Management of financial services

Management of Financial Services MBA Second Year (Financial Management) School of Distance Education Bharathiar University, Coimbatore - 641 046 Author: Shankari Parivallal Copyright © 2008, Bharathiar University All Rights Reserved Produced and Printed by EXCEL BOOKS PRIVATE LIMITED A-45, Naraina, Phase-I, New Delhi-110028 for SCHOOL OF DISTANCE EDUCATION Bharathiar University Coimbatore-641046 CONTENTS Page No UNIT I Lesson Introduction to Financial Services Lesson Non-Banking Finance Companies 23 UNIT II Lesson Leasing and Hire-purchase 71 Lesson Cross Border Leasing 90 Lesson Bills Discounting 96 UNIT III Lesson Factoring 109 Lesson Credit Rating 118 Lesson Venture Capital 136 Lesson Venture Capital in India 149 UNIT IV Lesson 10 Merchant Banking 159 Lesson 11 Mutual Funds 173 Lesson 12 Mutual Funds in India 181 UNIT V Lesson 13 Securitisation and Recent Developments in Financial Services Model Question Paper 197 213 MANAGEMENT OF FINANCIAL SERVICES SYLLABUS UNIT I Financial services - Meaning - Types - Fund based and Fee based financial services - Non-Banking Financial Companies - Functions Prudential Norms for NBFCs UNIT II Leasing and Hire-Purchase - Types of Lease - Financial Evaluation of a Lease Cross Border Leasing - Contents of a lease agreement - Bills Discounting UNIT III Factoring - Meaning and Types; Credit rating - Rating Agencies - function - Rating Methodology - Venture Capital and Venture capital industry in India UNIT IV Merchant Banking - activities in new issue market - Managing issue of shares and bonds; Mutual Funds - mechanism - types of schemes - Mutual funds industry in India - recent developments UNIT V Securitisation and Financial Reconstruction and Enforcement of Security interest Act - regulations - Recent developments in the financial Services industry Introduction to Financial Services UNIT I Management of Financial Services Introduction to Financial Services LESSON INTRODUCTION TO FINANCIAL SERVICES CONTENTS 1.0 Aims and Objectives 1.1 Introduction 1.2 Meaning of Financial Services 1.3 1.4 1.2.1 Functions of Financial Services 1.2.2 Characteristics of Financial Services 1.2.3 Constituents of Financial Services Market Types of Financial Services 1.3.1 Merchant Banking Era 1.3.2 Investment Companies Era 1.3.3 Modern Services Era 1.3.4 Depository Era 1.3.5 Legislative Era 1.3.6 Flls Era 1.3.7 Problems of Financial Services Sector Fund Based and Fee Based Financial Services and Regulatory Framework 1.4.1 The Need for Regulation 1.4.2 Types of Regulatory Framework 1.4.3 Framework of Regulations 1.5 Let us Sum up 1.6 Lesson End Activities 1.7 Keywords 1.8 Questions for Discussion 1.9 Suggested Readings 1.0 AIMS AND OBJECTIVES After studying this lesson, you should be able to: z Comprehend the concept of financial services z Know about the types of financial services z Learn about fund based and fee based financial services Management of Financial Services 1.1 INTRODUCTION Financial services form important constituents of the financial system Financial services, through the system of elements such as financial organizations, financial markets and financial instruments, meet the needs of individuals, institutions and corporate It is through this network that the functioning of the financial system is facilitated 1.2 MEANING OF FINANCIAL SERVICES Services that are offered by financial service companies are called financial services Financial service companies comprises of both asset management companies and liability management companies Asset management companies include leasing companies, mutual funds, merchant bankers and issue portfolio managers, liability management companies comprise of the bill discounting and acceptance houses 1.2.1 Functions of Financial Services Following are the objectives of financial services that are generally provided by financial service companies: Raising Funds: Financial services facilitate to raise the required funds from a host of investors, individuals, institutions and companies For this purpose, various instruments of finance are used The funds are demanded by corporate organizations, individuals, etc Effective Usage of Funds: A number of financial services are available in the financial markets, which enable the players to ensure an effective usage of the funds raised Financial services also help in the decision making regarding the financing mix Bills discounting factoring, credit rating, e-commerce, and securitization of debts are some of the financial services offered by firms to make sure that there is efficient management of funds Variety of Services: The financial services sector provides specialized services such as credit rating, venture capital financing, lease financing factoring, mutual funds, merchant banking and insurance Agencies, subsidiaries of financial institutions, banks and insurance companies also extend these services Legal Regulation: There are some agencies that are regulating the financial services activities In India, agencies like the Securities and Exchange Board of India (SEBI), Reserve bank of India (RBI) and the Department of banking and insurance of the government of India, through various legislations, regulate the operations of the financial service institutions Economic Growth: Financial services contribute greatly to speeding up the process of economic growth and development This is done through the mobilization of the savings of a cross section of people, for the purpose of diverting them into productive investments In this regard, it is to be noted that a number of developed and developing countries which have a highly organized financial market, have seen a greater rate of savings and investments 1.2.2 Characteristics of Financial Services Like any other service, financial services have the following characteristics: Intangibility: One of the basic characteristics of financial services is that they are intangible (lack of physical structure) in nature For financial services to be successfully created and marketed, the institutions offering them must have a good image and the confidence of its clients Quality and innovativeness of services are the focal point for building credibility and gaining the trust of the clients Customer Orientation: The institutions providing the financial services study the needs of the customers in detail Based on the results of the study, they come out with innovative financial strategies that give due regard to costs, liquidity and maturity considerations for various financial products This way, financial services are customer-oriented Inseparability: The functions of producing and supplying financial services have to be carried out simultaneously This calls for a perfect understanding between the financial services firms and their clients Perish-ability: Financial services have to be created and delivered to the target clients They cannot be stored They have to be supplied according to the requirements of customers Hence, it is imperative that the providers of financial services ensure a mach between demand and supply Dynamism: The financial services have to be created and delivered on the basis of socio-economic changes occurring in the economy, such as disposable income Standard of living, level of education, etc financial services institutions must by proactive in nature, and evolve new services by visualizing the expectations of the market The market for the exchange of financial products and instruments through a wide variety of players, each one offering a unique type of service, may be designated as the financial services market 1.2.3 Constituents of Financial Services Market The financial services market comprises of four major constituents as stated below: Market Players: Financial services offered by a host of intuitions and agencies that understand and meet the requirements of a wide spectrum of customers The players include banks, financing institutions, mutual funds, merchant bankers, stockbrokers, consultants, consultants, underwriters, market makers, etc Instruments: Financial instruments constitute an important part of the financial services market; the instruments include equity instruments, debt instruments, hybrid and exotic instruments It is characteristic of a financial services market that a member of innovative instruments such as zero – coupons bonds etc are floated, on a continuous basis Specialized Institutions: These include acceptance houses Discount houses Faction depositories The regulatory bodies include the department of banking and insurance of the central government bank of India securities and the exchange board of India, board for industrial and financial reconstruction, etc Regulatory Bodies: The financial services market is regulated by a host of institutions and agencies The regulatory bodies include: The Department of Banking and Insurance of the Central Government, Reserve Bank of India, Securities and Exchange Board of India, Board for Industrial and Financial Reconstruction Introduction to Financial Services 10 Management of Financial Services Check Your Progress Fill in the blanks: One of the basic characteristics of financial services is that they are ………… (lack of physical structure) in nature For financial services to be successfully created and marketed, the institutions offering them must have a good image and the confidence of its………… Quality and innovativeness of services are the focal point for building credibility and gaining the trust of the ………… The institutions providing the financial services study the ………… of the customers in detail 1.3 TYPES OF FINANCIAL SERVICES The growth of financial services in India has taken place under various tags It is outlined below: 1.3.1 Merchant Banking Era The period between 1960 and 1980 may be called the merchant banking era During this period, financial services such as merchant banking, insurance and leasing services began to grow Merchant bankers carried out the following functions: Identifying project, preparing feasibility reports and developing detailed project reports Conducing marketing, managerial financial and technical analysis on behalf of their clients Assist in designing an appropriate capital structure Acting as a bridge between the capital market and the fund-seeking institutions Underwriting Assisting enterprises in getting their issues listed on the stock exchange Offering legal advice relating to mergers and acquisitions Providing technical advice on leveraged buyouts and takeovers Extending syndication facility as part of arranging project finance 10 Arranging working capital loans 1.3.2 Investment Companies Era This era marked the setting up of variety of investment institutions and banks The investment companies include the unit trust of India, which is the largest public sector mutual fund in the world, the life insurance corporation of India that initiated the life insurance businesses and the general insurance corporations The life insurance corporation of India has grown as a public monopoly In 1970, insurance, which until then was in the private sector, was nationalized On nationalization, an insurance corporation was set up as a holding company with four subsidiaries to handle the general insurance businesses in the public sector The leasing business started emerging at the close 1970s Although such companies were initially engaged in equipment lease financing, later they undertook leasing operations of different kinds, such as financial, operation and wet leasing ™ Asset Reconstruction ™ Enforcing security interest i.e taking over the assets given as security for the loan ™ Establishment of Central Registry for regulating and registering securitisation transactions ™ Offences & Penalties ™ Boiler - plate provisions ™ Dilution of provisions of SICA ™ Exempted transactions Incorporation & Registration of Special Purpose Companies: The Securitisation Act proposes to provide security and reconstruct the financial assets through two special purpose vehicles viz 'Securitisation Company ('SCO')' and 'Reconstruction Company (RCO)' SCO and RCO ought to be a company incorporated under the Companies Act, 1956 having securitisation and asset reconstruction respectively as main object The Securitisation Act requires compulsory registration of SCO and RCO under the Securitisation Act before commencing its business Further a minimum financial stability requirement is also provided by requiring SCO and RCO to possess owned fund of Rs.2 crore or up to 15% of the total financial assets acquired or to be acquired The RBI has the power to specify the rate of owned fund from time to time Different rates can be prescribed for different classes of SCO and RCO Existing SCO and RCO are also required to get registered under the Securitisation Act The application for registration will have to be made to RBI The SCO or RCO which has obtained the registration certificate under the Securitisation Act shall be a Public Financial Institution within the meaning of Section 4A of the Companies Act, 1956 Besides it's core business of securitisation and asset reconstruction a SCO/RCO may perform the following functions: ™ Acting as recovery agent on behalf of any bank or financial institution ™ Acting as manager1 to manage the secured assets the possession of which has been taken over by the secured creditor ™ Acting as receiver if appointed by any Court or Debt Recovery Tribunal A SCOO or RCOO, which is carrying on any other business other than that of securitisation or asset reconstruction before commencement of the Securitisation Act, has to discontinue such other business within one year from the commencement of the Securitisation Act Securitisation of Financial Assets: Under the Securitisation Act only banks and financial institutions can provide security to their financial assets pertaining to NPAs with a securitisation company Securitisation means, according to the Securitisation Act, acquisition of financial assets by any securitisation company or reconstruction company from any financial institution or banks The necessary funds for such acquisition may be raised from 'qualified institutional buyers ('QIB')'2, by issuing security receipts representing undivided interest in such financial assets or other wise 199 Securitization and Recent Developments in Financial Services 200 Management of Financial Services Financial assets are as under: ™ A claim to any debt or receivables or part thereof, whether secured or unsecured ™ Any debt or receivables secured by, mortgage of, or charge on, immovable property ™ A mortgage, charge, hypothecation or pledge of movable property ™ Any right or interest in the security whether full or part underlying such debt or receivables ™ Any beneficial interest in property, whether movable or immovable, or in such debts, receivables, whether such interest is existing, future, accruing, conditional or contingent ™ Any financial assistance The much-needed legal framework for the securitisation of financial assets has been made by the enactment of the Securitisation Act Securitisation of financial assets is a financial tool for the lenders to provide security to their future cash flows from the secured assets and thus to release their funds blocked in them In the hands of the SCO and RCO the secured assets become "merchandise", realization of which gives them their return This aspect brings in the muchneeded expertise in adept handling in realization of the secured assets The legal impediments of normal civil law procedure to foreclose the mortgaged assets have thus been effectively removed by empowering the enforcement of the secured assets Securitisation of financial assets may take some time to fructify as it requires sound accounting principles also for which standards to be prescribed In other words there should be accounting framework, as well, besides legal framework Acquisition of Rights and Interests in Financial Assets: This is the main part of securitisation Section provides for the acquisition of rights or interests in financial assets of any bank or financial institution by SCO / RCO, notwithstanding any thing contrary contained in any agreement or any other law for the time being in force, in either of the following manner: ™ Issuing a debenture or bond or any other security in the nature of debenture, as consideration agreed upon by a SCO /RCO and bank/financial institution, incorporating therein the terms and conditions of issue ™ Entering into an agreement with bank/financial institution for the transfer of such financial assets on such terms and conditions as may be agreed upon Upon acquiring the financial assets from the bank/financial institution, the SCO/RCO steps into the shoes of the lender qua the borrower The Securitisation Act has provided for all necessary rights and powers for SCO/RCO to realize the financial assets from the borrower Funding of Securitisation: The SCO/RCO may raise the necessary funds, for the acquisition of financial assets, from the QIB by issuing a security receipt Security receipt is exempted from compulsory registration under the Registration Act Security receipts issued by any SCO or RCO shall be "securities" within the meaning of Section 2(h) (ic) of the Securities Contracts (Regulation) Act, 1956 A Scheme of acquisition has to be formulated for every acquisition detailing therein the description of financial assets under acquisition, the quantum of investment, rate of return assured etc Further separate and distinct accounts have to be maintained in respect of each scheme of acquisition Realizations made from the financial assets have to be held and applied towards the redemption of investments and payment of assured returns In the event of non-realization of financial assets, the QIB holding not less than 75% of the total value of the security receipts issued, are entitled to call a meeting of all QIB and pass resolution and every such resolution is binding on the SCO/RCO Assets Reconstruction: A SCO or RCO may, according to the guidelines prescribed by RBI, carry out asset reconstruction in any one of the following manners: ™ Taking over the management of the business of the borrower ™ Changing the management of the business of the borrower ™ Selling or leasing of a part or whole of the business of the borrower ™ Rescheduling of the payment schedule of the debt ™ Enforcing the security interest ™ Entering into settlement with the borrower for the payment of debt However, the above measures are subject to the provisions contained in any other law for the time being in force Enforcing 4Security Interest: The second objective of the Securitisation Act is to provide for the enforcement of security interest i.e taking possession of the assets given as security for the loan Section 13 of the Securitisation Act contains elaborate provisions for a lender (referred to as 'secured creditor') to take possession of the security given by the borrower The sum and substance of the provisions are as under: ™ The Lender has to send a notice of demand, giving details of the amount payable and the secured assets5 intended to be enforced in the event of non payment, to the defaulting borrower to discharge his liabilities ™ No borrower, after the receipt of the demand notice, shall transfer the secured assets in whatsoever manner without prior written consent from the lender ™ The Borrower has to discharge the liabilities within 60 days from the date of receipt of notice of demand ™ In the event of non payment of demand by the borrower, the lender may take any one or more of the following measures: ™ Taking possession and / or management of the secured assets of the borrower with a right to transfer the same by way of lease, assignment or sale for realising the secured asset ™ Appointing any person as manager to manage the secured assets the possession of which has been taken over ™ Asking any person, who has acquired any of the secured assets from the borrower and owes money to the borrower, to pay so much of the money, which is sufficient to pay the secured debt ™ Any transfer of secured assets made by the lender shall be deemed to be made by the owner of such secured asset 201 Securitization and Recent Developments in Financial Services 202 Management of Financial Services ™ If the borrower pays all the dues together with all costs, charges and expenses incurred by the lender before the date fixed for the sale of the secured assets, the lender shall not transfer or sell the secured assets ™ When the are more than one lender or joint financing, the approval of lender(s) representing not less than 75% of the amount due is required to take any steps to enforce the security interest and such approval is binding on all the lenders ™ In the case of a corporate borrower under liquidation the sale proceeds from the secured assets shall be distributed as per Section 529A of the companies Act, 1956 ™ In the event of lender opts to realise his security instead of relinquishing his security and proving his debt, may retain the sale proceeds of his secured assets after depositing the workmen's dues with the Liquidator ™ If the sale proceeds of the secured assets are not fully satisfying the debt due, the lender may file a claim before the DRT or before a competent court for the recovery of the shortfall ™ The lender also has an option to proceed against any of the guarantors or sell the pledged assets without taking any measures against the borrower ™ The lender can take the assistance of the Chief Metropoliton Magistrate or District Magistrate, as the case may be, in taking possession of the secured assets from the borrower ™ If any person, including the borrower, is aggrieved by any of the measures adopted by the lender, he may prefer an appeal to the DRT within 45 days by depositing at least 75% of the claim of the lender The decision of the DRT is further appealable to an Appellate Tribunal ™ The lender can initiate any proceedings to enforce the security interest unless his claim of the financial asset is made within the period prescribed under the Limitation Act, 1963 Enforcement of security interest has taken a flying start It is pertinent to mention here that ICCI (having NPA of Rs.6918 Crore) and IDBI (having NPA of Rs.13297 Crore) has already taken measures under the Securitisation Act, against 20 corporate houses, to enforce their security interest6 Many banks and financial institutions may follow suit 10 Establishment of a Central Registry: The functions relating to securitisation, asset reconstruction and creation of security interest is sought to be administered and regulated by a Central Registry Branch offices of the Central Registry may be established as and when the need is required A Central Registrar shall head the Registry The functions of the Central Registry are as under: ™ Particulars relating to securitisation of assets, reconstruction of financial assets and creation of security interest are entered in a record called Central Register ™ The records can be kept in electronic form also i.e in floppies, diskettes etc ™ The particulars of every transaction of securitisation, asset reconstruction or creation of security interest, shall be filed within 30 days of the transaction by SCO, RCO or the lender as the case may be ™ Modifications made in the security interest registered with the Registry are to be filed within 30 days of such modification ™ Satisfaction of security interest is required to be filed with the Registry within 30 days of satisfaction ™ Records maintained at the Central Registry are open to inspection for any person on payment of the prescribed fee ™ Offences & Penalties ™ Following are the offences prescribed under the Securitisation Act: ™ Default in filing particulars of transactions relating to asset securitisation, asset reconstruction and creation of security interest ™ Default in filing particulars of modification ™ Default in giving intimation of particulars satisfaction ™ Non-compliance of RBI directives by SCO and RCO ™ Contravention, including attempt to contravene and abetting in contravention, of any of the provisions of the Securitisation Act or any rules made thereunder Following are the penalties prescribed in the Securitisation Act: ™ For default in filing particulars of transactions mentioned above, every company and every officer of the company or every lender or officer of the lender shall be punished with a fine which may extend to Rs.5000/- for every day during which the default continues ™ For non-compliance of RBI directives every company and every officer of the company shall be punished with a fine which may extend to Rs.5, 00,000/-; and for continuing offence an additional fine of Rs.10, 000/- for every day during which the default continues ™ For contravention of any provisions of the Securitisation Act, the punishment is imprisonment for a term which may extend to one year, or with a fine, or with both ™ Only a Metropolitan Magistrate or Judicial magistrate of the First Class has powers to take cognizance and try an offence under the Securitisation Act ™ Boiler-plate Provisions ™ The following are the general provisions of the Securitisation Act: ™ The matters, over which DRT or Appellate Tribunal has jurisdiction under this Securitisation Act, shall not be tried by any Civil Court ™ The provisions of the Securitisation Act shall override the provisions of other laws or any instruments However the provisions of the Securitisation Act are in addition to and not in derogation of the following enactments: ™ The Companies Act, 1956 ™ The Securities Contracts (Regulation) Act, 1956 ™ The Securities and Exchange Board of India Act, 1992 ™ The Recovery of Debts due to Banks and Financial Institutions Act, 1993 ™ The Central Government has powers to make rules for carrying out the provisions of the Securitisation Act 203 Securitization and Recent Developments in Financial Services 204 Management of Financial Services Since the Central Registry is not yet established, the provisions relating to the Central Registry shall be applicable after the setting up of the Central Registry 11 Dilution of Provisions of SICA: The protective umbrella of registering with BIFR under Sick Industrial Companies (Special Provisions) Act 1985('SICA'), which has hitherto encouraged industrial sickness, has been removed by inserting two provisos in Section 15 of the SICA They are as under: ™ After the commencement of the Securitisation Act, where any SCO or RCO has acquired financial assets, no reference shall be made to BIFR ™ After the commencement of the Securitisation Act, any pending reference before BIFR shall come to an end where secured creditors, representing not less than 75% of the value of the amount outstanding, have taken any measures to recover their secured debts under the provisions of the Securitisation Act 12 Exempted Transactions: The following transactions are exempted from the provisions of the Securitisation Act: ™ Lien on any goods, money or securities given under the Contract Act,1872 ™ Pledge of movables under the Contract Act,1872 ™ Creation of security on aircraft ™ Creation of security interest on vessel ™ Conditional sale, hire-purchase or lease in which no security interest is created ™ Rights of unpaid seller under the Sale of Goods Act,1930 ™ Non attachable properties under the civil Procedure Code ™ Security interest on an amount less than or equal to Rs.1 lakh ™ Security interest created on agricultural land Amount due is less than 20% of the principal sum and interest thereon 13.3 SARFAESI ACT AMENDED, (FRIDAY, 19 NOVEMBER, 2004) The Supreme Court, in its judgment in the matter of Mardia Chemicals Ltd and Others Vs Union of India and Others upheld the constitutional validity of the Securitisation And Reconstruction Of Financial Assets And Enforcement Of Security Interest (SARFAESI) Act but struck down Sub-Section (2) of Section 17 which provides for a deposit of 75% of the claimed amount before the appeal is admitted by DRT The Supreme Court also held that after the service notice, if the borrower raises any objection or places facts for consideration of the creditor, the same may be considered with due application of mind and the reasons for not accepting the objection must be communicated to the borrower However, the borrower will be able to move the Secured Creditor has taken the DRT only after the possession of secured asset To bring the provisions of the Act in conformity with the Judgment of the Hon'ble Supreme Court Order, to dissuade the borrower from indulging in dilatory tactics with a view to postpone the repayment of dues and to enable secured creditors to make speedy recovery by enforcement of securities, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 has been amended by promulgation of the Enforcement of Security Interest and Recovery of Debt Laws (Amendment) Ordinance, 2004 (Ord of 2004) on 11.11.2004 The salient amendments are as under: (i) The Secured Creditor will be able to take possession of the secured assets only after reasons for not accepting the objections of the borrower have been communicated to him in writing After possession of the secured asset has been taken, the borrower can file an application before the DRT without any deposit If the DRT does not dispose off the petition within months, the borrower or the Secured Creditor can move the Debt Recovery Appellate Tribunal (DRAT) for directing the DRT for expeditious disposal of the application After the disposal of the case by the DRT the borrower, if aggrieved, can appeal to the DRAT with a deposit of 50% of the decreed amount or as determined by the DRT but not lower than 25% (ii) To confer power upon the Appellate Tribunal to transfer all pending applications before different DRTs to one DRT (iii) To empower RBI to call for periodic returns and information from Securitisation Companies and Asset Re-construction Companies (iv) To provide for taking over of management of the business of the borrower under Section 13(4) This was omitted in the original Act Though Section 15 provides for the manner and effect of take over of management of business, Section 13(4) did not provide for taking over the borrower's business by the Secured Creditor Other amendments are of clarificatory and consequential nature 13.4 RECENT DEVELOPMENT IN THE FINANCIAL SERVICES INDUSTRY A look at some recent developments, in the financial services industry, introduces us about the range of activities and events, and raises a number of issues, which are increasingly being faced by managers of firms providing financial services Why are traditional boundaries being broken? What are the underlying economic strategies that lead financial institutions to expand into new areas? Why did barriers exist in the first place and are they likely to be rebuilt? 13.4.1 Global Competition: Japanese Banks in the United States Japanese Banks in the mid – 1980s flush with low cost (low interest) deposits raised in regulated and uncompetitive markets at home and serving a booming economy generating floods of foreign exchange, sought new business frontiers Between 1985 and 1990, Japanese bank assets in the United States rose from $180 to $ 436 billion, largely competing with US banks in California and New York Their market share of bank assets in California grew from 16 to 27.5 percent; Japanese banks now own five of the ten largest banks in California They aggressively entered the construction and real estate loan markets By 1992, falling property values caused 9.4 percent of California loans and 15.5 percent of the New York loans to be bad The Japanese lost vast amounts of money in their investments in U.S Banking Expansion of Financial Institutions outside of their home countries raises interested questions, especially in view of the eagerness of American, European, and Japanese 205 Securitization and Recent Developments in Financial Services 206 Management of Financial Services financial institutions to enter emerging markets in Southeast Asia, Eastern Europe, and Latin America What can financial firms bring to foreign markets to add value to their customers and investors? What the lessons to be learned from the problems experienced by the Japanese? What is the best strategy for the Japanese banks now that the Japanese economy has weakened? Check Your Progress Fill in the Blanks: SARFAESI ACT was amended by Honourable Supreme Court of India on ………………… The Supreme Court amended SARFAESI Act in its judgment in the matter of ………………… and Others Vs Union of India and Others SICA stands for …………………………………… Under the Securitisation Act only ………………… can provide security to their financial assets pertaining to NPAs with a securitisation company SEBI stands for …………………………………… 13.5 NEW OPPORTUNITIES The fall of communist governments and the spread of democracy and market economies in Eastern Europe, the former Soviet Union, and China have opened vast opportunities for rapid transformation and modernization of huge economies and populations Governments in these countries are writing entire new laws to regulate newly formed financial entities Outside government officials, executives, and consultants are advising them on how to structure their financial systems Reduced government intervention and opening to foreign competition in India, Mexico and other Latin America and Asian Markets have produced more high-return investment opportunities than domestic savings can finance Financial services promote growth by placing funds from savers around the world into investments with the highest expected returns Financial institutions and individual investors seeking geographical diversifications want to participate in these investment returns and finance this growth What determines the demand for financial services in growing economies? How can financial institutions participate in the high returns these economies offer and avoid the problems experienced by Japanese banks in the United States? Should these emerging economies model their laws and regulations on those of developed economies? What can be learned from the experience of advanced economies? Is regulation useful? What rationale is offered for regulation? How laws and regulations and changes in them condition the business environment for mangers of financial institutions? What is the role in deregulation in recent financial crises? What financial institutions that they command such power and influence? How can they get into such trouble? What is their role in our economy and what services they provide? What kinds of jobs have to be done in these institutions? What major managerial problems these institutions face? The dramatic developments in the financial services industry in the last few decades have been accompanied by major innovations in the organization, regulation, products and services of firms in the industry In the early 1960s, large computerized databases of financial data were developed especially the University of Chicago’s Center of Research in Securities Prices (CRSP) database of stock returns These computerized databases revolutionized the analysis of corporate financial performance by making possible the use of computers to conduct sophisticated statistical studies Resulting path breaking research on the efficiency of financial markets was summarized and review by Eugene Fama ( 1970) in another widely cited article Growing use of mathematics in Finance made possible the solution of complex analytical problems One problem proving to have wide application was the equilibrium value of a call option on equity A major study on pricing options by Fisher Black and Myron Scholes (1973) is an example of a theoretically powerful and practically useful solution to equilibrium pricing of financial assets in efficient capital markets From an intellectual viewpoint, developments like these in finance are extremely exciting Some are fairly sophisticated and difficult to comprehend at first, but efforts to understand how these ideas relate to financial problems have payoffs with important applications in the real world These innovations have had a dramatic impact on the study of corporate finance Application of these ideas and insights will be hard to avoid, since corporate treasurers, investment advisors and financial service firm representatives must be conversant with the most current financial techniques in order to interact effectively in today’s financial market place 13.6 FINANCIAL SERVICES IN INDIA The first four decades of India’s Independence saw a highly regulated financial sector dominated by state owned entities and relatively isolated from the global financial system The business environment was relatively uncomplicated, with a few distinct product segments proffered by a limited group of players The Indian Financial system was highly segmented on account of interest rate controls and balance sheet restrictions, which inhibited proper pricing of resources and limited allocative efficiency Direct credit programmes to the priority sectors at subsidized rates had to be covered by charging higher rates from other borrowers, paying lower rates to depositors and limiting profits of the financial institutions The resource mobilization in the primary market was subject to several controls, including pricing and timing, which prevented the process of price discovery During the early 1990s, various reforms were initiated in the Indian financial system with a view to improving allocative and operational efficiency The presence of overseas players in the Indian financial industry has traditionally been restricted to the banking sector, where certain players such as Standard Chartered Bank, Hong Kong Bank and ANZ Grindlays bank have had a presence dating back over a 100 years However subsequent to the deregulation of the economy, several other global majors have established a presence in the Indian banking industry Foreign banks, despite accounting fro only around 8% of the total assets of the banking system have managed to establish a niche for themselves by virtue of their superior technology and expertise in offering specialized banking products such as derivatives, advisory services and trade finance Among the foreign entities, players from the European Union (EU) have a significant presence, but a notable feature is that several of them have established operations with the aim of serving their MNC clientele in India rather then targeting the opportunities offered by the India Market Overseas entities have also established a significant presence in other areas such as asset management, where they have made steady inroads into the market share of the incumbent Unit Trust of India Stock-broking has proven another attractive opportunity with 38 foreign brokers registered in the country, catering largely to Foreign Institutional Investors 207 Securitization and Recent Developments in Financial Services 208 Management of Financial Services A decade of financial sector liberalization has given rise to far reaching changes, which are creating trends and spurring innovation and forcing financial sector intermediaries to rethink the way they business Deregulation has exposed in its wake, cost inefficiencies and outdated technology, and created significant opportunities for new entrants 13.7 CHANGE DRIVERS Going forward, there have been certain fundamental events that are likely to throw up significant business opportunities in newer areas Firstly, there has been an easing of the regulatory framework, leading to private sector and foreign entry being permitted in certain restricted areas such as insurance In the future, Capital Account Convertibility (CAC) is also expected to throw up new opportunities particularly for asset managers and portfolio managers, as Indian customers will have an option of investing overseas but lack the necessary expertise Moreover, the easing of Foreign Direct Investment (FDI) norms applicable to NBFC’s is expected to foster the entry of several global players in the Indian financial sector Further, the RBI has now clarified its stance on Universal Banking, which is expected to facilitate the emergence of onestop financial service providers, straddling the entire product spectrum As a start, ICICI has announced a reverse merger with ICICI bank, to emerge as the second largest bank (in terms of assets) in the Indian economy Secondly, there has been a subtle shift in certain demographic patterns that have a direct impact on the financial sector At the start, there has been a shift away from physical savings towards financial savings While physical savings comprise mainly farm assets, assets related to other businesses, house property, gold and jewellery and consumer durables, financial savings, comprise mainly bank deposits, pension and provident funds, currency, shares ad debentures, and life and health insurance The shift in favor of financial savings has been driven by the development of the financial sector, the stagnation in prices of physical assets such as gold and the high risks associated with investing in real estate owing to price volatility As per the RBI annual report, financial assets in household savings amounted to 10.5% as a proportion of GDP during FY 1999 – 2000 as compared to 9.2% for physical assets Further, within financial savings, there has been a perceptible long term shift away from bank deposit and towards other avenues such as mutual funds, though the trend has somewhat dampened of late given the depressed conditions in the equity markets To summarize, the financial services environment in India has undergone significant changes The relevant questions that need to be answered in this regard are: what will be the impact of these changes? How can the existing players in the financial services market use these changes to their own benefit? Check Your Progress Fill in the Blanks: SARFAESI stands for …………………………… SARFAESI was passed in the year …………………………… The dramatic developments in the financial services industry in the last few decades have been accompanied by …………………………… and …………………………… CAC stands for …………………………… Opportunities are available for overseas players in …………………………… and …………………………… India in 13.8 INSURANCE AND PENSION MANAGEMENT 13.8.1 New Opportunities All these events have thrown up a series of opportunities in the Indian financial sector for overseas players These include: Insurance and pension Management Outsourcing and back-office services Asset Management Wealth Management and Private Banking Insurance and Pension Management Internationally, insurance trends are related to the importance of insurance in economic development Insurance not only plays an important role in national development but is itself affected by the stage of development that the economy is in thus insurance spreads are the highest in those countries that are developed market – economies Correspondingly, insurance plays a major role in hastening the development process in these economies The Indian insurance has recently been opened to private players Vast Market GDP projected to grow at 6.7% over the next years Population projected to grow to 1304 million by 2020 AD Growing middle class of 350 million Autonomous growth in business Current low penetration 22% of the insurable public are covered Premium collection constitute 2.46% of GDP compared to more than 7% of world average Amongst the World’s least insured market US$8.6 premium per capita Huge demand of investible funds Well developed capital markets Rapidly growing infrastructure and housing finance sectors High savings growth rate 24% with an annual growth rate of 12.3% Household saving 19% of GDP Corporate saving 4% of GDP Literacy rate Literacy rate of approximately 55% Growing at close to 4% Huge untapped areas Personal insurance Unit linked insurance Flexible business specific general insurance products Insurance is already emerging as an attractive market with several large international insurance companies, from both the US and Europe, having started operations in India in the life and the non-life sectors The next sector to be opened up to private participated is likely to be that of pension provision to the self-employed and the unorganized segment of the population Outsourcing and Back office Services The current business environment is increasingly leading financial services organizations to consider outsourcing as a strategic option, aimed not only at costcutting, but also as a means of supporting operations that help create a superior customer experience While some financial services organization have begun to outsource core back – office processes such as customer servicing and transaction processing, this has not yet become a mainstream practice A number of global financial services leaders are transcending geographical boundaries by maintaining 209 Securitization and Recent Developments in Financial Services 210 Management of Financial Services core back – office operations in India, which offers the twin benefit of ready availability of an educated labour force and lower costs HSBC group (formerly Hong Kong Shanghai Banking groups) is already outsourcing transaction management, and has had enough success to prompt opening its second outsourcing global services center at Hyderabad Other players having fairly extensive back-office operations in India include American Express, Citigroup, Dresdner Bank and GE capital Asset Management The asset management industry in India consisted of only the Unit Trust of India The sector was opened up to participation from bank-owned players in 1987, and finally to the private sector as recently as 1991 the first private sector player – Kothari Pioneer (now Pioneer ITI) commenced operation as recently as 1994 Subsequently, private sector players have rapidly grown their assets under management, both by virtue of a market expansion and also by capturing market share from the incumbent players The steady increase in private sector AUM, even amidst one of the worst capital market downturns witnessed in recent times, bodes well for future players looking to establish a presence in the Indian Market Wealth Management and Private Banking The rapid increase in the number of wealthy households in the economy has given rise to a need for personalized wealth management services While several players such as BNP, Citibank and HSBC offer such services, the scope and range of services is constricted by a lack of available investments avenues Going forward, with the advent of Capital Account Convertibility, the number of available avenues for investments is expected to dramatically increase, leading to a need for expert investment advice across multiple product classes and locations Such a need would be best fulfilled by foreign players having a global presence and with experience in handling multiple asset classes The deregulation of the Indian financial sector has thrown up a number of new business opportunities Recent developments, both on the regulatory front, as well as from a demographic perspective are expected to give rise to a growing demand for certain categories of financial services including insurance and pension funds management, outsourcing, asset management and wealth management Players from the global market have traditionally been at the forefront of foreign presence in the Indian financial sector Going forward, in light of the above mentioned opportunities, it is hoped that their presence would be enhanced so as to strengthen the ties between India and the global financial markets 13.9 LET US SUM UP The securitization act 2002 was passed with the objective of securitization of financial assets and funding of financial assets and reconstruction of assets The Securitisation Act contains 41 sections in Chapters and a Schedule Chapter contains sections dealing with the applicability of the Securitisation Act and definitions of various terms Chapter contains 10 sections providing for regulation of securitisation and reconstruction of financial assets of banks and financial institutions, setting up of securitisation and reconstruction companies and matters related thereto Chapter contains sections providing for the enforcement of security interest and allied and incidental matters Chapter contains sections providing for the establishment of a Central Registry, registration of securitisation, reconstruction and security interest transactions and matters related thereto Chapter contains sections providing for offences, penalties and punishments Chapter contains 10 sections providing for routine legal issues 13.10 LESSON END ACTIVITY Compare the performance of the financial services sector of India with that of Japan 13.11 KEYWORDS SARFAESI Act: Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest act SICA Act: Sick Industrial Companies (Special Provisions) Act 1985 Securitisation of Financial Assets: Under the Securitisation Act only banks and financial institutions can provide security to their financial assets pertaining to NPAs with a securitisation company SEBI Act: The Securities and Exchange Board of India Act, 1992 13.12 QUESTIONS FOR DISCUSSION What determines the demand for financial services in which growing economies? How can financial institutions participate in the high returns these economies offer and avoid the problems experienced by developed countries? Should the emerging economies model their laws and regulations on those developed economies? Discuss the different forms of business enterprises, which offer financial services What are the basic services the financial industry provides and why are they demanded? Discuss the four classes of financial service firms What determines the risk and return to participants in the financial services? Where financial services to produce value? what factors determine changes and shifts in the need for and satisfaction of financial services “Financial firms are a specialized part of the economic system” Discuss Discuss the recent measures initiated to improve the allocative efficiency of the financial system in India Critically examine the recent developments in the financial services 211 Securitization and Recent Developments in Financial Services 212 Management of Financial Services Check Your Progress: Model Answers CYP 1 Friday, 19 November 2004 Mardia Chemicals Ltd Sick Industrial Companies (Special Provisions) Act, 1985 banks and financial institutions The Securities and Exchange Board of India Act, 1992 CYP The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 innovtion and new financial products capital asset convertibility wealth management and asset management 13.13 SUGGESTED READINGS Aglietta, M (1982) World Capitalism in the Eighties, New Left Review, 136 pp., 5-41 Bhalla, V.K & Singh D., (1997) Selected International Financial Centres, Anmol Publications, Delhi Channon, D (1978) Services Industries: Structure, Strategy and Financial Performance, Macmillan, London Eurofi, (1988), 1992 Planning for Financial Services and Insurance Sector, Butteworths and Europe, London Fuchs, V.R (1968), The Service Economy, Colombia University Press, New York Hall, M.J.B (1987) Financial Deregulation, Macmillan, London Moran, M (1991), The Politics of the Financial Services Revolution, Macmillan, London Frice, K (1986) The Global Financial village, Banking World, London Wood, P (1991) Conceptualizing the role of services in Economic Change, Area, 23.1 pp 66-72 MODEL QUESTION PAPER MBA Second Year Sub: Management of Financial Services Time: hours Total Marks: 100 Direction: There are total eight questions, each carrying 20 marks You have to attempt any five questions Define financial services Discuss the special features of financial services Give an outline of the prudential norms to be followed by Non-banking financial companies What is a financial lease? Differentiate it from operating lease Also discuss the contents of a lease agreement Explain briefly the process involved in discounting of bills State the benefits it offers to various parties Elucidate the rating methodology adopted by credit rating agency and explain the advantages and limitations of credit rating Also discuss the role played by CRISIL in India What are venture capital funds? Discuss the various stages involved in venture capital financing Define mutual funds Give a detailed account of various schemes of mutual funds Write short notes on: a securitisation b Factoring c Merchant banking 213 Model Question Paper ... Meaning of Financial Services 1.3 1.4 1.2.1 Functions of Financial Services 1.2.2 Characteristics of Financial Services 1.2.3 Constituents of Financial Services Market Types of Financial Services. .. concept of financial services z Know about the types of financial services z Learn about fund based and fee based financial services Management of Financial Services 1.1 INTRODUCTION Financial services. .. of financial services Briefly discuss the various types of financial services Outline the status of financial services sector in India 21 Introduction to Financial Services 22 Management of Financial