Ibfs 2015 Full Notes

Dr.
Mukund Sharma, BNMIT
INVESTMENT BANKING & FINANCIAL SERVICES
Module 1: (8 Hours)
Investment Banking- Introduction-Functions of Investment Banks- Types of Investment
Banks- Investment Banking Services- Merchant Banking Services-Issue Management-
Pre issue and Post issue obligations-Changing landscape of Investment Banking
Regulation of the Capital Market- SEBI regulations for merchant bankers, brokers and
sub brokers, intermediaries and portfolio managers- SEBI issue and Listing of Debt
securities Regulation 2008
Module 2: ( 8 Hours)
Depository System: Objectives, activities, interacting systems, role of depositories and
their services, Advantages of depository system -NSDL and CDSL. The process of
clearing and settlement through Depositories, Depository Participants.
Regulations relating to Depositories-SEBI (Depositories and Participants) Regulations
1996- Registration of depository and participant- Rights and Obligations of depositories
and participants- Recent amendments Custodial services- The Stock Holding
Corporation of India Limited
Module 3: (7 Hours)
Housing Finance: Role, Types of housing loans, Institutions and banks offering
Housing Finance, Procedure and Interest rates. Income Tax Implication. Reverse
mortgage loan Non-Banking Finance Companies: Types, Growth, Functions, RBI
Guidelines, Prudential Norms.
Module 4: (7 Hours)
Factoring: Origin, Types, Factoring mechanism, advantages, factoring charges,
International factoring, Factoring in India. Forfeiting: Origin, characteristics, benefits,
difference between factoring and forfeiting, growth of forfeiting in India
Module 5: (8 Hours)
Underwriting: Concept – Devolvement - Business model - Underwriting in fixed price
offers and book built offers.
Venture Capital: Concept, features, Origin and the current Indian Scenario. Private
equity- Investment banking perspectives in private equity
Microfinance: The paradigm - NGOs and SHGs - Microfinance delivery mechanisms –
Future of micro finance
Module 6: (12 Hours)
Leasing: Concept, Steps in Leasing Transactions, Types of Lease, Legal frameworks,
Advantages and disadvantages of Leasing, Contents of a Lease Agreement, Matters on
Depreciation and Tax, Problems in leasing, Factors influencing Buy or Borrow or Lease
Decision.
Hire Purchasing: Concepts and features, Hire Purchase Agreement, Comparison of
Hire Purchase with Credit sale, Instalment sale and Leasing. Banks and Hire Purchase.
Problems related to outright purchase, Hire purchase and Leasing.
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Dr. Mukund Sharma, BNMIT
Module 7: (6 Hours)
Credit rating: Definition and meaning, Process of credit rating of financial instruments,
Rating methodology, Rating agencies, Rating symbols of different companies. Rating
agencies for SMEs
Securitization of debt: Meaning, Features, Special Purpose Vehicle, Types of
securitisable assets, Benefits of Securitization, Issues in Securitization.
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INTRODUCTION TO FINANCIAL SYSTEM
Financial system acts as nerve system of country’s economy. A nation’s economic

development is principally rely on the effective and efficient financial system . The financial
system consists of many subsystems like financial services, financial markets, financial
institutions etc. Generally developing economies financial system is also in the process of
development. In any economy individuals and organizations earn and spend money. Financial
system is the system, which induces savings, transfer of those savings into an industrial effort
and stimulates an entrepreneur to undertake various business ventures. It is a key weapon in
monitoring the economic progress of any country, because eventually all efforts and resources
are measured in financial terms.
Any economy in the world cannot function unless there is a well developed financial system.
Financial system facilitates the transfer of economic resources from one section of the economy
to another. The financial system or financial sector of any country consists of specialized and
non-specialized financial institutions, organized and unorganized financial markets, and financial
instruments and services, which facilitate transfer of funds from one hand to another. The word,
“system” in the term “financial system” implies a set of complex and closely connected or
intermixed institution, markets, transactions, claims, agents, practices, and liabilities in the
economy. The financial system is concerned about credit, money, and finance.
The financial inputs emanate from the financial system, while real goods and services are part
of the real system. The interaction between the real system (goods and services) and the
financial system (money and capital) is necessary for the productive process. Trading in money
and monetary assets constitute the activity in the financial markets and are referred to as the
financial system. Savings mobilization and promotion of investment are functions of the money
and capital markets, which are a part of the organized financial system in India. The objective of
all economic activity is to promote the well being and standard of living of the people, which
depends on the income and distribution of income in terms of real goods and services in the
economy. The financial system is also geared to the mobilization of savings and canalization of
savings into productive activity. The efficient functioning of the financial system facilitates these
flow of funds. The financial system provides the intermediation between investors and
institutions and helps the process of investment leading to greater financial development that is
prerequisite for faster economic development.
A sound and efficient financial system of any country contributes to economic growth
and development in number of ways by :
• Mobilizing savings and converting it into investment.

• Providing required capital to the business organizations to carry out their activities.
• Generating income or profit
• Raising productivity of capital through efficient allocation
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The financial system of any economy consists of financial institutions, financial markets,
financial instruments and financial services.
Functions of Financial System
• It helps to mobilize financial resources for the economy.

• It ensures effective allocation of resource to different investment channels;
• It generates disposable income in the hands of people which in turn helps in exchange of
goods and services.
• It plays the role of transferor of resources from one part of the economy to another.
• It accelerates the rate of economic development:
• It provides mechanism to control risk and uncertainties.
• Financial system helps in passing on financial information.
• It promotes self employment and improves employment level.
Four major components of Financial system

1. Financial Markets
2. Financial Institution
3. Financial Instruments
4. Financial Services
Financial Institutions mobilize the savings either directly or indirectly through financial markets
by using various financial instruments and in the process utilizing the services of various
financial services providers. The brief outline of these four components is given below.
Source: Financial Institutions and markets, L M Bhole, TMH, New Delhi.
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MAJOR COMPONENTS OF THE FINANCIAL SYSTEM

1. Financial Markets: This is a place or mechanism where funds or savings
are transferred from one section to another section of financial system. These
markets can be broadly classified into (i) Money market and capital market (ii)
Primary and secondary market. Money market deals with short-term claims or
financial assets(less than a year) whereas capital markets deal with those financial
assets which have maturity period of more than a year This classification is
artificial as both these markets perform the same function of transferring surplus
funds to needy units. Another classification could be primary markets and
secondary markets. Primary markets deal in new issue of securities whereas
secondary markets deal with securities which are already issued and available in
the market. Primary markets, by issuing new securities mobilise the savings
directly where as secondary markets provide liquidity to the securities and
thereby indirectly helping in mobilizing the savings.
2.Financial Institutions: These are institutions which are dealing in the financial
market. They mobilize and transfer the savings or funds from surplus units to
deficit units and provide various financial services. These financial institutions
include, Commercial banks, Merchant Banks, Insurance companie s, Mutual funds
etc. They are the back bone of financial system.
3.Financial Instruments: The instruments that are traded or dealt in a financial
market are financial assets or securities or financial instruments. There are various
type of securities which are traded in the financial market as the requirements of
lenders/investors and borrowers are varied. Financial assets represent a claim
on the repayment of principal at a future date and or payment of a periodic or
terminal sum in the form of interest or dividend. Financial instruments may be
classified into capital market instruments and money market instruments. Some of
the examples of these financial instruments are equity shares, preference shares
debentures, bonds, Certificate of deposits, Commercial papers etc.
4.Financial Services: Financial services are the services offered by financial
institutions in financial markets. The financial services help not only to raise the
required funds but also ensure their efficient use. The various finan cial services
provided includes, leasing, merchant banking, credit cards, factoring, banking,
insurance etc.
Important Financial Services offered in India
1. Merchant Banking
2. Project Management
3. Issue Management
4. Portfolio Management
5. Equipment Leasing
6. Banking
7. Hire Purchase Finance
8. Investment Services
9. Housing Finance
10. Mutual Fund
11. Factoring
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12. Credit Rating

13. Loan Syndication
14. Stock Broking
15. Depository services
16. Venture Capital Financing
17. Insurance
18. Credit Card/Debit Card
19. Securitization of debt
20. Corporate Counseling
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Module 1
Investment Banking
NATURE AND SCOPE OF MERCHANT BANKING

One of the important financial service that emerged in Indian financial system is Merchant
Banking. Amidst the rapid change in the financial world, merchant banking has emerged as
indispensable financial advisory packages. Merchant banking is a service oriented function that
transfers capital from those owns to those who can use it. They try to identify the needs of the
investors and corporate sector and advise entrepreneurs what to do to be a successful. A
merchant banker is defined as any person who is engaged in the business of issue
management either by making arrangements regarding selling, buying or subscribing to
securities, or acting as manager, consultant, advisor or rendering corporate advisory services in
relation to issue management.
The origin of merchant banking is to be traced to Italy in late medieval times and France during
the seventeenth and eighteenth centuries. The Italian merchant bankers introduced into
England not only the bill of exchange but also all the institutions and techniques connected with
an organized money market during seventeenth and eighteenth centuries. In France a merchant
banker (le merchant banquer) was not merely a trader but an entrepreneur par excellence. He
invested his accumulated profits in all forms of promising activities. He added banking business
to his merchant activities and became a merchant banker.
“Merchant banking is defined as what merchant banker does.” A Merchant banker has
been defined by SEBI (Merchant Bankers) rules, 1992 as “any person who is engaged in
the business of issue management either by making arrangements regarding selling,
buying, or subscribing to securities or acting as manager, consultant, advisor, or
rendering corporate advisory services in relation to such issue management”. A bank
that deals mostly in (but is not limited to) international finance, long term loans for
companies and underwriting. Merchant banks do not provide regular banking services to the
general public. Their knowledge in international finances makes merchant banks specialists
in dealing with multinational corporations.
In banking, a merchant bank is a traditional term for an Investment Bank. It can also be
used to describe the private equity activities of banking. A bank that deals mostly in (but is
not limited to) issue management, international finance, long-term loans for companies and
underwriting . Merchant banks do not provide regular banking services to the general public.
The Guidelines for Merchant Bankers (issued by Ministry of Finance, Deptt. of Economic Affairs,
Stock Exchange Division on 9-4-1990) instead of defining merchant banking stated that these
guidelines shall apply to those presently engaged in merchant banking activity including as
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managers to issue and undertakes authorized activities. These activities interalia include
underwriting, portfolio management etc. Thus, to defines merchant bankers a definite better
approach is to include those agencies as merchant bankers which do what a merchant banker
does.
'Merchant' and 'Commercial' have similar connotations yet commercial banking and
merchant banking are different.
• Commercial bankers are basically a financing agency where as merchant banks provide
basically financial (not financing) services.
• Commercial bankers are comparatively retail banking activity where as merchant

banking is a whole sale banking (even if it provides financing services also).
• A merchant banking firm does not undertake commercial banking where as its, reverse
is possible.
• Commercial banking involves collections of sayings and putting it, to optimum use as per
plans and guidelines where as merchant banking refers to just an agency facilitating
transfer capital from those who own to those who can use it without handling the amount
of its own.
• Merchant bankers are more of an intermediary.
• In the same context a merchant bank can be distinguished from a development bank
since the latter is more involved in fund raising and lending. Like commercial banks,
development banks may also have separate merchant banking division.
Need for Merchant Bankers
• Growing complexity in rules and procedures of the government.
• Growing industrialization and increase of technologically advanced industries.
• Need for encouragement of small and medium industrialists, who require specialist
services.
• Promoting the role of new issue market in mobilizing saving.
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SERVICES PROVIDED BY MERCHANT BANKER
Merchant banks provide the following specialized functions to their clients.
1. Issue Management
2. Project management
3. Loan syndication
4. Portfolio management
5. Corporate counseling
6. Managing joint ventures
7. Other specialized services
1. Issue management
Issue management is considered to be one of the most important functions performed by a

merchant banker. Most companies are usually started privately by their promoter(s).
However, the promoters’ capital and the borrowings from banks and financial institutions
may not be sufficient for setting up or running the business over a long term. So
companies invite the public to contribute towards the equity and issue shares to
individual investors. The way to invite share capital from the public is through a ‘Public
Issue’. Simply stated, a public issue is an offer to the public to subscribe to the share
capital of a company. Once this is done, the company allots shares to the applicants as
per the prescribed rules and regulations laid down by SEBI. While public and rights
issues involve a detailed procedure, private placements or preferential issues are
relatively simpler. A company can raise finance by issuing equity shares in different forms like:
 IPO
 Subsequent issue/FPO
 Right issue
 Private placement
 Preferential allotment
 Bought out deals (offer for sale)
The role of a merchant banker is predominant in all the forms of issue management,
especially IPO and FPO. Merchant banker is the agency that plan, coordinate and
control the entire issue activity and direct different agencies to contribute to the
successful marketing of securities. The procedure of the managing a public issue by a
merchant banker is divided into two phases, viz;
• Pre-issue management
• Post-issue management
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Number of Merchant Banker required for Issue management
Pre-Issue Management activities:
The activities performed by a merchant banker before the issue becomes open for public is
called as pre issue activities which include
Step 1: Obtaining stock exchange approvals to memorandum and articles of associations and
taking permission of SEBI to go ahead with the issue.
Step 2: Finalizing the appointments of the following agencies:

• Co-manager/Advisers to the issue
• Underwriters to the issue
• Brokers to the issue
• Bankers to the issue and refund Banker
• Advertising agency
• Printers and Registrar to the issue
Step 3: Advise the company to appoint auditors, legal advisers and broad base Board of
Directors which is as per the SEBI norms
Step 4: pricing the issue.

Merchant banker has to price the issue in consultation with the company authorities. Nowadays
in India most of the issues are carried out by book building mechanism. “Book Building” means
a process undertaken by which a demand for the securities proposed to be issued by a body
corporate is elicited and built up and the price for the securities is assessed on the basis of the
bids obtained for the quantum of securities offered for subscription by the issuer. This method
provides an opportunity to the market to discover price for securities.
Step 5: Drafting of prospectus:

Most important function of merchant banker is finalizing the prospectus for the issue. The
merchant bank is expected to exercise due diligence insuring compliance by company in regard
to prospectus and after the prospectus is ready. Merchant banker in consultation with the
company prepares the prospectus and submits it to the SEBI for approval. Prospectus generally
contains almost all the relevant information about the company
Step 6: Merchant banker has to obtain approvals for draft prospectus from the company’s
legal advisers, underwriting financial institutions/Banks. Similarly he has to obtain consent from
parties and agencies acting for the issue to be enclosed with the prospectus.
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Step 7: Merchant banker has to file the prospectus with the SEBI and should get the approval
of prospectus from Securities and Exchange Board of India. The next activity is Filing of the
prospectus with Registrar of Companies and Making an application for enlistment with Stock
Exchange along, with copy of the prospectus.
Step 8: Marketing of the issue.

The merchant bankers should arrange a meeting with company representatives and advertising
agents to finalize arrangements relating to the publicity and marketing of the issue. It includes
launching publicity campaign. Publicity campaign covers the preparation of all publicity materials
and brochures, prospectus, announcement, advertisements in the press, radio, TV,
conferences, and hoarding. Success of an issue depends on the size of the publicity materials.
Merchant bankers play a key role by helping them in the choice of media, size, and publications
in which advertising should appear. Publicity is a function of size of issue, image of issuer and
company location. Effective marketing include arrangements of conferences at potential centers
to explain nature and strength of the project to various cross section of investors and their
counselors.
Step 9: Underwriting the issue

Securities issues are underwritten to ensure that in case of under subscription they are taken by
underwriters. No person can act as an underwriter without obtaining a certificate of registration
from SEBI. Major underwriters are financial institutions, commercial banks merchant bankers
and members of stock exchange. Financial strength is a major consideration in selecting
underwrites. Others factors considered while appointing under writers are experience in the
primary market, past underwriting performance and defaults, understanding underwriting
commitments, the network of investor clientele of the underwriter and overall reputation.
Post issue management activities
Post management consist of collection of application forms form bankers and the statement of
amounts received, screening applications and deciding allotment procedure in consultation with
stock exchange .post management concludes with the mailing of allotment letters/share through
electronic form and refund orders.
Step1: collecting and processing of application.
Registrars to the issue management play a major role in post issue management. They work in
collaboration with bankers to issue. Merchant banks assist the company by coordinating this
activity till final allotment is made. Registrar reconcile the total applications collected by the
bankers to the issue. They should verify the applications received from the public and multiple
applications and applications with the technical defects or which do not conform to the
conditions stipulated on the application form are removed and rejected. They submit a proposed
basis of allotment with the details of applications received. after the basis of allotment is
approved by the stock exchange and allotted by the board, the auditor has to certify allotment.
Registrars have to ensure that the applications are processed and allotment, within 30 days of
the close of issue.
Step 2: Allotment
The allotment against application for shares offered should be made fairly and equitably. An
oversubscription arises if the applications for shares received are more than the number of
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shares offered. If it is marginal, firm allotment to the extent possible will be made to all
categories of applicants by reducing the allotment to the applicants who have applied for a large
number of shares. In case of issues, which are heavily oversubscribed, where the number of
shares applied is much more than offered the allotment has to be made on a proportionate
basis.
Step 3: Listing Agreement
Before the securities of a company are admitted for dealing on a stock exchange, the company
has to execute with the stock exchange a listing agreement which is in the form of a covenant
designed to facilitate smooth and orderly trading in the market and to protect the interests of
shareholders and others who invest or deal in securities. To this end the agreement requires the
listed company to make certain disclosure and perform certain acts.
Step 4: Merchant banker has to ensure the issue of refund notification, allotment confirmation /
certificates within the prescribed time limit and report periodically to SEBI about the progress in
the matters related to allotment and refunds
Step 5: Merchant banker has to attend the investors grievances regarding the public issue
2. Project management:
Merchant banker takes care of project management right from planning to commission of
the project. They render various services as a part of project management are
• Counseling
• Preparation of report
• Feasibility report
• Preparation of loan application
• Government clearance
• Foreign collaboration etc
3. Loan syndication
Merchant banker arranges huge amount of loans for their clients from different banks and
financial institutions this service is called loan syndication. Merchant banker prepares project
report for loan syndication, approaches different institutions and finalises the deal. For this
service merchant banker charges some percentage of commission. Some of the important
credit syndication services offered are.
• Preparing applications for financial assistance to be submitted to financial institutions and
banks.
• Monitoring the sanction of funds while acting as a specialised liaison agency.
• Negotiating the term of assistance on behalf of client.
• Post sanction formalities with these institutions and banks.
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4. Portfolio management services
Different merchant bankers provide portfolio management services, by managing the

portfolios of their clients. Merchant banker charges fees for providing portfolio services.
Merchant bankers may or may not have the discretionary power of investing the funds. The
basic portfolio management services includes
 Advising on time of buying and selling.

 Arranging buying and selling of securities.
 Communicating changes in investment market to the client investor
 Meeting the compliance requirement of regulator for sale of purchase of
portfolio.
 Evaluating the portfolio at regular intervals as per the direction of investors.
 Providing tax advisory services pertaining to income from and investment in
portfolio
5. Corporate counseling
Merchant banker provides different types of corporate counseling to their clients. These
counseling may be relating to areas such as product development, mergers and acquisitions,
rehabilitation of sick units, foreign collaboration etc. Some of the specific assignments for the
merchant banker are:-
 Rejuvenating old line and ailing/sick unit
 Evolving rehabilitation programmes/packages.
 Assisting in obtaining approvals from Board for Industrial and Financial Reconstruction
(BlFR)
 Monitoring implementation of schemes of rehabilitation.
 Identifying potential buyers for disposal of assets
 Advice on tactics in approaching potential acquisition.
6. Managing Joint venture abroad
Merchant bankers play a key role in arranging and managing the joint venture of the client with
foreign partner. They facilitate meeting of foreign partner, get sanctions under various
provisions, make techno economic surveys, legal documentations under local as well as foreign
legal provisions etc.
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7. Merchant bankers provides some of the other specialized services such as
a) Advice on Expansion and Modernization : Merchant bankers give advice for

expansion and modernization of the business units. They give expert advice on mergers
and amalgamations, acquisition and takeovers, diversification of business, foreign
collaborations and joint-ventures, technology up-gradation, etc.
b) Handling Government Consent for Industrial Projects : A businessman has to get

government permission for starting of the project. Similarly, a company requires
permission for expansion or modernization activities. For this, many formalities have to
be completed. Merchant banks do all this work for their clients.
c) Special Assistance to Small Companies and Entrepreneurs : Merchant banks advise

small companies about business opportunities, government policies, incentives and
concessions available. It also helps them to take advantage of these opportunities,
concessions, etc.
d) Services to Public Sector Units : Merchant banks offer many services to public sector
units and public utilities. They help in raising long-term capital, marketing of securities,
foreign collaborations and arranging long-term finance from term lending institutions.
e) Revival of Sick Industrial Units : Merchant banks help to revive (cure) sick industrial
units. It negotiates with different agencies like banks, term lending institutions, and BIFR
(Board for Industrial and Financial Reconstruction). It also plans and executes the full
revival package.
f) Corporate Restructuring : It includes mergers or acquisitions of existing business

units, sale of existing unit or disinvestment. This requires proper negotiations,
preparation of documents and completion of legal formalities. Merchant bankers offer all
these services to their clients.
g) Money Market Operation : Merchant bankers deal with and underwrite short-
term money market instruments, such as:
• Government Bonds.
• Certificate of deposit issued by banks and financial institutions.
• Commercial paper issued by large corporate firms.
• Treasury bills issued by the Government
h) Arranging External Commercial Borrowings (ECB)
i) Arranging and participating in international loan syndication
j) Loans backed by Export Credit Agencies
k) Foreign currency loans under the FCNR (B) scheme
l) Import Finance for Indian corporate
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m) Arranging leasing and hire purchasing deals
n) Debt Issue Management
CODE OF CONDUCT FOR MERCHANT BANKERS
The Merchant Bankers have to abide by the following Code of Conduct:

1. A merchant banker in the conduct of his business shall observe high standards of
integrity and fairness in all his dealings with his clients and other merchant bankers.
2. A merchant banker shall render at all times high standards of service, exercise due
diligence, ensure proper care and exercise independent professional judgement. He shall
wherever necessary, disclose to the clients, possible sources of conflict of duties and
interests, while providing unbiased services.
3. A merchant banker shall not make any statement or become privy to act, practice or
unfair competitor, which is likely to be harmful to the interests of other merchant bankers or
is likely to place such other merchant bankers in a disadvantageous position in relation to
the merchant banker, while completing for or executing any assignment.
4. A merchant banker shall not make any exaggerated statement, whether oral or written, to
the client either about the qualification or the capability to render certain services or his
achievements in regard to services rendered to other clients.
5. A merchant banker shall always endeavour to —
(a) render the best possible advice to the clients having regard to the client’s needs and the
environments and his own professional skill; and
(b) ensure that all professional dealings are effected in a prompt, efficient and cost effective
manner.
6. A merchant banker shall not —
(a) divulge to other clients, press or any other party any confidential information about his
client, which has come to his knowledge; and (b) deal in securities of any client company
without making disclosure to the Board as required under the regulations and also to the
Board of Directors of the client company.
7. A merchant banker shall endeavour to ensure that —
(a) the investors are provided with true and adequate information without making any
misguiding or exaggerated claims and are aware of attendant risks before any investment
decision is taken by them;
(b) copies of prospectus, memorandum and related literature are made available to the
investors;
c) adequate steps are taken for fair allotment of securities and refund of application money
without delay; and
(d) complaints from investors are adequately dealt with.
8. The merchant bankers shall not generally and particularly in respect of issue of any
securities be party to —
(a) creation of false market;
(b) price rigging or manipulation;
(c) passing of price sensitive information to brokers, members of the stock.
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SEBI REGULATIONS RELATING TO MERCHANT BANKERS
SEBI (Merchant Bankers’) Regulations 1992 define merchant banker as “any person who is
engaged in the business of issue management either by making arrangements regarding
selling, buying or subscribing to securities or acting as manager, consultant, adviser or
rendering corporate advisory service in relation to such issue management.” Thus regulations
are applicable only to limited activities undertaken by merchant banker. On the basis of
regulations, merchant banking activities can be categorised as ‘authorised’ and ‘not authorised’
activities.
Categories of Merchant Bankers

The merchant banking regulations categorize the merchant bankers into four categories for the
purpose of registration and imposing regulations
Category 1 : These merchant bankers can carry on any activity of the issue management,
which will inter-alia consist of preparation of prospectus and other information relating to the
issue, determining financial structure, tie up of financiers and final allotment and refund of
subscription. They can also act as adviser, consultant, manager, underwriter, portfolio manager.
Category 2 : Such merchant bankers can act as adviser, consultant, co-manager, underwriter
and portfolio manager. This means they can not undertake issue management of their own.
Category 3 : These merchant bankers can neither undertake issue management nor act as co-
manager. They cannot conduct business of portfolio management. Thus the area of their
operation restricts to act as underwriter, adviser and consultant to the issue.
Category 4 : Such merchant bankers do not undertake any activities requiring funds. They can
act only as adviser or consultant to an issue.
Some of the Important SEBI guidelines relating to merchant bankers are as follows
A. Registration :
Merchant bankers require compulsory registration with the SEBI to carry out their activities.
Previously there were four categories of merchant bankers, depending upon the activities. Now,
since Dec. 1997, there is only one category of registered merchant banker and they perform all
activities.
B. Grant of Certificate :
The SEBI grants a certificate of registration to applicant if it fulfills all the conditions like
(i) it is a body corporate and is not a NBFC
(ii) it has got necessary infrastructure to support the business activity
(iii) it has appointed at least two qualified and experienced (in merchant banking) persons
(iv) its registration is in the general interest of investors.
C.Capital Adequacy Requirement :
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A merchant banker must have adequate capital to support its business. Hence SEBI grants
recognition to only those merchant bankers who have paid up capital and free reserves of
minimum Rs. 1 crore.
D.Fee
A merchant banker has to pay a registration fee of Rs. 5 lakh and renewal fees of Rs. 2.5 lakh
every three years from the fourth year from the date of registration.
E. Restriction on Business :
No merchant banker, other than a bank/public financial institution is permitted to carry on

business other than that in the securities market w.e.f. Dec.1997. However a merchant banker
who is registered with RBI as a primary Dealer/satellite dealer may carry on such business as
may be permitted by RBI w.e.f. Nov.1999. The maximum number of lead managers is related
to the size of the issue.
 For an issue of size less than Rs. 50 crores, two lead managers are appointed.
 For size groups of 50 to 100 crores and 100 to 200 crores, the maximum permissible
lead managers are three and four respectively.
 A company can appoint five and five or more (as approved by SEBI) lead managers in
case of issue sizes between Rs.200 to 400 crores and above Rs.400 crores
respectively.
F. Responsibilities of Lead Managers :
• Every lead manager has to enter into an agreement with the issuing companies setting
out their mutual rights, liabilities and obligation relating to such issues and in particular to
disclosure, allotment and refund.
• A statement specifying these is to be furnished to the SEBI at least one month before
the opening of the issue for subscription.
• It is necessary for a lead manager to accept a minimum underwriting obligation of 5% of

the total underwriting commitment or Rs. 25 lakh whichever is less.
G. Due diligence certificate :
The lead manager is responsible for the verification of the contents of a prospectus / letter of
offer in respect of an issue and the reasonableness of the views expressed in them. He has to
submit to the SEBI at least two weeks before the opening of the issue for subscription a due
diligence certificate.
H. Submission of documents :
The lead managers to an issue have to submit at least two weeks before the date of filing with
the ROC, particulars of the issue, draft prospectus/ letter of offer, other literature to be circulated
to the investors / shareholders, and so on to the SEBI. They have to ensure that the
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modifications/ suggestions made by it with respect to the information to be given to the

investors are duly incorporated.
I. Acquisition of Shares :
A merchant banker is prohibited from acquiring securities of any company on the basis of
unpublished price sensitive information obtained during the course of any professional
assignment either from the client or otherwise.
J. Disclosure to SEBI :
As and when required, a merchant banker has to disclose to SEBI
• (i) his responsibilities with regard to the management of the issue,
• (ii) names of the companies whose issues he has managed or has been associated with
• (iii) the particulars relating to the breach of capital adequacy requirements and
• (iv) information relating to his activities as manager, underwriter, consultant or advisor to

an issue.
K. Action in case of Default :
A merchant banker who fails to comply with any conditions subject to which the certificate of
registration has been granted by SEBI and / or contravenes any of the provisions of the SEBI
Act, rules or regulations, is liable to any of the two penalties
(a) Suspension of registration or
(b)Cancellation of registration.
MERCHANT BANKING IN INDIA
In India merchant banking activities started from the year 1967, following the footsteps of
similar activities in UK and USA, (which started in the beginning of 20th century). Currently
merchant banking activity has mushroomed in the Indian Capital market with both public
and private sectors setting up their respective merchant banking divisions. Currently, the
total number of merchant bankers in India are approximately 1450 with more than 930
registered with SEBI. The SEBI authorised merchant bankers include merchant banking
divisions of All India financial institutions, nationalised and foreign banks, subsidiaries of the
commercial banks, private merchant banks engaged in stock-broking, underwriting activities
and financial consultancy and investment advisory service firms.
Organizational set up of merchant bankers
From the point of Organizational set up India’s merchant banking organizations can be
categorized into 4 group on the basis of their linkage with parent activity. They are:
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a) Institutional Base:-
b) Banker Base:-
c) Broker Base :-
d) Private Base:-
a) Institutional Base:-
Where merchant banks function as an independent wing or as subsidiary of various Private/

Central Governments/State Governments Financial institutions. Most of the financial institutions
in India are in public sector and therefore such set up plays a role on the lines of governmental
priorities and policies.
b) Banker Base:-
These merchant bankers function as division/ subsidiary of banking organization. The parent
banks are either nationalized commercial banks or the foreign banks operating in India. These
organizations have brought professionalism in merchant banking sector and they help their
parent organization to make a presence in capital market.
c) Broker Base :-
In the recent past there has been an inflow of Qualified and professionally skilled brokers in
various Stock Exchanges of India. These brokers undertake merchant baking related operating
also like providing investment and portfolio management services.
d) Private Base:-
These merchant banking firms are originated in private sectors. These organizations are the
outcome of opportunities and scope in merchant banking business and they are providing skill
oriented specialized services to their clients.
Some of the leading merchant bankers in India are:
1. Public Sector:
 ICICI Securities Ltd. (promoted by ICICI)
 SBI Capital Markets Ltd. (promoted by State Bank of India),
 Merchant Banking Divisions of IDBI and IFCI,
 PNB Capital Services Ltd. (promoted by Punjab National Bank) etc.
2. Private Sector:
 Kotak Mahindra Capital Co
 J.M. Financial & Investment Consultancy Pvt.Ltd.
 DSP Financial Consultants
 Enam Financial Services
 Jardine Fleming India Ltd
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 Escorts Financial Services Ltd

 DCM Financial Services Ltd.
The quality and integrity of the manager is the key factor to their success both in the
medium term and long term. Only with keen perception for growth and capital adequacy,
merchant bankers are able to carve out a niche for themselves in the competitive capital
market. The success can no more be measured by the number of issues they have handled
nor the total amount of the issues but the performance standards and the quality of the
issues handled.
Investment Banking
A specific division of banking related to the creation of capital for other companies.
Investment banks underwrite new debt and equity securities for all types of
corporations. Investment banks also provide guidance to issuers regarding the issue
and placement of stock. investment banks also aid in the sale of securities in some
instances. They also help to facilitate mergers and acquisitions, reorganizations and
broker trades for both institutions and private investors. hey can also trade securities
for their own accounts.
Activities performed by Investment Banker
1) Research Services
2) Sales and Trading
3) Raising capital
4) Underwriting
5) Merger and acquisition
6) Restructuring
Leading Investment Banks in India

1 - Goldman Sachs
2 - Morgan Stanley
3 - JPMorgan Chase
4 - Bank of America Merrill Lynch
5 - Deutsche Bank
6 - Citigroup
6 - Credit Suisse
8 - Barclays Capital
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9 - UBS
10 - HSBC
11 - Nomura Holdings
12 - RBC Capital Markets
13 - BNP Paribas
14 - The Royal Bank of Scotland Group
15 - TD Securities
16 - Wells Fargo
17 - Lazard
18 - Jefferies Group
19 - Société Générale
20 - BMO Capital Markets
SEBI ISSUE AND LISTING OF DEBT SECURITIES REGULATIONS, 2008
In order to facilitate development of a vibrant primary market for corporate bonds in

India, Securities and Exchange Board of India (SEBI) has notified on 19th June
2008, Regulations for Issue and Listing of Debt Securities to provide for simplified
regulatory framework for issuance and listing of non-convertible debt securities
(excluding bonds issued by Governments) issued by any company, public sector
undertaking or statutory corporations.
21
Module 2
Depository System
NATURE AND SCOPE OF DEPOSITORY
The erstwhile settlement system on Indian stock exchanges was also inefficient and
increased risk, due to the time that elapsed before trades were settled. The transfer was
by physical movement of papers. There had to be a physical delivery of securities -a
process fraught with delays and resultant risks. The second aspect of the settlement
relates to transfer of shares in favour of the purchaser by the company. The system of
transfer of ownership was grossly inefficient as every transfer involves physical
movement of paper securities to the issuer for registration, with the change of
ownership being evidenced by an endorsement on the security certificate. In many
cases the process of transfer would take much longer than the two months stipulated in
the Companies Act, and a significant proportion of transactions would end up as bad
delivery due to faulty compliance of paper work. Theft, forgery, mutilation of certificates
and other irregularities were rampant. In addition, the issuer has the right to refuse the
transfer of a security. All this added to costs and delays in settlement, restricted liquidity
and made investor grievance redressal time consuming and, at times, intractable.
To obviate these problems, the Depositories Act, 1996 was passed. It provides for the
establishment of depositories in securities with the objective of ensuring free
transferability of securities with speed, accuracy and security. It does so by (a) making
securities of public limited companies freely transferable, subject to certain exceptions;
(b) dematerialising the securities in the depository mode; and (c) providing for
maintenance of ownership records in a book entry form. In order to streamline both the
stages of settlement process, the Act envisages transfer ownership of securities
electronically by book entry without making the securities move from person to person.
The Act has made the securities of all public limited companies freely transferable,
restricting the company's right to use discretion in effecting the transfer of securities,
and the transfer deed and other procedural requirements under the Companies Act
have been dispensed with. Two depositories, viz., NSDL and CDSL, have come up to
provide instantaneous electronic transfer of securities.
A depository functions in India falls under the following rules and regulations:
1. The Depositories Act, 1996,

2. SEBI (Depositories and Participant) Regulations.
3. Depository Bye-laws which are framed under the above two documents.
4. Prevention of Money Laundering Act (PMLA), 2002
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A depository is an organisation which holds securities (like shares, debentures, bonds,

government securities, mutual fund units etc.) of investors in electronic form at the
request of the investors through a registered Depository Participant. It also provides
services related to transactions in securities.In any stock exchange, trades or
transactions have to be settled by either squaring up the carrying forward positions or
settling by payment of net cash or net delivery of securities. This account settlement
period, if it is long leads to several price distortions and allows for market manipulation.
It increases the chances of speculation resulting in volatility, which hurts the small
investors. With the application of IT in the securities market - screen-based trading and
trading through the Internet - it has been possible to reduce this settlement period.
The Depository system to some extent works like the banking system. There is a
central bank and the rules and regulations related to the working of all the commercial,
foreign, co-operative and other types of banks are framed by the central bank. In order
to do the daily transactions, the investors open an account with the associate banks,
and not with the central one. Like an investor can have a bank account with more than
one bank, similarly one can have more than one Demat Account. We can further bring
out the similarities as well as the differences between the two in understanding the
depository system.
Depository (NSDL/CDSL) – BANK: The Similarities
BANK NSDL
Holds funds in accounts Holds securities in accounts
Transfers funds between accounts Transfers securities between accounts
Transfers without handling cash Transfers without handling physical
Securities
Safekeeping of money Safekeeping of securities
Depository (NSDL/CDSL) – BANK: The Differences
BANK NSDL
Either of holders can sign All joint holders to sign instructions
Instructions
Minimum balance to be maintained No minimum balance required
Entitled for interest Interest can be earned only by
participating in Stock Lending Scheme
Uses balances in accounts Does not move balances in account
without account holder’s authorization
Nomination is kept confidential Signature and photograph of nominee
to be provided
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DEMATERIALIZATION
Dematerialization is a process by which the physical share certificates of an investor are taken
back by the company (Registrar transfer agent on behalf of the company) and an equivalent
number of securities are credited in electronic form at the request of the investor. The
dematerialized securities are converted into electronic data and stored in computers by a
Depository. . It is safe, secure and convenient buying, selling and transacting stocks
without suffering endless paperwork and delays.
An investor will have to first open a ‘DEMAT’ account with a Depository Participant and then
request for the dematerialisation of his share certificates through the Depository Participant so
that the dematerialised holdings can be credited into that account. This is very similar to
opening a Bank Account. Dematerialisation of shares is optional and an investor can still hold
shares in physical form. However, he/she has to demat the shares if he/she wishes to sell the
same through the Stock Exchanges. Similarly, if an investor purchases shares, he/she will get
delivery of the shares in demat form.
Types of securities eligible for dematerialization
According to regulation 28 of the SEBI (Depositories and Participants) Regulation 1996, the
following securities shall be eligible for being held in Dematerialized form in depository:
a. Shares, scrip, stocks, bonds, debentures, debentures stock or other marketable securities of
any incorporated company or other body corporate.
b. Units of Mutual Funds, Rights under collective Investment Schemes and

Venture Capital Funds, Commercial paper, Certificate of Deposit, Securities Debt, Money
Market Instruments and unlisted form in a depository
Process of Dematerialization
The following steps may be followed for getting physical securities converted into Demat form.
The following diagram will make the understanding of the steps even better.
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Step: 1 Client/Investor submits the DRF (Demat Request Form) and physical certificates (to be
dematted) to the DP. DP checks whether the securities are available for demat. Client defaces
the certificate by stamping ‘Surrendered for Dematerialisation”. DP punches two holes on the
name of the company and draws two parallel lines across the face of the certificate. This
ensures that your shares are not lost in transit or misused till credit is received by client in their
demat account. The DP upon receipt of the shares and the DRF, will issue the client an
acknowledgement and will send an electronic request to the Company.
Step: 2 DP enters the demat request in his system to be sent to NSDL.
Step: 3 DP dispatches the physical certificates along with the DRF to the R&T Agent.
Step: 4 NSDL records the details of the electronic request in the system and forwards the
request to the R&T Agent.
Step: 5 R&T Agent, on receiving the physical documents and the electronic request, verify and
check them. Once the R&T Agent is satisfied, dematerialization of the concerned securities is
electronically confirmed to NSDL.
Step: 7 NSDL credits the dematerialised securities to the beneficiary account of the investor
and intimates the DP electronically.
Step: 8 The DP issues a statement of transaction to the client.
BENEFITS OF DEMATERIALIZATION
Benefits of holding securities in the Dematerialised Form are
a) Elimination of all risks associated with physical certificates: There is no risk of loss, mutilation or
theft of certificates.
b) Elimination of bad deliveries: In the depository environment, securities cannot be returned “under
objection” for any reason and hence the question of bad delivery does not arise nor does the
investor face any uncertainty on the genuinity of securities purchased by him.
c) Immediate transfer and registration of securities: After the payout, once securities are credited to
the investor’s demat account, the investor becomes the owner of the securities, as there is no need
to seek registration from the company or its registrar.
d) Faster settlement cycles: All stock exchanges currently follow the T+2 rolling settlement cycle i.e.
nd
settlement of trades is done on the 2 working day from the trade day. This has become possible
because of demat, which enables faster transfer of securities and enhances liquidity.
e) Faster receipt of securities in case of bonus/split/merger etc.: Direct credit of securities issued as
bonus or on allotment of IPO/rights, split and merger ensures faster receipt of securities and
eliminate the risk of loss of certificates in transit.
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f) Waiver of stamp duty: No stamp duty is payable by the investors for transfer of any kind of securities
in demat form.
g) Facilitates ease in recording change of address, transmission, etc. – For all investments held in the
BO’s a/c, instead of informing each company separately about the change in address, bank account
details, nomination, one single instruction to the DP takes care of all such changes.
h) Ease of portfolio monitoring : The statement of account periodically sent by the DP provides the
investor the consolidated position of all his investments in the demat account. This makes it
convenient for an investor to monitor his portfolio.
DEPOSITORIES IN INDIA
There are two depositories operating in India, NSDL established in 1996 and co
promoted by NSE and CDSL established in 1999 and co promoted by BSE. The brief
profile of them is provided below.
National Security Depository Limited
NSDL( National Security Depository Limited), the first and largest depository in India,
established in August 1996 and promoted by institutions of national stature responsible
for economic development of the country has since established a national infrastructure
of international standards that handles most of the securities held and settled in
dematerialised form in the Indian capital market.
The paper-based settlement of trades in India caused substantial problems like bad
delivery and delayed transfer of title till recently. The enactment of Depositories Act in
August 1996 paved the way for establishment of NSDL, the first depository in India. This
depository was promoted by institutions of national importance responsible for
economic development of the country.
Using innovative and flexible technology systems, NSDL works to support the investors
and brokers in the capital market of the country. NSDL aims at ensuring the safety and
soundness of Indian marketplaces by developing settlement solutions that increase
efficiency, minimise risk and reduce costs. NSDL, play a quiet but central role in
developing products and services that will continue to nurture the growing needs of the
financial services industry.
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Promoters / Shareholders
NSDL was promoted by

 Industrial Development Bank of India Limited (Now, IDBI Bank Limited), largest
development bank of India
 Unit Trust of India, - the largest mutual fund in India
 National Stock Exchange of India Limited, - the largest stock exchange in India.
Central Depository Services Limited
Central Depository Services Limited (CDSL), is the second Indian depository based
in Mumbai. CDSL was promoted by BSE Ltd. jointly with leading banks such as State Bank of
India, Bank of India, Bank of Baroda, HDFC Bank, Standard Chartered Bank and Union Bank of
India. CDSL was set up with the objective of providing convenient, dependable and secure
depository services at affordable cost to all market participants.
CDSL was promoted by BSE Ltd. in association with Bank of India, Bank of Baroda, State Bank
of India and HDFC Bank. BSE Ltd. has been involved with this venture right from the inception
and has contributed overwhelmingly to the fruition of the project. The initial capital of the
company is 104.50 crores(INR). The list of shareholders with effect from July, 2010 is as under.
BENEFITS OF DEPOSITORIES (NSDL AND CDSL)
In the depository system, the ownership and transfer of securities takes place by means of
electronic book entries. At the outset, this system rids the capital market of the dangers related
to handling of paper. NSDL and CDSL provides numerous direct and indirect benefits like
 Elimination of bad deliveries - In the depository environment, once holdings of an investor are
dematerialised, the question of bad delivery does not arise i.e. they cannot be held "under
objection". In the physical environment, buyer was required to take the risk of transfer and face
uncertainty of the quality of assets purchased. In a depository environment good money
certainly begets good quality of assets.
 Elimination of all risks associated with physical certificates - Dealing in physical securities
have associated security risks of theft of stocks, mutilation of certificates, loss of certificates
during movements through and from the registrars, thus exposing the investor to the cost of
obtaining duplicate certificates etc. This problem does not arise in the depository environment.
 No stamp duty for transfer of any kind of securities in the depository. This waiver extends to
equity shares, debt instruments and units of mutual funds.
 Immediate transfer and registration of securities - In the depository environment, once the
securities are credited to the investors account on pay out, he becomes the legal owner of the
securities. There is no further need to send it to the company's registrar for registration. Having
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purchased securities in the physical environment, the investor has to send it to the company's
registrar so that the change of ownership can be registered. This process usually takes around
three to four months and is rarely completed within the statutory framework of two months thus
exposing the investor to opportunity cost of delay in transfer and to risk of loss in transit. To
overcome this, the normally accepted practice is to hold the securities in street names i.e. not to
register the change of ownership. However, if the investors miss a book closure the securities
are not good for delivery and the investor would also stand to loose his corporate entitlements.
 Faster settlement cycle - The settlement cycle follow rolling settlement on T+2 basis i.e. the
settlement of trades will be on the 2nd working day from the trade day. This will enable faster
turnover of stock and more liquidity with the investor.
 Faster disbursement of non cash corporate benefits like rights, bonus, etc. – NSDL and
CDSL provides for direct credit of non cash corporate entitlements to an investors account,
thereby ensuring faster disbursement and avoiding risk of loss of certificates in transit.
 Reduction in brokerage by many brokers for trading in dematerialised securities - Brokers
provide this benefit to investors as dealing in dematerialised securities reduces their back office
cost of handling paper and also eliminates the risk of being the introducing broker.
 Reduction in handling of huge volumes of paper
 Periodic status reports to investors on their holdings and transactions, leading to better
controls.
 Elimination of problems related to change of address of investor - In case of change of
address, investors are saved from undergoing the entire change procedure with each company
or registrar. Investors have to only inform their DP with all relevant documents and the required
changes are effected in the database of all the companies, where the investor is a registered
holder of securities.
 Elimination of problems related to transmission of demat shares - In case of
dematerialised holdings, the process of transmission is more convenient as the transmission
formalities for all securities held in a demat account can be completed by submitting documents
to the DP whereas, in case of physical securities the surviving joint holder(s)/legal
heirs/nominee has to correspond independently with each company in which shares are held.
 Elimination of problems related to selling securities on behalf of a minor - A natural
guardian is not required to take court approval for selling demat securities on behalf of a minor.
 Ease in portfolio monitoring since statement of account gives a consolidated position of
investments in all instruments.
DEPOSITORY PARTICIPANTS
A Depository Participant (DP) is an agent of the depository through which it interfaces with the
investor and provides depository services. Public financial institutions, scheduled commercial
banks, foreign banks operating in India with the approval of the Reserve Bank of India, state
financial corporations, custodians, stock-brokers, clearing corporations /clearing houses, NBFCs and
Registrar to an Issue or Share Transfer Agent complying with the requirements prescribed by SEBI
can be registered as DP. Banking services can be availed through a branch whereas depository
services can be availed through a DP.DP is an entity who is registered as such with SEBI under
the sub secton 1A of Section 12 of the SEBI Act. As per the provisions of this Act, a DP can
offer depository-related services only after obtaining a certificate of registration from SEBI.SEBI
(D&P) Regulations, 1996 prescribe a minimum net worth of Rs. 50 lakh for stockbrokers, R&T
28
agents and non-banking finance companies (NBFC), for granting them a certificate of
registration to act as DPs. The important DP,s in India includes, ICICI Securities, Karvy Stock
broking, IL&FS etc.
Important DPs in India:
 Axis Bank
 Barclays Securities (India)
 BNP Paribas
 Citibank N.A.
 Citigroup
 Deutsche Bank
 A.G Geojit
 BNP Paribas
 HDFC Bank
 ICICI Bank
 IL&FS Securities Services
 India Infoline
 Interactive Brokers (India)
 J M Financial Services
 Karvy Stock Broking
 Kotak Mahindra Bank
 Kotak Securities
 Marwadi Shares & Finance
 Orbis Financial Corporation
 Philipcapital India
 Religare Securities
 SBI-SG Global
 Securities Services
 Sharekhan
 SMC Global Securities
 Standard Chartered Bank
 Standard Chartered Securities (India)
 Stock Holding Corporation
STOCK BROKING SERVICES
A stockbroker is an individual / organization who are specially given license to

participate in the securities market on behalf of clients. The stockbroker has the role of
an agent. When the Stockbroker acts as agent for the buyers and sellers of securities, a
29
commission is charged for this service. As an agent the stock broker is merely
performing a service for the investor. This means that the broker will buy for the buyer
and sell for the seller, each time making sure that the best price is obtained for the
client. An investor should regard the stockbroker as one who provides valuable service
and information to assist in making the correct investment decision. They are
adequately qualified to provide answers to a number of questions that the investor might
need answers to and to assist in participating in the regional market.
Services provided by a stock broker is what called as stock broking services. Apart
from buying and selling of shares they provide various other services such as, buying
and selling of various types of derivative products, advising the clients on market
condition and cautioning them on adversities in the market, collecting dividend and
bonus shares on behalf of the client etc
Stock brokers are governed by SEBI Act, 1992, Securities Contracts (Regulation) Act,
1956, Securities and Exchange Board of India [SEBI (Stock brokers and Sub brokers)
Rules and Regulations, 1992], Rules, Regulations and Bye laws of stock exchange of
which he is a member as well as various directives of SEBI and stock exchange issued
from time to time. Every stock broker is required to be a member of a stock exchange
as well as registered with SEBI. For registering SEBI checks - eligibility of the applicant
to become the member of stock exchange, has the necessary infrastructure to
effectively discharge his duties, past experience etc.
Every broker displays registration details on their website and on all the official
documents. You can confirm the registration details on SEBI website. The SEBI
website provides the details of all registered brokers. A broker’s registration number
begins with the letters “INB” and that of a sub broker with the letters “INS”. Before start
of trading with a stock broker, customers are required to furnish your details such as
name, address, proof of address, etc. and execute a broker client agreement.
CODE OF CONDUCT FOR STOCK BROKERS
The intermediaries and persons associated with securities market shall buy, sell or deal in
securities after obtaining a certificate of registration from SEBI, as required by Section 12 of
SEBI Act. Trading in securities market requires some link from intermediaries to client and
stock exchange. Therefore, it is necessary to watch on the working of these intermediaries.
The Stock brokers are very important link between stock exchanges and investor. Hence, in
the exercise of powers conferred by section 30 of the Securities and Exchange Board of
India Act, 1992, the board has made regulation to regulate the working of Stock Broker and
Sub brokers. In this chapter, we will discuss the regulations of stock broker and sub broker
30
imposed by the SEBI. Stock brokers and sub brokers are regulated by SEBI (Stock Brokers
and Sub- Brokers) Regulations 1992. Presently it ia amended and called the Securities and
Exchange Board of India (Stock Brokers and Sub-brokers) (Amendment) Regulations,
2013.
The following code of conduct applicable to stock brokers and sub-brokers
1. Integrity: A stock-broker, shall maintain high standards of integrity, promptitude and fairness
in the conduct of all his business.
2. Exercise of Due Skill and Care: A stock- broker, shall act with due skill, care and diligence
in the conduct of all his business.
3. Manipulation: A stock- broker shall not indulge in manipulative, fraudulent or deceptive
transactions or schemes or spread rumours with a view to distorting market equilibrium or
making personal gains.
4. Malpractices: A stock-broker shall not create false market either singly or in concert with
others or indulge in any act detrimental to the investors' interest or which leads to interference
with the fair and smooth functioning of the market. A stock-broker shall not involve himself in
excessive speculative business in the market beyond reasonable levels not commensurate with
his financial soundness.
5. Compliance with Statutory Requirements: A stock-broker shall abide by all the provisions
of the Act and the rules, regulations issued by the Government, SEBI and the stock exchange
from time to time as may be applicable to him.
6. Execution of Orders: A stock-broker, in his dealings with the clients and the general
investing public, shall faithfully execute the orders for buying and selling of securities at the best
available market price and not refuse to deal with a small investor merely on the ground of the
volume of business involved. A stock-broker shall promptly inform his client about the execution
or non-execution of an order, and make prompt payment in respect of securities sold and
arrange for prompt delivery of securities purchased by clients.
7. Issue of Contract Note: A stock-broker shall issue without delay to his client or client of the
sub-broker, as the case may be a contract note for all transactions in the form specified by the
stock exchange.
8. Breach of Trust: A stock-broker shall not disclose or discuss with any other person or make
improper use of the details of personal investments and other information of a confidential
nature of the client which he comes to know in his business relationship.
9. Business and Commission:
(a) A stock-broker shall not encourage sales or purchases of securities with the sole object of
generating brokerage or commission.
(b) A stock-broker shall not furnish false or misleading quotations or give any other false or
misleading advice or information to the clients with a view of inducing him to do business in
particular securities and enabling himself to earn brokerage or commission
thereby.
10. Business of Defaulting Clients: A stock- broker shall not deal or transact business
knowingly, directly or indirectly or execute an order for a client who has failed to carry out his
commitments in relation to securities with another stock-broker.
11. Fairness to Clients: A stock-broker, when dealing with a client, shall disclose whether he is
acting as a principal or as an agent and shall ensure at the same time that no conflict of interest
arises between him and the client. In the event of a conflict of interest, he shall inform the
client accordingly and shall not seek to gain a direct or indirect personal advantage from the
situation and shall not consider clients' interest inferior to his own.
12. Investment Advice: A stock- broker shall not make a recommendation to any client who
might be expected to rely thereon to acquire, dispose of, retain any securities unless he has
reasonable grounds for believing that the recommendation is suitable for such a client upon the
31
basis of the facts, if disclosed by such a client as to his own security holdings, financial situation
and objectives of such investment. The stock-broker should seek such information from clients,
wherever he feels it is appropriate to do so.
13 Investment Advice in publicly accessible media: A stock broker or any of his employees
shall not render, directly or indirectly, any investment advice about any security in the publicly
accessible media.
14. Competence of Stock Broker: A stock-broker should have adequately trained staff and
arrangements to render fair, prompt and competent services to his clients.
15. Protection of Clients Interests: A stock-broker shall extend fullest cooperation to other
stockbrokers in protecting the interests of his clients regarding their rights to dividends, bonus
shares, right shares and any other rights related to such securities.
16. Transactions with Stock-Brokers: A stock- broker shall carry out his transactions with
other stockbrokers and shall comply with his obligations in completing the settlement of
transactions with them.
17. Advertisement and Publicity: A stock- broker shall not advertise his business publicly
unless permitted by the stock exchange.
18. Inducement of Clients: A stock-broker shall not resort to unfair means of inducing clients
from other stockbrokers.
19. False or Misleading Returns : A stock- broker shall not neglect or fail or refuse to submit
the required returns and not make any false or misleading statement on any returns required to
be submitted to the Board and the stock exchange.
SUB BROKERS
“Sub-broker” means any person not being a member of a Stock Exchange who acts on
behalf of a member-broker as an agent or otherwise for assisting the investors in
buying, selling or dealing in securities through such member-brokers. To act as a sub-
broker, registration with SEBI is required. It grants a certificate of registration to a sub-
broker subject to the conditions that (a) he has to pay the prescribed fee, (b) he takes
adequate steps for redressal of investor grievances within one month of the receipt of
the complaint and keeps SEBI informed about the number, nature and other particulars
of the complaints (c) he is authorized in writing by a broker for affiliation in buying,
selling or dealing in securities. It is mandatory for member-brokers to enter into an
agreement with all the sub-brokers. The agreement lays down the rights and
responsibilities of member-brokers as well as sub-brokers.
Leading Stock Brokers in India.

There are a number of broking houses all over India. Many of them have International
presence too. Following are some of the leading Stock Broking firms in India.
 India Infoline
 ICICIdirect
 Share khan
 India bulls
 Geojit Securities
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 HDFC
 Reliance Money
 Religare
 Angel Broking
Clearing and Settlement
From April 1, 2003, the settlement cycle has been shortened from the T+3 rolling settlement
to T+2 by SEBI to facilitate still easier flow of funds and securities.
Settlement System: T+2 Settlement System

• Parties Involved in clearing and settlement
• Clearing Corporation: The clearing corporation is responsible for post-trade
activities such as risk management and clearing and settlement of trades executed
on a stock exchange. The first clearing corporation to be established in the country
and also the first clearing corporation in the country to introduce settlement
guarantee is the National Securities Clearing Corporation Ltd. (NSCCL), a wholly
owned subsidiary of NSE. NSCCL was incorporated in August 1995. It was set up
with the objectives of bringing and sustaining confidence in clearing and settlement
of securities; promoting and maintaining short and consistent settlement cycles;
providing counter-party risk guarantee, and operating a tight risk containment
system.
• Clearing Members: Clearing Members are responsible for settling their obligations
as determined by the clearing corporation. They do so by making available funds
and/or securities in the designated accounts with clearing bank/ depositories on the
date of settlement.
• Custodians: Custodians are clearing members but not trading members. They settle
trades on behalf of trading members, when a particular trade is assigned to them for
settlement. The custodian is required to confirm whether he is going to settle that
trade or not. If he confirms to settle that trade, then clearing corporation assigns that
particular obligation to him. As on date, there are 13 custodians empanelled with
NSCCL. They are Deutsche Bank A.G., HDFC Bank Ltd., Hongkong Shanghai
Banking Corporation Ltd., Infrastructure leasing and Financial Services Ltd., ICICI
Bank Ltd., Standard Chartered Bank Ltd., Stock Holding Corporation of India Ltd. ,
Axis Bank Ltd., DBS bank Ltd., JP Morgan Chase Bank N.A., Kotak Mahindra Bank
Ltd. State Bank of India and Citibank N.A and Orbis Financial Corporation Ltd.
• Clearing Banks: Clearing banks are a key link between the clearing members and
Clearing Corporation to effect settlement of funds. Every clearing member is
required to open a dedicated clearing account with one of the designated clearing
33
banks. Based on the clearing member’s obligation as determined through clearing,

the clearing member makes funds available in the clearing account for the pay-in
and receives funds in case of a pay-out. There are 13 clearing banks of NSE, viz.,
Axis Bank Ltd, Bank of India Ltd., Canara Bank Ltd., Citibank N.A, HSBC Ltd., HDFC
Bank Ltd., ICICI Bank Ltd IDBI Bank Ltd., Indusind Bank Ltd., Kotak Mahindra Bank,
Standard Chartered Bank, State Bank of India and Union Bank of India
• Depositories: Depository holds securities in dematerialized form for the investors in
their benefi ciary accounts. Each clearing member is required to maintain a clearing
pool account with the depositories. He is required to make available the required
securities in the designated account on settlement day. The depository runs an
electronic file to transfer the securities from accounts of the custodians/clearing
member to that of NSCCL and visa-versa as per the schedule of allocation of
securities. The two depositories in India are the National Securities Depository Ltd
(NSDL) and Central Depository Services (India) Ltd (CDSL).
Clearing and settlement Process

Day Time Description of activity
T 9:15 a.m. – 3:30 p.m. Trade Day
Confirmation of all trades (including custodial

trades) Facility of an exceptional window for late
By 11:00 a.m.
confirmations would be made available by the
T+1 exchanges
Processing and downloading of obligation files to

By 1:30 p.m.
brokers / custodians
By 11:00 a.m. Pay-in of securities and funds

T+2
By 1:30 p.m. Pay-out of securities and funds
34
1. Trade details from Exchange to NSCCL (real-time and end of day trade fi le).
2. NSCCL notifies the consummated trade details to clearing members/custodians who
affirm back. Based on the affirmation, NSCCL applies multilateral netting and
determines obligations.
3. Download of obligation and pay-in advice of funds/securities.
4. Instructions to clearing banks to make funds available by pay-in time.
5. Instructions to depositories to make securities available by pay-in-time.
6. Pay-in of securities (NSCCL advises depository to debit pool account of
custodians/CMs and credit its account and depository does it)
7. Pay-in of funds(NSCCL advises Clearing Banks to debit account of custodians/CMs
and credit its account and clearing bank does it)
8. Pay-out of securities (NSCCL advises depository to credit pool account of
custodians/CMs and debit its account and depository does it)
9. Pay-out of funds (NSCCL advises Clearing Banks to credit account of
custodians/CMs and debit its account and clearing bank does it)
10. Depository informs custodians/CMs through DPs.
11. Clearing Banks inform custodians/CMs.
The core processes involved in clearing and settlement include:

• a. Trade Recording: The key details about the trades are recorded to provide basis
for settlement. These details are automatically recorded in the electronic trading
system of the exchanges.
• b. Trade Confirmation: The parties to a trade agree upon the terms of trade like
security, quantity, price, and settlement date, but not the counterparty which is the
NSCCL. The electronic system automatically generates confirmation by direct
participants.
• c. Determination of Obligation: The next step is determination of what counter-
parties owe, and what counterparties are due to receive on the settlement date. The
NSCCL interposes itself as a central counterparty between the counterparties to
trades and nets the positions so that a member has security wise net obligation to
receive or deliver a security and has to either pay or receive funds. The settlement
process begins as soon as members’ obligations are determined through the
clearing process. The settlement process is carried out by the Clearing Corporation
with the help of clearing banks and depositories. The Clearing Corporation provides
a major link between the clearing banks and the depositories. This link ensures
actual movement of funds as well as securities on the prescribed pay-in and pay-out
day.
• d. Pay-in of Funds and Securities: This requires members to bring in their
funds/securities to the clearing corporation. The CMs make the securities available
35
in designated accounts with the two depositories (CM pool account in the case of
NSDL and designated settlement accounts in the case of CDSL). The depositories
move the securities available in the pool accounts to the pool account of the clearing
corporation. Likewise CMs with funds obligations make funds available in the
designated accounts with clearing banks. The clearing corporation sends electronic
instructions to the clearing banks to debit designated CMs’ accounts to the extent of
payment obligations. The banks process these instructions, debit accounts of CMs
and credit accounts of the clearing corporation. This constitutes pay-in of funds and
of securities.
• e. Pay-out of Funds and Securities: After processing for shortages of

funds/securities and arranging for movement of funds from surplus banks to deficit
banks through RBI clearing, the clearing corporation sends electronic instructions to
the depositories/clearing banks to release pay-out of securities/funds. The
depositories and clearing banks debit accounts of the Clearing Corporation and
credit accounts of CMs. This constitutes pay-out of funds and securities. Settlement
is deemed to be complete upon declaration and release of pay-out of funds and
securities.
Settlement Process
• Step: 1 Seller gives delivery out instructions to his DP to move securities from
his account to his broker’s account.
• Step: 2 Securities are transferred from broker’s account to CC on the basis of
a delivery out instruction.
• Step: 3 On the pay-out day securities are moved from CC to buying broker’s
account.
• Step: 4 Buying broker gives instructions and securities move to the buyer’s
account.
36
Custodial Services
A custodial service is offered by a custodian. A custodian is an institution or individual that can act
as an agent and exercise legal authority over the financial assets of another individual or company.
How it works
A custodian typically handles a variety of activities, including physically holding equities and bonds,
settling purchases and sales, reporting the status of assets, tax compliance and reporting, and
management of the client's accounts and transactions. For example, a bank may act as a custodian
for a customer's investment activities, moving funds into brokerage accounts, researching
investment alternatives such as companies and funds which might be appropriate investment
targets, instructing brokers to buy or sell securities, monitoring the investment activities within the
account, and reporting account activity to the owner. The custodian may also prepare the necessary
tax filings on behalf of the owner, based on the activities within the account.
Custodians may be appointed to hold control of assets of a minor or an incapacitated adult. An adult
with legal status may act as the custodian for the accounts of a minor. For example, a common tax
strategy is to give a financial gift to a minor when their tax rate is lowest. Under the Uniform
Transfers to Minors Act (UTMA), an adult or parent establishes the account on behalf of the minor
and serves as custodian, maintaining the legal authority and direction over the custodial
account. When the minor becomes an adult, the custodian relinquishes his or her authority over the
account.
The custodian role is often held by banks, law firms, or accounting firms which usually carry
additional fees for the services.
Stock Holding Corporation of India Ltd

Stock Holding Corporation of India Ltd (SHCIL), India’s largest[2] custodian and depository
participant based in Mumbai,Maharashtra.[3] It was established in 1986 under the Government of
India as public limited company. It is owned by the India's leading Banks and Financial Institutions
such as, SU-UTI, IFCI Ltd., LIC, GIC, NIA, NIC, UIC, and TOICL.[4] SHCIL is known for itsonline
trading portal with investors and traders.
It is also responsible for e-stamping system around India.Stock Holding Corporation of India
(SHCIL), the country's first and one of the largest security custodians to financial institutions.
37
MODULE 3
Housing finance and NBFC
NATURE AND SCOPE OF HOUSING FINANCE
Housing is in essence a significant component of the social and economic status of an individual
or a household. It represents one of the three most fundamental social needs, that is, food,
clothing and shelter. In the simplest form, housing is an abode as much for the poorest as for
the most affluent of persons. This is so because housing comprises one of the prime aspirations
for progressive lifestyles among all income groups. The social and economic transformation of
an urban centre is caused as well as manifested in the changing housing scenario. Housing has
evolved into a complex economic good, demanded not merely as a shelter but as a lucrative
investment asset. Not only does it render social returns in terms of achievement, social
acceptance and satisfaction to its owner but is also a source of household income in the form of
rent.
Housing finance covers a wide range of issues, and the concept often varies in its coverage
across different countries; however, it has been defined mainly in terms of residential mortgage
credit. Housing finance includes a broad array of institutional arrangements which include both
general and specialized institutions acting as primary or secondary lenders, with the common
purpose of channeling funds from savers to households demanding housing loans. Housing
finance is the provision of long-term financing for house purchase or funds used for building
and maintaining the housing stock of a country. The NHB report on Indian Housing Finance
System (2000), describe housing finance to mean financing of home purchase.
Housing finance is provided for the following purposes

• Purchase/ Construction of new House/ Flat
• Purchase of an existing House/ Flat
• Purchase of a plot of land for construction of House
• Extension/ repair/ renovation/ alteration of an existing House/ Flat
• Purchase of Furnishings and Consumer Durables as a part of the project cost
• Takeover of an existing loan from other Banks/ Housing Finance Companies
Housing Finance in India

The Housing finance sector in India has no doubt, experienced unprecedented change in its
structure from its formulation stage. Indian Housing Finance has far moved from the stage of
being a solely government undertaking provided service during the 1970’s to a very competitive
sector with more than 45 housing finance entities providing housing loans worth ` 7,81,000
million to home buyers across India. The housing finance revolution in India can be divided into
five distinct phases:
38
Phases of Indian Housing Finance
Phase I Before 1970 Government Domination
Phase 1970 – 1980 HUDCO and HDFC establishes

II
Phase 1980 – 1990 Establishment of NHB
III
Phase 1990 – 2000 Liberalization of Interest Rate
IV
Phase 2000 to present High Growth
V
The first phase began before 1970 when the sole provider of any house building support was
the government of India through its various social schemes for public housing. The government
implemented these schemes through state housing boards which were responsible for
allocating serviced land and houses to individuals based on the principles of social equity.
The second phase starts with the establishment of the public housing company, Housing and
Urban Development Corporation (HUDCO). HUDCO was created to assist and promote housing
and urban development programs with government agency. HUDCO still plays an important role
in implementing government initiatives such as the Valmiki Ambedkar Awas Yojna which was
launched by Government of India in 2001-02 to provide shelter or upgrade the existing shelter
for the people living below poverty line in the urban slums. Another important private player,
Housing Development Finance Company (HDFC) was established in 1977. HDFC pioneered in
individual lending, based on market principles. HDFC today is one of the largest home loan
providers of the country and its success displayed that financing homes can be a very profitable
business.
The third phase covers the decade of 1980s, which is marked by the establishment of the
country’s housing finance regulator - National Housing Bank in 1987. The era also involved the
government in directing various agencies like insurance companies, commercial banks (Under
priority lending requirements which allowed banks to allocate 1.5% of their incremental deposits
to housing under RBI guidelines.), provident funds and mutual funds to invest part of their
increment sources on housing. Two Insurance companies, LIC and GIC, started supporting the
sector both directly through their newly established housing finance companies and indirectly by
investing a proportion their net accretions in socially oriented schemes.
The fourth phase is the era after liberalization and is characterized by dramatic changes in
pricing of loans. Before 1994, the pricing of home loans were regulated by the NHB based on a
differential rates charged according to the size of the loan. This policy was amended in 1994
and providers were free to charge market rates for the loans above ` 25,000. The fourth phase
saw a dominance of fixed interest rates, but variable rate offers started emerging at the end of
the decade.
The fifth Phase of rapid growth in the sector started after the millennium. Home loan
disbursements rapidly grew during the first few years of this phase. The lower interest rate
regime, rising disposable incomes, stable property prices and fiscal incentives made housing
finance an attractive business. Home loan disbursements grew to ` 7,68,191.90 million in 2005
39
from ` 1,47,012 million in 2001. As per CRISIL estimates, housing finance disbursements are
estimated to have grown by around 16.1% in Fiscal 2012 to Rs 2,044 billion (as compared with
Rs 1,760 billion in Fiscal 2011).
THE STRUCTURE OF HOUSING FINANCE SECTOR IN INDIA
Easy access to institutional finance at affordable rates is a critical requirement for a dynamic
housing sector. While several financial institutions are involved in providing housing finance, the
need for specialized housing finance institutions for mobilization of resources and greater
efficacy cannot be overemphasized, given the distinctive nature of housing finance. The broad
structure of the Indian housing finance system is shown in the chart below. The housing finance
system in India comprises the National Housing Bank (NHB), the apex housing institution which
regulates the housing related functioning of other financial institutions such as the HDFC,
HUDCO, LIC, GIC and a host of HFCs and commercial banks. Depending upon whether
housing finance comprises their primary or secondary function, these institutions can be
classified into two categories, namely, specialized housing finance institutions and general
housing finance institutions (HFIs).
General Housing Finance Institutions
The general HFIs are called so as they lend only a small proportion of their funds for housing.
Either regulations do not permit them to lend beyond certain limits or their primary function is
40
other than housing finance. The foremost among these is the Life Insurance Corporation of
India.
1. Life Insurance Corporation of India and General Insurance Corporation
The Life Insurance Corporation of India (LIC) and the General Insurance Corporation (GIC)
provide support to housing activity directly as well as indirectly. The former is statutorily required
to invest 25% of its net annual accrual in socially oriented schemes which includes housing. LIC
undertakes projects of public residential housing in selected cities. Both LIC and GIC grant
loans for the rural housing programmes of the State Governments and State level Apex
Cooperative Housing Finance Societies. LIC also subscribes to the bonds issued by HUDCO
and the SHBs. It also lends to the NHB. Policy holders of LIC are also extended the facility of
loans. LIC is presently the single largest institutional lender to the housing sector. It invests
about 12% of its total credit disbursal to the housing sector largely indirectly through agencies
and institutions as mentioned above. In June 1989, LIC promoted the LIC Housing Finance
Company Limited as its subsidiary. It was set up with the aim of supplying long term finance for
purchase or construction of housing units to LIC policy holders in India. The General Insurance
Corporation started its housing finance related activities in 1977. GIC and its subsidiaries are
statutorily required to dedicate 35% of their new funds in each year for housing purpose . These
funds flow to the housing sector indirectly through loans to state governments, HUDCO and
other development authorities. It invests in bonds and debentures of these authorities that
undertake housing activities.
2. Provident Funds
Housing finance funds are also made available by the Provident Funds to its subscribers. In a
way they lend liquidity to the savings accumulated in the accounts of the subscribers. Provident
Funds such as the General Provident Fund, the Public Provident Fund and the Contributory
Provident Fund finance the house purchase of their members by granting advances or
permitting partial withdrawals of their subscriptions. However, only about one per cent of their
total accumulated funds are used for housing purpose.
3. Commercial Banks
The commercial banking sector consists of public sector banks and private sector domestic as
well as foreign banks. Traditionally, the mortgage market in India had been dominated for many
years by a diverse group of Housing Finance Companies (HFCs), with some focusing on
specific regions in India and others targeting specific consumer segments. The banking sector
was not involved in housing credit, its role perceived to be limited to providing for the working
capital needs of industry and trade. Besides, commercial banks face the typical issue of
mismatch between assets and liabilities with regard to their maturity term. It was only after
nationalization of banks in 1969, that social needs of the community were incorporated into the
normal course of business of the commercial banks. The Reserve Bank of India initially
encouraged the commercial banks to grant credit to the housing sector in the form of ‘directed
credit.’ Under directed lending, the major portion was provided in terms of subscribing to the
bonds and debentures of HUDCO and SHBs, which were guaranteed by the government, and in
the form of direct lending to individuals and groups of borrowers belonging to the scheduled
castes, scheduled tribes and the EWS . The remaining amount was contributed to HDFC. The
nationalized banks also financed housing projects independently or through a consortium
formed with other banks, HUDCO, LIC, SHBs and other bodies. Directed lending essentially
41
meant that banks were mandated to lend to housing finance intermediaries at subsidized rates.
The commercial banks’ housing finance activities take three discrete modes: direct lending in
terms of home loans; indirect lending through approved housing finance companies or State
housing boards which on-lend the funds; and investments in mortgage backed securities (MBS)
issued by housing finance companies .
4. Other Banks
As far as Cooperative Banks and the Regional Rural Banks are concerned, they have not been
very active in lending for housing although they are allowed to. Agriculture and Rural
Development Banks (ARDBs) are term lending institutions operating exclusively in the rural
sector. Though housing finance was at first not within their scope, with the importance attached
to the housing sector in the late eighties, especially after the setting up of the NHB, ARDBs
started lending for housing in the rural areas. In the year 2000, there were 19 ARDBs in the
country operating through their own branches or through those of the primary cooperative
agriculture and rural development banks.
Specialized Housing Finance Institutions

Specialized HFIs are those whose primary function is to lend for housing. While there are
market oriented specialized HFIs involved in the business of home loans, the government has
also set up specialized HFIs in the public sector with the primary purpose of improving the
housing situation in India by undertaking housing projects, financing house
construction/purchase activities and providing technical and financial assistance to various
stake holders in the housing market.
1. Housing and Urban Development Corporation (HUDCO)

Housing and Urban Development Corporation is a specialized HFI set up in 1970 as a public
sector apex body with the basic objective to fund state governments in infrastructure
development and to serve the shelter needs of the poor sections of the society. It finances and
undertakes housing and urban development programmes in the country by building satellite
towns, providing finance to building materials industries, conducting research in low cost
housing, etc. It also undertakes consultancy in the areas of housing and urban development.
With a special focus on the economically weaker sections of the society, HUDCO practices
progressive interest rate policy wherein the rates of interest on home loans are varied between
4 to 15 percent, according to the income levels of borrowers. It extends the benefit of longer
repayment facility for the poor. Out of its total disbursal of home loans, it ensures that a higher
proportion goes to the poor. It thereby seeks to foster greater equity and distributive justice
among households belonging to different income classes.
2. Housing Development Finance Corporation (HDFC)

One of the most important specialized HFI is the Housing Development Finance Corporation
(HDFC) which was established in 1977 as a private sector institution with the purpose of
providing long term loans to home buyers. In fact, private sector partaking in retail housing
finance that provided housing loans to individuals, cooperative societies and the corporate
sector, initiated with the establishment of HDFC. It raises long term funds from institutional
sources. It has also entered into international syndication. The USAID and Aga Khan
Foundation provide funds to HDFC for its housing finance activities. HDFC has played a
significant role in promoting the establishment of
42
3. Housing Finance Companies (HFCs)

The non-banking finance companies (NBFC) entered into the housing finance sector by
incorporating as Housing Finance Companies. A NBFC is classified as a HFC if its principal
objective is to provide housing finance or in the case of competing objectives, where housing
finance figures as the major component of the company’s asset.
In the mid and late 1980s, HFCs were set up as private limited companies like the Dewan
Housing Finance Limited or as joint ventures with state governments like the Gujarat Rural
Housing Finance Corporation, or bank-sponsored HFCs like Can Fin Homes, SBI Home
Finance, PNB Housing Finance, etc. State owned insurance companies like the LIC and the
GIC also set up their own housing finance subsidiaries. Some other HFCs are Global Home
Finance Ltd., Birla Home Finance Ltd., Tata Home Finance Ltd., Maharshi HFC Ltd.,
Parashwanath HFC, etc. While there are close to 400 HFCs, 95% of the total housing loans
sanctioned by them are provided by 29 major companies. Some of the above mentioned HFCs
were later merged with their parent banks or have been acquired by some other financial
institutions. The major sources of funds for HFCs include loans from banks, debentures, fixed
deposits and refinance from the NHB. The problem of mismatch of asset-liability as they
typically depended on public deposits and the general financial institutions for funds was
resolved to some extent with the establishment of the NHB. The NHB provided refinance
assistance which was synchronous with the repayment tenure fixed by the HFCs for the ultimate
borrower. Nevertheless, this does not solve the issue of sufficient long term funds for the
specialized institutions as there is a limit to which NHB can fund the entire portfolio of these
companies. The eligibility for approval of refinance facility is that a minimum of 75% of the
capital employed should have been by way of long-term finance for housing. Currently 54 HFCs
are registered with the NHB.
4. National Housing Bank (NHB)
The growing presence of private sector institutions necessitated the establishment of a

regulatory and supervisory agency specializing in the furtherance and financial functions of
housing finance. This role was being played by the RBI. Despite the large number of agencies
providing housing finance to individuals, the flow of funds through formal institutional finance
was not found to be adequate. The housing sector was underserved in terms of the volume of
loans to individuals, sufficient serviced land, building materials, and effective low-cost
technology . National Housing Bank was instituted in July 1988 under an Act of Parliament
(NHB Act 1987) to create the desired system.
The role of NHB can be divided under three heads, namely, promotional and developmental
function, regulatory function and financial function. The fundamental responsibility of the NHB is
to develop a healthy and self-sufficient housing finance system in the country. For this, it sought
to set up more local and regional level specialized institutions so as to have committed outlets
for the supply of housing credit. These institutions, NHB believed, would be able to tailor formal
credit for the differing needs of various income groups. Households with above average income
could well be served by market based HFIs operating under mandatory prudential norms by the
regulator. The below poverty line households on the other hand, would need an institutional
approach to housing that not only incorporates the factor of subsidy but that also integrates
employment and poverty alleviation programmes. The middle income group comprising the low
and moderate income households, and constituting nearly half the total number of households
also need to be catered. For this the NHB provides refinance schemes to encourage the
financial institutions to lend.
43
5. Cooperative Housing Finance Societies

Cooperative Housing Finance Societies represent the third category of institutions in the
structure of institutional housing finance intermediaries, the other two being, the commercial
banks and the HFCs. Among the three, cooperative societies are the most inclusive in terms of
catering to the credit requirements of the common man; however they are becoming
insignificant with each passing year . Cooperative housing finance societies have a two tier
structure that includes the apex cooperative housing finance society at the state level and the
primary cooperative housing finance society at the retail level. There are 26 state level apex
cooperative societies and more than 90000 registered cooperative housing finance societies in
the India. NHB provides financial assistance and support to help them cater to the housing
needs of the community.
KEY FEATURES OF HOUSING FINANCE

The following are some of the key features of housing finance provided by different
banks/financial institutions to Individuals
• No cap on maximum loan amount for purchase/ construction of house/ flat

• Option to club income of spouse and children to compute eligible loan amount
• Provision to club expected rent accruals from property proposed to compute eligible loan
amount
• Provision to finance cost of furnishing and consumer durables as part of project cost
• Repayment permitted upto 70 years of age
• Free personal accident insurance cover
• Optional Group Insurance from insurance companies at a concessional premium (Upfront
premium financed as part of project cost)
• Interest applied on daily diminishing balance basis
• different schemes which offer attractive packages with concessional interest rates to Govt.
Employees, Teachers, Employees in Public Sector Companies etc.
• Special scheme to grant loans to finance Earnest Money Deposits to be paid to Urban
Development Authority/ Housing Board, etc. in respect of allotment of sites/ house/ flat
• No Administrative Charges or application fee
• Prepayment penalty is recovered only if the loan is pre-closed before half of the original
tenure (not recovered for bulk payments provided the loan is not closed)
• Provision for downward refixation of EMI in respect of floating rate borrowers who avail
Housing Loans of ` 5 lacs and above, to avail the benefit of downward revision of interest
rate by 1% or more
• In-principle approval issued to give you flexibility while negotiating purchase of a property
44
Indian Housing Finance Industry
TYPES OF HOUSING FINANCE
Home loans are an attractive and popular means of buying a dream house for most people. In
India, the demand for home loans has increased manifold in the last decade. Every day
numerous people apply for home loans to own a perfect abode for themselves. The fact
that home loans come with added advantages (like tax benefits) is the icing on the cake.
Lenders provide home loans not only for buying houses but for a variety of related purposes.
The home loans market is brimming with diverse home loan products which cater to different
needs of individual customers. The following are some popular types of home loans available in
the Indian housing finance market:
1. Land Purchase Loans
Land purchase loans are taken to buy a plot of land on which a borrower wishes to construct his
house. Most banks offer up to 85 percent of the price of the land. These loans can be availed for
residential as well as for investment purposes. Almost all leading banks offer this loan like ICICI
Bank (Land Loan), Axis bank (Loan for land purchase) etc.
45
2. Home Purchase Loans
The home purchase loans are the most popular and the most commonly available home loan
variants. These loans can be used to finance the purchase of a new residential property or an
old house from its previous owners. In this type of loan also, lenders usually finance up to 85
percent of the market value of the house. These loans are provided either on fixed interest rates
or floating interest rates or as hybrid loans. All banking institutions and housing finance
companies provide this type of loan.
3. Home Construction Loans
These loans can be availed by those individuals who want to construct a house according to
their wishes rather than purchasing an already constructed one. The loan application and
approval process for home construction loans are somewhat different from those of the
commonly available housing loans. The plot of land on which the borrower wishes to construct
the house should have been bought within a year for the cost of the land to be included as a
component for calculating the total price of the house. If the plot has been purchased more than
a year ago, then the above clause is not applicable. The borrower has to make a rough estimate
of the cost that will be incurred for the construction of the house and then apply for the loan with
the same amount. The lender then takes over from their and analyses the application to decide
whether or not to sanction the loan. The approval or disapproval of the same is intimated by the
lender to the applicant. The loan amount may be disbursed at one go or in several installments
according to the progress in the construction of the house. Banks like Canara Bank, UCO Bank,
Bank of Baroda provide these loans.
4. Home Expansion/Extension Loans
Home expansion or extension loans are useful in situations when people want to expand their
existing house. Expansion includes alteration in the current structure of the residence to add
extra space such as constructing a new room, a floor, a bigger bathroom or enclosing a
balcony. Though many banks provide loans for these purposes as part of home expansion
loans, some banks lend for the same purposes as part of their home improvement loans. It
depends on how a bank has categorizes its loans. Some popular banks which provide home
expansion loans are HDFC Bank (HDFC Home Extension Loan), Bank of Baroda etc.
5. Home Improvement loans
Home improvement loans are availed by individuals who already own a house but lack the
funds to renovate it. All kinds of renovations and repair works can be financed using this variant
of home loans such as internal and external painting, external repair works, electrical work,
waterproofing and construction of underground or overhead water tank etc. ICICI Bank, Vijaya
Bank and Union Bank of India are among those banks which provide specialized home
improvement loans.
6. Home Conversion Loans
46
Those borrowers who have already purchased a house by taking a home loan but now want to
buy and move to another house opt for the home conversion loans. Through these loans, they
can fund the purchase of the new house by transferring the current loan to the new house.
There is no need to repay the loan on the previous home. Though useful, this segment of home
loans is accused of being quite expensive. This housing finance scheme is provided by HDFC
Bank among others.
7. NRI Home Loans
NRI home loans is a specialized home loan variant which has been developed to assist non-
residents in acquiring housing finance to buy residential property in India. These loans are
meant exclusively for the non-resident Indians. The formalities of availing this segment of home
loans is similar to the regular home loans which are offered to residents, only the paperwork is a
bit elaborate. Almost all public and private sector banks provide NRI home loans.
8. Balance Transfer Loans
Balance transfer option can be availed when an individual wants to transfer his home loan from
one bank to another bank. This is usually done to repay the remaining amount of loan at lower
interest rates or when a customer is unhappy with the services provided by his existing lender
and wants to switch to another lender. Banks such as Deutsche Bank, ICICI Bank, Kotak
Mahindra Bank offer this facility among other lenders.
9. Stamp Duty Loans
Stamp duty loans are provided to pay off the stamp duty charges on the purchase of a property.
The amount from this loan can be used solely for this purpose. This segment of home loans has
yet not gained much popularity.
10. Bridged Loans
Bridge loans are short term loans which are meant for people who already own a residential
property but are planning to buy a new house. It helps borrowers to fund the purchase of the
new house until a buyer is identified for the old house. It is extended for a period of less than
two years and requires the mortgage of the new house with the lender. Some banks offering this
type of loan are Vijaya Bank, HDFC Bank etc.
Documents Required for Approval of home Loans:

Businessman/ Self employed professional:
1. Application form with photograph
2. Educational qualification
3. Identity and residence proof
4. Proof of business existence with business profile and last three years income tax
return
5. Last 3 years income statement and balance sheet.
6. Last 3 month’s personal and business bank statements.
7. Processing fee check
47
Salaried customers:
2. Identity and Residence proof
3. Latest salary slip
4. Form16
5. Last 6 months bank’s statement
6. Processing fee cheque.
Important Housing Finance Companies in India
 Birla Home Finance Limited

 BOB Home Loan
 Canara Bank Home Loan
 Dewan Housing Home Loan
 GIC Home Loan
 HDFC Home Loan
 HSBC Home Loan
 ICICI Home Loan
 IDBI Home Loan
 LIC Home Loan
 PNB Home Loan
 SBI Home Loan
 Sundaram Home Finance
MERITS AND DEMERITS OF HOUSING FINANCE
Merits of Home Loan

• Home Loan helps many people to own their dream home
• Home Loan improves housing and infrastructure development in the country.
• Interest charged on Home Loan is very reasonable.
• Home Loan interest and principal repayments are eligible for Income Tax savings.
• Many unique schemes like insurance cover is available with Home Loan
• Longer repayment is allowed on home loan ( upto 20 years)
De-merits of Home Loan

• Amount of Home Loan repayment ( EMI) becomes more with the increase in interest rate,
especially when loan is taken on floating interest rates.
• There is no uniformity in interest rates charged by different banks.
• Easy availability of Home Loan has led to a tremendous increase in prices of property
48
Home Loan Interest rates of SBI With effect from 20.12.2013
For Women Borrowers
Loan Amount Spread over the Base Rate Effective Rate

(Base Rate: 10%)
Upto Rs. 75.00 lacs 10 bps above the Base Rate 10.10 % p.a.
Above Rs. 75.00 25 bps above the Base Rate 10.25% p.a.
lacs
No Fixed Rate option will be available in any limit brackets.
For other Borrowers
Loan Amount Spread over the Base Rate Effective Rate

(Base Rate: 10%)
Upto Rs. 75.00 lacs 15 bps above the Base Rate 10.15 % p.a.
Above Rs. 75.00 30 bps above the Base Rate 10.30% p.a.
lacs
No Fixed Rate option will be available in any limit brackets.
Interest charged on housing finance:
Fluctuating Home Purchase Loans Interest rates: Keep changing with change in the
prevailing market rate or the prime lending rate.
Fixed Loans Interest Rate: As the name suggests, do not change during the entire loan
period, irrespective of the prevailing market rate. generally fixed loan interest rates are higher
than the fluctuating loan rate.
Documents Required for Approval of home Loans:
Businessman/ Self employed professional:
2. Educational qualification
3. Identity and residence proof
4. Proof of business existence with business profile and last three years income tax return
5. Last 3 years income statement and balance sheet.
6. Last 3 month’s personal and business bank statements.
7. Processing fee check
Salaried customers:
49
2. Identity and Residence proof
3. Latest salary slip
4. Form16
5. Last 6 months bank’s statement
6. Processing fee cheque.
Tax Implications of Housing Loan
 Repayment of Principal Amount: Allowed as deduction U/s 80 C (Rs 1,50,000)

 Interest Payment: Allowed as deduction U/s 24(b) upto an amount of Rs 2,00,000
Reverse Mortgage
In simple terms, a reverse mortgage is the "opposite" of a conventional home loan.
A reverse mortgage enables a senior citizen to receive a regular stream of income from a
lender (a bank or a financial institution) against the mortgage of his home. The borrower (i.e. the
individual pledging the property), continues to reside in the property till the end of his life and
receives a periodic payment on it.
System of Reverse Mortgage
When the home is pledged, its monetary value is arrived at by the bank, on the basis of the
demand for the property, current property prices, and the condition of the house. The bank then
disburses a loan amount to the borrower in the form of periodic payments, after considering a
margin for interest costs and price fluctuations. The periodic payments also known as reverse
EMI are received by the borrower over fixed loan tenure. With each payment, whether monthly
or quarterly, the equity or the individual's interest in the house decreases. A reverse mortgage is
an ideal option for senior citizens who require regular income, or if the property is of illiquid
nature for some reason.
General guidelines for reverse mortgage
The Reserve Bank of India has formulated the following guidelines for a reverse mortgage.
50
2. Maximum loan amount would be up to 60% of the value of the residential property.
3. Maximum tenure of the mortgage is 15 years and minimum is 10 years. Some banks are
now also offering a maximum tenure of 20 years.
4. Option of monthly, quarterly, annual or lump sum loan payment.
5. Property revaluation to be undertaken by the lender once every 5 years. If at such time,
the valuation has increased, borrowers have the option of increasing the quantum of the
loan. In such a case, they are given the incremental amount in lump-sum.
6. Amount received through reverse mortgage is a loan and not income. Hence it will not
attract any tax. However, a borrower is liable to capital gains tax, at the point of
alienation of the mortgaged property by the mortgagee for the purposes of recovering
the loan.
7. Reverse mortgage interest rates could be either fixed or floating. The rate would be
determined by the prevailing market interest rates.
Eligibility Criteria for reverse mortgage
1. House owners above the age of 60 years. If spouse is a co-applicant, then she should
be above 58 years.
2. Owners of a self-acquired, self-occupied residential house or flat, located in India. The
titles should be clear, indicating the prospective borrower's ownership of the property.
3. Property should be free from any encumbrances.
4. The life of the property should be of minimum 20 years.
5. Property should be the permanent primary residence of the individuals.
Settlement of a reverse mortgage
A reverse mortgage loan becomes due when the last surviving borrower dies, or if the borrower
chooses to sell the house. The bank first gives an option to the next of kin to settle the loan
along with accumulated interest, without sale of property. If the next of kin is unable to settle the
loan, the bank then opts to recover the same from the sale proceeds of the property.
Any extra amount, after settlement of the loan with accrued interest and expenses, through the
sale of the property, will be passed on to the legal heirs. If the sale proceeds are lower than the
accrued principal plus interest amount, the loss is borne by the bank. This loss could happen in
cases where the banks original estimation is not in line with the real estate market movement.
Drawbacks of reverse mortgage
Lengthy documentation procedures: Banks require various documents of the property. For a
senior citizen this procedure could be tedious, complicated and difficult to understand.
Fixed monthly amounts: The monthly payouts are fixed. There is no provision to increase this
amount in case of an emergency or contingency.
Popularity of the scheme in India
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Though introduced in 2007, Reverse Mortgage has not gained much popularity in India for the
following reasons.
Inadequate marketing of the product. Recent reports indicate that many of the senior citizens
are not aware of the existence of such a product.
Many banks which offer Reverse Mortgage have capped the maximum loan amount available
for individuals to a maximum amount of Rs 50 lakhs to 1 crore.
Children have resentment for a reverse mortgage as they see it as giving away their family
home or legacy.
Non-banking financial companies
Non-banking financial companies
Non-banking financial intermediaries or companies have emerged as key players in

India’s economic development in the recent past. NBFIs have accelerated the pace of
financial market development by providing spectrum of unique services. Non Banking
Financial Intermediaries / companies are the institutions which mobilizes funds by way of
deposits from the public and channalise these to meet the equirements of the borrowers
in different sectors by making loans and advances, investments, leasing, factoring, hire
purchase etc.
Non-bank financial companies (NBFCs) also known as non-bank bank, these are financial
institutions that provide banking services without meeting the legal definition of a bank, i. e. one
that does not hold a banking license. Operations are, regardless of this, still exercised under
bank regulation. Non-bank institutions frequently acts as suppliers of loans and credit facilities,
however they are typically not allowed to take deposits from the general public and have to find
other means of funding their operations such as issuing debt instruments.
Non-Banking Financial Company (NBFC) is a financial intermediary that is engaged in certain

financing activities other than banking. These activities are specified in the Non-Banking
Financial Companies (Reserve Bank) Directions, 1977 and amendments thereto.
They include equipment leasing, HIRE-PURCHASE, housing finance and investments in

financial securities; however, insurance companies and stock broking enterprises are excluded.
Many of these intermediaries offer other FUND-BASED products too, as for instance bill
DISCOUNTING and FACTORING; also offered are fee-based services such as security issues
management and advice on MERGERS and ACQUISITIONS, capital restructuring etc.
The activities of NBFCs are both complementary and competitive to banks.
52
Function of NBFC’s
1. Financial Intermediation:
The most important function of the non-bank financial intermediaries is the transfer of funds
from the savers to the investors. Financial intermediation is economical and less expensive to
both small businesses and small savers. (a) It provides funds to small businesses for which it is
difficult to sell stocks and bonds because of high transaction costs, (b) It also benefits the small
savers by pooling their funds and diversifying their investments.
2. Inducement to Save:
3. Mobilisation of Saving:
4. Providing Economies of Scale:
5. Investment of Funds:
The NBFI’s can be classified as follows
1. Liabilities based classification:
On the basis of liabilities, NBFCs are classified into two categories (i) NBFCs-Deposit taking
(NBFCs-D) and (ii) NBFCs-Non-Deposit taking (NBFCs-ND). NBFCs-D are subject to
requirements of capital adequacy, liquid assets maintenance, exposure norms (including
restrictions on exposure to investments in land, building, and unquoted shares), ALM discipline
and reporting requirements, whereas contrastingly, until 2006 NBFCs-ND were subject to
minimal regulation.
2. Business based classification:
The NBFCs, depending upon its nature of business, are broadly categorized as loan companies
(LC), investment companies (IC), infrastructure finance companies (IFC), asset finance
companies (AFC), core investment companies (CIC), infrastructure debt funds (IDF), micro
finance institutions (MFI), and factors. NBFCs-IDF and NBFCs-MFI were created in FY12 and
were brought under a separate regulatory framework. NBFCs-Factors were introduced in Sep
2012.
3. Size based classification:
Among NBFCs-ND, companies with asset size of Rs 1 bn and more have been categorised as
systemically important NBFCs-ND (NBFC-ND-SI), and those with asset size of not more than
Rs 1 bn have been categorized as non-systemically important NBFCs-ND.
Regulatory Framework of Non Banking Financial Intermediaries
53
The Reserve Bank of India is entrusted with the responsibility of regulating and supervising
the Non-Banking Financial Companies by virtue of powers vested in Chapter III B of the
Reserve Bank of India Act, 1934. The regulatory and supervisory objective, is to:
a. ensure healthy growth of the financial companies;
b. ensure that these companies function as a part of the financial system within the policy
framework, in such a manner that their existence and functioning do not lead to systemic
aberrations; and that
c. the quality of surveillance and supervision exercised by the Bank over the NBFCs is
sustained by keeping pace with the developments that take place in this sector of the financial
system.
The RBI Act was amended in 1997 to include new regulations for NBFC’s:
 Compulsory registration for all NBFCs, irrespective of their holding of public deposits, for
commencing and carrying on business of a non-business financial institution
 The amended act also classified NBFCs into three broad categories i) NBFCs accepting
public deposits; ii) NBFCs not accepting/holding public deposits; and iii) core investment
companies
 Minimum entry point net-worth of Rs 2.5 million which was subsequently revised
upwards to Rs 20 million
 Deposit mobilisation linked to net-worth, business activities and credit rating
 Maintenance of 12.5% of their deposits in liquid assets
 Creation of a Reserve Fund and transfer of 20% of profit after tax but before dividend to
the fund
 Ceiling on maximum rate of interest that NBFCs can pay on their public deposits
 NBFCs with an asset size of at least Rs 1 billion or a deposit base of at least Rs 200
million are required to have Asset-Liability Management systems and constitute an
Asset-Liability Management Committee
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MODULE 4
FACTORING AND FORFEITING
MEANING AND SCOPE OF FACTORING
Factoring is a continuing arrangement between a financial institution and a business concern

selling goods and services to trade customers. As a result of this arrangement, the factor
undertakes collection of the client’s debts and finance to client on the basis of his accounts
receivable.
It is an agreement in which receivables arising out of sale of goods / services are sold by a firm
to the factor (financial intermediary) as a result of which title of goods represented by
receivables passed on to the factor. Factor becomes responsible for debt collection. Factoring is
a flexible alternative to traditional forms of funding. It allows business firms to respond quickly to
changes in market conditions and matches their cash flows with their business requirements,
thereby facilitating increased production and sales. However, the scope of factoring in modern
times has considerably increased. It is a continued service arrangement under which a financial
institution undertakes the task of recording, collecting, controlling and protecting the book debts
for its clients including the purchase of his bills receivable. Thus, as a result of factoring
services, the manufacturers, seller or dealer in goods can concentrate on manufacturing,
advertising and selling functions alone, the record keeping functions of sales, book debts, bills
receivable and their utilization are completely vested with the factoring agency. The results are
the following major benefits to the client.
i) Reduction in the cost of maintenance and collection of book debts.

ii) Saving in time, manpower needed for collection, and
iii) Monitoring of book debts and prevention of bad debts, since the debtors would not like to be
looked down in the eyes of factoring credit institution.
FUNCTIONS OF FACTORING:
The functions of a factoring credit institution can be grouped in the following categories:
i) Credit recording: It involves maintenance of debtors ledger, collection schedules, discount
allowed schedule, ascertainment of balance due.
ii) Credit administration: It includes the work of collecting the book debts. The factoring
institution receives service charges by way of discount or rebate deducted from the bill or bills.
iii) Credit protection: The factoring institution eliminates the risk of loss of the client by taking
over the responsibility of book debts due to the client.
iv) Credit financing: The factoring institution advances a proportion of the value of book debts
of the clients immediately and the balance on maturity of book debts. This improves the clients
liquidity position in the sense that book debts have been substituted by cash.
v) Finance and business information: A factoring institution also advises the client on the
prevailing business trend, financial and fiscal policy, impending development in commercial and
industrial sector, potentials for foreign collaboration, transfer of technology, export and import
potential, identification and selection of potential trade debtors.
55
FACTORING PROCESS
 Client concludes a credit sale with a customer.

 Client sells the customer’s account to the Factor and notifies the customer.
 Factor makes part payment (advance) against account purchased, after adjusting for
commission and interest on the advance.
 Factor maintains the customer’s account and follows up for payment.
 Customer remits the amount due to the Factor.
 Factor makes the final payment to the Client when the account is collected or on the
guaranteed payment date.
Chart showing process of Factoring
Difference between Bill discounting and Factoring
Bill Discounting Factoring
 Bill is separately examined and  Pre-payment made against all unpaid and
discounted. not due invoices purchased by Factor.
 Financial Institution does not have  Factor has responsibility of Sales Ledger
responsibility of Sales Ledger Administration and collection of Debts.
Administration and collection of Debts.
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 No notice of assignment provided to  Notice of assignment is provided to

customers of the Client. customers of the Client.
 Bills discounting is usually done with  Factoring can be done without or without
recourse. recourse to client. In India, it is done with
recourse.
 Financial Institution can get the bills re-  Factor cannot re-discount the receivable
discounted before they mature for purchased under advanced factoring
payment. arrangement.
Difference between securitization and Factoring
While both factoring and securitization involves capitalizing the receivables of the company,
however there are many differences between factoring and securitization such as
1. While factoring is arrangement between the banks and a company in which financial
institution purchases the book debts of a company and pays the money to the company against
receivables whereas Securitization is the process of converting illiquid assets into liquid assets
by converting longer duration cash flows into shorter duration cash flows.
2. Under factoring there are two parties that is the bank and the company while under
securitization there are many investors involved who invest in the securitized asset.
3. While factoring is done for short term account receivables ranging from 1 month to 6 months
whereas securitization is done for long term receivables of the company.
4. While factoring is of many types and can be with or without recourse while securitization is
done without recourse.
5. Since factoring involves only bank and the company there is no need for any credit rating
while securitization involves many investors and therefore it is necessary to take credit rating
before going for securitization of receivables.
TYPES OF FACTORING :
i) With recourse factoring:- If the factor is not able to collect the receivables from the buyers/
debtors the loss has to be incurred by the firm and not by factor. In other the firm has to bear
bad debt loss if any.
ii) Without recourse factoring:- If factor cannot collect it is his loss and it cannot be passed on
to the firm. In the case of non-recourse factoring, the factor besides providing assistance for
collection also assumes the risk of bad debts.
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Apart from above discussed two basic categories of factoring there are several other
classification of factoring.
1. Advance factoring: In the case of advance factoring, the factor provides an immediate
advance against the receivables assigned to it.
2. Maturity factoring: In the case of maturity factoring, the factor provides an assistance as
regards collection and possible insurance against bad debts.
3. Bank participation factoring: In case of an ordinary factory arrangement, a certain
percentage of the face value of receivables is set aside by the factor as reserve to protect
against sales returns or cash discount. For instance, if the receivables are of Rs.100, the factor
after keeping the reserve of about 10% will grant advance only against the balance of
receivables. In other words, the banker will advance only Rs. 90 to the firm. In case of
participation factoring, the firm creates a floating charge in favour of commercial bank and
borrows against such reserve.
4. Supplier guarantee factoring: In the case of supplier guarantee factoring, the factor
provides a guarantee to the supplier against the invoice raised by the supplier on the firm. The
firm raises the bills on the ultimate customers and assigns them to the factor. This arrangement
is advantageous to both the supplier and the firm since the factor takes care of the collection of
bills of both the parties.
5. Disclosed factoring: In case of this type of factoring the name of the factor is mentioned or
disclosed in the sales invoice. In a reverse case it is termed as undisclosed factoring.
6. International factoring: It refers to factoring of export sales. An international factoring
house, in addition to the usual service of a factor also undertakes the responsibility of
completing of all legal and procedural formalities concerned with the export sales. The firm is,
therefore, saved from the trouble of getting itself involved in the intricacies associated with the
international trade.
Advantages of Factoring:
• Instantly turn receivables to cash
• Ensures definite and continuous cash flows to the firms
• Avail credit protection for receivables
• Business organizations can take well informed credit decisions
• Business organizations can outsource their sales ledger administration
• Factoring thus not only helps in expanding the business, but also provides with an efficient
collection mechanism and protection against bad debts.
Limitations of Factoring:
• High cost especially in case of without recourse factoring.
• Using factoring services indicates financial weakness of the firm.
FACTORING SERVICES IN INDIA
Factoring service in India is of recent origin. It owes its genesis to the recommendations of the
Kalyanasundaram Study Group appointed by the RBI in 1989. Pursuant to the acceptance of
these recommendations, the RBI issued guidelines for factoring services in 1990. Banking
Regulation Act, 1949, was amended in 1991 for Banks setting up factoring services. The first
factoring company – SBI Factors and Commercial Ltd (SBI FACS) started operation in April
58
1991 followed by CanBank Factors Ltd was started in august 1991. February, 1994, the RBI has
permitted all banks to enter into factoring business departmentally.
Some of the important Factoring companies in India

• Canbank Factors Limited:
• SBI Factors and Commercial Services Pvt. Ltd:
• The Hongkong and Shanghai Banking Corporation Ltd:
• Foremost Factors Limited
• Global Trade Finance Limited:
• Export Credit Guarantee Corporation of India Ltd
• Citibank NA, India:
• Small Industries Development Bank of India (SIDBI):
• Standard Chartered Bank
RBI REGULATIONS RELATING TO FACTORING:
The Reserve Bank of India has introduced a new category of non-banking finance company,
NBFC- Factor. The NBFC–Factor (Reserve Bank) Directions, 2012 come into operations from
April 2012. A factor is a company which buys another company’s accounts receivable (invoices)
at a discount, assumes credit risk of the account and recovers cash at the end of the credit
period. Factoring is a financial transaction whereby a business sells its account receivable to a
third party (factor) at a discount. So far there were 6 types of NBFCs: Asset Finance
Companies, Investment Companies, Loan Companies, Infrastructure Finance Companies,
Systemically Important Core Investment Companies and Microfinance Institutions.
 According to the RBI’s directions, every company seeking registration as NBFC-Factor

has to have a minimum Net Owned Fund (NOF) of Rs 5 crore,.
 Existing companies seeking registration as NBFC-Factor but do not fulfil the NOF
criterion of Rs 5 crore can approach the RBI for time to comply with the requirement.
 An NBFC-Factor has to ensure that its financial assets in the factoring business
constitute at least 75 percent of its total assets and its income derived from factoring
business is not less than 75 percent of its gross income.
 Every company intending to undertake factoring business has to make an application for
grant of certificate of registration (CoR) as NBFC-factor to RBI.
59
 Existing NBFCs that satisfy all the conditions spelled out by the RBI can approach it,
along with the original CoR for a change in their classification as NBFC-Factor within six
months from the date of this notification.
 NBFC-Factor should ensure that its financial assets in the factoring business constitute
at least 75% of its total assets and its income derived from factoring business is not less
than 75% of its gross income.
REASONS FOR UNPOPULARITY OF FACTORING IN INDIA

a) Lack of Awareness: Most businesses in this sector felt that lack of awareness in the
corporate world of the presence of such a method to meet their working capital requirements
posed the biggest challenge in the growth of this sector. Factoring services are not easy to find
since there are few institutions providing access to these services.
b) Banks better placed to offer such services: Banks have an advantage of CASA. When
compared to banks, NBFCs possess some disadvantages inter alia, non-availability of owned
funds, high-cost short-term borrowings for providing factoring services, higher interest rates etc.
Further, banks facilities are fully secured, whereas it is mostly unsecured in case of factors. The
higher cost of funds for factors, coupled with high operations cost, unsecured facility and thin
spreads is making the environment highly challenging for the factors. On the other hand the
bank rates are 1%-2% lower than that of the factors and the facility is fully collateralized. Also
banks do not prefer parallel lines from factoring company along with their lines of credit as in
case of priority of claims there may be issues with regard to their claims being subordinated to
factor companies.
c) Availability of better options: Banks provide various lines of credits to corporates which are
well known and provide simpler options for the clients. Obtaining factoring services may seem
cumbersome and a client would rather prefer an overdraft facility offered by the banks, which
involves a simpler process and is easy to obtain. Where corporate seek funding above the bank
funding, that is where the factors have a role playing. Over and above these the turn-around
time for factors is very slow, so clients prefer banks over factors.
d) Non-availability of Credit Insurance: Internationally the practice of credit insurance is

prevalent in factoring by which factoring companies mitigate their risk and exposure on clients
with the help of credit insurance. However, in India, currently credit insurance is not permitted.
Currently the Factoring Act does not permit partial or no recourse on the client; factors to have
full recourse on the corporates. This creates two kinds of problems, one, for the clients it acts as
a hindrance for limiting its sales to the debtors to the extent of facility available from the factor
company and two, for the factoring company credit insurance would facilitate export factoring,
which is currently dormant in India.
e) No notification from states with regard to waiver of stamp duty: The market players have
been carrying an impression that though the Factoring Act provides for waiver of payment of
stamp duty on factoring agreements no clarification has been issued by the states, given that
payment of stamp duty on agreements is discretionary for individual states.
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f) No access to debt recovery platforms: Another major drawback to the Factoring business
in the non-availability of debt recovery platforms to NBFCs, such as Debt Recovery Tribunals
and under the SARFAESI Act. In the
absence of recourse to frauds and default on the part of the debtor, this sector is less attractive
to new entrants. Moreover no collateral security is available to secure the position of the
factoring companies.
g) Fake Bills: The current challenge that factoring companies are facing is that of fake bills.
This problem is pertinent to the textile, iron and steel and pharmaceuticals industries. Several
factors have accounted for losses due to
the fake bills issue.
h) Limited Reach: The major clients of factoring companies are typically the Small and Medium
Enterprises (SMEs) who find this route more preferable as bank loans are not easily available to
them.
Forfaiting
Forfaiting is the sale by an exporter of export trade receivables, usually bank

guaranteed, without recourse to the forfeiter. Such receivables include Letters of Credit
(with or without Bills of Exchange) Promissory Notes with guarantee, Bill of Exchange
with, Bank Guarantees Payable to an Exporter in one country from an Importer in
another country.
Forfaiting as a financing concept has been in use across the world since the 1960s.
The word forfait means to forgo one’s right to something. In the context of export
finance, the exporter forgoes his right to receive payment from the importer at later date
and surrenders the right to collect payment to a third party or agency (known as
forfaiter).
Instead the exporter receives an immediate reimbursement of his payment less
certain discounts from the forfaiter.
These are risks which expose a small or medium exporter to significant erosion of
profits. With forfaiting finance, the exporter passes on his debts as well as attendant
risks to the forfaiting agency.
This form of financing is referred to as without recourse financing (in case the debt
cannot be recovered there is no risk for the exporter).
Forfaiting is a medium term financing option typically for the three to seven year time
frame.
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Forfaiting comes with the following terms and conditions
 There is a discounting of the amount to be received from the importer

 Discounting is on a fixed rate
 Debt is in the form of bills of exchange or promissory notes guaranteed by
a bank
 Such financing is without recourse to the seller
 100% of the amount receivable can be financed in this manner
Benefits :
 Forfaiting eliminates risks(political, transfer and commercial risk).
 Improves cash flow by providing ready liquidity against transactional documents.
 Forfaiting allows you to discount long term debts too.
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MODULE 5
UNDERWRITING, VENTURE CAPITAL AND MICRO FINANCE
Underwriting
The underwriter, in essence, stands guarantee for public subscription and in turn he
receives underwriting commission.
He agrees to subscribe to a given number of shares in the event of public not

subscribing. The common practice, now a days is to go for a consortium underwriting.
Under this arrangement the public issue is underwritten by a group of underwriters.
This group usually comprises of the public financial institutions, commercial banks,
insurance companies and stock brokers. The person who assures is called an
"underwriter" and the consideration for the assurance is called "underwriting
commission". Thus an underwriting arrangement is in the nature of contingency
planning in issue management: The underwriters shall not buy and sell the securities,
but only stand as back-up supporters. The underwriting contract shall be reduced in
writing in the form of an agreement.
Thus "underwriting" is in the nature of an insurance against the possibility of inadequate

subscription. The significance of getting an issue underwriter is that the project is
assured of the fund it needs. "Underwriting is a contract by means of which, a person
gives an assurance to an effect that he would pick up the securities offered in the event
of its non-subscription by the persons to whom it was offered", which in case shall not
exceed the commitment extended by that person, for a consideration.
Underwriting, is an arrangement between the issuing company and a financial
institution, bank, merchant banker, broker or other person, providing for their taking up
the shares or debentures to the extent specified in the agreement between them, if the
public do not subscribe for them.
SEBI guidelines provide for compulsory underwriting for all the public issue to the extent
of the net offer made to the public. However, public issue by Development Financial
Institutions are granted explicit exception by SEBI from this mandate
Major underwriters in India are
 All India financial institutions

 Commercial banks
 Merchant bankers
 Members of the stock exchanges
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Criteria for Appointing Underwriters
Generally the task of arranging underwriting is undertaken by one of the Lead

Managers. The company also assists in the process. Since the underwriting contract is
the performance of an act ending in pecuniary liability, financial strength of a
prospective underwriter shall be a major consideration.
The other aspects that are to be considered are:

• Experience in the primary market.
• Past underwriting performance and defaults.
• Outstanding underwriting commitments
• The network of investor clientele of the underwriter
• Overall reputation.
SEBI Guidelines on Underwriters
 Compulsory Registration
 Capital adequacy and Infrastructure
 Code of conduct
 Fees;
 Agreement with clients
 Action in case of default
Rights of an underwriter
 Right to have information about the company and issues

 Right to have enough number of Application, Prospectus and Advertisement
Material
 Right to subject his commitment valid subject to conditions
 Right of discharge
 Right to be paid commission
 Right to sub underwrite
Benefits of Underwriting
(i) Assurance of Adequate Finance/ Success of share issue
(ii) Benefit of Expert Advice.
(iii) Increase in Goodwill of the Company.
(iv) Geographical Dispersion of Securities.
(v) Service to Prospective Buyers.
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VENTURE CAPITAL FINANCING
NATURE AND SCOPE OF VENTURE CAPITAL FINANCING
Venture capital plays a strategic role as a source of finance especially in case of small scale,
high technologies drivers and risky ventures. It is a very popular concept in advanced countries
and it is gaining its importance in developing countries also. A business organization involving in
new, innovative, and risky business/ project may not be able to get its financial requirements
fulfilled from any traditional sources. Therefore they approach a specialized agency specially
meant for financing such project. Such agencies are called as venture capitalist or venture
capital firm. Venture Capital is a form of “risk capital”. In other words, capital that is invested in a
project (in this case - a business) where there is a substantial element of risk relating to the
future creation of profits and cash flows. Risk capital is invested as shares (equity) rather than
as a loan and the investor requires a higher”rate of return” to compensate him for his risk.
Thus venture capital is the capital invested in young, rapidly growing or changing companies
that have the potential for high growth. The VC may also invest in a firm that is unable to raise
finance through the conventional means. Venture capital provides long-term, committed share
capital, to help unquoted companies grow and succeed. If an entrepreneur is looking to start-up,
expand, buy-into a business, buy-out a business in which he works, turnaround or revitalize a
company, venture capital could help do this. Obtaining venture capital is substantially different
from raising debt or a loan from a lender. Lenders have a legal right to interest on a loan and
repayment of the capital, irrespective of the success or failure of a business . Venture capital is
invested in exchange for an equity stake in the business. As a shareholder, the venture
capitalist’s return is dependent on the growth and profitability of the business. This return is
generally earned when the venture capitalist “exits” by selling its shareholding when the
business is sold to another owner.
The following are general forms of risk capital Financing
1) Angel investors: These are typically high-net-worth individuals (HNIs) who have often been
successful entrepreneurs themselves. They re-deploy their wealth in next-generation
businesses. They invest in new-idea enterprises (that do not yet have external validation), help
bring these ideas to market, take significant risks and invest a lot of time and energy in
mentoring, management guidance and networking. Angel investors are also governed by
considerations other than finance alone, such as belief in Entrepreneurship itself.
2) Venture capital (VC) funding provides funds for early stage companies. VC investments are
traditionally made for scaling up operations (i.e. developing, launching and expanding new
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products or services). VCs take lesser degree of risk and invest more money than angel
investors. However, a VC is about more than financial support alone. VCs provide
entrepreneurial support and partnership-based value-addition, often in the form of providing
financial advice, human resources, establishing networks with customers and overall guidance
in company strategy.
3) Private equity players are established investment bankers and typically invest into
proven/established businesses. PE funds/players are among the largest sources of funding for
enterprises that are relatively secure with an established track record, requiring significantly
large funds for expansion and growth. As such, they take reasonably well-defined risks and their
exit strategy is usually up to the stage when the company goes public or gets acquired at high
value. PE funds are generally seen to attract huge amount of capital from investors, including
pension funds, insurance funds, university foundations and individuals. PE investors can be
domestic or foreign private equity firms. Domestic PE firms are either established as trusts, or
set up as a company. All Private equity (PE) investments from outside the country are either
classified as Foreign Institutional Investment (FII) for investments in listed companies or Foreign
Direct Investment (FDI) for investment in unlisted companies. If a PE investment takes place in
an unlisted firm, it falls under India's FDI rules. A PE fund can also buy into listed companies.
However, in order to do such investments, the PE fund has to
become a registered FII.
4) Incubators are mostly non-profit entities that provide value added advisory, informational
and certain support infrastructure which includes productive office environment, finance and
complementary resources. Incubators are mostly promoted by government or professional
organisations seeking to develop small enterprises in a particular area. Some times venture
capital funds also have their own incubators and companies also set up in-house incubators.
Incubators support the entrepreneur in the pre-venture capital stage, that is, when he wants to
develop the idea to a viable commercial proposition which could be financed and supported by a
venture capitalist.
Difference between Venture Capital financing and Bank financing (Conventional

Financing)
Conventional financing generally extends loans to companies, while VC financing invests in

equity of the company. Conventional financing looks to current income i.e. dividend and interest,
while in VC financing returns are by way of capital appreciation. Assessment in conventional
financing is conservative i.e. lower the risk, higher the chances of getting loan. On the other
hand VC financing is a risk taking finance where potential returns outweigh risk factors.
Venture Capitalists also lend management support and provide entrepreneurs with many other
facilities. They even participate in the management process. VC generally invest in unlisted
companies and make profit only after the company obtains listing. VC extend need based
support in a number of stages of investments unlike single round financing by conventional
financiers.
VC are in for long run and rarely exit before 3 years. To sustain such commitment VC and
private equity groups seek extremely high return of 30% per year . A bank or an FI will fund a
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project as long as it is sure that enough cash flow will be generated to repay the loans. VC is not
a lender but an equity partner.
Venture capitalists take higher risks by investing in an early-stage company with little or no
history, and they expect a higher return for their high-risk equity investment. Internationally, VCs
look at an internal rate of return (IRR) north of 40% plus. In India, the ideal benchmark is in the
region of an IRR of 25% for general funds and more than 30% for IT-specific funds. With
respect to investing in a business, institutional venture capitalists look for average returns of at
least 40 per cent to 50 per cent for start-up funding. Second and later stage funding usually
requires at least a 20 per cent to 40 per cent return compounded per annum. Most firms require
large portions of equity in exchange for start-up financing.
FEATURES OF VENTURE CAPITAL FINANCING
 Venture capitalist or venture capital firm is inclined to assume a high degree of risk for
earning high return.
 They invest in high risk project/business having potential for high growth.
 Investment is usually made in small and medium scale businesses
 Venture capital is available only for commercialization/ implementation of new ideas or
new technologies and not for regular business
 Venture capitalist joins the business as a co-promoter and share the risks and rewards
of the business.
 Venture capital is usually in the form of an equity participation. It may also take the form
of long term debt
 Venture Capital Firm (VCF) not only provides fund but also takes active part in
management. Thus they are continuously involved in the organization.
 Financial burden of assisted firm is negligible in first few years.
 VCF normally plans to liquidate its investment once the potential venture reaches its
maturity stage ( 3 –7 years)
 VCF normally invests in equity capital of assisted firm and tends to invest for long term.
Types of VCs
Generally there are three types of organised or institutional venture capital funds: venture
capital funds set up by angel investors, that is, high net worth individual investors; venture
capital subsidiaries of corporations and private venture capital firms/ funds. Venture capital
subsidiaries are established by major corporations, commercial bank holding companies
and other financial institutions. Venture funds in India can be classified on the basis of the
type of promoters
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• Financial institutions led by ICICI ventures, RCTC, ILFS, etc.

• Private venture funds like Indus, etc.
• Regional funds: Warburg Pincus, JF Electra (mostly operating out of Hong Kong).
• Regional funds dedicated to India: Draper, Walden, etc.
• Offshore funds: Barings, TCW, HSBC, etc.
• Corporate ventures: venture capital subsidiaries of corporations
• Angels: high net worth individual investors
• Merchant bankers and NBFCs who specialize in “bought out” deals also fund
companies.
STEPS INVOLVED IN PROVIDING VENTURE CAPITAL FINANCING

The following are the steps involved in providing the venture capital financing by a venture
capitalist. The steps involved may vary depending upon the nature of project, amount of
financing required, promoters involved etc.
1 Deal Origination and screening of the Project:
Depending on thrust with which venture capitalist is operating the business plan of the
entrepreneur is studied by venture capitalist. Selection of the venture is made by viewing the
stage and types of investments it is evaluating. Internal as well as external factors are
considered, internal being management and technology and external are like industry
environment, industry structure, market- potential etc.
2 Detailed evaluation of the project:
Venture capitalist carries out detailed evaluation of the project which includes technical
aspect, marketing aspect and financial aspects. Project has to be technically feasible and
financially viable. Venture Capitalist is more interested in the value of the company at time of
potential exit as this would form the basis of his own profitability, which depends crucially on his
capital gains at exit time.
3 Financing the Project

In what form venture capital is to be provided, is a crucial decision. All types of investment
instruments available are to be weighed against 'risk-return' model in the given context. The
venture capital deal has to be structured targeting maximum value of the venture capitalist. The
different mode of financing by a venture capitalist is discussed in subsequent part of the
chapter.
4 Post investment activity

Like other financing agencies, venture capitalist continues to have association with assisted
project. They play an active role in the management of the venture unlike other financing
agencies. Their target is 'investment nurturing' so their involvement is more intimate and
constant during the entire-life of the investment. They ensure proper utilization of assistance
provided, check cost and time over run and make sure that no statutory defaults are made.
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They seek periodical reports, visit the plant, have personal discussion with the entrepreneurs,
get feed back from resource persons and feed back through nominee directors.
5 Valuation of Investment
Venture Capitalist has an ultimate target to exit at an opportune time. To decide opportune time
it is necessary that he constantly values his portfolio. Only on valuing the portfolio he gets an
idea about his capital gain. He targets to assess the fair value of the investment at a particular
point of time. The valuing technique should be such which incorporates accounting and financial
point of view as well as stages of investment The valuation basis should be consistent fair and
conservative.
6 Liquidating the Investment

Exit is a pre requisite for capital gain to the venture capitalist. Exit time has to be planned
broadly at the time of entering contract for venture capital. Exit time decision is not solely of
venture capitalist. Interest of the entrepreneur is also to be taken in account to decide exit time.
Exit can be by disposing of investment through many avenues like :
A) Going for IPO
B) Selling back the stake to entrepreneur
C) Sale of stake through Private placement to other investors
THE VENTURE CAPITAL FINANCING STAGES/ SPECTRUM

Venture capitalists cater to the needs of the entrepreneurs at different stages of their
enterprises. Depending upon the stage they finance, venture capitalists are called angel
investors or private equity supplier/investor. Venture capital was started as early stage
financing of relatively small but rapidly growing companies. However various reasons forced
venture capitalists to be more and more involved in expansion financing to support the
development of existing portfolio companies. With increasing demand of capital from newer
business, Venture capitalists began to operate across a broader spectrum of investment
interest. This diversity of opportunities enabled Venture capitalists to balance their activities in
term of time involvement, risk acceptance and reward potential, while providing on going
assistance to developing business.
There are different stages of entry for different Venture capitalists and they can identify and
differentiate between types of Venture capital investments, each appropriate for the given stage
of the investee company, The basic type of financing provided by venture capitalist are
1. Early Stage Finance
A. Seed Capital
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B. Startup Capital
C. Early/First Stage Capital
D. Second stage finance
2. Later Stage Finance
E. Expansion/Development Stage Capital
F. Replacement Finance
G. Management Buy Out and Buy ins
H. Turnarounds
I. Mezzanine/Bridge Finance
ADVANTAGES OF VENTURE CAPITAL

Venture capital has a number of advantages over other forms of finance, such as:
 Finance - The venture capitalist injects long-term equity finance, which provides a solid
capital base for future growth. The venture capitalist may also be capable of providing
additional rounds of funding should it be required to finance growth.
 Business Partner - The venture capitalist is a business partner, sharing the risks and
rewards. Venture capitalists are rewarded by business success and the capital gain.
 Mentoring - The venture capitalist is able to provide strategic, operational and financial
advice to the company based on past experience with other companies in similar
situations.
 Alliances - The venture capitalist also has a network of contacts in many areas that can
add value to the company, such as in recruiting key personnel, providing contacts in
international markets, introductions to strategic partners and, if needed, co-investments
with other venture capital firms when additional rounds of financing are required.
 Facilitation of Exit - The venture capitalist is experienced in the process of preparing a

company for an initial public offering (IPO) and facilitating in trade sales.
Limitations of Venture Capital Financing
• Inadequacy of equity capital financing by venture capitalists.

• Focus on low risk ventures by venture capital firms.
• Conservative approach followed by venture capital firms.
• Delay in project evaluation by venture capital firms.
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SEBI REGULATIONS FOR VENTURE CAPITAL FUNDS
VCF are regulated by the SEBI (Venture Capital Fund) Regulations, 1996. The regulation
clearly states that any company or trust proposing to carry on activity of a VCF shall get a grant
of certificate from SEBI. Section 12 (1B) of the SEBI Act also makes it mandatory for every
domestic VCF to obtain certificate of registration from SEBI in accordance with the regulations.
Hence there is no way that an Indian Venture Capital Fund can exist outside SEBI Regulations.
However registration of Foreign Venture Capital Investors (FVCI) is not mandatory under the
FVCI regulations.
(i) VCF is a fund established in the form of a trust/a company including a body corporate and
registered with SEBI. It has a dedicated pool of capital, raised in the specified manner and
invested in VCUs in accordance with the regulations. VCU is a domestic company whose
shares are not listed on a stock exchange and is engaged in specified business.
(ii) The minimum investment in a VCF from any investor would not be less than Rs. 5 lakh and
the minimum corpus of the fund before it could start activities should be at least Rs. 5 crore.
(iii) The norms of investment were modified. A VCF seeking to avail benefit under the relevant
provisions of the Income Tax Act will be required to divest from the investment within a period of
one year from the listing of the VCU.
(iv) The VCF will be eligible to participate in the IPO through book building route as Qualified
Institutional Buyer.
(v) The mandatory exit requirement by VCF from the investment within one year of the listing of
the shares of VCUs to seek tax pass-through was removed under the SEBI (VCF) Regulation to
provide for flexibility in exit to VCFs.
(vi) The VCFs were directed to provide with the information pertaining to their venture capital
activity for every quarter starting form the quarter ending December 31, 2000.
(viii) Automatic exemption was granted from applicability of open offer requirements in case of
transfer of shares form VCFs in Foreign Venture Capital Investors (FVCIs) to promoters of a
VCU.
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Microfinance
Definition of Microfinance Microfinance is the provision of a broad range of financial
services such as – deposits, loans, payment services, money transfers and insurance
products – to the poor and low-income households, for their microenterprises and small
businesses, to enable them to raise their income levels and improve their living
standards.
Core Principles for Microfinance

➣ The poor needs access to appropriate financial services
➣ The poor has the capability to repay loans, pay the real cost of loans and generate
savings
➣ Microfinance is an effective tool for poverty alleviation
➣ Microfinance institutions must aim to provide financial services to an increasing
number of disavantaged people
➣ Microfinance can and should be undertaken on a sustainable basis
➣ Microfinance NGOs and programs must develop performance standards that will
help define and govern the microfinance industry toward greater reach and
sustainability
The goals/ objectives of Micro finance
• Eradicate Extreme Poverty & Hunger.

• Achieve Universal Education.
• Promote Gender Equality & Women’s Empowerment.
• Reduce Child Mortality
• Combat Diseases
• Developing Entrepreneurial Spirit
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C. Definition of Microfinance loans

Microfinancing loans are small loans granted to the basic sectors, on the basis of the
borrower’s cash flow and other loans granted to the poor and low-income households
for their microenterprises and small businesses to enable them to raise their income
levels and improve their living standards. These loans are typically unsecured but may
also be secured in some cases.
Level of Microfinance Loan

Average microfinance loan of an NGO microfinance institution or of a cooperative bank
or credit union in the Philippine case is about P25,000 (from a low of P2,000 to P5,000).
To be realistic, the maximum principal amount of a microfinance loan can be pegged at
P150,000.
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MODULE 6
LEASING AND HIRE PURCHASE FINANCE
NATURE AND SCOPE OF LEASING
Leasing / equipment leasing is a asset based financial service provided by a Non banking
financial service company in the nature of leasing company. It is a financial service where in a
leasing company called as lessor, under the contract, gives the right of usage of an asset over
an agreed period of time for a consideration called as the lease rental to an user of asset called
as lessee. The acquisition of assets - particularly expensive capital equipment - is a major
commitment for many businesses. How that acquisition is funded requires careful planning.
Rather than pay for the asset outright using cash, it can often make sense for businesses to
look for ways of spreading the cost of acquiring an asset, to coincide with the timing of the
revenue generated by the business. The most common sources of medium term finance for
investment in capital assets is leasing. Leasing is a financial facility which allow a business
to use an asset over a fixed period, in return for regular payments. The business customer
chooses the equipment it requires and the finance company buys it on behalf of the
business.
ESSENTIAL ELEMENTS OF LEASING
The essential elements of a lease are as follows:
A. Parties to leasing: The basic parties to a lease are the lessor and the lessee. Lessor is
the owner of the asset and leasing is a core business to the lessor. The lessor are
generally in the form of Non banking financial companies providing leasing and hire
purchase services. The user of the capital asset is a lessee. For lessee leasing is a indirect
source of financing or a asset based financial service provided by lessor. Lessee may be an
individual, business entity or a government department who are willing to make use of a
capital asset on lease basis. There may be a financial intermediary between two parties.
B Subject matter of lease- The subject matter of lease may be immovable or immovable
property. Immovable property in the form of land and building may be leased, but it does not
covered as a part of equipment leasing. Many kinds of business asset are suitable for
leasing, such as :
 Plant and machinery

 Aircrafts
 Cars and Commercial vehicles
 Agricultural equipment
 Hotel equipment
 Medical and dental equipment
 Computers, including software packages
 Office equipments etc.
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C. Ownership of the equipment: Asset owned by lessor is used by lessee for, which he
makes periodical lease rentals. Ownership of the leased asset remains with the lessor
throughout the period of lease and will not get transferred to lessee.
D Duration of lease: Period of the lease agreement may be throughout the economic life
of the asset, or for a period shorter than that. Periodicity of leasing is based on type of
lease agreement.
E. Consideration: Consideration for using leased asset is in the form of lease rent. For
lessor it is a taxable income and for lessee it is a revenue expenditure. Lease rental
payment made by lessee is allowed as a deduction for tax purpose. Apart from lease
rentals, lessee may have to pay lease management fees.
F. Depreciation of leased asset: As lessor continues to enjoy the ownership of the asset,
he can charge the depreciation in his books at the rate prescribed under income tax act.. In
spite using the asset, lessee cannot get the benefit of charging the depreciation. Similarly,
the scrap/residual value of the asset is enjoyed by lessor, as he is the owner of the asset.
G. Sub-lease- A lessee can transfer the whole or any part of his interest in the property by
sub-lease. However, this right is subject to the contract to the contrary and he can be
restrained by the contract from transferring his lease by sub-letting. The lessee can create
sub-leases for different parts of the asset. The sub-lessee gets the rights, subject to the
covenants, terms and conditions in the lease deed.
Rationale behind Using Leasing option:
• Leasing frees working capital for more productive use.

• Leasing could provide 100% funding as opposed to other sources of capital that
usually provide only 60-70 percent.
• Accelerated depreciation write off is the USP of lease.
• A leasing arrangement is simple to negotiate and administer.
• Leasing provides off balance sheet funding.
• A leasing arrangement does not limit the firm’s ability to raise credit.
• The lessor can pass on part of the tax benefits to the lessee through reduced
rentals.
• The lease rental can be structured to accomodate the operational cash flow pattern
of the lessee.
• Most expenses associated with the leased equipment can be incorporated into the
lease and amortized over the lease period.
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TYPES OF LEASING
1) Financial lease:
Long-term, non-cancellable lease contracts are known as financial leases. The essential point of
financial lease agreement is that 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. Practically
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. Financial lease is also known as 'capital lease‘. In India, f’nancial
leases are very popular with high-cost and high technology equipment.
Characteristics:-
a) This type of lease is used in case of special types of assets needed specifically by a
lessee.
b) Period of lease is throughout the life of the asset
c) Lessee is responsible for insurance and maintenance of the asset.
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. 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.
Characteristics:-
i) Period of lease is less than economic life of the asset
ii) Lessee has got the right to terminate the lease.
iii) Usually lessor needs to take care of insurance and maintenance of the asset.
iv) Operating lease is used usually in case of general purpose asset.
Differences between a Financial Lease and an Operating Lease
A) A finance lease also called a capital lease, is only an exchange of money for money and
does not result in the creation of economic services. An operating lease, on the other hand,
is basically an economic service.
B) A lessor under a finance lease is the legal owner of the asset but does not bear any of
the risks of rewards of ownership while a lessor under an operating lease carries all the
benefits of ownership like the depreciation benefits.
C) The International Accounting Standard No. 17 has defined a finance lease as “a lease
that transfers substantially all the risks and rewards incident to ownership of an asset. Title
may or may not eventually be transferred”. Operating lease has simply been defined as a
lease other than a finance lease.
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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. However, under this arrangement, the assets are not physically
exchanged but it all happens in records only. 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) Single investor lease and Leveraged lease:

Under leveraged leasing arrangement, a third party is involved beside 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. The lessor, the owner of the asset is entitled to depreciation allowance associated
with the asset. Where as in case of single investor lease, the asset is fully financed by the lessor
alone.
5) Domestic lease and international lease:- If both the parties to lease agreement is
situated in the country it is termed as domestic lease and if any one party to the case is
residing abroad it is a international lease.
7) Sub-lease: A transaction in which the lease property is re-leased by the original lessee
to a third party and the lease agreement between the two original parties remains the same
8) Secondary Lease: A second lease period during which the lessee will pay nominal
peppercorn rentals in order to ensure that the lease period is long enough for the lessee to
gain maximum benefit from the lease.
9) 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 or is defined
as fair market value
10) Structured Lease: Structured rentals are not flat or equated over the lease term i.e. the
rentals vary over the lease term. The rental structure should typically fit the lessee’s inflows
from the asset. A structured lease will have some visible pattern. The main types of
structured leases are as follows:
Stepped-up Rentals:
The rentals are structured so that the lessee will pay smaller rental amounts at the
beginning of the lease period and larger rental amounts towards the end of the lease period
i.e. the rentals will increase in proportion over the rental period so that the rentals are
heavier towards the end of the lease period.
Stepped-down Rentals:
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The rentals are structured so that the lessee will pay larger rental amounts at the beginning
of the lease period and lower rental amounts towards the end of the lease period i.e. the
rentals will increase in proportion over the rental period so that the rentals are heavier at the
beginning of the lease period.
ADVANTAGES AND LIMITATIONS OF LEASING

Some of the advantages of leasing include:
a. Leasing helps to possess and use a new asset/ 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. However, 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. It is easy to access because it is secured – largely or entirely – on the asset being financed,
rather than on other personal or business assets.
i. 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.
j. Lease instalments are allowed as an expenditure while calculating the income tax..
k. 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.
Some of the Limitation of leasing include:
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 lease 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
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LEASE AGREEMENT
Lessee’s and Lessor’s legal rights and obligations are specified in a lease agreements. The
basic contents of lease agreement generally includes.
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.
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.
Rights and obligations of a lessor in a lease contract
 Right of ownership of the leased asset.

 Right to claim depreciation on the asset.
 Right to ensure that the asset is put to fair use and within the limitations contained in
the agreement.
 Right to recover the rentals and other sums payable by the lessee under agreement.
 Right to sue in case of conversion of the asset by the lessee.
 Right to terminate the lease in case of misuse of leased goods by the lessee
Rights and obligations of a lessee in a lease contract
 To use the asset during the lease period according to the terms of the lease
agreement.
 To use, operate, maintain and store the equipment properly.
 To pay the lease rentals periodically as specified in the lease agreement.
 To keep the asset insured at all times Lessor for an amount equal to the full
insurable value of the asset.
 To return the leased asset to the lessor upon the expiration or earlier termination of
this Lease Agreement, i.e., in the event of default by the lessee
TAX AND ACCOUNTING TREATMENT OF LEASING
The various acts and laws governing the leasing India are,
 Reserve Bank of India Act 1943 in case of involvement of NBFCs
 FEMA Laws
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 FDI Rules in case of companies having FDI

 Sale of Goods Act, 1930
 Indian Contract Act, 1872
 Transfer of Property Act, 1882
 Income Tax Act, 1961
 Limitation Act, 1930
 Indian Stamp Act, 1899
 Arbitration Act, 1940
 VAT Rules
Some of the important accounting and tax issues related with leasing are;
 Indian accounting standard AS19 and IAS17 covers Leasing aspects in India
 The lessee can claim lease rentals as tax-deductible expenses while paying Income tax
 The lease rentals received by the lessor are taxable under the head of 'Profits and Gains
of Business or Profession or income from other sources as the case may be
 The lessee is not eligible for depreciation as he is not the owner of the asset but, lessor
can claim depreciation on the investment made in leased assets.
 Lease transitions comes under the purview of 'sale and state government can levy sales
tax (VAT) on lease transactions.
 The lessor is not entitled for the confessional rate of central sales tax because the asset
purchased for leasing is meant neither for resale nor for use in manufacture. (It may be
noted that if a firm buys an asset for resale or for use in manufacture it is entitled for the
confessional rate of sales tax).
 The leased asset cannot be shown in the balance sheet of lessee, but it can appear on
the balance sheet of lessor.
 Lease rental is an income for lessor and expenditure for lessee.
Structure of leasing companies in India (Lessors in India)
1. Specialized leasing companies:

There are about 400-odd large companies which have an organizational focus on leasing,
and hence, are known as leasing companies. Till recently, most of them were diversified
financial houses, offering several fund based and non-fund based financial services.
However, recent SEBI rules on bifurcation of fund-based and non-fund based activities has
resulted into hiving-off of merchant banking divisions of these entities. Most of these
companies also offer hire-purchase activities, and some of them might have a consumer
finance division as well. These companies are known, in regulator’s jargon, as non-banking
financial companies, or NBFCs for short. The terms NBFCs includes several other financial
concerns too, and all such companies are regulated by the Reserve Bank of India. There
were no entry barriers to leasing business till recently, but the January 1997 amendments to
the RBI law now require any non-banking finance company to have a prior registration with
the RBI, and the conditions of registration virtually amount to authorization by the RBI.
2. Banks and bank-subsidiaries:
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Till 1991, there were some ten bank subsidiaries active in leasing, and over-active in stock-
investing. The latter variety was ravaged in the aftermath of the 1992 securities scam.
In Feb., 1994, the RBI allowed banks to directly enter leasing. So long, only bank
subsidiaries were allowed to engage in leasing operations, which was regarded by the RBI
as a non-banking activity. However, the 1994 Notification saw an essential thread of
similarity between financial leasing and traditional lending. Though State Bank of India,
Canara Bank etc have set up leasing activity, it is not currently at a scale to make any
difference on the leasing scenario. This is different from the rest of the World, where banks
are front-runners in leasing markets.
3. Specialized Financial institutions:
There is a wide variety of financial institutions at the Central as well as the State level in
India. Apart from the apex financial institutions, viz., the Industrial Development Bank of
India, the Industrial Finance Corporation of India, and the ICICI, there are several financing
agencies devoted to specific causes, such as sick-industries, tourism, agriculture, small
industries, housing, shipping, railways, roads, power, etc. In most States too, there are
multiple financing agencies for generic or focussed cause. Most of these institutions are
using the lease instrument along with traditional financing instruments. Significantly, the
ICICI was one of the pioneers in Indian leasing. At State level also, financial institutions are
active in leasing business.
4. One-off lessors :
Some of the companies engaged in some other business which gives them huge taxable
profits, have resorted to one-off leasing on a casual basis to defer their taxes. These people
are interested only in leasing of high-depreciation items, preferably those entitled to 100%
depreciation. The major items eligible for 100% depreciation are gas cylinders, certain
energy-saving devices, pollution control devices etc. Severe scrutiny by revenue officials
into lease transactions at the time of assessment has dampened the enthusiasm in this line
of leasing activity, however it carries on. Mostly such lease transactions are syndicated, at
times even funded, by active players in leasing markets.
5. Manufacturer-lessors :
This part of the lessor-industry is in highly under-grown form in India, for simple reasons.
Vendor leasing is a product of competition in the product market. As competition forces the
manufacturer to add value to his sales, he finds the best way to sell the product is to sell it
without the buyer having to pay for it instantly. Product markets so far for most durables
were oligopolistic, and good products used to sell even otherwise at a premium. With the
economy decisively moving towards market orientation, competition has become inevitable,
and competition brings in its wake sales-aid tools. Hence, the potential for vendor leasing is
truly great. Presently, vendors of automobiles, consumer durables, etc. have alliances or
joint ventures with leasing companies to offer lease finance against their products.
However, there is no devoted vendor leasing of the type popular in most of the advanced
markets, where a specific leasing company or leasing program takes exclusive charge of a
vendor’s products.
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Structure of lessees in India
a. Corporate customers with very high credit ratings: These essentially look at leasing
to leverage against assets which are otherwise not bankable, or for pure junk financing.
b. Public sector undertakings: This market has witnessed a very rate of growth in the
past. With budgetary grants to the PSUs coming to a virtual halt, there is an increasing
number of both centrally as well as State-owned entities which have resorted to lease
financing. Their requirements are usually massive.
c. Mid-market companies: The mid-market companies, that is, companies with reasonably
good creditworthiness but with lower public profile have resorted to lease financing basically
as an alternative to bank/institutional financing, which to them is time-consuming and
tedious.
d. Consumers: Retail funding for consumer durables was frowned-upon at one point of
time, but recent bad experience with corporate financing has focused attention towards
consumer durables which incidentally, is all the all-time favorite of financiers World-over.
Most of the larger companies have expressed interest in consumer funding.
e. Car customers: Car leasing World-over is a very big market, and the same is true for
India. So long, most car leases were plain-vanilla financial leases but one now finds few
instances of value-added car lease services also being offered.
f. Commercial vehicles customers: Commercial vehicles customers have always relied
upon funding by hire-purchase companies. The customer profile ranges from large fleet
owners to individual truckers.
g. Earth-moving machinery customers: These customers have also traditionally relied
upon lease financing. Their requirements are generally large – each excavators costs more
than `25 lacs. The income-stream is based on contracts they have - at times, the income
generation may be sporadic, or the need might itself be temporary. In fact, operating leases
would have been ideal in this market, but they are yet to be launched to any serious degree.
h. Government departments. and authorities: One of the latest entrants in leasing
markets is the Govt. itself. The department. of Telecommunications of the Central Govt.
took the lead by floating tenders for lease finance worth about ` 1000 crores. In its reforms
programme, India has limits to the extent to which it can resort to deficit financing, and
leasing is easily going to appeal to the Govt. , if not for cost reasons, at least for the fact that
it will not feature in national accounts as a commercial financing. As a spin-off, it might even
help reducing the reported deficit, as the Govt. resorts to what is loved World-over as a tool
of off-balance sheet financing.
Problems of leasing in India
Leasing has great potential in India. However, leasing in India faces serious handicaps which
may bar its growth in future. The following are the some of the problems.
1. Unhealthy competition – There is over supply of lessor in India. The stiff competition
between these lessors are force them to reduce their profit margin to bare minimum level. More
over 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.
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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. more over taxes like sales tax, wealth tax,
additional tax , surcharge etc, add to the cost of leasing. It makes leasing relatively more
expensive.
4. Stamp Duty- States treats the leasing transaction as a sale for the purpose of making them
eligible to sales tax. On the contrary, for stamp duty, the transaction is treated as pure lease
transactions. Accordingly 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.
HIRE PURCHASE FINANCE
NATURE AND SCOPE OF HIRE PURCHASE

Similar to leasing, hire purchase financing is also one of the method of capital asset financing.
Here gods are let on hire, the purchase price is to be paid in installments and hirer is allowed an
option to purchase the goods by paying all the installments.
Hire purchase is a type of installment credit under which the hire purchaser, called the hirer,
agrees to take the goods on hire at a stated rental, which is inclusive of the repayment of
principal as well as interest, with an option to purchase. Under this transaction, the hire
purchaser acquires the property (goods) immediately on signing the hire purchase agreement
but the ownership or title of the same is transferred only when the last installment is paid. The
hire purchase system is regulated by the Hire Purchase Act 1972. This Act defines a hire
purchase as “an agreement under which goods are let on hire and under which the hirer has an
option to purchase them in accordance with the terms of the agreement and includes an
agreement under which:
1) The owner delivers possession of goods thereof to a person on condition that such person
pays the agreed amount in periodic installments.
2) The property in the goods is to pass to such person on the payment of the last of such
installments, and
3) Such person has a right to terminate the agreement at any time before the property so
passes”.
Hire purchase should be distinguished from installment sale wherein property passes to the
purchaser with the payment of the first installment. But in case of HP (ownership remains with
the seller until the last installment is paid) buyer gets ownership after paying the last installment.
HP also differs form leasing.
Parties
• Hiree :- Owner of the asset who gets hire charges.
• Hirer: - User of the asset
Features
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• Hiree purchases the assets and gives it on hire to the hirer.

• Possession is delivered to the hirer at the time of entering into the contract.
• The hirer pays the regular installments over a specified period of time.
(The installments covers principle amount and interest).
• Usually interest is charged on flat basis on initial investment.
• Default in payment of installments entitus seller to take away the goods.
• Hirer becomes the owner of the asset on payment of last installments.
• The hire purchaser is tree to return the goods without required to pay any further
installments.
FORMS OF HIRE PURCHASE AGREEMENTS
Hire-purchase agreements are of two forms.

1. In the first form the goods are purchased by the financier from the dealer and the
financier obtains a hire-purchase agreement from the customer, under which the customer
becomes the owner of the goods on payment of all the installments of the stipulated hire
and exercising his option to purchase the goods on payment of a nominal price. The owner
gets his money from the financier, who recovers the cost from the customer.
2. In other form the customer purchases the goods and he executes a hire purchase
agreement with a financier, under which he remains in possession of goods, subject to
payment of amount paid by the financier on his behalf to the owner. The financier gets a
right to seize the goods in the event of non-fulfillment of conditions of hire-purchase
agreement by the customer.
NATURE OF AGREEMENT – The true nature of the transaction is determined from the
terms of the agreement and the court unless prohibited by statute can go behind the
documents to determine the true nature of the transaction. If the purchaser desiring to
purchase the goods, who is not having sufficient money for purchasing the same, borrows
the amount from a third party and pays it over to the vendor, the transaction between the
customer and the third party will be a loan transaction. The true nature of the transaction will
not change if the lender himself is owner of the goods and he accepts the promise by the
purchaser to pay the balance money due against delivery of goods.
Standard Provisions
To be valid, HP agreements must be in writing and signed by both parties. They must
clearly set out the following information in a print that all can read without effort:
1. A clear description of the goods
2. The cash price for the goods
3. The HP price, i.e., the total sum that must be paid to hire and then purchase the goods
4. The deposit
5. The monthly instalments (most states require that the applicable interest rate is disclosed
and regulate the rates and charges that can be applied in HP transactions) and
6. A reasonably comprehensive statement of the parties’ rights (sometimes including the
right to cancel the agreement during a “cooling-off” period).
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DIFFERENCE BETWEEN LEASING HIRE PURCHASING
Basis Leasing Hire purchasing

Meaning A lease transaction is a Hire purchase is a type of
commercial instalment credit under
arrangement, which the hire purchaser
whereby an equipment agrees to take the goods on
owner or manufacturer hire at a stated rental,
conveys to the which is inclusive of the
equipment repayment of principal as
user the right to use the well as interest, with an
equipment in return for option to purchase.
a
rental.
Asset purchase No option is provided to Option is provided to the

Option the lessee (user) to hirer (user).
purchase the goods.
Nature of Lease rentals paid by Only interest element

expenditure the included in the HP
lessee are entirely instalments is revenue
revenue expenditure by nature.
expenditure of the
lessee.
Claiming of Lessee cannot claim Hirer is although not the owner

Depreciation depreciation of the
for tax purpose asset can claim
depreciation
Income tax Entire lease rentals is Only interest component of hire
treatment tax deductable for lease purchase
installments is tax
deductable.
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THE RIGHT AND OBLIGATION OF HIRER AND HIREE
The hirer’s rights

The hirer usually has the following rights:
1. To buy the goods at any time by giving notice to the owner and paying the balance of the
HP price less a rebate (each state has a different formula for calculating the amount of this
rebate)
2. To return the goods to the buyer — this is subject to the payment of a penalty to reflect
the owner’s loss of profit but subject to a maximum specified in each state’s law to strike a
balance between the need for the buyer to minimise liability and the fact that the owner now
has possession of an obsolescent asset of reduced value
3. With the consent of the owner, to assign both the benefit and the burden of the contract
to a third person. The owner cannot unreasonably refuse consent where the nominated
third party has a good credit rating
4. Where the owner wrongfully repossesses the goods, either to recover the goods plus
damages for loss of quiet possession or to damages representing the value of the goods
lost.
The Hirer’s Obligations

The hirer usually has the following obligations:
1. to pay the hire installments
2. to take reasonable care of the goods (if the hirer damages the goods by using them in a
non-standard way, he or she must continue to pay the installments and, if appropriate,
compensate the owner for any loss in asset value)
3. to inform the owner where the goods will be kept.
The Hiree/Owner’s Rights

The owner usually has the right to terminate the agreement where the hirer defaults in
paying the installments or breaches any of the other terms in the agreement.
This entitles the owner:
1. To forfeit the deposit
2. To retain the installments already paid and recover the balance due
3. To repossess the goods (which may have to be by application to a Court depending on
the nature of the goods and the percentage of the total price paid)
4. To claim damages for any loss suffered.
Sources of Law on leasing and hire-purchase
Leasing and hire-purchase are essentially hiring transactions - transactions in which possession
of goods is handed over along with right to use, for a stated period and for consideration. Hiring
transactions are species of bailment in contract law - therefore, the transactions of lease and
hire-purchase are governed by the common law of contracts dealing with bailment transactions.
Contracts law, being common law, is codified in the Indian Contracts Act 1872 but is enriched
by history of precedents from both English and Indian Courts. Notably, the common law of
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contracts in India is based largely on the British legal principles, which have by and large been
accepted as applicable to India.
Therefore, the principal sources of applicable law on lease and hire-purchase transactions are
sections 148 to 171 of the Indian Contracts Act dealing with bailments, and a long series of
Court rulings, principally on hire-purchase transactions, but of late, on lease transactions as
well. The law of hire-purchase, essentially with a view to standardize procedures and eliminate
malpractice, on the lines of the English Hire-purchase Act, was enacted in 1972. However, the
has not been enforced as yet. In the meantime, there has been an attempt to amend it and
make it applicable.
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MODULE 7
CREDIT RATING AND SECURITIZATION
NATURE AND SCOPE OF CREDIT RATING

Credit rating is essentially giving opinion by a rating agency on the relative willingness and
ability at the issuer of a debt instrument to meet the debt servicing obligation in time and in full”.
In simple words it is a process whereby a credit rating agency after thorough analysis, gives its
opinion about creditworthiness of the company issuing financial instruments. It is a qualified
assessment and formal evaluation of company‘s credit history and capability of repaying
obligations.
CRISIL defines credit rating as ―an unbiased, objective and independent opinion as to an
issuer‘s capacity to meet financial obligations. It is the ―current opinion as to the relative safety
of timely payment of interest and principal on a particular debt instrument. Thus, rating applies
to a particular debt obligation of the company and is not a rating for the company as a whole.
According to American based agency Standard and Poor‘s, credit ratings are judgments of
borrowers‘ creditworthiness based on relevant risk factors, expressed by letter grade rating
symbol, which markets have come to depend on as reliable, user friendly tool for differentiating
credit quality. Thus a rating, provides a yardstick against which one can measure the risk
inherent in an instrument. The investor uses the rating to assess the risk level and compares the
offered rate of return with his risk return trade off and takes his investment decision accordingly.
Risk evaluation is only one factor amongst various other factors, which also counts in taking
investment decisions.
In India, the rating activities started with the incorporation of the Credit Rating Information
Services of India Ltd. (CRISIL) in 1987 which commenced its operations of rating of companies
in 1987-88 and was promoted by Industrial Credit and Investment Corporation of India Ltd.
(ICICI) and Unit Trust of India (UTI). CRISIL has its association with internationally recognized
rating agency Standard and Poor‘s (S&P) since 1996. The second rating agency Investment
Information and Credit Rating Agency of India Ltd. (ICRA) was incorporated in 1991 and was
jointly sponsored by Industrial Finance Corporation of India (IFCI) and other Financial
Institutions and banks. ICRA is an associate of the International Rating Agency Moody‘s
Investors Services. The other rating agency, Credit Analysis and Research Ltd. (CARE),
incorporated in April 1993, is a credit rating information and advisory services company
promoted by Industrial Development Bank of India (IDBI) jointly with Canara Bank, Unit Trust of
India (UTI), private sector banks and financial services companies. Another rating agency
Onicra Credit Rating Agency of India Ltd., which was incorporated in 1993, is recognized as the
pioneer of the concept of individual credit rating in India. Further, Duff and Phelps Credit Rating
(India) Private Ltd. (DCR) was established in 1996, presently known as Fitch Ratings India
Private Limited. One more rating agency, SME Rating Agency of India Limited (SMERA) which
was a joint venture of SIDBI, Dun & Bradstreet Information Services (D&B), Credit Information
Bureau of India Limited (CIBIL), and 11 other leading banks in the country, was established on
September 5, 2005. It is the country‘s first rating agency that focuses primarily on Indian SME
sector. A new rating agency, Brickwork Ratings (BWR) which is based in Bangalore was
incorporated in 2007.
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FEATURES OF CREDIT RATING
1. Specificity: credit rating is done specifically to a particular debt instrument and not to the
company/institution which is issuing the security.
2. Relativity: It is based on the relative capability and willingness of the issuer of the debt
instruments to meet obligation in time and in full.
3. Guidance: Credit rating is just a guidance/opinion given by the credit rating agency
about the instrument which it is rating.
4. Not a recommendation: Credit rating is just an opinion and not a recommendation to
buy the instrument.
5. Broad parameters: Credit rating is based on the broad parameters considered by the
rating agency at the time of rating
6. No guarantee: Credit rating is not an guarantee given by the credit rating agency.
Major credit rating agencies of the World

 "The Big Three" of Moody's, Standard & Poor's, and Fitch Ratings,
 Agusto & Co. (Nigeria),
 A. M. Best (U.S.),
 China Chengxin Credit Rating Group (China),
 CRISIL (India)
 Credit Rating Information and Services Limited (Bangladesh),
 Dagong Europe Credit Rating (Italy),
 DBRS (Canada),
 Dun & Bradstreet (U.S.),
 Egan-Jones Rating Company (U.S.),
 Global Credit Ratings Co. (South Africa),
 ICRA Limited (India),
 Japan Credit Rating Agency (Japan),
 Levin and Goldstein (Zambia),
 Morningstar, Inc. (U.S.),
 Muros Ratings (Russia, alternative rating company),
 Wikirating (Switzerland, alternative rating organization),
 Humphreys Ltd (Chile, previously known as Moody´s Partner in Chile)
SERVICES PROVIDED BY THE CREDIT RATING AGENCIES

Credit rating agencies (CRAs) specialize in analysing and evaluating the creditworthiness of
corporate and sovereign issuers of debt securities. CRAs perform many activities which
includes
 Rating and grading service
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 Economy and Company Research:

 Advisory services
 Risk consulting
 Fund Research
 Knowledge Process Outsourcing
Rating and Grading Services
Rating services basically includes the rating of the following
 Rating of long /medium-term debt instrument

 Rating of short-term debt instrument
 Claims paying ability of insurance company
 Corporate Governance rating
 Structured Finance/ Obligation rating
 Grading of Mutual Funds/Bond Funds
 Grading of real estate/ Project finance rating
 SSI/ SME rating
 Issuer credit rating
 IPO Grading
 Loan/ Bank Loan rating
 Assessment of State Governments/ Rating of Urban Local Bodies
 Micro Finance Institution(MFI) Grading
 Grading of Maritime Training Course
 Grading of Healthcare Institutions
 Rating of Subsidiaries & Joint Ventures of MNCs in India
Non-rating related activities

CRAs often undertake a variety of non rating related activities. These include the following:
1. Economy and Company Research: Some Indian CRAs have set up research arms to
complement their rating activities. These arms carry out research on the economy, industries
and specific companies, and make the same available to external subscribers for a fee. In
addition, they disseminate opinions on the performance of the economy or specific industries,
available through releases to the media. The research would also be used internally by the
rating agencies for arriving at their rating opinions. SEBI permits CRAs to carry out this activity
subject to relevant firewalls.
2. Advisory services: CRAs offer various kinds of advisory services, usually through dedicated
advisory arms. Most of this is in the nature of developing policy frameworks, bid process
management, public private partnership consulting, and creating an enabling environment for
business in India and globally.
3. Risk consulting: With the application of Basel II regulations for banks, there is considerable
demand for tools and products that will allow banks to compute their capital adequacy ratios
under the revised guidelines. The risk consulting groups of credit rating agencies would
leverage the agencies‘ understanding of credit risk to develop and provide the tools and data
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that banks would require. The products in this area include tools for internal ratings, operational
risk evaluation, and overall capital calculation.
4. Funds research: Some CRAs have diversified from mutual fund ratings into mutual fund
research. The services that are available under this head include fund rankings, performance
attribution tools (to help users understand the reasons for funds‘ performance), desktop tools,
and fixed income research.
5. Knowledge Process Outsourcing: Some Indian CRAs (CRISIL and ICRA) have KPO arms
that leverage their analytical skills and other process and manpower capabilities. These arms
provide services to the CRAs‘ affiliates in developed markets, and also to other clients outside
India.
THE CREDIT RATING PROCESS

Rating is a multilayered decision making process. The process of rating starts with a rating
request from the issuer, and the signing of a rating agreement. The rating agreement has
important clauses like confidentiality, agreement by the issuer to share information with the CRA
for the purpose of assigning the rating and thereafter on an ongoing basis when the rating is
under surveillance. The rating agency undertakes discussion with the management of the
issuing entity. Discussions during a management meeting are wide-ranging, covering
competitive position, strategy, financial policy, historical performance, and near- and long-term
financial and business outlook. A credit rating is an opinion on the relative credit risk (or default
risk) associated with the instrument being rated, where a failure to pay even one rupee of the
committed debt service payments on the due dates would constitute a default. For most
instruments, the process involves estimating the cash generation capacity of the issuer through
operations (primary cash flows) in relation to its requirements for servicing debt obligations over
the tenure of the instrument. The analysis is based on information obtained from the issuer, and
on an understanding of the business environment in which the issuer operates; it is carried out
within the framework of the rating agency‘s criteria.
The analytical framework involves the analysis of business risk, technology risk, operational
risk, industry risk, market risk, financial risk and management risk. Business risk analysis covers
industry analysis, operating efficiency, market position of the company whereas financial risk
covers accounting quality, existing financial position, cash flows and financial flexibility. Under
management risk analysis an assessment is made of the competence and risk appetite of the
management. In addition to the basic framework, rating agencies also have detailed
criteria/methodologies for various industries which take into account the specific features of that
industry. The CRA might also look at the sufficiency of other means of servicing debt in case the
primary cash flows are insufficient: for instance, in a securitised instrument, the credit
enhancement and structure will be examined, while in case of a guaranteed bond the credit
strength of the guarantor could drive the rating.
The quality of ratings is also affected by the timeliness of adjustment of the ratings. The issue is
whether there should be aggressive rating changes – such as downgrading a rating by several
notches immediately in reaction to adverse news rather than responding to a fundamental
change in creditworthiness. CRAs need to balance between the dual objectives of accuracy of
ratings and their stability. In other words, the point is whether ratings should reflect changes in
default risk even if they are likely to be reversed within a very short period of time – whether
ratings should focus on the long term or should they fluctuate with near term performance?
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The process of rating starts with a rating request from the issuer, and the signing of a rating
agreement. Credit rating process normally takes three to four weeks. However, rating can be
arrived at shorter timeframes, to meet urgent requirements. The credit rating process of the
most of the rating agencies includes the following steps:
1. Request for Rating: The rating process starts with the issuer‟s request for rating. Then the
rating agreement is signed between the client and the rating agency. The rating agency assigns
a rating team for the purpose, and the client provides the relevant information to the rating team
along with the rating fees.
2. Analysis of Information: The rating team conducts the preliminary analysis of the
information provided by the client. The team also conducts the site visits for the purpose of
analysis.
3. Meeting: Then the meetings between the rating team and management of the issuer are
conducted and the rating team does the final analysis of the information after clarification of any
doubts in the management meeting.
4. Assignment of Rating: The rating team presents its analysis to the rating committee which
assigns the rating to the given instrument and communicates the same to the issuer. The rating
is then accepted by the issuer or the issuer may appeal the rating agency to further refine the
rating.
5. Dissemination of Rating: In case the rating is accepted by the issuer it is disseminated to

agencies subscriber base, and to the local and international news media. Rating information is
also updated on line on the website of rating agency.
6. Continuous Surveillance: All ratings are kept under continuous surveillance throughout its
validity by the rating agency.
Key factors considered in credit rating
(i) Business analysis : In includes nature of business, risk associated with business growth
prospects etc.
(ii) Financial analysis: here it includes profitability, liquidity conditions, net worth etc.
(iii) Management evaluation: analysis of Promoters, their credit worthiness, their past tract
records are analyzed.
(iv) Regulatory and competitive environment: Which includes government regulations on the
basis of competitions the business etc.
(v) Fundamental analysis: It includes liquidity, profitability , interest loan
Credit Rating Process of CRISIL
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Source: website of CRISIL

ADVANTAGES OF CREDIT RATING
Various advantages derived from credit rating by different parties include:
To Issuers of financial Instruments
1. Rating provides access to international pool of capital as it creates a tendency amongst the
rated corporate units to maintain higher corporate standards and to remain healthy in the
business environment. This creates better image of the business class of the country as a whole
in the international market.
2. Rating reduces the cost of borrowing for the companies as companies with high rating can
quote lesser interest rate on fixed deposits or debentures or bonds. The investors with low risk
preferences would like to invest in such safe securities.
3. The wider access to investor base and investing instruments increase the financial flexibility
of the company.
4. Rating leads the companies to self-discipline as it encourages them to come out with more
disclosures about their accounting system, financial reporting and management pattern.
5. Rating facilitates best pricing and timing of issues.

6. The rating leads the companies to assess their own performance. It provides motivation to
the companies for growth as the promoters of the companies feel confident in their own efforts
and are encouraged to undertake expansion of their operations or new projects.
7. Companies with rated instruments avail of the rating as a marketing tool to create better
image in dealings with their customers, lenders and creditors.
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8. Credit rating provides recognition to some unknown or new issuers as investors invest their
money after considering the rating grade given to them rather than just by their names. So, a
relatively new issuer with good credit rating can have a strong standing in the financial market.
To Investors in Financial Instruments
1. Credit rating gives superior information about the rated product and that too at low cost,
which the investor, otherwise, would not be able to get so easily. This helps the investors to take
calculated risk.
2. With the help of credit rating the investors can take quick decisions about the investment to
be made in any particular security of the company.
3. Credit rating reduces the dependence of investors on advice of financial intermediaries, the
stock brokers, merchant bankers, the portfolio managers or financial consultants about the good
investment proposals.
4. Highly rated securities/instruments of the company give an assurance to the investors of
safety of the instrument, thus, this safeguard the investors against bankruptcy as highly rated
securities are considered as safe ones.
5. Credit rating is done by the highly qualified analysts of the agencies, who recognize all the
quantitative and qualitative variables of the company before assigning the rating. It relieves the
investors from botheration of knowing about fundamentals of a company, as such rating saves
time and energy of investors.
6. As investors need not to see into the fundamentals of the companies, so with the help of
rating they can compare many instruments of various companies at a time and they can make
choice depending upon their own risk profile and diversification plan.
7. Investors can make the correct investment decisions after considering or evaluating the rating
of instruments, without just relying on the criteria of name recognition.
8. After rating the instruments, the rating agencies are involved in the ongoing surveillance of
the instrument being rated. The rating agencies downgrade or upgrade the instruments after
considering the subsequent financial strength of the company whose instrument is rated by it.
This ongoing surveillance gives a great benefit to the investors as they can change their
investment decision accordingly.
9. Credit rating encourages the investors to invest in securities or instruments of companies as

rating gives them clear cut idea about the financial strength of the company without putting any
extra efforts. Thus, rating induces/encourages habit of saving among investors.
10. The investing community is also benefited from the allied services provided by credit rating
agencies such as research in the form of industry reports, corporate reports, seminars and open
access to the analysis of agencies.
To Brokers and Financial Intermediaries
The brokers and other financial intermediaries also gain benefits from credit rating as through
rated instruments these parties need to make less efforts in studying the company‘s credit
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position to convince their clients to select a particular investment proposal. The time, cost and
energy of brokers and financial intermediaries is saved.
LIMITATIONS OF CREDIT RATING

Specifically, a credit rating, in the words of the CRAs, is:
 Not a recommendation to buy, hold or sell any shares, bonds, debentures or other
instruments issued by the rated entity, or derivatives thereof. A rating is one of the many
inputs that is used by investors to make an investment decision.
 Not Intended to measure many other factors that debt investors must consider in relation
to risk - such as yield offered, liquidity risk, pre-payment risk, interest rate risk, taxation
aspects, risk of secondary market loss, exchange loss risk, etc.
 Not a general-purpose credit or performance evaluation of the rated entity, unless
otherwise specified. The rating is usually specific to the instrument and is not the rating
of the issuer.
 Not an opinion on associate, affiliate or group companies of the rated entity, or on
promoters, directors or officers of the rated entity.
 Not a statutory or non-statutory audit of the rated entity
 Not an indication of compliance or otherwise with legal or statutory requirements
 Not a guarantee against default of the rated instrument. Even the highest-rated
instrument faces some risk of default, although the risks associated with this are lower
than lower-rated instruments.
Credit Ratings are typically ordinal in nature – for example we know that a rating of BB has a
higher likelihood of default than BBB, but we do not know how much higher. It is not until each
rating is assigned a probability of default that we can say how much more risky a BB rated
instrument is thus making the system cardinal. Cardinality is more useful for pricing an
instrument. Translation of credit ratings to default probabilities is, however, not a straight
forward task.
Some of the serious limitations of credit rating are its backward looking nature (depends on past
data) which in a dynamic market framework can have serious consequences including
accentuating a systemic crisis like the current global crisis, and its failure and unwillingness to
capture/cover market risks. Estimating market risk can potentially make the rating exercise
forward looking, could avoid sudden, multiple downgrades and reduce the pro-cyclicality of
rating. A really informed forward looking rating could potentially also capture tail risks and
forewarn the system to help take systemic steps well in advance to avoid panic and knee-jerk
reactions. If rating is to straddle the high ground it aspires to hold rating exercise has to achieve
this dynamism to really help measure all the risks of the market, rather than sticking to a partial
methodology of expressing an opinion on a few aspects of the product they rate. No product can
be usefully rated in a vacuum, isolated from the caprices of the market as a whole.
SEBI REGULATIONS ON CREDIT RATING

The Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999
empower SEBI to regulate CRAs (Credit rating Agencies) operating in India. In fact, SEBI was
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one of the first few regulators, globally, to put in place an effective and comprehensive
regulation for CRAs. In contrast, the US market saw CRA regulations only recently (in 2007),
and the European Union is still in the process of framing its regulations. SEBI‘s CRA regulations
have been used as model by other regulators in the emerging economies. In terms of the SEBI
Regulations, a CRA has been defined as a body corporate which is engaged in or proposes to
be engaged in, the business of rating of securities offered by way of public or rights issue. The
term ―securitiesǁ has been defined under the Securities Contract (Regulation) Act, 1956. SEBI
has also prescribed a Code of Conduct to be followed by the rating agencies in the CRA
Regulations. However, SEBI administers the activities of CRAs with respect to their role in
securities market only.
SEBI regulation for CRAs has been designed to ensure the following:
 Credible players enter this business (through stringent entry norms and eligibility criteria )
 CRAs operate in a manner that enables them to issue objective and fair opinions (through
well-defined general obligations for CRAs)
 There is widespread investor access to ratings (through a clearly articulated rating
dissemination process).
 The applicant should be registered as a company under the Companies Act, 1956 and
possess a minimum network of Rs.5 crore.
The following are some of the General Obligations specified in the CRA regulations. CRAs are
amongst the very few market intermediaries for which such detailed operating guidelines have
been prescribed under the regulations.
 Code of Conduct stipulated by SEBI

 Agreement with the client
 Monitoring of ratings
 Procedure for review of rating
 Ministry of Finance, Capital Markets Division
 Internal procedures to be framed by the CRA
 Disclosure of Rating Definitions and Rationale by the CRA
 Submission of information to the Board
 Compliance with circulars etc., issued by the Board
 Appointment of Compliance Officer
 Maintenance of Books of Accounts records, etc.
 Confidentiality
 Rating process
These regulations cover issues with respect to confidentiality of information and disclosure with
respect to the rationale of the rating being assigned. Several other provisions exist, like the
regulator‘s right to inspect a CRA. An important feature of the regulation is that CRAs are
prohibited from rating their promoters and associates.
Eligibility Criteria: Certain conditions have been prescribed by SEBI, for granting
certificate of registration to the body corporate, which must be fulfilled by the body corporate
in order to get the certificate. These conditions include the following:
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 The body corporate must be registered as a company under the Companies Act,
1956.
 The Body Corporate must have adequate infrastructure so that it can provide rating
services in accordance with the provisions of the act.
 The Body Corporate must have a minimum net worth of rupees five crore.
 The Body Corporate and its promoters must have professional competence, financial
soundness and general reputation of fairness and integrity in business transactions.
 The Body Corporate, its promoters or directors might not be convicted of any offence
involving moral turpitude or any economic offence, any time in the past.
 The employees of the Body Corporate must have an adequate professional and
relevant experience to the satisfaction of the board.
 The Body Corporate in all respects must be fit and proper for the grant of a
certificate.
 The grant of certificate must be in the interest of the investors and securities market.
SEBI Code of conduct
SEBI‘s code of conduct for CRAs addresses some of the basic issues relating to conflicts of
interest. The Code of Conduct is designed to ensure transparent and independent functioning of
CRAs. Some of the salient provisions of the Code of Conduct are:
 A CRA shall make all efforts to protect the interests of investors.

 A CRA shall at all times exercise due diligence, ensure proper care and exercise
independent professional judgment in order to achieve and maintain objectivity and
independence in the rating process.
 A CRA shall have in place a rating process that reflects consistent and international
rating standards.
 A CRA shall keep track of all important changes relating to the client companies and
shall develop efficient and responsive systems to yield timely and accurate ratings.
Further a CRA shall also monitor closely all relevant factors that might affect the
creditworthiness of the issuers.
 A CRA shall disclose its rating methodology to clients, users and the public.
 A CRA shall not make any exaggerated statement, whether oral or written, to the client
either about its qualification or its capability to render certain services or its
achievements with regard to the services rendered to other clients.
Provisions relating to conflict of interest
Credibility is the cornerstone of acceptability of credit rating services in the market. SEBI has
prescribed certain provisions in the Code of Conduct to ensure credible rating devoid of conflict
of interest. The important ones are as follows.
 A CRA shall, wherever necessary, disclose to the clients, possible sources of conflict of
duties and interests, which could impair its ability to make fair, objective and unbiased
ratings. Further it shall ensure that no conflict of interest exists among any member of its
rating committee participating in the rating analysis, and that of its client.
 A CRA or any of its employees shall not render, directly or indirectly, any investment
advice about any security in the publicly accessible media.
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 A CRA shall not offer fee-based services to the rated entities, beyond credit ratings and
research.
 A CRA shall maintain an arm‘s length relationship between its credit rating activity and
any other activity.
Multiplicity of regulators
A significant portion of CRAs‘ revenues are from products that come under the purview of SEBI.
However, there are rating agency products that are regulated by RBI (such as bank loans, fixed
deposits, and commercial paper). RBI carried out a detailed and rigorous evaluation of Indian
CRAs before granting them External Credit Assessment Institution status for rating of bank
loans under Basel II. Further, some regulators (such as IRDA and PFRDA) have incorporated
ratings into the investment guidelines for the entities they regulate. The list of various products,
and the relevant regulators, are as noted below:
CREDIT RATING IN INDIA
Rating agencies in India

1 | Crisil Limited
Corporate office – Mumbai, Maharashtra | Establishment – 1987 |
Business – Credit Rating, Risk & Policy Advisory
CRISIL headquartered at Mumbai is India’s largest and first credit rating agency; and a global
leader in research, ratings and risk & policy advisory services. It is one of the top credit rating
agency in India which has won many prestigious awards in the credit rating category and had
assessed more than 61000 entities.
2 | Credit Information Bureau India Limited -(CIBIL)

Business – Credit Rating information
CIBIL headquartered at Mumbai is an Credit Information Company which maintains records of
an individual‘s payments related to credit cards and loans. The information about users credit
cards and loans is later used by the CBIL to generate Credit information reports which are used
to approve loan applications.
3 | Fitch Ratings India Private Ltd. (Presently known as India Rating)

Corporate office – New York, USA | Establishment – 1913 |
Business – Financial Information Services
Fitch Ratings, a Fitch Group company is a among the top credit rating agencies in India
incorporated in 1913 in New York, USA. Fitch Ratings provides financial information services in
more than 30 countries and has over 2000 employees working at 50+ offices worldwide.
4| Equifax
Corporate office – Atlanta, United States | Establishment – 1899 |
Business – Credit rating
Equifax Inc started operations in 1899 and has managed to be among the top credit rating
agencies in India and at global level. Equifax Inc provides information management services
that process thousands of records of its members which can be used by them for various
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purposes and to supply risk management solutions, credit risk management and analysis, fraud
detection triggers, decision technologies, marketing tools etc.
5 | Credit Analysis & Research Ltd. (CARE)

Business – Credit Rating
CARE Ratings is second-largest among the credit rating agencies in India as far as Indian origin
company is concerned. CARE’s rating businesses can be divided into various segments like for
banks, IPO grading and sub-sovereigns. Company’s shareholders includes leading domestic
banks and financial institutions in India.
6| ICRA Limited
Corporate office – Gurgaon, Haryana | Establishment – 1991 |
Business – Investment Information and Credit Rating
ICRA limited is a joint venture between Moody’s Investors and various financial services
companies is a part of ICRA group which was founded in 1991. It is a Credit rating agency listed
on the National Stock Exchange and Bombay Stock Exchange. ICRA has four subsidiaries
ICRA Management Consulting Services Ltd, ICRA Techno Analytics Ltd, ICRA Online Ltd, PT.
ICRA Indonesia and ICRA Lanka Ltd.
7| ONICRA
Corporate office – Gurgaon, Haryana | Establishment – 1993 |
Business – Research, Risk & Ratings
Onicra Credit Rating Agency is a Credit and Performance Rating company based in Gurgaon
and founded in 1993. Onicra is among the top 10 credit rating agencies in India offering smart
and innovative solutions like risk assessment, analytical solutions and ratings to MSMEs,
corporate and individuals.
8| High Mark Credit Information Services

Business – Financial Services
High Mark Credit Information Services is a recognized credit rating company in India. It provides
bureau services, analytic solutions and risk management to banks and financial institutions
operating in Micro-finance, Retail consumer finance, MSME, Rural & Cooperative Sectors.
9|SME Rating Agency of India Ltd. (SMERA)

Corporate office -Mumbai, Maharashtra | Establishment – 2005 |
SMERA Ratings Ltd a Mumbai based company now expanded to 13 more locations was
founded in year 2005. SMERA a joint venture of SIDBI, several private sector banks in the
country and Dun & Bradstreet Information Services India Pvt. Ltd. (D&B). Since 2005 SMERA
rated over 23,000 MSMEs pan India.
10| Brickwork Ratings India Private Ltd

Corporate office – Bengaluru, Karnataka | Establishment – 2007 |
Brickwork Ratings was established in 2007 by Sangeeta Kulkarni as a credit rating firm. The
company is registered with SEBI, RBI & NSIC and operates in wide range of areas such as
NCD, Bank Loan, Commercial paper, MSME ratings. It is among the leading credit rating
companies in India having already rated Rs 200,000 crores of bonds and bank loans.
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Types of products/Instruments rated by different agencies in India
Rating Symbol of Different Credit Rating Agencies in India
Rating Symbols for Long-term Instruments
CRISIL ICRA CARE FITCH Explanation

AAA LAAA CARE AAA AAA (ind) Highest safety
AA LAA CARE AA AA (ind) High safety
A LA CARE A A (ind) Adequate safety
BBB LBBB CARE BBB BBB (ind) Moderate safety
BB LBB CARE BB BB (ind) Inadequate safety
B LB CARE B B (ind) High risk (ICRA risk prove)
C LC CARE C C (ind) Substantial risk (ICRA poor credit quality)
D LD CARE D D (ind) Default (ICRA lowest credit)
Source: Websites of agencies
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Rating Symbols for Medium-term Instruments

FAAA MAAA CARE AAA (FD)/(CD) tAAA (ind) Highest safety
FAA MAA CARE AA(FD)/(CD) tAA (ind) High safety
FA MA CARE A(FD)/(CD) tA(ind) Adequate safety
-- -- CARE BBB(FD)/(CD) -- Sufficient safety(CARE only)
-- -- CARE BB(FD)/(CD) -- Inadequate safety(CARE only)
FB MB CARE B(FD)/(CD) tB (ind) Inadequate safety ( susceptible to
default)
FC MC CARE C(FD)/(CD) tC (ind) High risk
FD MD CARE D(FD)/(CD) tD (ind) Default
Rating Symbols for Short-term Instruments

P1 A1 PR1 F1(ind) Highest credit quality /safety
P2 A2 PR2 F2(ind) Above average credit quality/Strong safety
P3 A3 PR3 F3 (ind) Adequate credit quality/ safety
P4 A4 PR4 F4(ind) Risk prone/Highly uncertain
P5 A5 PR5 F5(ind) Lowest credit quality/Default
Rating Symbols Used for Claims Paying Ability of Insurance Company

AAA iAAA CARE AAA(In) AAA (ind) Highest ability to repay policyholders‟ claims
AA iAA CARE AA (In) AA (ind) High ability to repay policyholders, claims
A iA CARE A (In) A (ind) Adequate ability to repay policyholders‟
claims
BBB iBBB CARE BBB (In) BBB (ind) Moderate ability to repay policyholders‟
claims
BB iBB CARE BB(In) BB (ind) Inadequate ability to repay policyholders‟
claims
B iB CARE B(In) B (ind) Weak ability to repay policyholders‟ claims
C iC CARE C(In) C (ind) Lowest/poor ability to repay policyholders‟
claims
D __ CARE D(In) D (ind) Default to repay policyholders‟ claims
Rating Symbols Used for Mutual Funds Grading

AAAf mfAAA CARE AAAf AAA (ind) Minimal credit risk
AAf mfAA CARE AAf AA (ind) Very low credit risk
Af mfA CARE Af A (ind) Low credit risk
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BBBf mfBBB CARE BBBf BBB (ind) Moderate credit risk

BBf mfBB CARE BBf BB (ind) High credit risk
Bf mfB CARE Bf B (ind) Very high credit risk
Cf mfC CARE Cf C (ind) Extremely higher credit risk
IPO Grading Symbols

5/5 IPO Grade 5 CARE IPO FITCH IPO Grade Strong Fundamentals of the
Grade 5 5(ind) issuers concerned
4/5 IPO Grade 4 CARE IPO FITCH IPO Grade Above average fundamentals of
Grade 4 4(ind) the issuers concerned
3/5 IPO Grade 3 CARE IPO FITCH IPO Grade Average fundamentals of the
2/5 IPO Grade 2 CARE IPO FITCH IPO Grade Below average fundamentals of
Grade 2 2(ind) the issuers concerned
1/5 IPO Grade 1 CARE IPO FITCH IPO Grade Poor fundamentals of the
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SECURITIZATION OF DEBT
NATURE AND SCOPE OF SECURITIZATION

Securitization is the process by which financial assets such as loan receivables, mortgage
backed receivables, credit card balances, hire-purchase debtors, lease receivables, trade
debtors, etc., are transformed into securities. Securitization is different from 'factoring' in that
'factoring' involves transfer of debts without transformation thereof into securities.
securitization means the conversion of existing or future cash in-flows of any person into
tradable security, which then may be sold in the market.
According to Kenneth Cox securitization is a process in which pools of individual loans or

receivables or actionable claims are packaged, under written and distributed to investors in the
form of securities. It is a process of liquidizing assets appearing in the balance sheet of a Bank
or financial institution which represent long term receivables by issuing marketable securities
there against. It involves conversion of cash flow from a portfolio of assets in negotiable
instruments or assignable debts which are sold to investors. The name securitization is derived
from the fact that the form of financial instruments used to obtain funds from the investors is
securities. All assets can be securitized so long as they are associated with cash flow. Hence,
the securities which are the outcome of securitization processes are termed asset-backed
securities (ABS). From this perspective, securitization could also be defined as a financial
process leading to an issue of an ABS.
Parties to a Securitization Transaction
There are primarily three parties to a securitisation deal, namely –
a. The Originator: This is the entity on whose books the assets to be securitised exist. It is the
prime mover of the deal i.e. it sets up the necessary structures to execute the deal. It sells the
assets on its books and receives the funds generated from such sale. In a true sale, the
Originator transfers both the legal and the beneficial interest in the assets to the SPV.
b. The SPV: The issuer also known as the SPV is the entity, which would typically buy the
assets (to be securitised) from the Originator. The SPV is typically a low-capitalised entity with
narrowly defined purposes and activities, and usually has independent trustees/directors. As
one of the main objectives of securitisation is to remove the assets from the balance sheet of
the Originator, the SPV plays a very important role in as much as it holds the assets in its books
and makes the upfront payment for them to the Originator.
c. The Investors: The investors may be in the form of individuals or institutional investors like
FIs, mutual funds, provident funds, pension funds, insurance companies, etc. They buy a
participating interest in the total pool of receivables and receive their payment in the form of
interest and principal as per agreed pattern.
Besides these three primary parties, the other parties involved in a securitisation deal are
given below:
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a) The Obligor(s): The Obligor is the Originator's debtor (borrower of the original loan). The
amount outstanding from the Obligor is the asset that is transferred to the SPV. The credit
standing of the Obligor(s) is of paramount importance in a securitization transaction.
b) The Rating Agency: Since the investors take on the risk of the asset pool rather than the
Originator, an external credit rating plays an important role. The rating process would assess
the strength of the cash flow and the mechanism designed to ensure full and timely payment by
the process of selection of loans of appropriate credit quality, the extent of credit and liquidity
support provided and the strength of the legal framework.
c) Administrator or Servicer: It collects the payment due from the Obligor/s and passes it to
the SPV, follows up with delinquent borrowers and pursues legal remedies available against the
defaulting borrowers. Since it receives the instalments and pays it to the SPV, it is also called
the Receiving and Paying Agent.
d) Agent and Trustee: It accepts the responsibility for overseeing that all the parties to the
securitisation deal perform in accordance with the securitisation trust agreement. Basically, it is
appointed to look after the interest of the investors.
e) Structurer: Normally, an investment banker is responsible as structurer for bringing together

the Originator, credit enhancer/s, the investors and other partners to a securitisation deal. It also
works with the Originator and helps in structuring deals.
The different parties to a securitization deal have very different roles to play. In fact, firms
specialise in those areas in which they enjoy competitive advantage. The entire process is
broken up into separate parts with different parties specialising in origination of loans, raising
funds from the capital markets, servicing of loans etc. It is this kind of segmentation of market
roles that introduces several efficiencies securitisation is so often credited with.
SECURITIZATION PROCESS
The following are the basic activities involved in securatisation. It is followed by a

diagrammatic presentation followed by a detailed analysis.
 Assets are originated through various loans.

 The company on whose B/S the asset exists is called as “originator”.
 Once large portfolio of homogeneous have been originated its securitized and
sold to a SPV (owned by a trust/originator).
 SPV issues tradable securities to fund the purchase of the asset.
 Investor purchase the security because they are satisfied that security would be
paid in full and on time from the cash flow available in the asset pool.
 SPV agrees to pay any surplus which may arise during its funding of assets back
to the originator.
 As cash flow arises on the asset, these are used by the SPV to repay funds to
the investor in the securities.
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The process involved in securitization transaction includes several steps.
(A) The originator pools the similar set of assets that generate a predictable stream of
payment and sells/ assigns them to special purpose vehicle (SPV). Any asset having a
cash flow profile over a period of time can be securitized. Some of the assets which has
the potential to be securitized are housing loans, car loans, term loans, export credits,
and future receivables like credit card payments, ticket sales, album sales, car rentals,
electricity and telephone bills receivables etc.. These assets are known as ‘financial
assets’
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(B) Under section 5(1) of the Scarfaesi Act, 2002 only banks and financial institutions
can securitize their financial assets, thereby restricting the originator of the
securitization. The SPV converts the financial assets into securities for the purposes of
selling them to the investors. SPV has the option to take the credit rating for the
securities from the credit rating agency and investor receives the return on capital from
the securities over the financial assets
(C)Broadly, securitization transaction can be divided into main players and the
facilitators. The main players being the originator, obligor, SPV, and Investors (also
known as QIBs - qualified institutional buyers). On the other hand, the facilitators of the
securitization transaction can be considered as credit rating agency, insurance
company or underwriters, trustees, and receiving & paying agent .
(D) The very inception of the securitization transaction starts from the originator.
Originator is the one who owns the financial assets by making loans to the borrowers or
obligors. In India, the originator can only be banks or financial institutions. Hence, the
scope and limits of the securitization transaction in India is not as broad as UK and US.
The obligor or the borrower, can be any one person including legal person, who takes
the loan from the originator, which are to be returned to the originator (receivables). The
SPV can be institutionalised in the form of a trust or company with the main object to
support the securitization transaction. Its main aim is to buys receivables from the
originator and convert them into security receipts, which are sold to the investors.
Section 2(v) and 2(za) of the Act describes the SPV as a company under the
Companies Act, 1956. However, nothing under the Act stops the SPV from floating a
trust. Further, to have proper supervision over SPV-like companies, Section 3 of the Act
prescribes ‘registration’, ‘net worth’ and corporate governance requirements, to keep a
check on the transaction and the SPV. Investors under Section 7 the Act are restricted
to only the QIBs, who can invest in the security receipts.
(E) Facilitators play a very important role in enhancing the credit worthiness of the
financial assets. Credit rating agency evaluates the securitized instruments and their
credit worthiness. This helps the investors and other players to take prudent steps in
investing their money. Insurance company and underwriters covers the risk, which
might be faced by the investors in future due to any unforeseen losses. The Trustee
owes a responsibility towards the beneficiary i.e., investors. Trustee acts on behalf of its
beneficiaries i.e., the investors. This legal relationship gives the right to the trustee to
have the priority interest in the financial asset for their beneficiaries. The Trustee can
protect the investor’s interest by way of reviewing the assets, distributing cash flow to
the investors and taking legal action to protect the investors interest. And, last but not
the least is the role of the receiving and paying agent. This role is normally played by
the originator himself. In this, the agent has to make sure periodic payments from the
obligor and further payment transferred to the investors.
(F) A usual feature of securitisation is 'credit enhancement', i.e., an arrangement which

is designed to protect the holders of the securities issued by an SPE from losses and/or
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cash flow mismatches arising from shortfall or delays in collections from the securitised
assets. The arrangement often involves one or more of the following:
(i). Provision of cash collateral, i.e., a deposit of cash which in specified

circumstances can be used by the SPE for discharging its financial obligation in respect
of the securities held by the investors.
(ii). Over collaterisation, i.e., making available to the SPE assets in excess of the
securitised assets, the realization of which can be used in specified circumstances to
fund the shortfalls and/or is matches in fulfillment of its financial obligations by the SPE.
(iii). Recourse obligation accepted by the Originator.
(iv). Third party guarantee, i.e., a guarantee given by a third party by accepting the
obligation to fund any shortfall on the part of the SPE in meeting its financial obligations
in respect of the securitisation transaction.
(v). Structuring of the instruments issued by an SPE into senior and subordinated
securities such that the senior securities (issued to investors) are cushioned against the
risk of shortfalls in realization of securitised assets by the subordinated securities
(issued normally to the Originator). Payments on subordinated securities are due only
after the amounts due on the senior securities are discharged.
Pass and Pay Through Structures
The nature of the investors’ interest in the underlying assets determines whether a securitisation
structure is a ‘Pass Through’ or ‘Pay Through’ structure. In a pass through structure, the SPV
issues ‘Pass Through Certificates’ which are in the nature of participation certificates that enable
the investors to take a direct exposure on the performance of the securitised assets. Pay
through, on the other hand, gives investors only a charge against the securitised assets, while
the assets themselves are owned by the SPV. The SPV issues regular secured debt
instruments. The term PTCs has been used in the report referring to pass through as well as
pay through certificates.
Pay through structures permit de-synchronization of servicing of the securities from the
underlying cash flows. In the pay through structure, the SPV is given discretion (albeit to a
limited extent) to re-invest short term surpluses - a power that is not available to the SPV in the
case of the pass through structure. In the pass through structure, investors are serviced as and
when cash is actually generated by the underlying assets. Delay in cash flows is of course
shielded to the extent of credit enhancement. Prepayments are, however, passed on to the
investors who then have to tackle re-investment risk. A further advantage of the pay through
structure is that different issues of securities can be ranked and hence priced differentially.
107
Asset and Mortgage Backed Securities
Securities issued by the SPV in a securitisation transaction are referred to as Asset Backed
Securities (ABS) because investors rely on the performance of the assets that collateralise the
securities. They do not take an exposure either on the previous owner of the assets (the
Originator), or the entity issuing the securities (the SPV). Clearly, classifying securities as
‘asset-backed’ seeks to differentiate them from regular securities, which are the liabilities of the
entity issuing them.
In practice, a further category is identified – securities backed by mortgage loans (loans secured
by specified real estate property, wherein the lender has the right to sell the property, if the
borrower defaults). Such securities are called Mortgage Backed Securities (MBS). The most
common example of MBS is securities backed by mortgage housing loans. All securitised
instruments are either MBS or ABS.
RATIONALE FOR SECURITIZATION

Securitisation is one way in which a company might go about financing its assets. There are
generally the following reasons why companies consider securitisation:
1. Improve capital returns:

To improve their return on capital, since securitisation normally requires less capital to support it
than traditional on-balance sheet funding;
2. Raise finance:
To raise finance when other forms of finance are unavailable (in a recession Banks are often
unwilling to lend - and during a boom, Banks often cannot keep up with the demand for funds);
3. Better return on assets:

Securitisation can be a cheap source of funds, but the attractiveness of securitisation for this
reason depends primarily on the costs associated with alternative funding sources;
4. Diversify portfolio:
To diversify the sources of funding which can be accessed, so that dependence upon Banking
or retail sources of funds is reduced;
5. To lower risk:
To reduce credit exposure to particular assets for instance, if a particular class of lending
becomes large in relation to the balance sheet as a whole, then securitisation can remove some
of the assets from the balance sheet;
7. Manage Mortgage Assets:

To match-fund certain classes of asset - mortgage assets are technically 25 year assets, a
proportion of which should be funded with long term finance; securitisation normally offers the
ability to raise finance with a longer maturity than is available in other funding markets;
8. Benefits:
To achieve a regulatory advantage, since securitisation normally removes certain risks which
can cause regulators some concern, there can be a beneficial result in terms of the availability
108
of certain forms of finance (for example, in the UK building societies consider securitisation as a
means of managing the restriction on their wholesale funding abilities).
SECURITISATION IN INDIA
Securitisation in India began in the early nineties. It has been of a recent origin. Initially it started
as a device for bilateral acquisitions of portfolios of finance companies. These were forms of
quasi-securitizations, with portfolios moving from the balance sheet of one originator to that of
another. Originally these transactions included provisions that provided recourse to the
originator as well as new loan sales through the direct assignment route, which was structured
using the true sale concept. Through most of the 90s, securitisation of auto loans was the
mainstay of the Indian markets. But since 2000, Residential Mortgage Backed Securities
(RMBS) have fuelled the growth of the market.
The need for securitization in India exists in three major areas –
1. Mortgage Backed Securities (MBS),

2. The infrastructure Sector and
3. Other Asset Backed Securities (ABS).
Some examples of securitisation in the Indian context are:
 First securitisation deal in India between Citibank and GIC Mutual Fund in 1991 for Rs
160 mn
 L&T raised Rs 4,090 mn through the securitisation of future lease rentals to raise capital
for its power plant in 1999.
 India’s first securitisation of personal loan by Citibank in 1999 for Rs 2,841 mn.
 India’s first mortgage backed securities issue (MBS) of Rs 597 mn by NHB and HDFC in
2001.
 Securitisation of aircraft receivables by Jet Airways for Rs 16,000 mn in 2001 through
offshore SPV.
 India’s first sales tax deferrals securitisation by Govt of Maharashtra in 2001 for Rs
1,500 mn.
 India’s first deal in the power sector by Karnataka Electricity Board for receivables worth
Rs 1,940 mn and placed them with HUDCO.
 India’s first Collateralised Debt Obligation (CDO) deal by ICICI bank in 2002
 India’s first floating rate securitisation issuance by Citigroup of Rs 2,810 mn in 2003. The
fixed rate auto loan receivables of Citibank and Citicorp Finance India included in the
securitisation
 India’s first securitisation of sovereign lease receivables by Indian Railway Finance
Corporation (IRFC) of Rs 1,960 mn in 2005. The receivables consist of lease amounts
payable by the ministry of railways to IRFC
 India’s largest securitisation deal at that time by ICICI bank of Rs 19,299 mn in 2007.
The underlying asset pool was auto loan receivables.
109
ADVANTAGES OF SECURITIZATION
To originator:
 Securitization result in shifting the assets off the balance sheet and thus giving the
originator recourse to off balance sheet funding.
 It converts the illiquid asset into liquid portfolio.
 It facilitate the better balance sheet management as assets are transferred off balance
sheet facilitating satisfaction of capital adequacy norms.
 The credit rating of the Originator enhances
To Investors
 Securitization is a new investment avenue.

 Though the investors face credit risk, the securities are tied to definite asset.
 As the securities are rated by credit rating agencies, it becomes easier for the investors
to compare the risk return profile and make informed investment decision.
 Securitization help to convert steam of cash receivables into a source of long term
finance
**********
110

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Dr.

Mukund Sharma, BNMIT

INVESTMENT BANKING & FINANCIAL SERVICES

INTRODUCTION TO FINANCIAL SYSTEM

Financial system acts as nerve system of country’s economy. A nation’s economic

• Mobilizing savings and converting it into investment.

Functions of Financial System

• It helps to mobilize financial resources for the economy.

Four major components of Financial system

Source: Financial Institutions and markets, L M Bhole, TMH, New Delhi.

MAJOR COMPONENTS OF THE FINANCIAL SYSTEM

12. Credit Rating

NATURE AND SCOPE OF MERCHANT BANKING

• Commercial bankers are comparatively retail banking activity where as merchant

• Merchant bankers are more of an intermediary.

Need for Merchant Bankers

• Growing complexity in rules and procedures of the government.

• Growing industrialization and increase of technologically advanced industries.

• Promoting the role of new issue market in mobilizing saving.

SERVICES PROVIDED BY MERCHANT BANKER

Merchant banks provide the following specialized functions to their clients.

Issue management is considered to be one of the most important functions performed by a

Number of Merchant Banker required for Issue management

Pre-Issue Management activities:

Step 2: Finalizing the appointments of the following agencies:

Step 4: pricing the issue.

Step 5: Drafting of prospectus:

Step 8: Marketing of the issue.

Step 9: Underwriting the issue

Post issue management activities

Step1: collecting and processing of application.

Step 3: Listing Agreement

4. Portfolio management services

Different merchant bankers provide portfolio management services, by managing the

 Advising on time of buying and selling.

6. Managing Joint venture abroad

7. Merchant bankers provides some of the other specialized services such as

a) Advice on Expansion and Modernization : Merchant bankers give advice for

b) Handling Government Consent for Industrial Projects : A businessman has to get

c) Special Assistance to Small Companies and Entrepreneurs : Merchant banks advise

f) Corporate Restructuring : It includes mergers or acquisitions of existing business

h) Arranging External Commercial Borrowings (ECB)

i) Arranging and participating in international loan syndication

j) Loans backed by Export Credit Agencies

k) Foreign currency loans under the FCNR (B) scheme

l) Import Finance for Indian corporate

m) Arranging leasing and hire purchasing deals

n) Debt Issue Management

CODE OF CONDUCT FOR MERCHANT BANKERS

The Merchant Bankers have to abide by the following Code of Conduct:

SEBI REGULATIONS RELATING TO MERCHANT BANKERS

Categories of Merchant Bankers

(i) it is a body corporate and is not a NBFC

(ii) it has got necessary infrastructure to support the business activity

(iv) its registration is in the general interest of investors.

C.Capital Adequacy Requirement :

No merchant banker, other than a bank/public financial institution is permitted to carry on

F. Responsibilities of Lead Managers :

• It is necessary for a lead manager to accept a minimum underwriting obligation of 5% of

G. Due diligence certificate :

modifications/ suggestions made by it with respect to the information to be given to the

As and when required, a merchant banker has to disclose to SEBI

• (i) his responsibilities with regard to the management of the issue,

• (iv) information relating to his activities as manager, underwriter, consultant or advisor to