comply with his obligations in completing the settlement of transactions with them. Advertisement and Publicly A stockbroker should not advertise his business publicly unless permitted by the stock exchange Inducement of Clients He should not resort to unfair means to induce clients from other stock False or Misleading Returns A stockbroker should not neglect or fail or refuse to submit the required returns and not make any false or misleading statement on returns required to be submitted to the SEB1 and the stock exchange d)General Obligations and Responsibilities Every stock broker is required to keep and maintain the following books of accounts, records and documents: (a) Register of transactions (b) Client ledger (c) General ledger (d) Journals

(e) Cash book (f) Bank pass book (g) Documents register containing, inter alia, particulars of securities received and delivered in physical rbrmtnd the statement of account and other records relating to receipt and delivery of securities provided by the depository participant in respect of dematerialised (demat) sec uri ties (h) Member's contract books showing details of all contracts entered into by him with other members of the same exchange, or counterfoils of duplicates of confirmationptnemos issued to such other Membe (j) Counterfoils or duplicates of contract notes issued to clienisi (it Written consent of clients in respectof contracts entered into as principals (k) Margin deposit book (L) Registers of accounts of sub-brokers/ (m) An agreement with a sub-broker specifying the scope of mutual authority and responsibilities, of accounts and other records should be preserved for at least five years (i)An agreement With the sub-broker and with the client of the sub-broker to establish priority of contract between the stock broker and the client of the sub-broker. appointment of Compliance Officer Every stock broker should appoint a compliance officer to monitor the compliance of the SEBI He should immediately and independently report any non-compliance observed by him to the SEBI. e)Stock Broker Not to Deal with Unregistered Sub-broker A stock broker should not deal with any person as a sub-broker unless he has obtained a certificate of registration from the SEBI.) Procedure for Inspection

The SEBI is empowered to appoint one or more persons as inspection authority to inspect the books of accounts, other records and documents of the stockbroker. The SEBI can also appoint a qualified auditor to carry out

inspection/investigation into the records of the brokers. Liability for Contravention of the SEBI Act, Rules/Regulations A stock broker or a sub-broker who contravenes any of the provisions of the SEBI Act, rules or regulations would be liable for any one or more of the following actions lability for Monetary Penalty A stock broker or a sub-broker would be liable for monetary penalty in respect of the following violations, namely: Failure to file any return or report with the SEBI. Failure to furnish any information, books or other documents within 15 days of issue of notes by 1the SEBI. Failure to maintain books of account or records as per the SEBI Act, rules or regulations. Failure to redress the grievances of investors within 30 days of receipts of notice from the SEBI. Acting as an unregistered sub-broker or dealing with unregistered sub-brokers. (xv) Failure to comply with directions issued by the SEBI under the SEBI Act or the regulations. (wi) Failure to exercise due skill, care and diligence (xvii) Failure to seek prior permission of the SEBI in case of any change in its status and constitution. (xviii) Failure to satisfy the net worth or capital adequacy norms, if any, specified by the SEBI. Extending use of trading terminal to any unauthorised person or place.) Violations for which no separate penalty has been provided Liability for Action Under the Enquiry Proceeding Regulations A stock broker or a sub-broker would be liable for any action as specified in the SEBI Regulation, including suspension or cancellation of his certificate of registration, if he Ceases to

be a member of a stock exchange; or '' (ii) Has been declared defaulter by a stock exchange as a member within a period of six months or

Surrenders his certificate of

registration to the SEB1or fails to pay the prescribed fee; or) Fails to comply with the rules, regulations and bye-laws of the stock exchange of which he is a member (x) Fails to cooperate with the inspecting or investigating authority; or (x) Fails (o abide by any award of the Ombudsman or decision of the SEBI under the SEBI (Ombudsman) Regulations, 2003; or d) Fails to pay the penalty imposed by the adjudicating officer; or J(Xti) Indulges in market manipulation of securities or index (xiii) Indulges in insider trading in violation of SEBI (Prohibition of Insider Trading) Regulations, 1992; (vi) Fails to comply with the circulars issued by the SEBI: or (xv) Commits violations specified pertaining to liability for monetary penalty which in the opinion of the SEBI are of a grievous nature Liability for Prosecution A stock broker or a sub-broker would be liable for prosecution under iction 24 of the SEBI Act for any of the following violations, namely:We dealing in securities without obtaining certificate of registration from the SEBI. (ii) Dealing in securities or providing trading floor or assisting in trading outside the recognised stock exchange in violation of provisions of the Securities Contract (Regulation) Act, or rules made or notifications issued thereunder.

(iii) Market manipulation of securities or index.


(iv) Indulging in insider trading in violation of SEBI() Regulations 1992. Violating the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market Regulations 2003 Failure to pay penalty imposed by the adjudicating officer or failure to comply with any of his directions or orders. f)Capital Adequacy Norms for Brokers Base Minimum Capital An absolute minimum of Rs 5 lakh should be maintained as a deposit with the stock exchange by member brokers of the Mumbai and Kolkata Stock Exchanges, and Rs 3.5 lakh tor those of Delhi and Ahmedabad Exchanges, irrespective of the volume of business. In case of the other stock exchanges, the minimum requirement is Rs 2 lakh- aditional Capital Related to Volume of Business The additional or optional capital required from a member should, at any point of time, be such that together with the base minimum capital, it is not less than 8 per cent of the gross outstanding business in the stock exchange defined as the ciggregate of up to date sales and purchases by a member-broker in all the securities put together Calculation the capital of a member-broker is computed by adding capital and fee reserves less non-allowable assets, that is, (a) fixed assets, (b) pledged securities, (c) member's card, (d) non-allowable securities, (e) bad deliveries, (f) doubtful debts and advances/overdue for more than three months or given toissociates(g) prepaid expenses, (h) tangible assets and, (i) 30 per cent of marketable securities

The members who do not maintain proper books of accounts/submit copies of their audited accounts in the stipulated time are liable to be asked to deposit additional capital in the form of cash with the stock exchange Sub brokers A sub-broker acts on behalf of a stockbroker as an agent or otherwise for assisting investors in buying, selling or dealing in securities through such brokers, but he is not a member of a stock exchange. To act as a sub-broker, a certificate of registration from the SEBI is required. It grants a registration certificate to a subbroker subject to the condition that he (a) pays the prescribed fee, (b) takes adequate steps for redressal of investor grievances within one month of the receipt of the complaint and keeps the SEBI informed about the number, nature and other particulars of the complaints and (c) is authorised in writing by a broker for affiliation in buying, selling or dealing in securities Sub-brokers wanting to do business with more than one broker need to be separately registered with the SEBI for each broker g)Registration of Sub-Brokers According to the SEBI regulations currently in force, a sub-broker is required to submit along with the application (1) a recommendation from a stockbroker with whom he will be affiliated and (2) two references, including one from his banker. The application has to be submitted to the concerned stock exchange h)General Obligations Payment of Fee The annual fee payable by a sub-broker is Rs 1,000 for an initial period of five years; After the expiry of five years, an annual fee ofRs 500 is payable as long as the certificate remains in force. Code of Conduct The sub-brokers have to follow the code of conduct as detailed below:

General A sub-broker should maintain high standards of integrity, promptness and fairness and act with due skill, care and diligence in the conduct of all investment business. Duty to the Investors A sub-broker, in his dealings with the clients and the general investing public, should faithfully execute the orders for buying and selling of securities at the best available market price and promptly inform his client about the execution or non-execution of an order He should render necessary assistance to his client in obtaining the contract note from the stock broker. A sub-broker should not disclose or discuss with any other person or make improper use of the details of personal investments and other information of confidential nature about the client) which he comes to know in the course of his business.

' sub-broker should not deal or transact business knowingly, directly or

indirectly, or execute an order for a client who has failed to carry out his Conduct of Dealings A sub-broker should cooperate with his broker in comparing unmatched transactions. He should knowingly and willfully deliver documents that constitute bad delivery. Protection Of Clients Interests A sub-broker should extend full cooperation to his stockbroker in protecting the interests of the clients regarding the latter's rights to dividends, bonus shares, or any other rights related to such securities. Transactions With Brokers A sub-broker should not fail to carry out his stock broking transactions with his broker nor should he fail to meet his business liabilities or show negligence in completing the settlement of transactions with them legal Agreement between Brokers A sub-broker should execute an agreement or contract

with his affiliating brokers that would clearly specify the rights and obligations of the sub-brokers and the principal broker. Advertisement and Publicity A sub-broker should not advertise his business publicly unless permitted by the stock exchange. Inducement of Clients A safe-Woker should not resort to unfair means to induce clients from other brokers TRADING AND CLEARING/SELF-CLEARING MEMBERS A trading member is a member of a derivative exchange/derivative segment of a stock exchange who .settles the trade in the clearing corporation or clearing house (i.e. clearing corporation/house of a recognised stock exchange to clear and settle trades in securities) through a clearing mcmber A self-clearing member means a member of a clearing corporation house (CC/CH) who may clear and settle transactions on its own account or on account of its clients only. He cannot clear/settle transactions in securities for any other trading member(s) III.FOREIGN BROKERS Foreign institutional investors (FIIs) now play a significant role in stock markets a)Registration with the SEBI While applying for registration, a foreign broker has to, inter-alia, disclose to the SEBI namefs registration number(s) of the overseas stock exchanges where he is registered in the capacity of a broker-dealer together with an undertaking that he would operate and assist only on behalf of registered FTIs and would not deal in securities on his own account as principal in India

IV.Credit Rating a)Introduction

Credit rating is, essentially, the symbolic indicator of the current opinion of the rating agency regarding the relative ability and willingness of the issuer of a financial (debt) instrument to meet the (debt) service obligations as and when they arise. It provides a relative ranking of the credit quality of debt/financial instruments or their grading according to investment qualities. In other words, credit rating provides a simple system of gradation by which the relative capacities of companies (borrowers) to make timely repayment of interest and principal on a particular type of debt/financial instrument. The first rating agency, the Credit Rating Information Services of India Ltd(CRISIL), was started in 1988. since 1991 by the Government/SEBI, credit rating has emerged as a critical element in the functioning of the Indian debt/financial markets. In response to the ever increasing role of credit rating, two more agencies were set up, the Information and Credit Rating Services (ICRA) Ltd in 1990 and the Credit Analysis and Research (CARE) Ltd in 1990 and 1993, respectively. b)REGULATORY FRAMEWORK Credit rating agencies are regulated by the SEBI. The main elements of its Credit Rating Agencies Regulations are: (i) their registration, (ii) their general obligations, (iii) restrictions on the rating of securities, (iv) procedure for inspection and investigation and (v) action in case of default.

c)Eligibility Criteria The eligibility criteria for a rating agency are as specified below. The agency: Is set up and registered as a company has specified rating activity as one of its main objects in its Memorandum of Association; as a minimum networth of Rs 5 crore; has adequate infrastructure; its promoters have professional competence, financial soundness and a general reputation of fairness and integrity in business transactions, to the satisfaction of the SEBI; is in all respects a fit and proper person for the grant of the certificate; Grant of Certificate of Registration The SEBI will grant to eligible applicants a certificate of registration on the payment of a fee of Rs 5,00,000, subject to the conditions specified below: Code of Conduct A credit rating agency should: Make all efforts to protect the interests of investors. In the conduct of its business, observe high standards of integrity, dignity and fairness in the conduct of its business. Fulfil its obligations in a prompt, ethical and professional manner. Hava in place a rating process that reflects consistent and international rating standards. Not render, directly or indirectly any investment advice about any security in the public accessible media.

Provide adequate freedom and powers to its compliance officer for the effective discharge of his duties. Ensure that good corporate policies and corporate governance are in place.

V.CREDIT RATING AGENCIES a)Crisil Ltd As the first credit rating agency in India, the CRISIL was promoted in 1987 jointly by the ICICI Ltd and the Unit Trust of India. Other shareholders include the Asian Development Bank, Life Insurance Corporation of India, HDFC Ltd, General Insurance Corporation of India and several foreign and Indian banks. It commences operation on January 1,1988. As a matter of fact, it pioneered the concept of credit rating in the country and has, since, been the vanguard of innovations by introducing new concepts in rating services and has diversified into related areas of information and advisory activites. Initially, the CRISIL was set up to rate debt obligations that would guide investors as to the risk of timely payment of interest and principal. Objectives: To assist both individual and institutional investors in making investment decisions in fixed interest securities; To enable companies to mobilize funds in large amounts from a wide investor base, at a fair cost; To enable intermediaries to place debt instruments with investors by providing them with an effective marketing tool, To provides regulators with a market-driven system for bringing about discipline and a healthy growth of capital markets.

Credit Rating Services (CRS) The principal function of the CRISIL is to rate mandated debt obligations of Indian companies, chit funds, real estate developers, LPG/kerosene dealers, nonbanking finance companies, Indian states and so on. Rating of Debt Obligations The CRISIL has developed a framework for the composite rating of real estate projects. Such a rating is expected to help prospective investors to identify and narrow down their investment options. Bond Fund Ratings This rating is an opinion of the credit quality of bond funds underlying portfolio holdings. (i) Credit associated with securities in the fund portfolio; (2) the systems and procedures followed by funds and (3) management quality and expertise. Bank Loan Rating The creditworthiness of a banks borrower-clients is assessed by CRISIL, offering comments on the likelihood of repayment of loans to banks. (1) For the borrower-manufacturing client companys underlying assets liquidity profile, operating systems and risk management initiative of the management;
(2) For non-banking finance companies quality-of-assets portfolio, loans


investments. Collective Investment Schemes Rating

This covers the rating of collective investment schemes of plantations and other companies, offering opinions on the degree of certainty of the scheme to deliver the assured returns in terms of the quantity of produce and/or cash, as mentioned in the offer document. Grading for Healthcare Institutions The CRISILS grading for healthcare institutions is an opinion on the relative quality of healthcare delivered by the institution to its patients. Grading Scale and Definition The grading scale has two components. The first is the hospital classification, such as: nursing home, general secondary care, specialty secondary care, multispecialty tertiary care and single-specialty tertiary care. The second component of the grading scale is the hospitals grading, within that classification, on a four-point scale. Grade A Reflects Very Good Quality Grade B Reflects Good Quality Grade C Reflects an Average Quality Grade D Reflects Poor Quality The CRISIL Advisory Services(CAS) The CAS offers consultancy services that aim identifying is transaction and policy level assignments in the areas of energy, transport and urban structures, banking and finance, and disinvestment, privatization and valuation. The CRISIL has a pact with National Economic Research Associates (NERA), USA to strengthen its research advisory services. CRISIL Research and information Services (CRIS)

The CRISIL Research and information Services (CRIS) disseminates, valueadded research and undertakes customized studies in four areas, namely: Indian economy, Indian capital markets, Indian industries and the Indian corporate studies in four areas, large client base, both in India and overseas, comprising institutional investors, investment bankers, commercial banks, financial institutions, corporate planners, mutual funds and asset management companies. The services rendered earlier by the CRISIL as the CRISIL Card services and CRISIL Economic services have been reorganized and assimilated under the CRIS.

CRISIL Sector wise The contents of the CRISIL Sector wise include the following: (I) (II) A brief of history of the industry Structure of the industry, and its characteristics; Structure of the industry, and its characteristics; product specifications, cost structure, capacities, technology, sector use; (IV) Demand supply analysis, both present and future; (V) An analysis of the major players in the industry; (VI) Government policies; (VII) Industry risks/constraints; (VIII) International competitiveness; (IX) Key factors and (X) The CRISILS outlook on the industry. (III) An analysis of the different projects in the industry, based on factors like

CRISIL VIEW The CRISIL VIEW is based on the CRISIL s IN-DEPTH understanding of the industry in which the company operates, as well as its understanding of the relevant

qualitative and quantitative factors affecting the companys performance. It present a powerful report on listed corporate in India, serving as a comprehensive and interactive tool for business managers, investors, creditors and corporate decision makers.

CRISIL Markets Wire The CRISIL Marketwise, established in October 2001, is the leading source of news and commentary on Indias fixed-income market. With about 20 experienced journalists, the news service provides a blow-by-blow account of developments in all segments of this market. Capital Markets Group The Capital Markets Group at the CRISIL provides customized research and advisory assistance to meet specific transactional and strategic requirements of clients. The Group is supported by the CRISIL Research and information services, which continuously tracks over 50 sectors and 500 corporates. CRISIL Training services The CRISIL is the only rating agency in the country that provides technical assistance and training to the Malaysian Rating agency (RAM) and Israeli Securities Rating Agency (MAALOT). ICRA Ltd The ICRA Ltd has been promoted by the IFCI Ltd as the main promoter to meet the requirements of the companies based in the northern parts of the country. Apart from the main promoter, which holds 26 percent of the share capital, the other shareholders are the Unit Trust of India, banks, LIC,GIC, Exim Bank, HDFC Ltd and ILFS Ltd. It stared operations in 1991. In order to bring international experience and

practices to the Indian capital markets, the ICRA has entered into a MOU with Moodys investors services to provide, through is company Financial programmers inc (FPI), credit education, risk management software, credit research and consulting services to banks, financial/investment institutions, financial services companies and mutual funds in India. As in the case of the CRISIL, the main objectives of the ICRA are: To assist investors, both individual and institutional, in making well informed decisions; To assist issuers in raising funds, from a wider investor base, in large amounts and at a lower cost for highly rated entities; To enable banks, investment bankers, brokers in placing dept with investors by providing them with a marketing tool and To provide regulators with market driven systems to encourage the healthy growth of the capital markets in a disciplined manner, without additional burden on the government. Over the years, the ICRA has diversified the range of its services. It currently provides three types of services: (1) rating services; (2) information services and (3) advisory services. b)CARE Ltd The CARE is a credit rating and information services company promoted by the Industrial Development Bank of India (IDBI) jointly with financial institutions, public/private sector banks and private finance companies. It commenced its credit information and equity research. Unlike the CRISIL and the CRISIL and the ICRA,

the CARE is very cautious in entering new areas of business. Currently, it offers the following services: Credit Rating The CARE undertakes credit rating of all types of dept instruments, both shortterm and long-term. Advisory Service The CARE provides advisory services in the areas of: Securitization transactions; Structuring financial instruments; Municipal finances.

FITCH Ratings INDIA Ltd It is the latest in the credit rating business in the as a joint venture between the international credit rating agency Duff and Phelps and JM Financial and Alliance Group. In addition to debt instruments, it also rates companies and countries, on request. RATING PROCESS AND METHODOLOGY The process/procedure followed and the methodology used generally by CRAs Rating process/procedure All the four rating agencies in the country adopt a similar rating process. The steps followed by them in the rating process are illustrated with reference to (1) New issues/instruments (2) Review of rating and (3) Flow chart of rating.

Rating process of New Issues The following steps are involved in rating the issuers of instruments for the first time, before going public.

Rating Agreement and Assignment of Analytical Team The process of rating starts with the issue of the rating request letter by the issuer of the instrument and the signing of the rating agreement. On receipt of the request, the rating agency (CRA) assigns an analytical team, comprising two/more analysts, one of whom would be the lead analyst and would serve as the relevant business areas are responsible for carrying out the rating assignments. Meeting with Management Prior to meeting with the issuer, the analytical team obtains and analyses information relating to its statements, cash flow projections and other relevant information details blow: (I) (II) Annual reports for the past five years and interim reports for the past three years Two copies of the latest prospectus offering statements and applications for listing on any major stock exchanges. (III) Consolidated financial statements for the past three fiscal years by the principal, subsidiary or division. (IV) Two copies of the statements of projected sources and application of funds, balance sheets and operating statements for at least the next three years. Along with assumptions on which projections have been based.


Copies of the existing loan agreements along with recent compliance letters, if any.

(VI) A certified copy of the resolution adopted by the board of the company authorizing the issuance of commercial paper and or other short-term dept instruments, including the name of authorized signatories. (VII) List of the banks, showing lines or credit and contact officers for each, along with duty completed short-term borrowings from them, in the prescribed format. (VIII) If applicable, the name of commercial paper dealer of the company, the planned use of proceeds from the scale of commercial paper, the amount of commercial paper to be used, and a specimen copy of the commercial paper note. (IX) Biographical information on the companys principal officers and the names of the board members. There is no prescribed format for supplying the above information. Hence, any format could be flexibly used to cover all the required information adequately. A complete brief followed by a Discussions with the management philosophy and plans should also be obtained. Rating Committee After meeting with the management, the analysts present their report to a rating committee, which then decides on the rating. The rating committee meeting is the only aspect of the process in which the issuer does not participate directly. Communication to the Issuer After the committee has assigned the rating, the decision is communicated to the issuer, with the reasons or rationale supporting the rating.

For a rating to have value or an issuer or an investor, the CRA must have credibility. The thoroughness and transparency of its rating methodology and the integrity and fairness of its approach are important factors in establishing and maintaining credibility. The CRAs are therefore, always willing to discuss with the management, the critical analytical factors that the committee focused on while determining the rating and also any factors that the company feels may not have been considered while assigning the rating. In the event that the issuer disagrees with the rating outcome, he may appeal the decision for which new/additional information, which is material to the appeal and specifically address the concerns expressed in the rating rationale, need to be submitted to the analysts. Dissemination to the Public Once the issuer accepts the rating, the CRAs disseminate it, along with the rationale, through the print media. RATING Review for Possible Change In the case of rated instruments, the rated company is on the surveillance system of the CRA, and from time to time, the earlier rating is reviewed. The CRA constantly monitors all ratings with reference to new political, economic and financial developments and industry trends. New Data of Company Analysts review the new information or data available on the company, which might be sent to it by the company or it might have been procured through routine channels, as strategic information under its surveillance approach. Rating Change

On preliminary analysis of the new data, if the analysts feel that there is a possibility for changing the rating, then the analysts request the issuer for a meeting with is management and proceed with a comprehensive rating analysis.

Credit Rating Watch During the review monitoring or surveillance exercise, rating analysts might become aware of imminent events like mergers and so on, which affect the rating and warrants a rating change. In such a possibility, the issuers rating is put on credit watch indicating the direction of a possible change and supporting reasons for a review. Credit watch indicates four situations for changing the rating, namely: (1) Negative change, indicating the downgrade; (2) Positive change, indicating an upgrade; (3) Stable, implying no change in rating and (4) Developing, implying an unusual situation in which the future events are so unclear that the rating may be changed either in negative or positive directions. Rating Methodology The rating methodology involves an analysis of the industry risk, the issuers business and financial risks. A rating is assigned after all the factors that could affect the credit worthiness of the entity. A rating is assigned after assessing all the factors that could affect the credit worthiness of the entity. Typically, the industry risk assessment sets the stage for analyzing more specific company risk factors and establishing the priority of these factors in the evaluation. For instance, if the industry is highly competitive, careful assessment of the issuers market position is stressed. If possibility of a

the company has large capital requirements, the examination of cash flow adequacy assumes importance. The ratings are based on the current information provided by the issuer or facts obtained from reliable sources. Both qualitative and quantitative criteria are employed in evaluating and monitoring the ratings. The rating methodology is illustrated blow with reference to (i) (ii) Manufacturing companies and Financial services companies.

For Manufacturing Companies The main elements of the rating methodology for manufacturing companies are outlined below.

Business Risk Analysis The rating analysis begins with an assessment of the companys environment, focusing on the strength of the industry prospects, pattern of business cycles as well as the competitive factors affecting the industry. The nature of competition is different for different industries, based on price, product quality, distribution capabilities, image, product differentiation, service and so on. The industries characterized by a steady growth in demand, ability to maintain margins without impairing future prospects, flexibility in the timing of capital outlays, and moderate capital intensity are in a stronger position. Industry Risk Nature and basis of competition, key success factors, demand and supply position, structure of industry, cyclical/seasonal factors, government policies and so on.

Market Position of the Issuing Entity Within the Industry Market share, competitive advantages, selling and distribution arrangements, product and consumer diversity and so on.

Operating Efficiency of the Borrowing Entity Vocational advantages, labor relationships, cost structure, technological advantages and manufacturing efficiency as compared to competitors and so on. Legal position Terms of the issue document/prospectus, trustees and their responsibilities, systems for timely payment and for protection against fraud/forgery and so on. While the CRAs do not have a minimum size criterion for any given rating level, the size of the company is a critical factor in the rating decision as smaller companies are move vulnerable to business cycle swings as compared to larger companies. In general, small companies are more concentrated in terms of product, number of customers and geography and, consequently, lack the benefits of diversification that can benefit larger firms. Financial Risk Analysis After evaluating the issuers competitive position and operating environment, the analysts proceed to analyze the financial strength of the issuer. Financial risk is analyzed largely through quantitative means, particularly by using financial rations. As ratings rely on audited data (the rating process does not entail a companys financial records), the analysis of the audited financial results begins with a review of accounting quality. The purpose is to determine whether rations and statistics derived

from financial statements can be used to accurately measure a companys performance and its position, relative to both its peer group and the larger universe of companies.

Accounting Quality Overstatement/understatement of profits, auditors qualifications, method of income recognition, inventory valuation and depreciation policies, off-balance sheet liabilities and so on. Earnings prospects Source of future earnings growth, profitability rations, earnings in relation to fixed income charges and so on. Adequacy of Cash Flows In relation to dept and working capital needs, stability of cash flows, capital spending flexibility, working capital management and so on.

Financial Flexibility Alternative financing plans in times of stress, ability to raise funds, asset deployment potential and so on. Management Risk A proper assessment of dept protection levels requires an evaluation of the management philosophies and its strategies. The analyst compares the companys business strategies and financial plans (over a period of time) to provide insights into

a managements abilities, with respect to forecasting and implementing of plans. Specific areas reviewed include: (I) (II) Track record of the management planning and control systems, depth of managerial talent, succession plans; Evaluation of capacity to overcome adverse situations and (III) Goals, philosophy and strategies. Financial services sector When rating dept instruments of financial institutions, banks and non-banking finance companies, in addition to the financial analysis and management evaluation outlined above, the assessment also lays emphasis on the following factors: Regulatory and Competitive Environment (I) (II) structure and regulatory framework of the financial system; Trends in regulation and their impact on the company/institution.

Fundamental Analysis Fundamental analysis should include:

Capital Adequacy Assessment of the true net worth of the issuer, its adequacy in relation to the volume of business and the risk profile of the assets. Resources Overview of funding sources; funding profile; cost and tenor of various sources of funds. Asset Quality

Quality of the issuers credit risk management; systems for monitoring credit; sector risk; exposure to individual borrowers, management of problem credits and so on. Liquidity Management Capital structure; term matching of assets and liabilities; policy on liquid assets in relation to financing commitments and maturing deposits. Profitability and Financial Position Historic profits; spreads on funds deployment; revenues on non-fund based services; accretion to reserves and so on. Interest and Tax Sensitivity Exposure to interest rate changes; tax law `changes and hedging against interest rate.