FINANCIAL SERIVICES

UNIT-I Introduction to Indian Financial System-Financial Markets and Types-Financial Institutions in India-Reserve Bank of India-Commercial Banks-State Bank of 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.

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

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

 Convertible debentures with options

easy exit regular income and retirement bonds. The money market has organized players are the Reserve Bank of India. lakhpati bonds. 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. Securities Trading Corporation of India Ltd and Discount and Finance House of India. Life Insurance Corporation. The money or credit market is the centre for dealings in monetary assets of short-term nature generally below one year. encash bonds.b)TYPES OF MARKETS: Money Market The financial system consists of the money market and capital market as found elsewhere in the world. . junk bonds and indexed bonds. Unit Trust of India. growth bonds. 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. deep discount bonds and capital gain bonds. step-up liquid bonds. The financial markets abroad have seen a wide variety of asset-backed securities. index bonds. General Insurance Corporation. II.

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

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

2. To change cash for bank deposits and bank deposits for cash. the secured and unsecured promises of trade and industrial units. advise on tax problems and undertake executive and trustee services. government bonds. 3. 5. 4.III. They also offer their constituents services to pay insurances. . To exchange deposits for bills of exchange. They are also allowed to invest 5% of three incremental deposit liabilities in shares and debentures in the primary and secondary markets. where exchange control do not exist. 2. Other financial intermediaries such as savings and loans. III. bank deposits are used as a means of settling debts.d) Payment Systems 1. Commercial banks are institutions which combine various types of transactions services with financial intermediation. Secondly. Thirdly. another type of financial service organizations have developed financial product against which checks may be written.c)FUNCTIONS OF COMMERCIAL BANK The functions of a commercial bank are: 1. To underwrite capital issues. Bank provides three types of transactions to convert deposits into notes and coins to enable holders of deposits to undertake transactions in cash. banks exchange cash and deposits from one currency Commercial banks earlier had a monopoly on transaction services. 3. saving banks and credit unions in the United States have been authorized to offer transaction accounts. Money market mutual funds. To transfer bank deposits between individuals and/or companies.

Firstly. Bank money constitutes 38 per cent of the money supply of the Indian economy. Commercial banks along with other financial institutions channel the funds of surplus economic units to those wanting to spend on real capital investments. . brokerage firms and non-banking financial institutions worldwide. While doing so they take on part of their risk. asset and size transformation consisting of mobilization funds and their allocation (provision of large loans on the basis of numerous small deposits). maturity transformation by offering the savers.Commercial banks are at the very centre of the payment systems. Secondly. Banks collect deposits from savers by offering interest. Banks have to manage the risks through appropriate structuring of their activities and hedge risks through derivative contracts to maximize their profitability. liability. An efficient payment system is vital to a stable and growing economy and the banks role is important. Transformation Services Banks combine various types of transformation services with financial intermediation. In advanced economics commercial banks are also at the heart of the electronic payment system which is replacing paper based payment methods. Through their intermediary activities banks provide a package of information and risk sharing services to their customers. Swift (the Society for Worldwide Interbank Financial Telecommunication) based in Brussels is operated by 2000 banks. Intermediation Commercial banks undertake the important process of financial intermediation whereby the funds or savings of the surplus sectors are channeled to deficit sectors. Finally. Financial intermediaries including banks buy and sell the right to future payments. They provide three transformation services when they undertake intermediation process.

32 private sector banks and 42 foreign banks.469 crores(39.43.11. Rs.27%) bank credit of Rs.447 crores(1.4.368 crores consist of capital of Rs.368 crores consist of cash in hand and balances with RBI of Rs.1%).834 crores(3. risk transformation by transforming and reducing the risk involved in direct lending by acquiring more diversified portfolios than individual savers can.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). Finally. These new instruments reflect considerable flexibility in responding to market situations and adjusting continually assets and liabilities both on and off balance sheet. 9.4.10. Size: Assets of Rs.94%). 85. options and forward agreements. 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. The public sector banks (PSBs) dominate the banking system with more than 80% share in the total assets of SCBs.307 crores(81.30%) investments of Rs. Transformation Services and Risks: Banks incur while undertaking transformation services. 81.371 crores(7.69% of total assets). .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. Liabilities of all scheduled commercial banks.18.019 crores(7.95%) and deposits from public of Rs. assets with banking system of Rs.66%) reserves and surplus of Rs.10.00.43.13. III.11. while enhancing profitability.871 crores(37.

The Reserve Bank entered upon its career as a state-owned institution from January 1. The Bank sits on the board of all banks and it counsels the Central and State governments and public sector institutions . 834 crores in 19992000 together constituted 5. 1949. It is the watchdog of the entire financial system. b)Functions of the Bank: The main functions of the Bank are to act as the note-issuing authority. 447 crores and reserves of Rs. 1935. NABARD and NHB.Liabilities Paid-up Capital and Reserves Paid-up capital of Rs. Banker to the government and to promote the growth of the economy within the framework of the general economic policy of the government.61% of liabilities of scheduled commercial banks.RESERVE BANK OF INDIA a)Introduction: The Reserve Bank of India was established on April 1. The Reserve Bank is the controller of foreign exchange. the entire share capital was deemed to be transferred to the Central Government. The Act of 1948 empowered the Central Government to issue such directions to the Bank as it might. 1934. consistent with the need to maintain price stability. IV. IDBI. under the Reserve Bank of India Act. The Bank’s share capital was Rs. 1948. The Bank also performs a wide range of promotional functions to support the pace of economic development. after consultation with the Governor of the Bank. Banker’s Bank. consider necessary in the public interest.5 crores.43. The Bank is the sponsor bank of a wide variety of top-ranking banks and institutions such as SBI. In the terms o the Reserve bank (Transfer to Public Ownership) Act.18.

five thousand and ten thousand. even in the developed world. Currency notes are legal tender in payment or on account. one thousand. c)Issue of Currency: The Reserve Bank is the sole authority for the issue of currency in India. ten. The assets which form the backing for the note issue are kept wholly distinct from those of the Banking Department. One rupee notes and coins are legal tender for unlimited amounts. five hundred. Rupee coins/notes and subsidiary coins are issued by the government of India but they are put into circulation only through the Reserve Bank. hundred. fifty. twenty.1000 are being used.on monetary and money matters. 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- . No central bank. 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. fifty paise coins for a sum not exceeding ten rupees and smaller coins for any sum not exceeding one rupee. Cash deposits and withdrawals by scheduled banks are handled by the Banking Department. At present denominations up to Rs. The Act permits the issue of notes in the denominations of rupees two. The affairs of the bank relating to note issue and its general banking business are conducted through two separate departments. The expansion and contraction of currency in circulation is effected through the Banking Department. without limit. is saddled with such onerous responsibilities and functions. the Issue and Banking Department.

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.determined. . The requirements may e stipulated as a proportion of aggregate outstanding deposits or on the increment after a base date. The Reserve Bank manages the public debt and issues new loans on behalf of the Central Government and state governments. 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 move to market –related rates of interest is likely to strengthen the development of the secondary market. The cash reserve ratio could be varied between 3 per cent and 15 per cent of their total demand and time liabilities. Primary dealers are approved by the RBI and help in the placement of government securities in primary issues by committed participation in auctions. of a proportion of its deposit liabilities in the form of specified liquid assets. The system of primary dealers would enable the development of an orderly market. and statutory liquidity ratio involving the maintenance by the bank. 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. SECONDARY DEBT MARKET Debt management policy can be effective if there is a secondary market with depth.

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 plays the key role of a leader in rural credit management.V.NATIONAL BANK FOR AGRICULTURE AND RURAL DEVELOPMENT (NABARD) a)Introduction NABARD is apex rural credit institution which plays an active role in implementation of various Rural Development Programmes. NABARD has to accelerate the flow of credit for long term investment in agricultural sector. 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. The NABARD came into existence in July 1982. NABARD has to ensure that there is adequate flow of credit for seasonal agricultural operation to maintain agriculture production. NABARD provides refinance for promoting agricultural activities as well as non-farm sectors particularly programme covered under poverty alleviation. Similarly. which are very helpful in raising the income level of rural people and bring them above the poverty line. NABARD has general lines of credit from the Reserve Bank of India for meeting the credit requirements of seasonal and other than agricultural operations. Apart from these funds. Some important promotional activities supported by NABARD are discussed below: . NABARD provides support through formulation of some innovative non-farm schemes. NABARD has two funds to finance agricultural operations. They are.

698 crore during 1997-98.b) Nabard strategies For enlarging the scope for catalyzing credit follow. This credit is expected to increase further to Rs. NABARD has formulated the following strategies: a) Involving state level functional and financial-cum-developmental corporations. co-operative and regional rural banks for agricultural and other approved activities will be refinanced by NABARD at certain interest rate. 38. 31. A major portion of the money (usually between 70 and 90 percent) lent by commercial. It also extends refinance facilities to Land Development Banks. Remember. voluntary agencies. The total quantum of agricultural credit provided by commercial banks. Khadi and village commission under automatic refinance facility as also under group/bulk lendings. NABARD plays the following promotional roles for the development of Indian Rural Economy: . NABARD does not extend direct credit facilities to production units/individual borrowers.054 crore in 1998-99 as per NABARD Annual Report for 1998-99. like a commercial bank. c)PROMOTIONAL ROLES BY NABARD Besides the above. co-operative banks and regional rural banks with or without assistance from NABARD amounted to Rs. 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.

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

sanctions credit limits and refinances co-operative Banks. 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. The NABARD being the apex bank for rural credit.Further. The National Agricultural Credit(Stabilization) Fund. 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. The two Funds. including the investment credit provided by them under various schemes. 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. 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 CRAFICARD has recommended the reorganization of the cooperative credit structure. 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. namely. NABARD . The assets and Liabilities of the RBI relating to rural credit were also transferred to this Bank. In the case of commercial banks. The Agriculture Refinance Development Corporation (ARDC) was merged with NABARD. all the functions of the Reserve Bank of India relating to Rural Credit have been handed over to this apex bank NABARD. It has advocated a speedy reorganization of primary agricultural credit societies into multipurpose service institutions.

the share capital of co-operative societies. loans and advances issued by the Reserve Bank and outstanding against State Cooperative Banks and RRBs aggregating to Rs. d) Production and marketing activities of village artisans. As . with the establishment of NABARD. and State Co-operative Banks. Regional Rural Banks. b) Distribution and marketing of agricultural inputs for the purpose of rural development. 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. e)Performance of NABARD As studied already.759 crores were transferred to NABARD. Scheduled Banks. NABARD can provide ling-term loans by way of refinancing through financial institutions like Land Development Banks. 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. small-scale industries etc. It can also contribute or invest in the securities of any institutions connected with agricultural or rural development. On the date of establishment of NABARD. as the commercial banks are expected to meet the short-term requirements out of their own resources.provides refinance against the term loans issued by them under schematic lending for agricultural and certain non-agricultural purposes. the NABARD can convert short-term loans into medium-term loans granted to State Co-operative Banks and Regional Rural Banks. all assets and liabilities relating to Rural Credit of the Reserve Bank of India were transferred and taken over by NABARD. Besides short-term and medium-term loans. During drought and famine conditions. c) Bonafide commercial transactions or trade transactions.

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

HRD

SGSY scheme

Inspection for co – operative BK & RRB

Women children development NABARD participation

Training centres

External aid project SHG

VVVP

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

which have proved very helpful for credit institutions in extending credit to poor farmers. Organisation of Petroleum Exporting Countries Fund for International Development etc. NABARD gives its recommendations to RBI with the matter relating to licensing of Co-operative Banks and Regional Rural Banks. 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. 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. External Aid Project NABARD has been implementing various foreign aided projects. 6. 8. Vikas Volunteer Vahini Programe NABARD has been organizing farmers club in association with voluntary agencies in rural areas particularly in tribal areas. These banks are also to submit periodical information to NABARD for monitoring purposes. 7. 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. it conducts inspections of Co-operative Banks and Regional Rural Banks. Training facilities are extended at its two training institutions-Bankers Institute for Rural Development (BIRD) and Regional Training Centres (RTCs) . 9.NABARD conducts studies of on-going schemes and completed studies to obtain feedback on performance of those projects. For this purpose. The projects are assisted by World Bank Group.

d) Reserves and Surplus The excess of income over expenditures is further in 1999. These agencies include Co-operative Credit Institutions. The demand for funds for rural development has come up considerably in recent times. Regional Rural Banks and Commercial Banks. NABARD raises funds from the following sources: a) Capital It went up from Rs. b) Deposits The deposit mainly come from Rural Infrastructural Development Fund (RIDF) introduced in Central Government Budget from the year 1995-96.100 crore in March 1992 to Rs. Loans from Union Government and borrowings in Foreign Currency from abroad. 1500 crore in March 1998 and Rs. . The total Capital of NABARD is contributed by Government of India and generally accumulated as ‘Reserves and surplus’. c) Borrowings NABARD raises funds through market borrowings. 2000 crore RBI. Apart from these they also borrow funds from RBI. To meet the increasing demand of rural credit.g)RESOURCES OF NABARD NABARD has been providing financial assistance to various financial institutions engaged in Rural Credit Delivery System.

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. bridges and flood control measures.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.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. The RIDF was set up with a contribution of Rs. rural roads. Such classification is given below: 1 2 3 4 Establishment of SBI Before 1921 From 1921 to 1934 From 1934 to 1955 . f) Rural Infrastructural Development Fund (RIDF) The setting up of RIDF was announced in the Union Budget for 1995-96. a)Evolution of State Bank OF India: The evaluation of the State Bank of India can be divided into four periods. 2000 crore mainly to provide assistance to State Governments to take up infrastructure projects pertaining to irrigation. VI. These Stabilisation Fund) given out of profits earned by RBI.

The Imperial Bank was functioning on this line till 1934 when a separate central bank i. by the amalgamation of these three banks the Imperial Bank was established.e. It was governed by the Imperial Bank of India Act of 1920. . It was nationalized in 1955 according to the recommendations of Rural Credit Survey Committee. 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. In 1921. Besides its regular functions.After 1955 Before 1921. But it was simultaneously performing some of the functions of Central Bank such as the banker to the government. For this purpose.. RBI was established. The Imperial Bank was mainly a commercial bank owned by private shareholders. which would undertake rapid expansion of banking facilities in rural areas. it suggested the government to nationalize the Imperial Bank and other state associated banks. The committee recommended that the government should establish a strong government owned commercial bank. Then the Imperial Bank of India Act was amended by the Imperial Bank (amendment) Act of 1934. 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. bankers’ bank and national clearing house. Calcutta and Madras. there were three Presidency Banks of Bombay.

industry.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. 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 .

(3) Currency Chest: The RBI maintains currency chests at its own offices. SBI. i)Central Banking Functions: The SBI as agent of the RBI at the places where the RBI has no branch. 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. When the banks face financial shortage. (a) collection of charges on behalf of the government e.. the SBI provides assistance to them as it is considered a big brother in the banking industry.d)FUNCTIONS OF STATE BANK OF INDIA The functions of SBI can be grouped under two categories. collection of tax and other payments (b) grants loans and advances to the governments (c) provides advises to the government regarding economic conditions etc. the Central Banking functions and ordinary banking functions. Accordingly. But RBI Offices are situated only in big cities. It receives and pays money on behalf of the governments. viz. It discounts the bills of the other commercial banks. .g. (2) Banker’s Bank: Commercial Banks have accounts with SBI. buy its wide network of branches operate in urban as well as rural areas.

discounting. savings. 3. ii)General Banking Functions Besides the above specialized functions. 2. 5. accepting. 6. securities etc. the SBI renders the functions of clearing house. . buying and selling of bills Investing funds. Advancing and lending money and opening cash credits Drawing. Accepting deposits from the public under current. 4. fixed and recurring deposit accounts. 1. 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. where RBI has no branch. (5) Renders Promotional Functions: State Bank of India also renders various promotional functions. of exchange and other negotiable instruments. upon the security of stocks. the SBI renders the following functions under Section 33 of the Act. in specified kinds of securities Advancing and lending money to court of wards with the Issuing and circulating letters of credit.(4) Acts as Clearing House: In all the places. previous approval of State Government.

The Rural Credit Survey Committee envisaged a . 21. 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. 17. 13. stocks. Ltd”. Export Finance. public. Offering remittance facilities such as demand drafts. mail Acting as administrator. 10. 15. 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. Government. 11. 16. trustee or otherwise. 14. 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. executor. 18.7. 20. 19. Currency Accounts. 9. 12. Provides Project Provides Merchant Banking Facilities. Provides specialized services like “Global Link Services”. 8.

Financial assistance to Central Land Development Banks 5. (b) Tiny Sector Small scale industrial units with investment in plant and machinery up to Rs. repairing or service operations with original investments in plant and machinery not exceeding Rs. processing. ) . Sponsoring Regional Rural Banks 10.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. Small Scale Industry Industrial units. Direct finance to farmers 2. Loans and advances to co-operative marketing and processing societies 4.Ware Housing Finance 11. Agricultural Development Branches 8. The SBI provides agricultural and rural finance in the following ways: 1. In small scale industry the following categories of business units are included.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. engaged in manufacturing. Village Adoption Scheme and Service Area Approach 9. Loans and advances to co-operative banks 3. Small Farmers Scheme 6.300 crore are classified as Small Scale Industries. Farm Graduates Schemes 7.dominant part for the State Bank in rural finance. Expansion of Rural Branches. preservation.

. Medium-term Loans and Installment Credit 3. preference and debenture issues. Industrial Finance Corporation of India (IFCI) This was first in the chain of establishment of financial corporations to provide financial assistance for industrial development. preference and debenture issues. Promotion of village and cottage industry 7. Encouraging Women Entrepreneur 6. 5 lakh. Discounting of bills 4. Underwriting of equity.10 lakh.Project uptech. Provides technical and financial consultancy services 9. not exceed Rs. both in rupees and foreign currencies. not exceed Rs.(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. Encouraging self-employment schemes 8. IFCI provides assistance to the industrial concerns in the following ways: (i) (ii) Long-term loans. g)SBI ASSISTANCE TO SMALL UNITS The SBI helps the small units in the following ways: 1. 1948 under the Act of the Parliament. This was established on July 1. Special Village Industries Division 10. Offers working capital 2. Entrepreneur Development Programmes 5. 10 lakh. VII. Subscribing to equity.

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

380 corers fertilizers . financial institutions.Since its inception up to March 2007 the financial assistance sanctioned by IFCI aggregated to Rs. The Bank came into existence in 1982. b) One director is nominated by the RBI. cement industries industrial machinery . director appointed by the Central Government: provided that the same person may be appointed to function both as chairman and as managing director.44. Not more than twelve directors nominated by the central government of .900 corers against which total disbursements amounted to rs 15. and the business community The Board of Directors of the EXIM Bank consists of: a) chairman and a managing. 1981. and power generation industries were beneficiary . c) One director nominated by the Development Bank. Organization 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. the ExportImport Bank of India Act. d)One e) whom: director is nominated by the Export Credit and Guarantee Corporation Limited. facilitating and promoting foreign trade of India.EXIM BANK OF INDIA a)Introduction Export-Import Bank of India was created by an Act of Parliament. VIII. banks. for he purpose of financing. It is the principal financial institution in the country for coordinating and working of institutions engaged in financing exports and imports.

Loans by central government. Committees The Board may constitute such committees whether consisting wholly of directors or wholly of other persons or partly of directors and partly of other persons for such purpose or purposes as it may think fit. or professional experience in. Export development fund. c)Functions of the EXIM Bank The export finance is the main function of EXIM Bank. Another salient feature is the extensive involvement of developing Indian economy. export or import or both. Borrowings and Acceptance of Deposits by EXIM Bank 3. donations etc. and also involves a significant extent in other kinds of export promotional activities. b)Resources of the EXIM Bank The resources of the EXIM Bank are: 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. The EXIM Bank facilitates the following functions: 1. Grants. to EXIM Bank. It also carries on and transacts all or any of the following functions relating to export and import business..(i) Five directors are nominated by the central government (ii) Not more than three directors are from the schedule banks. namely: . Loans in foreign currency 4. 5. (iii) Not more than four directors are persons who have special knowledge of. 2. 2.

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

Thus. 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. By leasing an asset the lessee essentially acquires its use value from the lessor. periodic. who actually purchased and owns (retains title to) the asset. is a process by which a firm can obtain the use of certain fixed assets for which it must make a series of contractual. taxdeductible payments. In this context. 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.LEASING SERVICES a)Introduction: Leasing. b)The Concept of Leasing: Leasing is an alternative to purchase an asset in order to acquire the services of that asset.UNIT-II I. like long-term debt. leasing . Simply stated. The lessor retains title to the asset and hence the right to sell or dispose of it for its salvage value.

The lessor will raise the money. enjoys the benefits of tax deductions and various grants extended by governments to the new capital investment in the industry. During the life of the contract all of the cost of the property plus financing and servicing charges should be recovered through periodic payments. The lessor is simply interested in the equipment as its legally owned asset.distributes the rights of ownership by separating the asset’s use value from its salvage value. In this kind of ‘lease agreement’ the leasing company will act simply as a financial institution. The lessee will specify the equipment needed and act as the lessor’s agent in the matters of ordering it. (ii) Non-tax base leasing: Lessor. 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. accept the invoice from the supplier and pay accordingly. (iii) Net Lease: . inspecting it and maintaining it. (i) Floating rental rate lease contracts: This kind of lease permits a lessee to undertake the risk and awards of interest rate variations. in general. 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.

The rentals do not have any direct correlation towards the recovery of capital costs. for a relatively short period. respectively. USE VS. interest and lessors’ profit in the lease period. 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. In this kind of lease. the lessee pays the costs associated with partnership.In a net lease. Lessors’ primary objective while offering the lease rentals is to have a regular income and the interest on the capital. generally automobiles. (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 . office and domestic equipment. These costs include property taxes. Different kinds of operating lease writing: (a) Service lease A service lease resembles to ‘Contract Hire’ but has a different legislative outlook. insurance premiums and capital and maintenance expenses. the ‘lessor’ renders the services of the equipment. OWNERSHIP Financial leasing is a means of financing the use rather than the ownership of an asset. Moreover these rentals are fixed keeping in view the useful working life of the equipment.

For example. (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. Once the broker has found a company interested in acquiring an asset by means of a leverage lease. . equipment. New assets are frequently sold and leased back. 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. The lender will receive interest and principal repayments paid out of the lease payments. 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. a firm may be building a new plant.maintain the monopoly of their products in the market. 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. During the construction period. Under this type a sole and leaseback arrangement consists of the sale of machinery. and arranges to borrow the remaining portion from institutional lenders. 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. machine tools etc. or building by a firm to a financial institution that in turn leases the assets back to the firm . This type of leasing is significantly popular in computers. the firm takes construction loans from a bank to handle the financing.

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. SALE-AID LEASING: By the advent of intensive competition in product marketing. a manufacturer directly extends facility of leasing either by one of his own subsidiaries or through a third party. In this kind of leasing. The lessor provides the additional funds not provided by the lender and purchases the asset. Equipment financed by cross border leasing displays one or more of the following characteristics: . CROSS BORDER LEASE: When a lessor leases equipment to a lessee who is not falling in the jurisdiction of the lessor’s territory then the lease written is known as Cross Border leasing.(c) Lessor (equity participants): The lessor comprises one or more banks or finance companies with sufficient profits to take the full tax advantage. a leasing company. of the depreciation charges and investment allowances allowable on the asset. a number of companies adopted this technique as a marketing tool because under this scheme. the period of the lease is shorter than the economic life of 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. 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. Usually.

Disposal problem 16. Equipment procurement 2.Convenience 11.  Used in an economically essential sector with strong and lasting profitability.Step-by-step financing 14. Availability 6. Debt capacity 4. Limited claims in the event of bankruptcy or re-organisation 9. d)ADVANTAGES AND DISADVANTAGES: The merits of leasing from a potential lessee’s point of view are stated below: 1.Avoiding of the risk of obsolescence 12. Flexibility 8. and. Taxation 7. Undisputed title( giving rise to registration).  Long life and a good second hand value in many different countries. Additional source of finance 3.Flotation costs 15.  Relative mobility. Hedging risks 10. Certainty 5.Increase in liquidity 13.Higher incomes .

10. A lease can be evaluated either as an investment decision or as a financing alternative.A well-defined cost 18.17. 2. 3. essentially involves a choice between debts . 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. The lease evaluation from the lessee’s point of view. 5. thus. 4. 7. 6. 8. 9. LESSEE’S PERSPECTIVE Finance lease effectively transfers the risks and rewards associated with the ownership of an equipment from the lessor to the lessee.Maintenance is cheap and certain The disadvantages are: 1.

NPV (L)/NAL = Investment cost Less: Present value of lease payment (discounted by Kd). 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. (discounted by (discounted by .financing versus lease financing. the leasing alternative should be used. Evaluation of lease financing from the view point of lessee is presented. otherwise the borrowing alternative would be preferable. The decision-criterion used is the Net Present Value of Leasing [NPV (l)]/Net Advantage of Leasing (NAL). The value of the interest tax shield id included as a foregone cash flow in the computation of NPV (L)/NAL. 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.

b) Inflows such as lease rentals. residual value and security deposit. BELR has NAL as zero. It reflects the maximum level of rental which the lessee would be willing to pay. 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. expenses on suits for recovery and other direct cost and so on. if any. The decision-criterion is to select the alternative with the lower present value of cash outflows. Alternatively.An alternative approach is to determine the present values of the cash outflows after taxes under the leasing and the borrowing alternatives. As in the case of the evaluation by a lessee. the lease proposal would be accepted. i)LESSOR’S VIEWPOINT: The lease evaluation from the point of view of the lessor aims at ascertaining whether to accept a lease proposal or to choose from alternative proposals. lease administration expenses such as rental collection charges. income-tax on lease payments. 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. If the BELR exceeds the actual lease rental. the appraisal method used is the discounted cash flow technique based on the lessor’s cash flows. tax shield on depreciation. if any and so on. management fee. otherwise rejected. sales-tax on lease transaction. Break-Even Lease Rental: .

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

(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:

. and (b) An element of sale which fructifies when the option to purchase is exercised by the intending purchaser/hirer. Each installment is treated as hire charges so that if default is made in payment of any one installment. and 5. Thus. The property in the goods passes to the purchaser on payment of the last installment. The hirer/purchaser is free to return the goods without being required to pay any further installments falling due after the return. The possession is delivered to the purchaser at the time of entering into the contract. and only passes later when the option is exercised by the intending purchaser. the seller becomes entitled to take away the goods. 2. a hire-purchase agreement has two aspects: (a)An aspect of bailment of goods subjected to the hire-purchase agreement. 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. but it has to be in writing and signed by both the parties to it. 4. Where a hire-purchase agreement involves a guarantee. the agreement must be signed by the surety also. Payment is to be made in installments over a specified period. otherwise the agreement shall be avoidable at the option of the owner. f)Form and Contents of a Hire-Purchase Agreement: There is no prescribed form for a 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. 3.

that is reasonably fit for the purpose for which they have been produced and marketed. Free of Encumbrances: The goods are warranted as free from any charge or encumbrance in favour of any third party. and (e) The description of the goods.e. (d) The number of installments in which the hire-purchase price is to be paid. Merchantable Quality: That the goods are of merchantable quality. Thus. and the owner enters into a hire-purchase agreement. where the goods are already pledged or hypothecated. 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. the person to whom and the place where each of the installments is to be paid. it amounts to a breach of warranty. at the time the property in the goods is to pass. the price at which the goods may be purchased by the hirer for cash. (b) The cash price of the goods i. (c) The date of commencement of the agreement. 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.A hire-purchase agreement must contain the following particulars: (a) The hire-purchase price of the goods. no such conditions are implied: . the amount. However. due date..

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

. the hirer has to pay to the owner. the balance of hire-purchase price after deducting a rebate. and he makes a payment which is not sufficient to discharge the total amount when due under all the agreements. the owner gets the right to apply the payment to the agreements in the order of their time. 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. he may appropriate the payment to such agreement(s) as he likes. 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. If the hirer does not exercise his right of appropriation. the hire has to give to the owner at least 14 days’ notice of this intention to terminate the agreement. To Terminate Agreement: The hirer has a right to terminate the agreement at any time before the final hire purchase installment falls due. where the agreement provides for a higher rebate. To Appropriate Payments: Where the hirer is required to pay several hire-purchase installments under two or more agreements to the same owner. For making the purchase. at any time during the continuance of the agreement. For this purpose.g) Rights of Hirer: To purchase with Rebate: The hirer has a right to purchase the goods under the agreement. the hirer is entitled to it. by giving to the owner at least 14 days’ notice of his intention to do so. However.

When the owner refuses to give his consent on a request by the hirer. The owner’s consent is deemed to be unreasonably withheld of he demands any consideration thereof. the hirer may make assignment without his consent. 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. If the owner unreasonably withholds his consent. he is not liable for any loss. destruction or deterioration of the goods. consent is deemed to have been reasonably withheld. he is liable to pay interest @ 12 percent on that amount. 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. the hirer may apply to the court for a declaration that the consent has been unreasonably withheld. . 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 Assign and Transmit: The hirer has right to assign his right. with the consent of the owner. If the hirer exercises so much care. after the expiry of the notice period. quality and value under similar circumstances. To Refund on seizure of Goods: Where the owner seizes the goods in exercise of his right. If the owner fails to refund the amount within 30 days after receiving notice from the hirer. title and interest under the agreement. If the court makes such an order.

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

the owner may terminate the agreement after giving the hirer a notice of writing.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. To enter Premises and seize goods: The owner has the right to enter the premises of the hirer and seize the goods. . 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. the owner has the right to recover damages for non-delivery of the goods. on breach of which the owner becomes entitled to terminate the agreement. This is. subject to the hirer’s right to refund in case of seizure of goods. unless there is a contract to the country. To Recover Damages: Where the hirer delays the return of goods. however. (b) When the hirer makes any unauthorized use of the goods or breaks an express condition of the agreement. To Forfeit Initial Deposit: The owner has the right to forfeit the initial deposit of the agreement so permits. for the period between the date of termination of agreement and the date of delivery. 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 the hirer immediately after execution of the agreement. 3. To supply on demand. as a fund-based financial service. the date on which each unpaid installment becomes due and the amount of each such installment: (c) The amount which is to e payable.FACTORING AND FORFAITING a)INTRODUCTION: Factoring. the term “factoring” has been defined in various countries in different ways. Rome during 1988. International Institute for the Unification of Private Law (UNIDROIT). III.Obligations of Owner: The owner has the following obligations: 1. a true copy of the agreement. To supply on demand by the hirer. 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 . To supply. the dates on which such installments are to become due and the amount of each such installment. free of cost. provides resources to finance receivables as well as facilitates the collection of receivables. (b) The amount due and unpaid. the following information. via: (a) The amount paid by or on behalf of the hirer. recommended. 2. signed by him. a copy of the agreement to the surety. b)CONCEPT AND MECHANISM: Concept: In the absence of any uniform codified law.

Mechanism: Credit sales generate the factoring business in ordinary course of business dealings. The Buyer: (a) Buyer negotiates terms of purchasing the material with the seller. . MOU instructions to make payment to factor given to buyer. (e) Seller receives balance payment from factor after deduction of factor’s service charges.(v) across national boundaries (vi) to trade or professional debtors (vii) when notice of assignment has been given to the debtors. Once sale transaction is completed. delivery challan. 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) 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 factor steps in to realize the sales. Thus. (c) Delivers copies of invoice. (d) Seller receives 80 per cent or more payment in advance from factor on selling the receivables from the buyer to him. etc. factor works between the seller and the buyer and sometimes with seller’s banks together. Realisation of credit sales is the main function of factoring services. (b) Buyer receives delivery of goods with invoice and instructions by the seller to make payment to the factor on due date.

in general terms. charge. (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. hypothecation or mortgage or right of set-off or counter-claim from another etc. 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. the main functions of a factor.c)The Factor: (a) The factor enters into agreement with seller for rendering factor services to it. pledge. (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. lien.  Collection facility/of accounts receivable. (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. 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. can be classified into five categories:  Maintenance/administration of sales ledger. . (c) The factor receives payment from the buyer on due dates and remits the money to seller after usual deductions. d)FUNCTIONS OF A FACTOR: Depending on the type/form of factoring. (e) The seller should confirm in writing to the factor that all payments arising out of these bills are free from any encumbrances. (d) The invoice.

The ledger is generally maintained under the open-item method in which each receipt is matched against the specific invoice. the factor undertakes to purchase all trade . receipts of payments from the customers and other useful information. The factor also gives periodic (fortnightly/ weekly depending on the volume of transaction) reports to the client on the current status of his receivables.  Assumption of credit risk/ credit control and credit protection. an invoice is sent by the client to the customer and a copy of the same is sent to the factor. Credit Control and Credit Protection: Assumption of credit risk is one of the important functions of a factor. Administration of Sales Ledger: The factor maintains the clients’ sales ledgers. The factor in consultation with the clients fixes credit limits for approved customers. Within these limits. The balance 15-20 per cent is retained as a factor reserve. and  Provision of advisory services. time and efforts. On transacting a sales deal. Financing facility/trade debts. 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 service is provided where debts are factored without recourse. The customer’s account clearly reflects the various open invoices outstanding on any given date. This also enables the client to reduce the cost of collection by way of savings in manpower. 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.

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

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

The factors take requisite assistance and avail facilities provided in the exporting country for export promotion. international factoring is also called Two-Factor System of Factoring. client (seller-supplier) and factor. Factoring contract is like any other sale-purchase agreement regulated under the law of contract. They handle exporter’s overseas sales on credit terms.invoice in undisclosed factoring although the factor maintains the sales ledger of the supplier-manufacturer. International factoring provides a non-recourse factoring deal. (a) Between the exporter (client) and the export factor and (b) Between the export factor and import factor. namely. customer (buyer). While in domestic factoring three parties are involved. Since two factors are involved in the deal. The process of export factoring is almost similar to domestic factoring except in respect of the parties involved.(iii) export factor and (iv) import factor. the three parties involved. The legal relationship between a factor and a client is largely . there are usually four parties to a cross-border factoring transaction. Domestic and Export/Cross-Border/International Factoring: In the domestic factoring. They are: (i) Exporter (client) (ii) importer(customer). The two-factor system results in two separate but inter-linked agreements. The clients (exporters) have cent per cent protection against bad debt loss on credit-approved sales. f) LEGAL ASPECTS OF FACTORING: FACTORING CONTRACT: There is no codified legal framework/code to regulate factoring services in India.

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

(b) The importer draws a series of promissory motes in favour of the exporter for payment including interest charge. Alternatively. All risks and collection problems are fully the responsibility of the purchaser (forfeiter) who pays cash to seller after discounting the bills/notes. The bills/notes are sent to the exporter. The guarantee by the bank is referred to as an Aval. The promissory notes/bills are guaranteed by a bank which may not necessarily be the importer’s bank.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. The purchase is in the form of discounting the documents covering the entire risk of non-payment in collection. It denotes the purchase of trade bills/promissory notes by a bank/financial institution without recourse to the seller. IV. the exporter sells and delivers the goods to the importer on a deferred payment basis. The salient features of forfeiting: b)Salient Features: (a) In pursuance of a commercial contract between an exporter and importer.FORFAITING: a) Introduction: Forfeiting is a form of financing of receivables pertaining to international trade. the exporter draws a series of bill which are accepted by the importer. defined as an endorsement by a bank guaranteeing payment by the buyer (importer). .

The exporter sells the avalled notes/bills to the bank (forfeiter) at a discount without recourse. b) The availing bank which provides an unconditional and irrevocable guarantee is a critical element in the forfeiting arrangement. (e) The forfeiter may hold these notes/bills till maturity for payment by the importer’s bank. (d) Payment to forfeiter to the exporter of the face value of the bill/note less discount. he can securitize them and sell the short-term paper in the secondary market as high-yielding unsecured paper. rate of interest and so on. days of grace. fee to compensate the forfeiter for loss of interest due to transfer and payment delays. usually bi-annual installment. The forfeiter’s decision to provide financing depends upon the financial standing of the availing bank.(c) The exporter enters into a forfeiting arrangement with a forfeiter which is usually a reputed bank including exporter’s bank. commitment charges. The implication is that forfeiting is hundred percent financing arrangement of receivables finance. 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. period of forfeiting contract. . Alternatively. The agreement provides for the basic terms of the arrangement such as cost of forfeiting. installment of repayment. margin to cover risk.

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

 Benefit associated with Non-recourse Factoring e)Operational Problems: The factoring service in India is still at a nascent stage. Its future depends on the removal of a number of genuine operational obstacles. namely. Discount charges 3. Its quantitative growth is relatively limited.2. bad debt loss. Credit Information: The factors do not have access to any authentic common source of information. . It inflates the cost of operations of service and erodes the profitability of the factors. 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). Legal Framework: Changes are also called for in other components of the present legal framework to ensure success of factoring in India. 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 is high time to provide export factoring to Indian exporters. Limited Coverage: At present only domestic factoring of the advance with recourse is permitted and offered in India. . Virtual dependence on equity funds does not permit them to have optimal funding. a factor needs a disclaimer certificate from banks. Disclaimer Certificate: To purchase a book debt of its clients.Funding: The factors in India are not allowed access to wider funding sources on scales available to other finance companies.

Unit III I. 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. b) Creation of a B/E Suppose a seller sells goods or merchandise to a buyer. In most cases. the seller draws a B/E of a given maturity on the buyer. is called the drawee.Bill discounting a)INTRODUCTION Bill discounting as a fund-based activity. The buyer. 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 . or to the order of. 1881: "The bill of exchange is an instrument in writing containing an unconditional order. the seller would like to be paid immediately but the buyer would like to pay only after some time. that is." The bill of exchange (B/E) is used for financing a transaction in good which means that it is essentially a trade-related instrument. 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. who is the debtor. directing a certain person to pay a certain sum of money only to. and is called the drawer of the bill. or to the bearer of that instrument. a certain person. The seller has now assumed the role of a creditor. signed by the maker. 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. To solve this problem. the buyer would wish to purchase on credit.

The act of handing over an endorsed B/E for ready money is called Financial Services . Discount the B/E with a discounting agency. who is the holder of an accepted B/E has two options: 1. Normal maturity periods 30. 60. discounting the B/E. 90 or 120 days but bills maturing within 90 days seem to be the most popular. Option (2) is by far more attractive to the seller. 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. The seller can take over the accepted B/E to a discounting agency [bank. company. . 2. Hold on to the B/E till maturity and then take the payment from the buyer.The seller. high net worth individual] and obtain ready cash. NBFC.

the type of activity they finance. 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. These documents include the invoices and oil documents of title such as railway receipts. The term usance refers to the lime period recognised custom or usage for payment 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. 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. i so on. Usance Bill this is also called time bill. lorry receipts and bills of lading issued by custom officials Documentary bills can be .c)Types of Bills Bills Demand Usance bill Documentry Clean D/a bills D/p bills There are various types of bills.

D/P Bllls In case a bill is a "documents against payment" bill and has been accepted by the drawee. 3. and TO . Since it is not a lending. but also from the point of view of companies that do envisage tax liabilities. not only from cash flow point of view. Bills discounting being in the nature of a transaction is outside the purview of Section 370 of Indian Companies Act 1956. Rates of discount are better than those available on ICDs. Clean BillS These bills are not accompanied by any documents that show that a trade has taken between the buyer and the seller. the documentary evidence accompanying the bill of exchange is deliverable against acceptance by the drawee. that restricts the amount of loans that can be given by group companies. d)Advantages The advantages of bill discounting to investors and banks and finance companies are as follows: Investors 1. This means the documentary bill becomes a clean bill after delivery the documents. no tax at source is deducted while making the payment charges which is v convenient. the interest rate charged on such bills is higher than rate charged on documentary bills. documents of title will be held by the bank or the finance company till the maturity of the B/E.further classified as: (i) Documents against acceptance (D/A) bills i (ii) Documents against payment (D/P) bills. Short-term sources of finance. 4. Because of this. D/A Bills In this case. 2.

where interest is paid quarterly or half yearly. the effective rate of interest is higher than the quoted rate (discount). the discount is payable in advance. The rate of discount applicable to clean hills is usually higher than the rate applicable to L/C-based bills. 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. TO e)BILL MARKET SCHEMES . The discount rate varies from time to time depending upon the short-term interest rate the call liquidity need credit for system. The bills are generally discounted up-front. ideal cash balances as under the cash It also provides banks greater control over their drawls. bill finance obviates the maintaining large. 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.5. As a consequence. the yield is much higher than in other loans and advances. un utilised. that is. 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. Profitability Since the discount on a bill is front-ended. not only in the quantum of investments but also in the duration of investments. 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. Flexibility. Thus.

(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. 1969. cash credit or overdraft accounts were. This Section briefly outlines the efforts made by the RBI in the direction of the development of a full-fledged bill market.Bill Market Scheme.) e. 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. (iii) The existing loan. 19SO and (iv)(iv) Vaghul Committee. (iii) (iii) Chore Committee.(i). The most notable of these were. 1985. The Reserve Bank of India (RBI) has constantly endeavoured to develop the commercial bills market. that is: . 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.The development of bill discounting as a financial service depends upon the existence of a full-fledged bill market. (i) Dehejia Committee. therefore. 1974. (ii) Tandon Committee. required to be split up into two parts.

(vii)The RBI could also make such appropriate enquiries as it deemed fit. 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. in this account further withdrawals or repayments were as usual being permitted. (y) The amount advanced by the RBI was not to exceed the amount lent by the scheduled banks to the respective borrowers. 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. 1970 In pursuance of the recommendations of the Dehejia Committee. e. the RBI . were made at one-half of one per cent below the bank rate. the RBI agreed to bear half the cost of the stamp duty incurred converting demand bills into time bills. (b) the other part.(a) one part was to remain covered by the demand promissory notes. (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. Banks could lodge the usance promissory notes with RBI for advances as eligible security for borrowing so as to replenish their loanable funds.(ii)Bill Market Scheme. 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. 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.

Eligible Institutions All licensed scheduled banks and those which do not require a licence (i. In case bills are retired before the dates. its associate banks and natioanlised banks) are eligible to offer bills of exchange to the RBI for rediscount. 1970. 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.e. 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. the State Bank of India. sale and rediscount of bills of exchange and promissory notes. 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. the new bill market scheme in order to facilitate the re-discounting of eligible bills of exchange by banks with it. not less than three working days before the dates of maturity of the hills concerned.introduced with effect from November 1. 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. 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. pro-rata refund of discount is allowed by the RBI. Regular credit limits arc fixed by banks and NBFCs for individual parties for purchase and discounting of clean bills and documentary bills separately. For rediscounting purposes. bills already rediscounted with RBI may be lodged with it. These limits are renewed annually and are based on the following considerations: .

that is. (iv) Nature of customer's industry The earlier sanctioned limits are fully utilised by the client'. (iii) In case of unpaid bills.(i) Quantum of business undertaken by the party. (d) Hundi/Promissory note. (b) Challan. (e) Truck receipt/Railway receipt. turnover of inventory. Once the party is granted a bill discounting limit. The following documents are submitted alongwith the letter of request: (a) Invoice. (f) Post dated cheque for the interest amount. (Hi) Credit worthiness of drawee and details of dishonour. (c) Receipt of goods acknowledged by buyer. 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. (ii) Credit worthiness of drawer (client). the party approaches the finance company for each and every bill for discounting. Precautions The finance companies take following precautions while discounting bills: (i)The bills are not accommodation bills but are genuine trade bills. funds were paid by the drawer. (iii)The goods covered by the documents are those in which they party deals. . if any. (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. The bills were promptly paid on maturity date.

the bank/NBFC looks mainly to its customer (drawer or drawee) for recovery of its dues. (viii) The goods are properly insured. Dealing with Default The cycle of liabilities in a bill discounting transaction is as follows: The "drawee is liable to the drawer. (xiii) The truck receipt is in the form of prescribed by the Indian Banks Association. (vii) The goods are not consigned directly to the buyer. the discounting agency can resort to noting and protesting as laid down by the negotiable instrument act II. (v)The credit report on the drawee is satisfactory. In case of default. (ix) The usance bill is properly stamped. (x) Bills offered for discount do not cover goods whose prices fluctuate too much. and the drawer to the discounting agency. (xii) The bills are not stale.(iv)The amount of the bills commensurate with the volume of business turnover of the party. (xi) The goods covered under the bill are not of perishable nature.a)Introduction .Bills are drawn on a place where the goods have been consigned. However. (vi) The description of goods mentioned in the invoice and railway receipt/truck receipt are same. Housing Finance II. (xiv) The bills are drawn in favour of the finance company and have been accepted by the drawee.

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

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

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. (i) Formulating scheme(s) for the economically weaker sections of society. such manner and on such terms as may be prescribed borrow money from the Central Government. (k)Providing guidelines to HFIs to ensure their growth on sound lines' (l)Providing technical/administrative assistance to HFI.(d) Guaranteeing the financial obligations of HPIs and underwriting the issue of stocks/shares/bonds/ debentures/other securities of HFIs (e) Drawing. .s ' (m) Generally. bonds/debentures. 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. 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. (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. the NHBmay: (a) issue and sell bonds and debentures with or without the guarantee of the Central Government. financial institutions. accepting. banks. buying/selling and dealing in bills of exchange/ promissory notes. discounting/rediscounting. hundies. which may be subsidised by the Government or any other source (j) Organising training progninimes/.seminars/symposia on matters relating to housing.

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. (d) borrow money from the RBI fi) by way of loans and advances and.(c) accepting deposits repayable after such period and. generally. premia. consultancy charges. With the prior approval of the NHB. service charges. operations) Fund established under Section 46-D of the RBt Act. remuneration. licence fees and other considerations of any description. grants. (e) receive. obtain financial assistance in a manner specified by the RBI. commission. (f) receive gifts. royalties. (ii) out of the National Housing Credit (long-term . commitment charges. donations or benefactions from the Government or any other source. such terms -as may generally or specially be approved by the RBI.. 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. to the extent of the accommodation granted by it and . The NHB may also provide guarantee as to payment of interest and other incidental charges. for services rendered. 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. as well as repayment of the principal.

1908. (a) any instrument in the form of debt obligations/trust certificates of beneficial interest/other instruments. in respect of the securitisation of loans of HFIs/banks. or otherwise. / Exemption from Registration Subject to Section 17(1) of the Registration Act. by whatever name called. would be deemed to have been received by it in trust and should accordingly be paid by the institution to the NHB. 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. 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. 1882 Power to Acquire Rights The NHB has the right to acquire. 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. 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. the NHB may impose such conditions as it may think necessary/expedient in respect of any transaction entered into with any borrowing institution . by transfer/assignment.remaining outstanding. 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. Not with standing such transfer. except in so far as it entitles the holder to an undivided interest offered by a registered instrument. the NHB may act as a trustee for the transferee in terms of Section 3 of the Indian TrustsAct.

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 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. the NHB may direct an institution at any time.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. (iii) the guarantees furnished and (iv) any information that which has a bearing on the borrowers' credit worthiness. to submit to its credit information in the specified form and within the time specified by it from time to time. housing and settlement. (ii) the nature of security taken for them. e)Deposits with Housing Finance Institutions Registration and Net Owned Funds to commence/carry on business. 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. Credit information refers to any information relating to (i) the amount of loans/advances/other credit facilities granted for housing purposes. by the NHB. Advisory Services The NHB is authorised to provide advisory services to the Goverment(s). every HFI set-up as a company should (a) obtain a certificate of registration from the NHB and . is totally prohibited.

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. subject to which the registration was issued. 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. or particulars relating to. as required under the provisions of the NHB Act. with deposits ' received by them. they should submit a report to the NHB giving the aggregate amount of deposits held by them . minus accumulated balance of loss. 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. discussed above. information. 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. (c) at any time fails to fulfil any of the conditions laid down for grant of registration. and deposits with. Except where satisfied on such enquiry about compliance.-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. or connected. (b) has failed to comply with any condition.(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. (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.

(iii) has been prohibited by the NHB from receiving deposits. 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. by an order in force for a period of at least three months. (ii) ha^ become disqualified in terms of registration and net owned funds requirements to carry on business. on being called up. In addition. it may. create charge/mortgage or deal in any manner with its property and assets without the NHB's prior written permission. NHB may file an application for its winding-up under the Companies Act. 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.Power of the NHB to Prohibit Acceptance of Deposits The NHB may prohibit any HFI from accepting any deposit on violation of provisions or failure to comply with any direction/order given by it in relation to the acceptance of deposits. accounts and other documents in custody / power to furnish any statement / information related to the business of the HFI. if necessary in public/depositors' interest. 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. (iv) continuing in business is detrimental to the public interest/interest of depositors. 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. It had also issued guidelines to them on prudential norms on . transfer. the NHB may conduct an inspection by its officers) (inspecting authority). direct such a HFI not to sell.

Life Insurance Corporation of India. ' (a) Amount received from (i) the Central government and state government. capital adequacy and concentration of credit/investments. (iii) a local authority (b) Amount received from the NHB. General Insurance Corporation of India and its subsidiaries ©Amount received from another company (d)Amount received by way of subscription to any shares. (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. bonds.income recognition. stock. Industrial Development Bank of India. provisioning for bad and doubtful debts. 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. (ii) any other source whose repayment is guaranteed by the Central Government or a slate government. asset classification. 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 . accounting standards. including paid-up preference shares compulsorily convertible into equity capital A public deposit means a deposit but does not include the following. NOFs mean Net Owned Fund (NOF) defined under Section 29-A of the NHB.

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

such shares should be valued at one rupee only. in the nature of current investments should be valued at cost or break-up value. While "fair value" refers to the mean of the earning value and the break-up value. MFCs may substitute fair value for break-up value of the shares. for the purposes of valuation. Where the balance sheet of the investce company is not available for two years. including treasury bills.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. Accounting for Investments All investments in securities should be classified as current and long-term investments. 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. whichever is lower. (c) debentures and bonds. However. the "earning value" means the value of an equity share . he grouped into the following categories: (a) equity shares: (b) preference shares. (d) Government securities. whichever is Unquoted Equity Shares This. 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. if considered necessary. Quoted current investments for each category should be valued at cost or market value. (e) units of mutual funds and (f) others.

which covers losses caused by fire. under which a specified amount becomes payable on the death of the insured or upon the expiry of a specified period of time. (ii) trading company and (iii) any other. 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. and further divided by the number of equity shares of the investee company and capitalised at 8 per cent.computed by taking the average of profits after tax as reduced by the preference dividend and adjusted for extraordinary and non-recurring items. 1938 The Insurance Act provides the broad framework for the insurance sector/industry/services in the country Eligibility . whichever is earlier. 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. in consideration of a sum of money (premium). there are two parties to an insurance contract: insurer/assurer/underwriter and (ii) insured/ass ured/beneficiary. or damage to. for the immediately preceding three years. The document laying down the terms of the contract is called (insurance) policy.A General insurance.Insurance services INTRODUCTION Insurance is pooling of risks. the insurer (insurance company) agrees/undertakes. In a contract of insurance. accident and marine adventures and so on b ) INSURANCE ACT. Thus. 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. 10 per cent and 12 percent in the case of predominantly (i) manufacturing company. III.

having paid-up capital of Rs 100 crore. 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. an insurance cooperative society. 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. cargos and freights. to some other class of insurance business. a cooperative society. 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.and any contract which is subject to payment of premiums for a term dependent on human We. other than incidental. freights and other interests which may be legally insured in or in relation to such vessels. cither by itself or through subsidiaries/nominees. .Any class of insurance business in India can be carried out only by a public company. only Indian insurance companies arc permitted to carry out any class of insurance business after the enactment of the IRDA Act. tire insurance business means the business of effecting. 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. a body corporate other than a private company incorporated in any country outside India) However. 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. marine/miscellaneous insurance business whether carried on singly or in combination with one/more of them.

While undertaking this exercise. and exercised all powers vested with the COI.\ c. It had been entrusted with the task of preparing a comprehensive legislation to establish a statutory. 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. 1998. It could also examine the powers of the government under the Insurance Act. pending the enactment of a comprehensive legislation. 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. which could be transferred to the IRA as and when it would be set upc.Salient Features of Interim IRA The chairman of the IRA was the ex-officio COI under the Insurance Act. 1938. the IRA had to bear in mind the possibility of privatisation of the insurance industry. on January 23. 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.(ii)Insurance Regulator/ and Development Authority (IRDA) Act. (i).goods/warcs/merchan disc/ properly of whatever description insured for any transit by land or water or both and whether or noi including warehouse risks or similar risks in addition or as incidental to such transit. 1999 In order to provide better insurance cover to citizens and also to augment the flow of long-term sources of financing infrastructure.The IRDA Act was enacted in 1999 to provide for the . wholly/ partially and make appropriate recommendations regarding the role and powers which it would need in such a scenario. 1996. the government reiterated its announcement of 1996 in its budget speech. 1938. autonomous IRA on the pattern of the Securities and Exchange Board of India (SEBI). to open up the insurance sector and also set up a statutory IRDA.

the LIC Act. 1956. Insurance Act. 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 . 1972. and the General Insurance Business (Nationalisation) Act. modify. insurable interest. are stated below: a) Issue to the applicant a certificate of registration: to renew. promote and ensure orderly growth of the industry and for matters connected therewith/incidental thereto and also to amend the. 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. . to be appointed by the government from amongst persons of ability.establishment of the IRDA to protect the interests of policy holders. c. to regulate. surrender value of policy. 1938. nomination by y policy-holders. settlement of insurance claim. withdraw. 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. integrity and standing who have knowledge/experience of life insurance/general insurance/actuarial service.(iii)Powers and Functions The powers and functions of the IRDA. suspend or cancel such registration. inier-alia. promote and ensure orderly growth of the insurance and reinsurance businesses. preference in registration to be given to companies providing with health insurance (b) Protection of the interests ofpolicyholders in matters concerning assigning of policy.

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. for ail or any of the following Matters relating to registration of insurers The manner of suspension or cancellation of registration . levying fees and other charges for carrying out the purposes of the IRDA Act (g) Calling for information from. --Supervising the functioning of the Tariff Advisory Committee (m). including audit of insurers. regulating maintenance of margin of solvency k)Adjudication of disputes between insurers and intermediaries or insurance intermediaries (L).(f) Promoting and regulating professional organisations connected with the insurance and reinsurance business. insurance. intermediaries and other organisations connected with the insurance business h) Control and regulation of the rates. undertaking inspection of.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. 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. conducting enquiries and investigations.

The requisite qualifications and practical training to act as an insurance agent (xiv) he passing of examination to act as an insurance agent (xv).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. as may be determined by the issue of a . manner and the other conditions of investment of assets held by an insurer. 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.000.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 .Such fee. not exceeding Rs 5. 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. 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 manner in which such information should be maintained. The minimum information to be maintained by an insurer in their books.

when guidelines were issued for setting up of . 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. 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. commercialisation of new technologies and support to small and medium enterprises in the manufacturing and the service sectors.(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 . irrespective of the nature of their projects. 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. VENTURE CAPITAL FINANCING Introduction Venture capital institutions which emerged the world over to fill gaps in the conventional financial mechanism focused on new entrepreneurs. 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. Over the years. 1988. The initial steps for the institutionalisation of venture capital in India were taken by the Government in November. their duties. the concept of venture capital has undergone significant changes.

thus. to obtain long-term capital gains let is the provision of risk-bearing capital. usually in the form of participation in equity. somehow. In addition. 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 . The acquisition of outstanding shares from other shareholders cannot be considered venture capital investment''^ is new.venture capital funds/companies (VCFs/VCCs) for investing in unlisted companies and to avail of a concessional facility of capital gains tax. Venture capital is a way in which investors support entrepreneurial talent with finance and business skills to exploit market opportunities and. in return for minority shareholding in the business or the irrevocable right to acquire it. The relatively high risks are compensated by the possibility of high return. long-term /capital that is injected to enable the business to grow rapidly. to companies with high-growth potential. it provides some value addition in the form of management advice and contribution to overall strategy. It is defined as an equity/equity-related investment in a growth-oriented small/medium business to enable investees to accomplish corporate objectives. usually through substantial capital gains in the medium term. 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. come to acquire various connotations. According to a very widely-accepted definition. b)Features Venture capital has.

(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.(iii). From analytical angle. the different stages of investments are recognised and vary as regards the time-scale.Second Round Financing This represents the stage at which the product has already been launched in the market but the business has not. become profitable enough for public offering to attract new investors. very few VCIs invest in this pre-commercialisalion/seed stage of product development. The promoter has invested his own funds but further infusion of funds by the VCIs is necessary . However. risk perceptions and other related characteristics of the investment decision process of the VCIs c. the timing of launching the product and so on. Venture capital financing here is provided for product development and initial marketing. c.(ii)Start-Up This is the stage when commercial manufacturing has to commence. 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. awareness of competition. The essence of this stage is that the product/ service is being commercialised for the first time in association with the VCIs c. are important elements of the appraisal.returns. The returns in such financing are essentially through capital gains at the time of -exits from disinvestments in the capital market. The risk perception of investment at this stage is extremely high. The commercial acumen of the promoter to take advantage of the market opportunity. yet.

They usually bring three elements together: a management team. bridge/expansion.Stages of Financing The selection of investment by a VCI is closely related to the stages and type of investment. It includes mezzanine/development capital. Two Kinds of inputs are required in a turnaround namely.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. From analytical angle. money and . Turnarounds These are a sub-set of buyouts and involve buying the control of a sick company. Management Buyins MBIs are funds provided to enable an outside group [of manager(s)] to buy an Ongoing company. 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. VCIs provide funds to enable the current operating management/ investors to acquire an existing product line/business. 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. 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. They fall into two categories: management buyouts (MBOs) and management buyins 'anagement BuyOuts In MBOs.(iv).

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

In case of later stage financing. market conditions. safety of the principal. 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. As pointed out earlier. maturity date of the issue. The precise timing of exit depends on several factors such as nature of the venture. the state of actual and potential competition. early stage financing typically takes a long-term view of eventual realisation/exit from five to seven years. For example. the potential exit in terms of the realisation horizon (exit timing) has to be planned at the time of the initial investment itself. for unquoted convertible debt investments. the extent and type of financial stake. debt-service coverage. If it is doubtful. In fact. 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. the realisation horizon could be shorter in the range of three to fives e) VENTURE CAPITAL FUNDS . the style of functioning as well as perception of VCIs and so on.Value Method This is appropriate. as in the case of unquoted equity investments. 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. 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.

Nodal Agency for VCFs To simplify procedure. VCFs shall enjoy a complete pass-through status. It has a dedicated pool of capital. The income distributed by the funds will only be taxed in the hands of investors at the rates applicable to the nature of income. 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). 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. There will be no tax on distributed or undistributed income of such funds. .Regulations of VCFs SEBI amended regulations for VCFs. e. 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. the Finance Act. 5 lakh and the minimum corpus of the fund before it could start activities should be at least Rs. 2000 has made SEBI the single-point nodal agency for registration and regulation of both domestic and overseas Venture Capital funds (VCFs).(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. 5 crore. (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. No approval of VCFs by tax authorities is required.

Discounting of bills.Encouraging self employment schemes . 7.Entrepreneur development programmes. (VCF) Regulation to provide for flexibility in exit to VCFs. 2000. 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. 5. 3. 13 new domestic VCFs and only 1 FVCI were registered. . 6. Promotion of village and cottage industry.(iii) The norms of investment were modified.Medium term loans and installment credit . (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.offers working capital 2. (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. 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.Encouraging women entrepreneur. 4. During the year 2000-01.

There are also areas where compliance can be monitored and enforced. Issue management activity has a big fall out on the integrity of the market.Special village industrial division. Actually. UNIT -IV I. merchant banking includes the entire range of financial services. The services provided by a merchant bank outfit. 9. MERCHANT BANKING 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. are subject to their inclination and resources. Merchant bankers (Category I) however are mandated by SEBI to manage public issues (as lead managers).Project uptech. technical and financial.8. It affects inventors’ interest and hence transparency has to be ensured. The Commission was in favour of a separate institution (distinct from commercial banks . 10. 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. however.Provides technical and financial consultancy services.

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

hydropower installation. 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. Commercial banks. financing local authorities. mergers and takeovers.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. railways. organized and undertaken in several forms. Merchant banking activities are of course. equipment leasing. e) REGULATION Merchant banking activities are regulated by (1) Guidelines of SEBI and Ministry of Finance. (2) Companies Act. Apart from meeting specially. 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). Indian and . financing of hire-purchase transactions. the needs of small scale units. it provided management consultancy services to large and medium sized companies. 1956. assistance in financial management. raising Eurodollar loans and issue of foreign currency bonds. ships. investment management and promotion of investment trusts. acceptance of house business. valuation of assets. 1956 and (3) Listing guidelines of Stock Exchanges and (4) Securities Contracts (Regulation) Act. 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. financing export of capital goods.

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

DEFINITION OF MERCHANT BANKER The notification of the Ministry of Finance defines a merchant banker as. investor’s confidence depends in a large measure on the efficiency of the issue management function which covers drafting and issue of prospectus or letter of offer after submitting it to SEBI and timely dispatch of share certificates or refund orders. . integrity and solvency. honesty. The regulations would promote a primary market which is fair. 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. “ any person who is engaged in the business of issue management either by making arrangements regarding selling. 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. 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. buying or subscribing to securities as manager.12. at a low cost. efficient. In the primary market. flexible and inspires confidence. consultant. advisor or rendering corporate advisory service in relation to such issue management.REGULATIONS OF MERCHANT BANKING a)NOTIFICATIONS OF THE MINISTRY OF FINANCE AND SEBI Merchant bankers have to be organized as body corporate. IV.II.1992) RATIONALE OF NOTIFICATIONS Investor’s confidence is a prerequisite for an orderly growth and development of the securities market.

AUTHORISED ACTIVITIES The authorized activities would include issue management which consists of preparation of prospectus and other information relating to the issue. corporate advisors to the issue.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. Registration of Merchant Bankers SEBI abolished on 5-9-1997 all categories of merchant bankers below category I. CRITERIA FOR AUTHORISATION The criteria for authorization takes into account (a) professional qualification in finance. Portfolio management requires separate registration. consultants or advisors to issue and underwriting. law or business management (b) infrastructure like adequate office apace. which will inter alia consist . managers. Further. general reputation and fairness in all their transactions. experience. V. Merchant bankers operating in the categories below I have to apply for category I status or take up some other activity. tie-up of finances and final allotment and/or refund of subscription. (c) employment of two persons who have the experience to conduct the business of merchant bankers (d) capital adequacy and (e) past track record. Underwriting could be done without any additional registration. Other authorized activities would be portfolio management services. equipment and manpower. 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. Merchant bankers can carry on any activity of issue management. determining financing structure.

100-200 crores. for issues between Rs. Code of Conduct The code of conduct stipulates that in the performance of duties.for issues above Rs. tie-up of financiers and final allotment and refund of the subscription and act in the capacity of managers. endeavor to ensure that true and adequate information is provided to investors and to abide by all rules. five or as may be agreed by SEBI. 1 lakh in third year and Rs.400 crores. Number of lead managers: The number of lead managers depends on the size of the public issue. give best advice. 2. regulations. and for issues above Rs. the number of lead managers should not exceed two. render high standard of service and exercise due diligence. . advisor or consultant to an issue. not to divulge confidential information about the clients.50 crores.of preparation of prospectus and other information relating to the issue determining financial structure. resolutions issued by the Government of India and SEBI from time to time.5 lakhs annually in the first two years and Rs. 400 crores.50-100 crores maximum of three. Networth Minimum networth is Rs. five. inform the client that he is obliged to comply with the code of conduct. guidelines. 1 lakh to pay annually. portfolio manager and underwriter.5 crores. Registration fee is Rs. for issues between Rs. merchant bankers should act in an ethical manner. not to make misrepresentations. not to indulge in unfair practices. The guidelines stipulate that for an issue of upto Rs.four.200 crores but less than Rs.

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

Defaults 1.2/6/cci/89 dated 10-1-1990. Major default 4. 1990. F2/14/cci$90 dated 6th April. 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. (d) Failure to ensure submission of certificate of minimum 90 per cent subscription to the issue as required under Government of India. Minor default 3. shares/debentures certificates. before filing with Registrar of Companies/Stock Exchange. filing of listing application by the issuer as required under Government of India press notification No. (b) Non-receipt of inter se allocation of responsibilities of lead managers in an issue by SEBI prior to the opening of issue.defaults a)General Defaults: Penalty points 1 2 3 4 For the purpose of penalty point. (c) Non-receipt of due diligence certificate in the prescribed manner by SEBI. . General default 2. before opening of the issue. (e) Failure to ensure publicing of dispatch of refund orders. press note No. Serious default VIII.

(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. (b) Exaggerated information or information extraneous to the prospectus is given by the issuer or associated merchant banker in any press conference. circular. (a) Advertisement. (e) Failure to exercise due diligence in verifying contents of prospectus/letter of offer. brochure. . (f) Failure to provide adequate and fair disclosure to investors and objective information about risk factors in the prospectus and other issue literature. investor conference. press release and other issue related materials not being in conformity with contents of the prospects. brokers conference or other such conference/meet prior to the issue for marketing of the issue arranged/participated by the merchant banker. (h) Non handling of investor grievances promptly. (c) Failure to substantiate matters contained in highlights to the issue in the prospectus.b)Minor Defaults: The following activities are categorized under minor defaults and attract two penalty points. (g) Delay in refund/allotment of securities.

. 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) Excess number of lead managers than permissible under SEBI press release of 28th February. To enable a merchant banker to take corrective action. all lead managers to the issue are awarded the penalty points. In the event of joint responsibility. evidence as may be called for. maximum penalty points awarded in a single issue managed by a merchant banker are restricted to four. documents. A merchant banker on reaching cumulative penalty points of eight (8) attracts action from SEBI in terms of suspension/cancellation of authorization.c)Major Defaults: The following activities are categorized under major defaults and attract three penalty points: a) Mandatory underwriting not taken by lead managers. same penalty point is awarded to all lead managers jointly responsible for the activity. b) Non cooperation with SEBI in furnishing desired information. 1991. In the absence of receipt of inter se allocation of responsibilities. c) Association of unauthorized merchant banker in an issue.

will attract negative point of -0.5. .Defaults in Prospectus: If highlights are provided. General Negative Marks: If at all ‘Highlights’ are provided in the issue.5 iii) Any matter extraneous to the contents of the 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+. > > < < 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. should form a part of ‘Highlights’. with 4 or less than 6 points as B and with score of less than 4 points. those with 6 or less than 8 points as A. otherwise it will attract negative point of -1 ii) Listing details. otherwise it will attract negative point of -0. i) Risk factors should form part of ‘Highlights’. Absence of listing in highlights iii) Extraneous contents to prospectus. the following deficiencies will attract negative points: i) ii) Absence of risk factors in highlights. the prospectus falls into Category C. if stated in highlights.

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

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. However.Merchant Bankers: A merchant banker who is associated with the issuer company as a promoter/director/associate should not lead/manage its issue.  Incorporate a statement in the offer document to the effect that in their opinion the underwriters’ assets are adequate to meet their underwriting obligations. a merchant banker holding securities of a company can lead/manage its 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.  Obtain written consent of the underwriters before including their names in the offer document. Underwriting: The lead merchant banker(s) should:  Satisfy themselves about the ability of the underwriters to discharge their underwriting obligations. whenever required and (ii) bankers to the issue are appointed in all the mandatory collection centres. They should further ensure that (i) issuer companies would enter into an MOU with intermediary/intermediaries concerned. They should independently assess their capability/capacity to carry out the assignment. wherever applicable. .

(ii) an option be given to the investors to receive allotment of securities in demat format. refund and dispatch and regularly monitor the redressal of investors’ grievances arising there-from. 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. 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. 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.  Ensure that the relevant details of underwriters are included in the offer document.POST-ISSUE OBLIGATIONS/REQUIREMENTS Post-Issue Monitoring Reports: Irrespective of the level of subscription.25 lakh. in case of issue through book building. the outstanding underwriting commitments of a merchant banker should nor exceed 20 times of its networth at any point of time. allotment. X. including fixed price portion of bookbuilt issue (c) final post-issue monitoring report for all issues Redressal of Investor’s Grievances The post-issue lead merchant banker should actively associate himself with post-issue activities namely. whichever is less. Undertake in respect of every underwritten issue a minimum underwriting obligation of five per cent of the total underwriting commitment or Rs.

. including registrars to an issue. 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. 1956. at a later date. as per the provisions of Section 73(3) of the Companies Act. with respect to their liability.Stockinvest: The lead merchant banker should ensure compliance with the instructions issued by the RBI on the handling of stockinvest by any person. bankers to an issue).e. by the underwriters. the issue should be kept open for the required number of days to take care of the underwriters’ interests and avoid any dispute. the lead merchant banker must satisfy himself that the issue is fully subscribed before announcing closure of the issue. Underwriters: If the issue is proposed to be closed at the earliest closing date. 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. In case there is no definite information about subscription figures.

As a legal process. The acquiring company should prepare the . they have to prepare a scheme of amalgamation.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.MERGERS/AMALGAMATIONS AND ACQUISITION/TAKEOVERS a)Introduction Following the economic reforms in India in the post-1991 period. 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. An amalgamation is an arrangement in which the assets/liabilities of two or more firms become vested in another firm. 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. 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.UNIT V I.

The main contents of a model scheme. Sick Industrial Companies (Special Provisions) Act. A. The Companies (Court) Rules 1959. 1956. 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. Determination of Effective Date by when all the required approvals under various statutes. Protection of employment.. their number and participation of transfree companys' directors on the board. viz. Conditions of the scheme to become effective and operative. object clause and accounting year. Their authorised.scheme in consultation with its merchant banker financial consultants. 1961. to obtain High Court's approval. Income Tax Act. movable us well as immovable and rights attached thereto are sought to be transferred from amalgamating company to the amalgamated company. c)Expenses of amalgamation. Application under sections 391 and 394 of the Companies Act. would be obtained and the transfer and vesting of the undertaking of amalgamating . issued and subscribed/paid-up capital. are as listed below. Description of the transfer and the transfree company and the business of the transferor. 1985. Change of name. Management: Board of directors. Dividend position and prospects. the Companies Act 1956. inter-aUa.

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. it should be ascertained whether the authorised capital of the transferee company would be sufficient after the merger/ amalgamation. Similarly. Company Law Board. This date is called effective date. . it is necessary to amend the objects clause. 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. 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. confirming the scheme of amalgamation are required. The objects clause of Transferee Company should allow for carrying on the business of the transferor company. If it is not so.company with the amalgamated company would take effect. 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. 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. 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. 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.

Where the application is .Members or even any of the creditors. In this context means any person who has agreed to be a member and whose name appears on the register of members. d)Application for Amalgamation An application for amalgamation can be submitted by the company. ii) The shareholders and other members of the companies should also be informed through press release. (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. A creditor includes all persons having pecuniary claims against the company for some amount whether present or future. (iii) The transfer or the and transferee companies should inform the financial institutions. A member. definite or contingent. (i) Inform the stock exchanges concerned about the proposed amalgamation immediately after the board meetings. Even one member or one such creditor can make an application for amalgamation.Preparation of a scheme of amalgamation on the lines explained earlier. 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. 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.

hearing takes place in the judge's chamber. A copy of the proposed compromise or arrangement should be annexed to the affidavit On receipt of" the application by the high court. 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. 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. 1959. If meetings of incorrect classification are convened and objection is taken with regard to any particular creditor of having interest competing with others. 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 court may not even order the calling of meeting of creditors and/or members. It is. only a person authorised by the company in this behalf can make an application for amalgamation. the company runs the risk of the scheme being dismissed . The members and the creditors are require to be classified into different classes for the purpose of convening meetings.proposed to be made by the company. 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. 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. This process has to be followed immediately on receipt of application under section 391(1). The resolution approving the scheme may be passed by voting in person or by proxy as per the directions of the high court.

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

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

(ii) (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
(i)

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

(ii)

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

The continuation by or against the transfree company of any legal proceedings pending by or against any transferor company; 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)

(vi)

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

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

Acquisition costs include the payment made to the largel firm's shareholders and debenture-holders. estimated value of the obligations assumed. this plan is also known as earn-out plan base-period earn-out. as a method of acquiring a firm. may be used for the purpose Deferred Payment Plan Under this method. 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 . other types of securities. the present value of the expected benefits from the merger are to be compared with the cost of the acquisition of the target firm. besides making an initial payment. 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. However. the shareholders of the target firm are to receive additional shares for a specified number of future years. 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. 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 payment made to discharge the external liabilities. 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. Under this plan.Debt and Preference Shares Financing . the acquiring firm. involves a bid by the acquiring firm for controlling interest in the acquired firm. The target firm should be valued in terms of its potential to generate incremental future cash inflows Like the capital budgeting decision. in conjunction with/in lieu of equity shares. since some firms may have a relatively lower P/E ratio as also the requirement of some investors might be different. Since the future payment is linked to the firm's earnings.

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. 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 . its subsidiary or by a nominee of the said company) become shareholders of the amalgamated company by virtue of the amalgamation. 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 . g)Tax Concessions to Amalgamated Company The following are the major benefits available to the amalgamation i. 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. in relation to companies.Adjusted Present Value (APV) Approach The APV approach is a variant of the DCF approach used to value the target firm. According to Section 2 (1 B) 'amalgamation'.

Preliminary Expenses 7. Capital Expenditure on Family Planning 9. (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 . Expenditure on Scientific Research 3. acquired in the scheme of amalgamation. (iv) The amalgamation should be of a company owning an industrial undertaking or ship 2. provided the following conditions are fulfilled: (i) The amalgamated company continuously holds. Bad Debts Tax Concessions to Amalgamating Company The tax concessions to the amalgamating are summarised below. for a minimum period of 5 years. Expenditure for Obtaining License to Operate Telecommunication Services 6. Expenditure on Know-how 5. Expenditure on Prospecting of Certain 8. from the date of amalgamation at least three-fourths of the above value of fixed assets of the amalgamating company. Expenditure on Acquisition of Patent Rights or Copy Rights 4. (ii) The amalgamated company continues the business of the amalgamating company for a minimum period of 5 years from the date of amalgamation.depreciation of the amalgamating company. (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.

gift tax will not be attracted II. As a member of a stock exchange. such transfer will not be considered as a transfer for the purpose of capital gain. has past experience in the business of buying. regulations and bylaws. regulations and by-laws of the stock exchange with respect to his business and is a lit and proper person. has the necessary infrastructure including manpower to effectively discharge his activities. While forwarding the application. A certificate Registration from SEBI is mandatory to act as a broker. 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. where there is a transfer of any asset by an Indian amalgamating company. sells or deals in securities.STOCK-BROKERS a) introduction Stockbroker is a member of a recognised stock exchange who buys. . The application must be forwarded by the exchange to SEBI within 30 days from the date of receipt. seeking registration with SEBI. nature and other particulars of such complaints. selling or dealing in securities and is subject to disciplinary proceedings under the rules. he will have to abide by its rules. b)Registration A broker. has to apply through the stock exchange of which he is a member.company. SEBI checks whether or not he is eligible to be a member of a stock' exchange. SEBI is empowered to impose conditions while granting the certificate. (ii) Free of Gift-Tax According to Section 45 (b) of the Gift Tax Act. 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.

that is. Code of Conduct Registered stockbrokers have to abide by a code of conduct specified as follows: General First. 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. on his own account as well as on account of his clients. a stockbroker has to maintain high standards of integrity. the aggregate of the sale and purchase prices of securities received and receivable by the stockbroker during any financial year. he should not disclose or discuss with any other person or make improper use of the details uf personal investments and other . make prompt payment in respect of securities sold and arrange for prompt delivery of securities purchased by clients. For an annual turnover up to Rs 1 crore. without delay. a sum of Rs 5. 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.Payment of Fee Every registered broker has to pay the SEBI a specified registration fee based on the annual turnover.000 plus one hundreth of one per cent of the turnover in excess of Rs I crore. for each financial year. 2. He should issue his clients. He should not indulge in manipulative. a contract note for all transactions in the form specified by the stock exchanged 3 to avoid breach of trust. promptness and fairness with due skills. the registration fee is Rs 5. care and diligence in the conduct of all his business.000 is to be paid as fee to the SEBI. or clients of the broker. For an annual turnover in excess of Rs 1 crore.

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. he must inform the client accordingly and not seek to gain a direct or direct personal advantage from the situation. The employee should also . about any security in the publicly accessible media. retain any securities unless he has reasonable grounds for believing that the recommendation suitable for such a client upon the basis of the facts. 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. at ihe same time. that no conflict of interest arises between him and the client in the even of such a conflict.informationfif a confidential nature regarding his clients. financial situation and objectives of such investment. he is required to disclose whether he is acting as a principal or as an agent and should ensure. which he comes to know in the course of his business 4 Merely for generating business. while rendering such advice. including their short long position in the security. depose of. 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. whether real-time or non-real-time. 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. if disclosed by such a client as to his own security holdings. only after disclosing his interest/interest of his independent family members and the employer. with the sole objective of earning commission and brokerage.

and 8A stockbroker should have adequately trained staff and arrangements to render fair. rights issues and any other I rights related to such securities.disclose the interest of his dependent family members and the employer including their short/long position. bonus shares. he comply with his obligations in completing the settlement of transactions with them. records and documents: (a) Register of transactions (b) Client ledger (c) General ledger (d) Journals . 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. 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. . Transactions With Stockbrokers While carrying out his transactions with other brokers.

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. 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.(e) Cash book (f) Bank pass book (g) Documents register containing.) Procedure for Inspection . 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.

including suspension or cancellation of his certificate of registration. Failure to redress the grievances of investors within 30 days of receipts of notice from the SEBI. namely: Failure to file any return or report with the SEBI. Acting as an unregistered sub-broker or dealing with unregistered sub-brokers. Rules/Regulations A stock broker or a sub-broker who contravenes any of the provisions of the SEBI Act. Failure to maintain books of account or records as per the SEBI Act. books or other documents within 15 days of issue of notes by 1the SEBI.) 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. if any. Failure to furnish any information. specified by the SEBI. Extending use of trading terminal to any unauthorised person or place. (xviii) Failure to satisfy the net worth or capital adequacy norms. 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. if he Ceases to .The SEBI is empowered to appoint one or more persons as inspection authority to inspect the books of accounts. 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 or regulations. (xv) Failure to comply with directions issued by the SEBI under the SEBI Act or the regulations. care and diligence (xvii) Failure to seek prior permission of the SEBI in case of any change in its status and constitution. other records and documents of the stockbroker. (wi) Failure to exercise due skill.

or d) Fails to pay the penalty imposed by the adjudicating officer. 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. (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. or rules made or notifications issued thereunder. 2003. (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. regulations and bye-laws of the stock exchange of which he is a member (x) Fails to cooperate with the inspecting or investigating authority.be a member of a stock exchange. or) Fails to comply with the rules. 1992. 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. namely:We dealing in securities without obtaining certificate of registration from the SEBI. or (x) Fails (o abide by any award of the Ombudsman or decision of the SEBI under the SEBI (Ombudsman) Regulations. .

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. In case of the other stock exchanges. (f) doubtful debts and advances/overdue for more than three months or given toissociates(g) prepaid expenses. (b) pledged securities. 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. (a) fixed assets.. (d) non-allowable securities. irrespective of the volume of business. (i) 30 per cent of marketable securities . (c) member's card. (e) bad deliveries. (h) tangible assets and. at any point of time. be such that together with the base minimum capital. . (iv) Indulging in insider trading in violation of SEBI() Regulations 1992. that is. 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.aditional Capital Related to Volume of Business The additional or optional capital required from a member should. and Rs 3.5 lakh tor those of Delhi and Ahmedabad Exchanges. the minimum requirement is Rs 2 lakh.(iii) Market manipulation of securities or index.

000 for an initial period of five years. After the expiry of five years. 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. (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.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. but he is not a member of a stock exchange. selling or dealing in securities through such brokers. nature and other particulars of the complaints and (c) is authorised in writing by a broker for affiliation in buying. It grants a registration certificate to a subbroker subject to the condition that he (a) pays the prescribed fee. To act as a sub-broker. Code of Conduct The sub-brokers have to follow the code of conduct as detailed below: . a certificate of registration from the SEBI is required. including one from his banker. an annual fee ofRs 500 is payable as long as the certificate remains 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. 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.

or any other rights related to such securities.General A sub-broker should maintain high standards of integrity. promptness and fairness and act with due skill. 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. A ' sub-broker should not deal or transact business knowingly. 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. 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. care and diligence in the conduct of all investment business. He should knowingly and willfully deliver documents that constitute bad delivery. 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. directly or indirectly. bonus shares. Duty to the Investors A sub-broker. 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 .

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 . 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 .e.settles the trade in the clearing corporation or clearing house (i.FOREIGN BROKERS Foreign institutional investors (FIIs) now play a significant role in stock markets a)Registration with the SEBI While applying for registration. inter-alia. a foreign broker has to. He cannot clear/settle transactions in securities for any other trading member(s) III.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. 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.

It provides a relative ranking of the credit quality of debt/financial instruments or their grading according to investment qualities. was started in 1988. credit rating has emerged as a critical element in the functioning of the Indian debt/financial markets. The main elements of its Credit Rating Agencies Regulations are: (i) their registration. 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.IV. 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. b)REGULATORY FRAMEWORK Credit rating agencies are regulated by the SEBI. two more agencies were set up. the Credit Rating Information Services of India Ltd(CRISIL). . essentially. In response to the ever increasing role of credit rating. since 1991 by the Government/SEBI. the Information and Credit Rating Services (ICRA) Ltd in 1990 and the Credit Analysis and Research (CARE) Ltd in 1990 and 1993.Credit Rating a)Introduction Credit rating is. (ii) their general obligations. respectively. (iii) restrictions on the rating of securities. The first rating agency. (iv) procedure for inspection and investigation and (v) action in case of default. In other words.

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

 To enable intermediaries to place debt instruments with investors by providing them with an effective marketing tool. As a matter of fact. . been the vanguard of innovations by introducing new concepts in rating services and has diversified into related areas of information and advisory activites. it pioneered the concept of credit rating in the country and has. Provide adequate freedom and powers to its compliance officer for the effective discharge of his duties. V. General Insurance Corporation of India and several foreign and Indian banks.  To provides regulators with a market-driven system for bringing about discipline and a healthy growth of capital markets. since. at a fair cost. Life Insurance Corporation of India.  Ensure that good corporate policies and corporate governance are in place. Objectives:  To assist both individual and institutional investors in making investment decisions in fixed interest securities. It commences operation on January 1.1988.  To enable companies to mobilize funds in large amounts from a wide investor base. Initially. Other shareholders include the Asian Development Bank.CREDIT RATING AGENCIES a)Crisil Ltd As the first credit rating agency in India. the CRISIL was set up to rate debt obligations that would guide investors as to the risk of timely payment of interest and principal. the CRISIL was promoted in 1987 jointly by the ICICI Ltd and the Unit Trust of India. HDFC Ltd.

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

multispecialty tertiary care and single-specialty tertiary care. Grading for Healthcare Institutions The CRISIL’S grading for healthcare institutions is an opinion on the relative quality of healthcare delivered by the institution to its patients. within that classification. on a four-point scale. specialty secondary care. such as: nursing home. CRISIL Research and information Services (CRIS) . Grading Scale and Definition The grading scale has two components. general secondary care. 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.This covers the rating of collective investment schemes of plantations and other companies. privatization and valuation. The CRISIL has a pact with National Economic Research Associates (NERA). The second component of the grading scale is the hospital’s grading. transport and urban structures. banking and finance. The first is the hospital classification. USA to strengthen its research advisory services. and disinvestment. as mentioned in the offer document. 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.

corporate planners. Structure of the industry. both present and future. (VI) Government policies. investment bankers. The services rendered earlier by the CRISIL as the CRISIL Card services and CRISIL Economic services have been reorganized and assimilated under the CRIS. Indian industries and the Indian corporate studies in four areas. (VIII) International competitiveness. (V) An analysis of the major players in the industry. 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. (IV) Demand supply analysis. namely: Indian economy. (VII) Industry risks/constraints. as well as its understanding of the relevant . sector use. Indian capital markets. capacities. product specifications. financial institutions. cost structure.The CRISIL Research and information Services (CRIS) disseminates. and its characteristics. commercial banks. large client base. (IX) Key factors and (X) The CRISIL’S outlook on the industry. technology. comprising institutional investors. and its characteristics. 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. both in India and overseas. mutual funds and asset management companies. valueadded research and undertakes customized studies in four areas. (III) An analysis of the different projects in the industry.

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. 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. CRISIL Markets Wire The CRISIL Marketwise. 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). With about 20 experienced journalists. The Group is supported by the CRISIL Research and information services. which continuously tracks over 50 sectors and 500 corporate’s. established in October 2001. HDFC Ltd and ILFS Ltd. In order to bring international experience and . the news service provides a blow-by-blow account of developments in all segments of this market. Apart from the main promoter. Exim Bank. banks. It stared operations in 1991. serving as a comprehensive and interactive tool for business managers. the other shareholders are the Unit Trust of India. which holds 26 percent of the share capital. is the leading source of news and commentary on India’s fixed-income market. LIC. creditors and corporate decision makers.GIC. It present a powerful report on listed corporate in India.qualitative and quantitative factors affecting the company’s performance. investors.

the ICRA has entered into a MOU with Moody’s investors services to provide. financial services companies and mutual funds in India. Unlike the CRISIL and the CRISIL and the ICRA. Over the years. risk management software. in large amounts and at a lower cost for highly rated entities. the ICRA has diversified the range of its services. public/private sector banks and private finance companies. both individual and institutional. To assist issuers in raising funds. It commenced its credit information and equity research. 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. (2) information services and (3) advisory services. To enable banks. 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. in making well informed decisions. investment bankers. financial/investment institutions. from a wider investor base. through is company Financial programmers inc (FPI). credit education.practices to the Indian capital markets. without additional burden on the government. . As in the case of the CRISIL. the main objectives of the ICRA are: To assist investors. It currently provides three types of services: (1) rating services. credit research and consulting services to banks.

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

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.

(V)

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

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

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

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

demand and supply position. The ratings are based on the current information provided by the issuer or facts obtained from reliable sources. the examination of cash flow adequacy assumes importance. key success factors. Industry Risk Nature and basis of competition. service and so on. government policies and so on. product quality. The industries characterized by a steady growth in demand. Both qualitative and quantitative criteria are employed in evaluating and monitoring the ratings. pattern of business cycles as well as the competitive factors affecting the industry. For Manufacturing Companies The main elements of the rating methodology for manufacturing companies are outlined below. . distribution capabilities. image. and moderate capital intensity are in a stronger position. flexibility in the timing of capital outlays. The rating methodology is illustrated blow with reference to (i) (ii) Manufacturing companies and Financial services companies. focusing on the strength of the industry prospects. based on price. product differentiation. ability to maintain margins without impairing future prospects. structure of industry. Business Risk Analysis The rating analysis begins with an assessment of the company’s environment. The nature of competition is different for different industries.the company has large capital requirements. cyclical/seasonal factors.

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

ability to raise funds. inventory valuation and depreciation policies. Earnings prospects Source of future earnings growth. off-balance sheet liabilities and so on. Financial Flexibility Alternative financing plans in times of stress. Adequacy of Cash Flows In relation to dept and working capital needs. method of income recognition. relative to both its peer group and the larger universe of companies. asset deployment potential and so on. profitability rations. The analyst compares the company’s business strategies and financial plans (over a period of time) to provide insights into . auditors qualifications. working capital management and so on. earnings in relation to fixed income charges and so on. capital spending flexibility.from financial statements can be used to accurately measure a company’s performance and its position. Management Risk A proper assessment of dept protection levels requires an evaluation of the management philosophies and its strategies. Accounting Quality Overstatement/understatement of profits. stability of cash flows.

funding profile. Fundamental Analysis Fundamental analysis should include: Capital Adequacy Assessment of the true net worth of the issuer. in addition to the financial analysis and management evaluation outlined above. Trends in regulation and their impact on the company/institution. Resources Overview of funding sources. with respect to forecasting and implementing of plans. Asset Quality . philosophy and strategies. Financial services sector When rating dept instruments of financial institutions. succession plans. Evaluation of capacity to overcome adverse situations and (III) Goals. depth of managerial talent. cost and tenor of various sources of funds. banks and non-banking finance companies. its adequacy in relation to the volume of business and the risk profile of the assets.a management’s abilities. the assessment also lays emphasis on the following factors: Regulatory and Competitive Environment (I) (II) structure and regulatory framework of the financial system. Specific areas reviewed include: (I) (II) Track record of the management planning and control systems.

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