MODULE II

FINANCIAL SERVICES
Objectives of Financial Services

To raise Funds: It helps in raising funds from investors, institutions and corporates and mobilize
them to those who are in need of the same.

To ensure specialized services: The financial service sector provides specialized services like credit
rating, venture capital financing, leasing, housing finance etc.

To concentrate on economic growth: Financial services sector speeds up the process of economic
growth of the financial system, which in turn improves the growth and development of entire nation.

Funds Deployment: If financial services are available in the financial markets which help the
players to ensure an effective deployment of the funds raised.

Regulation: Agencies such as SEBI, RBI, Department of banking and insurance of the government
of India regulate the functioning of financial service institute.
Types of Financial Services

Financial services offered are

1. Capital Market Services: It consist of term lending institutions which mainly provide long term funds.

2. Money Market Services: It consist of commercial banks, financial institutions, cooperative banks which providing short term funds
agencies.

3. Fund based Financial Services:

Fund based finance is a specialized method of providing structured working capital and term loan that are secured by account receivables,
inventory, machinery, equipment, and real estate. Fund based services are used for creating assets or supported by assets where funds are
transformed into assets. Following are types of fund based financial services:

Leasing : A lease is an agreement between Lessee and Lessor, here a company or a firm, acquires the right to make use of a capital assets like
machinery, building etc. one payment of a prescribed fee called ‘rental charges’/ leasing charges. The lessee here cannot acquire any ownership
to the asset, but he can use it for the prescribed time and have full control over it for the same period.

Hire purchase: Hiring of an assets for a period of time and at the end of the period, purchasing the same. This is the time sharing of the asset,
the person hiring assets acquires the possession and the right to use it. As it is a legal device it is being used for financing of consumer goods
and for selling consumer goods on hire purchase.

Consumer credit: Consumer credit includes all fund based financing plans offered to primarily individual to acquire durable consumer goods.
In a consumer credit transaction the individual consumer buyer pays a fraction of the cash purchase price at the time of the delivery of the
assets and pays the balance with interest over a specific period of time.

Venture capital: The capital which is available for financing the new business venture is called venture capital. Venture capitalist are long term
investors who take a hand on approach with all of their investments and works actively with the entrepreneurial management teams in order to
build great companies.
Housing finance: The main purpose of housing finance is to provide the funds to buyers who need to buy their
homes. The housing finance market I India has recorded robust growth is last few years. Housing finance acts as
a bridge to provide financing and open up the housing market to aspiring house owners.

Factoring: The sale ledger of a client is managed by a financial services company, this process is called
factoring. It is an arrangement under which a financial intermediary assumes the credit risk in the collection of
book debts for its clients. Factoring is a financial transaction whereby a business sells its accounts receivable to
a third party at a discount.

Bill discounting: bill discounting is a short tenure financing instrument for companies willing to discount their
purchase / sales bill to get funds for the sort run and as for the investor in them, it is a good instrument to park
their spare funds for a very short duration.

Insurance: Insurance is a form of risk management in which the insured transfers the cost of potential loss to
another entity in exchange for monetary compensation known as premium.
4. Fee based Financial Services:

Fee based financial services are those services wherein financial institution operate in specialized fields to earn
a substantial income in the form of fees or dividend or brokerage on operation. Following are types of fee based
financial services:

Merchant banking: A merchant banker is a financial intermediary who helps to transfer capital from those who
possess it to those who need it. Merchant banking includes a wide range of activities such as management of
customer, securities, portfolio management, project counselling and appraisal, underwriting of shares, and
debentures etc.

Credit rating: Evaluates the credit worthiness of a debtor, especially a business or a government. It is an
evaluation made by a credit rating agency of the debtor’s ability to pay back the debt and the likelihood of
default. Some credit rating agencies are ICRA, CRISIL, S & P, Moody’s.

Stock broking: Stock broker is a regulated professional individual, usually associated with a brokerage firm or
broker dealer, who buy and sell stocks and other securities for institutional clients through a stock exchange or
over-the-counter in return for a fee or commission.

Mergers: Mergers refers to a situation where one company acquires the net assets of another company and the
latter is dissolved. The acquired company pays the cash or securities to the shareholders of that merged
company.
Financial Intermediaries

A financial intermediary is a firm or an institution that acts an intermediary between a provider of service and the consumer. It
is the institution or individual that is in between two or more parties in a financial context. In theoretical terms, a financial
intermediary channels savings into investments. Financial intermediaries exist for profit in the financial system and sometimes
there is a need to regulate the activities of the same.

1. Banking Financial Corporation

Bank is an institution that deals in money transactions. According to Indian Companies Act of 1956 “Bank is the acceptor for
purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdraw able
by cheque, draft, order or otherwise.” Banking institutions consists of all scheduled commercial banks and scheduled
cooperative banks.

I. Scheduled Commercial Banks: Commercial Banks can be defined as a financial institution that provides services, mainly
accepting deposits, giving various kinds of loans like business loans and auto loans, mortgage lending, and it also offers basic
investment products like savings accounts and certificates of deposits etc.
Scheduled Banks in India constitute those banks which have been included in the second schedule of Reserve Bank of
India(RBI) Act. RBI in turn includes only those banks in this schedule which satisfy the criteria laid down vide section 42 (6)
(a) of the Act. The banks included in this schedule list should fulfil two conditions:-
1. The paid up capital and collected funds of bank should not be less than Rs. 5 lac.
2. Any activity of the bank should not adversely affect the interests of depositors.
Commercial banks in India are categorized into five different groups according to their ownership / nature of operation:

State Bank of India and Associates:- on 1st July, 1955, on the recommendation of Rural Credit Survey Committee, the
Imperial Bank of India was converted in to state Bank of India. RBI acquired its 92% shares; therefore SBI had the distinction
of becoming the first state owned commercial bank in the country. The SBI Act was passed in 1959 and this smoothen the way
for creating state bank group. Presently five associates and the Bharatiya Mahila Bank (BMB) became part of the SBI.

Nationalized Banks:- Another category of public sector is 19 commercial banks, of which 14 were nationalized on July 19,
1969. This changed the banking structure in Indian economy. Each one of these 14 banks has deposits of Rs. 50 crore or more.
The nationalization was justified by government because major banks have a larger social purpose.
Again on April 15, 1980 six more private owned commercial banks were nationalized. The intention was to promote the
welfare of the people in compliance with the policy of the state. With this nationalization, the share of private sector in the
entire banking industry declined to just 9%.

Foreign Banks:- From a long time a there is a good number of foreign banks which carry their operations in India. A foreign
bank refers to those banks which are established in one country and does their baking operations ad services in a foreign
country. Like Citibank, standard chartered bank etc.

Regional Rural Banks:- The RRBs were set up under the act of 1976. One of the main objectives of establishing RRBs was
to help the poor rural people from the hands of money lenders and traders. The working group on rural banks recommended
the setting up of RRBs as part of multi-agency approach to rural credit. RRB is sponsored by a public sector bank which also
subscribes to its share capital.

II. Other Scheduled Commercial Banks

Scheduled Cooperative Banks:- All functions of commercial banks like deposit mobilization, supply of credit
and provision of remittance facilities etc. are also performed by cooperation banks. But cooperative banks
provides limited banking products and are functionally specialists in agriculture related products.
II Non-Banking Financial Corporation

Non-banking financial companies (NBFCs) plays a crucial role in the context of Indian economy. NBFCs are an intermediary
who engages in the business of accepting deposits and delivering credit. A non-banking financial company is a company
registered under the companies Act, 1956 and is engaged in the business of :-
a. Loans and advance
b. Acquisition of shares/ stocks/ bonds/ debentures/ securities issued by government or local authority or other securities of
marketable nature
c. Leasing and hire-purchase
d. Insurance business
e. Chit business.

But it is very important to mention here that it does not include any institution whose principal business is that of agriculture
activity, industrial activity, and sale / purchase / construction of immovable property.
They play a very crucial role in channelizing the scarce financial resources to capital formation. NBFCs supplement the role in
channelizing the sector in meeting the increasing financial needs of the corporate sector, delivering credit to the unorganized
sector and to small local borrowers. NBFCs have more flexible structure than banks, this flexibility helps in broadening the
market by providing the saver and investor a bundle of services on a competitive basis. NBFCs at present providing financial
services partly fee based and partly fund based. NBFCs differ widely in their ownership. Some are subsidiaries of large
manufacturers, many others are owned by banks such as ICICI Banks, ICICI securities Ltd, SBI Capital Market Ltd. Some of
the prominent NBFCs in India are:-

1. Infrastructure Development Finance Corporation(IDFC)

2. Rural Electric Corporation (REC)
3. Industrial Finance Corporation of India (IFCI)
4. GE Capital
III. Insurance Corporation

The Insurance Regulatory and Development Authority of India (IRDAI) is an autonomous, statutory body
tasked with regulating and promoting the insurance and re-insurance industries in India. It was constituted by
the Insurance Regulatory and Development Authority Act, 1999, an Act of Parliament passed by the
Government of India.

Insurance is an important aid to commerce and industry. Every business enterprise involves large number of
risks and uncertainties. It may involve risk to premises, plant and machinery, raw material and other things.
Goods may be damaged or may be destroyed due to fire or flood. Some risk can be avoided by timely
precautions and some are unavoidable and are beyond the control of a business. These unavoidable risks can be
protected by insurance.

Insurance is a legal agreement between two parties i.e. the insurance company (insurer) and the individual
(insured). In this, the insurance company promises to make good the losses of the insured on happening of the
insured contingency.
Type of Insurance

Insurance cover various types of risks and include various insurance policies which provide protection against various losses.

Life Insurance: Life insurance is a contract under which one person, in consideration of a premium paid either in lump sum or
by monthly, quarterly, half yearly or yearly installments, undertakes to pay to the person (for whose benefits the insurance is
made), a certain sum of money either on the death of the insured person or on the expiry of a specified period of time.

General Insurance: The general insurance includes property insurance, liability insurance and other form of insurance.
Property insurance includes fire and marine insurance. Property of the individual and business involves various risks like fire,
theft etc. This need insurance Liability insurance includes motor, theft, fidelity and machine insurance

Social Insurance: Social insurance provide protection to the weaker sections of the society who are unable to pay the
premium. It includes pension plans, disability benefits, unemployment benefits, sickness insurance and industrial insurance.

Fire Insurance: Fire insurance covers risks of fire. Fire insurance is a contract under which the insurer agrees to indemnify
the insured, in return for payment of the premium in lump sum or by instalments, losses suffered by the him due to destruction
of or damage to the insured property, caused by fire during an agreed period of time.

Marine Insurance: Marine insurance is an arrangement by which the insurer undertakes to compensate the owner of the ship
or cargo for complete or partial loss at sea. So it provides protection against loss because of marine perils. The marine perils
are collisions with rock, ship attack by enemies, fire etc.

Miscellaneous Insurance: It includes various forms of insurance including property insurance, liability insurance, personal
injuries are also insured. The property, goods, machine, furniture, automobile, valuable goods etc. can be insured against the
damage or destruction due to accident or disappearance due to theft.
Problems of Financial service sector

However, the financial services sector sector has to face many challenges in its attempt to fulfil the ever-
growing financial demands of the economy. Some of the important problems are:-

Lack of qualified personnel:- The financial service sector is fully geared to the task of ‘financial creativity’.
However, this sector has to face many challenges. In fact, the dearth of qualified and trained personnel is an
important impediment in its growth. Hence, it is very vital that a proper and a comprehensive training must be
given to the various financial intermediaries.

Lack of investor awareness:- The introduction of new financial products and instruments will be of no use
unless the investor is aware of the advantages and uses of the new and innovative products and instruments.
Hence, the financial intermediaries should educate the prospective investors/users of the advantages of the
innovative instruments through literature, seminars, workshops, advertisements and even through audio-visual
aids.

Lack of transparency:- The whole financial system is undergoing a phenomenal change in accordance with the
requirements of the national and global environments. It is high time that this sector gave up their orthodox
attitude of keeping accounts in a highly secret manner. Hence, this sector should opt for better levels of
transparency. In other words, the disclosure requirements and the accounting practices have to be in line with
the international standards.
Lack of specialisation:- In the Indian scene, each financial intermediary seems to deal in different financial
service lines without specialising in one or two areas. In other words, each intermediary is acting as a financial
supermarket delivering so many financial products and dealing I different varieties of instruments. In other
countries, financial intermediaries like Newtons, Solomon Brothers, etc., specialise in one or two areas only.
This helps them to achieve high levels of efficiency and excellence. Hence, in India also, financial
intermediaries can go for specialisation.

Lack of recent data:- Most of the intermediaries do not spend more on research. It is very vital that one should
build up a proper database on the basis of which one could embark upon ‘financial creativity’. Moreover, a
proper database would keep oneself abreast of the recent developments in other parts of the whole world and
above all, it would enable the fund managers to take sound financial decisions.

Lack of efficient risk management system:- With the opening of the economy to multinationals and the
exposure of Indian companies to international competition, much importance is given to foreign portfolio flows.
It involves the utilisation of multicurrency transactions which exposes the client to exchange rate risk, interest
rate risk and economic and political risk. Unless a proper risk management system is developed by the financial
intermediaries as in the west, they would not be in a position to fulfil the growing requirements of their
customers. Hence, it is absolutely essential that they should introduce Futures, Options, Swaps and other
derivative products which are necessary for an efficient risk management system.

The above challenges are likely to increase in number with the growing requirements of the customers. The
financial service sector should rise up to the occasion to meet these challenges by adopting new instruments and
innovative means of financing so that it could play a very dynamic role in the economy.
Financial Sector Reforms

The growth and evolution of financial market in India since the 1950’s can be viewed in three broad phases. The
first two decades of the 1950s and 1960s constitute a phase of transition. The period from 1969 to 1985, a span
of a decade and a half, can be called the period of expansion and diversification. The subsequent period after
1985 has been marked by consolidation, innovation, and liberalization.

The first of these three phases witnessed strengthening of the banking system by a process of amalgamation of
weak, small banks as also through development of major term lending institutions, with active intervention by
the Reserve Bank of India, in consonance with its developmental role. Special efforts were also made during
this period to strengthen the cooperative financial structure.
With the ‘big push’ provided by the nationalization of banks and introduction of the Lead Bank scheme, the
fifteen year period from 1969 through 1985 saw an unprecedented geographical expansion and functional
diversification of the commercial banking system. This period also marked not only a very rapid expansion of
branch network of banks, but also a complete re-orientation of their lending operations, seeking to combine
socio-economic national aspirations with baking and at the same time, an increasing role in funding the public
sector.
In the present phase of growth of the financial market which started from 1985, the stress on efficiency and
competitiveness has been conducive to relaxations in the control mechanism and allowing for innovation,
diversification, and healthy competition among banks and other financial institutions. A series of policy changes
which are under implementation have been introduced, encompassing several sectors of the financial system.
This is in consonance with the economic liberalization measures adopted with regard to industry, external trade
and technology.
In the evolution of economic institutions, development of corporate form of organization marks the turning
point in triggering rapid industrialization and economic growth. This organization has flourished on account of
several positive features such as limited liability, separation of ownership and management, and easy
transferability of ownership interest. The growth of capital market, where the ownership interest is initially sold
and later traded is, therefore an essential prerequisite for faster industrial growth.

The Government of India implemented the economic reforms, including financial sector reforms, with the
object of improving efficiency and effectiveness of the financial system, it was also aimed at conceding
operational freedom for flexibility to the financial system through prudential regulation and supervision in a free
financial environment.
The last two decades have seen a phenomenal expansion in the geographical coverage and financial spread of
our financial system. The development of the financial sector is a major achievement and has contributed
significantly to the increase in our savings rate, especially of the household sector. A financial system essentially
comprises the financial institutions, instruments, and the market that together provide the necessary framework
for mobilization and allocation of savings.
A vibrant, efficient and innovative financial system is the key to the rapid and sustained growth of the economy.
Financial service is a segment of the financial system. The financial system consist of organized sector and
unorganized sector. Unorganized financial system comprises money lenders, indigenous bankers, lending pawn
brokers, land lords, traders etc. this part of the financial system is not directly under the control of Reserve Bank
of India. On the other hand, the organized financial system comprises money market, capital market, new issue
market, and stock market.