Financial ServiceS

Sandeep GoelAssistant Professor—Finance

Management Development InstituteGurgaon

New Delhi-1100012012

Financial ServiceSSandeep Goel

© 2012 by PHI Learning Private Limited, New Delhi. All rights reserved. No part of this book may be reproduced in any form, by mimeograph or any other means, without permission in writing from the publisher.

iSBn-978-81-203-4445-7

The export rights of this book are vested solely with the publisher.

Published by Asoke K. Ghosh, PHI Learning Private Limited, M-97, Connaught Circus, New Delhi-110001 and Printed by Mudrak, 30A, Patparganj, Delhi-110091.

Contents

iii

Preface .....................................................................................................xi

Chapter 1: FinanCial SyStem .................................... 1–21Introduction 1Financial System: Nature and Scope 1 The Structure of Financial Markets 2 Financial Institutions 3 What are Financial Instruments? 3The Indian Financial System 4 Globalisation 5 Securitisation 5 Financial Engineering 5 E Finance 5Financial Markets in India 5 Money Market 6 Capital Market 6 Derivatives Market 7 Forex Market 9Indian Financial Institutions 9 Regulatory Institutions 9 Intermediaries 9 Financial Assets/Instruments 10Concept of Financial Services 12 Bank 13 Intermediation or Advisory Services Companies 13 Insurance Companies 13 Investment Services Companies 13 Mutual Funds 14 Credit Rating Agencies 14Financial Services in India 14 Highlights 15 Deals 16 Stock Markets 16

iv Contents

Insurance 16 Banking Services 17Regulatory Framework of Financial Services in India 17 Regulation of Banking and Non-Banking Finance Companies (NBFCs) 17RBI as a Financial Regulator 18 Objective 18 Constitution 19 BFS Meetings 19 Functions 19 Main Functions 19 Regulation of Indian Capital Market (Stock Market) 20 Regulatory Framework in the Forex Market 21 Regulatory Framework for Insurance Industry 21

References 21

Chapter 2: Regulation oF FinanCial maRketS .....22–34Introduction 22Financial Market Regulation: Nature and Objectives 22 Objective of Financial Market Regulation 23Development of Financial Regulation In India 24 First Phase 25 Second Phase 25 Third Phase: Developments during 2000–01 26Guidelines Issued by Regulatory Bodies for The Regulation of Financial Markets 30 Guidelines Issued by Reserve Bank of India 30 Guidelines Issued by Securities and Exchange Board of India 32

References 34

Chapter 3: Banking SeRviCeS ................................. 35–52Introduction 35Concept of Bank 36Growth of Banking in India 37 Phase I (Pre-Independence) 37 Phase II (Post-Independence) 37 Phase III (Post-Liberalisation) 38Banking Reforms in India 38 India’s Pre-reform Period 38 Gradual Privatisation 40 Diversification ofBankingActivities 41Present Picture of Indian Banking Sector 41 A Mix of Public and Private Sector Banks 41 Prudential Accounting Norms for Banks 41 Asset Liability Management (ALM) System 41 Risk Management 42

Contents v

Better Transparency 42 Technological Developments 42Structure of Indian Banking Industry 42The Central Bank 43Reserve Bank of India and Banking and Financial Institutions 44 Commercial Banks 44 Structure of Schedule Commercial Banks 45 Specialised Banks 46 Non-banking Financial Institutions/Development Financial Institution 46Functions of Commercial Banks 48 Primary Functions 48 Secondary Functions 49

References 50Appendix: Narasimham Committee report 1991 50

Chapter 4: inSuRanCe .............................................. 53–75Introduction 53Concept of Insurance 53 Every Asset has a Value 54 How does Insurance Work? 55Principles of Insurance 55Growth of Insurance Sector in India 57 Before Independence 57 Post Independence 57 Post Liberalisation 57 Important Milestones in the Indian Life Insurance Business 58 Important Milestones in the Indian General Insurance Business 58Insurance Companies in India 59Important Aspects of Insurance Business 60 Actuary 60 Underwriting 61 Policy Owner Services 61 Claim Administration 61 Marketing 61 Investment 62 Accounting 62 Information Systems 62 Legal and Compliance 62 Distribution Channels 63 Agents 63 Insurance Brokers 63 Insurance Consultants 63 Banking Outlets 64Regulation and Legislation Applicable to Insurance 64 History of Insurance Regulation in India 64

vi Contents

Life Insurance and Its Practice in India 67 Types of Insurance 67Other Aspects of Insurance 69 Surrender Value 69 Options 70 Guarantees 70 Premium 70General Insurance 74 Groups of General Insurance 75

References 75

Chapter 5: Capital maRket SeRviCeS .................... 76–98Introduction 76Capital Markets in India 76Types of Capital Market 78 Primary Market 78 Secondary Market 79 Initial Public Offering 79Capital Market Reforms 79Structure of The Indian Capital Market 81 Government Securities Market 81 Industrial Securities Market 82 Development Financial Institutions (DFIs) 82 Financial Intermediaries 82Stock Exchanges in India 82 Bombay Stock Exchange 83 National Stock Exchange 83 Regional Stock Exchanges (RSE) of India 84Factors for Investment in Capital Markets 85 Volatility Risk and Risk of Contagions 85 Liquidity Risk 85 Clearance and Settlement Risk 86 Political Risk 86 Currency Risk 86 LimitedDisclosure and InsufficientLegal Infrastructure 86References 86Appendix: poliCy DevelopmeNts of primary market 87

Chapter 6: mutual FundS .................................... 99–120Introduction 99What are Mutual Funds? 100Different Categories of Mutual Funds 102 Based on Structure 102 Based on Asset Class 103 Based on Industry 103 Based on Indices 104Importance of Mutual Funds 106

Contents vii

Regulations of Mutual Funds in India 107 Registering of a Mutual Fund in India 108Structural Arrangement of Mutual Funds 109 Examples of the Struc tural Arrangement 110Net Asset Value (NAV) of a Mutual Fund 110Performance Measures of Mutual Funds 112 The Treynor Measure 113 The Sharpe Measure 113 Jenson Model 114 Fama Model 114Index Funds vs. Ordinary Mutual Funds 115Fund of Funds (FoF) 116SIP, SWP, STP, Dividend Sweep and Triggers 117 Systematic Investment Plans (SIPs) 117 Systematic Withdrawal Plan (SWP) 117 Systematic Transfer Plan (STP) 117 Dividend Sweep 118 Triggers 118Emerging Challenges of Mutual Funds 118 The Issue of Fluctuating Returns 118 Expenses 119 Sub-Optimal Purchases 119 Diversification orOverDiversification 119 Forced Redemption 119 Taxes 120

References 120

Chapter 7: leaSing and HiRe puRCHaSe .......... 121–131Introduction 121What is Leasing? 121 Essential Elements 122Types of Leasing 123 Financial Lease 123 Operating Lease 124Leasing in India 124Regulations of Leasing in India 125 Laws and Acts Governing Leasing in India 125 Documents Required for Leasing 126 Contents of Lease Agreement 126Hire Purchase 127 Standard Provisions 128 Evolution of Hire Purchase 128 The Seller and the Owner 129 Implied Warranties and Conditions to Protect the Hirer 129 The Hirer’s Rights 129 The Hirer’s Obligations 130 The Owner’s Rights 130Distinction between Leasing and Hire Purchase 130References 131

viii Contents

Chapter 8: FaCtoRing SeRviCeS ......................... 132–149Introduction 132Factoring: The Concept 133 Factoring Means ‘Instant Cash’ 133 Characteristics of Factoring 133 Factoring Mechanism 134 Parties to Factoring 134 Benefits of Factoring 135Exemplary Cases of Factoring 136 Example: Account Receivables 136 Example: Converting Invoices to Cash 137 Example: Avoiding Hassle of Collecting Bad Debt 137 Example: Smoothing Cash Flow 137 Example: Borrowing Money, Secured by Debt 137Factoring vs. Other Financial Services 137 Factoring vs. Invoice Discounting 138 Factoring vs. Bank Loan 138 Factoring vs. Forfeiting 138Types of Factoring 139 DisclosedFactoring (Notified factoring) 139 Undisclosed (Non-notified orConfidential factoring) 139 Recourse Factoring 139 Non Recourse Factoring 140 Other Factorings 140Other Aspects of Factoring 140 Cost of Services 141Factoring in India 141 Major Players 142 Legal Aspects 143 The RBI Guidelines 143Products of Factoring: Corporate Cases 144 SBI Factors 144 HSBC 145Emerging Issues in Factoring Services 146 How toGetPayroll Funding for StaffingCompanies? 146 For a Small Business Loan Factoring is a Better Proposition 146Factoring: The Road Ahead 147References 149

Chapter 9: plaStiC money ................................... 150–169Introduction 150Plastic Money: An Overview 150Growth of Plastic Money Services In India 151 ProfitableUtilisation 151 Increasing Reach 151 Utmost Safety 151 Feature-oriented 151

Contents ix

Types of Plastic Cards 152 Credit Card 152 Debit Card 153 Charge Card 153 In-Store Card 153 Smart Card 153 Add-on Cards 154 Petro Cards 154Performance of Credit Cards 154 Major Banks Issuing Credit Cards in India 154 Global Players in Credit Card Market 155 Different Variants of Credit Cards 155 Do’s and Don’ts of Credit Cards 156 Reasons for Credit Card being Rejected at Retail Outlet 157Performance of Debit Cards 157 Features of a Debit Card 158 Tips for Responsible Use of Debit Card 158 Debit Card Service Rewards 159No Credit Cards Please ... 160 Most Common Mistakes 160Prevention of Frauds/Misuse 161 Ways to Prevent Credit Card Frauds 161 What to Look for in a Credit Card 162Terms Used in Plastic Money 163 Card Issuers 163 Cardholders 163 Member Establishment (MEs) 163 MemberAffiliates (MAs) 163 Charge Slip 164BenefitsOfferedwithCreditCards 164The Road Ahead for Plastic Money 165 Plastic Money Problems Create Pressures 165 Is Plastic Money for Real? 165Case Study: The True Story of a Victim 168References 169

Chapter 10: ventuRe Capital ............................. 170–184Introduction 170Nature and Characteristics of Venture Capital 171 Characteristics 171History of Venture Capital 171 Venture Capital in India 172Venture Capital Funding 173 Why Venture Capital? 173 Conventional v/s Venture Capital Funding 174 Risks in Start-ups/Early Stage Companies 174 What Venture Capitalists Look For? 175Types of Venture Capital 175

continue

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