Financial Markets and Services

MODULE 4
FINANCIAL INTERMEDIARIES AND SERVICES

SYLLABUS
Financial Intermediaries And Services: Commercial banks - Development financial
institutions (DFIs) - Non-Banking Financial Companies (NBFCs) – Insurance companies -
Mutual Funds – Classification of mutual fund schemes – Lease financing – Meaning and
types – Venture capital – Concept and meaning - Factoring and forfaiting - Objectives and
functions.

FINANCIAL INSTITUTIONS / FINANCIAL INTERMEDIARIES

Financial institutions are the participants in a financial market. They are business
organizations dealing in financial resources. They collect resources by accepting deposits
from individuals and institutions and lend them to trade, industry and others. They buy and
sell financial instruments. They generate financial instruments as well. They deal in financial
assets. They accept deposits, grant loans and invest in securities. Financial institutions are the
business organizations that act as mobilises of savings and as purveyors of credit or finance.
This means financial institutions mobilise the savings of savers and give credit or finance to
the investors.
Financial institutions or intermediaries can be classified into
 Capital market and money market intermediaries and
 Banking and non-banking intermediaries

Money Market Intermediaries: These are the institutions that help in borrowing and
lending of short-term funds (less than one year). Example: Commercial banks, NBFCs,
primary dealers, money market mutual funds. Money Market Intermediaries help in raising
short-term finance.
Capital Market Intermediaries: These are the institutions that facilitate the issue and
trading of long-term securities (more than one year). Example: Stock exchanges, investment
bankers, brokers, depositories, mutual funds, underwriters. Capital Market Intermediaries
help in raising long-term finance.
Banking Institutions: Banking institutions mobilise the savings of the people. They provide
a mechanism for the smooth exchange of goods and services. They extend credit while
lending money. They not only supply credit but also create credit. There are three basic

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categories of banking institutions. They are commercial banks, co-operative banks and
developmental banks.
Non-banking Institutions: The non-banking financial institutions also mobilize financial
resources directly or indirectly from the people. They lend the financial resources mobilized.
They lend funds but do not create credit. Companies like LIC, GIC, UTI, Development
Financial Institutions, Organisation of Pension and Provident Funds etc. fall in this category.
Non-banking financial institutions can be categorized as investment companies, housing
companies, leasing companies, hire purchase companies, specialized financial institutions
(EXIM Bank etc.) investment institutions, state level institutions etc.
Difference Between Banking Institutions and NBFCs

NBFCs (Non-Banking Financial

Point of Difference Banking Institutions (Banks)
Companies)

Regulated by RBI under Banking Regulated by RBI under Companies Act,

Regulator
Regulation Act, 1949 2013 & RBI Act, 1934

Acceptance of Can accept demand deposits (savings & Cannot accept demand deposits (only
Deposits current accounts) term deposits if permitted)

Payment System Part of payment & settlement system Not part of payment system (cannot issue
Role (issue cheques, debit cards, UPI, etc.) cheques drawn on itself)

Deposits insured by DICGC up to ₹5

Deposit Insurance No deposit insurance available
lakhs

CRR & SLR Must maintain CRR & Statutory No CRR; limited liquid asset
Requirement Liquidity Ratio (SLR) with RBI requirements for some NBFCs

Foreign Investment Allowed up to 74% in private sector Allowed up to 100% under automatic
(FDI) banks route

Wide services: deposits, loans, credit Limited services: loans, hire purchase,
Services Provided
cards, remittances, forex, investments leasing, microfinance, investments

Bajaj Finance, Muthoot Finance, LIC

Examples SBI, ICICI Bank, HDFC Bank, PNB
Housing Finance, HDB Finance

FUNCTIONS OF COMMERCIAL BANKS

Banks satisfy the financial needs of the sectors such as agriculture, industry, trade,
communication, so they play very significant role in process of economic social needs. The
functions performed by banks, since recently, are becoming customer-centred and are
widening their functions. Generally, the functions of commercial banks are divided into two
categories; primary functions and the secondary functions.

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Primary Functions of Banks

1. Receiving deposits
Most important function of a commercial bank is to accept deposit from those who can save
but cannot profitably utilise this savings themselves. By making deposits in bank, savers can
earn something in the form of interest and avoid the danger of theft. To attract savings from
all sorts of customers, banks maintain different types of accounts such as current account,
Savings bank account, Fixed Deposit account, Recurring deposit account and Derivative
Deposit account.
2. Lending of funds
The second important function of commercial banks is to advance loans to its customers.
Banks charge interest from the borrowers and this is the main source of their income. Modern
banks give mostly secured loans for productive purposes. In other words, at the time of
advancing loans, they demand proper security or collateral. Generally, the value of security or
collateral is equal to the amount of loan. This is done mainly with a view to recover the loan
money by selling the security in the event of non-refund of the loan. Commercial banks lend
money to the needy people in the form of Cash credits, Term loans, Overdrafts (OD),
Discounting of bills, Money at call or short notice etc.
(i) Cash Credit: A short-term credit facility given to businesses against security (like
stock, receivables, or other assets) to meet the working capital needs of current account
customers. Under this scheme, banks enter into an agreement with its customers to which
money can be withdrawn many times during a year.
(ii) Term loans: A term loan is a monetary loan that is repaid in regular payments
over a set period of time. In other words, a loan from a bank for a specific amount that has a
specified repayment schedule and a fixed/floating interest rate is called Term loan. Term
loans usually last between one and ten years, but may last as long as 30 years in some cases.
It may be classified as short term, medium term and long-term loans.
(iii) Over-Drafts: A facility that allows you to withdraw more money than your
account balance, usually against fixed deposits, salary accounts, or other securities to meet
temporary liquidity requirements. It is the extension of credit from a bank when the account
balance reaches zero level. Banks advance loans to its customer’s up to a certain amount
through overdrafts. For this, banks demand a security from the customers and charge very
high rate of interest. Overdraft facility will be allowed for savings and current account
holders.
(iv) Discounting of Bills of Exchange: This is the most prevalent and important
method of advancing loans to the traders for short-term purposes. Under this system, banks
advance loans to the traders and business firms by discounting their bills. While discounting a
bill, the Bank buys the bill (i.e. Bill of Exchange or Promissory Note) before it is due and
credits the value of the bill after a discount charge to the customer's account.
3. Credit Creation
When a bank advances a loan, it does not lend cash but opens an account in the borrower’s
name and credits the amount of loan to this account. Thus, a loan creates an equal amount of

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deposit. Creation of such deposit is called credit creation. Banks have the ability to create
credit many times more than their actual deposit.
4. Promoting cheque system and plastic card
Banks also render a very useful medium of exchange in the form of cheques. Through a
cheque, the depositor directs the banker to make payment to the payee. In the modern
business, transactions by cheques have become much more convenient method of settling
debts than the use of cash, and for businesses to get credit with post-dated cheques. Plastic
cards like debit and credit cards are also promoted by banks, having VISA and MASTER and
RuPay cards.
5. Transfer of Funds
Banks provides facilities to transfer funds to anywhere across the globe almost instantly
through RTGS, NEFT, SWIFT, bank drafts, telegraphic transfers, etc.
Secondary or Subsidiary Functions of Banks
I. Agency Services
A banker performs a number of functions on behalf of the customer. It acts as an agent of its
customers. This type of services is called agency services.
Usually, the bank performs the following agency services.
1. Collection of credit instruments: They collect cheques, bill of exchange and promissory
notes on behalf of the customer and credit the amount in their accounts.
2. Collection of dividends: The bank collects dividend and interest warrants on behalf of the
customer and credit the amount in their accounts.
3. Acts as a trustee or executer: They act as executors; trustee and attorney for the
customers will and execute them after death.
4. Execution of standing orders: The banks execute the standing orders of their customers.
A customer can instruct the banker to pay insurance premium, rent, and subscription to
certain persons or institutions on certain dates, against a small commission.
5. Purchase and sale of securities: Banks purchase and sell shares, debentures and
government securities on behalf of their customers.
6. Acting as a representative or correspondent: They also act as representatives of tickets,
book vehicles, plots for customers, and receives letters on behalf of their correspondents of
their customers and other banks. They get passports for traveller customers.
7. Remittance of funds: They help the customers to transfer money from one place to
another.
8. Deals foreign exchange: They buy and sell foreign exchange on behalf of the customer
9. They act as agents for any Government, local authority, etc.
10. Acts as an administrator: They undertake the administration of estates as executor,
trustee or otherwise.

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11. Banks will make applications on behalf of their customers for allotments arising from
new capital issues.
II. General Utility Services
Modern banks perform many general utility services for the community. Following are the
important general utility services offered by Commercial Banks
1. Locker facility: Bank provide locker facility to their customers. The customers can keep
their valuables such as gold, silver, important documents, securities etc. in these lockers for
safe custody.
2. Issue travelers' cheques: Banks issue traveler’s cheques to help their customers to travel
without the fear of theft or loss of money. It enables tourists to get fund in all places they visit
without carrying actual cash with them.
3. Issue Letter of Credits: Banks issue LOC for importers certifying their credit worthiness.
It is a letter issued by importer’s banker in favour of exporter informing him that issuing
banker undertakes to accept the bills drawn in respect of exports made to the importer
specified therein.
4. Act as Referee: Banks act as referees and supply information about the financial standing,
business reputation and respectability of their customers on enquiries made by other
businessmen.
5. Collect information: Banks collect and supply information about other businessmen
through the fellow bankers and supply information to their customers.
6. Underwrites shares
7. Issue of gift cheques and gift cards of various denominations to their customers.
8. Collection and publication of various industry related statistics in relation to trade and
commerce, money and banking etc. Also publish journals and bulletins.
III. Innovative Functions
The adoption of Information and Communication technology enable banks to provide many
innovative services to the customers such as;
1. ATM and CDM facilities: ATM services (Automated Teller Machine) is an electronic
telecommunications device that enables the clients of banks to perform financial transactions
by using a plastic card. Automated Teller Machines are established by banks to enable its
customers to have anytime money. It is used to withdraw money, check balance, transfer
funds, get mini statement, make payments etc. It is available at 24 hours a day and 7 days a
week. Cash Deposit Machines help to deposit money to the accounts by themselves.
2. Internet Banking: Online banking (or Internet banking or E-banking) is a facility that
allows customers of a financial institution to conduct financial transactions on a secured
website operated by the institution. To access a financial institution's online banking facility, a
customer must register with the institution for the service, and set up some password for
customer verification. Online banking can be used to check balances, transfer money, shop
online, pay bills etc.

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3. Bancassurance: It means the delivery of insurance products through banking channels. It

can be done by making 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.

DEVELOPMENT FINANCIAL INSTITUTIONS (DFI)

With the objective of giving term loans, Govt. has set up some specialized financial
institutions. These specialized financial institutions are called development banks. The
development banks have to sacrifice business principles of conventional financial institutions
and pay due regard to public interest so as to act as an instrument of economic development
in conformity with national objectives, plans and priorities. Development banks are viewed as
financial intermediary supplying medium- and long-term funds.
These institutions help economic development in the following ways.
1. Providing funds: These institutions help large number of persons for taking up some
industrial activity. The addition of new industrial units and increasing the activities of
existing units will certainly help in accelerating the pace of economic development. Financial
institutions have large investible funds which are used for productive purposes.
2. Infrastructural facilities: Financial institutions prepare their investment policies by
keeping national priorities in mind. The institutions invest in those areas which can help in
increasing the development of the country.
3. Promotional activities: Financial institutions have the expertise and manpower resources
for undertaking the exercise of starting a new unit. So, these institutions take up this work on
behalf of entrepreneurs. The promotional role of financial institutions is helpful in increasing
the development of a country.
4. Development of backward areas: In order to help the development of backward areas
financial institutions provide special assistance to entrepreneurs for setting up new units in
these areas. IDBI, IFCI, ICICI give priority in giving assistance to units set up in backward
areas and even charge lower interest rates on lending. Such efforts certainly encourage
entrepreneurs to set up new units in backward areas.
5. Planned development: Different institutions earmark their spheres of activities so that
every business activity is helped. Some institutions like SIDBI, SFCIs especially help small
scale sector while IFCI and SIDC’s finance large scale sector or extend loans above a certain
limit. Some institutions help different segments like foreign trade, tourism etc.
6. Accelerating industrialization: The setting up of more industrial units will generate direct
and indirect employment make available goods and services in the country and help in
increasing the standard of living. Financial institutions provide requisite financial, managerial
and technical help for setting up new units.

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The following are the major Developmental Financial Institutions:

 The Industrial Finance Corporation of India Ltd (IFCI)
 ICICI (Industrial Credit and Investment Corporation of India)
 Industrial Development Bank of India (IDBI)
 Small Industries Development Bank of India (SIDBI)
 State Financial Corporations (SFCs)
 State Industrial Development Corporations (SIDCS)

Specialized Financial Institutions:

1. Export Import Bank of India (EXIM Bank)
2. Industrial Investment Bank of India Ltd (IIBI Ltd)
[Link] and Finance House of India (DFHI)
4. National Bank for Agriculture and Rural Development (NABARD)
5. National Housing Bank (NHB)

THE INDUSTRIAL FINANCE CORPORATION OF INDIA LTD (IFCI)

IFCI was set up in the year 1948. It is the first development finance institution set up in the
country. In 1993, IFCI became a company. The registered office of IFCI is in Delhi.
The services provided by IFCI are as follows:
(a) Project finance
(b) Financial services
(c) Promotional services
(a) Project Finance:
 Assistance is available for units in corporate a well as co-operative sectors for new
units, expansion/diversification OR modernization programmes.
 IFCI will extend rupee and foreign currency loans, underwrite the issues, directly
subscribe to the issues, give guarantee for the payments of industrial units, etc.
 Granting loans or advances to or subscribing to debentures of industrial concerns
repayable within 25 years.
 Underwriting the issue of industrial securities to be disposed off within 7 years.
 Subscribing directly to the shares and debentures of public limited companies.

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 Guaranteeing of loans raised by industrial concerns from scheduled banks or state co-
operative banks.
 Guaranteeing of deferred payments for the purchase of capital goods from abroad or
within India etc.
(b) Financial services: IFCI will extend merchant banking services, leasing of equipment,
instalment credit, finance the leasing/ hire purchase companies, etc.
(c) Promotional services:
IFCI will provide technical consultancy, risk capital, venture capital, seed capital,
management development, support research & development activities, etc. It will provide
subsidy support to village and small industries. IFCI has promoted institutional infrastructure
through specialized institutions like Technical Consultancy Organisations (TCOs) in various
states, Management Development Institute (MDI), Tourism Finance Corporation of India
(TFCI), Investment Information and Credit Rating Agency (ICRA), etc.

INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA (ICICI)

ICICI was established in 1955 to finance industrial development. It is a leading financial
institution and was behind the setting up of Housing Development Finance Company
(HDFC), Credit Rating Information Services of India Ltd (CRISIL), Mutual Fund and ICICI
Banking Corporation Ltd (ICICI Bank). ICICI was as a private sector development bank at
the initiative of the World Bank. Capital of ICICI is contributed by Banks, Insurance
Companies, Foreign promoted share Institutions and the World Bank. It is located in
Mumbai.
Functions of ICICI
 The core activity of ICICI is to provide project finance to industrial houses in the
form of rupee and foreign currency loans.
 It will also underwrite the issues, subscribe the issues and will give guarantee to the
suppliers of the equipments and foreign lenders.
 The modernisation/ diversification/ expansion programmes of business houses are
financed by ICICI.
 Other services offered by ICICI include equipment leasing, deferred credit, hire
purchase, venture capital financing.
Other functions
1. It sanctions rupee loans for capital assets such as land, building, machinery etc. for long
term, and foreign exchange loans for import of machinery and equipment.
2. It guarantees loans from other private investment sources.
3. It subscribes to ordinary or preference capital and underwrites new issues of securities.

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4. It renders consultancy services to Indian industry in the form of managerial and technical
advice.
5. It also undertakes financial services such as deferred credit, equipment leasing, instalment
sale etc.

INDUSTRIAL DEVELOPMENT BANK OF INDIA (IDBI)

IDBI was formed as a wholly owned subsidiary of Reserve Bank of India in the year 1964.
The functions and working of IDBI are governed by the Industrial Development of India Act,
1964.
In 1976, when IDBI was delinked from RBI and the ownership was transferred to
Government of India, it was entrusted with the additional responsibility to act as principal
financial institution for co-ordinating the activities of institutions engaged in the financing,
promotion and development of industry. IDBI provides finance for the establishment of new
industrial projects/expansion/ diversification/modernisation of projects. It is located in
Mumbai. In 2004, it transitioned from a Development Finance Institution (DFI) to a full-
service bank.
IDBI's services can be explained under different heads.

In 1982, IDBI transferred its international financial division which was providing export
finance to industries to Export Import Bank of India (EXIM Bank), which was established as
a wholly owned corporation of the Government of India. In 1990, IDBI's portfolio relating to
small scale industrial sector was transferred to the Small Industries Development Bank of
India (SIDBI). SIDBI is a wholly owned subsidiary of IDBI.
Functions of IDBI
1. It co-ordinates the operation of other institutions providing term finance to industries.
2. It provides assistance to medium and large industries by way of direct finance and
refinance of industrial loans.
3. It extends resource support to all India and state level financial institutions and other
financial intermediaries.
4. It renders services like asset credit equipment finance, equipment leasing and bridge loans.

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5. It also undertakes merchant banking.

6. It provides technical and administrative assistance to industrial concerns.
7. It guarantees deferred payments due from any industrial concern. It guarantees loans
raised by industrial concerns from any financial institution

SMALL INDUSTRIES DEVELOPMENT BANK OF INDIA (SIDBI)

SIDBI is a wholly owned subsidiary of IDBI. It was formed in 1990 by the act of Parliament.
The main objective of SIDBI has been to work as a principle financial institution for the
promotion, financing and development of industries in the small-scale sector.
Functions of SIDBI
1. Supplement efforts of existing institutions to help financing small scale sector.
2. Direct lending to SSI units.
3. Refinance primary lending organisations to help them to finance SSI units.
4. Bills rediscounting and refinance of bills
Presently SIDBI is performing following functions also:
 It renders equity type of assistance to new promoters, women and ex- servicemen
under National Equity Fund.
 It provides assistance to the voluntary organizations working for development/
upliftment of under privileged women.
 It also provides technical support to small scale sector for promotion, development
and growth.
 It also extends financial support to NSIC (National Small Industries Corporation) and
SIDCs for purchase of material and marketing of SSI products and for financing hire-
purchase and leasing activities.

STATE FINANCIAL CORPORATIONS (SFCS)

Under the State Financial Corporations Act, 1951, various State Governments established
SFCS for meeting the term credit needs of small and medium industries. In Kerala, Kerala
Financial Corporation (KFC) was set up. Assistance given by SFCs to industrial units is
mainly through loans, underwriting of shares, bonds and debentures, and guaranteeing of
deferred payments for capital goods purchases.
Functions of State Finance Corporations
The main function of the SFCs is to provide loans to small and medium scale industries
engaged in the manufacture, preservation or processing of goods, mining, hotel industry,

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generation or distribution of power, transportation, fishing, assembling, repairing or

packaging articles with the aid of power etc.

Other functions are as follows:

1. Granting loans or advances or subscribing to shares and debentures of the industrial
undertaking repayable within twenty years.
2. Guaranteeing loans raised by the industrial concerns repayable within twenty years.
3. Underwriting of the shares, bonds and debentures subject to their disposal in the market
within seven years.
4. Guaranteeing deferred payments for the purchase of capital goods by industrial concerns
within India.
5. Providing loans for setting up new industrial units as well as for expansion and
modernisation of the existing units.

STATE INDUSTRIAL DEVELOPMENT CORPORATIONS (SIDCs)

State Industrial Development Corporations (SIDCs) were established under the Companies
Act 1956, in the sixties and early seventies as wholly owned State Government undertakings
for promotion and development and provide impetus to investment in their respective states.
The SIDCS provide financial assistance in the form of term loans, underwriting/direct
subscription to shares and debentures.
SIDCs undertake a lot of promotional activities such as of feasibility reports, conducting
industrial potential surveys and development programmes and developing industrial areas.

SPECIALIZED FINANCIAL INSTITUTIONS

1. EXPORT IMPORT BANK OF INDIA (EXIM BANK)
EXIM Bank was established in 1982, as per the Export Import Bank of India Act, 1981. The
major goal of EXIM bank is the promotion of India's international trade. EXIM bank is
wholly owned by the Government of India. The headquarters of EXIM bank is at Mumbai.
EXIM Bank is the principal financial institution in India for coordinating the working of
institutions engaged in financing export and import trade. It is a statutory corporation wholly

owned by the Government of India. The main functions of the EXIM Bank are as follows:

(i) Financing of exports and imports of goods and services, not only of India but also of
the third world countries;
(ii) Financing of exports and imports of machinery and equipment on lease basis;

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(iii) Financing of joint ventures in foreign countries;

(iv) Providing loans to Indian parties to enable them to contribute to the share capital of
joint ventures in countries;
(v) To undertake limited merchant banking functions such as underwriting of stocks,
shares, bonds or debentures of Indian companies engaged in export or import; and
(vi) To provide technical, administrative and financial assistance to parties in connection
with export and import.

EXIM Bank has a variety of programmes to meet the needs of Indian exporters, Commercial
banks and Overseas entities.
The schemes for exporters include:
(a) Pre shipment credit
(b) Suppliers' credit
(c) Overseas investment finance
(d) Export product development loans
(e) Loans for export marketing
(f) Finance for consultancy and technology services
(g) Finance for deemed exports

2. INDUSTRIAL INVESTMENT BANK OF INDIA LIMITED

(FORMERLY INDUSTRIAL RECONSTRUCTION BANK OF INDIA)
Industrial Reconstruction Bank of India was set up in 1985 as a Statutory Corporation under
IRBI Act in Calcutta. In 1997, the bank has been renamed as Industrial Investment Bank of
India. The main aim was revival of sick industrial units. Long-term and medium-term
assistance is provided for this purpose.
Functions
1. Provide term loan assistance to sick units
2. Financing of green field projects
3. Provide equipment finance and hire purchase for acquiring equipments
4. Give short term loans for working capital

3. DISCOUNT AND FINANCE HOUSE OF INDIA (DFHI)

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DFHI was set up in 1988 by the RBI jointly with sector banks and all India financial
institutions. The purpose of DFHI is to deal in and develop an active secondary market for
the money market instruments, just like stock exchanges for capital market operations. DFHI
deals in Treasury Bills, Commercial Bills, CDs and CPs. It also participates in the call and
short notice markets and the inter-bank term deposit market both as a borrower and lender.
The headquarters of DFHI is at Mumbai.
Functions
1. Develop an active secondary market for money market instruments.
2. Integrate the various segments of the money market.
3. Smoothen the imbalances in the short-term money market liquidity.
4. Act as market maker for treasury bills (to buy and sell treasury bills)
5. Provide REPO facility in treasury bills and Government dated securities to

4. NATIONAL BANK FOR AGRICULTURE AND RURAL

DEVELOPMENT (NABARD)
NABARD was established in 1982 by an Act of Parliament. It is the apex institution for the
policy, planning and operations in the field of agriculture and other rural economic activities.
NABARD is set up for strengthening the institutions providing rural credit. NABARD is to
overcome the weaknesses of the institutions like cooperative banks and regional rural banks.
This specialized bank is a central or apex institution for financing agricultural and rural
sectors. It can provide credit, both short- term and long-term, through regional rural banks. It
provides financial assistance, especially, to co- operative credit, in the field of agriculture,
small-scale industries, cottage and village industries handicrafts and allied economic
activities in rural areas.
Objectives of NABARD
1. Refinance the rural credit of scheduled commercial banks, state co- operative banks,
regional rural banks and state land development banks.
2. Coordination of the activities of different agencies in the field of agriculture and rural
credit.
3. Monitoring and evaluation of projects refinanced by it.
Functions of NABARD
i. To refinance the loans granted by the State Government, State Co- operative Bank, Land
Development Bank and other financial institutions for purposes of rural development.
ii. To perform all the functions relating to agricultural credit.
iii. To execute/ implement rural development programmes funded by the World Bank and
other International Development Agencies.

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iv. To co-ordinate the activities of Central and State Governments, the planning commission
and other institutions involved with the development of SSIs, village and cottage industries
etc.
v. To extend long term loans to state Government to enable them to subscribe to the share
capital of co-operative credit societies.
vi. To promote research in agriculture and rural development, to formulate and design
projects and programmes to suit the requirements of different areas.

Credit facilities available from NABARD

(a) Short term credit facilities
(b) Medium term credit facilities
(c) Facilities for conversion/rescheduling of loans under conditions of natural calamities
(d) Long term loans to State Governments for contribution to share capital of co-operative
credit institutions.

5. NATIONAL HOUSING BANK (NHB)

National Housing Bank (NHB) was established in July 1988 as a subsidiary of the Reserve
Bank of India. It is the apex financing institution for the housing sector with the mandate to
promote efficient, viable and sound housing finance companies (HFCs). By the financial
sector reforms and deregulations, India witnessed a mushroom growth of housing finance
companies. The very purpose of NHB, is to augment the flow of institutional credit for the
housing sector and to promote and regulate the housing finance institutions.

NON-BANKING FINANCIAL COMPANIES (NBFCS)

NBFCs in India are financial institutions that provide a wide range of financial products and
services, but do not hold a full banking license and not recognised as a bank. NBFCs play a
crucial role in the Indian financial system by catering to the diverse financial needs of various
segments of the population. NBFCs are not banks, but their activities include lending and
other activities such as providing loans and advances, credit facilities, savings and investment
products, trading in the money market, managing stock portfolios, money transfers, hiring,
leasing, infrastructure finance, venture capital finance, housing finance and so on. Deposits
can be accepted by NBFC, but only term deposits. Deposits repayable on demand is not
accepted.
According to RBI, an NBFC is a company registered under the Companies Act,
engaged in the business of loans and advances, acquisition of
shares/stocks/bonds/debentures/securities, leasing, hire-purchase, insurance business, or
the chit fund business. Unlike banks, NBFCs cannot accept demand deposits and do not

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form part of the payment and settlement system. They are prohibited from issuing
cheques drawn on itself.
Some examples of well-known NBFCs are:
 Bajaj Finance Limited
 HDB Financial Services Ltd
 Muthoot Finance
 Kotak Mahindra Finance, etc

TYPES OF NBFCs
The NBFCs can be categorised under three broad heads:

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Regulation of NBFCs
The RBI's Department of Non-Banking Supervision (DNBS) is tasked with
regulating and supervising NBFCs in accordance with the regulatory provisions contained in
Chapters III B and C and Chapter V of the Reserve Bank of India Act, 1934. The
Reserve Bank's Regulatory and Supervisory Framework provides for, among other things,
registration of NBFCs, prudential regulation of various categories of NBFCs, the issuance of
directions on the acceptance of deposits by NBFCs, and sector surveillance through off-site
and on-site supervision.

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FUNCTIONS OF NBFCS IN INDIA

[Link] Facilities: Different loans and advances in specific sectors such as consumer
finance, vehicle loans, and microfinance.
2. Investment Activities: including the acquisition of shares, stocks, bonds, and debentures.
They may act as intermediaries in the capital market.
3. Leasing and Hire Purchase: Many NBFCs are involved in leasing and hire-purchase
activities, providing individuals and businesses with the option to use assets without outright
ownership.
4. Insurance Business: Some NBFCs operate in the insurance sector, offering a range of
insurance products like life insurance, general insurance, and other related services.
5. Chit Fund Business
6. Foreign Exchange Services: facilitating currency exchange, international remittances, and
related financial transactions.
7. Microfinance: NBFCs may focus on microfinance, providing small loans and financial
services to low-income individuals and businesses, promoting financial inclusion.
8. Advisory Services: Some NBFCs offer financial advisory services, including wealth
management, investment advice, and financial planning.

ROLES OF NBFCS IN INDIA

1. Financial Inclusion: extending financial services to underserved and unbanked areas,
contributing to the government's efforts towards financial inclusion.
2. Diversification of Financial Products: introduce innovative financial products and
services
3. Flexibility and Agility: more flexible and agile compared to banks, and adapt quickly to
changing market conditions and customer needs.
4. Complementary to Banks: While not competing directly with banks, NBFCs complement
the banking sector by addressing specific market segments, often with a focus on niche areas.
5. Credit Delivery: by providing loans and financial services to segments that may face
challenges in accessing credit from traditional banking channels.

Supervision of NBFCs
In order to ensure that NBFCs function on sound lines and avoid excessive risk
taking, the RBI has developed a four-pronged supervisory framework based on the following.
• On-site inspection structured on the basis of assessment and evaluation of CAMELS
(Capital, Assets, Management, Earnings, Liquidity, and Systems) approach.

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• Off-site monitoring supported by state-of-the-art technology. It is through periodic control

reports from NBFCs.
• Use of market intelligence system.
• Reports of statutory auditors of NBFCs.
The RBI supervises companies not holding public deposits in a limited manner. Companies
with asset size of Rs. 100 crore and above are subject to annual inspection while other non-
public deposit companies are supervised by rotation once in every five years.

INSURANCE COMPANIES
According to Mc Gill, “Insurance is a process in which uncertainties are made certain”. In
the words of Jon Megi, “Insurance is a plan wherein persons collectively share the losses of
risks”. Insurance is a contract between two parties. One party is the insured and the other
party is the insurer.
Insured is the person whose life or property is insured with the insurer. That is, the person
whose risk is insured is called insured. Insurer is the insurance company to whom risk is
transferred by the insured. That is, the person who insures the risk of insured is called insurer.
Thus, insurance is a contract between insurer and insured. It is a contract in which the
insurance company undertakes to indemnify the insured on the happening of certain event for
a payment of consideration. It is a contract between the insurer and insured under which the
insurer undertakes to compensate the insured for the loss arising from the risk insured
against.
Insurance is a device by which a loss likely to be caused by uncertain event is spread
over a large number of persons who are exposed to it and who voluntarily join themselves
against such an event. The document which contains all the terms and conditions of insurance
(i.e. the written contract) is called the ‘insurance policy’. The amount for which the
insurance policy is taken is called ‘sum assured’. The consideration in return for which the
insurer agrees to make good the loss is known as ‘insurance premium’. This premium is to
be paid regularly by the insured. It may be paid monthly, quarterly, half yearly or yearly.
Major insurance companies in India includes Life Insurance Corporation of India (LIC),
General Insurance Corporation of India (GIC) and Unit Trust of India (UTI).
Insurance Companies accept or underwrite the risk in return for an insurance premium.
Insurance underwriters evaluate the risk and exposures of potential clients. They decide how
much coverage the client should receive, how much they should pay for it, or whether even to
accept the risk and insure them. Underwriting involves measuring risk exposure and
determining the premium that needs to be charged to insure that risk. The function of the
underwriter is to acquire-or to "write"-business that will make the insurance company money,
and to protect the company's book of business from risks that they feel will make a loss. Each
insurance company has its own set of underwriting guidelines to help the underwriter
determine whether or not the company should accept the risk.

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Insurance companies have two sources of income namely the initial underwriting
income (insurance premium) and investment income. Investment income may vary according
to the performance of the financial markets. The major expense of an insurance company is
the payment on the insurance policies. These payments vary among the different type of
insurance policies. The other important expense of an insurance company is the operating
expenses. The insurance companies profits mainly depend upon insurance premium and
returns on the one hand and the operating expenses and payment to insured on the other hand.
The insurance companies are financial intermediaries as they collect and invest large amount
of premiums. They offer protection to the investors, provide means for accumulating savings,
and channelize funds to the government and other sectors.
Insurance companies may be classified into two groups:
1. Life insurance companies, which sell life insurance, annuities and pensions products.
2. Non-life, general, or property/casualty insurance companies, which sell other types
of insurance.
Insurance other than Life Insurance falls under the category of General Insurance.
General Insurance comprises of insurance of property against fire, burglary, theft etc,
personal insurance such as Accident and Health Insurance, and liability insurance which
covers legal liabilities. There are also other covers such as Errors and Omissions insurance
for professionals, credit insurance etc. Non-life insurance companies have products that cover
property against Fire and allied perils, flood storm and inundation, earthquake and so on. The
non-life companies also offer policies covering machinery against breakdown, there are
policies that cover the hull of ships and so on. A Marine Cargo policy covers goods in transit
including by sea, air and road. Insurance of motor vehicles against damages and theft forms a
major chunk of non-life insurance business.
Accident and health insurance policies are available for individuals as well as groups.
A group could be a group of employees of an organization or holders of credit cards or
deposit holders in a bank etc. Normally when a group is covered, insurers offer group
discounts.
Most general insurance covers are annual contracts. However, there are few products that
are long-term. Today we have a wide assortment of risk coverage commencing from health
insurance to travel insurance to theft insurance to even a wedding insurance.
Main insurance companies in India
Before liberalisation and enactment of Insurance Development and Regulatory Act the
number of insurance companies is limited in India and majority of them are public sector
companies. The LIC had monopoly till the late 90s when the insurance sector was reopened
to the private sector. Before that, the industry consisted of only two state insurers: Life
Insurers (Life Insurance Corporation of India- LIC) and General Insurers (General Insurance
Corporation of India, GIC). GIC had four subsidiary companies. With effect from December
2000, these subsidiaries have been de-linked from the parent company and were set up as
independent insurance companies: Oriental Insurance Company Limited, New India
Assurance Company Limited, National Insurance Company Limited and United India
Insurance Company Limited.

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LIFE INSURANCE CORPORATION OF INDIA

The life insurance company of India (LIC) is owned by the state and has been termed as the
biggest life insurance corporation in India now. It is fully owned by the Government of India.
It was founded in 1956 with the merger of 243 insurance companies and provident societies.
It's Headquarters is in Mumbai which is the financial and commercial capital of India. The
Life Insurance Corporation of India was set up with the objective of spreading life insurance
especially in rural areas and to socially and economically backward session of the society.
Objectives of LIC
1. Spread Life Insurance widely and in particular to the rural areas and to the socially and
economically backward classes with a view to reaching all insurable persons in the country
and providing them adequate financial cover against death at a reasonable cost.
2. Maximize mobilization of people's savings by making insurance-linked savings adequately
attractive.
3. Bear in mind, in the investment of funds, the primary obligation to its policyholders, whose
money it holds in trust, without losing sight of the interest of the community as a whole; the
funds to be deployed to the best advantage of the investors as well as the community as a
whole, keeping in view national priorities and obligations of attractive return.
4. Conduct business with utmost economy and with the full realization that the moneys
belong to the policyholders.
5. Act as trustees of the insured public in their individual and collective capacities.
6. Meet the various life insurance needs of the community that would arise in the changing
social and economic environment
7. Involve all people working in the Corporation to the best of their capability in furthering
the interests of the insured public by providing efficient service with courtesy.
8. Promote amongst all agents and employees of the Corporation a sense of participation,
pride and job satisfaction through discharge of their duties with dedication towards
achievement of Corporate Objective.

GENERAL INSURANCE CORPORATION OF INDIA

General Insurance Corporation of India (GIC Re) is the sole reinsurance company in the
Indian insurance market with over three decades of experience. GIC has its registered office
and headquarters in Mumbai. The entire general insurance business in India was nationalized
by the Government of India (GOI) through the General Insurance Business (Nationalization)
Act (GIBNA) of 1972. 55 Indian insurance companies and 52 other general insurance
operations of other companies were nationalized through the act. GIC was formed to control
and operate the business of general insurance in India. Insurance companies spread their risk
by an arrangement with other underwriters or reinsurance companies known as reinsurers. As

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an Indian reinsurer, GIC has been giving reinsurance support to four public sector and other
private general insurance companies.
Functions of GIC:-
The following are the main functions of GIC
1. Carrying on of any part of general insurance business as deemed desirable.
2. Aiding, assisting, and advising the companies in the matter of setting up of standard of
conduct and sound practice in general insurance business and in rendering efficient customer
service.
3. Advising the acquiring companies in the matter of controlling the expenses including the
payment of commission and other expenses.
4. Advising the acquiring companies in the matter of investment of funds.
5. Issuing directions to acquiring companies in relation to the conduct of general insurance
business.

MUTUAL FUNDS
Mutual funds are financial intermediaries which mobilise savings from the people and
invest them in a mix of corporate and government securities. Mutual funds are investment
vehicles that pool money from multiple investors to invest in a diversified portfolio of stocks,
bonds, or other securities. The mutual fund operators actively manage this portfolio of
securities and earn income through dividend, interest and capital gains. The incomes are
eventually passed on to mutual fund shareholders.
Mutual funds corporations are financial intermediaries that collect the savings of
investors and invest them in a large and well diversified portfolio of securities such as money
market instruments, corporate and government bonds and equity shares of joint stock
companies. They invest the funds collected from investors in a wide variety of securities i.e.
through diversification and reduces risk.
Mutual fund works on the principle of “small drops of water make a big ocean”. It is a
form of collective investment. To get the surplus funds from investors, it adopts a simple
technique. Each fund is divided into a small share called ‘units’ of equal value. Each investor
is allocated units in promotion to the size of his investment.
SEBI (mutual funds) Regulations, 1993 defines a mutual fund as ‘a fund established
in the form of a trust by a sponsor, to raise monies by the trustees through the sale of units to
the public, under one or more schemes, for investing in securities in accordance with these
regulations.

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According to the Mutual Fund Fact Book (published by the Investment Company
Institute of USA), “a mutual fund is a financial service organization that receives money from
shareholders, invests it, earns return on it, attempts to make it grow and agrees to pay the
shareholder cash demand for the current value of his investment”.
In India first mutual fund started in 1964 when United Trust of India (UTI) was
established in the similar line of operation of the UK based Investment Trust Companies.

Features of Mutual Funds

1. Mutual fund mobilizes funds from small as well as large investors by selling units.
2. Mutual fund provides an ideal opportunity to small investors an ideal avenue for
investment.
3. Mutual fund enables the investors to enjoy the benefit of professional and expert
management of their funds.
4. Mutual fund invests the savings collected in a wide portfolio of securities in order to
maximize return and minimize risk for the benefit of investors.
5. Mutual fund provides switching facilities to investors who can switch from one scheme to
another.
6. Various schemes offered by mutual funds provide tax benefits to the investors.
7. In India mutual funds are regulated by agencies like SEBI.
8. The cost of purchase and sale of mutual fund units is low.
9. Mutual funds contribute to the economic development of a country.

Types of Mutual Funds (Classification of Mutual Funds)

A. On the basis of Operation

1. Close ended funds 2. Open-ended funds 3. Interval schemes/ funds
B. On the basis of return/ income
1. Income fund 2. Growth fund 3. Conservative fund
C. On the basis of Investment
1. Equity fund
2. Bond fund
3. Balanced fund
4. Fund of fund scheme

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5. Taxation fund
6. Leverage fund
7. Index bonds
8. Money market mutual funds
9. Off shore mutual funds
10. Guilt funds

Closed-ended schemes /funds:

 A closed ended scheme means any scheme of mutual fund in which the period of
maturity of the scheme is specified.
 Under this type of fund, the size of the fund and its duration are fixed in advance.
 The corpus of close-ended scheme is fixed and an investor can subscribe directly to
the scheme only at the time of initial issue.
 Once the subscription reaches the predetermined level, the entry of investors will be
closed.
 After the initial issue is closed a person can buy or sell the units of the scheme in the
secondary market.
 After the expiry of the fixed period, the entire corpus is disinvested and the proceeds
are distributed to the unit holders in proportion to their holding.
 It is always easier to manage a close-ended scheme as the fund managers can evolve
long term investment strategies depending upon the life of the scheme.

Features of Close ended Funds

(a) The period and the target amount of the fund is fixed beforehand.
(b) Once the period is over and/ or the target is reached, the subscription will be closed (i.e.
investors cannot purchase any more units).
(c) The main objective is capital appreciation.
(d) At the time of redemption, the entire investment is liquidated and the proceeds are
liquidated and the proceeds are distributed among the unit holders.
(e) Units are listed and traded in stock exchanges.
(f) Generally the prices of units are quoted at a discount of upto 40% below their net asset
value.

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Open- ended schemes/funds:

 This is the just reverse of close-ended funds.
 Open ended scheme means a scheme of Mutual funds which offers units for sale
without specifying any duration for redemption.
 These schemes do not have a fixed maturity and entry to the fund is always open to
investors who can subscribe it at any time.
 The investor have a option to get their holdings redeemed at any time.
 The fund redeems or repurchases the units/ shares at periodically announced rates.
 These repurchase rates are based upon the net current assest value of the fund.

Features of Open-ended Funds

(a) The investors are free to buy and sell units. There is no time limit.
(b) These are not trade in stock exchanges.
(c) Units can be sold at any time.
(d) The main motive income generation (dividend etc.)
(e) The prices are linked to the net asset value because units are not listed on the stock
exchange.

Difference between Open-ended and Close-ended Schemes

1. The close-ended schemes are open to the public for a limited period, but the open-ended
schemes are always open to be subscribed all the time.
2. Close-ended schemes will have a definite period of life. But the open-ended schemes are
transacted in the company
3. Close-ended schemes are transacted at stock exchanges, where as open-ended schemes are
transacted (bought and sold) in the company.
4. Close-ended schemes are terminated at the end of the specified period. Open-ended
schemes can be terminated only if the total number of units outstanding after repurchase fall
below 50% of the original number of units.

Interval schemes/ funds:

 An interval scheme is a scheme of Mutual fund which is kept open for a specific
interval and after that it operates as a closed scheme.
 Interval schemes have been permitted by the SEBI in recent years only.

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 The scheme is open for scale or repurchase at fixed predetermined intervals which are
disclosed in the offer document.
Income funds:
 These funds aim at providing maximum current return to the investor.
 There may be income funds of two types.
 Some funds may concentrate on low risk, constant returns while others, may aim at
maximum return even at the cost of some risk.
Features of Income Funds
(a) The investors get a regular income at periodic intervals.
(b) The main objective is to declare dividend and not capital appreciation.
(c) The pattern of investment is oriented towards high and fixed income yielding
securities like bonds, debentures etc.
(d) It is best suited to the old and retired people.
(e) It focuses on short run gains only.
Growth fund:
Growth fund offers the advantage of capital appreciation. It means growth fund
concentrates mainly on long run gains. It does not offers regular income. In short, growth
funds aim at capital appreciation in the long run. Hence they have been described as “Nest
Eggs” investments or long haul investments.

Features of Growth Funds

(a) It meets the investors’ need for capital appreciation.
(b) Funds are invested in equities with high growth potentials in order to get capital
appreciation.
(c) It tries to get capital appreciation by taking much risk.
(d) It may declare dividend. But the main objective is capital appreciation.
(e) This is best suited to salaried and business people.
Balanced or Conservative funds:
 Balanced funds spend both on common stock and preferred stock.
 Some part of funds is spent on buying equity while other part is used in acquiring
interest bearing debentures and preference shares ensuring certain amount of
dividend.

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 This aims at providing a reasonable rate of return, protecting the value of the
investment and getting capital appreciation. Hence the investment is made in growth
oriented securities that are capable of appreciating in the long run.
Stock/ equity fund: These are mainly invested in shares of the companies. The investments
may vary from blue chip companies to newly established companies.
Bond funds: These funds employ their resources in bonds. These investments ensure fixed
and regular income.
Specialised funds: These invest in a particular type of securities of companies dealing in a
particular product, firms in a particular industry or of certain income producing securities.
Leverage funds:
Leveraged funds are a class of mutual fund that are designed to multiply the returns of an
underlying index or asset class using financial derivatives and debt. These funds aim to
achieve a return that is a multiple of the benchmark they track such as 2x or 3x the daily
performance. They can offer potentially higher returns than traditional funds by leveraging
borrowed capital. These maximise capital appreciation.
However, the increased exposure also comes with greater risks that make leveraged funds
suitable primarily for experienced investors.
Taxation funds: Mutual funds may be designed to suit the tax payers. The contributors to
such funds get some concession in income tax.
Domestic funds: These are the funds which mobilise savings of people within the country
where investment are made.
Off-shore funds: Off-shore mutual funds are those which raise or mobilise funds in country
other than where investments are to be made. These funds attract foreign savings for
investment in India.
Gilt funds: This is a type of mutual fund in which the funds are invested in gilt edged
securities like government securities. It means funds are not invested in corporate securities
like shares, bonds etc.
Index funds: These are linked to a specific index of share prices. This means that the funds
mobilized under such schemes are invested principally in the securities of companies whose
securities are included in the index concerned and in the same proportion. The value of these
index-linked funds will automatically go up whenever the market index goes up and vice
versa.
Fund of Funds:
A Fund of Funds (FoF) or super fund is a Mutual Fund that pools money from investors to
buy units of other Mutual Funds. This fund does not invest in securities like shares and
debentures. The fund pool is invested in multiple types of other mutual funds, such as Global
Funds, Exchange-traded Funds (ETFs), and Gold Funds.

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ADVANTAGES OF MUTUAL FUNDS

i. Diversificaion
ii. Expert supervision and managament.
iii. Liquidity.
iv. Reduced risk
v. Tax advantage.
vi. Low operating costs.
vii. Flexibility.
viii. Higher returns.
ix. Investor protection.

PROBLEMS OF MUTUAL FUNDS IN INDIA

1. Liquidity crisis.
2. Lack of innovation.
3. Inadequate research.
4. Conventional pattern of investment.
5. No provision for performance guarantee.
6. Inadequate disclosures

LEASE FINANCING
Meaning of leasing
 Leasing is a process by which a firm can obtain the use of a certain fixed assets for which
it must pay a series of contractual, periodic, tax deductible payments.
 The lessee is the receiver of the services or the assets under the lease contract and the
lessor is the owner of the assets.
 The relationship between the tenant and the landlord is called a tenancy, and can be for a
fixed or an indefinite period of time (called the term of the lease).
 The consideration for the lease is called rent.

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 A lease transaction is a commercial arrangement whereby an equipment owner or

manufacturer conveys to the equipment user the right to use the equipment in return for a
rental.
 Lease is a contract between the owner of an asset (the lessor) and its user (the lessee) for
the right to use the asset during a specified period in return for a mutually agreed periodic
payment (the lease rentals).
 The important feature of a lease contract is separation of the ownership of the asset
from its usage.
 Lease financing is based on the observation made by Donald B. Grant:
 “Why own a cow when the milk is so cheap? All you really need is milk and not the
cow.”

Advantages of Leasing
a. Leasing helps to possess and use a new piece of machinery or equipment without huge
investment.
b. Leasing enables businesses to preserve precious cash reserves.
c. The smaller, regular payments required by a lease agreement enable businesses with
limited capital to manage their cash flow more effectively and adapt quickly to changing
economic conditions.
d. Leasing also allows businesses to upgrade assets more frequently ensuring they have the
latest equipment without having to make further capital outlays.
e. It offers the flexibility of the repayment period being matched to the useful life of the
equipment.
f. It gives businesses certainty because asset finance agreements cannot be cancelled by the
lenders and repayments are generally fixed.
g. They can also be structured to include additional benefits such as servicing of equipment or
variable monthly payments depending on a business’s needs.
h. The rental, which sometimes exceeds the purchase price of the asset, can be paid from
revenue generated by its use, directly impacting the lessee's liquidity.
i. Using the purchase option, the lessee can acquire the leased asset at a lower price, as they
pay the residual or non-depreciated value of the asset.
j. For the national economy, this way of financing allows access to state-of-the-art technology
otherwise unavailable, due to high prices, and often impossible to acquire by loan
arrangements.

Limitations of Leasing

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a. It is not a suitable mode of project financing because rental is payable soon after entering
into lease agreement while new project generate cash only after long gestation period.
b. Certain tax benefits/ incentives/subsidies etc. may not be available to leased equipments.
c. The value of real assets (land and building) may increase during lease period. In this case
lessee may lose potential capital gain.
d. The cost of financing is generally higher than that of debt financing.
e. A manufacturer (lessee) who want to discontinue business need to pay huge penalty to
lessor for pre-closing lease agreement.
f. There is no exclusive law for regulating leasing transaction.
g. In undeveloped legal systems, lease arrangements can result in inequality between the
parties due to the lessor's economic dominance, which may lead to the lessee signing an
unfavourable contract.

TYPES OF LEASE
(a) Financial Lease or Capital Lease
(b) Operating Lease
(c) Sale and Lease back
(d) Leveraged Leasing
(e) Direct Leasing
1) Financial Lease or Capital Lease
 Long-term, non-cancellable lease contracts are known as financial leases.
 It contains a condition whereby the lessor agrees to transfer the title for the asset at the
end of the lease period at a nominal cost. At lease it must give an option to the lessee to
purchase the asset he has used at the expiry of the lease.
 Under this lease the lessor recovers 90% of the fair value of the asset as lease rentals and
the lease period is 75% of the economic life of the asset.
 The lease agreement is irrevocable.
 All the risks incidental to the asset ownership and all the benefits arising there from are
transferred to the lessee who bears the cost of maintenance, insurance and repairs. Only
title deeds remain with the lessor.
 In India, financial leases are very popular with high-cost and high technology equipment.
2) Operating Lease
 An operating lease stands in contrast to the financial lease in almost all aspects.
 This lease agreement gives to the lessee only a limited right to use the asset.

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 The lessor is responsible for the upkeep and maintenance of the asset.
 The lessee is not given any uplift to purchase the asset at the end of the lease period.
 Normally the lease is for a short period and even otherwise is revocable at a short notice.
 Mines, Computers hardware, trucks and automobiles are found suitable for operating
lease because the rate of obsolescence is very high in this kind of assets.
Differences between financial lease and operating lease
1. While financial lease is a long term arrangement between the lessee (user of the asset) and
the owner of the asset, whereas operating lease is a relatively short term arrangement between
the lessee and the owner of asset.
2. Under financial lease all expenses such as taxes, insurance are paid by the lessee while
under operating lease all expenses are paid by the owner of the asset.
3. The lease term under financial lease covers the entire economic life of the asset which is
not the case under operating lease.
4. Under financial lease the lessee cannot terminate or end the lease unless otherwise
provided in the contract which is not the case with operating lease where lessee can end the
lease anytime before expiration date of lease.
5. While the rent which is paid by the lessee under financial lease is enough to fully amortize
the asset, which is not the case under operating lease.
3) Sale and Lease back
 It is a sub-part of finance lease.
 Under this, the owner of an asset sells the asset to a party (the buyer), who in turn leases
back the same asset to the owner in consideration of lease rentals.
 The assets are not physically exchanged but it all happens in records/papers only.
 Sale and lease back transaction is suitable for those assets, which are not subjected to
depreciation but appreciation, say land.
 The advantage of this method is that the lessee can satisfy himself completely regarding
the quality of the asset and after possession of the asset convert the sale into a lease
arrangement.
4) Leveraged Leasing
 Under leveraged leasing arrangement, a third party (lender) is involved besides the
lessor and lessee.
 The lessor borrows a part of the purchase cost (say 80%) of the asset from the third
party i.e., lender, and the asset so purchased is held as security against the loan.
 The lender is paid off from the lease rentals directly by the lessee and the surplus after
meeting the claims of the lender goes to the lessor.

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 The lessor, the owner of the asset is entitled to depreciation allowance associated with
the asset.
5) Direct Leasing
 Under direct leasing, a firm acquires the right to use an asset from the manufacture
directly.
 The ownership of the asset leased out remains with the manufacturer itself.
 The major types of direct lessor include manufacturers, finance companies,
independent lease companies, special purpose leasing companies etc.
Wet Lease and Dry Lease
Wet lease and dry lease are terms most commonly used in the aviation industry for aircraft
leasing.
Wet Lease
The aircraft is leased along with crew, maintenance, and insurance (ACMI). The lessor
(owner of the aircraft) provides the aircraft, pilots, cabin crew, maintenance staff, and
insurance. The lessee (airline hiring it) usually pays for fuel, airport fees, and other
operating costs. Typically used for short-term needs, such as seasonal demand, sudden
aircraft shortages, or starting new routes quickly. Example: Airline A hires a plane from
Airline B with full crew for 6 months.
Dry Lease
The aircraft is leased without crew, maintenance, or insurance. The lessee (airline hiring it)
is responsible for providing crew, maintenance, and insurance (CMI). Generally, for long-
term use, often several years. Used when airlines want to expand their fleet but avoid the
cost of purchasing aircraft. Example: An airline leases a Boeing 737 for 5 years and operates
it fully under its own Air Operator Certificate (AOC).
The concepts can apply in other transport sectors too:
Shipping industry (maritime sector): Ships are also leased on wet lease (chartered with
crew and services) and bareboat/dry lease (without crew, only the vessel) basis.
Rail transport: In some cases, locomotives or wagons are leased with or without
crew/maintenance agreements, though the terms “wet” and “dry” are not as commonly used.

Other types of leasing:

1) First Amendment Lease: The first amendment lease gives the lessee a purchase option at
one or more defined points with a requirement that the lessee renew or continue the lease if
the purchase option is not exercised.
The option price is usually either a fixed price intended to approximate fair market value or is
defined as fair market value determined by lessee appraisal and subject to a floor to ensure
that the lessor's residual position will be covered if the purchase option is exercised.

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2) Full Payout Lease: A lease in which the lessor recovers, through the lease payments, all
costs incurred in the lease plus an acceptable rate of return, without any reliance upon the
leased equipment's future residual value.
3) Guideline Lease: A lease written under criteria established by the IRS to determine the
availability of tax benefits to the lessor.
4) Net Lease: A lease wherein payments to the lessor do not include insurance and
maintenance, which are paid separately by the lessee.
5) Open-end Lease: A conditional sale lease in which the lessee guarantees that the lessor
will realize a minimum value from the sale of the asset at the end of the lease.
6) Sales-type Lease: A lease by a lessor who is the manufacturer or dealer, in which the lease
meets the definitional criteria of a capital lease or direct financing lease.
7) Synthetic Lease: A synthetic lease is basically a financing structured to be treated as a
lease for accounting purposes, but as a loan for tax purposes. The structure is used by
corporations that are seeking off-balance sheet reporting of their asset-based financing, and
that can efficiently use the tax benefits of owning the financed asset.
8) Tax Lease: A lease wherein the lessor recognizes the tax incentives provided by the tax
laws for investment and ownership of equipment. Generally, the lease rate factor on tax leases
is reduced to reflect the lessor's recognition of this tax incentive.
9) True Lease: A type of transaction that qualifies as a lease under the Internal Revenue
Code. It allows the lessor to claim ownership and the lessee to claim rental payments as tax
deductions.

Contents of a lease agreement:

The lease agreement specifies the legal rights and obligations of the lessor and the lessee.
It typically contains terms relating to the following:
1. Description of the lessor, the lessee, and the equipment.
2. Amount, time and place of lease rentals payments.
3. Time and place of equipment delivery.
4. Lessee’s responsibility for taking delivery and possession of the leased equipment.
5. Lessee’s responsibility for maintenance, repairs, registration, etc. and the lessor’s right in
case of default by the lessee.
6. Lessee’s right to enjoy the benefits of the warranties provided by the equipment
manufacturer/supplier.
7. Insurance to be taken by the lessee on behalf of the lessor.
8. Variation in lease rentals if there is a change in certain external factors like bank interest
rates, depreciation rates, and fiscal incentives.

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9. Options of lease renewal for the lessee.

10. Return of equipment on expiry of the lease period.
11. Arbitration procedure in the event of dispute.

Problems of leasing in India

[Link] competition: There is over supply of lessors in India. The stiff competition
between these lessors are forcing them to reduce their profit margin to bare minimum level.
Moreover, subsidiaries of banks and financial institution have competitive edge over private
sector lessor due their cheap source of finance.
2. Lack of qualified personnel: Leasing requires qualified and experienced personnel at the
helm of its affairs. In India, leasing is of recent one and hence it is difficult to get right man to
deal with leasing business.
3. Tax Consideration: In reality, the lessee’s tax shelter is lessors’ burden. The lease
becomes economically viable if lessors effective tax rate is low. Taxes like sale tax, wealth
tax, additional tax, surcharge etc, add to the cost of leasing. It makes leasing relatively more
expensive.
4. Stamp Duty: Heavy stamp duty imposed on lease document.
5. Delayed payment and bad debts: The problem of delayed payment of rents and bad debts
add to the cost of lease. This problem would disturb prospects of leasing business.

VENTURE CAPITAL
 Venture capital means the financial investment in a high risk project with the objective of
earning a high rate of return.
 The term venture capital comprises of two words, namely, ‘venture’ and ‘capital’.
 The term ‘venture’ literally means a ‘course’ or ‘proceeding’, the outcome of which is
uncertain (i.e., involving risk).
 The term capital refers to the resources to start the enterprise.
 Thus venture capital refers to capital investment in a new and risky business enterprise.
 Money is invested in such enterprises because these have high growth potential.
 The money invested in new, high risk and high return firms is called venture capital.
 Venture capitalists not only provide money but also help the entrepreneur with guidance
in formalizing his ideas into a viable business venture.
 They get good return on their investment. The percentage of the profits the venture
capitalists get is called the carry.

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 Venture capital can be visualized as ‘your ideas and our money’ concept of developing
business.
 It is ‘patient’ capital that seeks a return through long term capital gain rather than
immediate and regular interest payments as in the case of debt financing.
 When venture capitalists invest in a business, they typically require a seat on the
company’s board of directors.
 But professional venture capitalists act as mentors and provide support and advice on a
number of issues relating to management, sales, technology etc.
 They assist the company to develop its full potential.
 They help the enterprise in the early stage until it reaches the stage of profitability.
 When the business starts making considerable profits and the market value of the shares
go up to considerable extent, venture capitalists sell their equity holdings at a high value
and thereby make capital gains.

Characteristics of Venture Capital

1. It is basically equity finance.
2. It is a long term investment in growth-oriented small or medium firms.
3. Investment is made only in high risk projects with the objective of earning a high rate of
return.
4. In addition to providing capital, venture capital funds take an active interest in the
management of the assisted firm. It is rightly said that, “venture capital combines the qualities
of banker, stock market investor and entrepreneur in one”.
5. The venture capital funds have a continuous involvement in business after making the
investment.
6. Once the venture has reached the full potential, the venture capitalist sells his holdings at a
high premium. Thus his main objective of investment is not to earn profit, but capital gain.

Types of Venture Capitalists

Generally, there are 3 types of venture capital funds.
1. Venture capital funds set up by angel investors (angels): They are individuals who
invest their personal capital in start up companies. They are about 50 years old. They have
high income and wealth. They are well educated. They have succeeded as entrepreneurs.
They are interested in the start up projects.
2. Venture capital subsidiaries of Corporations: These are established by major
corporations, commercial banks, holding companies and other financial institutions.

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3. Private capital firms/funds: The primary source of venture capital is a venture capital
firm. It takes high risks by investing in an early stage company with high growth potential.

Methods or Modes of Venture Financing (Funding Pattern) /Dimensions of Venture

Capital
Venture capital is typically available in 4 forms in India:
1. Equity
2. Conditional loan
3. Income note
4. Conventional loan
Equity: All VCFs in India provide equity but generally their contribution does not exceed
49% of the total equity capital. Thus, the effective control and majority ownership of the firm
remain with the entrepreneur. They buy shares of an enterprise with an intention to ultimately
sell them off to make capital gains.
Conditional loan: It is repayable in the form of a royalty after the venture is able to generate
sales. No interest is paid on such loans. In India, VCFs charge royalty ranging between 2 and
15 per cent; actual rate depends on the other factors of the venture, such as gestation period,
cost-flow patterns and riskiness.
Income note: It is a hybrid security which combines the features of both conventional loan
and conditional loan. The entrepreneur has to pay both interest and royalty on sales, but at
substantially low rates.
Conventional loan: Under this form of assistance, the enterprise is assisted by way of loans.
On the loans, a lower fixed rate of interest is charged, till the unit becomes commercially
operational. When the company starts earning profits, normal or higher rate of interest will be
charged on the loan. The loan has to be repaid as per the terms of loan agreement.

Stages of Venture Capital Financing

Venture capital takes different forms at different stages of a project. The various
stages in the venture capital financing are as follows:
1. Early stage financing: This stage has three levels of financing. These three levels are:
(a) Seed financing: This is the finance provided at the project development stage. A small
amount of capital is provided to the entrepreneurs for concept testing or translating an idea
into business.
(b) Start up finance/first stage financing: This is the stage of initiating commercial production
and marketing. At this stage, the venture capitalist provides capital to manufacture a product.
(c) Second stage financing: This is the stage where product has already been launched in the
market but has not earned enough profits to attract new investors. Additional funds are
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needed at this stage to meet the growing needs of business. Venture capital firms provide
larger funds at this stage.
2. Later stage financing: This stage of financing is required for expansion of an enterprise
that is already profitable but is in need of further financial support. This stage has the
following levels:
(a) Third stage/development financing: This refers to the financing of an enterprise which has
overcome the highly risky stage and has recorded profits but cannot go for public issue.
Hence it requires financial support. Funds are required for further expansion.
(b) Turnarounds: This refers to finance to enable a company to resolve its financial
difficulties. Venture capital is provided to a company at a time of severe financial problem for
the purpose of turning the company around.
(c) Fourth stage financing/bridge financing: This stage is the last stage of the venture capital
financing process. The main goal of this stage is to achieve an exit vehicle for the investors
and for the venture to go public. At this stage the venture achieves a certain amount of market
share.
(d) Buy-outs: This refers to the purchase of a company or the controlling interest of a
company’s share. Buy-out financing involves investments that might assist management or an
outside party to acquire control of a company. This results in the creation of a separate
business by separating it from their existing owners.
Advantages of Venture Capital
1. It is long term equity finance. Hence, it provides a solid capital base for future growth.
2. The venture capitalist is a business partner. He shares the risks and returns.
3. The venture capitalist is able to provide strategic operational and financial advice to the
company.
4. The venture capitalist has a network of contacts that can add value to the company. He can
help the company in recruiting key personnel, providing contracts in international markets
etc.
5. Venture capital fund helps in the industrialization of the country.
6. It helps in the technological development of the country.
7. It generates employment.
8. It helps in developing entrepreneurial skills.
9. It promotes entrepreneurship and entrepreneurism in the country.

FACTORING
The word factor is derived from the Latin word facere. It means to make or do or to get
things done. Factoring simply refers to selling the receivables by a firm to another party.

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The buyer of the receivables is called the factor.

Factoring refers to the agreement in which the receivables are sold by a firm (client) to the
factor (financial intermediary).
The factor can be a commercial bank or a finance company.
When receivables are factored, the factor takes possession of the receivables and generally
becomes responsible for its collection.
It also undertakes administration of credit i.e. credit control, sales accounting etc.
Factoring may be defined as selling the receivables of a firm at a discount to a financial
organisation (factor). The cash from the sale of the receivables provides finance to the selling
company (client). Out of the difference between the face value of the receivables and what
the factor pays the selling company (i.e. discount), it meets its expenses (collection,
accounting etc.).
The balance is the profit of the factor for the factoring services.
Factoring can take the form of either a factoring agreement or an assignment (pledging)
agreement.
The factoring agreement involves outright sale of the firm’s receivables to a finance company
(factor) without recourse. According to this agreement the factor undertakes the receivables,
the credit, the collection task, and the risk of bad debt. The firm selling its receivables (client)
receives the value of the receivables minus a commission charge as compensation for the
risks the factor assumes. Thereafter, customers make direct payments to the factor. In some
cases receivables are sold to factor at a discount. In this case factor does not get commission.
The discount is its commission
In an assignment (pledging) agreement, the ownership of the receivables is not transferred;
the receivables are given to a finance company (factor) with recourse. The factor advances
some portion of the receivables value, generally in the range of 50 – 80%. The firm (client) is
responsible for service charges and interest on the advance (due to the factor) and losses due
to bad debts. According to this arrangement, customers make direct payment to the client.

Objectives of Factoring
Factoring is a method of converting receivables into cash.
1. To relieve from the trouble of collecting receivables so as to concentrate in sales and other
major areas of business.
2. To minimize the risk of bad debts arising on account of non-realisation of credit sales.
3. To adopt better credit control policy.
4. To carry on business smoothly and not to rely on external sources to meet working capital
requirements.

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5. To get information about market, customers’ credit worthiness etc. so as to make necessary
changes in the marketing policies or strategies.

Types of Factoring
1. Recourse Factoring:
In this type of factoring, the factor only manages the receivables without taking any risk like
bad debt etc. Full risk is borne by the firm (client) itself.
2. Non-Recourse Factoring:
Here the firm gets total credit protection because complete risk of total receivables is borne
by the factor. The client gets 100% cash against the invoices (arising out of credit sales by the
client) even if bad debts occur. For the factoring service, the client pays a commission to the
factor. This is also called full factoring.
3. Maturity Factoring:
In this type of factoring, the factor does not pay any cash in advance. The factor pays clients
only when he receives funds (collection of credit sales) from the customers or when the
customers guarantee full payment.
4. Advance Factoring:
Here the factor makes advance payment of about 80% of the invoice value to the client.
5. Invoice Discounting:
Under this arrangement the factor gives advance to the client against receivables and collects
interest (service charge) for the period extending from the date of advance to the date of
collection.
6. Undisclosed Factoring:
In this case the customers (debtors of the client) are not at all informed about the factoring
agreement between the factor and the client. The factor performs all its usual factoring
services in the name of the client or a sales company to which the client sells its book debts.
Through this company the factor deals with the customers. This type of factoring is found in
UK.
7. Cross boarder factoring:
It is similar to domestic factoring except that there are four parties, viz,
a) Exporter b) Export Factor c) Import Factor and d) Importer.
It is also called two-factor system of factoring.
Exporter (Client) enters into factoring arrangement with Export Factor in his country and
assigns to him export receivables. Export Factor enters into arrangement with Import Factor
and has arrangement for credit evaluation & collection of payment for an agreed fee.
Notation is made on the invoice that importer has to make payment to the Import Factor.

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Import Factor collects payment and remits to Export Factor who passes on the proceeds to the
Exporter after adjusting his advance, if any. Where foreign currency is involved, factor covers
exchange risk also.
Functions of a Factor
1. Provision of finance: Receivables or book debts is the subject matter of factoring. A factor
buys the book debts of his client. Generally a factor gives about 80% of the value of
receivables as advance to the client. Thus the non-productive and inactive current assets i.e.
receivables are converted into productive and active assets i.e. cash.
2. Administration of sales ledger: The factor maintains the sales ledger of every client.
When the credit sales take place, the firm prepares the invoice in two copies. One copy is sent
to the customers. The other copy is sent to the factor. Entries are made in the ledger under
open-item method. In this method each receipt is matched against the specific invoice. The
customer’s account clearly shows the various open invoices outstanding on any given date.
The factor also gives periodic reports to the client on the current status of his receivables and
the amount received from customers. Thus the factor undertakes the responsibility of entire
sales administration of the client.
3. Collection of receivables: The main function of a factor is to collect the credit or
receivables on behalf of the client and to relieve him from all tensions/problems associated
with the credit collection. This enables the client to concentrate on other important areas of
business. This also helps the client to reduce cost of collection.
4. Protection against risk: If the debts are factored without resource, all risks relating to
receivables (e.g., bad debts or defaults by customers) will be assumed by the factor. The
factor relieves the client from the trouble of credit collection. It also advises the client on the
creditworthiness of potential customers. In short, the factor protects the clients from risks
such as defaults and bad debts.
5. Credit management: The factor in consultation with the client fixes credit limits for
approved customers. Within these limits, the factor undertakes to buy all trade debts of the
customer. Factor assesses the credit standing of the customer. This is done on the basis of
information collected from credit relating reports, bank reports etc. In this way the factor
advocates the best credit and collection policies suitable for the firm (client). In short, it helps
the client in efficient credit management.
6. Advisory services: These services arise out of the close relationship between a factor and a
client. The factor has better knowledge and wide experience in the field of finance. It is a
specialised institution for managing account receivables. It possesses extensive credit
information about customer’s creditworthiness and track record. With all these, a factor can
provide various advisory services to the client. Besides, the factor helps the client in raising
finance from banks/financial institutions.

Advantages of Factoring
A firm that enters into factoring agreement is benefited in a number of ways. Some of the
important benefits of factoring are summarised as follows:

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1. Improves efficiency: Factoring is an important tool for efficient receivables management.

Factors provide specialised services with regard to sales ledger administration, credit control
etc. Factoring relieves the clients from botheration of debt collection.
2. Higher credit standing: Factoring generates cash for the selling firm. It can use this cash
for other purposes. With the advance payment made by factor, it is possible for the client to
pay off his liabilities in time. This improves the credit standing of the client before the public.
3. Reduces cost: The client need not have a special administrative setup to look after credit
control. Hence it can save manpower, time and effort. Since the factoring facilitates steady
and reliable cash flows, client can cut costs and expenses. It can avail cash discounts. Further,
it can avoid production delays.
4. Additional source: Funds from a factor is an additional source of finance for the client.
Factoring releases the funds tied up in credit extended to customers and solves problems
relating to collection, delays and defaults of the receivables.
5. Advisory service: A factor firm is a specialised agency for better management of
receivables. The factor assesses the financial, operational and managerial capabilities of
customers. In this way the factor analyses whether the debts are collectable. It collects
valuable information about customers and supplies the same for the benefits of its clients. It
provides all management and administrative support from the stage of deciding credit
extension to the customers to the final stage of debt collection. It advocates the best credit
policy suitable for the firm.
6. Acceleration of production cycle: With cash available for credit sales, client firm’s
liquidity will improve. In this way its production cycle will be accelerated.
7. Adequate credit period for customers: Customers get adequate credit period for payment
of assigned debts.
8. Competitive terms to offer: The client firm will be able to offer competitive terms to its
buyers. This will improve its sales and profits.

Limitations of Factoring
1. Factoring may lead to over-confidence in the behaviour of the client. This results in
overtrading or mismanagement.
2. There are chances of fraudulent acts on the part of the client. Invoicing against non-existent
goods, duplicate invoicing etc. are some commonly found frauds. These would create
problems to the factors.
3. Lack of professionalism and competence, resistance to change etc. are some of the
problems which have made factoring services unpopular.
4. Factoring is not suitable for small companies with lesser turnover, companies with
speculative business, companies having large number of debtors for small amounts etc.

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5. Factoring may impose constraints on the way to do business. For non - recourse factoring
most factors will want to pre- approve customers. This may cause delays. Further ,the factor
will apply credit limits to individual customers.

FORFAITING
Generally, there is a delay in getting payment by the exporter from the importer. This
makes it difficult for the exporter to expand his export business. However, for getting
immediate payment, the concept of forfeiting shall come to the help of exporters. The concept
of forfaiting was originally developed to help finance German exports to Eastern block
countries. In fact, it evolved in Switzerland in mid 1960s.
Meaning of Forfaiting
 The term ‘forfait’ is a French word which means ‘to surrender something’ or ‘give up
one’s right’.
 Thus forfaiting means giving up the right of exporter to the forfaitor to receive payment
in future from the importer.
 It is a method of trade financing that allows exporters to get immediate cash and relieve
from all risks by selling their receivables (amount due from the importer) on a ‘without
recourse’ basis.
 This means that in case the importer makes a default the forfaitor cannot go back to the
exporter to recover the money.
 Under forfaiting the exporter surrenders his right to a receivable due at a future date in
exchange for immediate cash payment, at an agreed discount.
 Here the exporter passes to the forfaitor all risks and responsibilities in collecting the
debt.
 The exporter is able to get 100% of the amount of the bill immediately. Thus, he gets the
benefit of cash sale.
 However, the forfaitor deducts the discount charges and he gives the balance amount to
the exporter.
 The entire responsibility of recovering the amount from the importer is entrusted with
the forfaitor.
 The forfaitor may be a bank or any other financial institution.
 In short, the non-recourse purchase of receivables arising from an export of goods and
services by a forfaitor is known as forfaiting.
 Forfaiting is not the same as international factoring.
 The tenure of forfaiting transaction is long. International factoring involves short term
trade transactions.

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 In case of forfaiting, political and transfer risks are also borne by the forfaitor. But in
international factoring these risks are not borne by the factor.

Characteristics of Forfaiting
1. It is 100% financing without recourse to the exporter.
2. The importer’s obligation is normally supported by a local bank guarantee (i.e., ‘aval’).
3. Receivables are usually evidenced by bills of exchange, promissory notes or letters of
credit.
4. Finance can be arranged on a fixed or floating rate basis.
5. Forfaiting is suitable for high value exports such as capital goods, consumer durables,
vehicles, construction contracts, project exports etc.
6. Exporter receives cash upon presentation of necessary documents, shortly after shipment.

Advantages of Forfaiting
1. The exporter gets the full export value from the forfaitor.
2. It improves the liquidity of the exporter. It converts a credit transaction into a cash
transaction.
3. It is simple and flexible. It can be used to finance any export transaction. The structure of
finance can be determined according to the needs of the exporter, importer, and the forfaitor.
4. The exporter is free from many export credit risks such as interest rate risk, exchange rate
risk, political risk, commercial risk etc.
5. The exporter need not carry the receivables into his balance sheet.
6. It enhances the competitive advantage of the exporter. He can provide more credit. This
increases the volume of business.
7. There is no need for export credit insurance. Exporter saves insurance costs. He is relieved
from the complicated procedures also.
8. It is beneficial to forfaitor also. He gets immediate income in the form of discount. He can
also sell the receivables in the secondary market or to any investor for cash.

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Difference between Factoring and Forfaiting

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