This chapter deals with some of the important special finance such as leasing, venture
capital, foreign direct investment etc. and also this chapter covers the advantages and
disadvantages, application in the present position and institution, which are providing.
These finance to the business concern. This part is divided into the following major parts
such as:
1. Lease Financing
2. Venture Capital
3. Factoring
4. Foreign Direct Investment
5. Merchant Banking
6. Credit Rating
7. Mutual Funds
LEASE FINANCING
Lease financing is one of the popular and common methods of assets based finance, which
is the alternative to the loan finance. Lease is a contract. A contract under which one
party, the leaser (owner) of an asset agrees to grant the use of that asset to another leaser,
in exchange for periodic rental payments.
Lease is contractual agreement between the owner of the assets and user of the assets
for a specific period by a periodical rent.
Definition of Leasing
Lease may be defined as a contractual arrangement in which a party owning an asset provides
the asset for use to another, the right to use the assets to the user over a certain period of
time, for consideration in form of periodic payment, with or without a further payment.
200 Financial Management
According to the equipment leasing association of UK definition, leasing is a contract
between the lesser and the leaser for hire of a specific asset selected from a manufacturers
or vender of such assets by the lessee. The leaser retains the ownership of the asset. The
leassee pass possession and uses the asset on payment for the specified period.
Elements of Leasing
Leasing is one of the important and popular parts of asset based finance. It consists of the
following essential elements. One should understand these elements before they are going to
study on leasing.
1. Parties: These are essentially two parties to a contract of lease financing, namely
the owner and user of the assets.
2. Leaser: Leaser is the owner of the assets that are being leased. Leasers may be
individual partnership, joint stock companies, corporation or financial institutions.
3. Lease: Lease is the receiver of the service of the assets under a lease contract.
Lease assets may be firms or companies.
4. Lease broker: Lease broker is an agent in between the leaser (owner) and lessee.
He acts as an intermediary in arranging the lease deals. Merchant banking divisions
of foreign banks, subsidiaries indian banking and private foreign banks are acting
as lease brokers.
5. Lease assets: The lease assets may be plant, machinery, equipments, land,
automobile, factory, building etc.
Term of Lease
The term of lease is the period for which the agreement of lease remains for operations.
The lease term may be fixed in the agreement or up to the expiry of the assets.
Lease Rental
The consideration that the lesae pays to the leaser for lease transaction is the rental.
Type of Leasing
Leasing, as a financing concept, is an arrangement between two parties for a specified
period. Leasing may be classified into different types according to the nature of the
agreement. The following are the major types of leasing as follows:
(A) Lease based on the term of lease
1. Finance Lease
2. Operating Lease
(B) Lease based on the method of lease
1. Sale and lease back
2. Direct lease
Special Financing 201
(C) Lease based in the parties involved
1. Single investor lease
2. Leveraged lease
(D) Lease based in the area
1. Domestic lease
2. International lease
1. Financing lease
Financing lease is also called as full payout lease. It is one of the long-term leases
and cannot be cancelable before the expiry of the agreement. It means a lease
for terms that approach the economic life of the asset, the total payments over
the term of the lease are greater than the leasers initial cost of the leased asset.
For example: Hiring a factory, or building for a long period. It includes all
expenditures related to maintenance.
2. Operating lease
Operating lease is also called as service lease. Operating lease is one of the short-term
and cancelable leases. It means a lease for a time shorter than the economic life of
the assets, generally the payments over the term of the lease are less than the leaser’s
initial cost of the leased asset. For example : Hiring a car for a particular travel. It
includes all expenses such as driver salary, maintenance, fuels, repairs etc.
3. Sale and lease back
Sale and lease back is a lease under which the leasee sells an asset for cash to
a prospective leaser and then leases back the same asset, making fixed periodic
payments for its use. It may be in the firm of operating leasing or financial leasing.
It is one of the convenient methods of leasing which facilitates the financial
liquidity of the company.
4. Direct lease
When the lease belongs to the owner of the assets and users of the assets with
direct relationship it is called as direct lease. Direct lease may be Dipartite lease
(two parties in the lease) or Tripartite lease. (Three parties in the lease)
5. Single investor lease
When the lease belongs to only two parties namely leaser and it is called as single
investor lease. It consists of only one investor (owner). Normally all types of
leasing such as operating, financially, sale and lease back and direct lease are
coming under this categories.
6. Leveraged lease
This type of lease is used to acquire the high level capital cost of assets and equipments.
Under this lease, there are three parties involved; the leaser, the lender and the lessee.
Under the leverage lease, the leaser acts as equity participant supplying a fraction of
the total cost of the assets while the lender supplies the major part.
202 Financial Management
7. Domestic lease
In the lease transaction, if both the parties belong to the domicile of the same
country it is called as domestic leasing.
8. International lease
If the lease transaction and the leasing parties belong to the domicile of different
countries, it is called as international leasing.
Advantages of Leasing
Leasing finance is one of the modern sources of finance, which plays a major role in the
part of the asset based financing of the company. It has the following important advantages.
1. Financing of fixed asset
Lease finance helps to mobilize finance for large investment in land and building,
plant and machinery and other fixed equipments, which are used in the business
concern.
2. Assets based finance
Leasing provides finance facilities to procure assets and equipments for the
company. Hence, it plays a important and additional source of finance.
3. Convenient
Leasing finance is convenient to the use of fixed assets without purchasing. This
type of finance is suitable where the company uses the assets only for a particular
period or particular purpose. The company need not spend or invest huge amount
for the acquiring of the assets or fixed equipments.
4. Low rate of interest
Lease rent is fixed by the lease agreement and it is based on the assets which are
used by the business concern. Lease rent may be less when compared to the rate
of interest payable to the fixed interest leasing finance like debt or loan finance.
5. Simplicity
Lease formalities and arrangement of lease finance facilities are very simple and
easy. If the leaser agrees to use the assets or fixed equipments by the lessee, the
leasing arrangement is mostly finished.
6. Transaction cost
When the company mobilizes finance through debt or equity, they have to pay
some amount as transaction cost. But in case of leasing finance, transaction cost
or floating cost is very less when compared to other sources of finance.
7. Reduce risk
Leasing finance reduces the financial risk of the lessee. Hence, he need not buy
the assets and if there is any price change in the assets, it will not affect the lessee.
Special Financing 203
8. Better alternative
Now a days, most of the commercial banks and financial institutions are providing
lease finance to the industrial concern. Some of the them have specialised lease
finance company. They are established to provide faster and speedy arrangement
of lease finance.
Leasing Finance Institutions in India
Presently, leasing finance becomes popular and effective financial sources for most of the
business concerns. With the importance of lease finance, now a days banks and financial
institutions provide leasing financial assistance to the industrial concern. The following
institutions are famous and widely providing lease finance in India:
Leasing financial institutions in India may be classified into the following groups.
Leasing Institutions
Public Sector Private Sector
Leasing Institutions Leasing Institutions
Leasing by
Development
Institutions
Leasing by
Specialized
Institutions
Leasing
Company
Finance
Company
Fig. 12.1 Leasing Institutions
Leasing by Development Institutions
All India development institutions are providing leasing finance assistance to industrial
concerns. Some of the public sector leasing finance company in India are follows:
• Industrial Credit & Investment Corporation of India (ICICI)
• Industrial Finance Corporation of India (IFCI)
• Industrial Investment Bank of India (IIBI)
• Small Industries Development Corporation (SIDC)
• State Industrial Investment Corporation (SIIC)
Leasing by Specialized Institutions
Specialized financial institutions also provide lease finance to the industrial concern. Some
of the lease finance providing institutions are as follows:
• Life Insurance Corporation of India (LIC)
• General Insurance Corporation of India (GIC)
204 Financial Management
• Unit Trust of India (UTI)
• Housing Development Finance Corporation of India (HDFC)
Private Sector Leasing Company
Private sector leasing companies also provide financial assistance to the industrial concerns.
The following are the example of the private sector leasing companies in India:
• Express Leasing Limited
• 20th Century Leasing Corporation Ltd.
• First Leasing Company of India
• Mazda Leasing Limited
• Grover Leasing Limited
Private Sector Financial Company
Private sector financial companies also involve in the field of leasing finance. The following
are the example of the private sector finance companies:
• Cholamandal Investment and Finance Company Ltd.
• Dcl Finance Limited
• Sundaram Finance Limited
• Anagram Finance Limited
• Nagarjuna Finance Limited.
VENTURE CAPITAL
Introduction
Venture Capital finance is a new type of financial intermediary which has emerged in India
during 1980s. It is a long-term financial assistance provided to projects, which are established
to introduce new products, inventions, idea and technology. Venture capital finance is more
suitable to risky oriented business which consists of huge investment and provides results
after 5 to 7 year.
Meaning of Venture Capital
The term Venture Capital fund is usually used to denote Mutual funds or Institutional
investors. They provide equity finance or risk capital to little known, unregistered, highly
risky, young and small private business, especially in technology oriented and knowledge
intensive business.
Venture Capital termed as long-term funds in equity or semi-equity form to finance hi-tech
projects involving high risk and yet having strong potential of high profitability.
Definition of Venture Capital
According to Jame Koloski Morries, venture capital is defined as providing seed, start up
and first stage financing and also funding expansion of companies that have already
Special Financing 205
demonstrated their business potential but do not yet have access to the public securities
market or to credit oriented institutional funding sources. Venture Capital also provides
management in leveraged buy out financing.
1995 finance bill define Venture Capital as long-term equity investment in novel
technology based projects with display potential for significant growth and financial return.
Features of Venture Capital
Venture Capital consists of the following important features:
(1) Venture Capital consists of high risk and high return based financing.
(2) Venture Capital financing is equity and quasi equity financing instruments.
(3) Venture Capital provides moderate interest bearing instruments.
(4) Venture Capital reduces the financial burden of the business concern at the initial
stage.
(5) Venture Capital is suitable for risky oriented and high technology based industry.
Venture Capital in India
ICICI Venture Capital is the first Venture Capital Financing in India. It was started in 1988
by the joint venture of ICICI and UTI.
The UTI launched Venture Capital Unit Scheme (VECAUS-I) to raise finance in 1990.
Technology Development and Information Company (TDICI) is another major Venture
Capital financing institution in India.
Risk Capital and Technology Finance Corporation Ltd. (RCIFC) provides Venture
Capital finance to technology based industries.
ANZ Grindlays Bank has set up India’s first private sector Venture Capital fund.
SBI and Canara Bank are also involved in Venture Capital Finance. They provide
either equity capital or conditionals loans.
S.No Name of Venture Capital Year Funds under Management
1. Alliance Venture Capital Advisors Ltd May. 1997 SWISS TEC VCF Rs. 1000 Million
2. APIDC–Venture Capital Funds Aug. 1989 APIDE – VCF Rs. 300 Million
3. Baring Private Equity Partners India Ltd. Jan. 1992 BII – off shore fund
4. Canara Bank Venture Capital Fund Ltd. Feb. 1995 Canara Bank Venture Capital
Rs.164.25 Million
5. Draper International Mar. 1994 DII Rs. 2090 Million
6. Gujarat Venture Finance Ltd. July. 1990 GVCF Rs. 240 Million
7. HSBC Private Equity Management Mauritius Ltd. Apl. 1995 HSBC equity fund Rs. 2400 million
8. ICF Advisors Pvt. Ltd. July. 1997 Indian capital fund Rs. 750 Million
9. IL and FS Venture Corporation Ltd. Feb. 1986 IT fund Rs. 100 Million
10. Indus Venture Management Ltd. Feb. 1989 IVC Rs. 210 Million
Contd....
206 Financial Management
11. IDBI July. 1984 IDBI – Rs. 1823.32 Million
12. Industrial Venture Capital Ltd. Sep. 1996 TN Venture fund Rs. 90 Million
13. International Venture Capital Management Ltd. Feb. 1996 Nandi Investment $ 30 Million
14. JF Electra Advisors India Ltd. Aug. 1995 JFE–$ 24 Million
15. Marigold Capital Services Ltd. Aug. 1995 MM fund Rs. 200 Million
16. Pathfinder Investment Company Ltd. Nov. 1993 Rs. 299.50 Million
17. Risk Capital and Investment Company Pvt. Ltd. Jan. 1998 Rs.1000 Million
18. SIDBI Apl. 1990 Rs. 600 Million
19. TDICI Ltd. Jan. 1998 Rs. 5500 Million and $ 75 Million
20. Kitven Aug. 1998 Rs. 18 Crore
FACTORING
Factoring is a service of financial nature involving the conversion of credit bills into cash.
Accounts receivables, bills recoverables and other credit dues resulting from credit sales appear,
in the books of accounts as book credits. Here the risk of credit, risk of credit worthiness of the
debtor and as number of incidental and consequential risks are involved. These risks are taken
by the factor which purchase these credit receivables without recourse and collects them
when due. These balance-sheet items are replaced by cash received from the factoring agent.
Factoring is also called “Invoice Agent” or purchase and discount of all “receivables”.
Although these can be with recourse or without recourse, normally the risk is taken by the
factoring agent. The discount rate includes the loss of interest, risk of credit and risk of loss
of both principal and interest on the amount involved.
Myths on Factoring
Myth Fact
Factoring is nothing but bill discounting or bill finance Factoring and bill discounting are two different
products tailored for two different markets.
Factoring is meant for “Open account sales”
and caters largely to a buyer’s market. Bill
discounting is normally prevalent in a seller’s
market. Factoring unlike bill discounting offers
a continuous relationship.
Factoring reduces bankers business Factoring is not merely financing and includes
a package of services like collection and followup
of each invoice, credit insurance. MIS support
etc., and improves the health of bank’s clients,
improveds cash flow through factoring,
increases production cycles and need for more
working capital. Factoring essentially aims at
replacing high cost market credit and not
necessarily reduce bank finance.
Contd....
Special Financing 207
Factoring is an high cost borrowing Comparable to interest rates of banks. (SSI –
13.50% to 15.75% Non-SSI 13.50% to
17.25%) Will to offer SBI’s PLR selectively)
Factoring service charge is high Service Charge is 0.1% to 0.3% only whereas
in Bills discounting, the collection charge is
0.5% to 0.6%.
Factoring is meant for manufacturing units only Extended to all sectors namely Manufacturing,
Trading and Services.
Factoring limits falls within MBBF/ Assessed Factoring is to be classified as other Current
Bank finance liability as per RBI guidelines and Factoring
replaces market credit and not bank borrowings.
History of the Early Factoring in Roman
Factoring has not been documented as having been used by the Romans. However, the
word ‘factoring’ has a Roman root. It is derived from the Latin verb ‘facio’ which can be
translated as “he who does things”. In Roman times this referred to agent of a property
owner, i.e., his business manager. Though the root word has nothing to do with the industry,
as they attempt to help their clients through their financial problem.
Factoring in United States
Factoring arose in the United States during 19th century, as direct result of the inability of
manufacturers to maintain constant and timely communications with their sales forces in
the field. At that time, as the case today, the sales force was paid by communications. If all
sales were at the risk of the manufacturer, the salesman had no incentive to exercise prudence
in connection with whom to sell to on credit.
On the other hand, the distant manufacturer was not in the position to make the credit
risk on sales. The risk of defective or non-conforming merchandise remained with the
manufacturer. The credit risk was now separated from disputes as to quality, workmanship
and conformity of goods. Soon after, the salesman began to act as independent sales agencies.
It was common for them to act for more than one manufacturer. Still later the sales function
was separated from the credit function and “Traditional Factoring” as the people know, it
had, at that point, developed in the United States.
Factoring in India
Banks provide generally bill collection and bill discounting and with recourse. They provide
working capital finance based on these bills classified by amounts maturity wise. Such bills
if accumulated in large quantities will burden the liquidity and solvency position of the
company and reduces the credit limits from the banks. It is therefore felt necessary that the
company assigns these book debts to a factor for taking them off from the balance sheet.
This reduces the workload, increases the solvency and improves the liquidity position of
the company.
208 Financial Management
In 1998 a study group under the chairmanship of C.S. Kalyana Sundram was constituted
to examine the feasibility of factoring services in India, their constitution, organizational
set up and scope of activities. The group recommended the setting up of specialized agencies
or subsidiaries for providing the factoring services in India with a professional expertise in
credit assessment, debt collection and management of sales ledger, and other related services.
Defaults or delays in collection and repayment can still remain which is the risk to be
taken by the factor for a fee. The group has estimated a good potential for this service to
the tune of about Rs. 4000 crores mainly emerging a collection problem, and delays in
collection and consequential liquidity problems.
Later the Vaghul Committee report on money market reforms has confirmed the need
for factoring services to be developed in India as part of the money market instruments.
Many new instruments were already introduced like Participation certificates, Commercial
papers, Certificate of deposits etc., but the factoring service has not developed to any
significant extent in India.
The Reserve Bank allowed some banks to set up subsidiaries on a zonal basis to take care
of the requirements of companies in need of such service. Thus Canara Bank, State Bank of
India, Punjab National Bank and a few other banks have been permitted to set up jointly
some factor, for Eastern, Western, Northern, and Southern Zones. The progress of the activity
did not show any worth while dimension, so far.
Modus of Operations
If a company wants to factor its receivables it submits a list of customers, their credit
rating, amount involved in maturity and other terms. If the factor scrutinizes the list of
buyers and they are in the approved list, the factor gives its decision of the clients and the
amounts they may take all receivables on wholesale discounting basis. The factor then
takes all the documents in respect of approved list and pays up to 80% to 90% of the
amount due less commission to the company which in turn removes these instruments,
from base of accounts and shows cash flow as against bills receivables written off.
Factoring services rendered the following services:
1. Purchase of book debts and receivables.
2. Administration of sales ledger of the clients.
3. Prepayments of debts partially or fully.
4. Collection of book debts or receivables or with or without documents.
5. Covering the credit risk of the suppliers.
6. Dealing in book debts of customers without recourse.
Why Factoring?
Factoring is one of the most important and unavoidable part of the business concern which
meets the short-term financial requirement of the concern. Factoring is favorable to the
industrial concern for the following reasons.
Special Financing 209
1. Quickest response–Customer oriented timely decisions and decision on sanction
within a week.
2. Low cost.
3. Low service charges (0.1% to 0.3%).
4. Low margin (20% onwards).
5. Instant finance–against each invoice.
6. Generous grace period.
7. Improves cashflow.
8. Substitutes sundry creditors.
9. Increases sales through better terms on sales.
10. More operating cycles and more profits.
11. No upfront recovery of charges.
12. Interest on daily products.
13. Very easy to operate.
14. Flexible credit periods.
15. No penal interest up to grace period.
16. Empowers cash purchase.
17. Improves credit reputation.
18. Follow up of each invoice.
19. Collection of receivables.
20. MIS reports like customers overdue invoices enabling constant evaluation of
customers.
21. Outstation payments at nominal rates.
Mechanics of Factoring
(1) Places Order for Goods
(3) Delivery of Goods with Notice
Pay the Factor
CLIENT (SELLER) CUSTOMER (BUYER)
(2) Fixation of customer limits
(4) Copy of invoice
(5) Prepayment up to 80%
(9) Balance Amount unpaid
(8) Payment.
(7) Follow up of Unpaid by Due Date
(6) Monthly Statement
FACTOR
.
.
. .
.
.
Fig. 12.2 Mechanics of Factoring
210 Financial Management
The following are the steps for factoring:
1. The customer places an order with the seller (client).
2. The factor and the seller enter into a factoring agreement about the various terms
of factoring.
3. Sale contract is entered into with the buyer and the goods are delivered. The
invoice with the notice to pay the factor is sent alongwith.
4. The copy of invoice covering the above sale to the factor, who maintains the sale ledger.
5. The factor prepays 80% of the invoice value.
6. The monthly statement are sent by the factor to the buyer.
7. Follow up action is initiated if there are any unpaid invoices.
8. The buyer settles the invoices on the expiry of the credit period allowed.
9. The balance 20% less the cost of factoring is paid by the factor to the client.
Types of factoring
(1) Notified factoring: Here, the customer is intimated about the assignment of debt
to a factor, also directed to make payments to the factor instead of to the firm.
This is invariably done by a legend and the invoice has been assigned to or sold
to the factor.
(2) Non-notified or confidential factoring: Under this facility, the supplier/factor
arrangement is not declared to the customer unless or until there is a breach of
the agreement on the part of the client, or exceptionally, where the factor considers
himself to be at risk.
(3) With recourse or without recourse factoring: Under recourse arrangements,
the client will carry the credit risk in respect of debts sold to the factor. In without
recourse factoring, the bad debts are borne by the factor.
(4) Bank Participation Factoring: The client creates a floating charge on the
factoring reserves in favour of banks and borrow against these reserves.
(5) Export Factoring: There is usually the presence of two factors: an export factor
and an import factor. The former buys the invoices of a client exporter and assumes
the risk in case of default by the overseas customers. Because of distance, different
condition or lake of information, the export factor usually forms out to an agent,
known as the import factor, the administrative job of servicing the debts owed to
its exporting clients.
FOREIGN DIRECT INVESTMENT
According to the definition given by JMF, FDI is the category of international investment
that reflects the objective of a resident entity in one economy (direct investor or parent
enterprise) by obtaining a ‘lasting interest’ and control in an enterprise resident in another
economy (direct investment enterprise).
Special Financing 211
The IMF definition of FDI includes as many as twelve different elements, namely:
equity capital, reinvested earnings of foreign companies, inter-company debt transactions
including short-term and long-term loans, overseas commercial borrowings (financial leasing,
trade credits, grants, bonds), non cash acquisition of equity, investment made by foreign
vantage capital investors, earning data of indirectly held FDI enterprises, control premium,
non-competition fee and so on.
FDI in India
FDI is permitted as under the following form of investments:
Through financial collaborations;
Through joint ventures and technical collaborations;
Through capital markets Via Euro Uses.
Through Private Placements or Preferential Allotments
1. The government has reviewed the guidelines pertaining to foreign/technical
collaborations under automatic route for foreign financial/technical collaborations
with previous ventures/tie-ups in India as per Press Note No. 18 (1998), it has
been decided that new proposals for foreign investment/technical collaborations
would henceforth be allowed under the automatic route, subject to sectored policies
as per the following guidelines.
(a) Prior approval of the government would be required only in cases where
the foreign investor has an existing joint venture for technology transfer/
trade mark agreement in the ‘same’ field.
(b) Even in the above mentioned cases, the approval of the government would
not be required in respect of the following :
(1) Investments to be made by venture capital funds registered with SEBI.
(2) Where the existing joint venture investments by either of the parties
is less than 3%; or
(3) Where the existing, venture/collaboration is defunct or sick.
(c) In so far as joint venture to be ordered after the date of dated January, 12,
2005 are concerned, the joint venture agreement may embody a ‘conflict of
interest’ clause to safeguard the interest of joint venture partners in the event
of one of the partners desiring to set up another joint venture or a wholly
owned subsidiary in the ‘same’ field of economic activity.
2. Increase in the FDI limits in Air Transport Services (Domestic Airlines) up to
49% through automatic route and up to 100% by Non-resident Indians (RRIs)
through automatic routes (No direct or indirect equity participation by foreign
airlines is allowed).
3. Foreign investment in the banking sector has been further liberalized by raising,
FDI limit in private sector books to 74% under the automatic route including,
investment by FIIs.
212 Financial Management
4. FDI in telecom has been raised to 74% subject to certain security measures. From
August 1991 to August 2004, 926 proposals of FDI of Rs. 41,368 crore were
approved. The actual FDI inflow of approximately Rs. 5,763 crore between
January 2001 and August 2004 alone was about 56% of the total FDI flow in
telecom since its inception in 1991. In terms of approval of FDI, the telecom sector
is the second largest, after power and oil references.
5. FDI in construction sector has been opened. Still some more sectors vis-à-vis retail
mining and pension are under the consideration of the government.
6. A part of FDI comes from NRIs, to oversee the difficulties faced by NRIs
government has set up a separate NRI Ministry for facilitating hassle free investment
procedure and clearances.
A Comparative Study Between India and China
Country FDI Inflows ($bn)
India 0.08 0.24 0.54 0.97 2.15 2.53 3.35 2.64 2.17 2.32 3.40 3.45 4.27
China 4.32 16.16 27.52 33.79 36.85 40.18 44.24 45.46 40.2 40.72 46.88 52.74 53.51
World FDI 1581 168 208 226 332 338 473 691 1087 1388 818 679 560
* 2.22 6.67 13.23 14.98 10.80 11.90 9.35 6.58 3.71 2.93 5.73 7.77 9.56
** 6.06 0.14 0.26 0.43 0.65 0.75 0.71 0.38 0.20 0.17 0.42 0.51 0.76
* FDI in China as a % of World FDI.
** FDI in India as a % of World FDI.
Source : UNCTAD, World Investment Report, Various Issues (1991–2004).
Foreign Institutional Investors (FIIs)
The Union Government allowed Foreign Institutional Investors to enter both the primary
and secondary markets in India under liberalized policy resume. The large inflow and outflow
of capital by FIIs affect the sensex movements. A certain degree of front running by the
traders in anticipation of FIIs demand also determines the market direction.
FIIs have to appoint an agency as consolidation to deal in the securities and reporting.
Accounts have to be maintained on daily basis. Semi model reports should be submitted by
the custodian to SEBI and RBI. SEBI can conduct direct inspections on the accounting books
of a registered FII. A Foreign Institutional Investor is permitted to appoint more than one
domestic custodian with prior approval of the Board but only one custodian may be appointed
for a single sub-account of FIIs.
SEBI and FIIs
SEBI announced its guidelines for FIIs registration and their operations in India in 1992 in
February, 1993 SEBI has granted registration to 12 FIIs for investing in the Indian Stock
market. At the end of 1996, 97, 439 FIIs were registered with SEBI. SEBI permitted registered
FIIs to invest in all securities traded on the primary and secondary markets including: equity,
other securities and instruments of companies listed on stock exchanges including OTCEI.
Special Financing 213
According to the 1995 regulation, no person can buy or sell or otherwise deal in
securities as a foreign institutional investor unless he holds a certificate granted by SEBI.
The certificate would be given to FIIs only after considering—
1. The applicant’s track record, professional record, professional competence, financial
soundness, experience, general reputation of fairness and integrity.
2. Whether the applicant is regulated by an appropriate foreign regulatory authority.
3. Whether the applicant has been granted permission under the provisions of FERA
Act 1973, for making investments in India as FII.
4. Whether the applicant is
(a) An institution established or incorporated outsides Indian as Pension Fund
or Mutual Fund or Investment Trust, or
(b) An Asset Management Company or Nominee Company or Bank or Institutional
Portfolio Manager, established or incorporated outside India and proposing to
make investment in India on behalf of broad based funds or
(c) A Trustee or Power of Attorney holder, incorporated or established outside
India and proposing to make investments in India on behalf of broad based
funds.
The certificate is valid for a period of 5 years from the date of its grant. Provisions are
made for the renewal of the certificate.
FIIs are allowed to place orders directly. Separate codes are given to FIIs and stock
exchange have to use the code number. The code number have to be approved by SEBI.
All the transactions carried out on behalf to FIIs have to be on delivery basis. In other
words, the registered FIIs should not engage in short selling and have to take delivery of all
purchase and give delivery of sold securities .
To case the inflow of foreign capital, amendments have been made in the regulations
regarding the FIIs investment. They are given below.
1. SEBI exempted FIIs to attach copy of RBI approved with market lot where shares
are sold and a custodian signed the transfer deed on their behalf.
2. FIIs individual limit on investment in a company was raised from 5 per cent to
10 per cent. Further, they have been allowed to unlisted stock of any company.
The FIIs list has also been increased.
3. SEBI (FIIs) Regulations 1995, have been changed to allow the FIIs to invest not
only in the equity but also in debt instruments of corporate bodies. FIIs were
allowed to invest up to 100 per cent of the funds in debt instruments of Indian
companies through 100 per cent dedicated debt funds from January 15, 1997.
4. SEBI amended SEBI (FIIs) Regulations 1997, to make it mandatory for FIIs, having
securities of Rs.10 crore of these as on own interest.
5. In June 1998, SEBI permitted
(a) FIIs to invest in unlisted companies through the 100% debt route and to
tender their serenities directly in responses to an open offer made in terms
of the SEBI regulations 1997.
214 Financial Management
(b) SEBI simplified the process of approval of Sub-accounts of registered FIIs.
(c) SEBI permitted FIIs to buy derivative contracts, which are traded on the stock
exchanges.
6. The aggregate investment of FII/NRI/OCB has been raised to 30 per cent of the
equity of the company by the union budget for 1997–98. The Finance Minister
in his budget speech in February 2000 announced of this limit to 40 per cent.
MERCHANT BANKING
Introduction
Merchant banking is one of the fee based financial services which includes underwriting,
consultancy and other allied services to the business concern. The term merchant banking
has been used in different terms in different countries. In UK merchant banking is termed as
accepting and issuing house and in the USA it is known as investment banking.
Meaning
A merchant banking is one who underwrites corporate securities and advises clients on
issue like corporate mergers. Merchant banking is basically service banking which provides
non financial services such as issue management, portfolio management, asset management,
underwriting of new issues, to act as registrar, share transfer agents, trustees, provide leasing,
project consultation, foreign credits, etc. The merchant bankers may function in the form
of a bank, financial institutions, company or firm.
Merchant Banking in India
In India, the first merchant banking services were started only in 1967 by National Grindlays
Bank followed by Citi Bank in 1970. In 1972 State Bank of India started a merchant banking
division, followed by ICICI Bank in 1973. Nowadays, most of the public sectors, private
sectors, commercial banks and financial institutions established a separate division of
merchant banking services.
Classification of Merchant Banking
According to the Securities Exchange Board of India regulations, merchant bankings are
classified into the following categories on the basis of their activities and capital adequacy.
The merchant banking must register themselves with Securities Exchange Board of India.
Category Minimum Net worth for Activities Permitted by SEBI
Capital adequacy
Category I Rs. 5 Crore Issue Manager, Advisor, Consultant,
Underwriter and Portfolio Manager
Category II Rs. 50 Lakhs Advisor, Consultant, Underwriter and
Portfolio Manager
Category III Rs. 20 Lakhs Advisor, Consultant, Underwriter
Category IV –NIL Advisor and Consultant service only.
Special Financing 215
Functions of Merchant Banking
Merchant banking is one of the non financial services which provides to the corporate
sectors, commercial banks and financial institutions. The major functions of merchant
banking are explained as follows:
1. Management, Marketing and Underwriting of new issues.
2. Project finance and project promotion services.
3. Syndication of credit and other facilities.
4. Leasing including project leasing.
5. Corporate advisory services.
6. Investment advisory services.
7. Bought out deals.
8. Venture capital.
9. Mutual funds and off shore funds.
10. Investment Management.
11. Investment services for non resident Indians.
12. Management dealing in commercial paper.
13. Treasury management.
14. Stock broking.
15. Foreign Collaboration and foreign currency finance.
16. Counseling to Small Scale Industries.
17. Capital Structure counseling to cooperative sectors.
18. Meeting the working capital needs.
Merchant Banking Organizations
In India, merchant banking services are provided by the following types of organizations:
Merchant Banking Organizations
Commercial Banks Financial Institutions Private Consultancy
Fig. 12.3 Merchant Banking Organizations
The following commercial banks are wholly owned subsidiaries to carry out merchant
banking activities.
State Bank of India – SBI Capital Markets Limited.
Canara Bank – Can Bank Financial Service Limited
216 Financial Management
Bank of Baroda – BOB Fiscal Services Limited.
Grindlays Bank – Grindlays Merchant Banking Limited.
ICICI, IFIC and IDBI are some of the examples of the All India financial institutions
which are involving in the merchant banking activities.
DSP Financial Consultants, Credit Capital Finance Corporation Limited, J.M Financial
and Investment Services Limited are some of the examples of the private consultancy firms
which are involving merchant banking activities.
CREDIT RATING
Introduction
Credit rating is one of the fee based financial services which are provided by specialized
agencies like CRISIL, ICRA and CARE. It is a mechanism by which the reliability and viability
of a credit instrument is brought out. It is usually the effort of investors in financial instrument
to minimize or eliminate default risk. Credit rating service is useful to the investors.
According to Securities Exchange Board of India, credit rating is a compulsory mechanism
for listing of the companies in the stock market and also it is essential to the corporate
sectors who want to raise capital with the help of issue of fixed deposits, commercial papers
and other short-term instruments.
Meaning of Credit Rating
Credit rating is an act of assigning values to credit instruments by estimating or assessing the
solvency, and expressing them through predetermined symbols.
“Credit rating is designed exclusively for the purpose of granting bonds according to
their investment quality”.
Corporate or municipal debt rating is a current assessment of the credit worthiness of
the obligator with respect of a specific obligation.
Objectives of Credit Rating
These are the important objectives of the credit rating:
• To impose a healthy discipline on borrowings.
• To lend greater belief to financial and other representations.
• To facilitate formulation of public guidelines on institutional investment.
• To help merchant bankers, brokers and regulatory authorities.
• To encourage the information disclosure, better accounting standards, etc.
• To reduce interest cost for highly rated company.
Credit Rating in India
Credit rating in India begins from 1988. At present there are four credit rating agencies
very popular in rating.
Special Financing 217
Operational Performance of Credit Rating Business in India
Rs. in crore
Rating Agency 1994–95 1995–96 Cumulative Up to March 96
Number Amount Number Amount Number Amount
CRISAL 384 24,544 427 43,086 1736 1,14,873
ICRA 212 5,343 293 75,742 778 93,380
CARE 184 8,403 217 13,909 445 23,638
Total 780 38,290 937 1,32,737 2,959 2,31,891
Basis for Credit Rating
Credit rating agencies consider the following important informations for granting the rating
symbol to the borrowing company;
1. Historical background of the company.
2. Track record of the company.
3. Financial efficiency and profitable position.
4. Operational efficiency.
5. Market share of the company.
6. Labour efficiency and their turnover.
7. Future prospects.
Credit Rating Information Service of India Limited (CRISIL)
Credit Rating Information Service of India Limited was the first credit rating agency in
India, in January 1988 jointly by ICICI, UTI, LIC, GIC and ADB. The following are the
major objectives of the Credit Rating Information Service of India Limited.
(a) To rating of companies debentures, fixed deposits programmes, short-term
instruments etc.
(b) To provide corporate reports to business concern.
(c) To conduct industry studies.
Credit Rating Symbols of Credit Rating Information Service of India Limited
Long-term Medium-term Short-term Remarks
Instrument Instrument Instrument
AAA FAAA P1 Highest Safety
AA FAA P2 High Safety
A FA P3 Adequate Safety
BBB – – Moderate Safety
Contd....
218 Financial Management
BB FB P4 Inadequate Safety
B FC - Risk Prone
C - - Substantial Risk
D FD P5 Default
Operational Result of Credit rating Information Service of India Limited
Credit Rating Information Service of India Limited is one of the well known and largest
credit rating agencies in India which provides credit rating to corporate and banking sectors.
The operational performances of the Credit Rating Information Service of India Limited
are explained in the table below:
Instruments 1994-95 1995-96 Cumulative Up to March 96
Number Amount Number Amount Number Amount
Debenture 103 7,641 161 13,342 646 45,700
Fixed deposits 97 9,130 218 14,153 543 38,625
Commercial Papers 137 1,629 21 3,255 459 11,415
Others 49 6,144 27 12,336 88 19,133
Total 384 25,544 427 43,086 1,736 1,14,873
Source: RBI reports.
Investment Information and Credit Rating Agency of India Limited (ICRA)
Investment Information and Credit Rating Agency is one of the largest credit rating service
providers next to Credit Rating Information Service of India Limited. It was established
mainly for the purpose of rating of short-term, medium-term and long-term debt instruments
of the corporate and banking companies. It was set up in the year 1991 by the leading
banking and financial institutions.
Credit Rating Symbols of Investment Information and Credit Rating Agency of
India Limited
Long-term Medium-term Short-term Remarks
Instrument Instrument Instrument
LAAA MAAA A1 Highest Safety
LAA MAA A2 High Safety
LA MA A3 Adequate Safety
LBBB – – Moderate Safety
LBB MB – Inadequate Safety
LB MC A4 Risk Prone
LC – – Substantial Risk
LD MD P5 Default
(Rs. in crore)
Special Financing 219
Operational Result of ICRA
Investment Information and Credit Rating Agency of India Limited is also performing well
in the field of credit rating to various instruments. The operational result of the Investment
Information and Credit Rating Agency of India Limited is explained in the table below:
(Rs. in crore)
Instruments 1994–95 1995–96 Cumulative Up to March 96
Number Amount Number Amount Number Amount
Debenture 45 1,779 66 8,224 223 18,599
Fixed deposits 87 540 192 50,507 360 54,481
Commercial Papers 80 3,023 35 17,011 195 22,299
Total 212 5,343 293 75,742 774 93,380
Source: RBI reports
Credit Analysis and Research Limited (CARE)
Credit Analysis and Research Limited was set up by Industrial Development Bank of India
in November 1993, Credit Analysis and Research Limited also provides rating to long-term,
medium-term and short-term instruments.
The rating symbols of Credit Analysis and Research Limited are mentioned below:
Credit Rating Symbols of Credit Analysis and Research Limited
Long-term Medium-term Short-term Remarks
Instrument Instrument Instrument
CARE AAA CARE AAA PR1 Highest Safety
CARE AA CARE AA PR2 High Safety
CARE A CARE A PR3 Adequate Safety
CARE BBB CARE BBB - Moderate Safety
CARE BB CARE BB Inadequate Safety
CARE B CARE B PR 4 Risk Prone
CARE C CARE C - Substantial Risk
CARE CARE PR5 Default
Operational Result of Credit Analysis and Research Limited
Credit Analysis and Research Limited is one of the latest origins in the field of credit rating
which provides rating to various instruments. The operational result of the Credit
Analysis and Research Limited as explained in the table below:
220 Financial Management
(Rs. in crore)
Instruments 1994-95 1995-96 Cumulative Up to March 96
Number Amount Number Amount Number Amount
Debenture 34 3,429 54 9,330 93 13,572
Fixed deposits 112 1,639 39 1,692 179 3,704
Commercial Papers 38 3,335 124 2,887 173 6,362
Total 184 8,403 217 13,909 445 23,638
Source: RBI reports
MUTUAL FUNDS
Introduction
Mutual fund is one of the funds based financial services which provides the stock market
benefits to small investors. It is a concept, leading to attract the small investors to invest their
pooling of savings in a trusted as well as profitable manner. Mutual funds business becomes
very popular in developed countries and it is fast growing in developing countries like India
also. Mutual funds act as a link between the investor and the stock market. Now in India
mutual funds activities are performed by public, private and foreign sector financial institutions.
Origin of Mutual Funds
In the year 1822 the concept of mutual funds was found in Belgium. In 1868, foreign
colonial government trust was established in England to spread the risks in securities market.
Mutual funds concept was spread to USA and some of the mutual funds institutions were
established. Unit Trust of India was established in 1964 as a public sector mutual funds
institution by the central government. It is the first mutual fund in India.
Structure of Mutual Fund in India
Mutual Fund Sectors
Securities Exchange
Board of India
Association of Mutual
Funds
Mutual Fund
Sponsor Board of Trustee Custodian Investor
Public Sector Private Sector
Fig. 12.4 Structure of Mutual Fund in India
Special Financing 221
Meaning of Mutual Fund
A mutual fund is an investment vehicle for investors who pool their savings for investing in
diversified portfolio of securities with the aim of attractive yields and appreciation in their
value. Mutual fund is a trust that attracts savings which are then invested in capital markets.
According to SEBI, mutual fund define is as a fund, established in the form of a trust to
raise money through the sale of units to the public or a section of the public under one or
more scheme for investing in securities, including money market instruments.
Investment company institute of the US defined mutual fund is a financial service
organisation that receives money from shareholders, invests it, earns return on it, attempts
to make it grow and agrees to pay the shareholders cash on demand for the current value
of his investment.
Advantages of Mutual Funds
Mutual fund consists of the following important advantages:
1. Attract small and medium group investors: Mutual funds promote savings
among the lower and middle income groups of investors because mutual fund
units are available with a single unit of Rs. 10 and multiples by the same value.
2. Attractive return: If the investor invests in mutual fund, they can get attractive
returns because mutual funds are linked with stock market. The benefits of stock
market goes to the mutual fund investors.
3. Reduce the risk: Mutual fund investments minimize the risk on investments by
diversifying the investments into various portfolios such as shares, debentures,
bonds etc.
4. Assure return: Mutual funds are managed by experts in the field of investment
management; hence there is no risk and mutual fund offers assured return.
5. Tax concession: If the mutual funds belong to infrastructure development bonds,
there will be a tax concession to the mutual fund investment.
6. Liquidity: Mutual fund investment is one of the highly liquidity based investments
which can be recapitalized at any time or sold the mutual fund units at any time.
7. Convenience: Mutual fund investment is one of the most convenient investments
for those who want to invest or get back their investment through selling of
the units of mutual fund.
8. Flexibility: Mutual fund can be transfered from one scheme to the other scheme
on the basis of present market condition.
9. Benefits to minorities: Mutual fund investment schemes are most suitable to
the old age pensioners, widows middle class women, etc.
10. Contribution to the economy: Mutual fund companies promote the saving habits
of middle class people. Hence, the money invested in mutual fund schemes are
invested into the major economical activities like infrastructure development
construction of bridge, buildings, etc.
222 Financial Management
Types of Mutual Fund
Ownership
point of View Scheme of
Operation point of
View
Portfolio point of
View
Location point
of View
Growth Income Balanced
Public
Sector
Private
Sector MF
Domestic
Fund
Global
Fund
Regional
Fund
Sector
Fund
Open ended
Scheme
Closed ended
Scheme
Fig. 12.5 Types of Mutual Fund
Public Sector Mutual Fund
Unit Trust of India is one of the public sector mutual funds operating from 1964 and it
enjoys the monopoly power in the field of mutual funds up to 1987. After 1987, Public
Sector Commercial Banks and Life Insurance Corporation of India also entered into mutual
funds activities. State Bank of India, Canara Bank, Punjab National Bank, General Insurance
Corporation are some of the public sector mutual funds activities.
Private Sector Mutual Fund
Apart from UTI and public sector commercial banks, some of the private sector financial
institutions also entered into the mutual fund activities in India from 1990 onwards. Kothari
Pioneer mutual fund, Twentieth century mutual fund, ICKI mutual fund, Morgan Stanly
mutual fund, Taurus mutual fund and CRB mutual fund are some of the examples of the
private sector mutual fund.
Open Ended Mutual Fund
When the units are sold and redeemed at any time on-going basis at the price determined
by the funds Net Assets Value (NAV) is called as open ended mutual fund. These mutual
fund has no fixed maturity periods. There is no ceilling on the amount invested by the
investors in these funds, and they can sell the units back to mutual funds whenever they
decide. Net Assets Value of the mutual fund is calculated by the following formula:
Special Financing 223
Net asset value of the unit =
Net assets value of fund
Number of outstanding units
.
Closed Ended Mutual Fund
Closed ended mutual funds have fixed maturity period ranging from two to 15 years. The
units of closed ended mutual funds are not repurchased or redeemed by mutual funds
before the maturity period. The investors cannot buy units directly from the fund after
the closing period.
Growth Generated Mutual Fund
Mutual fund investments which are reinvested in highly growth oriented equity shares
are called as growth oriented mutual fund. It consists of high return with growth potentials.
Income Generated Mutual Fund
If the investor needs regular income for their investment, they can select income oriented
mutual fund. It provides regular income to its investors.
Balanced Mutual Fund
Balanced mutual fund is a combination of mutual fund investment in company securities
as well as the government bonds. Investors can get moderate return with safety options.
Domestic Mutual Fund
When the mutual fund mobilizes savings from a particular country or region, it is called
domestic mutual fund.
Global Mutual Fund
When the mutual fund investment stocks are traded in markets throughout the world
with the exemption of the country which launches the fund.
Regional Mutual Fund
When the mutual fund consists of a particular region or a country, it is also called as off
shore mutual fund.
Sector Mutual Fund
Sector mutual funds are specializing in a particular industry which consist of aggressive
funds.
Top Ten Mutual Fund
• UTI Mutual Fund • Reliance Mutual Fund
• Prudential ICICI Mutual Fund • HDFC Mutual Fund
• Franklin Templeton Mutual Fund • Birla Sun Life Mutual Fund
• SBI Mutual Fund • DSP Merrill Lynch Mutual Fund
• Kotak Mahindra Mutual Fund • Tata Mutual Fund
capital, foreign direct investment etc. and also this chapter covers the advantages and
disadvantages, application in the present position and institution, which are providing.
These finance to the business concern. This part is divided into the following major parts
such as:
1. Lease Financing
2. Venture Capital
3. Factoring
4. Foreign Direct Investment
5. Merchant Banking
6. Credit Rating
7. Mutual Funds
LEASE FINANCING
Lease financing is one of the popular and common methods of assets based finance, which
is the alternative to the loan finance. Lease is a contract. A contract under which one
party, the leaser (owner) of an asset agrees to grant the use of that asset to another leaser,
in exchange for periodic rental payments.
Lease is contractual agreement between the owner of the assets and user of the assets
for a specific period by a periodical rent.
Definition of Leasing
Lease may be defined as a contractual arrangement in which a party owning an asset provides
the asset for use to another, the right to use the assets to the user over a certain period of
time, for consideration in form of periodic payment, with or without a further payment.
200 Financial Management
According to the equipment leasing association of UK definition, leasing is a contract
between the lesser and the leaser for hire of a specific asset selected from a manufacturers
or vender of such assets by the lessee. The leaser retains the ownership of the asset. The
leassee pass possession and uses the asset on payment for the specified period.
Elements of Leasing
Leasing is one of the important and popular parts of asset based finance. It consists of the
following essential elements. One should understand these elements before they are going to
study on leasing.
1. Parties: These are essentially two parties to a contract of lease financing, namely
the owner and user of the assets.
2. Leaser: Leaser is the owner of the assets that are being leased. Leasers may be
individual partnership, joint stock companies, corporation or financial institutions.
3. Lease: Lease is the receiver of the service of the assets under a lease contract.
Lease assets may be firms or companies.
4. Lease broker: Lease broker is an agent in between the leaser (owner) and lessee.
He acts as an intermediary in arranging the lease deals. Merchant banking divisions
of foreign banks, subsidiaries indian banking and private foreign banks are acting
as lease brokers.
5. Lease assets: The lease assets may be plant, machinery, equipments, land,
automobile, factory, building etc.
Term of Lease
The term of lease is the period for which the agreement of lease remains for operations.
The lease term may be fixed in the agreement or up to the expiry of the assets.
Lease Rental
The consideration that the lesae pays to the leaser for lease transaction is the rental.
Type of Leasing
Leasing, as a financing concept, is an arrangement between two parties for a specified
period. Leasing may be classified into different types according to the nature of the
agreement. The following are the major types of leasing as follows:
(A) Lease based on the term of lease
1. Finance Lease
2. Operating Lease
(B) Lease based on the method of lease
1. Sale and lease back
2. Direct lease
Special Financing 201
(C) Lease based in the parties involved
1. Single investor lease
2. Leveraged lease
(D) Lease based in the area
1. Domestic lease
2. International lease
1. Financing lease
Financing lease is also called as full payout lease. It is one of the long-term leases
and cannot be cancelable before the expiry of the agreement. It means a lease
for terms that approach the economic life of the asset, the total payments over
the term of the lease are greater than the leasers initial cost of the leased asset.
For example: Hiring a factory, or building for a long period. It includes all
expenditures related to maintenance.
2. Operating lease
Operating lease is also called as service lease. Operating lease is one of the short-term
and cancelable leases. It means a lease for a time shorter than the economic life of
the assets, generally the payments over the term of the lease are less than the leaser’s
initial cost of the leased asset. For example : Hiring a car for a particular travel. It
includes all expenses such as driver salary, maintenance, fuels, repairs etc.
3. Sale and lease back
Sale and lease back is a lease under which the leasee sells an asset for cash to
a prospective leaser and then leases back the same asset, making fixed periodic
payments for its use. It may be in the firm of operating leasing or financial leasing.
It is one of the convenient methods of leasing which facilitates the financial
liquidity of the company.
4. Direct lease
When the lease belongs to the owner of the assets and users of the assets with
direct relationship it is called as direct lease. Direct lease may be Dipartite lease
(two parties in the lease) or Tripartite lease. (Three parties in the lease)
5. Single investor lease
When the lease belongs to only two parties namely leaser and it is called as single
investor lease. It consists of only one investor (owner). Normally all types of
leasing such as operating, financially, sale and lease back and direct lease are
coming under this categories.
6. Leveraged lease
This type of lease is used to acquire the high level capital cost of assets and equipments.
Under this lease, there are three parties involved; the leaser, the lender and the lessee.
Under the leverage lease, the leaser acts as equity participant supplying a fraction of
the total cost of the assets while the lender supplies the major part.
202 Financial Management
7. Domestic lease
In the lease transaction, if both the parties belong to the domicile of the same
country it is called as domestic leasing.
8. International lease
If the lease transaction and the leasing parties belong to the domicile of different
countries, it is called as international leasing.
Advantages of Leasing
Leasing finance is one of the modern sources of finance, which plays a major role in the
part of the asset based financing of the company. It has the following important advantages.
1. Financing of fixed asset
Lease finance helps to mobilize finance for large investment in land and building,
plant and machinery and other fixed equipments, which are used in the business
concern.
2. Assets based finance
Leasing provides finance facilities to procure assets and equipments for the
company. Hence, it plays a important and additional source of finance.
3. Convenient
Leasing finance is convenient to the use of fixed assets without purchasing. This
type of finance is suitable where the company uses the assets only for a particular
period or particular purpose. The company need not spend or invest huge amount
for the acquiring of the assets or fixed equipments.
4. Low rate of interest
Lease rent is fixed by the lease agreement and it is based on the assets which are
used by the business concern. Lease rent may be less when compared to the rate
of interest payable to the fixed interest leasing finance like debt or loan finance.
5. Simplicity
Lease formalities and arrangement of lease finance facilities are very simple and
easy. If the leaser agrees to use the assets or fixed equipments by the lessee, the
leasing arrangement is mostly finished.
6. Transaction cost
When the company mobilizes finance through debt or equity, they have to pay
some amount as transaction cost. But in case of leasing finance, transaction cost
or floating cost is very less when compared to other sources of finance.
7. Reduce risk
Leasing finance reduces the financial risk of the lessee. Hence, he need not buy
the assets and if there is any price change in the assets, it will not affect the lessee.
Special Financing 203
8. Better alternative
Now a days, most of the commercial banks and financial institutions are providing
lease finance to the industrial concern. Some of the them have specialised lease
finance company. They are established to provide faster and speedy arrangement
of lease finance.
Leasing Finance Institutions in India
Presently, leasing finance becomes popular and effective financial sources for most of the
business concerns. With the importance of lease finance, now a days banks and financial
institutions provide leasing financial assistance to the industrial concern. The following
institutions are famous and widely providing lease finance in India:
Leasing financial institutions in India may be classified into the following groups.
Leasing Institutions
Public Sector Private Sector
Leasing Institutions Leasing Institutions
Leasing by
Development
Institutions
Leasing by
Specialized
Institutions
Leasing
Company
Finance
Company
Fig. 12.1 Leasing Institutions
Leasing by Development Institutions
All India development institutions are providing leasing finance assistance to industrial
concerns. Some of the public sector leasing finance company in India are follows:
• Industrial Credit & Investment Corporation of India (ICICI)
• Industrial Finance Corporation of India (IFCI)
• Industrial Investment Bank of India (IIBI)
• Small Industries Development Corporation (SIDC)
• State Industrial Investment Corporation (SIIC)
Leasing by Specialized Institutions
Specialized financial institutions also provide lease finance to the industrial concern. Some
of the lease finance providing institutions are as follows:
• Life Insurance Corporation of India (LIC)
• General Insurance Corporation of India (GIC)
204 Financial Management
• Unit Trust of India (UTI)
• Housing Development Finance Corporation of India (HDFC)
Private Sector Leasing Company
Private sector leasing companies also provide financial assistance to the industrial concerns.
The following are the example of the private sector leasing companies in India:
• Express Leasing Limited
• 20th Century Leasing Corporation Ltd.
• First Leasing Company of India
• Mazda Leasing Limited
• Grover Leasing Limited
Private Sector Financial Company
Private sector financial companies also involve in the field of leasing finance. The following
are the example of the private sector finance companies:
• Cholamandal Investment and Finance Company Ltd.
• Dcl Finance Limited
• Sundaram Finance Limited
• Anagram Finance Limited
• Nagarjuna Finance Limited.
VENTURE CAPITAL
Introduction
Venture Capital finance is a new type of financial intermediary which has emerged in India
during 1980s. It is a long-term financial assistance provided to projects, which are established
to introduce new products, inventions, idea and technology. Venture capital finance is more
suitable to risky oriented business which consists of huge investment and provides results
after 5 to 7 year.
Meaning of Venture Capital
The term Venture Capital fund is usually used to denote Mutual funds or Institutional
investors. They provide equity finance or risk capital to little known, unregistered, highly
risky, young and small private business, especially in technology oriented and knowledge
intensive business.
Venture Capital termed as long-term funds in equity or semi-equity form to finance hi-tech
projects involving high risk and yet having strong potential of high profitability.
Definition of Venture Capital
According to Jame Koloski Morries, venture capital is defined as providing seed, start up
and first stage financing and also funding expansion of companies that have already
Special Financing 205
demonstrated their business potential but do not yet have access to the public securities
market or to credit oriented institutional funding sources. Venture Capital also provides
management in leveraged buy out financing.
1995 finance bill define Venture Capital as long-term equity investment in novel
technology based projects with display potential for significant growth and financial return.
Features of Venture Capital
Venture Capital consists of the following important features:
(1) Venture Capital consists of high risk and high return based financing.
(2) Venture Capital financing is equity and quasi equity financing instruments.
(3) Venture Capital provides moderate interest bearing instruments.
(4) Venture Capital reduces the financial burden of the business concern at the initial
stage.
(5) Venture Capital is suitable for risky oriented and high technology based industry.
Venture Capital in India
ICICI Venture Capital is the first Venture Capital Financing in India. It was started in 1988
by the joint venture of ICICI and UTI.
The UTI launched Venture Capital Unit Scheme (VECAUS-I) to raise finance in 1990.
Technology Development and Information Company (TDICI) is another major Venture
Capital financing institution in India.
Risk Capital and Technology Finance Corporation Ltd. (RCIFC) provides Venture
Capital finance to technology based industries.
ANZ Grindlays Bank has set up India’s first private sector Venture Capital fund.
SBI and Canara Bank are also involved in Venture Capital Finance. They provide
either equity capital or conditionals loans.
S.No Name of Venture Capital Year Funds under Management
1. Alliance Venture Capital Advisors Ltd May. 1997 SWISS TEC VCF Rs. 1000 Million
2. APIDC–Venture Capital Funds Aug. 1989 APIDE – VCF Rs. 300 Million
3. Baring Private Equity Partners India Ltd. Jan. 1992 BII – off shore fund
4. Canara Bank Venture Capital Fund Ltd. Feb. 1995 Canara Bank Venture Capital
Rs.164.25 Million
5. Draper International Mar. 1994 DII Rs. 2090 Million
6. Gujarat Venture Finance Ltd. July. 1990 GVCF Rs. 240 Million
7. HSBC Private Equity Management Mauritius Ltd. Apl. 1995 HSBC equity fund Rs. 2400 million
8. ICF Advisors Pvt. Ltd. July. 1997 Indian capital fund Rs. 750 Million
9. IL and FS Venture Corporation Ltd. Feb. 1986 IT fund Rs. 100 Million
10. Indus Venture Management Ltd. Feb. 1989 IVC Rs. 210 Million
Contd....
206 Financial Management
11. IDBI July. 1984 IDBI – Rs. 1823.32 Million
12. Industrial Venture Capital Ltd. Sep. 1996 TN Venture fund Rs. 90 Million
13. International Venture Capital Management Ltd. Feb. 1996 Nandi Investment $ 30 Million
14. JF Electra Advisors India Ltd. Aug. 1995 JFE–$ 24 Million
15. Marigold Capital Services Ltd. Aug. 1995 MM fund Rs. 200 Million
16. Pathfinder Investment Company Ltd. Nov. 1993 Rs. 299.50 Million
17. Risk Capital and Investment Company Pvt. Ltd. Jan. 1998 Rs.1000 Million
18. SIDBI Apl. 1990 Rs. 600 Million
19. TDICI Ltd. Jan. 1998 Rs. 5500 Million and $ 75 Million
20. Kitven Aug. 1998 Rs. 18 Crore
FACTORING
Factoring is a service of financial nature involving the conversion of credit bills into cash.
Accounts receivables, bills recoverables and other credit dues resulting from credit sales appear,
in the books of accounts as book credits. Here the risk of credit, risk of credit worthiness of the
debtor and as number of incidental and consequential risks are involved. These risks are taken
by the factor which purchase these credit receivables without recourse and collects them
when due. These balance-sheet items are replaced by cash received from the factoring agent.
Factoring is also called “Invoice Agent” or purchase and discount of all “receivables”.
Although these can be with recourse or without recourse, normally the risk is taken by the
factoring agent. The discount rate includes the loss of interest, risk of credit and risk of loss
of both principal and interest on the amount involved.
Myths on Factoring
Myth Fact
Factoring is nothing but bill discounting or bill finance Factoring and bill discounting are two different
products tailored for two different markets.
Factoring is meant for “Open account sales”
and caters largely to a buyer’s market. Bill
discounting is normally prevalent in a seller’s
market. Factoring unlike bill discounting offers
a continuous relationship.
Factoring reduces bankers business Factoring is not merely financing and includes
a package of services like collection and followup
of each invoice, credit insurance. MIS support
etc., and improves the health of bank’s clients,
improveds cash flow through factoring,
increases production cycles and need for more
working capital. Factoring essentially aims at
replacing high cost market credit and not
necessarily reduce bank finance.
Contd....
Special Financing 207
Factoring is an high cost borrowing Comparable to interest rates of banks. (SSI –
13.50% to 15.75% Non-SSI 13.50% to
17.25%) Will to offer SBI’s PLR selectively)
Factoring service charge is high Service Charge is 0.1% to 0.3% only whereas
in Bills discounting, the collection charge is
0.5% to 0.6%.
Factoring is meant for manufacturing units only Extended to all sectors namely Manufacturing,
Trading and Services.
Factoring limits falls within MBBF/ Assessed Factoring is to be classified as other Current
Bank finance liability as per RBI guidelines and Factoring
replaces market credit and not bank borrowings.
History of the Early Factoring in Roman
Factoring has not been documented as having been used by the Romans. However, the
word ‘factoring’ has a Roman root. It is derived from the Latin verb ‘facio’ which can be
translated as “he who does things”. In Roman times this referred to agent of a property
owner, i.e., his business manager. Though the root word has nothing to do with the industry,
as they attempt to help their clients through their financial problem.
Factoring in United States
Factoring arose in the United States during 19th century, as direct result of the inability of
manufacturers to maintain constant and timely communications with their sales forces in
the field. At that time, as the case today, the sales force was paid by communications. If all
sales were at the risk of the manufacturer, the salesman had no incentive to exercise prudence
in connection with whom to sell to on credit.
On the other hand, the distant manufacturer was not in the position to make the credit
risk on sales. The risk of defective or non-conforming merchandise remained with the
manufacturer. The credit risk was now separated from disputes as to quality, workmanship
and conformity of goods. Soon after, the salesman began to act as independent sales agencies.
It was common for them to act for more than one manufacturer. Still later the sales function
was separated from the credit function and “Traditional Factoring” as the people know, it
had, at that point, developed in the United States.
Factoring in India
Banks provide generally bill collection and bill discounting and with recourse. They provide
working capital finance based on these bills classified by amounts maturity wise. Such bills
if accumulated in large quantities will burden the liquidity and solvency position of the
company and reduces the credit limits from the banks. It is therefore felt necessary that the
company assigns these book debts to a factor for taking them off from the balance sheet.
This reduces the workload, increases the solvency and improves the liquidity position of
the company.
208 Financial Management
In 1998 a study group under the chairmanship of C.S. Kalyana Sundram was constituted
to examine the feasibility of factoring services in India, their constitution, organizational
set up and scope of activities. The group recommended the setting up of specialized agencies
or subsidiaries for providing the factoring services in India with a professional expertise in
credit assessment, debt collection and management of sales ledger, and other related services.
Defaults or delays in collection and repayment can still remain which is the risk to be
taken by the factor for a fee. The group has estimated a good potential for this service to
the tune of about Rs. 4000 crores mainly emerging a collection problem, and delays in
collection and consequential liquidity problems.
Later the Vaghul Committee report on money market reforms has confirmed the need
for factoring services to be developed in India as part of the money market instruments.
Many new instruments were already introduced like Participation certificates, Commercial
papers, Certificate of deposits etc., but the factoring service has not developed to any
significant extent in India.
The Reserve Bank allowed some banks to set up subsidiaries on a zonal basis to take care
of the requirements of companies in need of such service. Thus Canara Bank, State Bank of
India, Punjab National Bank and a few other banks have been permitted to set up jointly
some factor, for Eastern, Western, Northern, and Southern Zones. The progress of the activity
did not show any worth while dimension, so far.
Modus of Operations
If a company wants to factor its receivables it submits a list of customers, their credit
rating, amount involved in maturity and other terms. If the factor scrutinizes the list of
buyers and they are in the approved list, the factor gives its decision of the clients and the
amounts they may take all receivables on wholesale discounting basis. The factor then
takes all the documents in respect of approved list and pays up to 80% to 90% of the
amount due less commission to the company which in turn removes these instruments,
from base of accounts and shows cash flow as against bills receivables written off.
Factoring services rendered the following services:
1. Purchase of book debts and receivables.
2. Administration of sales ledger of the clients.
3. Prepayments of debts partially or fully.
4. Collection of book debts or receivables or with or without documents.
5. Covering the credit risk of the suppliers.
6. Dealing in book debts of customers without recourse.
Why Factoring?
Factoring is one of the most important and unavoidable part of the business concern which
meets the short-term financial requirement of the concern. Factoring is favorable to the
industrial concern for the following reasons.
Special Financing 209
1. Quickest response–Customer oriented timely decisions and decision on sanction
within a week.
2. Low cost.
3. Low service charges (0.1% to 0.3%).
4. Low margin (20% onwards).
5. Instant finance–against each invoice.
6. Generous grace period.
7. Improves cashflow.
8. Substitutes sundry creditors.
9. Increases sales through better terms on sales.
10. More operating cycles and more profits.
11. No upfront recovery of charges.
12. Interest on daily products.
13. Very easy to operate.
14. Flexible credit periods.
15. No penal interest up to grace period.
16. Empowers cash purchase.
17. Improves credit reputation.
18. Follow up of each invoice.
19. Collection of receivables.
20. MIS reports like customers overdue invoices enabling constant evaluation of
customers.
21. Outstation payments at nominal rates.
Mechanics of Factoring
(1) Places Order for Goods
(3) Delivery of Goods with Notice
Pay the Factor
CLIENT (SELLER) CUSTOMER (BUYER)
(2) Fixation of customer limits
(4) Copy of invoice
(5) Prepayment up to 80%
(9) Balance Amount unpaid
(8) Payment.
(7) Follow up of Unpaid by Due Date
(6) Monthly Statement
FACTOR
.
.
. .
.
.
Fig. 12.2 Mechanics of Factoring
210 Financial Management
The following are the steps for factoring:
1. The customer places an order with the seller (client).
2. The factor and the seller enter into a factoring agreement about the various terms
of factoring.
3. Sale contract is entered into with the buyer and the goods are delivered. The
invoice with the notice to pay the factor is sent alongwith.
4. The copy of invoice covering the above sale to the factor, who maintains the sale ledger.
5. The factor prepays 80% of the invoice value.
6. The monthly statement are sent by the factor to the buyer.
7. Follow up action is initiated if there are any unpaid invoices.
8. The buyer settles the invoices on the expiry of the credit period allowed.
9. The balance 20% less the cost of factoring is paid by the factor to the client.
Types of factoring
(1) Notified factoring: Here, the customer is intimated about the assignment of debt
to a factor, also directed to make payments to the factor instead of to the firm.
This is invariably done by a legend and the invoice has been assigned to or sold
to the factor.
(2) Non-notified or confidential factoring: Under this facility, the supplier/factor
arrangement is not declared to the customer unless or until there is a breach of
the agreement on the part of the client, or exceptionally, where the factor considers
himself to be at risk.
(3) With recourse or without recourse factoring: Under recourse arrangements,
the client will carry the credit risk in respect of debts sold to the factor. In without
recourse factoring, the bad debts are borne by the factor.
(4) Bank Participation Factoring: The client creates a floating charge on the
factoring reserves in favour of banks and borrow against these reserves.
(5) Export Factoring: There is usually the presence of two factors: an export factor
and an import factor. The former buys the invoices of a client exporter and assumes
the risk in case of default by the overseas customers. Because of distance, different
condition or lake of information, the export factor usually forms out to an agent,
known as the import factor, the administrative job of servicing the debts owed to
its exporting clients.
FOREIGN DIRECT INVESTMENT
According to the definition given by JMF, FDI is the category of international investment
that reflects the objective of a resident entity in one economy (direct investor or parent
enterprise) by obtaining a ‘lasting interest’ and control in an enterprise resident in another
economy (direct investment enterprise).
Special Financing 211
The IMF definition of FDI includes as many as twelve different elements, namely:
equity capital, reinvested earnings of foreign companies, inter-company debt transactions
including short-term and long-term loans, overseas commercial borrowings (financial leasing,
trade credits, grants, bonds), non cash acquisition of equity, investment made by foreign
vantage capital investors, earning data of indirectly held FDI enterprises, control premium,
non-competition fee and so on.
FDI in India
FDI is permitted as under the following form of investments:
Through financial collaborations;
Through joint ventures and technical collaborations;
Through capital markets Via Euro Uses.
Through Private Placements or Preferential Allotments
1. The government has reviewed the guidelines pertaining to foreign/technical
collaborations under automatic route for foreign financial/technical collaborations
with previous ventures/tie-ups in India as per Press Note No. 18 (1998), it has
been decided that new proposals for foreign investment/technical collaborations
would henceforth be allowed under the automatic route, subject to sectored policies
as per the following guidelines.
(a) Prior approval of the government would be required only in cases where
the foreign investor has an existing joint venture for technology transfer/
trade mark agreement in the ‘same’ field.
(b) Even in the above mentioned cases, the approval of the government would
not be required in respect of the following :
(1) Investments to be made by venture capital funds registered with SEBI.
(2) Where the existing joint venture investments by either of the parties
is less than 3%; or
(3) Where the existing, venture/collaboration is defunct or sick.
(c) In so far as joint venture to be ordered after the date of dated January, 12,
2005 are concerned, the joint venture agreement may embody a ‘conflict of
interest’ clause to safeguard the interest of joint venture partners in the event
of one of the partners desiring to set up another joint venture or a wholly
owned subsidiary in the ‘same’ field of economic activity.
2. Increase in the FDI limits in Air Transport Services (Domestic Airlines) up to
49% through automatic route and up to 100% by Non-resident Indians (RRIs)
through automatic routes (No direct or indirect equity participation by foreign
airlines is allowed).
3. Foreign investment in the banking sector has been further liberalized by raising,
FDI limit in private sector books to 74% under the automatic route including,
investment by FIIs.
212 Financial Management
4. FDI in telecom has been raised to 74% subject to certain security measures. From
August 1991 to August 2004, 926 proposals of FDI of Rs. 41,368 crore were
approved. The actual FDI inflow of approximately Rs. 5,763 crore between
January 2001 and August 2004 alone was about 56% of the total FDI flow in
telecom since its inception in 1991. In terms of approval of FDI, the telecom sector
is the second largest, after power and oil references.
5. FDI in construction sector has been opened. Still some more sectors vis-à-vis retail
mining and pension are under the consideration of the government.
6. A part of FDI comes from NRIs, to oversee the difficulties faced by NRIs
government has set up a separate NRI Ministry for facilitating hassle free investment
procedure and clearances.
A Comparative Study Between India and China
Country FDI Inflows ($bn)
India 0.08 0.24 0.54 0.97 2.15 2.53 3.35 2.64 2.17 2.32 3.40 3.45 4.27
China 4.32 16.16 27.52 33.79 36.85 40.18 44.24 45.46 40.2 40.72 46.88 52.74 53.51
World FDI 1581 168 208 226 332 338 473 691 1087 1388 818 679 560
* 2.22 6.67 13.23 14.98 10.80 11.90 9.35 6.58 3.71 2.93 5.73 7.77 9.56
** 6.06 0.14 0.26 0.43 0.65 0.75 0.71 0.38 0.20 0.17 0.42 0.51 0.76
* FDI in China as a % of World FDI.
** FDI in India as a % of World FDI.
Source : UNCTAD, World Investment Report, Various Issues (1991–2004).
Foreign Institutional Investors (FIIs)
The Union Government allowed Foreign Institutional Investors to enter both the primary
and secondary markets in India under liberalized policy resume. The large inflow and outflow
of capital by FIIs affect the sensex movements. A certain degree of front running by the
traders in anticipation of FIIs demand also determines the market direction.
FIIs have to appoint an agency as consolidation to deal in the securities and reporting.
Accounts have to be maintained on daily basis. Semi model reports should be submitted by
the custodian to SEBI and RBI. SEBI can conduct direct inspections on the accounting books
of a registered FII. A Foreign Institutional Investor is permitted to appoint more than one
domestic custodian with prior approval of the Board but only one custodian may be appointed
for a single sub-account of FIIs.
SEBI and FIIs
SEBI announced its guidelines for FIIs registration and their operations in India in 1992 in
February, 1993 SEBI has granted registration to 12 FIIs for investing in the Indian Stock
market. At the end of 1996, 97, 439 FIIs were registered with SEBI. SEBI permitted registered
FIIs to invest in all securities traded on the primary and secondary markets including: equity,
other securities and instruments of companies listed on stock exchanges including OTCEI.
Special Financing 213
According to the 1995 regulation, no person can buy or sell or otherwise deal in
securities as a foreign institutional investor unless he holds a certificate granted by SEBI.
The certificate would be given to FIIs only after considering—
1. The applicant’s track record, professional record, professional competence, financial
soundness, experience, general reputation of fairness and integrity.
2. Whether the applicant is regulated by an appropriate foreign regulatory authority.
3. Whether the applicant has been granted permission under the provisions of FERA
Act 1973, for making investments in India as FII.
4. Whether the applicant is
(a) An institution established or incorporated outsides Indian as Pension Fund
or Mutual Fund or Investment Trust, or
(b) An Asset Management Company or Nominee Company or Bank or Institutional
Portfolio Manager, established or incorporated outside India and proposing to
make investment in India on behalf of broad based funds or
(c) A Trustee or Power of Attorney holder, incorporated or established outside
India and proposing to make investments in India on behalf of broad based
funds.
The certificate is valid for a period of 5 years from the date of its grant. Provisions are
made for the renewal of the certificate.
FIIs are allowed to place orders directly. Separate codes are given to FIIs and stock
exchange have to use the code number. The code number have to be approved by SEBI.
All the transactions carried out on behalf to FIIs have to be on delivery basis. In other
words, the registered FIIs should not engage in short selling and have to take delivery of all
purchase and give delivery of sold securities .
To case the inflow of foreign capital, amendments have been made in the regulations
regarding the FIIs investment. They are given below.
1. SEBI exempted FIIs to attach copy of RBI approved with market lot where shares
are sold and a custodian signed the transfer deed on their behalf.
2. FIIs individual limit on investment in a company was raised from 5 per cent to
10 per cent. Further, they have been allowed to unlisted stock of any company.
The FIIs list has also been increased.
3. SEBI (FIIs) Regulations 1995, have been changed to allow the FIIs to invest not
only in the equity but also in debt instruments of corporate bodies. FIIs were
allowed to invest up to 100 per cent of the funds in debt instruments of Indian
companies through 100 per cent dedicated debt funds from January 15, 1997.
4. SEBI amended SEBI (FIIs) Regulations 1997, to make it mandatory for FIIs, having
securities of Rs.10 crore of these as on own interest.
5. In June 1998, SEBI permitted
(a) FIIs to invest in unlisted companies through the 100% debt route and to
tender their serenities directly in responses to an open offer made in terms
of the SEBI regulations 1997.
214 Financial Management
(b) SEBI simplified the process of approval of Sub-accounts of registered FIIs.
(c) SEBI permitted FIIs to buy derivative contracts, which are traded on the stock
exchanges.
6. The aggregate investment of FII/NRI/OCB has been raised to 30 per cent of the
equity of the company by the union budget for 1997–98. The Finance Minister
in his budget speech in February 2000 announced of this limit to 40 per cent.
MERCHANT BANKING
Introduction
Merchant banking is one of the fee based financial services which includes underwriting,
consultancy and other allied services to the business concern. The term merchant banking
has been used in different terms in different countries. In UK merchant banking is termed as
accepting and issuing house and in the USA it is known as investment banking.
Meaning
A merchant banking is one who underwrites corporate securities and advises clients on
issue like corporate mergers. Merchant banking is basically service banking which provides
non financial services such as issue management, portfolio management, asset management,
underwriting of new issues, to act as registrar, share transfer agents, trustees, provide leasing,
project consultation, foreign credits, etc. The merchant bankers may function in the form
of a bank, financial institutions, company or firm.
Merchant Banking in India
In India, the first merchant banking services were started only in 1967 by National Grindlays
Bank followed by Citi Bank in 1970. In 1972 State Bank of India started a merchant banking
division, followed by ICICI Bank in 1973. Nowadays, most of the public sectors, private
sectors, commercial banks and financial institutions established a separate division of
merchant banking services.
Classification of Merchant Banking
According to the Securities Exchange Board of India regulations, merchant bankings are
classified into the following categories on the basis of their activities and capital adequacy.
The merchant banking must register themselves with Securities Exchange Board of India.
Category Minimum Net worth for Activities Permitted by SEBI
Capital adequacy
Category I Rs. 5 Crore Issue Manager, Advisor, Consultant,
Underwriter and Portfolio Manager
Category II Rs. 50 Lakhs Advisor, Consultant, Underwriter and
Portfolio Manager
Category III Rs. 20 Lakhs Advisor, Consultant, Underwriter
Category IV –NIL Advisor and Consultant service only.
Special Financing 215
Functions of Merchant Banking
Merchant banking is one of the non financial services which provides to the corporate
sectors, commercial banks and financial institutions. The major functions of merchant
banking are explained as follows:
1. Management, Marketing and Underwriting of new issues.
2. Project finance and project promotion services.
3. Syndication of credit and other facilities.
4. Leasing including project leasing.
5. Corporate advisory services.
6. Investment advisory services.
7. Bought out deals.
8. Venture capital.
9. Mutual funds and off shore funds.
10. Investment Management.
11. Investment services for non resident Indians.
12. Management dealing in commercial paper.
13. Treasury management.
14. Stock broking.
15. Foreign Collaboration and foreign currency finance.
16. Counseling to Small Scale Industries.
17. Capital Structure counseling to cooperative sectors.
18. Meeting the working capital needs.
Merchant Banking Organizations
In India, merchant banking services are provided by the following types of organizations:
Merchant Banking Organizations
Commercial Banks Financial Institutions Private Consultancy
Fig. 12.3 Merchant Banking Organizations
The following commercial banks are wholly owned subsidiaries to carry out merchant
banking activities.
State Bank of India – SBI Capital Markets Limited.
Canara Bank – Can Bank Financial Service Limited
216 Financial Management
Bank of Baroda – BOB Fiscal Services Limited.
Grindlays Bank – Grindlays Merchant Banking Limited.
ICICI, IFIC and IDBI are some of the examples of the All India financial institutions
which are involving in the merchant banking activities.
DSP Financial Consultants, Credit Capital Finance Corporation Limited, J.M Financial
and Investment Services Limited are some of the examples of the private consultancy firms
which are involving merchant banking activities.
CREDIT RATING
Introduction
Credit rating is one of the fee based financial services which are provided by specialized
agencies like CRISIL, ICRA and CARE. It is a mechanism by which the reliability and viability
of a credit instrument is brought out. It is usually the effort of investors in financial instrument
to minimize or eliminate default risk. Credit rating service is useful to the investors.
According to Securities Exchange Board of India, credit rating is a compulsory mechanism
for listing of the companies in the stock market and also it is essential to the corporate
sectors who want to raise capital with the help of issue of fixed deposits, commercial papers
and other short-term instruments.
Meaning of Credit Rating
Credit rating is an act of assigning values to credit instruments by estimating or assessing the
solvency, and expressing them through predetermined symbols.
“Credit rating is designed exclusively for the purpose of granting bonds according to
their investment quality”.
Corporate or municipal debt rating is a current assessment of the credit worthiness of
the obligator with respect of a specific obligation.
Objectives of Credit Rating
These are the important objectives of the credit rating:
• To impose a healthy discipline on borrowings.
• To lend greater belief to financial and other representations.
• To facilitate formulation of public guidelines on institutional investment.
• To help merchant bankers, brokers and regulatory authorities.
• To encourage the information disclosure, better accounting standards, etc.
• To reduce interest cost for highly rated company.
Credit Rating in India
Credit rating in India begins from 1988. At present there are four credit rating agencies
very popular in rating.
Special Financing 217
Operational Performance of Credit Rating Business in India
Rs. in crore
Rating Agency 1994–95 1995–96 Cumulative Up to March 96
Number Amount Number Amount Number Amount
CRISAL 384 24,544 427 43,086 1736 1,14,873
ICRA 212 5,343 293 75,742 778 93,380
CARE 184 8,403 217 13,909 445 23,638
Total 780 38,290 937 1,32,737 2,959 2,31,891
Basis for Credit Rating
Credit rating agencies consider the following important informations for granting the rating
symbol to the borrowing company;
1. Historical background of the company.
2. Track record of the company.
3. Financial efficiency and profitable position.
4. Operational efficiency.
5. Market share of the company.
6. Labour efficiency and their turnover.
7. Future prospects.
Credit Rating Information Service of India Limited (CRISIL)
Credit Rating Information Service of India Limited was the first credit rating agency in
India, in January 1988 jointly by ICICI, UTI, LIC, GIC and ADB. The following are the
major objectives of the Credit Rating Information Service of India Limited.
(a) To rating of companies debentures, fixed deposits programmes, short-term
instruments etc.
(b) To provide corporate reports to business concern.
(c) To conduct industry studies.
Credit Rating Symbols of Credit Rating Information Service of India Limited
Long-term Medium-term Short-term Remarks
Instrument Instrument Instrument
AAA FAAA P1 Highest Safety
AA FAA P2 High Safety
A FA P3 Adequate Safety
BBB – – Moderate Safety
Contd....
218 Financial Management
BB FB P4 Inadequate Safety
B FC - Risk Prone
C - - Substantial Risk
D FD P5 Default
Operational Result of Credit rating Information Service of India Limited
Credit Rating Information Service of India Limited is one of the well known and largest
credit rating agencies in India which provides credit rating to corporate and banking sectors.
The operational performances of the Credit Rating Information Service of India Limited
are explained in the table below:
Instruments 1994-95 1995-96 Cumulative Up to March 96
Number Amount Number Amount Number Amount
Debenture 103 7,641 161 13,342 646 45,700
Fixed deposits 97 9,130 218 14,153 543 38,625
Commercial Papers 137 1,629 21 3,255 459 11,415
Others 49 6,144 27 12,336 88 19,133
Total 384 25,544 427 43,086 1,736 1,14,873
Source: RBI reports.
Investment Information and Credit Rating Agency of India Limited (ICRA)
Investment Information and Credit Rating Agency is one of the largest credit rating service
providers next to Credit Rating Information Service of India Limited. It was established
mainly for the purpose of rating of short-term, medium-term and long-term debt instruments
of the corporate and banking companies. It was set up in the year 1991 by the leading
banking and financial institutions.
Credit Rating Symbols of Investment Information and Credit Rating Agency of
India Limited
Long-term Medium-term Short-term Remarks
Instrument Instrument Instrument
LAAA MAAA A1 Highest Safety
LAA MAA A2 High Safety
LA MA A3 Adequate Safety
LBBB – – Moderate Safety
LBB MB – Inadequate Safety
LB MC A4 Risk Prone
LC – – Substantial Risk
LD MD P5 Default
(Rs. in crore)
Special Financing 219
Operational Result of ICRA
Investment Information and Credit Rating Agency of India Limited is also performing well
in the field of credit rating to various instruments. The operational result of the Investment
Information and Credit Rating Agency of India Limited is explained in the table below:
(Rs. in crore)
Instruments 1994–95 1995–96 Cumulative Up to March 96
Number Amount Number Amount Number Amount
Debenture 45 1,779 66 8,224 223 18,599
Fixed deposits 87 540 192 50,507 360 54,481
Commercial Papers 80 3,023 35 17,011 195 22,299
Total 212 5,343 293 75,742 774 93,380
Source: RBI reports
Credit Analysis and Research Limited (CARE)
Credit Analysis and Research Limited was set up by Industrial Development Bank of India
in November 1993, Credit Analysis and Research Limited also provides rating to long-term,
medium-term and short-term instruments.
The rating symbols of Credit Analysis and Research Limited are mentioned below:
Credit Rating Symbols of Credit Analysis and Research Limited
Long-term Medium-term Short-term Remarks
Instrument Instrument Instrument
CARE AAA CARE AAA PR1 Highest Safety
CARE AA CARE AA PR2 High Safety
CARE A CARE A PR3 Adequate Safety
CARE BBB CARE BBB - Moderate Safety
CARE BB CARE BB Inadequate Safety
CARE B CARE B PR 4 Risk Prone
CARE C CARE C - Substantial Risk
CARE CARE PR5 Default
Operational Result of Credit Analysis and Research Limited
Credit Analysis and Research Limited is one of the latest origins in the field of credit rating
which provides rating to various instruments. The operational result of the Credit
Analysis and Research Limited as explained in the table below:
220 Financial Management
(Rs. in crore)
Instruments 1994-95 1995-96 Cumulative Up to March 96
Number Amount Number Amount Number Amount
Debenture 34 3,429 54 9,330 93 13,572
Fixed deposits 112 1,639 39 1,692 179 3,704
Commercial Papers 38 3,335 124 2,887 173 6,362
Total 184 8,403 217 13,909 445 23,638
Source: RBI reports
MUTUAL FUNDS
Introduction
Mutual fund is one of the funds based financial services which provides the stock market
benefits to small investors. It is a concept, leading to attract the small investors to invest their
pooling of savings in a trusted as well as profitable manner. Mutual funds business becomes
very popular in developed countries and it is fast growing in developing countries like India
also. Mutual funds act as a link between the investor and the stock market. Now in India
mutual funds activities are performed by public, private and foreign sector financial institutions.
Origin of Mutual Funds
In the year 1822 the concept of mutual funds was found in Belgium. In 1868, foreign
colonial government trust was established in England to spread the risks in securities market.
Mutual funds concept was spread to USA and some of the mutual funds institutions were
established. Unit Trust of India was established in 1964 as a public sector mutual funds
institution by the central government. It is the first mutual fund in India.
Structure of Mutual Fund in India
Mutual Fund Sectors
Securities Exchange
Board of India
Association of Mutual
Funds
Mutual Fund
Sponsor Board of Trustee Custodian Investor
Public Sector Private Sector
Fig. 12.4 Structure of Mutual Fund in India
Special Financing 221
Meaning of Mutual Fund
A mutual fund is an investment vehicle for investors who pool their savings for investing in
diversified portfolio of securities with the aim of attractive yields and appreciation in their
value. Mutual fund is a trust that attracts savings which are then invested in capital markets.
According to SEBI, mutual fund define is as a fund, established in the form of a trust to
raise money through the sale of units to the public or a section of the public under one or
more scheme for investing in securities, including money market instruments.
Investment company institute of the US defined mutual fund is a financial service
organisation that receives money from shareholders, invests it, earns return on it, attempts
to make it grow and agrees to pay the shareholders cash on demand for the current value
of his investment.
Advantages of Mutual Funds
Mutual fund consists of the following important advantages:
1. Attract small and medium group investors: Mutual funds promote savings
among the lower and middle income groups of investors because mutual fund
units are available with a single unit of Rs. 10 and multiples by the same value.
2. Attractive return: If the investor invests in mutual fund, they can get attractive
returns because mutual funds are linked with stock market. The benefits of stock
market goes to the mutual fund investors.
3. Reduce the risk: Mutual fund investments minimize the risk on investments by
diversifying the investments into various portfolios such as shares, debentures,
bonds etc.
4. Assure return: Mutual funds are managed by experts in the field of investment
management; hence there is no risk and mutual fund offers assured return.
5. Tax concession: If the mutual funds belong to infrastructure development bonds,
there will be a tax concession to the mutual fund investment.
6. Liquidity: Mutual fund investment is one of the highly liquidity based investments
which can be recapitalized at any time or sold the mutual fund units at any time.
7. Convenience: Mutual fund investment is one of the most convenient investments
for those who want to invest or get back their investment through selling of
the units of mutual fund.
8. Flexibility: Mutual fund can be transfered from one scheme to the other scheme
on the basis of present market condition.
9. Benefits to minorities: Mutual fund investment schemes are most suitable to
the old age pensioners, widows middle class women, etc.
10. Contribution to the economy: Mutual fund companies promote the saving habits
of middle class people. Hence, the money invested in mutual fund schemes are
invested into the major economical activities like infrastructure development
construction of bridge, buildings, etc.
222 Financial Management
Types of Mutual Fund
Ownership
point of View Scheme of
Operation point of
View
Portfolio point of
View
Location point
of View
Growth Income Balanced
Public
Sector
Private
Sector MF
Domestic
Fund
Global
Fund
Regional
Fund
Sector
Fund
Open ended
Scheme
Closed ended
Scheme
Fig. 12.5 Types of Mutual Fund
Public Sector Mutual Fund
Unit Trust of India is one of the public sector mutual funds operating from 1964 and it
enjoys the monopoly power in the field of mutual funds up to 1987. After 1987, Public
Sector Commercial Banks and Life Insurance Corporation of India also entered into mutual
funds activities. State Bank of India, Canara Bank, Punjab National Bank, General Insurance
Corporation are some of the public sector mutual funds activities.
Private Sector Mutual Fund
Apart from UTI and public sector commercial banks, some of the private sector financial
institutions also entered into the mutual fund activities in India from 1990 onwards. Kothari
Pioneer mutual fund, Twentieth century mutual fund, ICKI mutual fund, Morgan Stanly
mutual fund, Taurus mutual fund and CRB mutual fund are some of the examples of the
private sector mutual fund.
Open Ended Mutual Fund
When the units are sold and redeemed at any time on-going basis at the price determined
by the funds Net Assets Value (NAV) is called as open ended mutual fund. These mutual
fund has no fixed maturity periods. There is no ceilling on the amount invested by the
investors in these funds, and they can sell the units back to mutual funds whenever they
decide. Net Assets Value of the mutual fund is calculated by the following formula:
Special Financing 223
Net asset value of the unit =
Net assets value of fund
Number of outstanding units
.
Closed Ended Mutual Fund
Closed ended mutual funds have fixed maturity period ranging from two to 15 years. The
units of closed ended mutual funds are not repurchased or redeemed by mutual funds
before the maturity period. The investors cannot buy units directly from the fund after
the closing period.
Growth Generated Mutual Fund
Mutual fund investments which are reinvested in highly growth oriented equity shares
are called as growth oriented mutual fund. It consists of high return with growth potentials.
Income Generated Mutual Fund
If the investor needs regular income for their investment, they can select income oriented
mutual fund. It provides regular income to its investors.
Balanced Mutual Fund
Balanced mutual fund is a combination of mutual fund investment in company securities
as well as the government bonds. Investors can get moderate return with safety options.
Domestic Mutual Fund
When the mutual fund mobilizes savings from a particular country or region, it is called
domestic mutual fund.
Global Mutual Fund
When the mutual fund investment stocks are traded in markets throughout the world
with the exemption of the country which launches the fund.
Regional Mutual Fund
When the mutual fund consists of a particular region or a country, it is also called as off
shore mutual fund.
Sector Mutual Fund
Sector mutual funds are specializing in a particular industry which consist of aggressive
funds.
Top Ten Mutual Fund
• UTI Mutual Fund • Reliance Mutual Fund
• Prudential ICICI Mutual Fund • HDFC Mutual Fund
• Franklin Templeton Mutual Fund • Birla Sun Life Mutual Fund
• SBI Mutual Fund • DSP Merrill Lynch Mutual Fund
• Kotak Mahindra Mutual Fund • Tata Mutual Fund
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