introduction to financial services

1. Chapter--------------1
Introduction to Financial Services.
Introduction
Finance is the life blood of business. Thetwo main area of finance are:
1) Financial Management 2) Financial Services.
Financial Management is concerned with duties of the finance manager in an
organisation and who performthe duty of preparing budgets, financial
forecasting, cash management, credit analysis, investmentdecision making, fund
management etc.,. Financial Services is concerned with the design and delivery of
advice and Financial products to individuals and business in the area of Banking
and insurance, personalfinancial planning, investment in real and financial assets
etc.,. Financial Services constitute an important componentof the financial
system. Financial Services, through the network of element such as financial
institutions, financial markets and financial instruments, servethe need of
individuals, institutions and corporates. Considering its nature and importance,
financial services are regarded as the fourth element of the financial system.
Meaning And Concepts:
The term 'Financial Services'can be defined as, ''Activities, Benefits and
Satisfactions, connected with the sale of money, that offer to users and customers,
financial related value.'' Financial Serviceorganisation provides services to industrial
enterprises and ultimate consumer markets. Following are the institutional financial
servicesuppliers:
1) Banks and Non- Banking Finance Companies.
2) InsuranceCompanies
3) Mutual Fund Companies
4) Stock Exchanges
5) Housing finance societies.

2. 6) Leasing companies.
7) Credit Rating companies.
Features of Financial services:
Like any other service, the financial services havethe following characteristics:
i) Intangibility: For Financial services to be successfully created and marketed, the
institutions providing them must havea good image and enjoy the confidence of
their clients. Quality and innovativeness of serviceare the focus points for building
credibility and gaining the trustof the clients.
ii) Dynamic: Financial Services haveto be constantly redefined and redefined on the
basis of socio-economic changes occurring in the economy, such as disposable
income, standard of living, level of education, etc.,.
iii) Customer Orientation: The responsibility of any financial services organisation is
to protect customer's interest and it is not only important in banking and insurance,
but also in other sectors of the financial services.
iv) Inseparability: Thefunctions of production and supply of financial services have
to be carried out simultaneously. This calls for a perfect understanding between the
financial services firms and their clients.
v) Geographical Dispersion: FinancialServices musthave both appeal and wider
application. To ensure this, the serviceproviding organisation musthave massive
branch networks so that benefit of convenience are enjoyed by local, national and
international customers.
vi) Information Based: FinancialServices involves creation, dissemination, and use of
information. Information is the very important element in the creation of financial
services. Costof processing information is quite irrelevantin the best production
and supply of financial services.
Problems in the Financial Service Sector
The Indian financial services industry has been making rapid progress in the
financial services. In the pastrecession environment, this sector is fast integrating
with global financial markets. However, the financial servicesector faces many
problems, someof these problems are discussed below:

3. 1) Lack of Experience: To implement the financial serviceschemes, the institutions
and professionalbodies haveno specialised knowledgeto manage this sector in
India.
2) Limited Innovations: Thegrowth and development of financial systemis
measurablein terms of the width and depth of the rangeof products offered by it.
There has been limited innovation in the financial products. For instance, a number
of tailor-made and imaginatively designed financial products.
3) Inefficient Technology: One of the basic problem faced by Indian financialservices
firms is that they lack adequate and time tested technology to efficiently create and
deliver the financial products to their clients.
4) Restrictions in Operations: The scope of operations relating to financial service is
currently restricted to certain areas only. For example, the venture capital
operations in India is restricted to providefinance for start- ups, high-tech projects,
and to convertR&D efforts into Commercial production.
5) Lack of institutional mechanisms: There must be a wide range of financial services
available too. The establishment of a sound institutional mechanism, whereby the
existing financial institutions, banks and insurancecompanies are allowed to open
fully-fledged subsidiaries, is therefore, called for.
Types of Financial Services
Financial Services provided by various financial institutions, commercial banks
and merchantbankers can be broadly classified into two categories:
1) Asset Based/Fund based Services.
2) Fee Based/Advisory Services.
The Fund based/AssetBased Services include:-
a. Equipment Lease Financing.
b. Hire Purchaseand Consumer Credit.
c. Venture capital.
d. Housing Finance.
e. Bill discounting.
f. Factoring.

4. g. InsuranceServices.
h. Securitization of debt.
The Fee based/Advisory Services include:-
a. IssueManagement.
b. Portfolio Management.
c. Loan Syndication.
d. Capital Restructuring.
e. Stock Broking.
f. Credit Rating.
The various Fund based and Fee based financial services provided by banking and
non-banking financial institutions are discussed below:
(1) Equipment Leasing/ Lease Financing
Lease is a legal contract, and thus enforceable by all parties under the
contract law of applicable jurisdiction. A lease should be contracted to a license,
which may entitle a person (called a licensee) to useproperty, but which is subject
to termination at the will of the owner of the property (called the licensor). Leasing
is an alternative to purchase of an asset in order to acquire the services of that asset.
By leasing an assetthe lessee essentially acquires it use value fromthe lessor, who
actually purchaseand owns the assets. Thelease agreement provides for a number
of obligations on the part of the lessee which do not form partof his implied
obligations under the legislative frame work. The legal framework and the lease
agreements provides the regulatory framework of lease financing in India. Leasing
industry in India is a growing business activity in the country.
(2) Hire Purchaseand Consumer Credit
Itis an agreement under which goods are let on hire and under which the
hirer has an option to purchasethem in accordancewith the terms of the
agreement. Hire purchaseis used as a sourceof finance, usually for acquiring
relatively low cost assets such as auto-mobiles, office equipments etc.,. Consumer
credit includes all assetbased financing plans offered to individuals to help them for
acquiring durable consumer goods in a consumer credit transaction. The consumer
pay a partof the cash purchaseprice at the time of the delivery of the goods and

5. pay the balance amount with interest over a specified period of time. Itis an asset
based financial servicein India.
(3) Venture Capital
Venture Capital means the investmentof long term risk equity finance where
the primary reward for its provider, the venture capitalist, is an eventual capital gain,
rather than interest income or dividend yield. Venturecapital financing is one of the
most recent entrants in the Indian Capital Market. Moreover the guidelines issued
by the governmentfor the setting up of venture capital companies are too non-
restrictive and unrealistic and have come in the way of their growth. A venture
capital investment is illiquid, i.e., not subjectto repaymenton demand as with an
overdraftor following a loan repaymentschedule. The investment is realised when
the company is sold or achieve a stock marketlisting. It is lost when as sometimes
occurs, the company goes into liquidation. Venture Capital is risk financing at its
extreme.
(4) Housing Finance
The responsibility to providehousing finance rested with the governmentof
India till the mid-80s. Thesetting up of the National Housing Bank (NHB), a fully
owned subsidiary of the Reserve Bank of India (RBI) in 1998 as the apex institution,
marked the beginning of the emergence of housing finance as a fund based financial
servicein India. TheNHB was established in 1988 under the NHB Act, 1987, to
operate as a principal agency to promote Housing Finance Institutions (HFIs), atboth
local and regional level, and to providefinancial and other supportto them. The HFIs
include institutions, whether incorporated or not, that primarily transactor have as
one of their principal objects viz. Transacting business of providing finance for
housing, either directly or indirectly. Making of loans and advances or rendering
other forms of financial assistance, whatsoever, for housing activities to HFIs, banks,
state cooperatives, agriculturaland rural development banks or any other
institutions, class of institutions notified by the government.
5) Bill Discounting
Bill Discounting is an attractive fund based financial serviceprovided by the
finance companies. Itemerged as a profitable business in the early 90s for finance

6. companies and represented a diversification in their activities in tune with the
emerging financial scene in India. According to the Indian Negotiable Instrument
Act,1881, ''TheBill of Exchange is an instrumentin writing containing an
unconditional order, signed by the maker, directing certain people to pay a certain
sumof money only to, or to the order of, a certain person, or to the bearer of that
instrument.''The Bill of Exchange (B/E) is used for financing the transactions in
goods which means that it is essentially a trade-related instrument. The seller can
take over the accepted B/E to a discounting agency and obtain ready cash. The
margin between the ready money paid and the face value of the bill is called the
discountand is calculated at a rate percentage per annum on the maturity value.
The maturity of B/E is defined as the date on which payment will fall due. Normal
maturity periods are 30, 60, 90 or 120 days but bills maturity within 90 days are
seems to be the mostpopular.
6) Factoring
Factoring as a fund based financial service, provides resources to finance
receivables as well as facilitates the collection of receivables. Accounting to the
international institute for unification of privatelaw (UNIDROIT) Rome. Factoring
means an agreement between a factor and his client that includes at-least two of
the following services provided by the factor:
(a) Finance.
(b) Maintenance of accounts.
(c) Collection of debts and
(d) Protection against credit risk.
At present, Factoring in India is rendered by only a few financial institutions on a
recoursebasis. However, thereport of the working group on money market(Vulva
Committee) constituted by the RBI has recommended that banks should be
encouraged to set up factoring divisions to providespeedy and healthy finance to
the corporateentities.
7) InsuranceServices
Insuranceis a formof risk management primarily used to hedge againstthe
risk of a contingent loss. Itis to be defined as the transfer of risk of a potential loss
fromone to another, in exchange for a premium. Insuranceapplies to situations

7. wherea loss may or may not occur. Itcannot be applied to situations whereloss is
expected to happen. InsuranceContracts pay insurancebenefits or compensation in
the event of adverseoutcome like deaths, accidents, or losses fromother causes.
Until 1999, theinsuranceorganisation in India comprised two state- owned
monolithic institutions, namely, the Life InsuranceCorporation of India (LIC) and
General InsuranceCorporation of India (GIC) and its four subsidiaries. In order to
improvethe quality of insuranceservices in the country, the Malhotra Committee
(1993) had recommended a comprehensiveframework of reformin the insurance
sector. The insurancesector in the country is emerging in responseto the follow-up
action on the recommendation of the committee.
8) Securitization of Debt
Securitization, as a financing technique, originated in the United States during
the 1970s when theGovernmentNational Mortgage Association started trading in
securities backed by pools of mortgageloans. These securities known as 'mortgage
pass through securities'facilitated investors in purchasing fractionalundivided
interest in a pool of mortgageloans by providing for a sharein the income and
principal payments generated by the underlying assets in to securities, securities
into liquidity, and subsequently into assets on an ongoing basis, increasing thereby
the turnover of business and profit while also providing for flexibility in yield, pricing
pattern, issuing risk, and marketability of instruments used to the advantageof both
borrowers and lenders. Simply Banks and Financial Institutions makeloans and
advances for the purchaseof assets such as cars, houses, trucks, machinery etc.,.
Therefore, they hold a pool of individual loans and receivables that generate cash
flows. Securities are then created againstthem, which are rated and sold to
investors.
9) IssueManagement
The management of issues for raising funds through various types of
instruments by Companies is known as 'IssueManagement'. The function of capital
issuemanagement in India is carried out by Merchant bankers who havethe
requisite professionalskills and competence. A fast growing economy like India
offers tremendous scopefor issue management and the merchant bakers provide
their skills and expertise to companies in the management of capital issues. This
essentially aims at challenging households saving into the corporatesector through
issueof corporatesecurities.

8. 10) Portfolio Management
Th term portfolio means the total holdings of securities belonging to any
person. A list of all those services and facilities that are provided by a portfolio
manager to its client, relating to the management and administration of portfolio of
securities or funds of the clients, is referred to as 'Portfolio Management Services'.
The objective of portfolio management is to develop a portfolio that has a maximum
return at whatever level of risk the investor deems appropriate. According to SEBI,
Portfolio Manger means 'any person who pursuantto a contract or arrangement
with a client, advices or directs or undertakes on behalf of the client the
management or administration of a portfolio securities on the funds of the clients,
as the case may be.
11) CorporateRestructuring
CorporateRestructuring implies activities related to expansion or contraction
of a firm's operations or changes in its assets or financial or ownership structure.
The most common form of corporate restructuring aremergers/amalgamation and
acquisitions/turnovers, financialrestructuring, divestitures/de-mergers and buyouts.
Portfolio growth constitute one of the prime objectives of mostof the firms. Itcan
be achieved internally through the process of introduction and development of new
products, expanding the capacity of existing products. Alternatively, the growth
process can be facilitated externally through mergers, acquisitions, amalgamations,
turnovers, absorption, consolidation and so on.
12) Loan Syndication
This is a specialised services in preparation of projects, loan applications for
raising shortterm as well as long term credit fromvarious banks and financial
institutions for financing the projector meeting the working capitalrequirements.
They also manage Euro issues and help in raising funds abroad. The institutions of
Finance with which the merchantbankers syndicateinclude IndustrialFinance
Corporation of India(IFCI), IndustrialDevelopmentBank of India(ICICI),Industrial
Reconstruction Bank of India(IRBI), and shipping creditand investment company of
India Ltd. (SCICI Ltd.). In addition, CommercialBanks, Mutual Funds and Venture
Capital Firms are also involved in the Loan Syndication for meeting the working
capital requirement of trade and industry.
13) Stock Broking

9. The process by which buyers and sellers of stock of securities are brought
together under a common platform called the stock exchange is known as 'Stock
Broking'. Stock Broking is essentially the job of a financial serviceintermediary. Stock
Broking is carried by brokers and sub brokers who arepermitted by the SEBI. A stock
broker may be an individual or a corporate. Stock Broking services areprovided both
online as well as offline to suit the requirements of clients. Stock Broking activities
are carried out by banking as well as non-banking financialcompanies. Stock Brokers
offer the services to both domestic as well as overseas clients. Most popular among
the domestic company stock brokers include Share-Khan, ICICI CreditKotak
Securities, IDBI CapitalMarkets, India Bulls, Geojit, Reliance Money, India Infoline
etc.,.
14) Credit Rating
Credit Rating is the symbolic indicator of the current opinion of the rating
agency regarding the relative ability of the issue of financial instruments to meet the
serviceobligations as and when they arise. Itprovides a relative thinking of credit
quality of financial instrument or their grading according to investment qualities. In
other words, creditrating provides a simple systemof gradation by which the
relative capacities of companies make timely repayment of of interest and principal
on a particular type of financial instrumentcan be noted. As a fee based financial
advisory service, creditrating is, obviously extremely useful to investors, corporates,
banks and financial institutions. For Investors, itis an indicator expressing the
underlying credit quality of an issueprogramme.
Financial Economics
Financial Economics means the application of economic theory to problems
that arise in finance. Much of economic theory begins with the concept of
competition and competitive markets. Fromthe implication of competitive markets
one learns that price in competitive markets are pulled or pushed into equality with
the marginalcost of producing the goods or services traded in the market. If there
are no barriers to competitions, economic forces erode the excessiveprofit of those
firms which are able to producerevenues from sales greatly exceeding costs.
Competitive markets are a conceptual benchmark upon which economic analysis of
industries and firms is built and area touchstonefromwhich to begin to analysethe
performanceand prospects of an industry.

10. Financial services in India
The Indian Financial Systemwas unorganized upto the 1970s. With the
nationalisation of the 14 major privatesector banks on 19th
July 1969, the Indian
Banking systembecame predominantly owned by the government. Interestrates
were controlled by the reservebank of India. The state developed monolithic
finance companies to providefinancial services:
IndustrialDevelopmentCorporation of India -1948
IndustrialDevelopmentBank of India -1964
Life InsuranceCorporation -1956
General InsuranceCorporation -1973
Unit Trustof India -1964
The financial services sector and financial markets were targets for financial
sector reforms in the period after 1991 and structuralchanges were introduced in
the financial sector.