UNIT III

Lease Financing
 FINANCIAL SERVICES
 Financial services refer to the activities of
channelizing the flow of funds from the savers to the
users.
 It involves the mobilization of savings of the persons
and institutions who have surplus funds and
allocating or lending them to the persons and
institutions who are in need of such funds.
 Thus, financial services enable the user to obtain any
asset on credit, according to his convenience and at a
reasonable interest rate.
 Importance of Financial services
[Link] investment-
Presence of FS creates more demand for financial instruments
2. Promoting savings
Various options are available as per needs and risk
3. Minimizing the risks
The risks of both financial services as well as producers are
minimized by the presence of insurance companies.
[Link] the Returns
5. Benefit to Government
The presence of financial services enables the government to raise
both short-term and long-term funds to meet both revenue and
capital expenditure.
 Traditional financial services
1. Fund based services 2. Non-fund based services
a. Lending or fee based services
b. Factoring a. Managing the capital issues
c. Leasing b. Investment consultancy
d. Venture Capital c. Portfolio management
e. Consumer Finance d. Making arrangement for
f. Housing and Vehicle Finance placement of capital and debt
g. Underwriting of Shares and e. Arrangement of funds from
Debentures other financial institutions
Modern services
 Capital restructuring
 Planning for mergers and acquisitions
 Rehabilitation of sick units
 Credit rating
 Credit cards
 Risk management services
 Mutual funds
 Merchant banking
 Rendering project advisory services
 Guiding corporate customers in capital restructuring
 LEASE FINANCING
 A contract under which one party, the owner of an
asset agrees to grant the use of that asset to another
person, in exchange for periodic rental payments.
 The owner of the asset is known as lessor and the
user is called lessee.
 The periodical payment made by the lessee to the
lessor is known as lease rental.
 lessee is given the right to use the asset but the
ownership lies with the lessor
Elements of Leasing
1. Parties: These are essentially two parties to a contract of lease financing, namely the
owner and user of the assets.
2. Lessor: Lessor is the owner of the assets that are being leased. Lessors may be
individual partnership, joint stock companies, corporation or financial institutions.
3. Lessee: Lessee is the receiver of the service of the assets under a lease contract.
Lease assets may be firms or companies.
4. Lease broker: Lease broker is an agent in between the leaser (owner) and lessee.
He acts as an intermediary in arranging the lease deals. Merchant banking divisions
of foreign banks, subsidiaries Indian banking and private foreign banks are acting as
lease brokers.
5. Lease assets: The lease assets may be plant, machinery, equipments, land,
automobile, factory, building etc.
6. Lease Rental- The consideration that the lessee pays to the leaser for lease
transaction is the rental.
Types of Leasing
 Leasing may be classified into different types according to the nature of the
agreement.
 The following are the major types of leasing as follows:
(A) Lease based on the term of lease
1. Finance Lease
2. Operating Lease

(B) Lease based on the method of lease

1. Sale and lease back
2. Direct lease
 Financing lease
 Financing lease is also called as full payout lease.
 It is one of the long-term leases and cannot be cancelled before the expiry of the
agreement.
 A capital/financial lease is a commercial arrangement wherein:
❖ the lessee (borrower or customer) selects an asset (equipment, software, vehicle
❖ the lessor (finance company) purchases that asset
❖ the lessee uses that asset during the lease
❖ the lessee pays a series of installments or rentals for using that asset
❖ the lessor recovers a large part or almost complete cost of the asset in addition to
earning interest from the rentals paid by the lessee
❖ the lessee has the option of acquiring ownership of the asset (bargain option
purchase price or paying the last rental)
Features of Finance Lease
a) A finance lease is a device that gives the lessee a right to
use an asset.
b) The lease rental charged by the lessor during the
primary period of lease is sufficient to recover his/her
investment.
c) The lease rental for the secondary period is much
smaller.
d) Lessee is responsible for the maintenance of asset.
e) No asset-based risk and rewards is taken by lessor.
f) Such type of lease is non-cancellable; the lessor’s
investment is assured
 Operating lease
 Operating lease is also called as service lease.
 Operating lease is one of the short-term and cancelable leases.
 It means a lease for a time shorter than the economic life of the assets, generally the
payments over the term of the lease are less than the leaser’s initial cost of the leased
asset.
 Here risks and rewards incidental to the ownership of asset are not transferred by the
lessor to the lessee.
 The term of such lease is much less than the economic life of the asset and thus the
total investment of the lessor is not recovered through lease rental during the primary
period of lease.
 In case of operating lease, the lessor usually provides advice to the lessee for repair,
maintenance and technical knowhow of the leased asset and that is why this type of
lease is also known as service lease.
 For example : Hiring a car for a particular travel. It includes all expenses such as
driver salary, maintenance, fuels, repairs etc.
Features of Operating/Service Lease
a) The lease term is much lower than the economic life of the
asset.
b) The lessee has the right to terminate the lease by giving a
short notice and no penalty is charged for that.
c) The lessor provides the technical knowhow of the leased
asset to the lessee.
d) Risks and rewards incidental to the ownership of asset are
borne by the lessor.
e) Lessor has to depend on leasing of an asset to different
lessee for recovery of his/her investment
 Difference
BASIS FOR COMPARISON FINANCE LEASE OPERATING LEASE

A commercial arrangement in A commercial arrangement in

which the lessor allows the lessee which the lessor allows the lessee
to use the asset for the maximum to use the asset for a term smaller
Meaning
part of its economic life against than the economic life of the asset
payment of rentals is known as against the payment of rentals is
finance lease. known as operating lease.

Nature Loan Agreement Rental Agreement

The lease term of finance lease is

The lease term of operating lease
Lease Term longer as compared to operating
is short.
lease.
BASIS FOR COMPARISON FINANCE LEASE OPERATING LEASE

Risk Bearing for obsolescence Rests with the lessee Rests with the lessor

Does not transfers from the lessor

From the lessor to the lessee, with
Transferability of risk and rewards to the lessee, with the transfer of
the transfer of asset.
the asset.

Only on the happening of certain

Cancellation of the lease Can be done
specified event.

Depreciation and finance charges

Lease rent is allowable as a
Tax Benefit are allowable as a deduction to
deduction to lessee.
lessee.

Cost of Repairs and Maintenance Are to be borne by the lessee. Are borne by the lessor.

The lease contains an option

where the lessee can purchase the
Bargain Purchase Option No such option in this regard
equipment at the price less than
the Fair Market Value.
Advantages of lease financing
1. Balanced Cash Outflow: Payments related to leasing are spread
out over several years, hence saving the burden of one-time significant
cash payment
2. Quality Assets: While leasing an asset, the ownership of the asset
still lies with the lessor whereas the lessee just pays the rental
expense. Given this agreement, it becomes plausible for a business to
invest in good quality assets which might look unaffordable or
expensive otherwise.
3. Better Usage of Capital: Given that a company chooses to lease
over investing in an asset by purchasing, it releases capital for the
business to fund its other capital needs or to save money for a better
capital investment decision.
4. Tax Benefit: Lease payments are tax deductible.
5. BETTER PLANNING
 Lease expenses usually remain constant for over the asset’s life or lease
tenor, or grow in line with inflation. This helps in planning expense or
cash outflow when undertaking a budgeting exercise.
6. LOW CAPITAL EXPENDITURE
 Leasing is an ideal option for a newly set-up business given that it
means lower initial cost and lower CapEx requirements.
7. NO RISK OF OBSOLESCENCE
 For businesses operating in the sector, where there is a high risk of
technology becoming obsolete, leasing yields great returns and saves
the business from the risk of investing in a technology that might soon
become out-dated. For example, it is ideal for the technology business.
8. TERMINATION RIGHTS
 At the end of the leasing period, the lessee holds the right to buy the
property and terminate the leasing contract, this providing flexibility
to business.
 To Lessor To Lessee

1. As lease rental is received regularly over the 1. Lessee need not have to spend a lot of
period of lease, the lessor is assured of regular money for acquiring an asset but he can
income use the asset by paying small monthly or
2. As the lessor transfers only the risk and rewards yearly rentals.
incidental to ownership to the lessee without 2. As lease payment can be deducted as a business
the transfer of ownership of asset, he can expense, the lessee can get the tax benefits.
preserve the ownership with himself 3. Leasing is a source of financing which is cheaper
3. As the lesser keeps the ownership of the asset he than almost all other sources of
can claim depreciation on the asset and obtain financing for the lessee.
tax benefit 4. Lessee gets some sort of technical support
4. As the return based on lease rental is much from the lessor in respect of leased asset.
higher than the interest payable on financing the 5. Leasing is inflation friendly, the lessee has
asset it is highly profitable. to pay fixed amount of rentals each year
5. As lease financing is one of the cost efficient even if the cost of the asset goes up.
forms of financing, economic growth can be 6. After the expiry of primary period, lessor
maintained even during the period of offers the lessee to purchase the assets at a
depression. very small sum of money.
6. As the lessor receives regular payment over a
period of time, the investment can be recovered
in full.
 DISADVANTAGES OF LEASING
1. LEASE EXPENSES
 Lease payments are treated as expenses rather than as payments
towards an asset.
2. LIMITED FINANCIAL BENEFITS
 If paying lease payments towards a land, the business cannot benefit
from any appreciation in the value of the [Link] long-term lease
agreement also remains a burden on the business as the agreement is
locked and the expenses for several years are fixed. In a case when the
use of asset does not serve the requirement after some years, lease
payments become a burden.
3. REDUCED RETURN FOR EQUITY HOLDERS
 Given that lease expenses reduce the net income without any
appreciation in value, it means limited returns or reduced returns for
an equity shareholder. In such case, the objective of wealth
maximization for shareholders is not achieved.
4. DEBT
 Although lease doesn’t appear on the balance sheet of a company, investors still
consider long-term lease as debt and adjust their valuation of a business to include
leases.
5. LIMITED ACCESS OF OTHER LOANS
 Given that investors treat long-term leases as debt, it might become difficult for a
business to tap capital markets and raise further loans or other forms of debt from the
market.
6. PROCESSING AND DOCUMENTATION
 Overall, to enter into a lease agreement is a complex process and requires thorough
documentation and proper examination of an asset being leased.
7. NO OWNERSHIP
 At the end of the leasing period, the lessee doesn’t end up becoming the owner of the
asset though quite a good sum of payment is being done over the years towards the
asset.
8. MAINTENANCE OF THE ASSET
 The lessee remains responsible for the maintenance and proper operation of the asset
being leased.
9. LIMITED TAX BENEFIT
 For a new start-up, the tax expense is likely to be minimal. In these circumstances,
there is no added tax advantage that can be derived
 To Lessor To Lessee

1. Lessor gets fixed amount of lease rental 1. Finance lease is non-cancellable and even if
every year and they cannot increase this a company does not want to use the asset,
even if the cost of asset goes up. lessee is required to pay the lease rentals.

2. As ownership is not transferred, the lessee 2. The lessee will not become the owner of
may uses the asset carelessly and there is a the asset at the end of lease agreement
great chance that asset cannot be useable unless he decides to purchase it.
after the expiry of primary period of lease.
3. Lease financing is more costly than other
sources of financing because lessee has to
pay lease rental as well as expenses
incidental to the ownership of the asset.

4. As lessee is not the owner of the asset, such

an asset cannot be shown in the balance
sheet which leads to understatement of
lessee’s asset.
 HIRE PURCHASE
1. Hire Purchase is a kind of installment purchase where the
businessman (hirer) agrees to pay the cost of the equipment in
different installments over a period of time.
2. This installment covers the principal amount and the interest cost
towards the purchase of an asset for the period the asset is utilized.
3. The hirer gets the possession of the asset as soon as the hire purchase
agreement is signed.
4. The hirer becomes the owner of the equipment after the last payment
is made. The hirer has the right to terminate the agreement anytime
before taking the title or the ownership of the asset.
5. Example-Hero Honda Motor Finance Co., Bajaj Auto Finance
Company
 Advantages of Hire Purchase

1. Financing of an asset through hire purchase is very easy.

2. Hire purchaser becomes the owner of the asset in future.
3. Hire purchaser gets the benefit of depreciation on asset hired by
him/her.
4. Hire purchasers also enjoy the tax benefit on the interest payable by
them.
Disadvantages of Hire Purchase:

1. Ownership of asset is transferred only after the

payment of the last installment.
2. The magnitude of funds involved in hire purchase are
very small and only small types of assets like office
equipment’s, automobiles, etc., are purchased through
it.
3. The cost of financing through hire purchase is very
high.
 BASIS FOR
HIRE PURCHASING LEASING
COMPARISON

Leasing is an agreement where one

The deal in which one party can use the
party buys the asset and allows the
asset of the other party for the payment
Meaning other party to use it by paying
of equal monthly installments is known
consideration over a specified period
as Hire Purchasing.
is known as Leasing.

Governing
No Specific Accounting Standard AS- 19
Accounting Standard

Down Payment Required Not Required

Installments Principal plus interest Cost of using the asset

Asset type Car, trucks, lorries etc. Land and Building, Property.

Ownership of the asset is transferred to

Transfer of ownership depends on the
Ownership the hire purchaser on the payment of
type of lease.
the last installment.
 BASIS FOR COMPARISON HIRE PURCHASING LEASING

Repairs & Maintenance Responsibility of hire purchaser. Depends upon the type of lease

Consideration Initial payment plus installment. Lease Rentals

Duration Short Term Comparatively Long term

 Commercial Banks
 A commercial bank is a financial institution that
provides various financial services
 Commercial bank customers can take advantage of a
range of investment products that commercial banks
offer like savings accounts and certificates of deposit.
 The loans a commercial bank issues can vary from
business loans and auto loans to property.
Classification of commercial banks
Scheduled banks :- Banks which have been included in the
Second Schedule of RBI Act 1934. They are categorized as
follows:
Public Sector Banks :- are those banks in which majority
of stake is held by the government. Eg. SBI, PNB, Syndicate
Bank, Union Bank of India etc.
Private Sector Banks :- are those banks in which
majority of stake is held by private indivisuals. Eg. ICICI
Bank, IDBI Bank, HDFC Bank, AXIS Bank etc.
Foreign Banks :- are the banks with Head office outside
the country in which they are located. Eg. Citi Bank,
Standard Chartered Bank, Bank of Tokyo Ltd. etc.
Non scheduled commercial banks :- Banks which are not
included in the Second Schedule of RBI Act 1934.
 To be included in the Second Schedule, a bank
(a) must have paid up capital and reserves of not less than Rs.
5 lakhs
(b) it must also satisfy the RBI that its affairs are not
conducted in a manner detrimental to the interests of its
depositors.
Schedule banks are required to maintain a certain amount of
reserves with the RBI; they in return, enjoy the facility of
financial accomodation and remittance facilities at
concessional rates from RBI.
The difference between schedule and non schedule is
immaterial as the number of non schedule bank is almost nil.
Functions
 Primary Functions
 Accepting Deposits : Commercial bank accepts various types of
deposits from public especially from its clients. It includes saving
account deposits, recurring account deposits, fixed deposits, etc. These
deposits are payable after a certain time period.
 Making Advances : The commercial banks provide loans and
advances of various forms. It includes an over draft facility, cash credit,
bill discounting, etc. They also give demand and demand and term loans
to all types of clients against proper security.
 Credit creation : It is most significant function of the commercial
banks. While sanctioning a loan to a customer, a bank does not provide
cash to the borrower Instead it opens a deposit account from where the
borrower can withdraw. In other words while sanctioning a loan a bank
automatically creates deposits. This is known as a credit creation from
commercial bank.
Secondary Functions
 Agency Functions : Various agency functions of
commercial banks are
 To collect and clear cheque, dividends and interest warrant.
 To make payment of rent, insurance premium, etc.
 To deal in foreign exchange transactions.
 To purchase and sell securities.
 To act as trusty, attorney, correspondent and executor.
 To accept tax proceeds and tax returns.
Secondary Functions
 General Utility Functions : The general utility functions
of the commercial banks includeTo provide safety locker
facility to customers.
 To provide money transfer facility.
 To issue traveller's cheque.
 To act as referees.
 To accept various bills for payment e.g phone bills, gas bills,
water bills, etc.
 To provide merchant banking facility.
 To provide various cards such as credit cards, debit cards,
Smart cards, etc.
Development Banks
 "Development banks are financial institutions established to
lend (loan) finance (money) on subsidized interest rate. Such
lending is sanctioned to promote and develop important
sectors like agriculture, industry, import-export, housing and
allied activities."
 Features/Functions/Role
 A development bank does not accept deposits from the public like commercial banks
and other financial institutions who entirely depend upon saving mobilization.
 It is a specialized financial institution which provides medium term and long term
lending facilities.
 It is a multipurpose financial institution. Besides providing financial help it undertakes
promotional activities also. It helps enterprises from planning to operational level.
 It provides financial assistance to both private as well as public sector institutions.
 The role of a development bank is of gap filler. When assistance from other sources is
not sufficient then this channel helps. It does not compete with normal channels of
finance.
 The objective of these banks is to serve public interest rather than earning profits.
 Development banks react to the socioeconomic needs of development.
 Features/Functions/Role
 Development bank plays a very important role in economic development of
our country.
 Since independence they have contributed to the inception of industrialization
and all other technological innovations.
 There basic objective is to assist the development in country which perform by
proving every kind of help possible i.e. financial, advisory, technological etc.
 Development banking plays a vital role in economic development of the
country. It figures the financial gap in the commercial banking sectors
 Industrial Finance Corporation of India Ltd.
(IFCI)
 Industrial Development Bank of India (IDBI)
 Industrial Investment Bank of India Ltd. (IIBI)
 Small Industrial Development Bank of India
(SIDBI)
 Export Import Bank of India (EXIM)
 National Bank For Agriculture & Rural
Development (NABARD)
Industrial Finance Corporation of India
Ltd.
 Set-up in 1948 to provide institutional credit to medium
and large industries.
 Project financing: Medium/Long term credit for setting
up new project, expansion schemes, financial assistance
by way of rupee loans, loans in foreign currencies,
underwriting of direct subscription of
shares/debentures.
 Financial Services and corporate advisory services.
Industrial Development Bank of India
 Established in 1964 for coordinating the working of
institutions at national level and state levels engaged in
financing, promoting and developing industries.
 Provides merchant banking & corporate advisory
services as a part of its fee based activities.
 Provide advice & services for issue management, private
placement of equity/debt instrument, project
evaluation, corporate restructuring etc.
Small Industrial Development Bank of
India
 Set up in 1990, the principal financial institution for the
promotion, financing and development of industries in
the small sector and to co-ordinate the functions of other
institutions engaged in similar activities.
 An apex institution, SIDBI makes use of the network of
the banks and state financial institutions.
 Financial Products- Micro finance, venture capital,
project finance, assistance for technology development,
export finance etc.
Export-Import Bank of India
 An apex institution which promotes foreign trade.
 Creating export capability by arranging competitive
financing at various stages of export cycle.
 Bank provides export credit on deferred payment terms on
exports of indian machinery, manufactured goods and
technology services.
National Bank for Agriculture & Rural
Development
 An apex institution set up for providing & regulating credit
and other facilities for the promotion & development of
agriculture, small scale industries, cottage & village
industries, handicrafts and other rural crafts and other allied
economic activities in rural areas.
Industrial Credit & Investment
Corporation of India Ltd.
 First development bank in the world to be set up in the
private sector
 Objective is to provide medium-term & long-term
financing to Indian business.
 ICICI Securities & Finance Co. Ltd.
 ICICI Venture Funds Management Co. Ltd.
 ICICI Prudential Life Insurance
 ICICI Home Finance Co. Ltd.
 ICICI Investment Management Co. Ltd.
Challenges faced by Indian Banks
 Asset quality:
The biggest risk to India's banks is the rise in bad loans. The slowdown in
the economy in the last few years led to a rise in bad loans or non-
performing assets (NPAs). These are loans which are not
repaid back by the [Link] are, thus, a loss for the bank.
Net NPAs amount to only 2.36% of the total loans in the banking
system. This may not seem like an alarming figure. However, it does not
take into restructured assets - when a borrower is unable to
pay back and the bank makes the loan more flexible to be
paid back over a longer period of time. Restructured assets too
put pressure on a bank's profitability. Together, such stressed assets
account for 10.9% of the total loans in the system. And these are just
loans which are identified as stressed assets. 36.9% of the total debt in
India is at risk, according to an IMF report. Yet, banks have capacity to
absorb only 7.9% loss. So, if these debts turn bad too, banks will face
major losses.
Challenges faced by Indian Banks
 Balance Sheet management:
 In the past few years, many banks have tried to delay setting aside
money as provisions (for future bad loans). One reason for this is
that a bank's chief executives have a short tenure, during which
time they want to post higher net profits and cheer investors. "It
must be appreciated that CEOs/ CMDs would come and go but
the institutions are perpetual entities. The only thing which can
perpetuate their existence is a stronger and healthier balance
sheet," Mundra said. Deferring provisioning is harmful in the long
term. It reduces the bank's ability to withstand financial pressures.
This is even more problematic considering the poor capital
adequacy in Indian banks. In fact, investors would be more happy
if the management addresses and sorts out problems rather than
posting high net profits that cannot be sustained in the long term,
the deputy governor said.
Challenges faced by Indian Banks
 Employee and technology:
 Public-sector banks are seeing more employees retire these days.
So, younger employees are replacing the elder, more-experienced
employees. This, however, happens at junior levels. As a result,
there would be a virtual vacuum at the middle and senior level.
"The absence of middle management could lead to adverse impact
on banks' decision making process as this segment of officers
played a critical role in translating the top management's strategy
into workable action plans," the deputy governor said. Moreover,
banks - especially government-owned banks - need to embrace
technology to offer better [Link] will also help make banks
more efficient.
Challenges faced by Indian Banks
 Capital adequacy:
 One way a bank tries to ensure it is protected from bad loans
is by setting aside money as a 'provision'. This money cannot
be used for any other purposes including lending. As a result,
banks have lower capital available to use for its various
operations. The Capital Adequacy Ratio measures how much
capital a bank has. When this falls, the bank has to borrow
money or use depositors' money to lend. This money,
however, is riskier and costlier than the bank's own capital. If
banks do not shore up their capital soon, some could fail to
meet the minimum capital requirement set by the RBI. In
such a case, they could face severe issues.
Challenges faced by Indian Banks
 PMJDY and beyond
 More than 14.5 crore accounts [Link] leads to the question-
what next? The opening of such a large number of accounts, is not
put to waste by allowing the accounts to turn inactive.
 The credit absorption capacity of the farmers can be enhanced
through consolidation of fragmented landholdings by ushering in
land reforms or through pooling of land holdings. Similarly,
customers may also be trained to undertake non-farm activities.
Efforts to enhance the credit absorption capacity must also be
supplemented through financial literacy and vocational training
initiatives. Improved financial literacy would aid the inculcation of
a savings culture and investment habit amongst the customers,
which can be leveraged by the banks by offering suitable small
savings, investment and pension products.
Challenges faced by Indian Banks
 Treating customers fairly
 Protection of bank customers has been one of the thrust areas
for RBI in recent times. RBI has issued a Charter of
Customer Rights based on the global best practices. The
Charter comprises of following five rights:
 Right to Fair Treatment
 Right to Transparency, Fair and Honest Dealing
 Right to Suitability
 Right to Privacy
 Right to Grievances Redress and Compensation
Challenges faced by Indian Banks
 Risk management
 Risk is inevitable in the banking business and hence, a sound risk
management framework is the touchstone of an efficient bank. The risk
management effectively aims at balancing the Risk-Return Trade-off
which is "maximizing return for a given risk" and "minimizing risk for a
given return". The responsibility of setting a risk appetite for the bank as
a whole is that of the Board and the Top Management. In practice,
however, we seldom see the articulation of an objective risk appetite
statement by the PSBs. If you haven't set out a risk limit for each type of
risk that the bank runs and an aggregate risk appetite for the bank as a
whole, how do you measure and monitor risk? We must understand that
risk management is integral to the success of the bank and hence, the
Top Management should strive to put in place an efficient risk
management framework keeping in view the changing market dynamics
and the regulatory prescriptions.
Universal Banking
 Universal banking is a system of banking where banks undertake a
blanket of financial services like investment banking, commercial
banking, development banking, insurance and other financial services
including functions of merchant banking, mutual funds, factoring,
housing finance, insurance etc.
 ln India, two reports in 1998 mentioned the concept of universal
banking. They are, the Narasimham Committee Report and the S.H.
Khan Committee Report. Both these reports advised to consolidate
(bring together) the banking industry through mergers and integration
of financial activities. That is, they advised a combination of all banking
and financial activities. That is, they suggested a Universal banking.
 Advantages of Universal Banking
 Investors' Trust : Universal banks hold stakes (equity shares) of many
companies. These companies can easily get other investors to invest in their
business. This is because other investors have full confidence and faith in the
Universal banks. They know that the Universal banks will closely watch all the
activities of the companies in which they hold a stake.
 Economics of Scale : Universal banking results in economic efficiency. That
is, it results in lower costs, higher output and better products and services. In
India, RBI is in favour of universal banking because it results in economies of
scale.
 Resource Utilisation : Universal banks use their client's resources as per the
client's ability to take a risk. If the client has a high risk taking capacity then the
universal bank will advise him to make risky investments and not safe
investments. Similarly, clients with a low risk taking capacity are advised to
make safe investments. Today, universal banks invest their client's money in
different types of Mutual funds and also directly into the share market.
 Advantages of Universal Banking
 Profitable Diversification : Universal banks diversify their activities. So,
they can use the same financial experts to provide different financial services.
This saves cost for the universal bank. Even the day-to-day expenses will be
saved because all financial services are provided under one roof, i.e. in the same
office.
 Easy Marketing : The universal banks can easily market (sell) all their
financial products and services through their many branches. They can ask their
existing clients to buy their other products and services. This requires less
marketing efforts because of their well-established brand name. For e.g. ICICI
may ask their existing bank account holders in all their branches, to take house
loans, insurance, to buy their Mutual funds, etc. This is done very easily because
they use one brand name (ICICI) for all their financial products and services.
 One-stop Shopping : Universal banking offers all financial products and
services under one roof. One-stop shopping saves a lot of time and transaction
costs. It also increases the speed or flow of work. So, one-stop shopping gives
benefits to both banks and their clients.
 Disadvantages of Universal Banking
 Different Rules and Regulations : Universal banking offers all financial products
and services under one roof. However, all these products and services have to follow
different rules and regulations. This creates many problems. For e.g. Mutual Funds,
Insurance, Home Loans, etc. have to follow different sets of rules and regulations, but
they are provided by the same bank.
 Effect of failure on Banking System : Universal banking is done by very large
banks. If these huge banks fail, then it will have a very big and bad effect on the banking
system and the confidence of the public. For e.g. Recently, Lehman Brothers a very
large universal bank failed. It had very bad effects in the USA, Europe and even in
India.
 Monopoly : Universal banks are very large. So, they can easily get monopoly power
in the market. This will have many harmful effects on the other banks and the public.
This is also harmful to economic development of the country.
 Conflict of Interest : Combining commercial and investment banking can result in
conflict of interest. That is, Commercial banking versus Investment banking. Some
banks may give more importance to one type of banking and give less importance to
the other type of banking. However, this does not make commercial sense.
Mergers and Acquisitions in
Banking Sector
 Mergers and Acquisitions Mergers and acquisitions activity can be
defined as a type of restructuring in that they result in some entity
reorganization with the aim to provide growth or positive value. The
abbreviation of merger is as: M= Mixing, E= Entities, R= Resources
for, G= Growth, E =Enrichment and R= Renovation From a legal point
of view, a Merger is a legal consolidation of two companies into one
entity, whereas an Acquisition occurs when one company takes over
another and completely establishes itself as the new owner (in which
case the target company still exists as an independent legal 218 Parveen
Kumari entity controlled by the acquirer). Mergers and Acquisition play
a crucial economic role of moving resources from zones of under-
utilization to zones of better utilization. Poorly run companies are more
prone to being taken over by the powerful and managers have an
incentive to ensure that their company is governed properly and
resources are used to produce maximum value.
Mergers and Acquisitions in
Banking Sector
 Mergers and Acquisitions in Indian Banking Sector Mergers and acquisitions in
the banking sector is a common phenomenon across the world. The primary
objective behind this move is to attain growth at the strategic level in terms of
size and customer base. This, in turn, increases the credit-creation capacity of
the merged bank tremendously. Small banks fearing aggressive acquisition by a
large bank sometimes enter into a merger to increase their market share and
protect themselves from the possible acquisition. Banks also prefer mergers and
acquisitions to reap the benefits of economies of scale through reduction of
costs and maximization of both economic and non-economic benefits. The
process of merger and acquisition is not a new happening in case of Indian
banking. Grind lays Bank merged with Standard Chartered Bank, Times Bank
with HDFC Bank, Bank of Madura with ICICI Bank, Nedungadi Bank Ltd. with
Punjab National Bank and Global Trust Bank merged with Oriental Bank of
Commerce. As the entire Indian banking industry is witnessing a paradigm shift
in systems, processes, strategies, it would warrant creation of new
competencies and capabilities on an on-going basis for which an environment of
continuous learning would have to be created so as to enhance knowledge and
skills.
 1. Merger of ICICI Bank with Bank of Madura in 2001: ICICI
one of the largest financial institution was formed in 1955 at
the initiative of the World Bank, the Government of India and
representatives of Indian Industry. In 1990’s, ICICI
transformed its business from a development financial
institution offering only project finance to a diversified
financial services group offering a wide variety of products
and services both directly and through a number of
subsidiaries and affiliates like ICICI Bank. In 2001, the ICICI
merged with the Bank of Madura to expand its customer base
and branch network.
 Merger of IDBI bank and United Western Bank ltd. In 2006:
The Reserve Bank of India told IDBI acquire the distressed
United Western Bank, which the central bank had put under
moratorium by the RBI on September2, 2006. Since IDBI is
adequately capitalized, it will not have to pump money into
United Western Bank, which has a net worth of Rs 70 crore
(Rs 700 million). However, IDBI had pay United Western
Bank shareholders Rs 150.55 crore (Rs 1.5 billion) at Rs 28 a
share, which works out to a 31 per cent premium over
United Western Bank's closing price of Rs 21.45 on the
Bombay Stock Exchange.
 Merger of HDFC and Centurion bank of Punjab in 2007:
HDFC Bank approved the acquisition of Centurion Bank of
Punjab for Rs 9,510 crore ($2.4 billion) in one of the largest
mergers in the financial sector in India in February, 2008.
Centurion Bank of Punjab shareholders got one share of
HDFC Bank for every 29 shares held by them. Post-
acquisition, HDFC Bank became the second-largest private
sector bank in India. The acquisition was also India's 7th
largest ever.
 Merger of HSBC, Canara bank and Oriental Bank of
Commerce in 2009: Canara HSBC Oriental Bank of
Commerce Life Insurance Co Ltd has informed that it has got
the license to operate in India. Three banking majors have
joined hands to offer services in Insurance sector. Two major
in Public Sector banks, Canara Bank and OBC, have joined
hands with global banking and investment services major
HSBC to offer innovative insurance products to Indian
consumers.
Non-Performing Assets
 A non performing asset (NPA) is a loan or advance for which
the principal or interest payment remained overdue for a
period of 90 days.
 However, in terms of Agriculture / Farm Loans; the NPA is
defined as under: For short duration crop agriculture loans
such as paddy, Jowar, Bajra etc. if the loan (installment /
interest) is not paid for 2 crop seasons , it would be termed
as a NPA. For Long Duration Crops, the above would be 1
Crop season from the due date.
Reasons for an account becoming NPA:
1) Internal Factors:
* Funds borrowed for a particular purpose but not use for the said
purpose.
* Project not completed in time.
* In-ability of the corporate to raise capital through the issue of
equity or other debt instrument from capital markets.
* Business failures.
* Diversion of funds for expansion\modernization\setting up new
projects\ helping or promoting sister concerns.
* Fraud, disputes, management disputes, misappropriation etc.
* Deficiencies on the part of the banks viz. in credit appraisal,
monitoring and follow-ups, delaying settlement of payments\
subsidiaries by government bodies etc.,
 Reasons for an account becoming NPA:
 2) External Factors:

* Sluggish Legal System i.e. long legal tangles, changes that had taken
place in labour laws & lack of sincere effort.
* Scarcity of raw material, power and other resources.
* Industrial Recession.
* Shortage of raw material, raw material / input price escalation, power
shortage, industrial recession, excess capacity, natural calamities like
floods, accidents.
* Failures, nonpayment over dues in other countries, recession in other
countries, externalization problems, adverse exchange rates etc.
* Government policies like excise duty changes, Import duty changes
etc.
There are four symptoms by which one
can recognize a Performing Asset
turning in to Non Performing Asset.
1) Financial:

* Non-payment of the very first installment in case of term loan.

* Bouncing of cheques due to insufficient balance in the accounts.
* Irregularity in installment.
* Irregularity of operations in the accounts.
* Unpaid overdue bills
* Declining Current Ratio.
2) Operational and Physical:

* If information is received that the borrower has either initiated the process of winding
up or are not doing the business.
* Overdue receivables.
* Stock statement not submitted on time.
* Nonpayment of wages.
There are four symptoms by which one
can recognize a Performing Asset
turning in to Non Performing Asset.
3) Attitudinal Changes:

* Avoidance of contact with bank.

* Problem between partners.

4) Others:

* Changes in Government policies.

* Death of borrower.
* Competition in the market.
 Preventive Measurement for NPA:
 1) Early Recognition of the Problem: Invariably, by the time banks start
their efforts to get involved in a revival process, it too late to retrieve the
situation- both in terms of rehabilitation of the project and recovery of bank s
dues.

2) Identifying Borrowers with genuine intent : Identifying borrowers

with genuine intent from those who are non- serious with no commitment or
stake in revival is a challenge confronting bankers. Here the role of frontline
officials at the branch level is paramount as they are the ones who have
intelligent inputs with regard to promoters sincerity, and capability to achieve
turnaround. Based on this objective assessment, banks should decide as quickly
as possible whether it would be worthwhile to commit additional
finance. "Special Investigation" In this regard banks may consider having
of all financial transaction or business transaction, books of account in order to
ascertain real factors that contributed to sickness of the borrower.
Preventive Measurement for NPA:
 3) Timeliness & Adequacy of response: Longer the delay in
response, grater the injury to the account and the asset. Time is a
crucial element in any restructuring or rehabilitation activity.
4) Management Effectiveness: The general perception among
borrower is that it is lack of finance that leads to sickness and
NPAs. But this may not be the case all the time. Management
effectiveness in tackling adverse business conditions is a very
important aspect that affects a borrowing unit s fortunes. A bank
may commit additional finance to angling unit only after basic
viability of the enterprise also in the context of quality of
management is examined and confirmed. Where the default is due
to deeper malady, viability study or investigative audit should be
done – it will be useful to have consultant appointed as early as
possible to examine this aspect.
 RISK: WHAT IS IT?

Risk = the possibility of

financial loss
Why is risk important for insurance?

•Risk is what makes you decide whether or not you need

insurance.

•Risk is what insurance companies measure when determining

whether to offer you insurance and how much it will cost.
HOW DO WE HANDLE RISK?
1. Avoidance: Choosing not to participate in an activity
because of the risk involved, e.g. not getting a driver’s
license;

2. Retention: Saving money in case of future losses, e.g.

putting $1000 in a savings account in case of a car
accident;

3. Transfer: Passing the risk on to an insurance company,

e.g. paying a monthly fee for an insurance policy and
expecting the insurance company to protect your assets.
 What is Insurance?

Insurance is a legal contract that transfers risk

from a policyholder to an insurance provider.
Premiums

Insurance
Company Claims

HOW INSURANCE WORKS

Risk factors determine whether you will be able to buy
a policy and how much it will cost.

Generally speaking:
> Risk = > Cost
 Everyone that wants to protect themselves or
someone else against financial hardship should
consider insurance.
Protecting family after one's death from loss of income
Ensuring debt repayment after death
Covering contingent liabilities
Protecting against the death of a key employee or person in your
business
Buying out a partner or co-shareholder after his or her death
Protecting your business from business interruption and loss of income
Protecting yourself against unforeseeable health expenses
Protecting your home against theft, fire, flood and other hazards
Protecting yourself against lawsuits
Protecting yourself in the event of disability
Protecting your car against theft or losses incurred because of accidents
How does Insurance work?
 Insurance works by pooling [Link] does this mean? It simply
means that a [Link] – the resource for investing and
personal finance education. large group of people who want to
insure against a particular loss pay their premiums into what we
will call the insurance bucket, or pool. Because the number of
insured individuals is so large, insurance companies can use
statistical analysis to project what their actual losses will be within
the given class. They know that not all insured individuals will
suffer losses at the same time or at [Link] allows the insurance
companies to operate profitably and at the same time pay for
claims that may arise. For instance, most people have auto
insurance but only a few actually get into an [Link] pay for
the probability of the loss and for the protection that you will be
paid for losses in the event they occur.
 Principles of Insurance
 i. Utmost goods faith
Insurance contracts are the contract of mutual trust and confidence. Both
parties to the contract i.e., the insurer and the insured must disclose all
relevant information to each other. For example, while entering into a
contract of life insurance, the insured must declare to the insurance company
if he is suffering from any disease that may be life threatening.
 ii. Insurable interest
It means financial or pecuniary interest in the subject matter of insurance. A
person has insurable interest in the property or life insured if he stands to gain
from its existence or loose financially from its damage or destruction. In case
of life insurance, a person taking the policy must have insurable interest at the
time of taking the policy. For example, a man can take life insurance policy on
the name of his wife and if later they get divorced this will not affect the
insurance contract because the man had insurable interest in the life of his wife
at the time of entering into the contract. In case of marine insurance insurable
interest must exist at the time of loss or damage to the property. In contract of
fire insurance, it must exist both at the time of taking the policy as well as at
the time of loss or damage to the property.
 Principles of Insurance
 iii. Indemnity
The word indemnity means to restore someone to the same position
that he/she was in before the event concerned took place. This principle
is applicable to the fire and marine insurance. It is not applicable to life
insurance, because the loss of life cannot be [Link] purpose of
this principle is that the insured is not allowed to make any profit from
the insurance contract on the happening of the event that is insured
against. Compensation is paid on the basis of amount of actual loss or
the sum insured, which ever is less.
 iv. Contribution
The same subject matter may be insured with more than one insurer. In
such a case, the insurance claim to be paid to the insured must be shared
or contributed by all insurers.
 Principles of Insurance
 v. Subrogation
In the contract of insurance subrogation means that after the insurer has
compensated the insured, the insurer gets all the rights of the insured with
regard to the subject matter of the insurance. For example, suppose goods
worth Rs. 20,000/- are partially destroyed by fire and the insurance company
pays the compensation to the insured, then the insurance company can
take even these partially destroyed goods and sell them in the
market.
vi. Mitigation
In case of a mishap the insured must take all possible steps to reduce or
mitigate the loss or damage to the subject matter of insurance. This principle
ensures that the insured does not become negligent about the safety of the
subject matter after taking an insurance policy. The insured is expected to act in
a manner as if the subject matter has not been insured.
Types of Insurance
General Insurance
 General insurance covers insurance of property against fire,
burglary, theft; personal insurance covering health,
travel and accidents; and liability insurance covering legal
liabilities. This category of insurance virtually covers all forms of
insurance except life. Other covers may include insurance against
errors and omissions for professionals, credit insurance etc.
Common forms of general insurance are motor, fire, home,
marine, health, travel, accident and other miscellaneous forms of
non-life insurance.
 Unlike life insurance policies, the tenure of general
insurance policies is normally not that of a lifetime. The
usual term lasts for the duration of a particular economic activity
or for a given period of time. Most general insurance products are
annual contracts. There are however, a few products which have a
long term.
 Types of General Insurance- Motor
Insurance
 Motor insurance covers all damages and liability to a vehicle against various on-road and off-road
emergencies. A comprehensive policy even secures against damage caused by natural and man-
made calamities, including acts of terrorism.
 Motor insurance offers protection to the vehicle owner against:
 Damage to the vehicle
 It also pays for any third party liability determined by law against the owner of the vehicle
 Motor insurance is mandatory in India as per the Motor Vehicles Act, 1988 and needs to be
renewed every year. Driving a motor vehicle without insurance in a public place is a punishable
offence.
 In fact, third party insurance is a statutory requirement in our country i.e. the owner of the
vehicle is legally liable for any injury or damage caused to a third party life or property, by or
arising out of the use of the vehicle in a public place.
 A comprehensive motor insurance policy would include personal accident and liability only
policy (third party insurance) in addition to own damage cover (damage to owner’s vehicle) in
one policy.
 Types of General Insurance- Health
Insurance
 Health care costs are increasing every year. Sedentary lifestyle and stress at work negatively affect
the health and can result in a critical illness or medical emergency. Such a scenario is sure to
adversely affect one financially, due to the massive outlay of money on medical expenditure. A
health insurance policy is the only way to mitigate the financial risks, apart from leading a healthy
lifestyle. Health insurance guarantees peace of mind in times of crisis, and helps secure own
health and that of one’s family.
 Health insurance covers the medical and surgical expenses of the insured individual due to
hospitalisation from an illness. Additional riders enhance the benefits and scope of the cover.
 Health insurance often includes cashless facility at empanelled hospitals, pre and post
hospitalisation expenses, ambulance charges, daily cash allowance etc.
 Common types of health insurance policies include:
 Individual Policy
 Family Floater Policy
 Surgery Cover
 Comprehensive Health Insurance
 Types of General Insurance- Travel
Insurance
 International travel, whether on vacation or business, can turn into a nightmare if one
experiences contingencies like loss of baggage, loss of passport, delay in flight, medical
emergency etc. Such eventualities will surely take the fun away from travelling.
 Travel insurance, also referred to as visitor insurance, covers one against unseen medical and
non-medical emergencies during overseas travel, ensuring a worry-free travel experience. It
protects the insured against misfortunes while travelling. Backed up by travel insurance, the
whole experience is like no other.
 Different types of travel insurance policies include:
 Individual Travel Policy
 Family Travel Policy
 Student Travel Insurance
 Senior Citizens Travel Policy
 In addition to the above, some insurance companies offer special plans like a corporate travel
policy or comprehensive policy for travel to special destinations like Asia and/or Europe.
 Types of General Insurance- Home
Insurance
 Home is often the most treasured possession of an individual and also the
largest financial investments one makes in life. Safeguarding the physical
structure and contents of home seems like a logical thing to do.
 Home insurance protects the house and/or the contents in it, depending
on the scope of insurance policy opted for. It secures the home against
natural calamities and man-made disasters and threats. Home insurance
provides protection against risks and damages from fire, burglary, theft,
flood, earthquakes etc. covering the physical asset (building structure)
and valuables (contents) in it.
 Home insurance ensures that one’s hard-earned savings are utilised to
meet important needs instead of using them for rebuilding the house if
some harm was to come to it.
 Types of General Insurance- Home
Insurance
 Home is often the most treasured possession of an individual and also the
largest financial investments one makes in life. Safeguarding the physical
structure and contents of home seems like a logical thing to do.
 Home insurance protects the house and/or the contents in it, depending
on the scope of insurance policy opted for. It secures the home against
natural calamities and man-made disasters and threats. Home insurance
provides protection against risks and damages from fire, burglary, theft,
flood, earthquakes etc. covering the physical asset (building structure)
and valuables (contents) in it.
 Home insurance ensures that one’s hard-earned savings are utilised to
meet important needs instead of using them for rebuilding the house if
some harm was to come to it.
 Types of General Insurance- Marine
Insurance
 Business involves the import and export of goods, within national borders and
across international borders. Movement of goods is fraught with risk of
mishaps which can result in damage and/or destruction of shipments. This
leads to substantial financial losses for both the importers as well as the
exporters.
 Marine cargo insurance covers goods, freight, cargo and other interests against
loss or damage during transit by rail, road, sea and/or air. Shipments are
protected from the time the goods leave the seller’s warehouse till they reach
the buyer’s warehouse. Marine cargo insurance offers complete financial
protection during transit of goods and compensates in the event of any loss
suffered.
 The party responsible for insuring the goods is determined by the sales
contract. Marine cargo insurance policy can be taken by buyers, sellers,
import/export merchants, buying agents, contractors, banks etc. The policy
usually covers the cargo, but can also be extended to cover the interest of a
third party post transfer of ownership as determined by terms of sale.
 Types of General Insurance- Rural
Insurance
 Rural Insurance
 Insurance solutions to meet the needs of agriculture and rural businesses
form part of rural insurance. IRDA has stipulated annual targets for
insurers to provide insurance to the rural and social sector.
 As per these regulations, insurers are required to meet year-wise targets:
 In percentage terms of policies underwritten and percentage of total
gross premium income by general insurers under rural obligation
 In terms of the number of lives under social obligation
Life Insurance
 A contract of life insurance (also known as ‘life assurance’) is a contract
whereby the insurer undertakes to pay a certain sum either on the death of the
insured or on the expiry of a certain number of years. In return, the insured
agrees to pay an amount as premium either in a lump sum or in periodical
instalments, annually or half-yearly. The risk insured against in this case is
certain to happen. Hence, life insurance is also referred to as life assurance. The
written form of contract is known as life insurance policy. It provides for the
payment of a fixed sum to the insured either on a fixed date or on the
happening of an event, which is certain. Businessmen can provide for life
insurance of all their employees by way of group insurance. It also develops
loyalty among employees and can be used as a security for raising loans. There
are two basic types of life assurance policies (a) Whole-life policy, and (b)
Endowment Policy. A whole life policy runs for the whole life of the insured
and premium is payable all along. The sum assured becomes due for payment to
the heirs of the insured only after his death. An endowment policy on the other
hand, runs for a limited period or upto a certain age of the insured. The sum
assured becomes due for payment at the end of the specified period or on the
death of the insured, if it occurs earlier
Bancassurance
 Bancassurance is an arrangement in which a bank and an
insurance company form a partnership so that the insurance
company can sell its products to the bank's client base. This
partnership arrangement can be profitable for both
companies. Banks can earn additional revenue by selling the
insurance products, while insurance companies are able to
expand their customer bases without having to expand their
sales forces or pay commissions to insurance agents
or brokers
 Benefits of Bancassurance:-
 It encourages customers of banks to purchase insurance policies
and further helps in building better relationship with the bank.
 The people who are unaware of and/or are not in reach of
insurance policies can be benefitted through widely distributed
banking networks and better marketing channels of banks.
 Increase in number of providers means increase in competition
and hence people can expect better premium rates and better
services from bancassurance as compared to traditional insurance
companies.
 Benefits of Bancassurance:-
 It encourages customers of banks to purchase insurance policies and
further helps in building better relationship with the bank.
 The people who are unaware of and/or are not in reach of insurance
policies can be benefitted through widely distributed banking networks
and better marketing channels of banks.
 Increase in number of providers means increase in competition and
hence people can expect better premium rates and better services from
bancassurance as compared to traditional insurance companies.
 Bancassurance companies:-
 SBI life insurance Company
 LIC is tied up with Vijaya bank, Oriental bank of commerce,
Corporation bank
 ICICI Lombard
 Barclays – MetLife India
 Axis bank – MetLife India
 Demerits of bancassurance:-
 Data management of an individual customer’s identity and contact
details may result in the insurance company utilizing the details to
market their products, thus compromising on data security.
 There is a possibility of conflict of interest between the other
products of bank and insurance policies (like money back policy).
This could confuse the customer regarding where he has to invest.
 Better approach and services provided by banks to customer is a
hope rather than a fact. This is because many banks in India are
known for their bad customer service and this fact turns worse
when they are responsible to sell insurance [Link] nature
to market insurance products require submissive attitude, which is
a point that has to be worked on by many banks in India.
Riders
 A rider is an add-on provision to a basic insurance policy that
provides additional benefits to the policyholder at an
additional cost. Standard policies usually leave little room for
modification or customization beyond choosing deductibles
and coverage amounts. Riders help policyholders
create insurance products that can meet their specific needs.
 Let’s have a look at the top five health
insurance riders:
 Room Rent Waiver: By including the room rent waiver rider in your policy,
you can opt for a room with a higher sub-limit or without sub-limits. Many
insurance companies put a cap on room rent and include general/standard or
semi-private rooms in their insurance plans. However, by adding the room rent
waiver rider, you can avail a room of your choice without paying extra at the
time of admission.
 Maternity Cover: This rider provides coverage against expenses incurred
during child birth, after the waiting period is over. The waiting period could be
24 months or more, depending on the insurance company and your insurance
plan. Some insurers also provides an option to cover new-born babies, from
birth till the end of policy tenure or maturity.
 Hospital Cash: This rider provides for the daily cash that a policyholder may
require for taking care of hospital and other medical expenses during
hospitalization. This hospital daily cash benefit will be paid once by the insurance
company during the tenure of your policy, and can be used for certain number
of days as mentioned in your health insurance plan.
 Let’s have a look at the top five health
insurance riders:
 Critical Illness Cover: Critical illness mainly refers to any disease or illness that is
terminal in nature such as a massive heart attack, kidney failure, organ transplant, cancer,
tumor or multiple sclerosis. Some insurance companies provide the critical illness cover
with their plans, and also the policyholder can purchase this cover as an add-on in his/her
policy. The critical illness cover provides immediate lump sum amount irrespective of the
total expenses incurred during the actual medical treatment. There are many insurers that
provide critical illness rider for 10-15 ailments, however, depending upon the company
and requirement of the policyholder, an insurance company may cover up to 38 critical
illnesses in case of comprehensive plans.
 Personal Accident Rider: This rider covers compensation for all kinds of accident
including permanent total disablement, accidental death, permanent partial disablement
and temporary total disablement. The personal accident rider can be added to your basic
insurance policy at an additional minimal cost. This waiver provides the insured with
coverage for medical expenses, any disability/injury suffered in an accident and can be
used for any unplanned expenses. The personal accident rider is also known as double
indemnity rider. If the insured dies in an accident then the insurance company pays out
additional amount of death benefit. The policyholder’s family gets twice the amount of the
policy as a result of death due to accidental bodily injury
Reinsurance
 Reinsurance is insurance purchased by an insurance company
from other insurance companies to manage their risk. It
protects against significantly large claims or disasters,
allowing the insurance company to cover more individuals
without fear of bankruptcy should a disaster occur, resulting
in multiple policyholders filing claims at one time. In some
reinsurance arrangements, several insurance providers pool
their policies and divide the risk among a number of
insurance providers, sometimes globally.
 The insurance business is based on laws of probability which
presupposes that only a fraction of the policies issued would result in
claims.

As a result, the total sum insured by an insurance company would be

several times its net worth. It is based on this same probability of loss
that insurance companies fix the insurance [Link] premiums are
fixed in such a manner that the total premium collected would be
enough to pay for the total claims incurred after providing for expenses.

However, there is a possibility that in a bad year, the total value of claims
may be much more than the premium collected. If the losses are of a
very large magnitude, there is a chance that the net worth of the
company would be wiped out. It is to avoid such risks that insurance
companies take out policies. Secondly, insurance companies take the
support of reinsurers when they do not have the capacity to provide a
cover on their own.
LIC vs Private Players
 [Link]
 [Link]
insurance-corp-lic-versus-private-insurers-
analysis/story/[Link]
 [Link]
insurance-companies/
 [Link]
[Link]
 Types of Life Insurance
What is a life insurance policy?
A life insurance policy provides financial protection to your family in the unfortunate event of your death.
At a basic level, it involves paying small sums each month (called premiums) to cover the risk of your
untimely demise during the tenure of the policy. In such an event, your family (or the beneficiaries you have
named in the policy) will receive a lump sum amount. In case you live till the maturity of the policy,
depending on the type of life insurance policy you have opted for, you will receive returns the policy may
have earned over the years. Today, there are many variations to this basic theme, and insurance policies cater
to a wide variety of needs.

 What are the various types of life insurance policies?

Term Insurance Policy
A term insurance policy which is now also available as E-term insurance policy is a pure risk cover policy
that protects the person insured for a specific period of time. In such type of a life insurance policy, a fixed
sum of money called the sum assured is paid to the beneficiaries (family) if the policyholder expires within
the policy term. For instance, if a person buys a Rs 2 lakh policy for 15 years, his family is entitled to the
sum of Rs 2 lakh if he dies within that 15-year period.
If the policy holder survives the 15-year period, the premiums paid are not returned back. The advantage,
apart from the financial security for an individual’s family is that the premiums paid are exempt from tax.
These insurance policies are designed to provide 100 per cent risk cover and hence they do not have any
additional charges other than the basic ones. This makes premiums paid under such life insurance policies
the lowest in the life insurance category.
 Types of Life Insurance
 Whole Life Policy
A whole life policy covers a policyholder against death, throughout his life term. The
advantage that an individual gets when he / she opts for a whole life policy is that the
validity of this life insurance policy is not defined and hence the individual enjoys the
life cover throughout his or her life.
Under this life insurance policy, the policyholder pays regular premiums until his
death, upon which the corpus is paid to the family. The policy does not expire till the
time any unfortunate event occurs with the individual.
Increasingly, whole life policies are being combined with other insurance products to
address a variety of needs such as retirement planning, etc.
 Premiums paid under the whole life policies are tax exempt.
 Types of Life Insurance
 Endowment Policy
Combining risk cover with financial savings, endowment policies are among the
popular life insurance policies.
Policy holders benefit in two ways from a pure endowment insurance policy. In case of
death during the tenure, the beneficiary gets the sum assured. If the individual survives
the policy tenure, he gets back the premiums paid with other investment returns and
benefits like bonuses.
In addition to the basic policy, insurers offer various benefits such as double
endowment and marriage/ education endowment plans.
The concept of providing the customers with better returns has been gaining
importance in recent times. Hence, insurance companies have been coming out with
new and better ULIP versions of endowment policies. Under such life insurance
policies the customers are also provided with an option of investing their premiums
into the markets, depending on their risk appetite, using various fund options provided
by the insurer, these life insurance policies help the customer profit from rising
markets.
The premiums paid and the returns accumulated through pure endowment policies
and their ULIP variants are tax exempt.
 Types of Life Insurance
 Money Back PolicY
This life insurance policy is favoured by many people because
it gives periodic payments during the term of policy. In other
words, a portion of the sum assured is paid out at regular
intervals. If the policy holder survives the term, he gets the
balance sum assured.
In case of death during the policy term, the beneficiary gets
the full sum assured.
New ULIP versions of money back policies are also being
offered by various life insurers.
The premiums paid and the returns accumulated though
a money back policy or its ULIP variants are tax exempt.
 Types of Life Insurance
 ULIPs
ULIPs are market-linked life insurance products that provide a
combination of life cover and wealth creation options.
A part of the amount that people invest in a ULIP goes toward
providing life cover, while the rest is invested in the equity and debt
instruments for maximising returns. .
ULIPs provide the flexibility of choosing from a variety of fund options
depending on the customers risk appetite. One can opt from aggressive
funds (invested largely in the equity market with the objective of high
capital appreciation) to conservative funds (invested in debt markets,
cash, bank deposits and other instruments, with the aim of preserving
capital while providing steady returns).
ULIPs can be useful for achieving various long-term financial goals such
as planning for retirement, child’s education, marriage etc.

House
Fixed Vs Floating
Finance Links
[Link]
one-to-choose-323701?amp=1&akamai-rum=off
[Link]
[Link]
floating-interest-rate-home-loans/amp_articleshow/[Link]
Factors affecting demand for housing finance
 [Link]
housing/
[Link]
of-housing/
[Link]
[Link]
Housing finance in India
 [Link]
Policy_Implications
Credit Rating
 Credit rating is an analysis of the credit risks associated with
a financial instrument or a financial entity. It is a rating given
to a particular entity based on the credentials and the extent
to which the financial statements of the entity are sound, in
terms of borrowing and lending that has been done in the
past.
 An assessment of the creditworthiness of a borrower in
general terms or with respect to a particular debt or financial
obligation. A credit rating can be assigned to any entity that
seeks to borrow money – an individual, corporation, state or
provincial authority, or sovereign government.
 Credit ratings are opinions expressed on an alphanumeric scale on the
relative ability and willingness of a debt issuer to meet financial commitments.
 Credit ratings published by the main global rating agencies aim to provide
ratings that are objective and transparent, as well as consistent and comparable
across instruments, maturities, industries and countries. Some sectors also have
their own specific rating scales.
The long-term global rating scale at S&P and Fitch contain nine grades and
goes from the highest grade to the lowest grade (in increasing order of
riskiness): AAA, AA, A, BBB, BB, B, CCC, CC, C.
 For Moody's, the scale contains nine grades and goes from the highest grade to
the lowest grade (in increasing order of riskiness): Aaa, Aa, A, Baa, Ba, B, Caa,
Ca, C.
Who can promote a credit rating
agency-
Any person belonging to-
• Public financial institution
• Scheduled commercial bank
• Foreign bank operating in India with approval of RBI
• Foreign credit rating agencies under Indian law (5 years
experience)
• Company or body corporate, having continuous net worth of
minimum 100 crore (previous five years).
Credit Rating In India (History)

 The concept came in India in 1987 with the

setting up of CRISIL.
 As the scope of credit rating widened ICRA &
CARE was set up in 1991 & 1993 respectively.
 The first private sector credit rating company
was Duffs & Phelps Credit Rating India Pvt. Ltd
formed in 1995.
Importance of CREDIT RATING in India
 Establish a link between RISK and RETURN
 Superior – Low Cost Information to Investors
 To guide investors in making investment decisions
 Helps merchant bankers, brokers, regulatory authorities,
etc., in discharging their functions related to debt issues
 Required by the regulators
 Build up market reputation
 Lower cost of funding
 Differentiate oneself from the competitors
 Easy and faster way of raising capital
 Increased investors’ acceptance
 Acts as a Marketing Tool
Benefits of Credit Rating : To Investors

✓ Safeguards against bankruptcy

✓ Recognition of Risk and/or Return
✓ Credibility/Reputation of the issuer
✓ Easy understandability (Ratings) of the
investment proposal
✓ Savings of resources (Time And Money)
✓ Quick investment decision
✓ Choice of Investments
✓ Superior Information at Low cost
Benefits of Credit Rating : To Issuers
✓ Low cost of borrowing
✓ Wider audience for borrowing (Increase the investor
population/interest)
✓ Rating as a marketing tool
✓ Reduction of cost in public issues (attract
investors with least efforts)
✓ Source of Motivation for Investors
✓ Sources of additional certification
✓ Warning Signals (About Risk Profile)
✓ Merchant bankers job made easy
✓ Foreign collaborations made easy
Need For Credit Rating…

 Growing number of cases of DEFAULTS in Payment of

Interest and Repayment of Principal Sum borrowed by
way of Fixed Deposits, Issue of Debentures or
Preference Shares or Commercial Papers.
 To Maintain the investors’ confidence, since defaults
break the confidence of investors in corporate
instruments.
 Protect the interest of investors who are not in a
position to analyze the prospects of co’s business.
 Motivate savers to invest their fund into Industries.
 Indian Credit Rating Industry

CRISIL ltd. ICRA ltd.

CARE CIBIL
ltd.
ONICRA credit SMERA India Rating
rating agency And Research Pvt.
Ltd.
CIBIL
 Indias first Credit Information Bureau (India) Limited , incorporated in
year 2000.
 It is a repository of factual information on the credit history and
repayment records of commercial and consumer borrowers.
 Established by the Government of India and the RBI.
 The legislation has enabled banks to submit data to CIBIL without
obtaining borrower’s consent.
 For consumers, they provide information and tools for gaining a clear
understanding of their credit history and financial reputation, and
guarding against the theft of personal information and potential fraud.
For businesses, they provide powerful information solutions, backed by
professional service and current, comprehensive data, for making better,
more informed decisions.
Major Objectives
 To provide comprehensive credit
information by gathering credit related
information regarding commercial and
consumer borrowers.
 To maintain a database of this information
and selling it in the form of credit reports to
a closed user group of Members.
 HOW DOES CIBIL OPERATES ?
 Collects, Collates and Disseminates credit information of borrowers
from its Members (who are actually credit grantors).
 This information will be supplement by CIBIL with public domain
information.
 Allows the credit grantors to have access to its database to search and
gain a complete picture of the payment history of a credit applicant.
 Reports could be obtained from CIBIL only by Members who
contribute all data about the borrowers
 CIBIL collects commercial and consumer credit-related data and
collates such data to create and distribute credit reports to Members
 CIBIL does not grant or deny credit.
MEMBERS OF CIBIL
 Banks
 Financial Institutions
 Non Banking Financial
Companies
 Housing Finance
Companies
 State Financial
Corporations
 Credit Card Companies
BENEFITS OF CIBIL
 For Credit Grantor:  For Borrowers:
 Provides access to better credit  Provides faster access to credit.
information by allowing credit grantors  Reduces cost of borrowing for
to exchange credit information while borrowers with good credit records.
ensuring they do not lose their
competitive advantage.  Reduces subjectivity in the credit
assessment process.
 Automated decisioning system leading
to lower cost of credit evaluation,  Encourages borrowers to maintain
consistent decisioning and greater greater self discipline in acquiring
efficiency. financial commitments.
 Assists in evaluating and monitoring  Allows borrowers to build reputational
repayment ability and payment collateral by following correct
diligence repayment behaviour.
 Lowers default risk by assisting credit
grantors improve their credit
portfolios.
 Allows credit grantors to price the risk
appropriately
1. CARE- (Credit Analysis And Research Ltd)

- Second largest credit rating agencies

- Eminent and experienced professionals.
Established : Mumbai in 1993.
Care ratings cover : rating segments such as banks,
sub-sovereigns and Ipo gradings.
Regional offices : Ahmedabad, Bangalore, Chennai,
Hyderabad, Jaipur, Kolkata, New Delhi,
Pune.
 Credit Analysis and Research Limited (CARE)

✓ Incorporated in April 1993, is a credit rating, information and

advisory services company promoted,
✓ By Industrial Development Bank of India (IDBI), Canara Bank, Unit
Trust of India (UTI) and other leading banks and financial services
companies. In all CARE has 14 shareholders. Canara Bank, UTI, Credit
Capital Venture Fund (I) Ltd, Sundaram Finance Ltd, The Federal Bank
Ltd, The Vysya Bank, First Leasing Company of India, ITC Classic Finance
Ltd, Kotak Mahindra Finance Ltd, IFB Leasing and Finance Ltd, Kalimati
Investment Company Ltd, The Investment Corporation of India Ltd,
Varuna Investments Ltd, and 20the Century Finance Corporation Ltd.

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 Services Offered by CARE
1. Advisory Services:
 Credit Reports - CARE offers credit reports on companies based on
published information and CARE's in-house data base. These confidential
credit reports are useful to entities considering financing options, joint
ventures, acquisitions and collaborations with Indian companies.
 Sector Studies - CARE from time to time conducts studies on select sectors
of the Indian economy, particularly those which were largely government
controlled and funded till recently, but have been thrown open for private
investment. Studies on the Indian Power Sector, Fertilizer Industry and
Municipal Finances have been completed. CARE has also prepared reports on
twelve of the larger states of the Indian Union, which account for the bulk of
foreign direct investment into India. CARE also regularly prepares reports on
important segments of the Indian economy. These reports are used by industry
participants, financial intermediaries and also by analysts in CARE for their
rating reports.

121 4/18/2017
 Services Offered by CARE contd….
 Project Advisory Services - For financing its infrastructure, India is
increasingly relying on private sector participation. CARE uses the
expertise gained in evaluating the credit risk of projects in areas such as
roads, ports, power and telecom to advise investors and banks about
the regulatory framework, the specific project risks and the ways of
risk mitigation. CARE has helped independent power producers in
India understand the functioning of the principal power purchasers, the
State Electricity Boards and evaluate options for mitigating purchaser
risk. CARE has also worked closely with project sponsors to structure
their debt securities based on estimates of cash flows.

122 4/18/2017
 Services Offered by CARE contd….
 Financial Restructuring - The business risk faced by Indian companies
increased following the liberalisation of Indian economy in 1991. To compete in
the changed environment, companies have had to reassess their capital
structures. CARE uses its knowledge about various industry sectors to advise
companies about the optimal capital structure and the financial restructuring
options.
 Valuation - CARE carries out enterprise valuations for company managements,
prospective and exisiting business partners or large investors. The Disinvestment
Commission, Government of India, has used CARE's services for valuing 20
state owned enterprises.
 Credit Appraisal Systems - CARE helps banks and non banking finance
companies to set up or modify their credit appraisal systems.
 Debt Market Review - CARE's Advisory division also publishes a monthly
bulletin "debt market review" on the happenings in the debt market and general
development in the economy in the previous month.
123 4/18/2017
 Services Offered by CARE contd….
2. Credit Rating Services:
- CARE's Credit Rating is an opinion on the relative ability and willingness of
an issuer to make timely payments on specific debt or related obligations over
the life of the instrument.
- CARE rates rupee denominated debt of Indian companies and Indian
subsidiaries of multinational companies.
- CARE undertakes credit rating of all types of debt and related obligations (all
types of medium and long term debt securities such as debentures, bonds and
convertible bonds and all types of short term debt and deposit obligations
such as commercial paper, inter-corporate deposits, fixed deposits and
certificates of deposits).
- CARE also rates quasi-debt obligations such as the ability of insurance
companies to meet policyholders obligations.
- CARE's preference share ratings measure the relative ability of a company to
meet its dividend and redemption commitments.

124 4/18/2017
 Credit Analysis and Research Limited (CARE)

✓ Long term debt instruments-Rating Symbols

CARE AAA : Highest Safety
CARE AA : High Safety
CARE A : Adequate Safety
CARE BB: Inadequate Safety
CARE B : High Risk
✓ Medium term debt instruments-Rating Symbols
CARE AAA : Highest Safety
CARE AA : High Safety
CARE A : Adequate Safety
CARE BB: Inadequate Safety
CARE C : High Risk

125 4/18/2017
 CARE

✓ Short term debt instruments Rating Symbols

PR 1: Superior capacity
PR 2: Strong capacity
PR 3: Adequate capacity
PR 4: Minimal degree of safety
PR 5: Default or likely in default on maturity
✓ Credit Analysis Rating
CARE 1: Excellent Debt Management Capacity
CARE 2: Very good Debt Management Capability
CARE 3: Good capability for Debt Management
CARE 4: Barely satisfactory capability for debt management
CARE 5: Poor capability for debt management

126 4/18/2017
 Services Offered by CARE contd….
✓ Other Rating / Grading Services : IPO GRADING
- CARE's IPO grading is a service aimed at facilitating the assessment of equity
issues offered to public.
- CARE's IPO grading is an independent and professional opinion on the
fundamentals of the issuer.
- The grade assigned to any individual issue represents a relative assessment of
the 'fundamentals' of that issuer.

✓ Useful to market participants like…

- Investors
- Issuer
- Merchant Bankers
- Regulatory Bodies

127 4/18/2017
 Services Offered by CARE contd….
IPO Grading Criteria:
✓ CARE would assess the fundamentals of an issue based on the following
factors:
✓ Quantitative – growth prospects of the industry, financial strength &
operating performance of the issuer
✓ Qualitative - business fundamentals & prospects, management quality,
promoter evaluation, accounting policies, corporate governance practices,
project risk, and compliance and litigation history.
✓ CARE would consider a time horizon of around 3 years for its assessment.

128 4/18/2017
2. ONICRA- Onida Individual Credit Rating Agency of India

Established : Haryana (1993).

Leading credit and performance rating agencies.
Provides ratings for : Risk assessment and analytical solutions to –
individuals, msmes and corporate.

3. SMERA- SME Rating Agency of India Ltd.

Founded in : 2005 by Small Industries Development Bank Of India

(SIDBI)
Set up for : Micro, small and medium enterprises (MSME).
Ratings are integral part of the risk assessment process within the
lending and investing community.
Instruments rated : IPO, NCDS, commercial papers, bonds, security
receipts, fixed deposits etc.
4. India Rating And Research Pvt. Ltd. - (formerly FITCH
Ratings India [Link])

Established in : 1913 in NEWYORK

Subsidiary : of a Fitch group . It is among the top credit rating
agencies in India
Provides services to : corporate issuers, financial institutions
(Banks and insurance companies).
Offices located at : Mumbai, Delhi, Chennai, Bangalore,
Hyderabad and Kolkata.
Recognized by : The Securities And Exchange Board Of India,
The Reserve Bank Of India and
National Housing Bank.
Credit Rating Information Services Limited (CRISIL)
The first credit agency floated on January 1, 1988, jointly started by ICICI and UTI
with an equity capital of Rs. 4 crores, as public Ltd company.
Capital Structure of CRISIL

Institution Percentage
ICICI 15
UIT 15
Asian Development Bank 15
LIC of India 05
GIC & its Subsidiaries 05
SBI 05
HDFC 05
Nationalized Banks – BOI, BOB, UCO, Canara bank, Central Bank of 18
India, Allahabad bank, IOB, Vysya Bank, and Bank of Madura

Foreign Banks -- Bank of Tokyo, Hongkong Bank, Citi Bank, Grindlays 17

Bank, Deutsche Bank, SOciete General Banque, Nationale de Paris.

131 4/18/2017
 Credit Rating Information Services Limited (CRISIL)

 The first credit agency floated on January 1, 1988, jointly started

by ICICI and UTI with an equity capital of Rs. 4 crores, as public
Ltd company.
 CRISIL is India's leading rating agency, and is the fourth largest in
the world.
 With over a 60% share of the Indian Ratings market, CRISIL
Ratings is the agency of choice for issuers and investors.

132 4/18/2017
 Credit Rating Information Services Limited (CRISIL)
contd….

✓ Objective of CRISIL - The principal objective of CRISIL is to

rate the debt obligations of Indian companies. Its rating guides the
investors about the risk of timely payment of interest and principal
on a particular debt instrument.
✓ Credit Rating Committee - CRISIL's rating process and rating
committee are designed to ensure that all assigned ratings are based
on the highest standards of independence and analytical rigor.
✓ The rating committee comprises members who have the
professional competence to meaningfully assess the credit analysis
that underlies the rating, and have no interest in the entity being
rated.A team of analysts carries out the credit analysis.

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 RATING METHODOLOGY OF CRISIL

✓ Key factors considered for rating are:

1. Business Analysis,
2. Financial Analysis,
3. Management evaluation,
4. Regulatory and competitive environment, and
5. Fundamental analysis.

✓ Factors listed above at serial numbers 1, 2, and 3 are evaluated for

manufacturing companies, while 4 and 5 factors are used to evaluate
finance companies apart from the 1, 2 and 3 factors.

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INTRODUCED VARIOUS INNOVATIONS :

• Launching of CRISILCARD service in 1990

• Launching of the CRISIL 500 Equity Index, in partnership with

National Stock Exchange of India Ltd (NSEIL)

• Setting up of India Index Services Ltd (IISL) in 1998

• Launching of the CRISIL Composite Performance Ranking

(CRISIL CPR) in 2000

• Setting up of its subsidiary, Global Data Services of India Ltd

in 2001
Credit rating process of CRISIL
ISSUER CRISIL

Request for Rating

Signs rating agreement Rating team assigned. Team collects
Provides information and Information, conducts preliminary
rating fees analysis

Management interactions Team conducts site visits

With the rating terms And performs analysis

Analysis presented to rating committee

Accepts the rating Rating assigned and

Or Appeal communicated to issuer

Rating disseminated and carried

in [Link]

All ratings kept under continuous surveillance

throughout validity
 RATING METHODOLOGY OF CRISIL contd…
1. Business Analysis – Industry risk, market position and
operating efficiency of the company, legal position.
2. Financial Analysis – Accounting quality, earnings position,
adequacy of cash flows, and financial flexibility.
3. Management Evaluation – Goals, philosophy, strategies,
ability to overcome adverse situations, managerial talents and
succession plans, commitment, consistency and credibility.
4. Regulatory and Competitive Environment -
5. Fundamental Analysis – Liquidity management, assets
quality, profitability and financial position, interest and tax
sensitivity.

137 4/18/2017
CRISIL Credit Rating Symbols
AAA : Highest Safety
AA : High Safety
A : Adequate Safety
BBB : Moderate Safety
BB : Inadequate Safety
B : High Risk
C : Substantial Risk
D : Default
NM : Not Meaningful
CRISIL’s Credit Rating Scales
These are categorized into following types :
• Long Term Scale
• Short Term Scale
• Long Term Structured Finance Scale
• Short Term Structured Finance Scale
• Fixed Deposit Scale
• Corporate Credit Scale

(A) Rating scale for Long Term (B) Rating Scale for Short Term
Instruments Instruments
• CRISIL AAA • CRISIL A1
• CRISIL A2
• CRISIL AA
• CRISIL A3
• CRISIL A
• CRISIL A4
• CRISIL BBB • CRISIL D
• CRISIL BB
• CRISIL B
• CRISIL C
• CRISIL D
(C) Rating scale for Long Term (D) Rating Scale for Short Term Structured
Structured Finance Instruments Finance Instruments
• CRISIL AAA (SO) • CRISIL A1 (SO)
• CRISIL AA (SO) • CRISIL A2 (SO)
• CRISIL A (SO) • CRISIL A3 (SO)
• CRISIL BBB (SO) • CRISIL A4 (SO)
• CRISIL BBB (SO) • CRISIL D (SO)
• CRISIL BB (SO)
• CRISIL B (SO)
• CRISIL C (SO)
• CRISIL D (SO)

(E) Rating Scale for Fixed Deposits (F) Corporate Credit Rating Scale
• FAAA • CCR AAA
• FAA • CCR AA
• FA • CCR A
• FB • CCR BBB
• FC • CCR BB
• FD • CCR B
• NM • CCR C
• CCR D
• CCR SD
 Benefits of CRISIL
To MSME (ministry of small and medium enterprises)-
• Availability of cheaper and faster credit
• Banks give preference to CRISIL reports over other agencies
• Govt agencies use it as additional document
• Rating services at discounted rates to individuals of these institutions
• Financial institutions offer interest rate benefits to high rated entities

To banks-
• Internal appraisal process reduced
• Customers of bank enjoy concession in rating fee with MOU in place
• CRISIL reports will help credit managers at branch in making
internal credit proposal and for taking financing decisions
 Investment Information and Credit Rating Agency of
India (ICRA)

✓ ICRA was set up by IFCI on 16th January 1991.

✓ ICRA Limited is an Associate of Moody's Investors Service and

an independent and professional company.
✓ It is a public limited company with an authorized share capital
of Rs.10 crores, Rs. 5 crores is paid up.
✓ ICRA’s major shareholders IFCI (26%), and the balance by
UTI, LIC, GIC, PNB, Central Bank of India, Bank of Baroda,
UCO Bank and banks (SBI).

142 4/18/2017
 OBJECTIVES OF ICRA

✓ To access the credit instrument and award it a grade consonant to the

risk associated with such instrument.
✓ To assist investors in making well informed investment decision
✓ To assist issuers in raising funds from a wider investors base
✓ To enable banks, investment bankers and brokers in placing debt
with investors by providing them with a marketing tool
✓ To provide regulators with a market driven system to encourage the
healthy growth of the capital markets in a disciplined manner
without costing an additional burden on the Government for this
purpose.

143 4/18/2017
 RATING METHODOLOGY OF ICRA
✓The rating methodology comprises the study of industry as well as
the company’s SWOT analysis.
- Marketing strategies,
- Competitive edge,
- Level of technological development,
- Operational efficiency,
- Competence and effectiveness of management,
- HRD policies and practices,
- Hedging of risks,
- Cash flow trends and potential,
- Liquidity,
- Financial flexibility,
- Asset quality and past record of servicing debts and obligations, and
- Government policies and status affecting the industry.

144 4/18/2017
ICRA’S RATING PROCESS
 Issuer requests for a rating
 Issuer signs rating agreement and pays the rating fee
 Issuer provides information
 Analysts process the information and meet the
management/bankers/auditor
 Rating report prepared by analysts
 Rating committee assigns rating
 Communication of rating to the issuer
 Decision of the issuer
ICRA’S RATING SCALES
 LONG TERM RATING SCALE
 MEDIUM TERM RATING SCALE
 SHORT TERM RATING SCALE
 LONG TERM STRUCTURED INSTRUMENTS
A. DEBT INSTRUMENT RATING
 LONG TERM RATING SCALE- It includes all bonds, NCDs
and other debt instruments with original maturity
exceeding one year.
o [ICRA]AAA - Highest degree of safety
o [ICRA]AA - High degree of safety
o [ICRA]A - Adequate degree of safety
o [ICRA]BBB - Moderate degree of safety
o [ICRA]BB - Moderate risk of default
o [ICRA]B - High risk of default
o [ICRA]C - Very high risk of default
o [ICRA]D - Default or expected to be in default soon
2. ICRA’S MEDIUM TERM RATING SCALE
(ONLY FOR PUBLIC DEPOSITS)

 MAAA - Highest credit quality rating

 MAA - High credit quality rating
 MA - Adequate credit quality rating
 MB - Inadequate credit quality rating
 MC - Risk prone credit quality
 MD - Lowest credit quality rating
3. ICRA’S SHORT TERM RATING SCALE
 [ICRA]A1 - Very strong degree of safety
 [ICRA]A2 - Strong degree of safety
 [ICRA]A3 - Moderate degree of safety
 [ICRA]A4 - Minimal degree of safety
 [ICRA]D - Default
B. ISSUER RATING
1. ICRA’S ISSUER RATING SCALE- LONG TERM
 IrAAA - Highest credit rating
 IrAA - High credit rating
 IrA - Adequate credit rating
 IrBBB - Moderate credit rating
 IrBB - Inadequate credit rating
 IrB - Risk prone credit rating
 IrC - Lowest credit rating
 IrD - Default
2. ISSUER RATING SCALE
 IrA1 - Very strong credit rating
 IrA2 - Strong credit rating
 IrA3 - Moderate credit rating
 IrA4 - Low credit rating
 IrD - Default
C. STRUCTURED FINANCE RATING
1. LONG TERM STRUCTURED FINANCE INSTRUMENTS
 [ICRA]AAA(SO) – Highest degree of safety
 [ICRA]AA(SO) - High degree of safety
 [ICRA]A(SO) - Adequate degree of safety
 [ICRA]BBB(SO) - Moderate degree of safety
 [ICRA]BB(SO) - Moderate degree of default
 [ICRA]B(SO) - High risk of default
 [ICRA]C(SO) - Very likelihood of default
 [ICRA]D(SO) - Default
 2. SHORT TERM STRUCTURED FINANCE
INSTRUMENTS

 [ICRA]A1(SO) - Very strong degree of safety

 [ICRA]A2(SO) – Strong degree of safety
 [ICRA]A3(SO) – Moderate degree of safety
 [ICRA]A4(SO) – Minimal degree of safety
 [ICRA]D(SO) - Default
D. MUTUAL FUND CREDIT RISK RATING
1. ICRA’S LONG TERM DEBT FUND CREDIT RISK
RATING SCALE
✓ [ICRA]AAAmfs – Highest degree of safety
✓ [ICRA]AAmfs - High degree of safety
✓ [ICRA]Amfs - Adequate degree of safety
✓ [ICRA]BBBmfs - Moderate degree of safety
✓ [ICRA]BBmfs - Moderate risk of default
✓ [ICRA]Bmfs - High risk of default
✓ [ICRA]Cmfs - High risk of default
 2. ICRA’S SHORT TERM DEBT FUND CREDIT
RISK RATING SCALE

 [ICRA]A1mfs – Very strong degree of safety

 [ICRA]A2mfs - Strong degree of safety
 [ICRA]A3mfs - Moderate degree of safety
 [ICRA]A4mfs - Minimal degree of safety
RATING FOR CLAIM PAYING ABILITY OF
INSURANCE COMPANIES
 Iaaa- Highest claims for paying ability
 Iaa - High claims paying ability
 Ia - Adequate claims paying ability
 Ibbb- Moderate claims paying ability
 Ibb- Inadequate claims paying ability
 Ib- Weak claims paying ability
 Ic- Lowest claims paying ability
CREDIT RATING AGENCIES AND CODE
OF CONDUCT
SEBI (Credit Rating Agencies ) Regulations were issued in 1990 and then
amended in 2003.
Following are some of the regulations:

A credit rating agency shall-

• make all efforts to protect the interest of investors.
• observe high standards of integrity, dignity and fairness.
• fulfill its obligations in prompt, ethical and professional manner.
 disclose its rating methodology to clients, users and public.
• have in place a rating process that reflects consistent and international
rating standards.
• keep track of all important changes relating to client company.
 not indulge in any unfair competition nor shall it wean away the
clients of any other rating agency on assurance of higher rating.
 not make any untrue statement, suppress any material fact or make
any misrepresentation.
RECOMMENDATIONS
SEBI’s recommendations in regard to the credit rating agencies
are:
 Operational Audits
 Cross-verification of analysis
 Standardized Rating symbols
 Awareness among general public
 Constitute different appeals committee
Credit Rating: Basic Analysis

Existing Risk
Business Risk

Financial Risk Project Risk

Management
Evaluation
Overall
Risk Rating
 Notes given in class on CRA Process, Methodology etc.
Examples of Credit Rating Companies
 In USA:

1. Moody’s investors service

2. Standard and poor’s corporation
3. Fitch Rating service
 In INDIA:

1. CRISIL - Credit Rating Information Services Limited

2. ICRA - Investment Infn. and Credit Rating Agency of India
3. CARE - Credit Analysis and research
4. BRICKWORK
5. ONICRA etc..
Disadvantages of Credit Rating:

 Biased Rating and Misrepresentation,

 Static Study,
 Concealment of Material Information,
 No Guarantee For Soundness of The Company,
 Human Bias,
 Reflection of Temporary and Adverse
Conditions,
 Present Rating May Change (Down Grade),
 Differences in Rating of Two Agencies.
 CIBIL Score
 Credit Information Report (CIR) summarizes your payment history of loans and credit
cards borrowed from all banks and financial institutions. Based on this credit history, a
‘Credit Score’ is generated. The CIBIL Score is a 3-digit number ranging from 300-900.
The closer your score is to 900, the stronger your credit profile.
 A Credit Score plays a critical role in the loan and credit card approval process. This is
the first screening criterion applied by banks and financial institutions when reviewing
your loan application.
 In the illustration below, two individuals with Credit Scores of 810 and 620 respectively
apply for a home loan. Depending on the credit policy of the bank, it is more likely that
the bank will screen the individual with an 810 Credit Score for further evaluation,
while the application with the Credit Score of 620 may not be processed.
How does the CIBIL Score affect me as
an individual?
 A Credit Score is looked upon by lenders to determine your
creditworthiness. So whilst a CIR is like a report card, a Credit
Score is like the overall rank you get. It analyzes all the
information in a CIR and returns a score value which quantifies
your credit and financial health. So by looking at your Credit
Score, you can get a sense of your financial standing.
 A low Credit Score does not mean that your loan will not be
sanctioned. In addition to your Credit Score, your CIR, income
and existing loan obligations (debt-burden ratio) also play a key
role in the evaluation of your loan application. So if you have a low
Credit Score, Bank A may not approve your loan while a Bank B
may do so, depending on their respective credit policies. It may do
so at a higher interest rate.
 How does my CIBIL Score impact loan
approval?
 Today, the CIBIL Score provides lenders the ability to differentiate between those who
have honored their obligations responsibly and those who have defaulted. Individuals
who have managed their obligations appropriately build a ‘reputational collateral’ with
lenders. In turn, this reputational collateral may allow individuals to negotiate better
terms with a lender.
 It is always advisable to purchase and review your Credit Score and CIR prior to
commencing your loan hunt. It helps you:
 To understand what the lender will review while evaluating your application.
 To identify and rectify any discrepancies in your CIR and thereby prevent unwelcome
surprises during the loan evaluation process.
 If on purchase of your Credit Score, you do not receive a score value- i.e., a number
between 300 and 900- but a “NA” or “NH” instead, this may be because:
 You do not have a credit history: you have not availed any credit facility be it loan or
credit cards till date.
 You have a credit history but no credit activity or transactions in the last two years.
 You only have add-on credit cards and have no direct credit exposure.
What can affect your CIBIL score?

 Mentioned below are a number of factors that may affect your CIBIL score.
 Payment history:Your payment history plays a major role in developing a good
CIBIL record. Making late payments on credit cards or delaying/defaulting on
your EMIs regularly can negatively affect your credit score, indicating that you
are not serious about or capable of clearing your existing debts.
 Increased credit limit: Increasing the current balance of your credit card may
negatively affect your credit score since it is considered to enhance your
repayment burden. However, increased spending on your credit card does not
affect your credit score as long as you’re credit utilisation is in proportion to your
credit limit.
 Unsecured loans: A high percentage of unsecured loans such as personal loans
and credit cards may affect your credit score. A balanced combination of secured
and unsecured loans adds positively to your credit score.
 Multiple loans & Credit Cards: If you have multiple loans, credits cards and
new accounts, this may affect your credit score, and banks may review your loan
application more carefully.
Functions of Credit Agencies
 Credit rating serves following functions:
 (1) Provides superior Information:
 Provides superior information on credit risk for three reasons: (i) An independent
rating agency, unlike brokers, financial intermediatories, underwriters who have
vested interest in an issue, is likely to provide an unbiased opinion; (ii) Due to
professional and highly trained staff, their ability to assess risk is better, and
finally, (iii) the rating firm has access to a lot of information which may not be
publically available.
 (2) Low cost information:
 Rating firm gathers, analyses, interprets and summarises complex information in
a simple and readily understood formal manner. It is highly welcome by most
investors who find it prohibitively expensive and simply impossible to do such
credit evaluation of their own.
 Functions of Credit Agencies
 (3) Basis for a proper risk and return:
If an instrument is rated by a credit rating agency, then such instrument enjoys higher confidence
from investors. Investors have some idea as to what is the risk associated with the instrument in
which he/she is likely to take, if investment is done in that security.
 (4) Healthy discipline on corporate borrowers:
 Higher credit rating to any credit investment tends to enhance the corporate image and visibility
and hence it induces a healthy discipline on corporate.
 (5) Greater credence to financial and other representation:
 When credit rating agency rates a security, its own reputation is at stake. So it seeks financial and
other information, the quality of which is acceptable to it. As the issue complies with the demands
of a credit rating agency on a continuing basis, its financial and other representations acquire
greater credibility.
 (6) Formation of public policy:
 Public policy guidelines on what kinds of securities are eligible for inclusions in different kinds of
institutional portfolios can be developed with greater confidence if debt securities are rated
professionally.
Do read this
 [Link]  FAQs on Credit Rating
q/[Link] Agencies
Credit Rating and Banking Sector
 [Link]
t-rating-agencies-impact-
on-banking/