UG B.B.a Banking B B A Banking - 122 23 Rural Banking

ALAGAPPA UNIVERSITY
[Accredited with ‘A+’ Grade by NAAC (CGPA:3.64) in the Third Cycle

and Graded as Category–I University by MHRD-UGC]
(A State University Established by the Government of Tamil Nadu)
KARAIKUDI – 630 003
B.B.A. [Banking]
II - Semester
122 23
RURAL BANKING
Author
Dr. Premvir Kapoor, Professor and Ex Director, IIMT College of Management, Greater Noida (UP)
Units: (1, 2, 3, 4, 7, 8, 9)
Dr. Punithavathy Pandian, Professor, Department of Commerce, Madurai Kamraj University
Units: (5.0-5.2, 5.4.1, 5.5-5.9, 10.0-10.2, 10.5-10.9)
C Rama Gopal, Chartered Accountant, Education Counsellor, The Institute of Company Secretaries of India
Units: (5.3-5.4, 6, 10.3)
KC Shekhar, Prof. & HOD of Accounting and Finance, University of Zambia
Lekshmy Shekhar, Chartered Accountant, Former Deputy General Manager, Finance, Yokogawa Blue Star - Bengaluru;
Manager SAP Global Enterprise System Support, Washington DC
Units: (11.3, 11.6-11.10, 13)
Vikas® Publishing House, Units: (10.4, 11.0-11.2, 11.4-11.5, 12)
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SYLLABI-BOOK MAPPING TABLE
Rural Banking
BLOCK - I: BASICS OF RURAL BANKING

Unit 1: Rural Banking: Meaning – Importance – Activities of a Rural Banker Unit 1: Overview of Rural Banking
– Project counselling – Loan Syndication – Management of Public Issues (Pages 1-18)
– Underwriting, Bankers to Issue and Other Services
Unit 2: Growth of Rural banking in India –– Meaning- Importance – Unit 2: Growth of Rural
Implication – Need for Control –Types- Scope, Features - Role of the SEBI Banking in India
in Regulating Rural Banking Industry - Role of NSE and OTCEI. (Pages 19-34)
Unit 3: Project Related Activities of a Rural Banker: Corporate Counselling: Unit 3: Project Related Activities
Organisational Goals ––Loan Syndication: Meaning and Scope – Steps in of a Rural Banker
Syndication– (Pages 35-51)
BLOCK - II: RURAL BANKING FEATURES

Unit 4: Capital Issue Related Activities of a Rural Banker: Changing Unit 4: Capital Issue Related
Structure of Indian Capital Market – Management of Pre-issue Activities Activities of a Rural Banker
(Pages 52-61)
Unit 5: Corporate Securities: Types and Characteristics – Marketing of Unit 5: Corporate Securities
Corporate Securities – Steps to be Taken by the Issuing Company and the (Pages 62-83)
Lead Manager – Underwriting.
Unit 6: Management of Post-issue Activities – Processing of Aata – Unit 6: Management of

Reporting to SEBI – Under Subscription – Bridge Loans – Allotment of Post-Issue Activities
Shares – Listing of Securities. (Pages 84-99)
Unit 7: Service Oriented Activities of a Rural Banker: Mergers and Unit 7: Service Oriented Activities
Amalgamations: Meaning – Purpose – Types of Mergers. of a Rural Banker
(Pages 100-114)
BLOCK - III: VENTURE CAPITAL AND MISCELLANEOUS

Unit 8: Role of Rural Bankers in Mergers – Portfolio Management: Functions Unit 8: Overview of Role of Rural
of Portfolio Managers – Explanation to Risk – CAPM Approach to Market Bankers in Mergers and Portfolio
Operations. Management
(Pages 115-129)
Unit 9: Miscellaneous Activities of a Rural Banker: Venture Capital – Origin Unit 9: Miscellaneous Activities
– Administration of Venture Capital Fund – Mutual Fund of a Rural Banker
(Pages 130-140)
Unit 10: Classification of Mutual Funds – Factoring – Mechanism and Unit 10: Classification of
Types of Factoring Domestic - Cash Management, ST/MT Funding, Mutual Funds
Meaning and Importance Cash Management, Objectives. (Pages 141-163)
BLOCK - IV: LRR AND CRR
Unit 11: Cash Flow Cycle, Cash Flow Budgeting and Forecasting, Electronic Unit 11: Cash Flow Cycle
Cash Management, MT and LT Funding, Term Loans, Securitization, Cost (Pages 164-180)
Center, Profit Center, Planning and Control, Capital Budgeting.
Unit 12: Liquidity Management- Objectives-Sources-Maturity Concerns: Unit 12: Liquidity Management
Projected Cash and Core Sources- Contingency Plans- ST/NT Liquidity – (Pages 181-186)
Maturity Ladder Limit- Internal Control-Information- Netting.
Unit 13: Regulation, Supervision and Compliance- Need and Significance Unit 13: Regulation, Supervision and
of Internal and External Audit. Compliance
(Pages 187-206)
CONTENTS
INTRODUCTION
BLOCK I: BASICS OF RURAL BANKING
UNIT 1 OVERVIEW OF RURAL BANKING 1-18
1.0 Introduction
1.1 Objectives
1.2 Rural Banking: Meaning and Important Activities
1.2.1 Project Counselling
1.2.2 Loan Syndication
1.3 Management of Public Issues
1.4 Answers to Check Your Progress Questions
1.5 Summary
1.6 Key Words
1.7 Self Assessment Questions and Exercises
1.8 Further Readings
UNIT 2 GROWTH OF RURAL BANKING IN INDIA 19-34
2.0 Introduction
2.1 Objectives
2.2 Meaning, Importance and Implication
2.3 Need for Control: Types, Scope and Control Features
2.3.1 Role of SEBI (Securities and Exchange Board of India) in Regulating Rural Banking Industry
2.3.2 Role of National Stock Exchange of India (NSE)
2.3.3 Role of OTC Exchange of India
2.5 Summary
2.6 Key Words
UNIT 3 PROJECT RELATED ACTIVITIES OF A RURAL BANKER 35-51
3.0 Introduction
3.1 Objectives
3.2 Project Activities
3.3 Corporate Counselling
3.3.1 Organizational Goals
3.4 Loan Syndication: Meaning and Scope
3.4.1 Steps in Loan Syndication
3.6 Summary
3.7 Key Words
BLOCK II: RURAL BANKING FEATURES
UNIT 4 CAPITAL ISSUE RELATED ACTIVITIES OF A RURAL BANKER 52-61
4.0 Introduction
4.1 Objectives
4.2 Capital Issues
4.2.1 Changing Structure of Indian Capital Market
4.3 Management of Pre-Issue Activities
4.5 Summary
4.6 Key Words
UNIT 5 CORPORATE SECURITIES 62-83
5.0 Introduction
5.1 Objectives
5.2 Types and Characteristics of Securities
5.3 Marketing of Corporate Securities
5.4 Steps to be taken by the Issuing Company
5.4.1 Lead Manager and Underwriting
5.6 Summary
5.7 Key Words
UNIT 6 MANAGEMENT OF POST-ISSUE ACTIVITIES 84-99
6.0 Introduction
6.1 Objectives
6.2 Processing of Data and Allotment of Shares
6.2.1 Under Subscription
6.2.2 Bridge Loans
6.3 Reporting to SEBI
6.4 Listing on Stock Exchanges
6.6 Summary
6.7 Key Words
UNIT 7 SERVICE ORIENTED ACTIVITIES OF A RURAL BANKER 100-114
7.0 Introduction
7.1 Objectives
7.2 Merger and Amalgamation: Meaning and Purpose
7.2.1 Types of Merger
7.4 Summary
7.5 Key Words
BLOCK III: VENTURE CAPITAL AND MISCELLANEOUS
UNIT 8 OVERVIEW OF ROLE OF RURAL BANKERS IN MERGERS
AND PORTFOLIO MANAGEMENT 115-129
8.0 Introduction
8.1 Objectives
8.2 Role of Rural Bankers in Mergers
8.3 Portfolio Management
8.3.1 Functions of Portfolio Managers
8.3.2 Capital Asset Pricing Model (CAPM)
8.5 Summary
8.6 Key Words
UNIT 9 MISCELLANEOUS ACTIVITIES OF A RURAL BANKER 130-140
9.0 Introduction
9.1 Objectives
9.2 Venture Capital and its Administration
9.2.1 Origin
9.2.2 Types of Venture Capital Financing
9.3 Mutual Funds
9.3.1 Kinds of Mutual Fund Schemes
9.5 Summary
9.6 Key Words
UNIT 10 CLASSIFICATION OF MUTUAL FUNDS 141-163
10.0 Introduction
10.1 Objectives
10.2 Types of Mutual Funds
10.3 Factoring: Mechanism and Types of Factoring
10.4 Cash Management: Meaning, Importance and Objectives
10.4.1 ST/MT Funding
10.6 Summary
10.7 Key Words
BLOCK IV: LRR AND CRR
UNIT 11 CASH FLOW CYCLE 164-180
11.0 Introduction
11.1 Objectives
11.2 Cash Flow Budgeting and Forecasting
11.2.1 Electronic Cash Management
11.3 Securitization
11.3.1 Term Loans
11.4 Capital Budgeting
11.5 Profit and Cost Centre
11.7 Summary
11.8 Key Words
UNIT 12 LIQUIDITY MANAGEMENT 181-186
12.0 Introduction
12.1 Objectives
12.2 Objectives and Sources
12.2.1 Projected Cash and Core Sources
12.2.2 Maturity Ladder
12.3 Contingency Plans
12.5 Summary
12.6 Key Words
UNIT 13 REGULATION, SUPERVISION AND COMPLIANCE 187-206
13.0 Introduction
13.1 Objectives
13.2 Need and Significance of Internal and External Audit
13.2.1 Objectives and Scope of an Audit
13.2.2 Advantages of an Audit
13.2.3 Classification of Audit: External and Internal Audit
13.4 Summary
13.5 Key Words
Introduction
INTRODUCTION
Rural banking refers to providing banking services to individuals living in rural

NOTES areas. Rural banking has become integral to the Indian financial markets with a
majority of Indian population still living in rural or semi-urban areas. Government
of India and the Reserve Bank of India have been continuously working to achieve
complete financial inclusion i.e. timely and sufficient access to financial services
and credit at an affordable cost, in the vast expanse of our country. Rural banking
in India began in earnest with the formation of the regional rural banks on October
2, 1975. Today, these rural banks are present in over 21,398 locations throughout
the length and breadth of the country.
This book, Rural Banking, is divided into thirteen units that follow the self-
instruction mode with each unit beginning with an Introduction to the unit, followed
by an outline of the Objectives. The detailed content is then presented in a simple
but structured manner interspersed with Check Your Progress Questions to test
the student’s understanding of the topic. A Summary along with a list of Key Words
and a set of Self-Assessment Questions and Exercises is also provided at the end
of each unit for recapitulation.
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10 Material
Overview of Rural
BLOCK - I Banking
BASICS OF RURAL BANKING
NOTES
UNIT 1 OVERVIEW OF RURAL
BANKING
Structure
1.0 Introduction
1.1 Objectives
1.2 Rural Banking: Meaning and Important Activities
1.2.1 Project Counselling
1.2.2 Loan Syndication
1.3 Management of Public Issues
1.5 Summary
1.6 Key Words
1.0 INTRODUCTION
A rural bank can be defined as rural financial institution/ cooperative/ community

bank or deposit taking financial institution that provides customised financial services
to rural communities. As a huge section of the country resides in rural areas, it is
important from a financial inclusion aspect that rural branches exist to cater to the
population. However, banking in the rural areas is different from merchant banking
that exists in cities. This unit will begin by examining the activities of a rural banker,
underwriting, bankers to issue and other services.
1.1 OBJECTIVES
After going through this unit, you will be able to:

 Explain the activities of rural banking
 Discuss project counselling and loan syndication
 Explain management of public issues
 Describe the role of underwriters
Self-Instructional
Material 1
Overview of Rural
Banking 1.2 RURAL BANKING: MEANING AND
IMPORTANT ACTIVITIES
NOTES Rural banking is banking that is done in an area that is not close to towns or cities,
making it difficult for those who need to conduct banking business. Many times a
bank agent will come to the rural area to offer basic banking services. The goals of
rural banks are to provide banking services to the rural/ village population of
India.
Rural banking is a common practice in places where banking institutions are
few and far between and people who need to carry out banking transactions may
have difficulty finding a way to do so. With modern technology, more and more
people have access to online systems that allow them to conduct certain types of
banking without a nearby branch but this technology is not available for everyone
and demand for rural banking is still high in some areas.
Rural banking is the process of conducting banking transactions out in the
country where bank branches are too far away to be of use. Rural banking is
popular for very small towns and farmers who live far away from areas of larger
population and cannot make the drive to these locations even when they need to
use banking services. Typically an agent of the bank will visit these rural locations
and offer to make transactions in an official capacity.
The regional rural banks were established with a view to developing the
rural economy by providing, for the purpose of development of agriculture, trade,
commerce, industry and other productive activities in the rural areas credit and
other faculties, particularly to small and marginal farmers, agricultural labourers
artisans and small entrepreneurs and for matters connected therewith and incidental
thereto. The institution of Regional Rural Banks (RRBs) was created to meet the
excess demand for institutional credit in the rural areas particularly among the
economically and socially marginalised sections. In order to provide access to
low-cost banking facilities to the poor, the Narsimham Working Group proposed
the establishment of a new set of banks, as institutions which combine the local
feel and the familiarity with rural problems which the cooperative possess and the
degree of business organisations ability to mobilize deposits, access to central
money markets and modernized outlook which the commercial banks have. The
multi-agency approach to rural credit was also to sub serve the needs of the input-
intensive agricultural strategy, that is, the green revolution, which by the mid-
seventies was ready to spread more widely throughout the Indian countryside. In
addition the potential and the need for diversification of economic activities in the
rural areas had begun to be recognised and this was a sector where the Regular
Rural Banks could play a meaningful role.
The Regional Rural Banks were established on 2nd October 1975. The
main objectives of these banks are to provide credit and other facilities particularly
to small and marginal farmers and small entrepreneurs so as to develop agriculture
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2 Material
trade, commerce industry and other productive activities in rural areas. The aim of Overview of Rural
Banking
rural banks is to bridge the credit gaps existing in the rural areas and they are
supposed to be effective instruments of economic development in rural India. They
will extend productive credit to the rural community and they will have purely rural
orientation in their activity and in the manner of extending their activity. NOTES
Regional rural banks (RRBs) are Indian scheduled commercial banks
operating at regional level in different states of India. They have been created with
a view of serving primarily the rural areas of India with basic banking and financial
services. The area of operation of Regional Rural Banks is limited to the area as
notified by Government of India covering one or more districts in the state. Regional
Rural Banking perform various functions. These are as follows:
 Providing banking facilities to rural and semi-urban areas
 Carrying out government operations like disbursement of wages of
MGNREGA workers, distribution of pensions etc.
 Providing para-banking facilities like locker facilities debit and credit
cards, mobile banking internet banking etc.
Functions of Regional Rural Bank
Regional Rural Bank grant loans and advances to small farmers and agricultural
labourers so that they can start their own farming activities including purchase of
land, seeds and manure. The RRBs charge a lower rate of interest and thus they
reduce the cost of credit in the rural areas functions of RRBs are as follows:
 RRBs grant loan and advances to small farmers and agricultural labourers
so that can start their own farming activities including purchase of land seed
and manure.
 RRBs provide banking services at the doorsteps of the rural people
particularly in those areas which are not served by any commercial bank.
 The RRBs charge a lower rate of interest and thus they reduce the cost of
credit in the rural areas.
 RRBs provide loan and other financial assistance to entrepreneurs in villages
sub-urban areas and small towns so that they become able to enlarge their
business.
 Loans to artisans to encourage them for the production of artistic and related
goods.
 Encourage the saving habit among the rural and semi-urban population.
A rural bank focuses on providing savings and credit services to people
who live in rural areas. The financial products offered respond to the needs of its
clients. A rural bank is a smaller size in assets than the very large banks. It is
located generally in smaller cities and concentrates in making loans and other
services to that immediate locations.
Self-Instructional
Material 3
Overview of Rural Earlier commercial banks hesitated to open the rural branches due to
Banking
profitability, infrastructure etc. So the government of India and Reserve Bank of
India decided to open a new banking channel i.e. regional rural banks. These
banks were allowed to work within a district. The focus of regional rural banks
NOTES was to provide finance in the agricultural sector only. They were not allowed to
finance for vehicles, housing, business loan etc. The salary of regional rural banks
was less than the commercial bank. The capital sharing of this district level was
50% of sponsored commercial bank. 35% of central Government and remaining
15% of the state Government. The competition in the banking sector changed all
basic rules. The regional rural banks were allowed to finance in every sector. The
salary of the employees of the RRBs is equal to commercial bank employees. The
sponsored banks were allowed to merge the different district regional rural banks
within a state.
Rural banking has become integral to the Indian financial markets. With the
majority of Indian population still living in rural or semi urban area, the Government
of India and Reserve Bank of India have been continuously working to achieve
complete financial inclusion, that is, timely and sufficient access to financial services
and credit at an affordable cost in the vast expanse of our country. Pradhan Mantri
Jan Dhan Yojana is one of the recent initiatives by the BJP Government which has
definitely contributed to bring banking to every household. This scheme with time
will significantly reduce the gap between rural and urban areas in terms of financial
inclusion. But the fact that about 70% of population of India is still rural and the
penetration of banking facilities is as low as only 24%, i.e., only this percentage of
people in these areas have formal bank accounts, cannot be ignored. Various
Regional Rural Banks have been set up under the Regional Rural Banks Act,
1976 to provide a continuous source of credit for agriculture and other activities.
These banks were set up with the aim of reaching every corner of the country and
cater to financial needs of rural society comprising small and marginal farmer,
agricultural labourers, self-help groups, artisans etc. The credit to weaker sections
was made haggle-free and given at cheap or concessional rates. RBI has also
encouraged the spread of these banks by undertaking the following:
 Allowing non-target group financing for RRBs
 Recapitalisation and restricting of RRBs
 Simplification of banking procedures as per Gupta committee
recommendations
 Special credit plans
 Kisan credit cards
 Deregulation of banking rates
 direct financing for SCBs
 Various relaxations in investment policies and non-fund business
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 Allowing direct access to refinance assistance at concessional rates for Overview of Rural
Banking
RRBs
These initiatives have promoted the banking culture by making formal credit
available to rural households. These facilities have helped to steer the agriculture
NOTES
dominated economy towards modernisation. The bank have to keep in mind
subtleties of the rural culture and understand that the rules of rural economy are
different from urban dynamics. However with increased mobility and connectivity
the urban and rural integration has increased and many factors which made the
urban landscape have come to mark rural settings as well. This has led to
diversification in activates and people have started to look at other factors of
employment too Agricultural activities have also been significantly commercialised
with increased role of cash crops. Thus, banks are getting a strong demand for
credit for both agricultural and non-agricultural uses. Bankers however, have to
pay attention to these little cultural cues and customer profits and accordingly
carry their services. The staff has to identify with rural customers who are not used
to banking procedures and need extra assistance at every step. This will help
customers to avail full benefit of banking without any hesitation.
The Pradhan Mantri Gram Sadak Yojana or PMGSY is a nationwide plan
in India to provide good all weather road connectivity to unconnected villages.
The centrally sponsored scheme was introduced in 2000 by then Prime Minister
of India Shri Atal Bihari Vajpayee. The Assam Tribune has reported that the scheme
has started to change the lifestyle of many villagers as it has resulted in new roads
and upgradation of certain inter-village routes in Manipur.
The objective of the Swarnjayanti Gram Swarozgar Yojana (SGSY) is to
bring the assisted poor families above the poverty line by ensuring appreciable
sustained level of income over a period of time. The objective is to be achieved by
inter alia organising the rural poor into Self Help Groups (SHGs) through the
process of social mobilization, their training and capacity building and provision of
income generating assets. The SHG approach helps the poor to build their self-
confidence through community action interactions in group meetings and collective
decision making enables term in identification and prioritization of their needs and
resources. This process ultimately lead to the strengthening and socio-economic
empowerment of the rural poor as well as improve their collective bargaining power.
The main purpose of Regional Rural Banks is to mobilise financial resources
from rural/semi-urban areas and grant loans and advances mostly to small and
marginal farmers, agricultural labourers and rural artisans. The area of operations
of RRBs is limited to the area as notified by Government of India covering one or
more districts in the state RRBs also perform a variety of different functions RRBs
perform various functions in following heads. Providing banking facilities to rural
and semi-urban areas. Carrying out government operations like disbursement of
wages MGNREGA workers, distribution of persons etc. Providing Para-Banking
facilities like locker facilities, debit and credit cards.
Self-Instructional
Material 5
Overview of Rural 1.2.1 Project Counselling
Banking
Project counselling includes preparation of project reports, deciding upon the
financing pattern, appraising the project relating to its technical, commercial and
NOTES financial viability. It includes filling up of application forms for obtaining funds
from financial institutions.
Project counselling may be rendered independently or may be, it relates to
project finance and broadly covers the study of the project and offering advisory
assistance on the project viability and procedural steps for its implementation,
proudly including following aspects: general review of the project idea/ project
profile, advice on procedural aspects of project implementation, review of technical
feasibility of the project on the basis of the report prepared by own experts or by
the outside consultants, selecting Technical Consultancy Organisation (TCO) for
preparing project reports and market survey, or review of the project reports or
market survey report prepared by the TCO preparing project report from financial
angle and advice and act on various procedural steps including obtaining
government, consent for implementation of projects. This assistance can include
obtaining of the following approvals licence/permission/grants etc. from the
government agencies viz letter of intent industrial license and DGTC registration
and government approval for foreign collaboration.
In addition, the facility provides guidance to Indian entrepreneurs for making
investment projects in India. Indian joint ventures overseas is also covered under
this activity.
Project counselling may also include identification of potential investments
avenues, precise capital structuring shaping the pattern of financing, arranging and
negotiating foreign collaborations, amalgamations, mergers and turnover financial
study of the project and preparation of viability reports to advice on the framework
of institutional guidelines and laws governing corporate finance, assistance in the
preparation of project profiles and feasibility studies based on preliminary project
ideas in order to indicate the potential. These reports would cover the technical,
financial and economic aspects of the project from the point of view of their
acceptance by the financial institutions and banks, advising and assisting clients in
preparing the applications for obtaining letters of intent industrial license and DGTD
registrations etc. seeking approvals from the government of India for foreign
technical and financial collaboration agreements, guidance on investment
opportunities for entrepreneurs coming to India.
Pre-investment studies are directed mainly for the prospective investor.
Some of the critical issues that a study of this genre deals will include in depth
investigation of environment and regulatory factors, location of raw material, supplies,
demand projections and financial requirements.
Such a study assess the financial and economic viability for a given project
and help the clients identify and shortlist those projects that are built upon his inherent
strength so as to accentuate corporate profitability and growth in long run.
Self-Instructional
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Project counselling as a facility to provide assistance to entrepreneurs though Overview of Rural
Banking
the services of merchant corporate banking will not only improve and shape the
support of project management, but will give a better skill set to entrepreneurs.
1.2.2 Loan Syndication NOTES
Loan syndication refers to the services rendered by the financial service expert or
firm in procurement of term loans and working capital facilities from financial
institutions banks and other financing and investment firms for its clients. The loan
syndication services are rendered by the merchant bankers, practising accounting
professionals financial and management consultants etc. The service is rendered
on fee base and generally as a percentage on the loan amount syndicated. These
services are rendered for both existing companies as well as new projects. This
will save the time of the management and the promoters in raising necessary finance
for the business. The expertise of the syndicators can be used for the advantage of
the concern for at a reasonable cost of raising finance. The major activities involved
in syndication of loans consists of the following:
 Preparation of project reports and other necessary information with the
help of his client
 Scouting for location or identification of source of finance
 Shortlisting the providers of funds and preliminary discussion with them
about the possibilities of finance and viability of the proposal
 Selection of financial institution for loan syndication
 Preparation and filing of loan applications with the finance firms which show
interest in financing
 Submission of all necessary information for appraisal of the proposal
 Obtain in principle letter sanctioning the loan.
 Getting the loan documentation completed between the lender and the
borrower and also help in creation of security for the loan.
 Compliance of terms and conditions for availment of loan
 Getting disbursement of loan to the client
 Ensure the clients in complying with the terms and conditions as per the loan
agreement entered.
The syndicator of loan will charge his client the fee for the services rendered.
Check Your Progress

1. What is the objective of the Swarnjayanti Gram Swarozgar Yojana?
2. What is loan syndication?
Self-Instructional
Material 7
Overview of Rural
Banking 1.3 MANAGEMENT OF PUBLIC ISSUES
Public issue of corporate securities as a source of financing projects has gained

NOTES tremendous popularity in the recent past. Due to the increased awareness on the
part of an average investor of the advantages of investing his funds in shares and
debentures, there is a rising trend in the issue activities of the capital market which
has reached a level beyond the expectation of Government and stock exchange
authorities. A choice of investment avenues is new being offered to the investors
giving rise to complexities in the manner of raising capital.
Public issue is essentially an exercise involving active participation of a number
of agencies. The situation, a couple of decades ago was that it was a sole effort on
the part of the company and its personnel. However, with the growth of the number
of public issues and the complexities in the efforts involved, today it has become
necessary to enlist the active participation and support of a number of agencies in
making any public issue a success. Following are the various agencies associated
with the public issue.
1. Managers to the Issue
The manager to the issue is actively associated and plans the timing of the issue,
strategies to be adopted by way of publicity and marketing of the issue etc. He
advises the company on the selection of the registrars to the issue, Underwriters
Brokers, Bankers to the issue, Advertising agents, printers etc. and also gives a
sense of direction to the entire issue. Besides, the other activities mainly performed
by them are drafting of prospectus, getting it vetted and approved from SEBI,
obtaining underwritings for the issue, assisting in selection of various agencies,
ensuring that one SEBI authorised agencies are involved with the public issue
work, preparing Budget of expenses, suggesting the appropriate timings for the
public issue assisting in marketing the public issue successfully etc.
There are a number of agencies specialising in the role of managers to the
issue. They include Merchant Banking Divisions of some of the all India Financial
Institutions Subsidiaries of commercial Bank’s Merchant Banking divisions, Private
sector, SEBI authorised merchant bankers are Traditional stock brokers who
have graduated into providing specialised merchant banking services.
2. Registrars to the Issue
The registrars to the issue, also known as issue house, are responsible normally
for receiving the share applications from various collection centres through controlling
branches of bankers to the issue, analysing them, recommending the basis of
allotment to the Regional Stock Exchange for its approval, arranging for despatch
of allotment letters and preparing the Register of Members etc.
Their job normally starts with sending instruction to all collecting branches,
the opening of subscription list, and continues till the share certificates are
Self-Instructional
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despatched and the Register of Members along with other related Registers/details Overview of Rural
Banking
are handed over to the company. Sometimes, the Registrars to the issue continue
their association with the company in the role of share Transfer Agents, even after
the issue is completed.
NOTES
Rules regulating the activities of the Registrars to the issue were notified by
the Central Government under the heading Securities and Exchanges Board of
India (Registrar to an Issue and Share Transfer Agents) Rules 1993.
3. Underwriters
The underwriters are the people who actually ensure that the company is able to
raise the capital issued by it for a commission charged by them. They make a
commitment to get the issue subscribed either by others or themselves usually the
underwriters can be divided into two categories, namely Financial Institutions and
Banks on the one hand and brokers underwriters and approved investment
companies on the other.
Keeping in view the huge devolvement on underwriters in some of the mega
issues, which could not be met by them and the lack of uniformity in the underwriting
agreement entered by the companies with the underwriters a model underwriting
agreement has been formulated by SEBI.
Bearing in mind the important role to be played by underwriters the SEBI
has notified Underwriters Rule 1993. According to which:
 Net worth norms have been prescribed for underwriters
 Members of OTCEI and NSE can etc. as underwriters
 Brokers-underwriters have to take approval for underwriting from their
respective Stock Exchanges.
4. Brokers to the Issue
These are the people who actually bring the prospective investors and the company
together. The success or failure of a public issue depends to a large extent on the
reaction of the brokers.
They are the members of recognised stock exchanges including OTCEI
and NSE with a view to provide better and professional services to investing
public and to promote development of capital on healthy lines, the Government
has since allowed multiple membership to members of stock exchanges and
accorded recognition to corporate entities and the financial institutions including
subsidiaries of the Banks. All the member of recognised Stock Exchanges including
OTCEI and NSE can work for the issue and the company has to pay brokerage
to them and statement to this effect can be given in prospectus. Only brokers
registered with SEBI can act for this purpose. SEBI has notified SEBI (Stock-
Brokers and Sub-Brokers) Rules 1992.
Self-Instructional
Material 9
Overview of Rural 5. Bankers to the Issue
Banking
The bankers to the issue are the commercial banks authorised by SEBI which will
receive the share application money along with the share application forms from
NOTES the prospective investors-depending upon the size of the issue the number of the
banks are designated as bankers to the issue. Different branches of these banks
are named at various locations where such application money is accepted. These
branches are called collecting branches. These collecting branches send application
forms and the money received by them to a Specified Branch where the details of
the applications are consolidated. Such specified branch of the Bankers to the
issue is called Controlling Branch. The controlling branch is usually selected in the
city where the Managers to the issue/Registrars to the issue/Registered office of
the company is situated. Public issue collection account is opened with the
Controlling Branch. The Company and Banker to the issue are required to enter
into a MOU (Memorandum of Understanding) SEBI has notified SEBI (Bankers
to an issue) Rules 1994 to regulate the work.
6. Publicity and Advertising Agents
Since public issue is an effort to motivate and persuade members of the public to
invest in the shares of the company, it is essential that the general public is made
aware of the company, it activities, its plans for future etc. It is of vital importance
that publicity as given before the public issue creating the right image about the
company to attract the prospective investors through the newspaper and TV
advertisements, Press releases, Press/Brokers conferences, leaflets and brochures,
hoardings and posters and even audio-visual shows are the usual media of publicity
used for public issue. There are some advertising agencies which specialise in
advertising and publicity campaigns for public issue. They are known as Financial
Advertising agencies. SEBI has laid down certain norms regarding issue
advertisement, minimum advertisement matter and print size which must be kept
in view.
7. Financial Institutions
Term lending institutions at the time of sanctioning underwriting support/term loans
to the company usually stipulate that the draft to the prospectus and also the
proposed programme for public issue is approved by them. Sometimes state
financial institutions also stipulate the same, therefore, it is advisable to check the
major loan covenants beforehand. The three principal All India Financial Institutions
are the IDBI, IFCI and ICICI. Even when all the three institutions jointly finance
a project under their participating finance scheme one of them is generally chosen
as the lead financial institution which acts on behalf of the other two hence, it is
generally adequate if the company obtains the necessary approval from the Regional
office of the lead institution only in some cases where other institutions like the
LIC, GIC, UTI etc. have also given financial assistance, it might be necessary to
seek separate approvals from them, if required. Generally, an advance copy of
Self-Instructional
10 Material
draft prospectus is sent to them with a request to forward their comments, if any, Overview of Rural
Banking
directly to the lead institution.
8. Other Agencies
The company also interacts with other agencies like auditors, legal advisers taxation NOTES
or technical experts whose names or statement are mentioned or quoted in the
prospectus.
9. Government/Statutory Agencies
Various statutory/government agencies that are connected with public issues are:
1. Securities and Exchange Board of India to whom the draft offer document/
prospectus made out in accordance with the SEBI guidelines for disclosure
and investor protection should be submitted for vetting.
2. Registrar of Companies of the State where the registered office of the
company is situated with whom the prospectus has to be fled for registration
before the public issue.
3. Reserve Bank of India from whom necessary permission has to be obtained
from non-resident investment, if any, in the company
4. The stock exchanges where the company share/debentures are to be listed
5. The Central Secretariat for Industrial Approvals, Foreign Investment
Promotion Board for approval, if any required.
6. Pollution control authorities and other local authorities from when the
clearance may have to be obtained and such clearance should be referred
to in the prospectus
7. Various other Government/Semi-Government agencies such as State
Electricity Boards Bankers to the company as their consent and Account
position in to be ascertained State Government for change of land, use
subsidiary availability or for any other backward area and tax benefits
availability etc.
Underwriting
The underwriters are the people who actually ensure that the company is able to
raise the capital issued by it for a commission charged by them. They make a
commitment to get the issue subscribed either by others or themselves. Usually,
underwriters can be divided into two categories, namely, Financial Institutions and
Banks, on the one hand, and broker underwriters and approved investment
companies on the other. As per SEBI guidelines, the lead managers have to
compulsory underwrite a minimum percentage of the issue. However, as per existing
SEBI guidelines, it is not mandatory to underwrite the issue company may or may
not get the issue underwritten.
 Mutual Funds have been allowed to underwrite the issue.
Self-Instructional
Material 11
Overview of Rural  All underwriters have to be SEBI authorised.
Banking
 SEBI has framed rules in this regards.
The major players in the underwriting business are:
NOTES (a) Lead Managers, Co-Managers, Advisors etc. related with the issue
(b) Banks
(c) Central and state Financial Institution
(d) SEBI authorised merchant Bankers
(e) Brokers of the recognised Stock Exchange
(f) Any other agency registered with SEBI
Under the relevant rules for the purpose while doing the underwriting the
agencies concerned cannot exceed their exposure more than the limits specified in
this regard. Therefore, certificate is taken in this regard from each underwriter.
Based on which lead manager and company generally gives a statement in the
prospectus that the sources of the underwriters are sufficient to meet their
obligations.
The brokers of the recognised stock exchange have to obtain specific
permission from their respective stock exchanges to underwrite the issue, which
must be ensured by the company and the names of only those brokers should be
included. Who have obtained such permission names of the brokers should be
mentioned under their respective stock exchange centres. The maximum
underwriting commission payable is 2.5% in case of equity shares.
However, the company may negotiate for less underwriting commission.
No underwriting commission is payable on promoters quota or preferential
allotment for employees/directors etc.
The managers to the issue will then write to the brokers along with a copy
of draft prospectus/project profile and obtain draft letter of underwriting from
then stating the amount of underwriting. SEBI while making out the rules/ regulations
for underwriters has suggested a model underwriting agreement. The company is
at option to underwrite that portion of issue which has been kept reserved for
preferential allotment for various categories, however, it is a general practice to
get this portion underwritten on contingent basis. No commission is allowed to be
paid on this portion. However, the commission can be paid on portion left
unsubscribed and merged with the public issue. The underwriting agreements are
addressed to the company and the company has to accept the same and send the
confirmation of the amount accepted to the respective underwrites. The company
is also required to obtain a consent from the underwriters pursuant to the provisions
of section 60 of the Act. The stockbrokers who are interested to underwrite the
public issue should also be requested to send a copy of the permission of their
respective stock exchanges to act as underwriter for the amount agreed by them
as well as official brokers to the issue. This has now been the practice to safeguard
Self-Instructional against the blacklisted or defaulter stock brokers.
12 Material
Bankers to the Issue Overview of Rural
Banking
As discussed, the bankers to the issue play an important role in public issues. They
receive applications with cheques/drafts/cash from the investors and acknowledge
receipt thereof by stamping and returning the acknowledgement slips attached at NOTES
the bottom of the application form. Depending upon the size of the issue at least 3
to 4 banks are designated as bankers to the issue. The branches of the bankers to
the issue which are directly accountable to the company are called controlling
branches and the branches which are under the direction of the controlling branches
are known as collecting branches.
Functions of Collecting Branches
The functions of the controlling branches and collecting branches of the bankers to
the issue are as follows:
 To receive instructions from the controlling branches for collection of
application forms from the investors, informing them of the daily collection
figures till the subscription list is closed, to receive information as to opening
and closure of subscription list to transfer funds realised to controlling branch
and forward the applications realised after tabulating them in the listing pad
or along with computer control sheet.
 To receive stationery (application forms, prospectus, brochures bank
schedules, posters, banners from the company).
 To affix rubber stamp of the branch under underwriting/broker column in
the application.
 To acknowledge receipt of the application with proceeds by stamping and
returning the acknowledgement slips attached at the bottom of the application
form.
 To send for immediate clearing cheques/demand drafts received from the
investors and to forward applications for which moneys realised to the
controlling branches for further processing by the company.
 To send the applications back to the investors by registered post where
cheques/drafts are returned dishonoured.
 To remit periodically the proceeds realised to the controlling branch.
 To issue certificate to the effect that no applications received by them have
been realised and remitted to the controlling branches to enable the registrar
to the issue for reconciling the applications collected and amount realised
branch-wise.
Functions of Controlling Branches
 To issue consent letters to the company for acting as bankers to the issue.
 To attend meetings convened by the company for finalising list of collecting
branches and for finalising the instruction manual. Self-Instructional
Material 13
Overview of Rural  To open separate bank account of the company to credit the proceeds
Banking
realised from the investors against applications.
 To forward the instruction manual prepared by the company to all collecting
branches with their instructions.
NOTES
 To inform all collecting branches as to opening and closure of subscription
list including extension if any of date of closure of the subscription list.
 To prepare a summary of daily collections made by them as also of their
collecting branches and forward the summary to the company/registrar to
the issue till the subscription list is closed.
 To hold in trust application money realised by them and collecting branches
till the allotment of securities.
 To liaison with the registrar to the issue for communicating all particulars as
would be required by them for processing the applications forms.
 To issue provisional final certificate indicating therein the total number of
applications collected by them and their collecting branches and amount
collected branch wise to reconcile the same by the registrar to the issue
with their records and to furnish the same to the stock exchanges at the time
of seeking their approval for allotment of securities.
Merchant Banking
A merchant bank is a bank whose function is provision of long term equity and
loan finance for industrial and other companies’ particularly new securities.
Merchant banker acts as a financial intermediary in providing long term finance to
the corporate. The merchant banks are called as investment banks in the US. The
activities performed by merchant bankers include the following:
1. Management of issue of corporate securities of existing companies as newly
floated companies
2. Offering financial expertise in mergers takeover, capital reorganisation to
corporate sectors
3. Management of investment trusts
4. Handling insurance business
5. Loan syndication and corporate advisory services
6. Portfolio management
7. Custodial and Depository Services
8. Broking of corporate securities
9. Attraction of foreign investment
10. Liquidity management
11. Underwriting of securities
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14 Material
12. Bill discounting Overview of Rural
Banking
13. Lease Financial
14. Arrangement of venture capital
15. Acting as trustees for debentures NOTES
16. Mobilisation of public deposits and managing fixed deposits etc.
The scope of merchant banking activities has been expanding in India over
the years. The recent changes in the Indian economy and financial markets has
given further impetus to the faster development of merchant banking. Merchant
banker benefit corporate clients in a number of way. They help in releasing valuable
management time by looking into the legal and procedural complications involved
in the securities issues and raising of loans. They also provide professionally
competent advice to corporate clients. Merchant bankers also help in cultivating
investment attitude and climate as well as financial innovativeness in the individual
investors as well as corporate clients merchant bankers deal with individual and
corporate clients. They require a high degree of integrity, transparency and
accountability in their dealings with clients. Therefore, there is a need for the prudent
regulation of the merchant banking activity. SEBI has been entrusted with the task
of regulating the merchant banking it. It has provided for a code of conduct, specified
obligations and responsibilities and is empowered to inspect the operation of
merchant bankers.
Check Your Progress

3. What is the role of the registrars to the issue?
4. Who are underwriters?
1.4 ANSWERS TO CHECK YOUR PROGRESS

QUESTIONS
1. The objective of the Swarnjayanti Gram Swarozgar Yojana (SGSY) is to

bring the assisted poor families above the poverty line by ensuring appreciable
sustained level of income over a period of time.
2. Loan syndication refers to the services rendered by the financial service
expert or firm in procurement of term loans and working capital facilities
from financial institutions banks and other financing and investment firms for
its clients.
3. The registrars to the issue, also known as issue house, are responsible
normally for receiving the share applications from various collection centres
through controlling branches of bankers to the issue, analysing them,
recommending the basis of allotment to the Regional Stock Exchange for its
Self-Instructional
Material 15
Overview of Rural approval, arranging for despatch of allotment letters and preparing the
Banking
Register of Members etc.
4. The underwriters are the people who actually ensure that the company is
able to raise the capital issued by it for a commission charged by them.
NOTES
They make a commitment to get the issue subscribed either by others or
themselves.
1.5 SUMMARY
 Rural banking is banking that is done in an area that is not close to towns or
cities, making it difficult for those who need to conduct banking business.
 Rural banking is a common practice in places where banking institutions
are few and far between and people who need to carry out banking
transactions may have difficulty finding a way to do so.
 The Regional Rural Banks were established on 2nd October 1975. The
main objectives of these banks are to provide credit and other facilities
particularly to small and marginal farmers and small entrepreneurs so as to
develop agriculture trade, commerce industry and other productive activities
in rural areas.
 Regional Rural Bank grant loans and advances to small farmers and
agricultural labourers so that they can start their own farming activities
including purchase of land, seeds and manure.
 A rural bank focuses on providing savings and credit services to people
who live in rural areas.
 Project counselling includes preparation of project reports, deciding upon
the financing pattern, appraising the project relating to its technical,
commercial and financial viability.
 Loan syndication refers to the services rendered by the financial service
expert or firm in procurement of term loans and working capital facilities
from financial institutions banks and other financing and investment firms for
its clients.
 The service is rendered on fee base and generally as a percentage on the
loan amount syndicated. These services are rendered for both existing
companies as well as new projects.
 Public issue of corporate securities as source of financing projects has gained
tremendous popularity in the recent past.
 Due to the increased awareness on the part of an average investor of the
advantages of investing his funds in shares and debentures, there is a rising
trend in the issue activities of the capital market which has reached a level
beyond the expectation of Government and stock exchange authorities.
Self-Instructional
16 Material
 The manager to the issue is actively associated and plans the timing of the Overview of Rural
Banking
issue, strategies to be adopted by way of publicity and marketing of the
issue etc. He advises the company on the selection of the registrars to the
issue, Underwriters Brokers, Bankers to the issue, Advertising agents,
printers etc. and also gives a sense of direction to the entire issue. NOTES
 The underwriters are the people who actually ensure that the company is
able to raise the capital issued by it for a commission charged by them.
 The bankers to the issue are the commercial banks authorised by SEBI
which will receive the share application money along with the share
application forms from the prospective investors-depending upon the size
of the issue the number of the banks are designated as bankers to the issue
 A merchant bank is a bank whose function is provision of long term equity
and loan finance for industrial and other companies’ particularly new
securities.
1.6 KEY WORDS
 Underwriting: It is the process through which an individual or institution

takes on financial risk for a fee.
 Debentures: They are medium- to long-term debt instruments used by
large companies to borrow money, at a fixed rate of interest.
 Brokers: It refers to persons who buy and sells goods or assets for others.
 Financial Institutions: They are corporations that provide services as
intermediaries of financial markets.
1.7 SELF ASSESSMENT QUESTIONS AND

EXERCISES
Short Answer Questions

1. Why were regional rural banks established in India?
2. What is project counselling?
3. List the activities involved in the syndication of loans.
4. Who are the brokers to the issue?
Long Answer Questions
1. Discuss the functions of Regional Rural Bank
2. Examine the activities of the rural banks.
3. Explain the functions of controlling and collecting branches.
Self-Instructional
Material 17
Overview of Rural 4. Discuss underwriting. Who are the major players in the underwriting
Banking
business?
NOTES
1.8 FURTHER READINGS
Ram Jitendra. 2015. Regional Rural Banks of India: Evolution, Performance

and Management. Gurgaon: Partridge Publishing.
Acharya S.C. and A. K. Mohanty. Operational Analysis of Regional Rural
Banks. New Delhi: Gyan Publishing House
Agrawal Meenu. 2009. Regional Rural Banks (RRBs) in India. New Delhi: New
Century Publications.
Ahmad Rais and Mahmudur Rahman. 1998. Rural Banking and Economic
Development. New Delhi: Mittal Publications.
Reddy, Ranga. 2004. Rural Banking and Overdues Management. New Delhi:
Mittal Publications.
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18 Material
Growth of Rural
UNIT 2 GROWTH OF RURAL Banking in India
BANKING IN INDIA
NOTES
Structure
2.0 Introduction
2.1 Objectives
2.2 Meaning, Importance and Implication
2.3 Need for Control: Types, Scope and Control Features
2.3.1 Role of SEBI (Securities and Exchange Board of India) in Regulating
Rural Banking Industry
2.5 Summary
2.6 Key Words
2.0 INTRODUCTION
In the previous unit, you were introduced to basic concepts of rural banking. In
this unit, the discussion will turn towards the growth of rural banking in India. As
you learnt, regional rural banks were established in India in 1975. Since then,
regional banks have been set up at 21,398 locations throughout the country. This
unit will discuss the role of SEBI in regulating rural banks, the need and types of
control of rural banks as well as the role of the NSE and OTCEI.
2.1 OBJECTIVES

 Discuss the role of the SEBI in regulating rural banking
 Explain the role of the NSE and OTCEI
 Describe the meaning and importance of rural banking
2.2 MEANING, IMPORTANCE AND IMPLICATION
Rural development has to play a vital role in the overall socio-economic

development of a country like India, where the majority of the population lives in
rural areas. The rural sector affects directly or indirectly almost all the economic
activities in the country and provides employment to the maximum number of
Self-Instructional
Material 19
Growth of Rural people. A large part of the revenue of the government is also generated from rural
Banking in India
regions. The necessity of rural finance arose because moneylenders, landlords
and traders etc. exploited farmers and small entrepreneurs by charging exorbitant
rate of interest and forced farmer to sell their products at a low price to them.
NOTES Rural people also face the risk of unpredictable production of crop due to high
dependency on monsoon. They also suffer from lack of seeds, fertilisers, water
supply and other facilities which lead to rural indebtedness.
In India, more than 70 per cent of the population live in rural areas. Obviously,
in any development planning, rural development has to get a priority. Finance
being the most important part of any development process, providing banking
facilities drew the attention of the policy makers since independence. Cooperative
banking structure made its appearance long before that in the British era in 1904
and the Reserve Bank in 1935. But the real effort in rural banking started in the
1950s with the All India Rural Credit Survey 1954. Subsequently the All India
Rural Credit Review in 1969 introduced social banking for commercial banks,
followed by bank nationalisation.
Role of Regional Rural Banking for Rural Development
Regional Rural Banks were established with the following responsibilities in mind:
1. Taking the banking services to the doorstep of rural masses, particularly in
hitherto unbanked rural areas.
2. Identifying financial need especially in rural areas.
3. Making available institutional credit to the weaker sections of the society
who had by far little or no access to cheaper loans and had been depending
on private money lenders.
4. To enhance banking and financing facilities in backward or unbanked areas.
5. Mobilise rural savings and channelize them for supporting productive
activities in rural areas.
6. To provide finance to the weaker sections of society like small farmers,
rural artisans, small producer, rural labourers etc.
7. To create a supplementary channel for the flow of the central money market
to the rural areas through references.
8. To provide finance to cooperative societies, primary credit societies,
agricultural marketing societies.
9. Generating employment opportunities in rural areas and bringing down the
cost of providing credit to rural areas.
10. Enhance and improve banking facilities to semi-urban, rural and other
untapped market
With these objectives in mind, knowledge of the local language by staff is an
important qualification.
Self-Instructional
20 Material
Every Regional Rural Bank is authorized to transact the business of banking Growth of Rural
Banking in India
as defined in the Banking Regulation Act and may also engage in other business
specified in Section 6(1) of the said Act. In particular, a RRB is required to
undertake the business of:
NOTES
1. Granting loans and advances to small and marginal farmers and
agricultural labourers whether individually or in groups and to cooperative
societies including agricultural marketing societies, agricultural processing
societies, cooperative farming societies, primary agricultural credit
societies, or farmers services societies, primary agricultural purposes,
or agricultural operatives or other related purposes and
2. Granting loans and advances to artisans, small entrepreneurs and persons
of small means engaged in trade commerce industry or other productive
activities, within its area of operation.
The Reserve Bank of India has brought RRBs under the ambit of priority
sector lending on par with the commercial banks. They have to ensure that forty
per cent of their advances are accounted for the priority section. Within the 40%
priority to get 25% should go to weaker section or 10% of their total advances to
go to weaker section.
Regional Rural Banks in India
The State Bank of India is one of the major commercial banks having regional
rural banks. These are 30 Regional Rural Banks in India, under the State Bank of
India and it is spread across 13 states in India. The number of branches of SBI
Regional Rural Banks is more than 2000. Several other banks, apart from the
State Bank of India, also function as the promoter of rural development in India.
The other Regional Rural Bank in India are:
Haryana State Cooperative Apex Bank Limited: The main purpose of
the Haryana State Cooperative Apex Bank Limited is to financially assist the artisans
in the rural areas, farmers and agrarian unskilled labour, and the small rural
entrepreneurs of Haryana. Haryana State Cooperative Apex Bank Limited also
referred as the HARCO BANK, is one of the apex organisations in the state of
Haryana. The HARCO BANK holds a special economic position in the state of
Haryana. The Haryana State Cooperative Apex Bank Limited offers several types
of financial assistance to the individuals. The financial aids include credit for the
promotion of agriculture, non-agrarian credit and bank deposit facilities. The
HARCO BANK have been functioning as an investor for many decades.
National Bank for Agriculture and Rural Development (NABARD)
is an apex development bank in India having headquarters based in Mumbai
(Maharashtra) and other branches are all over the country. The committee to
Review Arrangements for Institutional Credit for Agriculture and Rural Development
(CRAFICARD), set up the Reserve Bank of India (RBI) under the chairmanship
of Shri B Sivaraman conceived and recommended the establishment of the National
Self-Instructional
Material 21
Growth of Rural Bank for Agriculture and rural Development (NABARD). It was established on
Banking in India
12 July, 1982 by a special act of the parliament and its main focus was to uplift
rural India by increasing the credit flow for elevation of agriculture and rural non-
farm sector and completed its 25 years in 12 July, 2007. It has been accredited
NOTES with matter concerning policy, planning and operations in the field of credit for
agriculture and other economic activities in rural areas in India. RBI sold its stake
in NABARD to the Government of India, which now holds 99% stake. NABARD
is active in developing financial inclusion policy and is a member of the Alliance for
Financial Inclusion.
The main purpose of the National Bank for Agriculture and Rural
Development is to provide credit for the development and publicity of small scale
industries, handicrafts, rural crafts, village industries, cottage industries, agriculture
etc. The NABARD also supports all other related economic operations in the
rural economic operations in the rural sector promotion of sustainable growth in
the rural sector. The NABARD also plays the role of a contributor to the rural
development by the means of promoting institutional development, facilitating
reference to loan providers in the rural sector inspection, monitoring and evaluation
of client financial corporations. National Bank for Agriculture and Rural
Development (NABARD) was established as the premiere rural development
bank.
Sindhanaur Urban Souharda Cooperative Bank: The main purpose of
the Sindhanaur Urban Souharda Cooperative Bank is to provide financial support
to the rural sector. The Sindhanaur Urban Souharda Cooperative Bank is more
commonly known as the SUCO Bank.
United Bank of India: The role played by United Bank of India (UBI) as
one of the regional rural banks is phenomenal. The UBI has propagated the network
of branches in order to actively take part in the rural improvement and development.
Syndicate Bank: The Syndicate Bank has it grassroots in the rural sector.
The development of the Syndicate Bank was in accordance to the development
of the banking sector in India and the Syndicate Bank has performed actively in
the development of the small sector in India. The Regional Rural Banks in India
has actively contributed to the growth of the rural sector. The growth of the rural
industries in India and the development of the rural business and economy have
been dependent largely on the investment and financial aids provided by the Regional
Rural Banks in India.
Regional Rural Banks in Tamil Nadu: Indian Bank has sponsored two
Regional Rural Banks (RRBs) viz Saptagiri Grameen Bank and Pallavan Grama
Bank.
Pallavan Grama Bank with its Headquarters at Salem is operating in 14
districts of Tamil Nadu viz Salem, Namakkal, Krishnagiri, Dharmapuri, Villupuram,
Cuddalore, Coimbatore, Karur, Erode, Nilgiris, Vellore, Tiruvannamalai,
Self-Instructional
22 Material
Kancheepuram and Tiruvallur. The third RRB sponsored by Indian Bank is Puduvai Growth of Rural
Banking in India
Bharathiar Grama Bank at Union Territory of Puducherry with its headquarters at
Puducherry.
Commercial Banks face high transaction cost in their rural branches. The
NOTES
problematic issues in rural banking of commercial banks are lack of infrastructure,
reluctance of staff to serve in remote rural areas, large number of accounts dealing
in small amounts, difficulty in getting financial information on rural borrowers leading
to some amount of uncertainty in the minds of the bankers and lack of security for
carrying cash in remote areas by mobile banking. Considerable amount of paper
work requirement of multiple visits to the banks are other existing problems. As a
result, farmers incur considerable transaction costs in obtaining bank loans. This
state of affairs appears to be partly because of lack of effective enforcement of
directives to the scheduled commercial banks and RRBs in simplifying procedures.
In the context where banks are expected to play the role of providing credit
counselling to the farming community, simplifying procedures and transparency in
providing credit need special attention.
The problem areas observed by some studies are listed briefly below:
1. In spite of vast expansion of rural credit by banks, non-institutional credit
still continues in the rural areas.
2. The credit deposit rate shows that despite the intermediation of banks,
the ratio continues to be low in the rural area.
3. The all in costs of credit from banks, after factoring in timelines transaction
costs and access appear high for agriculture relative to private corporate
sector even after accounting for the risks as reflected by the level of
actual non-performing assets.
4. The performance of some of the public sector banks in rural and
agricultural lending is also inadequate, but that of most of the private and
foreign banks is even lower, despite considerable expansion of the scope
of priority sector lending.
5. Credit system in rural areas finds it difficult to cope with the rising demands
of commercialized agriculture and in any case, there are few credible
risk mitigation measures for the borrowers resulting in greater distress
to the farmers in areas with significant presence of commercial crops.
6. Although there has been notable progress in micro finance, it is mostly
confined to the states with fairly well-developed banking system. Further,
the cost of credit at around 20 to 30% also appears high.
7. The cooperative credit system is, in most parts, dormant and it is
commented that the three-tier structure helps finance the bureaucracy
rather than benefiting the farmers. Similarly, in many parts of the country,
RRBs are less active though in some others they are expanding.
Self-Instructional
Material 23
Growth of Rural 8. Although there has been significant growth in rural credit in the recent
Banking in India
years, its medium-term sustainability is contingent upon growth in
agriculture and improvements in the institutional settings.
The banks need to encourage agriculture by providing larger amount of
NOTES
term loans. Generally, the non-agricultural sector indirectly helps the rural economy
in many ways keeping in view, the RRBs may enhance the percentage of loan to
this sector. This finding may be of considerable use to rural banking institutions
and policy makers in developing and shaping the appropriate credit structure as
RRBs are integral part of the rural credit structure in India.
The importance of rural banking in the economic development of a country
cannot be over looked. As Gandhi Ji said, “Real India lies in villages” and the
village economy is the backbone of Indian economy. Without the development of
economic planning cannot be achieved. Hence, banks and other financial institutions
are considered to be a vital for the development of the rural economy in India. The
main goal of establishing Regional Rural Banks in India is to provide credit to the
rural people who are not economically strong enough, especially the small and
marginal farmers, artisans, agricultural labourers and even small entrepreneurs.
2.3 NEED FOR CONTROL: TYPES, SCOPE AND

CONTROL FEATURES
Control is the fundamental management function. It signifies the measurement and

correction of the performance of subordinates in order to make sure that enterprise
objectives and the plans devised to attain them are accomplished. Control consists
in verifying whether everything occurs in conformity with the plan adopted, the
instructions issued and principles established. It has for object to point out
weaknesses and errors in order to rectify them and prevent recurrence. Control
means to see that everything is done in accordance with the rules laid down and
the instructions given control ensures work accomplishment according to plans.
The basis for control action is information. Information shows that a deviation
has occurred and a complete analysis of the information is required to remedy the
situation. If all these details are not available control will be meaningless and self-
defeating. Control action can be taken only on the basis of reports and information,
generally called as feedback. Feedback enables a manager to determine how far
operations have gone in complying with plans and if there is any need for any
corrective action.
Effective control calls for personal observation on the part of managers.
Tools like budgets, charts, diagrams, statistical data reports and other devices of
control and the newer and more sophisticated control machineries help visualize
the nature of accomplishment. But the problem of control is still one of the measuring
activities of human beings which necessitates personal attention.
Self-Instructional
24 Material
Traditional control devices are called traditional because they have been Growth of Rural
Banking in India
used over the years as control techniques. The main traditional control devices are
budgetary control, standard costing, financial ratio-analysis, internal audit etc.
Non-traditional devices are of relatively recent origin and have brought
NOTES
management control into sharper focus to improve quality control. Some of the
non-traditional control devices are performance budgeting, zero base budgeting
programme planning and budgetary system, responsibility accounting. Critical Path
Method (CPM) Programme Evaluation and Review Technique (PERT) selective
quality centre etc.
Traditional devices focus on non-scientific methods, whereas non-traditional
devices are based on scientific methods and are more accurate.
A good control system fulfils the specific requirements of an enterprise. For
instance, if a deviation is feared at a certain point and an organisation feels that it
would need one week’s notice to put the action plan back on rails, then the control
system must provide for that one week’s notice. If it does not incorporate that one
week’s notice in its set up, then it is not suitable for that particular organisation.
Managers are all individuals. They differ from one another, only as a group.
They may differ greatly from another similar group in another organisation. A good
control system should meet the personal requirements of these managers. Modern
control system focus on workers rather than work or job. Control is good and
effective only when people who handle material resources for results are involved.
Where some corrective action is to be taken persons accountable for results are
to be found to take remedial action. When an organisation shows enough interest
in people, this kind of control through people yields better result.
Control is exercised through managers and as such they should reflect the
organisation pattern. Each managerial position should be provided with adequate
authority to exercise self-control and take corrective action.
Many a time in the name of modernity highly sophisticated control techniques
are recommended for an organisation, without keeping in view organisation size,
capacity and capability of managers to implement such a control programme
obviously such a programme is only not good but is also likely to fail. Really good
control involves tailoring control devices to suit the industrial plan, the organisation
the specific needs of the enterprise and to personal requirements of the manager.
2.3.1 Role of SEBI (Securities and Exchange Board of India) in
Regulating Rural Banking Industry
With a view to develop an effective and efficient monitoring and control system for
Indian capital markets, the Government of India has passed the Securities and
Exchange Board of India Act 1992. Under the provisions of the said Act, a Board
was established in the name Securities and Exchange Board of India (SEBI).
SEBI is a body having perpetual succession and a common seal. It has the
power to acquire, hold and dispose of movable and immovable property. It has
Self-Instructional
Material 25
Growth of Rural the power to enter into contracts. It can sue and be sued in its name. The head
Banking in India
office of SEBI is at Mumbai with power to establish offices at other places in
India. SEBI shall consist of members appointed by the Central Government. The
general superintendence direction and management of the affairs of SEBI Vest in
NOTES Board of Members.
The SEBI and Government of India issued various rules, regulations and
guidelines covering different aspects of operations and working of Indian Capital
markets. Different Stock exchanges too have introduced improved methods and
new operations. New rules, laws and byelaws have also been added by the stock
exchanges authorities for effective control of the working of members of stock
exchanges.
Powers of SEBI
SEBI has been obligated to protect the interests of the investors in securities and
to promote, develop and regulate the securities market by such measures as it
thinks fit. SEBI has been empowered in:
 Regulating the business in stock exchanges and any other securities market.
 Registering and regulating the working of stock brokers, sub brokers, share
transfer agents, bankers to as issue trustees of trust deeds, registrars to an
issue, merchant bankers, underwriters, portfolio managers, investment
advisers and such other intermediary who may be associated with securities
markets in any manner.
 Registering and regulating the working of the depositories participants,
custodians of securities, foreign institutional investors, credit rating agencies
and such other intermediaries as SEBI may, by notification, specify in this
behalf.
 Registering and regulating the working of venture capital funds and collective
investment schemes including mutual funds
 Promoting and regulating self-regulatory organisation.
 Prohibiting fraudulent and unfair trade practices relating to securities markets.
 Promoting investors education and training of intermediaries of securities
markets.
 Prohibiting insider trading in securities.
 Regulating substantial acquisition of shares and takeover of companies.
 Calling for information from undertaking inspection, conducting inquiries
and audits of the stock exchanges, mutual funds and other persons associated
with the securities market and intermediaries and self-regulatory organisations
in the securities market.
 Performing such functions and exercising such powers under the Securities
Contracts (Regulation) Act 1956 as may be delegated to it by the Central
Self-Instructional Government.
26 Material
 Laying fees or other charges for carrying out the purpose of this section. Growth of Rural
Banking in India
 Conducting research for the above purposes.
 Calling from or furnishing to any such agencies as may be specified by
SEBI such information as may be considered necessary by it for the efficient NOTES
discharge of its functions.
 Performing such other functions as may be preserved.
For discharging these functions SEBI has been vested with powers of a civil
court under the code of Civil Procedure 1908 while trying a suit in respect of the
following matters:
a) The discovery and production of stocks of account and other
documents, at such place and such time as may be specified by SEBI.
b) Summoning and enforcing the attendance of persons and examining
them on oath and
c) Inspection of any books, registers and other documents of any person
referred to in Section 12.
The National Stock Exchange of India Limited was promoted by IDBI, ICICI,
IFCI, GIC, LIC, State Bank of India, SBI Capital Markets Limited, SHCIL and
ILOFS as a Joint Stock Company under the Companies Act, 1956 on November
27, 1992. The Government of India granted recognition with effect from April 26,
1993 initially for a period of five years. The Government of India appointed IDBI
as a lead promoter. To form the infrastructure of NSE, IDBI had appointed a
Hong Kong Bound consulting firm M/s International Securities Consulting Limited
for helping in setting of the NSE. The main objective of NSE is to ensure
comprehensive nationwide securities trading facilities to investors through automated
screen based trading and automatic post trade clearing and settlement facilities.
The NSE encourages corporate trading members with dealer networks,
computerised trading and short settlement cycles. It proposes to have two segments,
one dealing with wholesale debt instruments and other dealing with dealer networks,
computerised trading and short settlement cycles. It proposes to have two segments,
one dealing with wholesale debt instruments and other dealing with capital market
instruments. The Electronic Clearing and Depository System (ECDS) proposed
to be set up by the stock Holding Corporation of India Limited (SHCIL) would
provide the requisite clearing and settlement systems.
Features
The recommendations of the High Power Committee setting up of the National
Stock Exchange, a Model Exchange at New Mumbai to act as a National Stock
Exchange (NSE) would provide access to investors from all across the country on
an equal footings, and work as integral component of the National Stock Market
System.
Self-Instructional
Material 27
Growth of Rural The NSE has the following features:
Banking in India
 NSE is promoted by Financial Institutions, Mutual Funds, and financed on
a self-sustaining basis through levy of membership fees. The capital outlay
of 30 crores of rupees could be financed by admitting 1000 members with
NOTES
an entry fee of 10 lakhs each. Fees for corporate and institutional members
could be pegged at a higher level of 25 lakhs.
 NSE is a company incorporated under the Companies Act of 1956. It is
constituted by the Board of Directors (Board) and managed by it. 50 per
cent of the Managing Board of the Exchange should comprise of
professionals who are not members. These professionals must be from a
cross section of finance and industry and must actively contribute to ensuring
that the stock exchange functions in a balanced and fair manner.
 It is trading on medium sized securities of equity shares and debt instruments.
 NSE receives full support from the National Clearing and Settlement
divisions. SHCIL and the Securities Facilities Support Corporation. It is
using modern computer technology for the clearance and settlement
procedures.
Better Transparency System for the Securities
NSE provides nationwide computerised debt and stock trading facility to investors.
NSE will operate in two segments i.e. the debt market and the capital market in
the debt segment, there would be transactions in securities such as Government
Securities, Treasury Bills, PSU bonds, Units of the UTI-64 Scheme of UTI,
Commercial Papers (CP) and certificates of Deposits (CD). The capital market
segment will cover trading in equities convertible/non-convertible debenture and
hybrids; the existing permissible Repo-transactions Treasury Bills can now be
routed through the NSE. This move is expected to provide a boost to trading in
the secondary market for debt instruments.
National Stock Exchange is a fully automated exchange both in terms of trading
in securities and settlement of transactions. NSE is different from other stock
exchanges on the point that brokers registered in other stock exchanges are also the
shareholders and therefore have a say in the management of such stock exchanges
whereas with respect to NSE, financial institutions lead by IDBI would be the
shareholders and would be allowed to trade on it just as brokers. Whole functioning
as a model this stock exchange provide access to investors across the country.
Brokers registered with any stock exchange in India are allowed to trade on NSE.
NSE provides nationwide stock trading facilities and equal access to investors
from all over the country through a network of trading members all over the country
without any trading floor. Each trading member can have a computer at his office
anywhere in India which will be connected to the central computer at the exchange
by a telecommunication link. Through this link the trading members enter their
order for sale or purchases of soups in computer which is stacked in its memory.
Self-Instructional
28 Material
The moment some other person enters his corresponding order for purchase or Growth of Rural
Banking in India
sale the deal is struck whole entering the order the member can enter various
conditions or options subject to which he wishes to strike the deal. All the end of
the day the computer will generate a list of transactions carried out by a member
through the computer network. For striking the deal the trading member may NOTES
specify limit on the price or the time period for which the order is valid.
The automatic trading and marketing system of NSE is very efficient and
transparent as it assures the members the best price and the securities can be
traded at the same price from anywhere in the country. Thus NSE provide good
trading and investment opportunities increase the volume of trade and improve
liquidity considerably.
Further, in order to expedite the settlement process so that the money/
securities are recovered on settlement day, a depository has been set up. As and
when securities are sold and delivery made to the clearing system, they are
transferred to a depository. Each trading member has a passbook account in the
depository wherein securities deposited by the trading member are recorded. Every
client of the trading member has a sub-account where records of shareholding
client will be maintained. As and when delivery is made or received by each trading
member, the passbook of the trading member and the client shall be updated by
electronic book entry transfer the investor in whose account the securities are hold
will be the beneficial owner of the securities and while the securities are kept with
the depository. These remains absolute safety of securities against loss by theft
and good delivery assured as there are no problems of unmatched signatures.
Physical with drawl of securities from the depository are allowed for investors
who wish to take physical possession of securities for whatever reason.
The NSE is different from the existing stock exchanges except OTCEI in
the following aspects- dealing in the scripts will be on a screen base instead of the
outcry system prevalent on other stock exchanges. Any broker registered with
any stock exchange in the country will be allowed to trade on NSE. The electronic
exchange works on international lines and prove a boon for investors. Presently,
brokers registered with other exchanges are also their shareholders, but in case of
NSE, financial institutions would be the shareholders and brokers are allowed to
trade on it just as brokers. In other words, NSE is operated by non-members and
without being influenced by the brokers.
The OTC Exchange of India (OTCEI) has been set up to provide a cost effective
and convenient platform for raising finance from the capital market. OTCEI was
promoted by a consortium of financial institutions and it started its operations in
1992. It is a ringless electronic nationwide stock exchange committed to providing
entrepreneurs with a smooth economical vehicle for going public, and investors
with a fair stable and efficient market. Thus the OTCEI brings investors and
promoters closer together.
Self-Instructional
Material 29
Growth of Rural In OTCEI there are two Product Segments– Listed Segment Comprises of
Banking in India
Securities which are listed on OTCEI and Permitted Segment Comprises of
Securities which are listed on other Stock Exchanges but are permitted for trading
on OTCEI.
NOTES
Features
The important features of OTCEI are as follows:
 Nationwide Listing: The OTC exchange is spread all over India through
member, dealer and representative, office counters. Hence by listing on just
one stock exchange, the company and its products get nationwide exposure
and investors all over India can start trading in that scrip.
 Sponsorship: The companies that seek listing on the OTC exchange have
to approach one of the members appointed by the OTC for acting as the
sponsor to the issue. The sponsor appraises the project. By entering into
the sponsorship agreement, the sponsor is committed to market in that scrip
by giving a buy/sell quote for a minimum period of 1½ years. Investors are
benefited by this as it enhances the liquidity of the soups listed on the OTC
Exchange.
 Bought-out Deals: Through the concept of bought-out deals OTC allows
companies to place its equity meant to be offered to the public with the
sponsor-member at a mutually agreed upon price. This ensures swifter
availability of funds to companies for timely completion of projects and a
listed status at a later date.
 Listing of Small and Medium Sized Companies: In the past many small
and medium sized companies were not able to enter the capital market, due
to the listing requirement of the Securities Contracts (Regulation) Act 1956
that specifies a minimum issued equity capital of 3 crores. The OTC
Exchange provides an ideal opportunity to these companies to enter the
capital market. In fact, any company with a paid up capital of more than
30 lakhs and less than 25 crores can raise finance from the capital
market through the OTC Exchange.
 Liquidity through Market Making: The sponsor member is required to
give two-way quotes (buy and sell) for the scrip for 18 months from the
date of commencement of trading. Besides the compulsory market maker,
there is an additional market maker and voluntary market makers who give
two way quotes for the scrip. Competition among market produces efficient
pricing, reduces spreads between buy and sell quotations and increases the
capacity to absorb larger volumes. The market makers continually analyses
companies and provide information about them to their investors, thus
intensifying investor interest.
 Ringless and Screen-based Trading: For the first time in India, the OTC
Exchange has introduced automated, screen based trading in place of the
Self-Instructional
30 Material
traditional trading ring found in other stock exchanges. The network of on- Growth of Rural
Banking in India
line computers provides all relevant information on the computer screens of
the market participants. Allowing them the luxury of executing their deals
from the comfort of their own offices.
NOTES
 Transparency of Transactions: At the OTC Exchange, the investor can
see the available quotations on the computer screen at the dealer’s office
before placing the order. The confirmation slip/trading document generated
through the computer gives him the exact price of the transaction and the
brokerage charge. So the investors’ interest is totally safeguarded. This
system also ensures that transactions are done at the best prevailing quotation
in the market.
 Faster Delivery and Payment: On the OTC Exchange, the transaction is
settled within an incredibly short span of 7 days. Which means, the investor
actually gets the delivery of the Scrip or the payment for the scrip sold
within 7 days.
 Technology: The most distinguishing characteristic of the OTC Exchange
is its state of the art technology. The OTC Exchange uses computers and
telecommunications technologies of the information age to bring members/
dealers together electronically, enabling them to trade with one another over
the computer rather than on a trading floor in a single location. All the
information needed for trading is in the open and easily accessible on the
OTC computer screen, by going into the respective units.
The eligibility criteria for listing says that the issued equity capital of the
company should be between 30 lakhs and 25 crores. The company should
make a minimum office of 25 per cent of its capital or 20 lakhs in face value,
whichever is higher. The company should not be listed on any other stock exchange
in India.
Benefits
The benefits which OTC Exchange offer are:
To Companies
a) Provide a method of raising funds through capital market instruments which
are priced fairly. In OTC the company is able to negotiate the issue price
with the sponsors who market the issue.
b) Save unnecessary issue expenses on raising funds from capital markets.
Almost all associated costs are eliminated.
c) Retain greater degree of management stability OTC Exchange list scrips
with 20% of the capital made available for public trading.
d) Provide greater accessibility to large pool of captive investor base-enhancing
fund raising power substantially. OTC Exchange create a nationwide network
Self-Instructional
Material 31
Growth of Rural where investors are serviced and form the captive investor base for
Banking in India
companies.
To Investors
NOTES a) Investment in stock has become easier with the OTC Exchange’s wide
network.
b) Provides greater confidence and fidelity of trade investor can look up the
prices displayed at each OTC Counter and the investor can trade scrips at
the right market price.
c) Enables transactions to be completed quickly. Investors can settle the deals
across the counter and the money or scrip proceeds from the deal are
settled in a matter of days.
d) Provide definite liquidity to investors and there is sufficient opportunity to
exit.
e) Investor get a greater sense of security because all scrips are researched.
Check Your Progress

1. What is the main purpose of Haryana State Cooperative Apex Bank
Limited?
2. What is control?
3. Why was the OTC Exchange of India (OTCEI) set up?

QUESTIONS
1. The main purpose of the Haryana State Cooperative Apex Bank Limited is
to financially assist the artisans in the rural areas, farmers and agrarian
unskilled labour, and the small rural entrepreneurs of Haryana.
2. Control is the fundamental management function. It signifies the measurement
and correction of the performance of subordinates in order to make sure
that enterprise objectives and the plans devised to attain them are
accomplished.
3. The OTC Exchange of India (OTCEI) has been set up to provide a cost
effective and convenient platform for raising finance from the capital market.
2.5 SUMMARY
 Rural development has to play a vital role in the overall socio-economic

development of a country like India, where the majority of the population
Self-Instructional
32 Material
lives in rural areas.
 The rural sector affects directly or indirectly almost all the economic activities Growth of Rural
Banking in India
in the country and provides employment to the maximum number of people.
 Every Regional Rural Bank is authorized to transact the business of banking
as defined in the Banking Regulation Act and may also engage in other
NOTES
business specified in Section 6(1) of the said Act.
 The State Bank of India is one of the major commercial banks having regional
rural banks. These are 30 Regional Rural Banks in India, under the State
Bank of India and it is spread across 13 states in India.
 Commercial Banks face high transaction cost in their rural branches. The
problematic issues in rural banking of commercial banks are lack of
infrastructure, reluctance of staff to serve in remote rural areas, large number
of accounts dealing in small amounts, difficulty in getting financial information
on rural borrowers leading to some amount of uncertainty in the minds of
the bankers and lack of security for carrying cash in remote areas by mobile
banking.
 The banks need to encourage agriculture by providing larger amount of
term loans. Generally, the non-agricultural sector indirectly helps the rural
economy in many ways keeping in view, the RRBs may enhance the
percentage of loan to this sector.
 Control is the fundamental management function. It signifies the measurement
and correction of the performance of subordinates in order to make sure
that enterprise objectives and the plans devised to attain them are
accomplished.
 With a view to develop an effective and efficient monitoring and control
system for Indian Capital Markets. Government of India has passed the
Securities and Exchange Board of India Act 1992.
 The National Stock Exchange of India Limited was promoted by IDBI,
ICICI, IFCI, GIC, LIC, State Bank of India, SBI Capital Markets Limited,
SHCIL and ILOFS as a Joint Stock Company under the Companies Act,
1956 on November 27, 1992.
 NSE provides nationwide stock trading facilities and equal access to investors
from all over the country through a network of trading members all over the
country without any trading floor.
 The OTC Exchange of India (OTCEI) has been set up to provide a cost
effective and convenient platform for raising finance from the capital market.
OTCEI was promoted by a consortium of financial institutions and it started
its operations in 1992.
2.6 KEY WORDS
 Scrips: It is a provisional certificate of money subscribed to a bank or

Self-Instructional
company, entitling the holder to a formal certificate and dividends. Material 33
Growth of Rural  OTCEI: It is an electronic stock exchange based in India that consists of
Banking in India
small- and medium-sized firms aiming to gain access to the capital markets
like electronic exchanges in the U.S.
 NSE: It is India’s largest financial market. Incorporated in 1992, the NSE
NOTES
has developed into a sophisticated, electronic market, which ranked fourth
in the world by equity trading volume in 2015.
 NABARD: It is an apex development financial institution in India entrusted
with ‘matters concerning policy, planning and operations in the field of credit
for agriculture and other economic activities in rural areas in India’.

EXERCISES

1. What is the main purpose of NABARD?
2. What are the benefits of the OTC Exchange of India?
3. Write a short-note on the role of the NSE.
4. Why is control needed in management?
1. Discuss the various regional rural banks in India.
2. Examine the features of OTCEI.
3. Describe the role of the SBI in regulating rural banking.

Self-Instructional
34 Material
Project Related Activities
UNIT 3 PROJECT RELATED of a Rural Banker
ACTIVITIES OF A RURAL
NOTES
BANKER
Structure
3.0 Introduction
3.1 Objectives
3.2 Project Activities
3.3 Corporate Counselling
3.4 Loan Syndication: Meaning and Scope
3.6 Summary
3.7 Key Words
3.0 INTRODUCTION
As has been discussed in the previuos units, rural banking is being promoted by
the Indian government with great impetus being given to this sector. Various rural
banks have been set up in different parts of the country with this objective in mind.
Pradhan Mantri Jan Dhan Yojana is one of the recent initiatives by the new
government which has definitely contributed to bring banking to every household.
These efforts have helped to direct the agriculture driven economy towards
modernization. This unit will help you understand the project related activities of a
rural banker, corporate counselling, categories of organizational goals, meaning,
scope and steps involved in loan syndication.
3.1 OBJECTIVES

 Discuss the project related activities of a rural banker
 Explain the concept of corporate counselling
 Describe the categories of organizational goals
 Define the scope of loan syndication
 List the steps involved in loan syndication
Self-Instructional
Material 35
of a Rural Banker 3.2 PROJECT ACTIVITIES
The appraisal of a project involves a thorough investigation into the project by a

NOTES financial institution which is not connected to the entrepreneur. The appraiser would
evaluate the objectives of the entrepreneur in the right perspective. It would involve
the consideration of the input data, analyse the data product outcome and measure
the attainability of the objectives of the project.
The project appraisal can be termed as an independent examination of the
project concerned by the entrepreneurs. The appraisal of the project is done to
make a second look on the assumptions made and to reassess the future projections
given by the promoters. Project appraisal is primarily intended to evaluate the
project from various facts to indicate the viability of the project. A project appraisal
involves a study of all aspects of the project including the product to be manufactured,
technical process involved in manufacturing, availability of infrastructure, plant and
machinery, technology and its adaptability to the local conditions, availability of
utilities, raw material, availability of skilled manpower, marketing facilities and
arrangements, proximity to the markets and overall prospects of the market.
The financial institutions appraise the project to ensure the technical feasibility,
environmental and economic viability, financial and commercial viability, managerial
competence of the promoters and their background. The financial institutions use
their knowledge and expertise to assess the overall position of the project and
decide whether the project is viable for consideration or not. The financial institutions
take a decision regarding the provision of financial assistance to the project after a
thorough project appraisal and after carefully considering the results of the project
appraisal.
The various steps involved in project appraisal are as follows:
1. Financial Feasibility: The basic data required for a financial feasibility
analysis can be grouped as under:
o Cost of project and means of financing
o Cost of production and profitability
o Cash flow estimates during currency of loans
o Proforma balance sheet as at the end of each financial year during
period of loan.
Cost of the Project
The cost of the project can be broadly classified into the following:
 Land and Site Development: It includes the cost of the land, conveyance
expenses, premium payable on leasehold land, cost of levelling the site and
other site development expenses, cost of internal roads, cost of fencing and
compound wall and cost of providing gates etc.
Self-Instructional
36 Material
 Building and Civil Works: It includes construction cost of the main factory Project Related Activities
of a Rural Banker
building, building of auxiliary services, factory administrative building,
storehouse, workshops, godowns, warehouses, open yard facilities, canteen,
workers rest rooms, sanitary works, staff quarters and so forth.
NOTES
 Plant and Machinery: It includes the cost of main plant and machinery,
stores and spares, auxiliary equipment, transportation cost, installation cost,
cost of test runs, foundation cost, cost of erection and commissioning.
 Technical Knowhow and Engineering Fees: It includes fees payable to
provide the technology and knowhow and travelling expenses payable to
technicians and foreign collaborators.
 Miscellaneous Fixed Assets: It includes the cost of office furniture and
equipment like tables, chairs, air conditioners, water coolers, miscellaneous
store items and others.
 Preliminary and Preoperative Expenses: The preliminary expenses
includes the cost of raising finances like public issue expenses, commission
and fees payable to brokers and consultants in raising term loans, expenses
incurred for incorporation of the company, legal charges, underwriters
commissions, cost of advertising the public issue etc. The preoperative
expenses include salaries, establishment expenses, rent, trial run expenses
and other miscellaneous expenses incurred before the commercial production.
 Provision for Contingences and Escalation: It includes the provision
for meeting the unforeseen expenses and costs not provided on the other
heads of the cost of the project. It also includes the cost of escalation of the
major heads of cost like land and site development building and civil works,
plant and machinery, technical knowhow fees and others.
 Working Capital Margin: The working capital margin required for the
project which is not being financed by the banks will also be included in the
cost of the project.
Though machinery cost often constitutes a major element in the total project
cost, its estimation need not pose major problems since this can be based on
competitive quotations. On the other hand, cost of items such as land, site
development expenses ancillary facilities like water and power connections,
intangibles like preliminary expenses and preoperative expenses necessitate a careful
inquiry and assessment. A realistic assessment of project cost with built in cushions
for absorbing normal cost escalations, could take care of the consequences of
delay and cost overrun.
Means of Financing
There is no ideal pattern concerning means of financing for a project. The means
of financing is determined by a variety of factors and considerations like magnitude
of funds required, risk associated with the enterprise, nature of industry, prevailing
taxation laws and others.
Self-Instructional
Material 37
Project Related Activities The following are the sources of finance:
of a Rural Banker
 Share Capital
 Subsidies
NOTES  Long term borrowing from financial institutions and banks
 Loans from friends and relatives
 Retained earnings
Financial institutions specify certain debt equity ratios and promoters will
have to raise their own finance to match these ratios.
Cost of Production and Profitability
The next step is the assessment of the earning capacity of the project. The unit
should be in a position to manufacture the product at a reasonable cost and sell
them at a reasonable price which would allow adequate profit margin even in a
competitive market. The profitability of an enterprise depends on the total cost of
production and the aggregate sale price of the output. The cost of production and
sale estimates are also useful in working out the breakeven point. The point at
which the income sales would cover the working costs of the project. At this point
the unit begins to make profit.
Cash Flow Estimates
The cash flow estimates are essential to ensure availability of cash to meet the
requirements of the project from time to time. The cash flows estimates will show
funds including repayment of term loan instalments. The debt service coverage
ratio is arrived at by dividing cash accruals comprising net profits (after taxes,
interest on term loans and depreciation added back) by total interest charges and
instalments. This will indicate whether the cash flows would be adequate to meet
the debt obligations and also provide sufficient margin of safety. The repayment of
term loans being drawn taking into consideration the above aspect.
Proforma Balance Sheets
Proforma balance sheets are drawn for existing concerns doing expansion as well
as for new projects. However, in the case of existing concerns going for expansion
the balance sheets for the past three years are also analysed and compared with
the projections. The projected balance sheets can be drawn for the cash flows
estimates and profitability projections. Various ratios are derived from the balance
sheets and inferences drawn therefrom.
2. Technical Competence: The technology may be indigenous or imported
through foreign collaborations. In the case of indigenous technology, it should
be ensured that suitable technical personnel are available. For technology
acquired through collaboration tie-ups the key areas to be considered are
the following:
Self-Instructional
38 Material
 The standing of the collaborators and past experience concerning tie-up Project Related Activities
of a Rural Banker
arrangements with them.
 Adequacy of the scope and competitiveness of the terms of the
collaboration in relation to the requirements of the project, project
NOTES
engineering equipment specifications, drawings, process knowhow,
erection and commissioning of the plant trial operations and performance
test training facilities.
 Performance guarantee and its adequacy in relation to rated capacity of
plant and machinery.
 Reasonableness of financial and other costs by way of down payment
royalties and so forth.
The cost of the project should provide for the knowhow fee, training expenses,
foreign trips and others.
The project needs to be examined with particular reference to the following
points regarding the technical feasibility are as follows:
 Location: The success of a project generally depends on its proper
location yielding the advantages of nearness to the sources of raw
materials, labour availability of power and transport facilities and market.
The subsidies and other concessions available at certain specified areas
are to be compared with these basic infrastructural aspects.
 Land and Building: The land should necessarily be sufficient to take
care of future expansion. If the land is on lease then the terms and
conditions of the base should be verified and as well as the municipal
laws regarding constructions of building. Actual plant layout is to be
studied before deciding the size of the building.
 Plant and Machinery: The important aspect to be noted in examining
the list of plant and equipment is to ascertain the appropriateness of the
process of technology, capacity and the related sectional balances
amongst various assembly lines. It has to be ensured that the cost of
equipment is based on proper quotations from suppliers and that suitable
provisions have been made for insurance, freight, duty and transportation
to site, erection charges and allied expenses. Adequate provision for
spare parts is also essential especially if the some have to be imported.
3. Economic Feasibility: Economic feasibility basically deals with the
marketability of the product. Basic data regarding demand and supply of a
product in the domestic market is needed. Manmade shortages are not to
be reckoned as genuine demand and the market analysis is an essential part
of a full appraisal. Projection or forecasting of demand is no doubt a
complicated matter but is of vital importance. Equally important is to examine
the sales promotion proposed by the enterprise and its adequacy.
Self-Instructional
Material 39
Project Related Activities Managerial Competence
of a Rural Banker
The success of a business enterprise depends largely on the resourcefulness
competence and integrity of its management. However, assessment of managerial
NOTES competence has to be necessarily qualitative, calling for understanding and
judgment. The managerial requirements are the experience and capability of the
principal promoters to implement and run the project. The adequacy of the
management set up for day to day operations like production, maintenance,
marketing, finance and so forth and also the homogeneity of the management set
up. For a new entrepreneur it will always advisable to build up a competent team
of specialists in the required discipline to join hands with an entrepreneur who has
the requisite organizational and managerial expertise in the implementation and
operation of the project.
Project approach could be applied for a small investment or a large
investment. It is a flexible approach to development wherein each project is
considered to be an independent unit having its own costs and benefits. Careful
project preparation and analysis is important for efficient use of financial resources.
In the liberalized environment and in the wake of financial section reforms, the
importance of project approach has increased. Project approach is an important
approach in economic and developmental activities. Project basically means an
investment activity in which financial resources are expended to create capital
assets that produce benefits over an extended period of time and which logically
lends itself to planning, financing and implementing as a unit. There are several
advantages of project approach including utility in prioritizing resource allocation
and case of monitoring and evaluation. But there are a few limitations of the approach
including inability to estimate realistic values of costs and benefits for the future
which is uncertain.
3.3 CORPORATE COUNSELLING
Corporate counselling refers to the activities performed by the merchant banks to

provide expertise knowledge to a corporate entity to ensure better performance
and also to portray a better image to investors resulting from distribution of dividend
and ensuring appreciation in market value of its equity shares.
Corporate counselling denotes the advice provided by merchant banking
to the corporate unit to ensure better corporate performance in terms of image
building among investors steady growth through good working and appreciation
in market value of its equity shares. The scope of corporate counselling, capital
restructuring and portfolio management and the full range of financial engineering
includes venture capital, public issue management and loan syndication, working
capital, fixed deposit, lease financing, acceptance credit and so forth. However,
counselling is limited to only opinions and suggestions and any detailed analysis
would form part of a specific service.
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40 Material
The scope of corporate counselling is restricted to the explanations of Project Related Activities
of a Rural Banker
concepts, procedures and laws to be observed by the client’s company.
Requirement of any action to be taken or compliance of statutory formalities to be
made for implementation of those suggestions would mean the demand for a specific
type of service other than corporate counselling being offered by the merchant NOTES
bankers. An academic analysis of corporate counselling presents a different picture
than that transpires from the literature of the merchant bankers. Firstly, corporate
counselling is the beginning of the merchant banking service which every client
whether new or existing (separately) for rendering the corporate counselling service
or includes the element of fee in the other heads of services but from the angle of
priority. Corporate counselling is first in line of the services which a merchant
banker offers and other services.
Secondly, the scope of corporate counselling is very vast. Its coverage
ranges from the managerial economics investments and financial management to
corporate laws and the related legal aspects of the organizational goals, location
factors, organizational size and operational scale, choice of product and market
survey, forecasting of product, cost reduction and cost analysis, allocation of
resources, investment decisions, capital management and expenditure control,
pricing methods and marketing strategy. As a financial and investment expert, a
merchant banker has to guide the corporate clients in areas covering financial
reporting, project measurements, working capital management, financial
requirements and the sources of finance, evaluating financial alternatives, rate of
return and cost of capital besides basic corporate changes of financial rearrangement.
Reorganization, mergers and acquisitions and so forth are the areas to be covered.
Organizational goals or objectives are the ends towards which the activities of an
organization are directed and the standards against which the performance is
assessed. The managerial objectives of an organization can be classified into these
major categories.
1. Organizational Objectives
Organizational objectives aim at prosperity and growth of the organization.
Generally, it is assured that profit maximization is the main objectives of every
organization but it is not true. The managers try to develop and attain variety of
objectives in all management areas which reduces cost and brings maximum
prosperity for the organization. Drucker was the first to point out the objectives of
survival, growth, profit and social objectives. Drucker has suggested the following
concrete and meaningful objectives for an organization.
a) Market Standing: It refers to the share and position of the company in the
market. The management always aim at maximizing the share and getting
control over large share of market in comparison to the competitor by
increasing sales in enterprises in the same industry. Concepts of productivity
Self-Instructional
Material 41
Project Related Activities of machines and of individual workers have been developed which can
of a Rural Banker
measure overall productivity.
b) Physical and Financial Resources: The management sets objectives with
regard to the use, acquisition and maintenance of capital and monetary
NOTES
resources so that there is sufficient capital available and there is no wastage
of financial resources.
c) Profitability: Earning adequate amount of profit is one of the important
organizational objectives of the management. Managers always assess
various investment proposals on the basis of return of each investment
proposal for the organization. Every company sets up its profit earning rate,
which leads to growth of the organization.
d) Management Performance and Development: The management should
set up objectives to assess the managerial productivity and growth. The
achievement of different objectives of the organization helps in assessing
the productivity of managers and developing techniques for performance
appraisal of individual managers. Training programmes for developing future
managers to replace the existing managers as and when they leave the
organization or allied matters would be meaningful and attainable. The
success and failure of every company depends upon the managerial efficiency
of that company.
e) Workers performance and attitude: Workers performance and attitude
are vital components for the prosperity and even survival of the organization
in the long run. Management make use of statistical information with reference
to labour. Turnover absenteeism, accidents, grievances, suggestions and so
forth are used to measure attitude of workers towards management. The
management develops positive attitude of workers as human resources are
one of the most important resources of every company.
f) Public Responsibility: The management should set up objectives which
fix the responsibility of company towards its customers and society. As
organizations are the part of society these cannot exist in isolation. So they
must do something for upliftment of society.
2. Social Objectives
Social objectives of the organization deal with the commitment of the organization
towards the society. Business organizations are part of society. They earn by using
the resources of society, so they must do something for the society as well. The
major social objectives of the organization are the following:
(i) Supply of quality products at reasonable price
(ii) Contribution towards desirable civic activities
(iii) Generation of economic wealth
(iv) Generation of employment opportunities
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42 Material
(v) Financial support to community Project Related Activities
of a Rural Banker
(vi) Organizing educational, health and vocational training programmes
(vii) Participating actively in social source projects of government and NGOs
3. Individual Objectives NOTES
Individual objectives are related to the employees of the organization. As employees

are most important resources of every company consequently, satisfied and
motivated employees contribute the maximum for the organizations. The man
individual objectives of management are the following:
(i) Competitive salary
(ii) Personal growth and development (promotion, training and other factors)
(iii) Peer recognition, self-respect and respect for colleague
(iv) Social reorganization
(v) Good and healthy working conditions
Workers may lose interest in fulfilling the objectives assigned to them. The
management must try to integrate the personal objectives with the organizational
objectives.
3.4 LOAN SYNDICATION: MEANING AND SCOPE
A syndicated loan is an essential source of debt financing for corporate loan

syndication refers to the services rendered by the financial service expert or firm in
procurement of term loans and working capital facilities from financial institutions
banks and other financing and investment firms for its clients. It is, thus, availed
from a group of lenders include commercial banks, Government Funding Institutions,
International Banks and Non-banking Finance Companies (NBFCs) and so forth.
They constitute a syndicate to offer loan facility. Syndicated loans provide funding
for large scale and capital intensive projects, for instance, infrastructure projects,
oil and gas projects, manufacturing projects and so forth. Moreover, banks also
participate in this loan syndication transaction to ensure risk mitigation and large
exposure.
Syndicated form of raising finance came into existence when the size of
individual loans got bigger and banks thought fit to share the risks with other lenders.
The concept of sole bankers was no longer feasible when a large amount of funding
was involved. Moreover, the syndicated mode of financing has two important
features, namely, amount (risks) and administrative saving (documentation to be
one principal lender). There will be one principal lender who will finance and the
other participant lenders in the syndicate will share the risks in a predetermined
share. The government of countries as well as the corporate sector tap the
syndicated loan route.
Self-Instructional
Material 43
Project Related Activities As the size of the individual loans increased, individual loans found it difficult
of a Rural Banker
to take the risk single handedly. Regulatory authorities in most countries limit the
size of the individual exposures. Hence, the practice of inviting other banks to
participate in the loan, to for me syndicate, came into being, thus, the term
NOTES syndicated loans. A syndicate is a general term describing any group that is formed
to conduct some type of business, for example, a syndicate may be formed by a
group of investment bankers who underwrite and distribute new issues of securities
or blocks of outstanding issues. Syndicates can be organized as corporation or
partnerships. A syndicate only works together temporarily. They are commonly
used for large loans or underwritings to reduce the risk that each individual firm
must take on.
A loan syndicate refers to the negotiation where borrowers and lenders sit
across the table to discuss about the terms and conditions of lending. At present,
large groups of banks are forming syndicates to arrange huge amount of loans for
corporate borrowers. The need for syndication arises as the size of the loan is
huge and a single bank cannot bear the whole risk of lending. Also the corporate
going for the issue is not aware about the banks which are willing to land. Hence,
syndication assumes significance. In the case of syndication, the risks gets diversified.
A syndicated loan or syndicated bank facility as a large loan, in which a
group of banks work together to provide funds for a borrower. There is usually
one lead bank that takes a percentage of loan amount and syndicates the rest to
other banks. The loan syndication work involves identification of sources from
where funds would be arranged. These sources with requisite application and
supporting documents and complying with all the formalities involved in the sanction
and disbursal of loan. A syndicated loan is the opposite of a bilateral loan, which
only involves one borrower and one lender—often a bank or financial institution.
Syndicated loans provide borrowers with a more complete menu of financing
options. In effect, the syndication market completes a continuum between traditional
private bilateral bank loans and publicly traded bond market.
The process of syndication starts with an invitation for bids from the borrower.
The borrower mentions the funds requirement, currency, tenor and so forth. The
mandate is given to a particular bank or an institution that will take the responsibility
of syndicating the loan by arranging for financing the banks. The syndication is
given to a particular bank or on institution that will take the responsibility of
syndicating the banks. The syndication is available for both, fund-based facilities
as well as non-fund based facilities like letters of credit and documentary credits.
As the syndicated loans are arranged a little quickly, these are popular with
corporate entities. The fees payable on syndicated loans consists of management
fees payable by the borrower on signing the loan documents or on first draw
down, commitment fees payable, underutilized portion of the loan during the period
when the loan was available and fees payable to the principal bank who has
arranged for syndication to cover all their administrative expenses.
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44 Material
Benefits of Syndicated Loans Project Related Activities
of a Rural Banker
Let us first look at the benefits of syndicated loans for borrowers.
For Borrowers
NOTES
 The total cost of borrowing is less
 Funding from multiple sources
 New banking relationships
 Ease of documentation
 Flexible Term and Conditions
For Lenders
 Diversified customer base
 Risk allocation among different companies
 Optimize risk and returns
 Limits exposure to a particular corporate group
 Develop new customer base
Parties to a Syndicated Loan Agreement
The parties of the syndicated loan agreement are as follows:
Lead Manager/Arranger
This term refers to those who receive an authority from the borrower to form a
syndicate for the required loan. Normally, it is a bank which is mandated by the
prospective borrower and is responsible for placing the syndicated loan with other
banks and ensuring that the syndication is fully subscribed. This bank charges
arrangement fees for undertaking the role of the lead manager. Its reputation matters
in that the participating banks would agree or disagree based on the credibility and
assessment expertise of this bank. In other words, since the appraisal of the
borrower and its proposed venture is primarily carried out by this bank, the onus
of default is indirectly on this bank. Thus, bank carries reputation risk in the
syndication process.
Underwriters
These banks including the lead bank will underwrite the total amount of the facility
and will try to get banks to take up the entire share of loan including them but with
no share or even major share. The arranger bank may underwrite to supply the
entire unsubscribed portion of the desired loan and in such a case arranger itself
plays the role of underwriting bank. Alternatively, a different bank may underwrite
(guarantee) the loans or portion percentage of the loan. This bank would be called
the underwriting bank. It may be noted that all the syndicated loans may not have
this underwriting arrangements. Risk of underwriting is obviously the underwriting
risk. It means it will have to carry the credit risk of the larger portion of the loan. Self-Instructional
Material 45
Project Related Activities Co-Manager
of a Rural Banker
They have to participate but with a lesser share than that of the leader. Co-manager
takes care of the administrative arrangements over the term of the loan, for example,
NOTES disbursements, repayments and compliance. It acts for and on behalf of the banks.
In many cases, the arranging/underwriting bank itself may undertake this role. In
larger syndication’s co-arrangers may be used.
Participants
All those banks/lenders who participate in the syndicated programme, as well as
the leader/underwriter would try to see that it is fully allocated. These banks charge
participation fees. These bank carry mostly the normal credit risk i.e., risk of
default by the borrower as like any other normal loan. These banks may also be
into passive approval and complacency risk. It means that these banks may not
carry rigorous appraisal of the borrower and has proposed project as it is done
by the lead manager and may other participating banks. It is this banker’s trust
that so many high profile banks cannot be wrong. This may be seen in the light of
reputation risk of the lead manager.
Creator of Memorandum of Information
Lead Manager/Arranger who will undertake to formulate the memorandum based
on the financial and other details of the borrower which function including agreeing
to the memorandum publishing and arranging and signing the same and the final
documentation.
Principal Documentation Agreement
It is the responsibility of the lead manager to get it drafted and get it approved
from all participants and is signed by all the participating banks and the borrower.
The agreement gives the details of loan or the facility, its nature, amount purpose,
maturity, amortization draw-down arrangement, interest of all types of fees,
warranties, undertaking law and its justification, default rules and others.
There are three stages or steps in syndication:
1. Pre-mandate stage
This is initiated by the prospective borrower. It may liaise with a single bank or it
may invite competitor’s bids from a number of banks. The borrower has to mandate
the lead bank and the underwriting bank, if desired. Once the lead bank is selected
and mandated by the borrower, the lead bank has to undertake the appraisal
process, the lead banks needs to identify the needs of the borrower, design an
appropriate loan structure and develop a persuasive credit proposal.
Self-Instructional
46 Material
2. Placing the Loan and Disbursement Project Related Activities
of a Rural Banker
At this stage, the lead bank can start to sell the loan in the market place, i.e., to
prospective participating banks this means that the lead bank needs to prepare a
memorandum, prepare a term sheet, prepare legal documents, approach selected NOTES
banks and write participation. A series of negotiations with the borrower are
undertaken, if prospective participants raise concerns. To conclude, at this stage
the lead bank must achieve closing of the syndication, including signing. If need be,
underwriting bank has to sign the balance portion of the loan. Loan is disbursed in
phases as agreed in the loan contract. Loan is disbursed in a bank account created
exclusively to disburse loan. This account and its withdrawls are monitored by
banks. This is to ensure that the loan is used only for the purpose defined in the
loan agreement and that the funds are not diverted to any other purpose.
3. Post-Closure Stage
This is the monitoring and follow-up phase. Escrow account is the account in
which the borrower has to deposit its revenues and the agent ensures that the loan
repayment is given due priority before payments to any other parties. Hence, in
this stage, the agent handles the day to day running of the loan facility.
Features of Syndicated Loan and its Composition
 The borrower finalizes the amount and the currency of the loan required
and invites offers from the banks to arrange for finance.
 Banks who give their quotes for interest rates, fees and so forth and
undertakes the responsibility of arranging syndication is normally called the
lead bank/Manager/Arranger.
 Borrower will examine the offers of the various banks and will chose the
best available offer, which is bests suited to its needs. After deciding or
selecting the loans, the borrower gives authority to that bank, which acts as
the leader to arrange the loan.
 Then the borrower and the arranger bank will formulate a memorandum of
information, giving financial and other details of the co-leader. This is the
important document on the basis of which the arranger will seek participation
of other interested banks/lenders.
 While seeking/inviting banks to participate in the syndication, the arranger
will have to give details of sharing of fees, securities and it is expected to
share in the proportion of the share to be picked by members in the
consortium. In case of any shortfall in the participation of lenders, then such
portion of loan is expected to be taken up the leader of the syndicate.
 Once the entire tie-up is done and finalized, the borrower and leader finalize
the loan agreement and the borrower executes the same.
Self-Instructional
Material 47
of a Rural Banker
Check Your Progress
1. List the sources of finance.
NOTES 2. Define corporate counselling.
3. Mention the benefits of syndicated loans.

QUESTIONS
1. The sources of finance are the following:

 Share Capital
 Subsidies
 Long term borrowing from Financial Institutions and Banks
 Loans from Friends and Relatives
 Retained Earnings
2. Corporate counselling refers to the activities performed by the merchant
banks to provide expertise knowledge to a corporate entity to ensure better
performance and also to portray a better image to investors resulting from
distribution of dividend and ensuring appreciation in market value of its
equity shares.
3. The benefits of syndicated loans are the following:
 The total cost of borrowing is less
 Funding from multiple sources
 New banking relationships
 Ease of documentation
 Diversified customer base
 Risk allocation among different companies
 Optimize risk and returns
3.6 SUMMARY
 The appraisal of a project involves a thorough investigation into the project

by a financial institution which is not connected to the entrepreneur. The
appraiser would evaluate the objectives of the entrepreneur in the right
perspective.
Self-Instructional
48 Material
 The project appraisal can be termed as an independent examination of the Project Related Activities
of a Rural Banker
project concerned by the entrepreneurs. The appraisal of the project is
done to make a second look on the assumptions made and to reassess the
future projections given by the promoters.
NOTES
 The financial institutions appraise the project to ensure the technical feasibility,
environmental and economic viability, financial and commercial viability,
managerial competence of the promoters and their background.
 A realistic assessment of project cost with built in cushions for absorbing
normal cost escalations, could take care of the consequences of delay and
cost overrun.
 There is no ideal pattern concerning means of financing for a project. The
means of financing is determined by a variety of factors and considerations
like magnitude of funds required, risk associated with the enterprise, nature
of industry, prevailing taxation laws and others.
 The cash flow estimates are essential to ensure availability of cash to meet
the requirements of the project from time to time. The cash flows estimates
will show funds including repayment of term loan instalments.
 Proforma balance sheets are drawn for existing concerns doing expansion
as well as for new projects. However, in the case of existing concerns going
for expansion the balance sheets for the past three years are also analysed
and compared with the projections.
 The success of a business enterprise depends largely on the resourcefulness
competence and integrity of its management. However, assessment of
managerial competence has to be necessarily qualitative, calling for
understanding and judgment.
 Corporate counselling refers to the activities performed by the merchant
banks to provide expertise knowledge to a corporate entity to ensure better
performance and also to portray a better image to investors resulting from
distribution of dividend and ensuring appreciation in market value of its
equity shares.
 Organizational goals or objectives are the ends towards which the activities
of an organization are directed and the standards against which the
performance is assessed.
 Individual objectives are related to the employees of the organization. As
employees are most important resources of every company consequently,
satisfied and motivated employees contribute the maximum for the
organizations.
 A syndicated loan is an essential source of debt financing for corporate loan
syndication refers to the services rendered by the financial service expert or
firm in procurement of term loans and working capital facilities from financial
institutions banks and other financing and investment firms for its clients.
Self-Instructional
Material 49
Project Related Activities  As the size of the individual loans increased, individual loans found it difficult
of a Rural Banker
to take the risk single handedly. Regulatory authorities in most countries
limit the size of the individual exposures. Hence, the practice of inviting
other banks to participate in the loan, to for me syndicate, came into being,
NOTES thus, the term syndicated loans.
 A loan syndicate refers to the negotiation where borrowers and lenders sit
across the table to discuss about the terms and conditions of lending. At
present, large groups of banks are forming syndicates to arrange huge amount
of loans for corporate borrowers.
 Co-manager takes care of the administrative arrangements over the term of
the loan, for example, disbursements, repayments and compliance.
 All those banks/lenders who participate in the syndicated programme, as
well as the leader/underwriter would try to see that it is fully allocated.
These banks charge participation fees. These bank carry mostly the normal
credit risk i.e., risk of default by the borrower as like any other normal loan.
 It is the responsibility of the lead manager to get it drafted and get it approved
from all participants and is signed by all the participating banks and the
borrower.
3.7 KEY WORDS
 Project appraisal: It is an independent examination of the project concerned

by the entrepreneurs.
 Syndicate: It is a general term describing any group that is formed to
promote a common interest.
 Letter of credit: It is a document that guarantees the buyer’s payment to
the sellers.
 Escrow account: It is the account in which the borrower has to deposit its
revenues and the agent ensures that the loan repayment is given due priority
before payments to any other parties.

EXERCISES

1. What are the project related activities of a rural banker?
2. Mention the factors determining the means of finance.
Self-Instructional
50 Material
3. What is the significance of managerial competence? Project Related Activities
of a Rural Banker
4. Briefly mention the scope of corporate counselling.
5. Write a short note on the steps involved in loan syndication.
Long Answer Questions NOTES
1. Discuss the various steps involved in project appraisal.

2. Explain the major categories of organizational goals.
3. Examine the meaning and scope of loan syndication.

Self-Instructional
Material 51
Capital Issue Related
Activities of a Rural BLOCK - II
Banker
RURAL BANKING FEATURES
NOTES
UNIT 4 CAPITAL ISSUE RELATED
BANKER
Structure
4.0 Introduction
4.1 Objectives
4.2 Capital Issues
4.3 Management of Pre-Issue Activities
4.5 Summary
4.6 Key Words
4.0 INTRODUCTION
Rural banking activities are primarily intended to serve small businesses and
communities in rural areas support the implementation of national development in
order to improve the welfare of the people, as well as serve the needs of farmers.
Rural banking is not only about a profit motive but also social motive, whose
activities include more community development without prejudice to its role as a
financial intermediary. This unit discusses the various capital issue related activities
of a rural banker.
4.1 OBJECTIVES

 Analyse the changing structure of the Indian capital market
 Explain Trade/Settlement Guarantee Fund
 Describe the role of SEBI in rural banking
 Discuss the management of pre-issue activities
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52 Material
4.2 CAPITAL ISSUES Activities of a Rural
Banker
Capital market reforms in India have led to spread of an equity cult even to the
rural areas, towns and cities where no stock exchanges or share capital market NOTES
related institutions are situated. As a corollary to this, new institutions concerning
capital markets to strengthen support and regulate the capital markets are emerging.
Some of the institutions like OTCEI and NSEI are inculcating the screen based
trading cult and are using computer networks in lieu of normal trading floor. The
financial markets on the other hand are becoming more complex with increase in
trade and competitiveness and transcending the geographical and time limitations
of local financial markets. This has necessitated emergence, growth and
development of various financial services in India to enable the companies to raise
funds at minimum possible cost and the investors to make right investment choices
and to trade conveniently. Thus the emerging financial services and new institutions
are playing an important role in deepening and widening the capital markets.
Securities market in India has grown exponentially as measured in terms of
amount raised from the market, number of stock exchanges and other
intermediaries, the number of listed stocks, market capitalisation, trading volumes
and turnover on stock exchanges and investor population. Along with this, the
profiles of the investors, issuers, and intermediaries have changed significantly.
The market has witnessed fundamental institutional changes resulting in drastic
reduction in transaction costs and significant improvements in efficiency
transparency and safety. Indian market is now comparable to many developed
markets. The number of issues and the amounts mobilised through the primary
market is predominantly by financial institutions and banks as opposed to industry.
In an institution based financial system, the role of financial intermediaries like
banks and financial institutions are prominent in mobilisation and allocation of
financial resources. In the current capital market system, the role of banks and
financial institutions as intermediary is diluted. In the market based system where
the investor and user of funds are expected to come into direct control with the
borrowers i.e. the corporates a tendency was developed among the corporate
houses to access savings directly through public deposits, commercial paper, equity
and debenture issues, external commercial borrowings, ADR/GDR issues, etc.
This process of transformation has been further facilitated by the introduction of a
set of new financial instruments, with varied degrees of liquidity, risks and returns.
Among the instruments, mutual funds, bonds and derivative instruments are
more active which have grasped a substantial share in resource mobilisation giving
a challenge to traditional monetary assets such as bank deposits. Similarly
instruments like deep discount bonds, zero coupon bonds and other bonds with
very long maturity period compete with traditional term saving instruments.
The smooth functioning of the capital market depends on the regulators,
participants and investors. Nowadays, the capital market is a far more important
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Capital Issue Related source of finance than traditional financial intermediaries for the corporate sector.
Activities of a Rural
Banker It is poised to dominate the future of corporate finance in India. The process of
reforms has led to a pace of growth of markets almost unparalleled in the history
of any country. Recent developments which have taken place in the capital market
NOTES have important implications in the industrial and economic development and the
growth of the country.
The capital market in India is undergoing a process of structural transformation,
with a view to improve market efficiency, make stock market transactions more
transparent, curb unfair trade practices and to bring capital markets up to
international standards. With this objective in mind, several institutional developments
have taken place e.g. The National Stock Exchange has been set up with a screen
based limit order book market, the National Securities Clearing Corporation Ltd
(NSCCL) has been set up to guarantee settlements NSDL has been established
to improve settlement process etc. These institutional developments have resulted
in a drastic reduction in transaction costs and have made the markets fair and safe
for investors. In fact, the process to restructure capital markets began in 1992
with the establishment of SEBI. Persistent efforts have been made since then. An
array of capital market reforms encompassing primary and secondary markets,
equity and debt and FII have been announced. These reforms have significantly
restructured capital markets.
During the last seven/eight years, significant efforts have been made to
restructure the Indian capital market. Many of the weaknesses and inefficiencies
of the Indian capital market have been removed. Today a sound regulatory
framework is in place for floatation of primary issues, operation of stock exchanges
and working of market intermediaries like brokers, merchant bankers, registrars
and custodians. Screen based trading has been introduced in the stock exchanges.
Depository has become a reality and transactions through depository will bring
down the cost and risks of trading associated with paper based trading. Cost of
transaction has come down. Stock exchanges have strengthened their internal
operating practices, surveillance system and infrastructure. Stock brokers and
merchant bankers are now better capitalized, more professionally organised and
more accountable. Margining system is now better implemented and defaulting
members are not allowed to continue trading.
NSE introduced for the first time in India a transparent screen based trading
system. Thus, the investor is assured of price which is not vulnerable to manipulation.
The national reach of the NSE has enabled it to have a deeper and more liquid
market and hence lower costs. The NSE also introduced the concept of novation
through clearing house to guarantee trades executed on NEAT (trading system of
NSE). All these factors have contributed to reducing the costs of trading.
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Fully computerised Stock Exchange Trading was pioneered by NSE in Capital Issue Related
India. This has removed the common investor’s biggest complaints viz unfair dealing Banker
practices and delays in settlement. It has improved transparency and trading
efficiency.
NOTES
The setting up of depositories and shift to paperless trading has helped to
overcome the major problem of handling physical share certificates such as problem
of theft, fake and/or forged shares, share transfer delays, particularly due to
signature mismatch. Transaction holding costs (Costs of handling, storage,
transportation and other back office costs) in the depository environment are
cheaper when compared to same in the physical and Demat segments.
The setting up of Trade/Settlement Guarantee Fund by
Stock Exchanges
The principal objective of this fund is to provide the necessary finance and ensure
timely completion of settlements in cases of failure of member brokers to fulfil their
settlement obligations. Establishment of such funds would give greater confidence
to investors in the settlement and clearing procedures of the stock exchanges.
The development of the debt market in India is central to the mobilisation of
long term funds for infrastructure development. The magnitude of funds required
for infrastructure underscores the urgency involved in the development of the debt
market.
The government securities segments is the most dominant in debt market. A
notable development in the debt market recently has been the significant increase
in the amounts raised by the corporate sector through debt instruments, bulk of
which were raised through the private placement route. This trend signifies the
emergence of a wholesale primary market in debt securities. A number of measures
have been initiated to provide depth and increase liquidity in the debt market.
The Indian capital market has exhibited a great measure of dynamism in the
recent years with globalisation of the Indian capital market and foreign rating
agencies upgrading India on their rating scales, the market is bound to take off in
a big way. The gradual process of India’s reform has firmly re-established macro-
economic stability and public confidence. Several measures were taken to deregulate
the rigid financial system and to move toward a more market-determined allocation
of credit. Indian capital market has become competitive and efficient and is attracting
foreign investment. The reforms measures initiated in the capital market started
with SEBI (Securities and Exchange Board of India) repealing Capital Issues
Control Act and the abolition of Controller of Capital Issues (CCI) have brought
about significant improvements in the functional and regulatory structure for the
efficient functioning of the capital market and protecting the interest of the investors
have helped in developing the capital market on healthy lines and will in due course
bring the functioning of the domestic capital market in line with the international
standards.
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Capital Issue Related A number of policy announcements relating to participants and the methods
Banker and procedures of raising finance have been made. The objective is to strengthen
the standards of disclosure, introduction of certain prudential norms for the issuers
and intermediaries and remove the inadequacies and systematic deficiencies in the
NOTES issue procedures.
After the abolition of CCI, SEBI as a regulatory authority, issued guidelines
for new issues of companies, the clarification to which provided for substantial
modifications in respect of promoters contribution for issue of capital at premium
by a new company being promoted by existing companies having a track record,
minimum promoter contribution from friends/relatives and reservations to various
institutions/persons such as mutual funds financial institutions, FIIs, eligible employees
etc.
A set of guidelines for development financial institutions for disclosure and
investor protection regarding their raising of funds from Capital Market was
announced. SEBI brought the merchant bankers under its regulatory framework.
The regulations covers among other things registration of merchant bankers, their
obligations and responsibilities, procedures for inspection and action to be initiated
against defaulting merchant bankers.
SEBI issued regulations relating to registrars to issues and share transfer
agents and laid down the capital adequacy requirements, general obligations and
responsibilities, procedures for inspection and actions in case of default.
Regulations for underwriters of capital issues were issued included among
other things the net worth requirements.
SEBI has also notified the regulations of Mutual Funds which stipulates that
they are required to be formed as trust or Trustee Company. It provide for arm’s
length relationship between the various constituents of the Mutual Funds and thus
bring about a structural change which ensure qualitative improvement in the
functioning of the Mutual Funds.
Guidelines for stock-brokers and sub-brokers were announced which
interalia, cover registration of brokers, their general obligations and responsibilities,
procedures for inspection of their operations and actions to be initiated in case of
default.
To bring about greater transparency in transactions SEBI has made it
mandatory for brokers to maintain separate accounts for their clients and for
themselves. They must disclose the transaction price and brokerage separately in
the contract notes issued to their clients. They must also have their books audited
and audit reports filed with SEBI.
SEBI has also issued directives to stock exchanges (SEs) to ensure that
contract notes are issued by brokers to clients within 24 hours of the execution of
the contract. They have to see that time limits for payment of sale proceeds and
deliveries by brokers and payment of margins by clients to brokers are complied
Self-Instructional
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with. For ensuring the fulfilment of deals in the market and protecting the investors Capital Issue Related
SEBI has introduced capital adequacy norms for the brokers. Banker
SEBI has directed the Stock Exchanges to broad base their governing
boards and change the composition of their arbitration, default and disciplinary
NOTES
committee which help stock exchanges to function with greater autonomy and
independence so that they become truly self-regulatory organisations.
Another major development in the capital market reforms is the increasing
role of banking institutions in the capital market activities by setting up subsidiaries/
mutual funds or contributing to the equity of companies offering financial services.
The areas involve leasing, merchant banking, factoring asset management
companies, money market, mutual funds, etc.
4.3 MANAGEMENT OF PRE-ISSUE ACTIVITIES
SEBI has circulated certain proposals for introducing reforms in the primary market.
As per the guidelines no compulsory appraisal has been envisaged. Where the
appraisal has been made by the choice of the issuer company for the purpose of
the issue, such appraisal, of made by financial institution, a banks or one of the
lead managers the same may be relied upon to make adequate and appropriate
disclosures in the offer documents. The issuer company should also make
arrangements in such cases with the concerned financial institution or bank to
make available to the lead manager a copy of the appraisal report where the
appraisal has been made by a bank, financial institution or any other agency for
purposes of grant of term loans, underwriting or any form of financial assistance
like guarantee etc. reference to such appraisal in the offer documents shall be
made, only of the lead manager has access to financial projection and other relevant
conclusions in that report. Thus is necessary for the lead manager to ensure
appropriate and adequate disclosures in the offer documents. The offer documents
should prominently disclose the name of the agency undertaking the appraisal and
the purpose thereof.
Companies will be allowed to raise fresh capital by freely processing their
further issues.
The issue price will be determined by the issuer in consultation with the lead
managers to the issue.
Disclosers
(i) The draft prospects will be vetted by SEBI to ensure adequacy of
disclosures.
(ii) The prospectus or offer documents shall contain the net asset value of the
company and a justification for the price of the issue.
(iii) High and low process of the shares for the last 2 years.
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Capital Issue Related Undertaking
Banker
(a) Underwriting is mandatory for the full issue and minimum requirement of
90% subscription is also mandatory for each issue of capital to public.
NOTES Number of underwriting would be decided by the issues.
(b) If the company does not receive 90% of issued amount from public
subscription plus accepted development from underwriters, within 120 days
from the date of opening of the issue the company shall refund the amount
of subscription. In case of disputed development, the company should refund
the amount of subscription of the above conditions are not met.
(c) The lead manager(s) must satisfy themselves about the net worth of the
underwriters and the outstanding commitments and disclose the same to
SEBI.
Underwriting should be only for issue to the public which will exclude
reserved/preferential allotment to reserved categories. Underwriting is mandatory
only to the extent of net offer to the public minimum subscription clause is applicable
for both public and rights issue with a right of renunciation.
Check Your Progress

1. On what factors does the smooth functioning of the capital market depend
on?
2. Who pioneered fully computerized stock exchange trading?
3. State the principle objective of Trade/Settlement Guarantee Fund.
4. How does SEBI bring about transparency in transactions?

QUESTIONS
1. The smooth functioning of the capital market depends on the regulators,

participants and investors.
2. Fully computerised stock exchange trading was pioneered by NSE in India.
3. The principal objective of this fund is to provide the necessary finance and
ensure timely completion of settlements in cases of failure of member brokers
to fulfil their settlement obligations.
4. To bring about greater transparency in transactions SEBI has made it
mandatory for brokers to maintain separate accounts for their clients and
for themselves. They must disclose the transaction price and brokerage
separately in the contract notes issued to their clients. They must also have
their books audited and audit reports filed with SEBI.
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4.5 SUMMARY Activities of a Rural
Banker
 Capital market reforms in India have led to spread of equity cult even to the
rural areas, towns and cities where no stock exchanges or share capital NOTES
market related institutions are situated. As a corollary to this, new institutions
concerning capital markets to strengthen support and regulate the capital
markets are emerging.
 The financial markets on the other hand are becoming more complex with
increase in trade and competitiveness and transcending the geographical
and time limitations of local financial markets. This has necessitated
emergence, growth and development of various financial services in India
to enable the companies to raise funds at minimum possible cost and the
investors to make right investment choices and to trade conveniently.
 Securities market in India has grown exponentially as measured in terms of
amount raised from the market, number of stock exchanges and other
intermediaries, the number of listed stocks, market capitalisation, trading
volumes and turnover on stock exchanges and investor population. Along
with this, the profiles of the investors, issuers, and intermediaries have
changed significantly.
 In an institution based financial system, the role of financial intermediaries
like banks and financial institutions are prominent in mobilisation and
allocation of financial resources. In the current capital market system, the
role of banks and financial institutions as intermediary is diluted.
 The capital market in India is undergoing a process of structural
transformation, with a view to improve market efficiency, make stock market
transactions more transparent, curb unfair trade practices and to bring capital
markets up to international standards.
 During the last seven/eight years, significant efforts have been made to
restructure Indian capital market. Many of the weaknesses and inefficiencies
of the Indian capital market have been removed.
 Today a sound regulatory framework is in place for floatation of primary
issues, operation of stock exchanges and working of market intermediaries
like brokers, merchant bankers, registrars and custodians.
 The principal objective of this fund is to provide the necessary funds and
ensure timely completion of settlements in cases of failure of member brokers
to fulfil their settlement obligations. Establishment of such funds would give
greater confidence to investors in the settlement and clearing procedures of
the stock exchanges.
 The Indian capital market has exhibited a great measure of dynamism in the
recent years with globalisation of Indian Capital market and foreign rating
Self-Instructional
Material 59
Capital Issue Related agencies upgrading India on their rating scales, the market is bound to take
Banker off in a big way. The gradual process of India’s reform has firmly re-
established macro-economic stability and public confidence.
 A number of policy announcements relating to participants and the methods
NOTES
and procedures of raising finance have been made. The objective is to
strengthen the standards of disclosure, introduction of certain prudential
norms for the issuers and intermediaries and remove the inadequacies and
systematic deficiencies in the issue procedures.
 SEBI has also notified the regulations of Mutual Funds which stipulates that
they are required to be formed as trust or Trustee Company. It provide for
arm’s length relationship between the various constituents of the Mutual
Funds and thus bring about a structural change which ensure qualitative
improvement in the functioning of the Mutual Funds.
 Another major development in the capital market reforms is the increasing
role of banking institutions in the capital market activities by setting up
subsidiaries/mutual funds or contributing to the equity of companies offering
financial services. The areas involve leasing, merchant banking, factoring
asset management companies, money market, mutual funds, etc.
4.6 KEY WORDS
 SEBI: The Securities and Exchange Board of India is the regulator for the
securities market in India. It was established in 1988 and given statutory
powers on 30 January 1992 through the SEBI Act, 1992.
 NSE: The National Stock Exchange of India Limited is the leading stock
exchange of India, located in Mumbai. The NSE was established in 1992
as the first demutualized electronic exchange in the country.

EXERCISES

1. Write a short note on capital issues.
2. How was the debt market developed in India?
1. Analyse the changing structure of Indian capital market.
2. How are pre-issue activities managed? Discuss.
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4.8 FURTHER READING Activities of a Rural
Banker

and Management. Gurgaon: Partridge Publishing. NOTES
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Material 61
Corporate Securities
UNIT 5 CORPORATE SECURITIES

NOTES Structure
5.0 Introduction
5.1 Objectives
5.2 Types and Characteristics of Securities
5.3 Marketing of Corporate Securities
5.4 Steps to be taken by the Issuing Company
5.6 Summary
5.7 Key Words
5.0 INTRODUCTION
Corporate securities can be termed as – shares, debentures, public deposits and

loans from institutions. For the purpose of building fixed capital, joint stock
companies mobilize funds from the public in the form of equity or ordinary shares
or preference shares.
Ordinary shares are not preferred shares and they do not have any
predetermined dividend amount. The dividend payable to the ordinary shareholders
may be high when the company performs well and it may be low or nil when the
performance of the company is found to be poor. This unit will examine the types
and characteristics of securities in detail.
5.1 OBJECTIVES

 Describe the different types of securities
 Discuss the characteristics of securities
 Explain the process of marketing of corporate securities
 Describe the steps taken by the issuing company and the lead manager
 Discuss the process of underwriting of shares
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5.2 TYPES AND CHARACTERISTICS OF
SECURITIES
Various types of securities are traded in the market. Securities broadly represent NOTES
evidence to property rights. A security provides a claim on an asset and any future
cash flows the asset may generate. We commonly think of securities as shares and
bonds. According to the Securities Contracts Regulation Act 1956, securities include
shares, scrips, stocks, bonds, debentures and other marketable products like
securities of incorporated companies, other body corporates or the government.
Securities are classified on the basis of return and the source of issue. On the basis
of income, they may be classified as fixed or variable income securities. In the
case of fixed income security, the income is fixed at the time of the issue itself.
Bonds, debentures and preference shares fall into this category. Sources of issue
may be government, semi-government and corporate. The incomes of variable
securities change from one year to another. Dividends of companies’ equity shares
can be cited as an example of this. Corporates generally raise funds through fixed
and variable income securities like equity shares, preference shares and debentures.
Equity Shares
Equity shares are commonly referred to as common stock or ordinary shares.
Even though the terms ‘shares’ and ‘stocks’ are interchangeably used, there is a
difference between them. The share capital of a company is divided into a number
of small units of equal value called shares. The term ‘stock’ means the aggregate
of a member’s fully paid-up shares of equal value merged into one fund. It is a set
of shares put together in a bundle. The ‘stock’ is expressed in terms of money and
not as many shares. Stock can be divided into fractions of any amount and such
fractions may be transferred like shares.
Share certificate means a certificate under the common seal of the company
specifying the number of shares held by any member. A share certificate provides
the prima facie evidence of title of the members to such shares. This helps the
shareholder to deal easily in the market. It enables him to sell his shares by showing
marketable title.
The share certificate is available in two forms.
 Physical form – share certificates are issued in the physical form.
 Demat form – share certificates are issued in the electronic form.
Equity shareholders have the following rights according to Section 85 (2) of
the Companies Act, 1956.
 Right to vote at the general body meetings of the company.
 Right to control the management of the company.
 Right to share in profits in the form of dividends and bonus shares.
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Corporate Securities  Right to claim on the residual after repayment of all claims in case of
winding up of the company.
 Right of pre-emption in the matter of issue of new capital.
NOTES  Right to apply to court in case of any discrepancy in the rights set aside.
 Right to receive a copy of the statutory report, copies of annual accounts
along with audited report.
 Right to apply to the central government to call an annual meeting when
a company fails to call such a meeting.
 Right to apply the Company Law Board for calling an extraordinary
general meeting.
In a limited company, the equity shareholders are liable to pay the company’s
debt only to the extent of their share in the paid up capital. Equity shares have
certain advantages. The main advantages are:
 Capital appreciation
 Limited liability
 Free tradability
 Tax advantages (in certain cases)
 Hedge against inflation
Sweat Equity
Sweat equity is a new equity instrument introduced in the Companies (Amendment)
Ordinance, 1998. The newly inserted Section 79A of the Companies Act, 1956
allows the issue of sweat equity. However, it should be issued out of a class of
equity shares already issued by the company. It cannot form a new class of equity
shares. Section 79A (2) explains that all limitations, restrictions and provisions
applicable to equity shares are applicable to sweat equity. Thus, sweat equity
forms a part of the equity share capital.
Non-voting Shares
Non-voting shares carry no voting rights. They carry additional dividends instead
of voting rights. Even though the idea was widely discussed in 1987, it was only in
the year 1994 that the Finance Ministry announced certain broad guidelines for
the issue of non-voting shares.
Shareholders in possession of non-voting shares have the right to participate
in bonus issues. Non-voting shares can also be listed and traded in stock exchanges.
If non-voting shares are not paid dividends for two years, shares would automatically
get voting rights. The company can issue this to a maximum of 25 per cent of the
voting stock. The dividend on non-voting shares would have to be 20 per cent
higher than the dividend on voting shares. All rights and bonus shares for non-
voting shares have to be issued in the form of non-voting shares only.
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64 Material
Right Shares Corporate Securities
Shares offered to existing shareholders at a price by the company are called right
shares. They are offered to shareholders as a matter of legal right. If a public
company wants to increase its subscribed capital by way of issuing shares after NOTES
two years from its date of formation or one year from the date of first allotment,
whichever is earlier, such shares should be offered first to existing shareholders in
proportion to the capital paid up on the shares held by them at the date of such
offer. This pre-emptive right can be forfeited by shareholders through a special
resolution. The shareholder can renounce right shares in favour of his nominee. He
may renounce all or part of the shares offered to him. Right shares may be partly
paid. The minimum subscription limit is prescribed for right issues. In the event of
the company failing to receive 90 per cent subscription, the company has to
return the entire money received. SEBI has, at present, removed this limit. Right
issues are regulated under the provisions of the Companies Act and SEBI.
Bonus Shares
A bonus share is the distribution of shares in addition to cash dividends to existing
shareholders. Bonus shares are issued to existing shareholders without any payment
of cash. The aim of a bonus share is to capitalize the free reserves. The bonus
issue is made out of free reserves built from genuine profit or share premium
collected in cash only. The bonus issue can be made only when all partly paid
shares are fully paid-up.
The declaration of the bonus issue has a favourable impact on the psychology
of shareholders. They take it as an indication of high future profits. Bonus shares
are declared by directors only when they expect a rise in the profitability of the
concern. The issue of bonus shares enables shareholders to sell shares and get
capital gains while retaining their original shares.
Preference Stock
The characters of the preferred stock are hybrid in nature. Some of its features
resemble the bond and others the equity shares. Like the bonds, their claims on
the company’s income are limited, and they receive a fixed dividend. In the event
of liquidation of the company, their claims on the assets of the firm are also fixed.
At the same time, like the equity, it is a perpetual liability of the corporate. The
decision to pay a dividend on the preferred stock is at the discretion of the Board
of Directors. In the case of bonds, payment of interest rate is mandatory.
The dividend received by the preferred stock is treated on par with the
dividend received from the equity share for tax purposes. These shareholders do
not enjoy any of the voting powers, except when any resolution affects their rights.
Cumulative preference shares: Here, the cumulative total of all unpaid
preferred dividends must be paid before dividends are paid on the common equity.
Unpaid dividends are known as arrearages—these do not earn interest. The non-
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Corporate Securities payment of dividend only continues to grow. The arrearages accrue only for a
limited number of years and not indefinitely. Generally three years of arrears accrue
and the accumulative feature ceases after three years. But the dividends in arrears
continue if no such provision is given in the Articles of Association. In case of
NOTES liquidation, no arrears of dividends are payable unless a provision is made in the
Articles of Association.
Non-cumulative shares: As the name suggests, the dividend does not
accumulate. If the company earns no profit or inadequate profit in a particular
year, the company does not pay a dividend. If the preference and equity shares
are fully paid while winding up a company, non-cumulative shareholders have no
further rights to have claims in the surplus. If a provision is made in the Articles of
Association for such claims, they have the right to claim.
Convertible preference shares: The convertibility feature makes the
preference share a more attractive investment security. The conversion feature is
almost identical to that of the bonds. These preference shares are convertible as
equity shares at the end of the specified period and are quasi-equity shares. This
gives the additional privilege of sharing the potential increase in equity value, along
with the security and stability of income.
Redeemable preference shares: If a provision in the Articles of
Association to issue redeemable preference shares is available, it can be issued.
However, redemption of the shares can be done only in the following conditions:
 The partly paid-up shares are made fully paid-up.
 The fund for redemption is created from profits, which would otherwise
be available for distribution of dividends or out of the proceeds of a
fresh issue of shares for the purpose.
 If a premium has to be paid on redemption, it should be paid out of the
profits or out of the company’s share premium account.
 When redemption is made out of profits, a sum equal to the nominal
value of the redeemed shares should be transferred to the capital
redemption reserve account.
Irredeemable preference shares: These shares are not redeemable
except on occasions like winding up of the business. In India, these shares were
permitted till 15 June 1988. The introduction of Section 80A in the Companies
Act, 1956 put an end to them.
Cumulative convertible preference shares (CCPS): These were
introduced by the government in 1984. This preference share gives a regular return
of 10 per cent during the gestation period from three years to five years and is then
converted into equity as per the agreement. According to guidelines, CCPS can
be issued for any of the following purposes: (a) setting up of new projects, (b)
expansion or diversification of existing projects, (c) normal capital expenditure for
modernization, and (d) working capital requirements. CCPS failed to attract the
Self-Instructional
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interest of investors because the rate of interest was very low and the gain that Corporate Securities
could be received from the conversion into equity also depended upon profitable
functioning of the equity.
Debenture NOTES
According to the Companies Act 1956, ‘Debenture includes debenture stock,
bonds and any other securities of the company, whether constituting a charge on
the assets of the company or not’. Debentures are generally issued by the private
sector companies as a long-term promissory note for raising loan capital. The
company promises to pay interest and principal as stipulated. A bond is an alternative
form of debenture in India. Public sector companies and financial institutions issue
bonds. The characteristic features of debentures are as follows:
 Form: It is given as a certificate of indebtedness by the company, specifying
the date of redemption and rate of interest.
 Interest: Rate of interest is fixed at the time of the issue itself, which is
known as the contractual or coupon rate of interest. Interest is paid as a
percentage of the par value of the debenture and may be paid annually,
semi-annually or quarterly. The company is legally bound to pay the interest
rate.
 Redemption: As stated earlier, the redemption date would be specified in
the issue itself. The maturity period may range from 5 to 10 years in India.
They may be redeemed in instalments. Redemption is done through the
creation of a sinking fund by the company. A trustee in charge of the fund
buys the debentures either from the market or from owners. Creation of the
sinking fund eliminates the risk of facing financial difficulty at the time of
redemption because redemption requires a huge sum. Buy-back provisions
help the company to redeem debentures at a special price before the maturity
date. The special price is usually higher than the par value of the debenture.
 Indenture: An indenture is a trust deed between the company issuing
debentures and the debenture trustee who represents the debenture holders.
The trustee takes the responsibility of protecting the interest of the debenture
holders and ensures that the company fulfils contractual obligations. Financial
institutions, banks, insurance companies or firm attorneys act as trustees to
the investors. In the indenture, the terms of agreement, description of
debentures, rights of the debenture holders, those of the issuing company
and responsibilities of the company are clearly specified.
Types of Debentures
Debentures are classified on the basis of security and convertibility:
 Secured or unsecured debenture
 Fully convertible debenture
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Corporate Securities  Partly convertible debenture
 Non-convertible debenture
Secured or unsecured debenture: A secured debenture is secured by a
NOTES lien on the company’s specific assets. In the case of default, the trustee can take
hold of the specific asset on behalf of the debenture holders. Secured debentures
in the Indian market include a charge on present and future immovable assets of
the company.
When the debentures are not protected by a security, they are known as
unsecured or naked debentures. Debentures in the American capital market mean
unsecured bonds, while bonds could be secured or unsecured. Unsecured
debentures find it difficult to attract investors because of the risk involved in them.
Debentures are generally rated by credit rating agencies.
Fully convertible debenture: This type of debenture is converted into
equity shares of the company on the expiry of a specific period. The conversion is
carried out according to the guidelines issued by SEBI. The FCD carries a lower
rate of interest than other types of debentures because of the attractive feature of
convertibility into equity shares.
Partly convertible debenture: This debenture consists of two parts, namely
convertible and non-convertible. The convertible portion can be converted into
shares after a specific period. Here, the investor has the advantage of convertible
and non-convertible debentures blended into one debenture. For example, Procter
and Gamble had issued fully convertible debenture (FCD) of 200 each to its
existing shareholders. The investor can get a share for 65 with the face value of
10 after 18 months from allotment (as in August 1997).
Non-convertible debenture: Non-convertible debentures do not confer
any option on the holder to convert the debentures into equity shares and are
redeemed at the expiry of the specified period.
Bond
A bond is a long-term debt instrument that promises to pay a fixed annual sum as
interest for a specified period of time. The basic features of the bonds are given
below:
 Bonds have face a value. This is known as par value. The bonds may be
issued at par, or at a discount.
 The interest rate is fixed. It may sometimes vary as in the case of a floating
rate bond. The interest is paid semi-annually or annually and is known as
the coupon rate. The interest rate is specified in the certificate.
 The maturity date of the bond is usually specified at the time of issue, except
in the case of perpetual bonds.
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 The redemption value is also stated in the bonds. It may be at par value or Corporate Securities
at a premium.
 Bonds are traded in the stock market. When they are traded, the market
value may be at par, at a premium or discounted. The market value and
NOTES
redemption value need not be the same.
Secured bonds and unsecured bonds: The secured bond is secured by
the real assets of the issuer. In case of the unsecured bond, the name and fame of
an issuer may be the only security.
Perpetual bonds and redeemable bonds: Bonds that do not mature or
never mature are called perpetual bonds. The interest alone would be paid. In
redeemable bonds, the bond is redeemed after a specific period of time. The
redemption value is specified by the issuer.
Fixed interest rate bonds and floating interest rate bonds: In fixed
interest rate bonds, the interest rate is fixed at the time of the issue, whereas in the
floating interest rate bonds, the interest rates change according to already fixed
norms. For example, in December 1993 the State Bank of India issued floating
interest rate bonds worth 500 crore, pegging the interest rate with its three and
five years’ fixed deposit rates to provide built-in yield flexibility to the investors.
Zero coupon bonds: These bonds sell at a discount and the face value is
repaid at maturity. The origin of this type of bond can be traced to the US Security
Market The high value of the US government security prevented investors from
investing their money in government security. Big brokerage companies like Merrill
Lynch, Pierce and others purchased government securities in large quantities and
sold them in smaller denominations—at a discounted rate. The difference between
the purchase cost and face value of the bond is the gain for the investor. Since the
investor does not receive any interest on the bond, the conversion price is suitably
arranged to protect the loss of interest to the investor. The discounted value is
calculated using the formula:
Face Value of the Bond
Present Value = n
1+R
R = interest rate and n = number of years.

For example, a zero coupon bond with a face value of 50,000 that matures
in 20 years’ time would be sold at 5,185 to give a return of 12 per cent per
annum.
The merit of this bond is that the company does not have the burden of
servicing the debt during the execution period of the project. The repayment could
be adjusted to fall after the completion of the project. This could result in
considerable cost savings for the company.
Deep discount bonds: A deep discount bond is another form of zero
coupon bond. The bonds are sold at a large discount on their nominal value and
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Corporate Securities interest is not paid on them. Also, they mature at par value. The difference between
the maturity value and the issue price serves as an interest return. The deep discount
bonds’ maturity period may range from three years to 25 years or more. IDBI first
issued deep discount bonds in India in 1992 with varying maturity period options.
NOTES Later, ICICI in 1997 issued deep discount bonds with four optional maturity
periods. Early redemption option is provided at the end of the 6th, 12th and 18th
year.
Capital indexed bonds: In the capital indexed bond, the principal amount
of the bond is adjusted for inflation for every year. For example, an investment of
1000 in inflation indexed bonds earns the investor a semi-annual interest income
for a five-years’ period. The re-selling of the principal amount is done semi-annually
based on the wholesale price index (WPI) movements. The principal amount of
the bond is adjusted for inflation for each of the years. A coupon rate of 6 per cent
is worked on the inflation-adjusted principal.
The bond is advantageous because it gives the investor more returns by
taking inflation into account. The investor enjoys the benefit of a return on his
principal, which is equal to the average inflation between the issue (purchase) and
maturity period of the instrument. The investor has to keep the instrument for the
entire five-year period, to avail the benefit of inflated principal amount.
If the investor wants to exit early, he can do it through the secondary market.
The value of the principal repayment is adjusted by the Index Rate (IR), which is
announced by the RBI two weeks prior to the repayment of the principal. The IR
is worked out as follows:
IR = Reference WPI as in Aug 2002/Base WPI
Financial institutions, banks, insurance companies or firm attorneys act as
trustees to the investors. In the indenture, the terms of agreement, description of
debentures, rights of debenture holders and of the issuing company, and
responsibilities of the company are specified clearly. Rates change according to
already fixed norms.
Warrants
A warrant is a bearer document of title to buy a specified number of equity shares
at a specified price. Warrants can usually be exercised over a number of years.
The life periods of warrants are long. Warrants are offered to make the bond or
preferred stock offering more attractive. Bonds may have a low interest rate but
the warrants offered along with them help the investor enjoy the equity appreciation
value. Warrants are detachable—the investor can sell them separately to be traded
in the market.
The person who holds the warrant cannot enjoy the benefits of the equity
holder before the conversion of the warrant. The price at which the warrants are
converted is called exercise price. The exercise price is always greater than the
current market price of the respective equity at the time of issue of the warrant.
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When warrants are issued along with host securities and are detachable, they are Corporate Securities
known as detachable warrants. In some cases, the warrants can be sold back to
the company before the expiry date. These are known as puttable warrants. Naked
warrants are issued separately and not with host securities. The investor has the
option to convert them into bonds or equities. NOTES
Advantages of Warrants
 Warrants make non-convertible debentures and other debentures more
attractive and acceptable.
 Debentures, along with warrants, are able to create their own market and
reduce the company’s dependence on financial institutions and mutual funds.
 As the exercise of warrants takes place at a future date, cash flow and the
capital structure of the company can be planned accordingly.
 The cost of debt is reduced if warrants are attached to it. Investors are
willing to accept a lower interest rate in anticipation of enjoying capital
appreciation of equity value at a later date.
 Warrants provide a high degree of leverage to the investor. He can sell the
warrant in the market, convert it into stocks or allow it to lapse. But if the
conversion is compulsory, investors have to shell out money from their
pockets even if the price of the share falls.
 Warrants are liquid and they are traded in stock exchanges. Hence, the
investor can sell the warrants before exercising them.
Table 5.1 Difference between Share Warrants and Share Certificates
Share Warrants Share Certificates

Issued by a public limited company Issued by public and private companies
Need for the provision in the Articles of Association No need to be contained in the Articles of
Association
Should be approved by the central government Central government approval is not needed
Share warrants are issued to fully paid-up shares Share certificates are issued to fully and partly
paid-up shares
Transfer of share warrants requires no registration Transfer of share certificates would be complete
only if registered
Share warrants are negotiable instruments Share certificates are not considered negotiable
instruments
Stock Derivatives
A stock derivative is an instrument whose value is derived from the value of one or
more underlying securities. It can be bonds, stocks, stocks indices, etc. Common
examples of derivative instruments are futures and options.
Index futures are future contracts where the underlying asset is an index.
Index futures are traded in the Sensex and Nifty.
Options are contracts that confer on the buyer of the contract certain rights
(rights to buy or sell an asset) for a predetermined price on or before a pre-
Self-Instructional
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Corporate Securities specified date. The buyer of the option has the right but not the obligation to
exercise the option.
The popular stock options are:
NOTES  Equity – index options and options on individual stocks
 Interest rates – bond options, interest rate futures options, options
embedded in bonds, caps and floors, etc.
5.3 MARKETING OF CORPORATE SECURITIES
Market makers are those who quote rates for buying and selling the securities they
deal in. This is to ensure adequate liquidity for both buyers and sellers in the securities
market.
A market maker is a firm or an individual prepared to buy and sell a particular
security throughout the trading session to maintain liquidity and a fair and orderly
market in that security. Market makers are essential for the success of both the
primary and secondary markets.
Market makers maintain inventory levels depending on demand and supply
situation just like any other commodity. As per SEBI guidelines, the requirements
for market makers are:
1. The market maker is required to provide a two-way quote on a continuous
basis for 75 per cent of the time in a day.
2. The minimum depth of the quote should be 5,000 or one market lot,
whichever is higher. In case of demat shares, for which there is no market
lot, the same market lot as existed in the physical segment would be
applicable for this purpose.
3. There will not be more than five market makers for each scrip; these
would be selected by each exchange on the basis of selected objective
criteria.
4. Each market maker may compete with other market makers for better
quotes to the investors.
5. Once registered as a market maker, an individual has to start providing
quotes within five trading days of registration.
6. The quote shall be provided in such a way that the quotes are not absent
from the screen for more than 30 minutes at a time.
7. Execution of the order on a continuous basis at the quoted price and
quantity must be guaranteed by the market maker.
8. Once registered as a market maker, an individual has to mandatorily act
in that capacity for a minimum period of three months.
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Capital Issue Management Corporate Securities
Management of capital issues in India is a professional service rendered by merchant

bankers. In fact, issue management is a major function for merchant bankers. The
role of merchant bankers has increased due to the tremendous growth of public NOTES
listed companies in number, size and complexity, SEBI’s guidelines and requirements
increase.
Capital issue management relates to the management of issues for raising
funds through various instruments by companies.
The issue can be a public issue through a prospectus, rights issue, private
placement and institutional placement programme. Issue management, in the case
of issues through prospectus, involves the following functions:
 Obtaining an observation letter for the issue from SEBI.
 Arranging underwriting for the proposed issue.
 Drafting and finalizing the prospectus and obtaining its clearance from
the various agencies concerned.
 Drafting and finalizing other documents, such as applications, forms,
newspaper advertisements and other statutory requirements.
 Selecting the registrar to the issues; the printing press; the advertising
agencies; the brokers and bankers to the issue and finalizing the fees
and charges to be paid to them.
 Arranging for the press conference and investors’ conferences.
 Coordinating printing, publicity and other work, to get everything ready
at the time of the public issue.
 Complying with the SEBI guidelines before and after the issue is over
(both in case of over-subscription or devolpment), by sending the various
reports as required by the authorities.
The procedures and practices for managing public issues fall under two
phases:
 Pre-issue management begins with the structuring of issues and ends
with the opening of a subscription list;
 Post-issue management continues until the securities are listed on the
stock exchange.
The management of capital issues in both phases is regulated and monitored
by SEBI.
SEBI’s objective in capital issue management is to protect the interests of
investors through regulations and guidelines, establishing transparency in market
dealings.
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Check Your Progress

1. State some advantages of equity shares.
NOTES 2. What are the two forms of share certificate?
3. What are the procedures and practices for managing public issues?
5.4 STEPS TO BE TAKEN BY THE ISSUING

COMPANY
Primarily, issues can be classified into the following categories:

 Public issue
 Rights issue
 Bonus issue
 Stock option/Employees stock option scheme
 Private placement
While public and rights issues involve a detailed procedure, private
placements are relatively simpler.
Types of Issues
The following are the different types of issues:
1. Public issue
Public issues can be further classified into initial public offerings (IPOs) and follow-
on public offerings.
(a) Initial public offering: An initial public offer (IPO) is selling of securities
to the public in the primary market for the first time.
An IPO is the selling of securities to the public in the primary market, which
can be either fresh issues, an offer of its existing securities or both, by its
promoters to the public for the first time. An IPO is, historically, considered
high-risk in nature.
In other words, the entire emphasis is on an issue to the public for the first
time, which can be either by the company or its existing shareholders,
including promoters. The issuer makes an offer for new investors to enter
into its shareholding family. The company involved in the issue makes detailed
disclosures as per SEBI’s Disclosure and Investor Protection guidelines
(DIP) in its offer document and offers it for subscription. This paves the
way for the listing and trading of the issuer’s securities.
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For example, Google’s IPO included both a primary offering (the issuance Corporate Securities
of Google stock by Google) and a secondary offering the sale of Google

stock held by shareholders, including the founders.
To make a public issue, it is necessary for every company to obtain a credit
NOTES
rating from at least one credit rating agency, registered with SEBI, before
the date of registering its prospectus or red herring prospectus with the
Registrar of Companies.
(b) A follow-on public offering: A follow-on public offering (FPO) is an issuance
of shares by the existing company, subsequent to its initial public offering.
This is an issuance of additional shares offered to the public by the existing
company. By the time an FPO is initiated, new shares are created by the
existing company to raise funds.
A follow-on public offering means the issuance of additional shares by an
existing company, after the IPO, through an offer document.
A follow-on offering can be made in any one of the following ways:
 Promoters dilute their stake by offering some of their shares to the public.
 The company issues fresh shares.
 Both these approaches are combined.
The basic difference between an IPO and an FPO is simple. An IPO is
made by a company for the first time to the public, while an FPO is a subsequent
issue to the public with an intention to raise additional capital.
2. Rights issue
A rights issue (RI) is one when a listed company proposes to issue fresh securities
to its existing shareholders on any specified date, known as a record date. The
rights are normally offered in a particular ratio to the existing security holders,
prior to the issue. This route is the most suitable for companies, which would like
to raise capital, without diluting the stake of its existing shareholders, provided the
existing shareholders subscribe to their entitlements.
3. Bonus issue
A bonus issue is a free issue of shares to the existing shareholders. A company
may decide to distribute free shares, known as bonus shares, as an alternative to
increasing the dividend payout. With the bonus issue, new shares would be issued
to existing shareholders in proportion to their holdings. For example, the company
may give one bonus share for every five shares held.
When bonus shares are announced, the market price of existing shares may
flare up as buyers would be eligible to get additional shares without payment. Of
course, this action depends on market expectations.
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Corporate Securities Sometimes, the market price goes down after the announcement of a bonus
issue, when market expectations are not fulfilled. For example, the market expected
a bonus issue of 1:1, but the company announces one bonus share for two shares
held.
NOTES
4. Stock option or employees’ stock option scheme
An employees’ stock option scheme (ESOP) is a common option given to
employees to purchase shares at a lower price, compared to the market price.
This is issued to existing employees, who provide valuable services, to retain their
loyalty.
Fig. 5.1 Types of Issues
This differs from sweat equity shares. Sweat equity is usually given to
directors or employees as consideration for some knowhow or knowledge obtained
from them, which is useful for the organization. Both employees stock option
scheme and sweat equity are similar but not the same (Table 5.2).
Table 5.2 Difference between Stock Option and Sweat Equity
Basis of Difference Stock Option Sweat Equity

Price At a predetermined price, At a discount or without
usually, at a lower price monetary consideration (free)
than the market price.
To whom issued Employees and promoters Only employees
Lock in period No lock in period 3 years
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5. Private placement Corporate Securities
The main purpose of private placement is to enable the company to speedily issue
shares and raise equity capital with minimal costs. Private placement can be of the
following types: NOTES
 Preferential allotment
 Qualified institutions placement
To go for private placement, there are certain regulations and criteria that a
company has to follow. The first thing is that the company has to be listed on a
stock exchange. It must meet the requirement of minimum public shareholding as
per the listing agreement.
Private placement consists of two kinds preferential allotment and qualified
institutional placement. Under the preferential allotment, a listed company issues
securities to a select group of entities not exceeding 49, which may be institutions
or promoters, at a particular price. The eligibility of investors is as per Chapter
XIII of SEBI (DIP) guidelines.
Under the SEBI rules and Companies Act, a private placement is defined
as issuance of shares or other securities to a select group of persons not exceeding
49, which is neither a rights issue nor a public issue. An issue that involves 50 or
more investors is considered a public offer.
In the 1960s and 1970s, a public issue was managed by the company and its
personnel. Now, a public issue involves a number of agencies. The rules and
regulations and the changing scenario of the capital market have made it necessary
for companies to seek the support of various agencies to make the public issue a
success. As a student of investment management, one should know the agencies
involved and their respective roles in the public issue. The promoters should also
have a clear idea about the agencies so that their activities can be coordinated
effectively in the public issue. The main agencies involved in the public issue are:
 Managers to the issue
 Registrars to the issue
 Underwriters
 Bankers
 Advertising agencies
 Financial institutions
 Government/statutory agencies
Managers to the Issue
Companies appoint lead managers to manage a public issue. Their main duties are
as follows: Self-Instructional
Material 77
Corporate Securities  Drafting the prospectus
 Preparing a budget of expenses related to the issue
 Suggesting the appropriate timing of the public issue
NOTES  Assisting in marketing the public issue successfully
 Advising the company in the appointment of registrars to the issue,
underwriters, brokers, bankers to the issue, advertising agents, etc.
 Directing the various agencies involved in the public issue
Many agencies perform the role of lead managers to the issue. The merchant
banking divisions of financial institutions, subsidiaries of commercial banks, foreign
banks, private sector banks, and private agencies are available to act as lead
managers. Some of them are SBI Capital Markets Ltd, Bank of Baroda, Canara
Bank, DSP Financial Consultants Ltd, and ICICI Securities & Finance Company
Ltd. The company negotiates with the prospective managers to its issue and settles
their selection and terms of appointment. Usually, companies appoint lead managers
with a successful background. There may be more than one manager to the issue.
Sometimes the banks or financial institutions impose a condition, while sanctioning
a term loan or underwriting assistance, that they be appointed as one of the lead
managers to the issue. The fee payable to the lead managers is negotiated between
the company and the lead manager. The amount agreed upon is revealed in the
memorandum of understanding filed along with the offer document.
Registrar to the Issue
The registrar to the issue is appointed in consultation with the lead managers.
Quotations with details of the various functions they will be performing and charges
for them are invited. The most suitable one is then selected. It is always ensured
that the registrar to the issue has the necessary logistical support such as access to
a computer, internet and a telephone.
The registrars usually receive the share applications from various collection
centres. They recommend the basis of allotment in consultation with the stock
exchange of listing the shares. They arrange for the despatch of the share certificates.
They hand over the details of the share allocation and other related documents to
the company. Usually, registrars to the issue retain the issue records for at least six
months from the last date of despatch of letters of allotment, to enable investors to
approach the registrars for redressal of their complaints.
Underwriters
Underwriting is a contract in which an underwriter gives an assurance to the issuer
that the he will subscribe to the securities offered in the event of non-subscription
by the persons to whom they are offered. The person who gives this assurance is
called an underwriter. Underwriters do not buy and sell securities. They stand as
back-up supporters, and underwriting is done for a commission. Underwriting
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78 Material
provides insurance against the possibility of inadequate subscription. Underwriters Corporate Securities
are divided into two categories:

 Financial institutions and banks
 Brokers and approved investment companies NOTES
Some examples of underwriters are financial institutions, commercial banks,
merchant bankers, members of the stock exchange, Export and Import Bank of
India and State Bank of India. The underwriters are exposed to the risk of non-
subscription, and for such risk exposure, they are paid an underwriting commission.
The underwriter’s financial strength is considered before appointing him,
because he has to undertake the agreed non-subscribed portion of the public
issue. The other aspects considered are the following:
 Experience in the primary market
 Past underwriting performance and default
 Outstanding underwriting commitment
 Network of investor clientele
 Overall reputation
The company, after the closure of the subscription list, communicates in
writing to the underwriter the total number of shares/debentures that remain
unsubscribed and the number of shares/debentures required to be taken up by the
underwriter. The underwriter will then take up the agreed portion. If the underwriter
fails to pay, the company is free to allot the shares to others or take up proceedings
against the underwriter to claim damages for any loss suffered by the company for
his denial.
Bankers to the Issue
Bankers to the issue are responsible for collecting the application money along
with the application form. They charge commission besides the brokerage, if any.
Depending upon the size of the public issue more than one banker to the issue is
appointed. When the size of the issue is large, three or four banks are appointed
as bankers to the issue. The number of collection centres is specified by the central
government. The bankers to the issue should have branches in the specified
collection centres. In metropolitan cities, more than one branch of the various
bankers to the issue is designated as the collecting branch for acceptance of money.
To create investment awareness among the people, collecting branches are
designated in the different towns of the state where the project is being set up. If
the collection centres for application money are located nearby, people are likely
to invest their money in company shares.
Advertising Agents
Advertising plays a key role in promoting a public issue. Hence, the past track
record of an advertising agency is studied carefully. Advertising agencies submit
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Corporate Securities their tentative programmes and the estimated cost. The issuer selects a suitable
advertising agency after comparing the effectiveness and cost of each programme
in consultation with the lead managers. The advertising agencies take responsibility
for giving publicity to the issue through appropriate platforms. These could be
NOTES newspapers, magazines, hoardings, press releases or a combination of all.
Financial Institutions
Financial institutions underwrite the issue and extend term loans to the companies.
Usually, they will scrutinize the draft prospectus, study the proposed programme
for public issue, and approve them. IDBI, IFCI and ICICI, LIC, GIC and UTI
are some of the financial institutions that underwrite and give financial assistance.
The lead manager will send a copy of the draft prospectus to the financial institutions
and include their comments, if any, in the revised draft.
Government and Statutory Agencies
The various regulatory bodies associated with a public issue are listed below:
 SEBI
 Registrar of Companies
 Reserve Bank of India (if the project involves foreign investment)
 Stock exchanges of the place where the issue is going to be listed
 Industrial licensing authorities
 Pollution control authorities (clearance for the project has to be stated in
the prospectus)
Check Your Progress

4. How can public issues be further classified?
5. What are the different ways in which a follow-on offering can be made?
6. What are the two types of private placement?

QUESTIONS
1. Equity shares have certain advantages. The main advantages are:

 Capital appreciation
 Limited liability
 Free tradability
 Tax advantages (in certain cases)
 Hedge against inflation
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80 Material
2. The share certificate is available in two forms. Corporate Securities
 Physical form – share certificates are issued in the physical form.

 Demat form – share certificates are issued in the electronic form.
3. The procedures and practices for managing public issues fall under two NOTES
phases:
 Pre-issue management begins with the structuring of issues and ends
with the opening of a subscription list;
 Post-issue management continues until the securities are listed on the
stock exchange.
4. Public issues can be further classified into initial public offerings (IPOs) and
follow-on public offerings.
5. A follow-on offering can be made in any one of the following ways:
 Promoters dilute their stake by offering some of their shares to the public.
 The company issues fresh shares.
 Both these approaches are combined.
6. Private placement can be of the following types:
 Preferential allotment
 Qualified institutions placement
5.6 SUMMARY
 Various types of securities are traded in the market. Securities broadly

represent evidence to property rights. A security provides a claim on an
asset and any future cash flows the asset may generate.
 Corporates generally raise funds through fixed and variable income securities
like equity shares, preference shares and debentures.
 Equity shares are commonly referred to as common stock or ordinary shares.
Even though the terms ‘shares’ and ‘stocks’ are interchangeably used, there
is a difference between them.
 Share certificate means a certificate under the common seal of the company
specifying the number of shares held by any member. A share certificate
provides the prima facie evidence of title of the members to such shares.
 Sweat equity is a new equity instrument introduced in the Companies
(Amendment) Ordinance, 1998. The newly inserted Section 79A of the
Companies Act, 1956 allows the issue of sweat equity.
 Non-voting shares carry no voting rights. They carry additional dividends
instead of voting rights. Even though the idea was widely discussed in 1987,
it was only in the year 1994 that the Finance Ministry announced certain
broad guidelines for the issue of non-voting shares. Self-Instructional
Material 81
Corporate Securities  A bonus share is the distribution of shares in addition to cash dividends to
existing shareholders. Bonus shares are issued to existing shareholders without
any payment of cash. The aim of a bonus share is to capitalize the free
reserves.
NOTES
 The characters of the preferred stock are hybrid in nature. Some of its
features resemble the bond and others the equity shares. Like the bonds,
their claims on the company’s income are limited, and they receive a fixed
dividend.
 A bond is a long-term debt instrument that promises to pay a fixed annual
sum as interest for a specified period of time.
 A warrant is a bearer document of title to buy a specified number of equity
shares at a specified price. Warrants can usually be exercised over a number
of years. The life periods of warrants are long. Warrants are offered to
make the bond or preferred stock offering more attractive.
 Market makers are those who quote rates for buying and selling the securities
they deal in. This is to ensure adequate liquidity for both buyers and sellers
in the securities market.
 Management of capital issues in India is a professional service rendered by
merchant bankers. In fact, issue management is a major function for merchant
bankers.
5.7 KEY WORDS
 Sweat equity: It is a party’s contribution to a project in the form of labour,

as opposed to financial equity such as paying others to perform the task.
 Non-voting share: A non-voting share is a share in the capital of a company
which belongs to a class that has no voting rights. This is distinct from, for
example, an ordinary share which gives the shareholder standard rights
to vote at shareholder meetings in proportion to their shareholding.

EXERCISES

1. Differentiate between right shares and bonus shares.
2. What are the different types of preference stock?
3. Write a short note on stock derivatives.
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Long Answer Questions Corporate Securities
1. How is marketing of corporate securities done? Discuss in detail.

2. What are the different types of issues? Analyse the different types of steps
to be taken by the issuing company? NOTES
3. Describe the role of lead managers and underwriters.

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Material 83
Management of
Post-Issue Activities
UNIT 6 MANAGEMENT OF POST-
ISSUE ACTIVITIES
NOTES
Structure
6.0 Introduction
6.1 Objectives
6.2 Processing of Data and Allotment of Shares
6.2.2 Bridge Loans
6.3 Reporting to SEBI
6.4 Listing on Stock Exchanges
6.6 Summary
6.7 Key Words
6.0 INTRODUCTION
In post-issue management, generally, the relative success or failure of public issue

mostly depends on response received for the issues. Thus, in a public issue, all the
players associated with are very much eager to know about the number of
applications received for subscription and also the amount collected thereon.
The market intermediaries who take part in the primary market to provide
specialised services in capital issue management are (a) merchant bankers,
(b) registrars, (c) underwrites, (d) brokers to the issue, (e) advisors to the issue,
(f) bankers to the issue, (g) advertising agencies, etc. This unit will examine various
post-issue management activities.
6.1 OBJECTIVES

 Describe the management of post-issue activities
 Analyse the processing on data and allotment of shares
 Discuss the process of listing of securities
 Define bridge loans and under subscription
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Management of
6.2 PROCESSING OF DATA AND ALLOTMENT OF Post-Issue Activities
SHARES
Corporates can raise funds through a fixed price issue, book building or a NOTES
combination of both. Free pricing of issues was introduced by SEBI in 1992.
SEBI gave a free hand to companies to set the issue price based on market dynamics
and no longer plays a role in price fixing. The issuer consults the merchant banker
and sets the price based on market demand. The offer document contains full
disclosures of the parameters that are taken into account by the merchant banker
and issuer to settle the price. The parameters include EPS, PE multiple, return on
net worth and comparison of these parameters with other companies in the same
industry. Based on comparative parameters, companies fix the price while issuing
shares.
An IPO can be made through the fixed price method, book building method
or a combination of both.
Fixed Price Issue
In a fixed price issue, the issuer decides the issue price at the outset and mentions
it in the offer document. The companies are free to price their equity shares.
However, they have to justify the price in the offer document / letter of offer.
The issue price can be the face value of the instrument, discounted price or
premium price, which is determined by the company. The allotment of securities to
different categories of investors in a fixed price issue is to be made on a proportionate
basis and the conditions are as below:
 A minimum 50 per cent of the net offer of securities to retail individual
investors.
 The remainder to:
o Individual applicants other than retail individual investors.
o Other investors, including corporate bodies/ institutions.
If shares set aside for either category remain unsubscribed, it would be
assigned to the other category, where there are more subscriptions. The issue
remains open for a minimum of three days and for a maximum of 10 days.
Book Building
SEBI introduced the practice of issuing shares through the book building process
in 1998—this was an important reform of the Indian market. The aim of book
building is to elicit demand and efficient price discovery for the issue of securities.
The book building process is undertaken, to determine investor appetite for a
share at a particular price.
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Management of Book building refers to the collection of bids from investors, based on an
indicative price range, to fix the issue price after the bid closing date. Book building
is a process of demand and price discovery of securities. SEBI Guidelines define
book building as a process undertaken by a corporate body to elicit the demand
NOTES and assess the price for the quantum of securities issued.
Types of Book Building
There are two types of book building 75 per cent book building and 100 per cent
book building.
Seventy-five per cent book building–allotment procedure: In case of
75 per cent book building, the balance 25 per cent of the net issue is allotted to the
public at the same price, determined through the book-building process.
Why is it called book building? The book building method provides an
opportunity to the market to discover the price for the securities offered, based on
the bids received. The process is so named because the investors can watch the
book being built in the form of a chart, indicating the price and the number of bids
received, which is updated at periodical intervals, not exceeding thirty minutes.
Book building is seen as an alternative to a fixed price issue mechanism.
The issuing company can issue the shares at a predetermined price or arrive at a
price through the book building process. The purpose of book building is to elicit
and build up the price of securities for the quantum offered by the issuing company.
In book building, the issuing company defines a price range, i.e,. floor (lower)
price and cap (upper) price. The issuer will notify the floor price or a price band
by way of an advertisement. After subscription, the company decides the basis of
allotment depending upon under or over subscription. On this basis, an applicant
may or may not get allotment of shares.
Floor price In case of book building, the floor price (base price) is the
minimum price at which bids can be made.
Band price The issuer sets a band within which the investors are allowed
to bid for shares. The cap in the price band should not be more than 20 per cent
of the floor price. Take the example of the recent issue of Yes Bank IPO; the floor
price was 38 and the band was 38–45.
Cut-off price In a book building issue, the issuer is required to indicate
either the price band or a floor price in the red herring prospectus. The actual
discovered issue price can be any price in the price band.
The issue price discovered in the book building process is the cut-off price.
Only an individual retail investor can apply at the cut off price, while submitting
the application. It means that the investor is ready to pay the price determined by
the company at the end of the book building process. An individual investor applies
for securities worth up to 2 lakh. SEBI has increased the earlier limit from 1–2
lakh in October 2010.
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When retail investors bid at the cut-off price, it indicates their willingness to Management of
accept the shares at any price within the price band. In such a case, they need not
indicate the price specifically. A retail investor has to pay the highest price along
with the application, while placing the bid at the cut-off price. They are required to
pay the margin amount calculated at the number of shares applied for multiplied by NOTES
the ceiling price. Those retail individual investors who have applied at the cut-off
price are eligible to be considered for allotment, irrespective of the issue price
finally determined through the price discovery process.
If the company settles on a final price lower than the highest price asked for
in the IPO, the remaining amount is returned to the retail investor.
The first 100 per cent book building issue was undertaken by Bharti
Televentures in 2001.
In 100 per cent book building process, the entire issue price is determined
through the book building process.
Red herring prospectus (RHP) A red herring prospectus does not contain
the details of either the price or the number of shares being offered or the amount
of issue. In other words, the full details of issue are not available. In case the price
is not disclosed, the number of shares and the upper and lower price bands are
disclosed. On the other hand, an issuer can state the issue size and the number of
shares are determined later. The issue size relates to the total amount that the
company wants to raise. In case, the final issue price is more than the minimum
price, the number of shares would be reduced as the issue size is fixed.
An RHP would be filed with the Registrar of Companies (RoC) without the
price band. In such a case, the issuer notifies the floor price or a price band by
way of an advertisement one day before the opening of the issue. The details of
the final price are included in the offer document only on completion of the bidding
process. The offer document, filed thereafter with the RoC, is called a prospectus.
Is book building compulsory? A company has the option to come out
with a fixed price issue or a book built issue. However, if the company does not
satisfy any of the conditions stipulated in Chapter III Part I Clause 26 (I) of the
SEBI ICDR Regulations 2009, then it has to go through the book built route.
Working mechanism of the book building process Book building is a
new buzzword in the capital markets. It is aimed to aid price and demand discovery.
The red herring prospectus may contain either the floor price for the securities or
a price band within which the investors can bid. The spread between the floor and
the cap of the price band shall not be more than 20 per cent. In other words, the
cap should not be more than 120 per cent of the floor price.
Book building is like a public auction. The process is as under:
Bidding takes place through an electronically linked transparent bidding
facility, provided by recognized stock exchange/s.
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Management of The issuer who is planning an offer nominates lead merchant banker(s) as
‘book runners’.
A red herring prospectus has to be filed with the registrar of companies,
before the bidding process begins.
NOTES
The issuer also appoints syndicate members with whom orders are to be
placed by the investors.
The syndicate members input the orders into an ‘electronic book’. This
process is called ‘bidding’ and is similar to open auction.
The book remains open for a minimum of three days for all categories of
applicants, which can be extended to ten days, in case of a revision in the price
band.
Investors who desire to participate in book building issues are required to
fill up a bid-cum-application form and deposit it with one of the designated bidding
centres along with the margin payment.
The issuer specifies the number of securities to be issued and the price band
for the bids.
Bids have to be entered within the specified price band.
Bids can be revised by the bidders any number of times, before the book
closes.
To maintain transparency in the bidding process, at the end of every bidding
session, the demand for the issue is shown in the graph format on the terminals at
periodical intervals.
On the close of the book building period, the book runners evaluate the
bids on the basis of the demand at various price levels.
The book runner and the company conclude the pricing and decide the
basis of allotment.
As the number of shares is fixed, the issue size gets frozen, based on the
final price per share.
Allocation of securities is made to the successful bidders and the rest get
refund orders.
Allotment is to be made within a period of 15 days from closure of the
issue, failing which the issuer will be liable to pay interest at the rate of 15 per cent
p.a. till the date of allotment.
The details of the final price are included in the offer document only on
completion of the bidding process. The offer document filed thereafter with ROC
is called a prospectus.
SEBI has not fixed any formula for arriving at the issue (price fixation),
which is left to the company to decide, depending on market dynamics.
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The issue price is the same for all who are allotted shares. Even if an applicant Management of
bidder has quoted a price higher than the final price, the excess amount is refunded.
Objective of case The objective of the following imaginary case is to explain
how allotment of shares is made, when the issue is oversubscribed, to please the
NOTES
investors as well as derive benefit from the issue.
Company XYZ Ltd issues 1,00,000 shares through book building. It has
fixed a price band of 60–72. The final demand is provided in Table 6.1.
Table 6.1 Final Demand
No. of Shares Subscribed Cumulative Quantity Price at Which Allotment

(in thousands) (in thousands) can be Made ( )
10 10 72
15 25 71
30 55 70
45 100 68
90 190 65
100 290 62
105 395 60
The issue is 1,00,000 shares, which the company wants to allot at the best
possible price in the price band. In the above example, all the 1,00,000 shares are
being subscribed at a price of 68 by investors. If the company wishes, it can fix
the price at 68 and allot all the shares offered to the public. The issuing company
can secure the maximum benefit, if it fixes the cut-off price at 68. However, the
company, in consultation with the lead manager, has decided to fix an issue price
at 65 and allot on a lottery basis as the number of eligible applicants are (1,90,000),
more than the number of shares (1,00,000) issued to the public. There would be
several disappointed applicants, at least 90,000 who have quoted a higher price
but would not get the allotment and may be keen to buy in the stock market, after
listing. So, the price may not fall below 65, at least for some time after the listing.
In this process, the issuing company receives some benefit and also leaves some
juice to the investors to satisfy their appetite, after listing. This action of company
establishes a good brand image that it cares for the investors, even after the issue
is fully subscribed at a price of 68.
Generally, when the issue is heavily oversubscribed, the issuing company
has the opportunity to allot the full issue at the top end of the price band. However,
there have been exceptions in the past where the issuers have fixed the issue price
at less than the cap price, despite the heavy oversubscription from the investors.
While determining the final issue price, the issuer as well as the book running lead
manager (BRLM) will take into account the likely price at which the issue will be
listed and traded.
The success of an issue is based on the market price, after being listed and
its stability, at least, for a reasonable period. This is the litmus test for the success
of an issue.
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Management of Most book running lead managers (BRLMs) and issuers take this aspect
into account and allow a little bit of juice to the investors so that there is sufficient
liquidity for the shares post-listing. After initial listing, the market price may not
remain stable and may fall below the issue price. The strategy of fixing a lower
NOTES price does not allow the market price to fall below the issue price, at least, for a
reasonable period.
SEBI, as regulator, does not participate in setting the price for issues. It is
up to the company to decide on the price or the price band, in consultation with
merchant bankers.
Listing: In case of book building, listing has to be completed within 12
days of the closure of the issue, which facilitates early trading.
Open outcry system for book building: Open outcry system for book
building is not permitted. As per SEBI, only an electronically linked transparent
facility is to be used in case of book building.
Quoting a price above the band will not in any way improve the purchaser’s
chances of getting an allotment.
Demat account for investors: As per the requirement, all the public issues
of size in excess of 10 crore are to made compulsorily in demat mode.
Guidelines for book building: The rules governing book building are
covered in Chapter XI of the Securities and Exchange Board of India (Disclosure
and Investor Protection) Guidelines 2000.
In a public issue, which follows the book building process, retail investors
have to deposit the application money based on the maximum price within the
price band, if they choose the cut-off option.
Rights of investors: The following are the rights of investors in book
building process:
1. An individual investor can revise his own bid at any time, before the
closure of the issue, using the book building facility.
2. A bidder can ask for a transaction registration slip as the proof of having
entered the bid. Whenever a bid is entered by trading members into the
system, a unique transaction registration slip is automatically generated.
The transaction registration slip gives details, such as the number of
shares in the bid, the price, the client’s name, etc.
3. An investor cannot enter a bid below the floor price. The system
automatically rejects the bids, if the price is less than the floor price.
4. Individual investors are certain to be eligible for an allotment, when they
exercise the option of a cut-off price. This privilege is only extended to
retail investors.
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Allotment: Allotment is to be made in case of book built issue as under: Management of
The other alternative is 100% book-building process. If the company makes
100% of the issue through the book-building process, the basis of allocation of the
issue should be as shown in Table 6.2.
NOTES
Table 6.2 Basis of Allocation of the Issue
Category to Whom Allotment is to be Made % of Issue

Retail investors 35% minimum
Non-institutional investors i.e., other than retail 15% minimum
investors and qualified institutional buyers (QIBs)
Qualified institutional buyers (QIBs) Not more than 50%
In a book built issue, allocation to individual retail investors, non-institutional

investors and QIBs is in the ratio of 35:15: 50 respectively. All allottees are allotted
shares on a proportionate basis within their respective investor categories.
Issue of share capital through book-building has been made compulsory for
those companies, which do not have a profitable track record. Book-building is
compulsory for those companies that do not have distributable profits for a minimum
period of three years. Such non-profit making companies have to allot at least 50
per cent of the net offer to the QIBs, failing which the full subscription monies shall
be refunded.
The media has commended the initiative taken by the SEBI, which will
enable retail investors to make a well informed decision (Box 6.1), while investing
in IPOs:
Box 6.1 SEBI Notifies IPO Reforms

Steps include keeping a strict vigil on issue proceeds and allotting a minimum
number of shares to retail investors.
The company would also have to open the issue at least three working days
from the date of registering the red herring prospectus with the Registrar of
Companies.
The companies would have to disclose the price band at least five days before
the opening of the offer period, as against the current provision of two days.
This will give the investors more time to analyse the IPO.
The minimum application size for all investors has also been increased to 10,000–
15,000, as against the existing 5,000–7,000.
In another step aimed at helping retail investors, SEBI has allowed retail individual
investors to either withdraw or revise their bids until finalization of the allotment,
but institutional buyers and non-institutional investors can neither withdraw
nor lower the size of their bids at any stage. The move is aimed at avoiding any
misleading signals to retail investors about the extent of the issue subscription.
Source: Live Mint, 15 October 2012
The applications supported by blocked amount (ASBA) process The

ASBA process is available in all public issues made through the book building
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Management of route. ASBA is an application containing an authorization to block the application
money in a bank account for subscribing to an issue. If an investor is applying
through ASBA, his application money will be debited from the bank account only
if his application is selected for allotment after the basis of allotment is finalized. In
NOTES this process, banks block the amount in the bank account and funds continue to
remain in the same account till allotment by the issuer.
Undersubscribed is a situation in which the demand for an initial public offering of
securities is less than the number of shares issued. An offering is undersubscribed
when the underwriter is not able to get enough interest in the shares for sale.
Because there may not be a firm offering price at the time, purchasers usually
subscribe for a certain number of shares. This process allows the underwriter to
gauge demand for the offering and determine whether a given price is fair.
6.2.2 Bridge Loans
A bridge home loan is a short-term loan when the owner of an existing house
wants to sell it and buy another, without waiting for the sale proceeds of the existing
house. The new home is normally bigger or located elsewhere to suit the changed
requirements of the person concerned.
If one is planning to move into a bigger, better and more convenient house
from the existing small home, without waiting for its sale proceeds, a short-term
bridge loan is the ideal choice.
Here, the individual owns a small house and wants to buy a bigger house.
But he does not want to sell the existing house before buying the bigger one. This
creates a mismatch in the cash flow. The short-term bridge loan helps him in the
interim period between the sale of the existing house and the purchase of a new
one.
The procedure is very similar to that of applying for a normal home loan in
terms of the eligibility criteria and the documents to be furnished. However, it is
mandatory for the borrower to identify the new house that is to be purchased
before going to a bank. The application for a bridge loan is generally considered
only after ensuring that the prospective borrower has entered into an agreement
for the sale of his property. On the negative side, the interest rates on bridge loans
are higher than those on home loans because it is a short-term loan, and also,
costs and fees are also involved in it.
Check Your Progress

1. How can an IPO be made?
2. What are the two types of book building?
3. What is the situation of under subscription?
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Management of
6.3 REPORTING TO SEBI Post-Issue Activities
The eligibility norms for public issue as issued by the SEBI are as follows:
1. Unlisted company NOTES
An unlisted company needs to satisfy all the following criteria to be eligible for
making a public issue, which is popularly known as the profitability route. It should
have the following:
 Net tangible assets of at least 3 crore for three full years, out of which 50
per cent is held in monetary assets
 Distributable profits in at least three years out of the past five years in terms
of section 205
 Net worth of at least 1 crore in each of the preceding three years
 If it has changed its name, at least 50 per cent of revenue for the preceding
one year should be from the new activity
 The issue size should not exceed five times the pre-issue net worth
The unlisted company has to comply with all the above five conditions to
make a public issue.
Alternative eligibility norms for public issue To provide sufficient
flexibility and also ensure that genuine entrepreneurs do not suffer on account of
the rigidity of the above parameters, SEBI has provided two alternative routes for
unlisted companies:
QIB route: The total issue has to be made through the book building process
(100 per cent), out of which at least 50 per cent of the net offer should be allotted
to QIBs, otherwise the full subscription money is to be refunded.
Appraisal route: The project should be appraised by public financial
institutions and scheduled commercial banks, who would be prepared to participate
to the extent of 15 per cent, 10 per cent of which will come from the appraisers. In
addition, 10 per cent of the issue size must be allotted to QIBs. Otherwise, the
subscription money has to be refunded.
 The post-issue size shall be a minimum of 10 crore or there must be
market making for at least two years subject to the following conditions:
 Market makers undertake to buy and sell for a minimum depth of 300
specified securities
 The spread in the bid-ask difference for sale and purchase is not to
exceed 10 per cent
 The inventory holding of market makers as on the date of allotment of
securities shall be at least 5 per cent of the proposed issue
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Management of The unlisted company can adopt any one of the above alternative routes to
make a public issue. In addition to the compliance of any one of the above eligibility
conditions, the company that makes the issue shall have at least 1,000 prospective
allottees in the issue.
NOTES
Minimum promoter’s contribution and lock-in: In a public issue by an
unlisted issuer, the promoters shall contribute not less than 20 per cent of the post-
issue capital, which should be locked in for three years. A lock-in indicates a
freeze on the shares. The remaining pre-issue capital should also be locked in for
a period of one year from the date of listing. In case of a public issue by a listed
issuer (i.e., FPO), the promoters shall contribute not less than 20 per cent of the
post-issue capital or 20 per cent of the issue size. This provision ensures that
promoters of the company have some minimum stake in the company for a minimum
period after the issue or after the project for which funds have been raised from
the public, commences.
2. Listed company
A listed company is eligible to make a public issue of equity shares or any other
security that can be converted into or exchanged into equity shares at a later date,
provided it complies with the following conditions:
 The issue size does not exceed five times its pre-issue net worth as per the
audited balance sheet of the last year.
 If the company has changed its name, at least 50 per cent of the revenue for
the preceding one year should be from the new activity.
If the issue size exceeds five times the company’s net worth, prior to the
issue, the listed company has to make the issue through the book building process
and allot 50 per cent of shares to QIBs; otherwise, the subscription money collected
has to be refunded.
3. Fast track issue
To enable listed companies to access the Indian primary market quickly, SEBI
has specified the requirements to make fast track issues (FTIs). The listed companies
can make a follow-on public offer/rights issue by filing a copy of their red herring
prospectus (in case their issue is made through book building) or a prospectus (in
case their issue is made through fixed price) with the Registrar of Companies. The
provisions relating to filing of offer documents are not applicable to a listed company
that wants to make a public issue of securities via a follow-on public offer/rights
issue, where the aggregate value of the securities, including premium, if any, exceeds
50 lakh.
The applicable conditions are as under:
Listing: The shares of the company have been listed on any stock exchange
that has nationwide terminals for a period of at least three years, immediately
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preceding the reference date. In case of non-compliance, adequate disclosure has Management of
been made in the offer document in respect of non-compliance.
Market capitalization: The average market capitalization of public
shareholding of the company is at least 5,000 crore (reduced from 10,000
NOTES
crore earlier) for a period of one year up to the end of the quarter, preceding the
month of issue. The average market capitalization of public shareholding means
the sum of the daily market capitalization of public shareholding divided by the
number of trading days.
Annualized trading turnover: The annualized trading turnover of the
shares of the company is 2 per cent of the weighted average of the number of
shares listed during the six months period, preceding the month of the reference
date.
Grievances/complaints: The company has redressed at least 95 per cent
of the grievances/complaints of the shareholders/investors received till the end of
the quarter, immediately preceding the month of issue.
Auditors’ qualifications: When the accounting treatment adopted by the
company is not acceptable, the statutory auditor makes qualifications in its audit
report. Further, the auditor also has to quantify the impact of qualification on profits
for the benefit of the readers. In the absence of quantification, the significance may
not be known. The impact of the auditors’ qualifications, if any, on the audited
accounts has not exceeded 5 per cent of the net profits/loss after tax for the
respective years.
Prosecution proceedings: No prosecution proceedings or show cause
notice has been issued by the SEBI against the company or the promoters or full-
time directors on the reference date.
Dematerialized shareholding: The entire shareholding of the promoters
group has been held in dematerialized form on the reference date.
Is the Book-building Process Compulsory for all Companies?
The book-building process is compulsory for those companies without an
established track record of profits. It is optional for profitability route companies,
which have to comply with specific conditions, including distributable profits for a
period of three years, before issue of share capital. As per SEBI’s guidelines, this
book building process is not compulsory for those IPOs that comply with all the
conditions in the profitability route. In case companies do not have a track record
of profitability and the required net worth as per SEBI guidelines, the book-building
process is compulsory in the QIB route. SEBI has tightened the entry norms for
IPOs to enhance the quality of issues in the primary market. Depending on the
entry route, the book-building process can be voluntary or compulsory. However,
infrastructure companies are exempt from the book building requirement.
The book-building process is not compulsory for those companies which
have an established track record of profits. Those companies have the option to
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Material 95
Management of issue shares either at a predetermined fixed price or through the book building
process.
Exempted Category of Entities
NOTES SEBI (Disclosure and Investor Protection) guidelines have provided certain
exemptions from the eligibility norms. The following are eligible for exemption
from entry norms.
 Private sector banks
 Public sector banks
 An infrastructure company, whose project has been appraised by approved
institutions
 Rights issue by a listed company
6.4 LISTING ON STOCK EXCHANGES
Listing means admission of securities to dealings on a recognized stock exchange.

The securities may be of any public limited company, central or state government,
quasi-governmental and other financial institutions/corporations, municipalities, etc.
The following are the reasons why a company may seek listing for its shares:
 Access to a wider pool of finance: Listing on the stock market
provides greater access to a number of potential investors. Listing also
improves the credit rating of a company, making debt finance easier and
cheaper to obtain.
 Improved marketability: Securities that are traded on the stock market
can be bought and sold in relatively small quantities at any time with
greater ease.
 Transfer of capital to other uses: Founder owners can sell part of
their holdings either for personal reasons or for investment in other
business opportunities.
 Enhancement of company image: Quoted companies are commonly
believed to be more financially stable. Listing improves the image of the
company with its customers and suppliers, allowing it to gain additional
business and improve its buying power.
 Offer for acquisition: A listed company is in a better position to make
a paper offer for a target company than an unlisted one.
Check Your Progress

4. State the full form of FTI?
5. What categories of entities are exempted from entry norms?
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Management of
6.5 ANSWERS TO CHECK YOUR PROGRESS Post-Issue Activities
QUESTIONS
1. An IPO can be made through the fixed price method, book building method NOTES
or a combination of both.
2. There are two types of book building– 75 per cent book building and 100
per cent book building.
3. Undersubscribed is a situation in which the demand for an initial public
offering of securities is less than the number of shares issued. An offering is
undersubscribed when the underwriter is not able to get enough interest in
the shares for sale.
4. The full form of FTI is Fast Track Issues.
5. The following are eligible for exemption from entry norms.
(a) Private sector banks
(b) Public sector banks
(c) An infrastructure company, whose project has been appraised by
approved institutions
(d) Rights issue by a listed company
6.6 SUMMARY
 Corporates can raise funds through a fixed price issue, book building or a
combination of both. Free pricing of issues was introduced by SEBI in
1992.
 SEBI gave a free hand to companies to set the issue price based on market
dynamics and no longer plays a role in price fixing. The issuer consults the
merchant banker and sets the price based on market demand.
 In a fixed price issue, the issuer decides the issue price at the outset and
mentions it in the offer document. The companies are free to price their
equity shares.
 The issue price can be the face value of the instrument, discounted price or
premium price, which is determined by the company.
 Book building refers to the collection of bids from investors, based on an
indicative price range, to fix the issue price after the bid closing date. Book
building is a process of demand and price discovery of securities.
 SEBI Guidelines define book building as a process undertaken by a
corporate body to elicit the demand and assess the price for the quantum of
securities issued.
Self-Instructional
Material 97
Management of  Book building is seen as an alternative to a fixed price issue mechanism.
The issuing company can issue the shares at a predetermined price or arrive
at a price through the book building process.
 The purpose of book building is to elicit and build up the price of securities
NOTES
for the quantum offered by the issuing company.
 When retail investors bid at the cut-off price, it indicates their willingness to
accept the shares at any price within the price band. In such a case, they
need not indicate the price specifically.
 A red herring prospectus does not contain the details of either the price or
the number of shares being offered or the amount of issue.
 Undersubscribed is a situation in which the demand for an initial public
offering of securities is less than the number of shares issued. An offering is
undersubscribed when the underwriter is not able to get enough interest in
the shares for sale.
 A bridge home loan is a short-term loan when the owner of an existing
house wants to sell it and buy another, without waiting for the sale proceeds
of the existing house. The new home is normally bigger or located elsewhere
to suit the changed requirements of the person concerned.
 Listing means admission of securities to dealings on a recognized stock
exchange. The securities may be of any public limited company, central or
state government, quasi-governmental and other financial institutions/
corporations, municipalities, etc.
6.7 KEY WORDS
 Red herring prospectus: A red herring prospectus, as a first or preliminary

prospectus, is a document submitted by a company as part of a public
offering of securities.
 Bridge loan: A sum of money lent by a bank to cover an interval between
two transactions, typically the buying of one house and the selling of another;
a bridging loan.

EXERCISES
Short-Answer Questions
1. Write a short note on fixed price issue.
2. What is a red herring prospectus?
3. Write a short note on allotment of shares.
Self-Instructional
98 Material
Long-Answer Questions Management of
1. Describe the different types of book building.
2. Analyse the different eligibility norms for public issue.
3. How is listing on stock exchanges done? Describe the process. NOTES

Self-Instructional
Material 99
Service Oriented
Banker UNIT 7 SERVICE ORIENTED
NOTES
BANKER
Structure
7.0 Introduction
7.1 Objectives
7.2 Merger and Amalgamation: Meaning and Purpose
7.4 Summary
7.5 Key Words
7.0 INTRODUCTION
As you have learnt previously, rural banks in India were established in the country
under RRB Act, 1976 with a view to develop the rural economy by providing for
the purpose of development of agriculture, trade commerce, industry and other
production activities in the rural areas, credit and other facilities particularly to
small and marginal farmers agricultural labourers artisans and small entrepreneurs
and for matters connected there with and incidental thereto. In the initial stages
during the 1970s and 1980s, RRBs were seen as primarily catering to the BPL
population by lending to them towards meeting their investment needs. The
recapitalization of RRBs during 1994-2000 along with a reorientation towers
profitable function helped to restore the fortunes of RRBs. Thereafter the process
of amalgamation which was started in 2005 has resulted in the number of RRBs
being brought down. The amendment to the RRBs Act passed in April 2015
facilitates the raising of share capital of RRBs. These changes has paved way for
their part privatisation and pure commercialisation and given access to institutional
credit. RRBs have been repositioned as development oriented banks in the service
of the poor as well as to be in harmony with the objectives and programmes of
financial credit.
7.1 OBJECTIVES

 Discuss the meaning and types of mergers
 Describe amalgamations and consolidation
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100 Material
Service Oriented
7.2 MERGER AND AMALGAMATION: MEANING Activities of a Rural
Banker
AND PURPOSE
Restructuring has become the compelling necessity to survive in this fiercely NOTES
competitive environment. Restructuring is required primarily to maintain status quo
and secondly for growth. Corporate houses are redefining their mission statements
by focusing on core competence and competitive advantage in a bid to achieve
market leadership.
The term corporate restructuring encompasses business portfolio restructuring
by the process of mergers, demergers, takeovers, acquisitions, foreign franchise
purchase of brands and hiring of unrelated businesses, strategic alliances and joint
ventures and above all internal financial restructuring and organizational restructuring.
Restructuring is a process by which a firm does an analysis of itself at a
point of time and alters what it owes and owns, refocuses itself to specific tasks of
performance improvements. Restructuring would radically alter a firm’s capital
structure, asset mix and organization to enhance the firm’s value. Corporate
restructuring refers to episodic exercise in the life of a business firm involving a
significant change in its pattern of ownership and contract, or structure of assets
and liabilities or both. Corporate restructuring may lead to (a) expansion and (b)
change in ownership and contract.
Corporate restructuring has become very vital for achieving all the ultimate
managerial objectives.
Corporate restructuring through mergers and acquisitions, takeovers, control
and change in ownership structure is undertaken by companies for enlarging their
size and for being benefited by the concept of economies of scale. Mergers and
acquisitions are crucial in ensuring a healthy expansion of organizations as they
evolve.
Various stages of developmental growth mergers and amalgamations may
facilitate entry into new services or product market.
Many experts feel that corporate restructuring is neither a panacea nor a
palliative for curing the problem of global competition. Corporate restructuring is
not an easy process to manage. It is a difficult task demanding strong management
skills, imagination, leadership attitude and also finance. Corporate restructuring
may be termed as a process of self-transformation of the promoters, managers
and the employees. Each corporation should re-examine itself to know whether it
has the willingness and ability to reorient itself to withstand the pains of restructuring
including adaptability to new processes and technologies and also the different
demands of the customers.
Self-Instructional
Material 101
Service Oriented Forms of Restructuring Business Firms
Banker
1. Expansion
 Mergers
NOTES  Acquisitions
 Amalgamations
 Consolidation
 Compromise
 Tender offers
 Arrangement
 Joint Ventures
 Reconstruction
2. Sell-offs
3. Spin-offs
4. Split-offs
5. Split-ups
6. Divestures
7. Equity carve-outs
8. Corporate control
 Premium buybacks
 Standstill agreements
 Anti-takeover amendments
 Proxy contests
9. Change in ownership structure
 Exchange offers
 Share repurchases
 Going private
 Leveraged buyout
Merger
A number of strategic imperatives have been driving companies towards mergers
and acquisitions. They include globalization, consolidation, product differentiation,
and customer demands, vertical integration, deregulation, technology requirements
and refashioning. There has been a substantial increase in acquisitions and mergers
by the corporate sector in India. This trend started in 1991, with the scrapping of
Self-Instructional
102 Material
the relevant sections of Monopolies and Restrictive Trade Practices (MRTP) Act Service Oriented
and Foreign Exchange Regulation (FERA) Act which required companies to get Banker
prior permission from the government for mergers.
The terms merger, amalgamation and acquisition are often used
NOTES
interchangeably to denote the situation where two or more companies combine
into one economic entity to share risks, keeping in view their long-term business
interest.
Amalgamation, merger and acquisition of undertakings are tools for
materializing several objectives of the organization. These tools have been in use
from a long time in one form or the other. At present, there are statutory requirements
to be complied with by a company under the Companies Act, 2013 for merger,
amalgamation and acquisition.
Meaning
If we go by the literal meaning of the words merger, acquisition or amalgamation,
they mean the blending of one undertaking with another which may either be existing
or new. It is a tool by which one or two undertakings come under the umbrella of
one undertaking.
The Income Tax Act provides that for taking benefits of carrying forward
losses and depreciation of the amalgamating undertakings, the following ‘conditions
must be fulfilled.
 All the assets and liabilities of the amalgamating companies must be
transferred to the amalgamated company.
 At least 90 per cent members of the amalgamating companies must
become the members of the amalgamated company.
 The shareholders of the amalgamated company must be given shares of
the amalgamated company in exchange.
According to M.A. Weinberg, ‘A merger may be defined as an arrangement
whereby the assets of two companies become vested in, or under the control of
one company, (which may or may not be one of the original two companies)
which has its shareholders all or substantially all the shareholders ‘of the two
companies’.
A merger involves the fusion of two or more separate companies into one.
It is a special case of combining companies where one survives and the other loses
its identity. The company that acquires the other company acquires the assets,
stock as well as liabilities of the merged company/companies in the form of equity
shares of the. Transferee Company. The shareholders of the transferor company
become shareholders in the’ transferee company. Merger generally means that
one company that is of less importance opts to become non-existent after the
merger, for example, TOMCO after the merger with Hindustan Lever.
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Service Oriented Amalgamation
Banker
The word amalgamation is not defined by the Companies Act. The word has no
precise legal meaning. In commercial parlance, the word amalgamation is used
NOTES when two or more independent companies combine to form a new business. In
case of amalgamation, a new company is formed and all the amalgamating
companies are liquidated.
In Halsbury’s Laws of England, amalgamation is stated as the blending
together of two or more undertakings into one undertaking and in such an act, the
shareholders of each blending company becomes the shareholders of the blended
undertaking. Amalgamation may take place either by transfer of two or more
undertakings to a new company or by the transfer of one or more undertakings to
an existing ‘company.
Incorporation of a new company to effect amalgamation is permissible. So
a new company may be formed for amalgamation and takeover of an old company.
However, it involves the formation of a new company to carry on the business of
the old company.
Generally, amalgamation paves the way for better and more efficient control
in running the operations and leads to saving costs and improved profitability.
Amalgamation is a legal process by which two or more companies are
joined together to form a new entity or one or more companies are absorbed or
blended with another, which will result in the amalgamating companies to lose its
existence and its shareholders to become the shareholders of the new company or
the amalgamated company. In an amalgamation, a new company may come into
existence or an old company may survive while the amalgamating company
may lose its existence.
Amalgamation signifies an arrangement to bring together the assets of two
companies under a single company’s control, which may or may not be one of the
original two companies.
Examples of mergers and amalgamations
Indian banks have adopted the merger strategy to compete with foreign banks,
since after the merger, the growth rate of deposits, income, total expenditure,
profit, capital, number of employees and the number of branches increase
considerably. Mergers help banks to increase asset size, strengthen their presence,
optimize resources and diversify the range of products and services. The following
is the list of mergers which has taken place in the last few years in our country.
 Times Bank (Bennett Coleman & Company) has been merged with HDFC
Bank.
 ICICI a leading development bank was merged with ICICI Bank in 2002.
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104 Material
 Global Trust Bank was amalgamated with the Oriental Bank of Commerce Service Oriented
in 2004. Banker
 IDBI Bank was merged with its parent institution IDBI a development bank
on 2 April 2005.
NOTES
 Lord Krishna Bank was merged with Centurion Bank of Punjab in 2007.
 Centurion Bank of Punjab was merged with HDFC Bank.
Acquisition
Acquisition implies that one of the firms loses its identity and that it has been
purchased by the firm that continues its existence. According to the Collins Business
Dictionary an acquisition is the act of getting or buying something.
In the context of business combinations, an acquisition means purchase of
share capital of an existing company by another company. Theoretically, more
than 50 per cent of the paid-up quality capital of the acquired company should be
bought by the acquirer for enjoying complete control. However, in practice, even
with 10-40 per cent shareholding, effective control can be exercised. Since the
remaining shareholders are usually scattered and ill-organized, they are not likely
to challenge the control of the acquirer.
An asset acquisition is an acquisition of all or part of the assets of a company
pursuant to a contract entered into between the buyer and the seller. Asset acquisition
requires that specific instruments of title must be delivered by the seller for
transferring, the legal title to the buyer.
A share acquisition or takeover is an acquisition in which all or part of the
outstanding shares of the seller is acquired from the shareholders of the seller
company. A takeover is defined as a transaction or series of transactions in which
a person (individual, group of individuals or company), acquires control of a
company’s assets either directly by becoming the owner of those assets or indirectly
by obtaining control of the company’s management where shares are closely held
(by a small number of persons). A takeover will come into effect by an agreement
with the holders of those shares. In case the shares are held by the public, a
takeover may come into effect by an agreement between the acquirers and the
controllers of the acquired company by purchasing shares on the stock exchange.
A takeover or acquisition may be effected by the following:
 An agreement between the acquirer and the majority
 Purchase of shares in the open market as in the case of Genelec Ltd and
Spencer Ltd
 A public offer to all the shareholders as in the case of Tata Tea Ltd and
Consolidated Coffee Ltd
 Private treaty for purchasing new shares
 By means of a takeover bid
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Material 105
Service Oriented Distinction between merger and acquisition
Banker
The word merger is commonly used as an alternative to acquisition or takeover.
However, there are some differences between the two also. The differences are
NOTES as follows:
(i) In takeover, the companies involved continue their corporate existence
without interruption, whereas in a merger only one company survives and
the other loses its existence.
(ii) The consideration payable in a takeover is generally in the form of cash
thought it may also be paid in the form of equity shares or debentures or a
mix of the various modes available.
Consideration in a merger paid for or received in shares. All shareholders
receive money in future periods of time in the form of future dividends and/
or capital appreciation.
(iii) Takeover generally takes longer than mergers because in a takeover the
bid for controlling the stake in the target company is frequently against the
wishes of the management of the target company, whereas in the case of a
merger the bid is generally by the consent of the management of both the
companies.
(iv) The legal routes to mergers and acquisitions are different in the Indian context.
Sections 230 to 240 of the Companies Act 2013 require consent of
shareholders, creditors and approval of the courts in case of mergers, whereas
takeovers/ acquisitions are governed by the Securities and Exchange Board
of India (SEBI) regulations.
Consolidation
Consolidation implies a completely new form that is created from the merged
firms. Consolidation represents a combination of two or more business firms into
a new business firm. The essence of consolidation is that all the combining firms
lose their identity.
Consolidation is preferred because when a large firms combine with small
firms, normally the smaller firms are merged into the larger firm. However, when
two firms of the -same size combine, it is very difficult to make one of the firms
agree to lose its identity and merge with the other firm. In such situations,
consolidations desired. Another reason is that the combining firms get an opportunity
to obtain a new corporate charter with more favourable features than that present
in the charter of the existing firms.
Compromise
If there is a dispute between two parties, say, between the company and its creditor
or between secured and unsecured creditors of a company or preference
shareholders and equity shareholders of a company, it can be resolved through a
Self-Instructional
106 Material
compromise. A compromise is a term which implies the existence of a dispute, Service Oriented
such as relating to rights (Sheath Valley Gold Ltd (1893) ICH 477). It means Banker
settlement or adjustment of claims in a dispute by mutual concession by the parties
to the disputes or differences. It is a mode of terminating a controversy by the
method of making mutual concessions. In compromise, the parties propose to NOTES
arrive at a settlement of an existing dispute which could relate to some kind of
rights, duties or powers, between themselves by a give and take arrangement.
Each party should be empowered to make the necessary concessions. A company
has the same right to compromise claims ‘brought against it as an individual person
has. A reasonable compromise must be a compromise which is reasonable and
beneficial to both sides making it. If the members have to give up their rights
entirely, it will not be a compromise. Similarly, a claimant who abandons his claims
not compromising it. A compromise pre-supposes the existence of a dispute for
there can be no compromise unless there is some dispute.
Arrangement
The Companies Act, 2013 defines arrangement as something analogous to
compromise and includes reorganization of share capital of the company by
consolidation of shares of different classes or by division of shares into share of
different classes or by both methods.
The word arrangement as defined under Section 230 of the Companies
Act, 2013 covers a wide range of arrangements, for example:
 For restarting a company that is being would up
 For reconstruction of a existing company by winding up and sale of its
undertaking for share in foreign company
 For transfer of shares to another company
 For debenture holders giving their consent for advancing the re-payment
period or for reducing the rate of interest
 Preference shareholders may reduce the rate of dividend or accept equity
share instead of preference shares
 Many other such arrangements
In the Oxford Law Dictionary, the expression ‘scheme of arrangement’ is
explained as follows:
1. An agreement between a debtor and his creditors to arrange the debtors’
offer to satisfy the creditors. The debtor usually agrees to such ail
arrangement in order to avoid bankruptcy. If the arrangement is agreed
upon when no bankruptcy order has been made, it is governed primarily
by the ordinary law of contract.
2. An agreement between a company and its creditors or members when
the company is in financial difficulties. To effect a takeover arrangement
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Material 107
Service Oriented implies rearrangement of rights or of liabilities without the existence of
Banker any dispute where under a scheme each shareholder of a company has
to transfer some of his shares to another company and some to the
shareholders of his own company.
NOTES
An arrangement can be resorted to even in the absence of any dispute and
includes agreements which modify rights about which there is no dispute and which
can be enforced upon without difficulty. Section 230 of the Companies Act provides
that the expression arrangement includes a reorganization of the share capital of
the company by consolidation of shares of different classes or by division of shares
into shares of different classes or by both those methods.
Reconstruction
The term reconstruction has not been defined anywhere in the Companies Act,
but it generally means reconstruction of the company as a whole or of the share
capital of the company which also includes varying rights of the shareholders in the
event of reconstruction. In reconstruction, the management of the company desires
to preserve the undertaking in some form. Management decides not to sell the
undertaking but to carry it on, may be in a modified form. It means that persons
now managing the firm will continue to manage the undertaking in substantially the
same manner as in the past and also the same business shall be carried on.
Reverse Merger
In reverse merger a smaller company acquires the larger company and is motivated
by tax benefits available wherever at least one of the companies in deal has
accumulated loss or unabsorbed expenses/allowance that can be earned forward
and set-off against future profit of the amalgamated, company. If the smaller firm
has better record and more promising future it is more appropriate to go for a
takeover. In some cases, the smaller company which may be listed may acquire a
larger company which is not listed in order to cover costs to keep the listing. In
normal practice, in corporate merger, the relative size in terms of either capital
employed or turnover of the companies determines which firm will be acquired.
However, in reverse merger a smaller company acquires a larger one. Restructuring
through reverse merger process is carried out by following the steps below:
 Capital reduction of the losing company to write off the share capital not
represented by assets
 Consolidation of shares after capital reduction to make face value of shares
of the acquirer at par with that of the target
 Change of name after merger
The basic philosophy of the reverse merger is to take advantage of the
provisions of the Income Tax Act, 1961. The Gujarat High Court has clarified in a
judgement that the basic principles of reverse merger should satisfy the following
conditions:
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108 Material
 The net assets of the amalgamating companies are greater than the net Service Oriented
assets of the amalgamated company. Banker
 Equity capital to be issued by the amalgamated company pursuant to
the acquisition exceeds its original issued capital.
NOTES
 The control of the amalgamated company goes into the hands of the
management of the amalgamated company.
When a healthy company amalgamates with a financially weak company, it
is reverse merger. In the context of the provisions of the Companies Act, 1956
there is no difference between a regular merger and ~ reverse merger. It is like any
other amalgamation.
If one of the merging companies is a sick industrial company under the Sick
Industrial Companies (Special Provisions) Act (SICA), it is also possible to carry
out the reverse merger through the High Court route. Such a merger must take
through the Board for Industrial and Financial Reconstruction (BIFR). The sick
company may get the name of the healthy company after amalgamation.
Reverse merger automatically makes the transferor company entitled to the
benefit of carry forward and set-off of loss and unabsorbed depreciation of the
transferee company according to Section 72 of the Income Tax Act.
Demerger
When for strategic reasons a conglomerate is split into two or more independent
bodies and assets are transferred to such bodies, it is known as demerger. Demerger
is not just the opposite to merger; it is also called spin-off or hiving-off. Demerger
refers to the situation where an undertaking is separated and transferred to a separate
company and decided to run as an independent unit from the earlier enterprise.
ABC Ltd, for example, carries on the business of chemicals and textile; if the
textile unit is not doing well or is doing exceptionally well, in either case, it may be
found desirable to split-off textiles business into a separate company to have sharp
focus. By demerging the business activities, a corporate body splits into two or
more corporate bodies with separation of management and accountability. The
main reason for making each division a profit centred organization may be to
make each head of the division accountable for profitability of their respective
divisions.
The provisions of the Income Tax Act, 1961 recognizes demerger only if
restructuring is pursuant to Sections 230 to 240 the Companies Act, 2013 and to
avail the tax advantage of demerger it should be in the spirit of Section. 2(19AA)
of the Income Tax Act. The tax benefits available to the resulting company is that
accumulated loss and unabsorbed depreciation of the demerged company will be
allowed to be carried forward and set-off in the hands of the resulting company
and the resulting company can carry the losses forward only for the remaining
period out of the permissible assessment year.
Self-Instructional
Material 109
Service Oriented Reasons for demerger
Banker
The strategic reasons for demerger are as follows:
 To restructure the existing business by segregating uncommon activities into
NOTES different corporate bodies
 Separation of management of different undertakings
 Introduction of the concept of responsibility and accountability
 Protection of business from high-risk activities and undertakings which are
continuously incurring cash losses
 Bringing clear lines of management
 Protection of crown jewel from the predator through hostile takeover
 Avoidance of frequent interference of government and its agencies in business
 Division of familiar managed business
 Tapping more opportunities
 Separation of unwanted activities and to concentrate on care activities
 Enable management buyouts
The potential disadvantages of demergers are as follows:
 Loss of economies of scale
 Increase in overhead cost
 Loss of ability to raise extra finances
 Lower turnover and profitability
 Loss of benefits from synergy.
Modes of demerger
There are three ways of demerger.
 Demerger by arrangement between promoters
 Demerger under the scheme of arrangement with apprbva1 from the rest
Under Section 238 of the Companies Act, 2013
 Demerger under voluntary winding up
The promoters of the company can enter into an agreement for division of
the company and in that case the company is wound up after division. The assets
are distributed after paying off the liabilities.
Similarly, a company which has been split up unto several companies after
division could be wound up voluntarily pursuant to the provisions of Sections 304
to 323 of the Companies Act, 2013
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110 Material
Service Oriented
Example of Grasim Demerger Banker
Grasim Industries Limited decided to separate its cement division. Grasim’s

cement related assets were to be transferred to a wholly-owned subsidiary
Samruddhi Cement Limited and Grasim shareholders were to get one share of
NOTES
Samruddhi for each share they hold. Grasim will hold 65 per cent of Samruddhi
and Grasim’s shareholders will hold 35 per cent shares. Grasim took this decision
because it wanted to continue to have a stake in the cement business and
Grasim’s cash flows from viscose staple fibre have contented to the expansion
of the cement business and in the cement operations many continue to need
these cash flows. The company gave only 35 per cent shares to Grasim
shareholders in Samruddhi and not 100 per cent because Grasim holds 55 per
cent of Ultra Tech and so when the merger with Grasim will take place, Grasim will
hold between 55 per cent and 65 per cent of the new company which will enable
it to reuse more resources if necessary by selling equity. A higher direct share to
Grasim shareholders in Samruddhi could mean Grasim shareholding slipping
below 55 per cent in Ultra Tech when Samruddhi is merged with it. Similarly,
directly giving Ultra Tech shares to Grasim shareholders would mean a lower
share for Grasim in Ultra Tech. The promoters hold just 25 per cent of equity in
Grasim and the entire promoters’ stake in Ultra Tech is through Grasim. Grasim
shareholders have got a 35 per cent direct share in Samruddhi. If Grasim
shareholders were directly given 100 per cent of Samruddhi, minority shareholders
would have got full exposure to the cement assets. Now they will get only 35 per
cent of the assets directly and 65 per cent indirectly through their shareholding
in Grasim. The company will however have to pay stamp duty twice-first for the
demerger and second for the proposed merger of Samruddhi with Ultra Tech.
Strategic alliance
An increasing number of companies find alliances a more efficient means of using
limited resources and with an alliance one can know where the greatest value
creation potential lies and form the partnership around those specific areas only
where the value created by the partnership will be greater than the sum of the
value provided by each industrial partner. According to Gones-Cassers, a
management expert, a successful partnership does not require two similar cultures.
For example, the Fuji-Xerox partnership is more than 45 years old partner; when
the differences are marked it becomes essential for the partners to communicate
closely. According to BMC Garvie, president of a consultancy firm, the success of
alliance depends upon the consistency in the two organizations’ values and
involvement of all the persons who will implement the alliance.
Mergers may be classified into several types viz.
1. Horizontal
2. Vertical
3. Conglomerate
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Material 111
Service Oriented A horizontal merger represents a merger of firms engaged in the same line
Banker of business. Most of the mergers were of this type. For example, the merger of
Punjab Communications with Siemens.
A vertical merger is one which the buyer expands backward towards the
NOTES
source of raw materials or forward in the direction of the ultimate consume. For
example, the vertical merger of Arihant Industries with Arihant Cotsyn.
A conglomerate merger represents a merger of firms engaged in unrelated
line of activities. Conglomerate mergers have become common in the recent years.
For example, TOMCO with Hindustan Lever.
Motives of merger
The principal economic rational of a merger is that the value of the combined entry
is expected to be greater than the sum of the independent values of the merging
entities.
A variety of reasons like growth diversification, economies of scale,
managerial effectiveness, utilization of tax sheets, lower financing costs, strategic
benefits etc., are cited in support of merger proposals.
Check Your Progress

1. Why do companies require restructuring?
2. Define arrangement.
3. What is a horizontal merger?

QUESTIONS
1. Restructuring is required by companies primarily to maintain status quo and

secondly for growth.
2. The Companies Act, 2013 defines arrangement as something analogous to
compromise and includes reorganization of share capital of the company
by consolidation of shares of different classes or by division of shares into
share of different classes or by both methods.
3. A horizontal merger represents a merger of firms engaged in the same line
of business.
7.4 SUMMARY
 Restructuring has become the compelling necessity to survive in this fiercely

competitive environment.
Self-Instructional
112 Material
 Restructuring is a process by which a firm does an analysis of itself at a Service Oriented
point of time and alters what it owes and owns, refocuses itself to specific Banker
tasks of performance improvements.
 A number of strategic imperatives have been driving companies towards
NOTES
mergers and acquisitions. They include globalization, consolidation, product
differentiation, and customer demands, vertical integration, deregulation,
technology requirements and refashioning.
 A merger involves the fusion of two or more separate companies into one.
It is a special case of combining companies where one survives and the
other loses its identity.
 Amalgamation is a legal process by which two or more companies are
joined together to form a new entity or one or more companies are absorbed
or blended with another, which will result in the amalgamating companies to
lose its existence and its shareholders to become the shareholders of the
new company or the amalgamated company.
 Acquisition implies that one of the firms loses its identity and that it has been
purchased by the firm that continues its existence. According to the Collins
Business Dictionary an acquisition is the act of getting or buying something.
 Compromise means settlement or adjustment of claims in a dispute by mutual
concession by the parties to the disputes or differences.
 Mergers may be classified into several types viz.
1. Horizontal
2. Vertical
3. Conglomerate
 A horizontal merger represents a merger of firms engaged in the same line
of business. Most of the mergers were of this type. A vertical merger is one
which the buyer expands backward towards the source of raw materials or
forward in the direction of the ultimate consume. A conglomerate merger
represents a merger of firms engaged in unrelated line of activities.
Conglomerate mergers have become common in the recent years.
7.5 KEY WORDS
 Merger: It means a combination of two things, especially companies, into

one.
 Consolidation: It represents a combination of two or more business firms
into a new business firm. The essence of consolidation is that all the combining
firms lose their identity.
 Amalgamation: It is the action, process, or result of combining or uniting.
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Service Oriented
Activities of a Rural 7.6 SELF ASSESSMENT QUESTIONS AND
Banker
EXERCISES
NOTES Short Answer Questions

1. Why is restructuring necessary?
2. List the forms of restructuring in a business.
3. What is acquisition?
1. What is a merger? Differentiate between merger and amalgamation.
2. What is demerger? Discuss the reasons for demerger.
3. Describe the various types of mergers.

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Overview of Role of Rural
BLOCK - III Bankers in Mergers and
Portfolio Management
VENTURE CAPITAL AND MISCELLANEOUS
NOTES
UNIT 8 OVERVIEW OF ROLE OF
RURAL BANKERS IN
MERGERS AND
PORTFOLIO
MANAGEMENT
Structure
8.0 Introduction
8.1 Objectives
8.2 Role of Rural Bankers in Mergers
8.3 Portfolio Management
8.5 Summary
8.6 Key Words
8.0 INTRODUCTION
Banking services have extended beyond that of merely being a money lending
institution. It has evolved through the ages and its activities have diversified over
the years. Today, banking companies assist other companies in their mergers through
their services like investment and merchant banking. The RBI too plays a crucial
role when it comes to mergers. Further, just like non-banking companies, banking
companies too have since long back in history, taken part in mergers for various
reasons including the interest of the creditors, better management or simply saving
itself from losses or poor operations. Rural banking in India, through the Regional
Rural Banks has also been ordered compulsory merger by the Central Government
over the years and time and again there have been arguments for and against the
move.
Another area where banking services have expanded is that of portfolio
management. The bankers simply the investment management of their customers
by providing advice as well as helping them achieve a portfolio with minimal risk
and increased profits.
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Overview of Role of Rural In this unit, you will learn about the banking legislations and services in the
Bankers in Mergers and
Portfolio Management context of mergers and portfolio management.
NOTES
8.1 OBJECTIVES

 Discuss the role of rural bankers in mergers
 Describe the concept of portfolio management
 Explain the functions of portfolio managers and explanation to risk
 Discuss the CAPM Approach to market operations
8.2 ROLE OF RURAL BANKERS IN MERGERS
Banks get and derive power from Banking Regulation Act, 1949 regarding merger
and amalgamation. The merger of banking companies is contained under Sections
44A, 44B and 45 under Part III of the Banking Regulation Act 1949. Voluntary
amalgamation in contained under Section 44 A of the Act. As per this Section,
RBI has the power to for merging two or more banking companies, however the
RBI does not have the power to do so for margining of banking company with a
non-banking company. This case is handled by the Tribunal under the relevant
applicable sections of the Companies Act, 2013. As per Section 44A the High
Court is not given the powers to grant its approval to the merger of banking
companies. RBI is given such powers. The Central Government has the powers
to order compulsory amalgamation of banking companies similar to any other
company under the Companies Act as per Section 237 of the Act. However, the
exercise of such powers should be only after consultation with the RBI. As per
Section 45, the Reserve bank has the power to prepare a scheme of amalgamation
of a banking company with other institution (the transferee bank) under subsection
15 of the same section. Under this Section, banks can be reconstructed or
amalgamated compulsorily without the consent of its members or creditors.
Legal Considerations in Case of Merger of Private Banking Companies
As per Reserve Bank of India (Amalgamation of Private Sector Banks) Directions,
2016, the following points are important:
1. Approval from at least a two-third majority of the total Board member of
the involved companies.
2. The scheme for merger needs to be approved majority in number i.e. two-
thirds in value of the shareholders, present in person or by proxy at a meeting,
of each banking company.
3. An application needs to be made to Reserve Bank of India, along with the
lists of information required.
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4. The note also provides that a dissenting shareholder is entitled to claim Overview of Role of Rural
within 3 months from the date of sanction, the value of shares held by him in Portfolio Management
the company and its determination by the Reserve bank of India.
The directions also provide considerations for an amalgamation of an NBFC
NOTES
with a banking company, which differs slightly from the aforementioned
considerations.
After the approval, the scheme should be submitted to RBI. Broadly RBI
will examine the following the objectives to be achieved by the merger what impact
the merger could have on the financial markets:
 The impact that the merger might have on the overall structure of the
industry.
 The possible costs and benefits to customer and to small and medium
size businesses including the impact on bank branches the availability of
financing price, quality and the availability of services.
 The timing and the socio-economic impact of any branch closure resulting
from the merger.
 The manner in which the proposal will contribute to the international
competitiveness of the financial services sector.
 The manner in which the proposal would indirectly effect employment
and the quality of file in the sector with a distinction made between
transitional and permanent effects.
 The manner in which the proposal would increase the ability of the banks
to develop and adopt new technologies.
 Remedial steps that the merger applicants would be willing to take to
mitigate the adverse effects identified to arise from the merger.
Legal Procedure of Mergers of the Companies
A merger is a complicated transaction involving fairly complex legal, tax and
accounting considerations. The following are the same:
1. Check the Memorandum of Association and the Articles of Association of
both the companies about the enabling provisions for the proposed merger,
and if there is no provision, then the provision should be made first for the
proposed merger.
2. Drafting of scheme including Valuation/Revaluation of Assets and
determination of exchange ratio by independent expert and decide cut-off
rate.
3. Approvals from Banks/Financial institutions etc., if any.
4. Hold the Board meeting for approval of the Draft Scheme of amalgamation,
cut-off date, exchange ratio and appointment of Advocate/Solicitor/Attorney
etc.
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Overview of Role of Rural 5. Applications to be made to the respective High Court(s) by each of the
Portfolio Management companies.
6. High Court to order the following:
NOTES (a) Appointment of chairman for each of the meeting and fix their
remuneration
(b) Fix date, time and venue for separate meetings of shareholders/creditors
of each of the companies
(c) Quorum of each meeting is to be fixed
(d) Prescribe mode of despatch and publication of notice of each meeting
7. Chairman has to make arrangements for notice, dispatch of notice, draft
scheme, proxy form, publication of notice in newspaper, file compliance
report with High Court.
8. Hold meeting of shareholders/creditors
9. Chairman has to file report of meetings with the High Court
10. Submit the application to the Regional Office of the Registrar of Companies,
regional director and to the official liquidator
11. Final petition is to be made to the respective High Court(s) for confirmation
of the Scheme of Amalgamation
12. High Court to issue notice to:
(a) Official liquidation (in case company to be dissolved without winding
up)
(b) Public notice in the newspaper
13. High Court to receive report from the Registrar of Companies, Regional
Director and from official liquidator about the affairs of the companies
concerned.
14. Final hearing before the High Court
15. High Court to order the confirmation of the scheme
16. Draft (format) orders to be submitted to the registry attached to the
respective High Court giving schedule of property to be transferred for the
transferor company
17. Filing of certified copy of order with the offices of the respective registrar of
companies
18. Transferee company to fix record date for the purpose of issue of shares to
the shareholders of the transferor company. (ies)
19. Transferee company to issue circular to the shareholders of the transferor
company as on the record date requesting for surrender of the share
certificate of the transferor company
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20. Finalise the allotment of shares to the shareholders of the transferor company Overview of Role of Rural
and despatch share certificates in exchange of the share certificate of Portfolio Management
transferor company.
Managing Mergers NOTES
As the chances of failure in a merger programme can be high, it should be planned
carefully. It pays to develop a disciplined merger programme consisting of the
following steps:
1. Manage the pre-merger phase: A good starting point of merger
programme is to institute a thorough valuation of the company itself. This
will enable the acquiring company to understand well its strengths and
weakness and deepen the acquirer’s insights into the structure of its industry.
Opportunities that strengthen or leverage the core business, or provide
functional economies of scale or transfer of skill or technology need to be
identified.
2. Screen Candidates
3. Evaluate the remaining candidates: A comprehensive evaluation must
cover in great detail the following aspects, operations, plant facilities,
distribution network, sales, personal and finances (including hidden and
contingent liabilities) special attention should be paid to the quality of the
management experienced, competent and dedicated management is a scarce
resource. Each candidate ought to be valued as realistically as possible.
4. Determine the mode of the merger/amalgamation.
5. Negotiate and consummate the deal: Negotiation requires considerable
skill. The acquiring firm should identify not only the synergies that it would
derive but also what other acquires may obtain further the acquiring firm
should assess the financial condition of the existing owner and other potential
acquires.
6. Manage post-merger integration: Many competent professional
managers believe that managing a complex multi-product, multi-technology
enterprise requires a culture and set of values which may be alien to the new
group to make adjustments in their values and styles and introduce changes
which are worked over cooperatively. Mutual trust and confidence should
be the bedrock for introducing changes meant to galvanise the enterprise to
reach greater heights of achievements. In this context, the two basic guidelines
are borne in mind:
(a) Anticipate and solve problems early: A thoughtful attempt has to
be made to think through the implications of the merger, anticipate
problems that may arise understand the nature of these problems, and
hammer out a sensible and mutually acceptable way to handle these
problems.
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Overview of Role of Rural (b) Treat people with dignity and concern: It has been said that making
Portfolio Management a merger work is the art of taking over a company without overtaking
it. Efforts should be made to rock the best as little as possible. If some
changes are envisaged, disseminate information effectively. Clarity is
NOTES the most potent antidote against morbid imagination.
Check Your Progress

1. Mention the sections and the act under which contains the provisions related
to merger of banking companies.
2. Who appoints a chairman for meeting in case of merger of companies?
3. Mention the approval quorum needed from the board members in case of
merger of banking companies.
8.3 PORTFOLIO MANAGEMENT
Portfolio management leads with the selection of optimal portfolios by rational

risk averse investors i.e. by investors who attempt to maximise the expected return
consistent with individually acceptable portfolio risk.
The term investment portfolio refers to various assets of an investor which
are to be considered as a unit. An investment portfolio is merely a collection of
unrelated assets but a carefully blended asset combination within a unified
framework.
Investment Portfolio Management involves maintaining a proper combination
of securities, which comprise the investor’s portfolio in a manner that they give
maximum return with minimum risk.
Portfolio management is the investment of funds in such combinations of
different securities in which total risk of portfolio is minimised while expecting
maximum return from it. An investor will invest his total funds in not just one type
of security but a combination of securities. This is diversification and every investor
prefers diversification. This is due to, every diversification reduces variability of
returns and this reduces total risk. “The basic principles of portfolio selection fall
down to a common sense statement that investors try to increase expected return
on their portfolio’s and reduce risk of that return. The portfolio that gives the
highest expected return known as efficient portfolio. To work out which portfolio,
are efficient an investor must be able to state the expected returns and risk of each
asset.”
Traditional vs Modern Portfolio Analysis
Traditional portfolio analysis has been subjective in nature, since it analysis individual
securities through evaluation of risk and return conditions in each security. In fact
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the investor has been able to get the maximum return of the minimum risk. The Overview of Role of Rural
normal method of calculating the return on an individual security was by finding out Portfolio Management
the amounts of hundreds that have been given by the company, the price earnings
ratio, and by an estimation of the market value of shares.
NOTES
The modern portfolio theory believes in the maximization of return through
a combination of securities. It discusses the relationship between different securities
and draws inter-relationships of risk between them. The theory states that by
combining a security of high risk, success can be achieved by an investor in making
a choice of investment outlets.
Traditional theory was based on the fact that risk could be measured on
each individual security through the process of finding out the standard deviation
and that security whose deviation was the lowest should be chosen. Greater
variability and higher deviations showed more risk than those securities, which has
lower variations.
The modern theory is of the view that by diversification risk can be reduced.
Diversification can be made by the investor either by having a large number of
shares of companies in different regions, in different industries or those producing
different types of product lines. But the modern theory states that there cannot be
only diversification to achieve the maximum return. The securities have to be
evaluated extent within which the maximum achievement can be sought by the
investor.
Thus traditional theory and modern theory are both framed under the
constraints of risk and return, the former analysing individual securities and the
better believing in the combination of securities. Traditional theory believes that
the market is inefficient and the fundamental analyst can take advantage of the
solution. By analysing internal financial statements of the company he can make
superior profits through higher returns. The technical analyst believed in the market
behaviours and past trends to forecast the future of securities. Modern portfolio
theory as brought out by Markowitz and Sharpe is the combination of securities to
get the most efficient portfolio.
Objectives of Portfolio Management
The key objective of the portfolio management is to ensure appreciation of wealth
creation based on financial goals. It is a process that requires regular monitoring
and analysis to make the most of one’s investment with the borated investment at
hand, managing an investment portfolio through a proper channel ensures an optimal
distribution of those funds to generate the best possible returns.
For many individuals an investment portfolio is a source of fixed or
supplementary income. In order to achieve this, it is important to invest in the right
assets classes and periodically after the investment portfolio based on its
performance. It is always important to jot down one’s short, medium and long-
term objectives based on one’s desired goals and then invests in those investment
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Overview of Role of Rural avenues that would fulfil those goals. All forms of investment have an inherent risk
Portfolio Management which changes from time to time, while equity and derivatives are high risk high
returns investment avenues, mutual funds offer a moderate risk return ratio. On
the other hand instruments such as FDs, RDs, PPFs etc. offer low risk lower
NOTES return investment options. The key is to have a balanced portfolio that hedges the
overall risk.
Portfolio Management Process
Building and managing an investment portfolio is one of the most critical and perhaps
the most complex tasks of financial planning while it requires planning and projecting
scenario at the beginning, it is an ongoing journey that requires attention and is a as
you go along in this section, we look at a four step portfolio management process
to help with one’s planning:
 Step I- Assessing finances and projecting future goals: The first step
in the process is to assess one’s current financial situation. This means listing
one’s current assets and liabilities as well as projecting one’s future goals.
The objective of this step is to identify the gaps between the current cash
flows and the future requirements.
 Step II- Creating an investment policy statement: The next step is to
create a formal investment policy statement based on the future goals and
one’s risk return profile. It takes into account various constraints and
limitations and the preferred approach to investments as well as the modalities
of managing the portfolio. This includes guidelines to investing, establishing
measurement benchmarks, reporting methodology as well as means to review
and rebalance the portfolio periodically. An investment policy statement is a
document that determines the rules of engagement between oneself and his
portfolio manager, hence it is important to be as clear and detailed as possible.
 Step III- Developing an asset allocation strategy: Based on one’s risk
return profile the next step is to choose and assign allocation weightage to
investments and assets from the available options. This needs to be done in
alignment with the investment objectives and in a manner so as to ensure
optimal utilisation of available funds. A key element of this step is also to
diversify the portfolio to reduce risk while yielding the best possible returns.
An asset an investor’s financial situation and goals as well as the risk profile
at a given point in time.
 Step IV- Establishing a monitoring and feedback method: Like any
process managing a portfolio also needs to be monitored and measured
from time to time. This requires setting up milestones and benchmarks to
compare the performance of the entire portfolio against the market. This
also enables to track changes in one’s financial goals and risk profile to
recommend ways to rebalance one’s portfolio at a given point. For example,
selling off underperforming assets or reducing the weightage of market-
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related investments as one approach retirement to reduce the volatility and Overview of Role of Rural
overall risk. Portfolio Management
Wealth creation is a lifelong and dynamic process that is influenced by various
internal and external factors such as marriage and childbirth, changes in one’s
NOTES
financial situation on a market downturn. While one may or may not be able to
control these factors, a robust portfolio management process and strategy enables
one to manage his investments better and make it work for one different stages of
life.
Portfolio diversification
Minimizing risk is a cornerstone of any investment portfolio and the most basic
way to do it is by diversifying one’s portfolio. A diversified portfolio consists of
different types of assets that have varying degrees of inherent risk. While it is not a
sure short way to hedge risks, it is among the most effective methods to help one
achieve one’s financial goals.
Below are some common ways in which one can diversify portfolio company
diversification.
The old adage do not put all your eggs in one basket holds true for investment
portfolios as well ensure that a person does not invest large portion of one corpus
in a single company else a drop in the performance of that stock could drag the
portfolio down. Investing in multiple companies hedges that risk and protects the
portfolio against market related risks.
Sector diversification
Different industries and sectors follow different business cycles, for example, a
bad monsoon may have an adverse effect on the agricultural stocks while it may
not have as much impact on the pharmaceuticals or it companies. So it is worthwhile
to consider and monitor the overall market conditions while one invest to capitalise
on emerging investment opportunities.
Asset class diversification
Different asset classes possess different risks and offer variable returns while
investments in equally and derivatives are inherently riskier than bonds and
government securities, they do often higher returns. Additionally, the performance
of each of these classes may also vary based on the economic and business
environment as well as factors specific to those assets. For example equity
investments can yield higher returns during a bull run, while debt instruments like
bonds or debentures are more productive during a bear phase.
Portfolio Rebalancing
A combinations of internal and external forces determines the performance of any
asset class. The process of adjusting one portfolio across different asset classes in
light of the portfolio performance is known as portfolio rebalancing. Self-Instructional
Material 123
Overview of Role of Rural For example, the investments in the technology sector may be growing by
Portfolio Management leaps and bounds while pharms stocks might be severely underperforming due to
prevalent market conditions. If it is a cyclical stock, it would be worth transferring
some funds from the high performing due to prevalent market conditions. If it is a
NOTES cyclical stock, it would be worth transferring some funds from the high performing
stocks to stocks performing moderately and which may be on its way up as the
business cycles changes. This will allow one to invest in a stock that is likely to
yield a better return during the next business cycle.
Approaches to Rebalancing
There are three common approaches to rebalancing:
 Redirecting funds from within the portfolio to under performing asset classes
to match their original allocation in the investment portfolio.
 Infusing fresh investments to the lagging asset classes to normalise their
weightage in the overall portfolio.
 Selling off a portion of the investments from within the better performing
asset class to convert in the underperforming asset classes.
It is important to map asset allocation with one’s financial objectives and
the current performance of one’s portfolio. The key here is to take a long term
view and prospects of ones investments, remember that it needs to be a financial
decision and not an emotional one.
In managing the investment portfolio effectively, the Portfolio Manager must have
the competence to make spot decisions. He should have thorough knowledge
about the stock market, movement of script prices, track record and working
results of companies opportunities available for companies to expand and diversify,
move towards mergers, acquisitions, takeover, etc. his decisions must match with
the investment objective of his client. He must keep track of the record dates,
timing of rights issue, bonus issue etc. It is important that he makes an analysis so
as to gather knowledge on net profit, earnings per share/dividend payout ratio and
rate of dividend of at least previous three years. He may adopt detailed analysis of
the company about its products, technology, performance management etc.
Prospects of each industrial segment also are to be assessed to decide on the
investments to be made undue concentration of investments in one particular
industry will not be advisable even if it is doing well at the time of the investment
decision. A good portfolio manager should consider all these aspects and take
investment decisions on behalf of his clients.
Regulations
1. The portfolio managers have to enter into an agreement with clients setting
out their mutual obligations and liabilities.
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2. The Discretionary Portfolio Manager is required to manage the funds of Overview of Role of Rural
each client individually and independently in accordance with the needs of Portfolio Management
the client in a manner, which does not partake the character of a mutual
fund.
NOTES
3. The Non-discretionary Portfolio Manager is required to manage the funds
in accordance with the discretions of his clients, restrictions have been
imposed on the number of investment.
4. Portfolio Manager is debarred from deploying the clients funds in bill
discounting, bill financing or for lending with corporate and non-corporate
bodies.
5. Portfolio Manager has been debarred from accepting money or securities
from his clients for a period of less than one year.
6. The transaction is to be affected at prevailing market price only.
7. Every portfolio manager is required to observe a high standard of integrity
and fairness in all his dealings.
8. A portfolio manager should not be a party to the creation of false market in
securities price ragging or manipulation of securities and passing of price
sensitive information to a broken on any other intermediary in the capital
market.
9. There must be proper maintenance of Books of Accounts and these are to
be kept open for inspection by the authority appointed by SEBI.
10. SEBI is empowered to suspend or cancel the registration after holding an
enquiry.
Portfolio manager has been brought under regulatory framework and
organisations carrying on portfolio management services are to be compulsory
registered with SEBI satisfying certain conditions. No person should carry on any
activity as portfolio manager unless he holds a certificate of registration granted by
SEBI under SEBI (Portfolio Managers) Rules, 1993. The intention of the regulation
is to ensure that organisations with the requisite background and expertise only
undertake such services and the investor gets professional services.
Harry Markowitz developed an approach that helps an investor to achieve his
optimal portfolio position. Hence, portfolio theory, in essence, has a normative
character as it prescribes what a rational investor should do.
Markowitz theory determines for the investor the efficient set of portfolio
through three important variables i.e. return standard deviation and coefficient of
correlation. This is also called the full covariance model. Through this method, the
investor can find out the efficient set of portfolio by finding out the trade-off between
risk and return between the limits of zero and infinity. According to this theory, the
Self-Instructional
Material 125
Overview of Role of Rural effects of one security, purchase over the effects of the other security purchase is
Portfolio Management taken into consideration and then the results are evaluated.
Assumptions
NOTES The CAPM is based on the following assumptions:
1. Individuals are risk averse.
2. Individuals seek to maximise the expected utility of their portfolios over a
single period planning horizon.
3. Individuals have homogeneous expectations they have identical subjective
estimates of the means, variances and covariance among returns.
4. Individuals can borrow and lend freely at a riskless rate of interest.
5. The market is perfect, there are no taxes, there are no transaction costs,
securities are completely visible, the market is competitive.
6. The quantity of risky securities in the market is given.
Check Your Progress

4. What was the method used for calculating return on an individual security
under the traditional portfolio analysis?
5. Mention examples of high, moderate and low risk investments.

QUESTIONS
1. The merger of banking companies is contained under Sections 44A, 44B

and 45 under Part III of the Banking Regulation Act 1949.
2. The High Court appoints the chairman for each of the meeting and fix their
remuneration in case of merger of companies.
3. Approval from at least a two-third majority of the total Board member of
the involved companies is needed in case of merger of banking companies.
4. The normal method of calculating the return on an individual security under
traditional portfolio analysis by finding out the amounts of hundreds that
have been given by the company, the price earnings ratio, and by an
estimation of the market value of shares.
5. All forms of investment have an inherent risk which changes from time to
time, while equity and derivatives are high risk high returns investment
avenues, mutual funds offer a moderate risk return ratio. On the other hand,
instruments such as FDs, RDs, PPFs etc. offer low risk lower return
investment options.
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126 Material
8.5 SUMMARY Bankers in Mergers and
 The banks get and derive power from Banking Regulation Act, 1949
regarding merger and amalgamation. The merger of banking companies is NOTES
contained under Sections 44A, 44B and 45 under Part III of the Banking
Regulation Act 1949.
 Voluntary amalgamation in contained under Section 44 A of the Act. As per
this Section, RBI has the power to for merging two or more banking
companies, however the RBI does not have the power to do so for margining
of banking company with a non-banking company. This case is handled by
the Tribunal under the relevant applicable sections of the Companies Act,
2013.
 The Central Government has the powers to order compulsory amalgamation
of banking companies similar to any other company under the Companies
Act as per Section 237 of the Act. However, the exercise of such powers
should be only after consultation with the RBI.
 As per Section 45, the Reserve bank has the power to prepare a scheme of
amalgamation of a banking company with other institution (the transferee
bank) under subsection 15 of the same section. Under this Section, banks
can be reconstructed or amalgamated compulsorily without the consent of
its members or creditors.
 After the approval, the scheme should be submitted to RBI. Broadly RBI
will examine the following the objectives to be achieved by the merger what
impact the merger could have on the financial markets.
 Legal procedure of mergers of the non-banking companies are slightly
different and the provisions related to it are contained in the Companies
Act, 2013.
 As the chances of failure in a merger programme can be high, it should be
planned carefully. It pays to develop a disciplined merger programme
consisting of the following steps: manage the pre-merger phase, evaluate
the remaining candidates, determine the mode of the merger/amalgamation,
negotiate and consummate the deal and manage post-merger integration.
 Portfolio management leads with the selection of optimal portfolios by rational
risk averse investors i.e. by investors who attempt to maximise the expected
return consistent with individually acceptable portfolio risk.
 Traditional portfolio analysis has been subjective in nature, since it analysis
individual securities through evaluation of risk and return conditions in each
security. In fact the investor has been able to get the maximum return of the
minimum risk.
Self-Instructional
Material 127
Overview of Role of Rural  The modern portfolio theory believes in the maximization of return through
Portfolio Management a combination of securities. It discusses the relationship between different
securities and draws inter-relationships of risk between them.
 The key objective of the portfolio management is to ensure appreciation of
NOTES
wealth creation based on financial goals.
 Portfolio management process includes the following steps: assessing finances
and projecting future goals, creating an investment policy statement,
developing an asset allocation strategy, and establishing a monitoring and
feedback method.
 Minimizing risk is a cornerstone of any investment portfolio and the most
basic way to do it is by diversifying one’s portfolio. A diversified portfolio
consists of different types of assets that have varying degrees of inherent
risk.
 A combination of internal and external forces determines the performance
of any asset class. The process of adjusting one portfolio across different
asset classes in light of the portfolio performance is known as portfolio
rebalancing.
 In managing the investment portfolio effectively, the Portfolio Manager must
have the competence to make spot decisions. He should have thorough
knowledge about the stock market, movement of script prices, track record
and working results of companies opportunities available for companies to
expand and diversify, move towards mergers, acquisitions, takeover, etc.
his decisions must match with the investment objective of his client.
 Markowitz theory determines for the investor the efficient set of portfolio
through three important variables i.e. return standard deviation and coefficient
of correlation. This is also called the full covariance model. Through the
CAPM method, the investor can find out the efficient set of portfolio by
finding out the trade-off between risk and return between the limits of zero
and infinity.
8.6 KEY WORDS
 Investment portfolio: It is merely a collection of unrelated assets but a

carefully blended asset combination within a unified framework.
 Portfolio management: It is the investment of funds in such combinations
of different securities in which total risk of portfolio is minimised while
expecting maximum return from it.
 Portfolio rebalancing: It refers to the process of adjusting one portfolio
across different asset classes in light of the portfolio performance.
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8.7 SELF ASSESSMENT QUESTIONS AND Bankers in Mergers and
EXERCISES
Short Answer Questions NOTES
1. Name the Act under whose purview comes the amalgamation of a banking
and a non-banking company.
2. What are the factors which are examined by the RBI incase it receives an
application for merger?
3. Write a short note on the basic guidelines that are two be borne in mind
which managing post-merger integration.
4. Differentiate between traditional and modern portfolio analysis.
5. Briefly explain the objectives of portfolio management.
6. What is Capital Asset Pricing Model?
1. Discuss the legal considerations in case of merger of private banking
companies along with that of mergers of non-banking companies.
2. Explain the portfolio management process, portfolio diversification and
rebalancing.
3. Describe the functions of portfolio managers.

Websites
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2998223
https://www.thehindubusinessline.com/economy/move-to-merge-rrbs-will-affect-
rural-customers-bankers-union/article24305663.ece
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Miscellaneous Activities
of a Rural Banker
UNIT 9 MISCELLANEOUS
ACTIVITIES OF
NOTES
A RURAL BANKER
Structure
9.0 Introduction
9.1 Objectives
9.2 Venture Capital and its Administration
9.2.1 Origin
9.3 Mutual Funds
9.5 Summary
9.6 Key Words
9.0 INTRODUCTION
The rural banks were established with a need to develop the rural economy, for
the purpose of development of agriculture, trade, commerce, industry and other
productive activities in the rural areas, credit and other facilities particularly to
small and marginal farmers, agricultural labourers, artisans and small entrepreneurs
and for matters connected therewith and incidental thereto. You have already learnt
about the scope of work of rural banks in the economy. The institution of Regional
Rural Banks (RRBs) was created to meet the excess demand for institutional
credit in the rural areas, particularly among the economically and socially
marginalized sections. In order to provide access to low-cost banking facilities to
the poor, the Narasimhan Working Group proposed the establishment of a new
set of banks, as institutions which confine the local feel and the familiarity with
rural problems which the cooperative possess and the degree of business
organisations, ability to mobilise deposits, access to control money markets and
modernised outlook which the commercial banks have. The multi-agency approach
to rural credit was also to sub serve the needs of the input-intensive agricultural
strategy (Green Revolution) which had initially focussed on betting on the strong
but by the mid-seventies was ready to spread widely through the Indian countryside.
In addition, the potential and the need for diversification of economic activities in
the rural areas had begun to be recognised and this was a sector where the RRBs
could play a meaningful role.
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There has been an unprecedented growth and diversification of banking Miscellaneous Activities
of a Rural Banker
industry. The banking industry has experienced a series of significant transformations
in the last few decades. Banks have increased the scope and scale of their activities
and several banks have become very large institutions with a presence in multiple
regions of the country. You have already learnt about the concepts of mergers and NOTES
portfolio management in the context of banking in Unit 8.
The banking sector has immensely benefitted from the implementation of
superior technology. Productivity enhancement innovative products, speedy
transactions, seamless transfer of funds, real time information system and efficient
risk management are some of the advantage derived through the technology.
Information technology has also improved the efficiency and robustness of business,
process across banking sector, India’s banking environment. Indian banking industry
in the midst of an IT revolution. Technological infrastructure has become an
indispensable part of the reforms process in the banking system, with the gradual
development of sophisticated instruments and innovations in market practices.
Real Time Gross Settlement system introduced in India since March 2004,
is a system through which electronics instructions can be given by banks to transfer
funds from their account to the account of another bank. The RTGS system is
maintained and operated by the RBI and provides a means of efficient and faster
funds transfer among banks facilitating their financial operations. Funds transfer
between banks takes place on a Real Time basis. Therefore, money can reach the
beneficiary instantaneously and the beneficiary’s bank has the responsibility to
credit the beneficiary’s account within two hours.
Electronic Funds Transfer (EFT) is a system whereby anyone who wants to
make payment to another person/company etc. can approach has bank and make
cash payment or given instructions/authorisation to transfer funds directly from his
own account to the bank account of the receiver/beneficiary. RBI is the service
provider of EFT.
Electronics Clearing Service is a retail payment system that can be used to
make bulk payments/receipts of a similar nature especially where each individual
payment is of a repetitive nature and of relatively smaller amount. This faculty is
meant for companies and government departments to make/receive large volumes
of payments rather than for funds transfer by individual.
Telebanking facilitates the customer to do entire non-cash related banking
on phone. Under this devise Automotive Voice Recorder is used for simpler queries
and transactions for complicated queries and transactions, manned phone terminals
are used.
Electronic Data Interchange is the electronic exchange of business documents
like purchase order, invoices shipping notices, receiving advices etc. in a standard,
computer processed, universally accepted format between trading partners. EDI
can also be used to transmit financial information and payments in electronic form.
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Miscellaneous Activities The banking today is re-defined and re-engineered with the use of
of a Rural Banker
Information Technology and it is sure that the future of banking will offer more
sophisticated services to the customers with the continuous product and process
innovations. Thus, there is a paradigm shift from the seller’s market to buyer’s
NOTES market in the industry and finally it effected at the bankers level to change their
approach from conventional banking to convenience banking and mass banking
to class banking the shift has also increased the degree of accessibility of a common
man.
In this unit, you will learn about some of the miscellaneous banking services
pertaining to venture capital and mutual funds.
9.1 OBJECTIVES

 Describe the concept of venture capital
 Discuss the origin of venture capital
 Explain the significance of mutual funds
9.2 VENTURE CAPITAL AND ITS

ADMINISTRATION
The term venture capital means different things to different people. Most commonly
it is used to mean risk capital. By definition venture capital is thought of as creative
capital and is expected to perform economic functions different from other investment
vehicles which primarily serve. Expansion capital in practice, venture capital is
equated to 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.
A venture capital company makes a very thorough and critical evaluation of
all investment proposals it receives like the banks or financial institutions. But the
extent of risk analysis carried out by a venture fund is more than that of other
lenders whose loans are secured.
In case of other financial institutions, they extend loans which are covered
by assets of the borrowing units. The escape route for such lenders is much easier.
For the venture capitalist, it is a question of swimming on sinking within main
promoter.
There is high mortality risk and the long gestation period in the area of
venture capital finances. The experience of the United States, where this concept
has most successfully operated shows that 40 per cent of the firms promoted
through venture capital fail with the loss of capital, 30 per cent just break even and
only 30 per cent become profitable ventures.
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Venture capitalists also provide substantial management inputs including seats Miscellaneous Activities
of a Rural Banker
on the Board to the assisted companies in the early years of the project once the
venture has reached the stage of profitability, they sell equity interest at the market
price to others thereby making millions or one-deploy their resources in new
ventures. NOTES
Venture capital companies/funds which avail concessional treatment of capital
gains have to employ the guidelines as prescribed. Approval is given for the
establishment of the venture capital companies/funds by the Department of
Economic Affairs, Ministry of Finance or such authority as may be nominated by
the government and the application for such approval is made with suitable
explanatory notes and details of the proposal is addressed to the department of
economic affairs.
All India Public Sector Institutions, State Bank of India and other scheduled
banks including foreign banks operative in India, the subsidiaries of the above are
eligible to start Venture Capital Fund companies subject to approval as may be
required from Reserve Bank of India.
It is required that the Venture Capital Funds/Companies are managed by
professionals such as bankers, managers and administrators and persons with
adequate experience of industry, finance accounts etc.
It is intended that venture capital assistance should go mainly to enterprise
where the risk element is comparatively high due to the technology involved being
relatively new and not efficient though otherwise qualified and the size being modest.
For successful units, the possibility of high returns would exist, but the projects
would initially find it different to raise equity from the market, especially when
public issues are no longer readily available for small green field companies. The
assistance should mainly be for equity support, though loan support to supplement
this also be done.
Venture capital assistance cover those enterprises which fulfil the following
parameters:
(a) Size: Total investment not to exceed 10 crores
(b) Technology: New on relatively introduced or very closely held or
being taken from pilot to commercial stage, or which incorporates
some significant improvement over the existing one in India.
(c) Promoters/entrepreneurs relatively new professionally or technically
qualified with inadequate resources or backing to finance the project.
Investment in enterprises engaged in trading, broking, investment or financial
service, agency or liaison work, shall not be permitted. Further investment in assisted
units for their expansion or strengthening, or investments for the revival of sick
units, would be permitted as a part of venture capital activity and the above
parameters will not apply. The recipient venture is established as a limited company
and must employ professionally qualified persons to maintain its accounts. Funds
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Miscellaneous Activities may be raised through public issues and/or promote placement of finance. The
of a Rural Banker
venture capital company may be listed according to the prescribed norms. Its
issue may be underwritten at the discretion of the promoters.
NOTES 9.2.1 Origin

The origin of venture capital goes back to one General Dariot, who in 1946
established the American Research and Development (ARD) at the Massachusetts
Institute of Technology, USA (MIT) in order to finance the commercial promotion
of new technologies developed in universities in the United States. The growth of
Venture Capital Companies (VCC’s) received a fillip in 1958 when the US
Congress passed the Small Business Act and the US Government set up the Small
Business Administration (SBA). The SBA licenses small business investment
companies which are private sector firms and also provides them long term loans.
Although in the early days of Indian industry, private sector provided the
funding for industry and in a way some of the managing agency houses were sort
of venture capitalist providing both finance and management for many new and
high-risk areas. The Tata Group Investment Corporate of India successfully
promoted a number of enterprises like Associated Bearings, National Rayon and
CEAT Tyres and these enterprises are example of formal venture capital type of
financing in India.
Today in India public sector financial institutions at the national and state
levels take care of the bulk of project financing in the private sector primarily
through concessional term loans and to a limited extent through equity financing.
These term bonding government institutions in discharging their role also meet a
part of the venture capital requirement of hi-tech and hi-risk industries. Conditions
in the India economy at present seem favourable for the development of venture
capital.
Venture capital companies invest their corpus in the form of equity purchase,
conditional loans, income notes and participating debentures.
(i) Equity participation: It is the basic avenue of investment in the assisted
firms. Equity holding does not generally exceed 49% of the total equity of
the assisted firms. As a result, overall control over the venture remains in
the hands of entrepreneurs.
(ii) Conditional loan: Loan is another form of investment, it is repayable by
the assisted firms in the form of royalty after the venture is able to generate
sales. Royalty charges normally range between 2 to 15 per cent as the cost
of financing.
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(iii) Income notes: It is a form of investment which is a compromise between Miscellaneous Activities
of a Rural Banker
conventional loans and conditional loans. The assisted firms are to pay both
interest and royalty on sales but at substantially low rate.
(iv) Participating debenture: Venture capitalists charge interest in these phases
NOTES
under the scheme of investment through participating debentures. No interest
is charged before the assisted firms attain operations on a minimum level, a
low rate of interest is charged after the firms attain operations up to a particular
level and a high rate of interest is charged once the venture operates
commercially in full swing. The terms and conditions of financing are decided
by mutual agreement between the entrepreneurs launching the ventures and
the venture capital funds.
Forms of venture capital assistance in India: Venture capital in India is
available in three forms viz. equity, conditional loans and income notes. All Venture
Capital Funds (VCFs) in India provide equity up to a maximum participation of
49 per cent of total equity capital of the firm, under which the ownership of the
firm remains with the entrepreneur.
A conditional loan is repayable in the form of royalty, ranging between 2 per
cent and 15 per cent, after the venture is able to generate sales and no interest is
paid on such loans. Income note has combinational features of conventional and
conditional loans. The entrepreneur has to pay both interest and royalty on sales at
lower rates.
Investment by VCFs: VCFs are interested to invest at three stages in a
company’s development (i) start-up, (ii) money to finance the launching of an
enterprise and (iii) growth capital for major expansion of the company. Among the
three, the first is the most risky but promises high returns. During the second stage,
the Venture Capital Company (VCC) helps the entrepreneur to develop his
company to a stage where he/she can secure capital or loans from various external
sources. Finally, in the growth stage, the VCC helps the company in major expansion
to enjoy the benefits of economies of scale.
Venture capital activity is regulated by three sets of regulations. First, the
SEBI (Venture Capital) Regulations, 1996; secondly, Guidelines for Overseas
Venture Capital Investments issued by MOF in 1995 and thirdly, CBDT Guidelines
for Venture Capital Companies in 1995, which were notified in 1999.
Check Your Progress

1. Whose approval is needed for the starting of venture capital by All India
Public Sector Institutions and State Bank of India?
2. Where can the origin of venture capital in the world be traced back to?
3. What is a conditional loan?
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of a Rural Banker 9.3 MUTUAL FUNDS
According to Association of Mutual Funds in India (AMFI), “A mutual fund is a

NOTES trust that pools the savings of a number of investors who share common financial
goal. Anybody with an investible surplus of a little as a few thousand rupees can
invest in mutual funds scheme that has a defined investment objective and strategy.”
According to SEBI Regulations, 1996, “Mutual Fund means a fund
established in the form of a trust to raise monies through the sale of units to the
public or a section of public under one or more schemes for investing in securities,
in accordance with regulations.”
Unit Trust of India was the first mutual fund set up in India in the year 1963.
In early 1990’s government allowed public sector banks and institutions to set up
mutual funds. SEBI formulates policies and regulates the mutual funds to protect
the interest of the investors.
A mutual fund is set up in the form of a trust, which has Sponsor, Trustees,
Asset Management Company (AMC) and Custodian. The trust is established by
a sponsor or more than one sponsor who is like promoter of a company.
 The trustees of the mutual fund hold its property for the benefits of the
court holders.
 Asset Management Company (AMC) approved by SEBI manager the
funds by making investments in various types of securities.
 Custodian who is registered with SEBI holds the securities of various
schemes of the fund in its custody.
The trustees are vested with the general power of superintendence and
directions over AMC. They monitor the performance and compliance of SEBI
Regulations by the mutual fund. All mutual funds are required to be registered with
SEBI before they launch any scheme.
A mutual fund scheme can be classified into open-ended or close-ended scheme
depending on its maturity period.
(i) Open-ended schemes
These schemes do not have a fixed maturity period. These schemes are available
for subscription and repurchase on a continuous basis. Investors can conveniently
buy and sell units at NAV related prices which are declared on a daily basis. The
key feature of these schemes is liquidity.
(ii) Close-ended schemes
A close ended fund or scheme has a stipulated maturity period, e.g. 5-7 years.
The fund is open for subscription only during a specified period at the time of
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launch of the scheme. Investors can invest in the scheme at the time of the initial Miscellaneous Activities
of a Rural Banker
public issue and thereafter they can buy or sell the units of the scheme on the stock
exchanges where the units are listed. In order to provide an exit route to the
investors, some close-ended funds give an option of selling back the units to the
mutual fund through periodic repurchase at NAV related prices. NOTES
(iii) Interval schemes

These combine the features of open ended and close ended schemes, which may
be traded on the stock exchange any time as will be open for sale or redemption
during predetermined intervals at NAV related prices.
Mutual funds collect money from individuals and organizations and pool it
to invest in stocks, bonds and other types of securities in financial markets. In
mutual funds there is simple and easy entry and exit options and tax benefits available
on certain schemes. Mutual fund units can be held in dematerialised form and can
be converted into statement form (paper form) to demat form.
Check Your Progress

4. Name the first mutual fund set up in India.
5. What is the key feature of open-ended mutual schemes?

QUESTIONS
1. All India Public Sector Institutions, State Bank of India and other scheduled
banks including foreign banks operative in India, the subsidiaries of the
above are eligible to start Venture Capital Fund companies subject to approval
as may be required from Reserve Bank of India.
2. The origin of venture capital goes back to one General Dariot, who in 1946
established the American Research and Development (ARD) at the
Massachusetts Institute of Technology, USA (MIT) in order to finance the
commercial promotion of new technologies developed in universities in the
United States.
3. A conditional loan is another form of investment, it is repayable by the assisted
firms in the form of royalty after the venture is able to generate sales. Royalty
charges normally range between 2 to 15 per cent as the cost of financing.
4. Unit Trust of India was the first mutual fund set up in India in the year 1963.
5. The key feature of open-ended schemes is liquidity.
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of a Rural Banker 9.5 SUMMARY
 The rural banks were established with a need to develop the rural economy,
NOTES for the purpose of development of agriculture, trade, commerce, industry
and other productive activities in the rural areas, credit and other facilities
particularly to small and marginal farmers, agricultural labourers, artisans
and small entrepreneurs and for matters connected therewith and incidental
thereto.
 In the banking field, there has been an unprecedented growth and
diversification of banking industry. The banking industry has experienced a
series of significant transformations in the last few decades. Banks have
increased the scope and scale of their activities and several banks have
become very large institutions with a presence in multiple regions of the
country.
 The banking sector has immensely benefitted from the implementation of
superior technology. Productivity enhancement innovative products, speedy
transactions, seamless transfer of funds, real time information system and
efficient risk management are some of the advantage derived through the
technology.
 The term venture capital means different things to different people. Most
commonly it is used to mean risk capital. By definition venture capital is
thought of as creative capital and is expected to perform economic functions
different from other investment vehicles which primarily serve.
 A venture capital company makes a very thorough and critical evaluation of
all investment proposals it receives like the banks or financial institutions.
But the extent of risk analysis carried out by a venture fund is more than that
of other lenders whose loans are secured.
 There is high mortality risk and the long gestation period in the area of
venture capital finances.
 Venture capitalists also provide substantial management inputs including seats
on the Board to the assisted companies in the early years of the project
once the venture has reached the stage of profitability, they sell equity interest
at the market price to others thereby making millions or one-deploy their
resources in new ventures.
 Venture capital companies/funds which avail concessional treatment of capital
gains have to employ the guidelines as prescribed. Approval is given for the
establishment of the venture capital companies/funds by the Department of
Economic Affairs, Ministry of Finance or such authority as may be nominated
by the government and the application for such approval is made with suitable
explanatory notes and details of the proposal is addressed to the department
of economic affairs.
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138 Material
 It is required that the Venture Capital Funds/Companies are managed by Miscellaneous Activities
of a Rural Banker
professionals such as bankers, managers and administrators and persons
with adequate experience of industry, finance accounts etc.
 It is intended that venture capital assistance should go mainly to enterprise
NOTES
where the risk element is comparatively high due to the technology involved
being relatively new and not efficient though otherwise qualified and the size
being modest.
 The origin of venture capital goes back to one General Dariot, who in 1946
established the American Research and Development (ARD) at the
Massachusetts Institute of Technology, USA (MIT) in order to finance the
commercial promotion of new technologies developed in universities in the
United States.
 Although in the early days of Indian industry, private sector provided the
funding for industry and in a way some of the managing agency houses were
sort of venture capitalist providing both finance and management for many
new and high-risk areas.
 Venture capital companies invest their corpus in the form of equity purchase,
conditional loans, income notes and participating debentures.
 VCFs are interested to invest at three stages in a company’s development
(i) start-up, (ii) money to finance the launching of an enterprise and (iii)
growth capital for major expansion of the company.
 According to SEBI Regulations, 1996, “Mutual Fund means a fund
established in the form of a trust to raise monies through the sale of units to
the public or a section of public under one or more schemes for investing in
securities, in accordance with regulations.”
 A mutual fund is set up in the form of a trust, which has Sponsor, Trustees,
Asset Management Company (AMC) and Custodian. The trust is established
by a sponsor or more than one sponsor who is like promoter of a company.
 A mutual fund scheme can be classified into open-ended or close-ended
scheme depending on its maturity period.
9.6 KEY WORDS
 Venture capital: It is used to mean risk capital. By definition venture capital

is thought of as creative capital and is expected to perform economic
functions different from other investment vehicles which primarily serve.
 Debenture: It is a long-term security yielding a fixed rate of interest, issued
by a company and secured against assets.
 Mutual Fund: It means a fund established in the form of a trust to raise
monies through the sale of units to the public or a section of public under
Self-Instructional
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Miscellaneous Activities one or more schemes for investing in securities, in accordance with
of a Rural Banker
regulations.
 Demat account: It is an account that allows investors to hold their shares
in an electronic form.
NOTES

EXERCISES

1. List the parameters of enterprises which are covered by venture capital
assistance.
2. What are the different types of venture capital financing?
3. Mention the stages of a company’s development in which VCF’s are
interested in.
4. What constitutes the form of a mutual fund set-up?
1. Discuss the concept of venture funds and its form in India. Also mention the
regulations which govern its administration in India.
2. Explain the concept and types of mutual funds.

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Classification of
UNIT 10 CLASSIFICATION OF Mutual Funds
MUTUAL FUNDS
NOTES
Structure
10.0 Introduction
10.1 Objectives
10.2 Types of Mutual Funds
10.3 Factoring: Mechanism and Types of Factoring
10.4 Cash Management: Meaning, Importance and Objectives
10.4.1 ST/MT Funding
10.6 Summary
10.7 Key Words
10.0 INTRODUCTION
Most investment companies are structured as open-ended mutual funds in terms

of both sheer number and assets under management. When an investor wants to
buy shares of a mutual fund, the mutual fund issues and sells them shares at net
asset value. Similarly, investors selling shares sell them at net asset value back to
the fund. These types of funds are known as open-end funds since they don’t
restrict the number of shares issued.
Closed-end funds (CEFs) are investment companies that issue a fixed number
of shares that trade intraday on stock exchanges at market prices. Since the market
price is determined by investors, the price does not necessarily reflect the underlying
value of the assets.
10.1 OBJECTIVES

 Discuss the different types of mutual funds
 Analyse the mechanism and types of factoring
 Describe the meaning and importance of cash management
 Discuss the concept of ST and MT funding
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Classification of
Mutual Funds 10.2 TYPES OF MUTUAL FUNDS
Mutual fund is a mechanism for pooling resources by issuing units in securities to

NOTES the investors and investing funds in accordance with the objectives disclosed in the
offer document. A mutual fund is a corporation, trust or partnership, which manages
the collected money with the help of professional expertise. Different persons
have defined mutual funds different ways. ‘A mutual fund is almost like a
cooperative society of investors. That is why the word ‘mutual’ is used. It collects
money from investors by issuing mutual fund units, invests it in securities, and
divides whatever dividend or interest is received among its members.’ (A.John
Halin)
The SEBI Mutual Fund Regulations, 1993 defines mutual fund as ‘a fund
established in the form of a trust by a sponsor, to raise money by the trustees
through sale of units to the public, under one or more schemes, for investing in
securities in accordance with the regulations’. Mutual funds are financial
intermediaries which bring a wide variety of securities within the reach of the most
modest investors. The financial intermediary is known as ‘investment company’ in
the US and most other countries. They are called ‘investment trusts’ in the United
Kingdom. In India, they are known by the term ‘mutual funds’.
Classification of Mutual Funds
A mutual fund scheme can be classified into close ended or open ended depending
on its maturity period.
Close-ended scheme
It has a prefixed maturity period, e.g., five to seven years. Both the corpus amount
and the number of units are prefixed. The fund is open for subscription only for a
specified period after the launch of the scheme. Mutual funds are required to
despatch certificates or statements of accounts within six weeks from the date of
closure of the initial subscriptions of the schemes. The investors can invest in the
scheme during this period. After the closure of the subscription period, investors
can buy and sell the units of the scheme at the stock exchanges where the units are
listed. They would either get a demat account statement or unit certificates as
traded in the stock exchanges.
According to SEBI regulations, one or two exit routes should be provided
to the investors. It may either be in the form of regular repurchase or by listing
them in stock exchanges. Some of the close-ended mutual funds provide the option
of selling back of the units to the mutual funds. The prices are fixed on the basis of
net asset value. The NAV of the schemes is disclosed on a weekly basis.
The entire corpus is disinvested after the maturity period and the proceeds
are distributed among the investors in proportion to their unit holdings.
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Open-ended schemes Classification of
Mutual Funds
These are available for subscription and repurchase on a continuous basis. These
schemes do not have a maturity period. Investors can buy and sell units at prices
fixed by a mutual fund. Prices are fixed on the basis of NAV. The NAVs of these NOTES
schemes are declared daily. Liquidity is the main advantage of the open-ended
scheme. The main difference between the open-ended and the close-ended
schemes is that the latter is traded on stock exchanges, whereas the former is not.
Also, open ended schemes are available at all times, whereas the close-ended
schemes are available only for a prescribed period.
Schemes on the basis of investment objectives
Schemes are classified as growth scheme, income scheme or balanced scheme as
per the investment objectives. These schemes may either be open-ended or close-
ended. Some of them are given below.
Index funds
These are equity funds that passively mimic a market index. The portfolio of the
index fund is designed to reflect the composition of some stock market index. The
index funds avoid the risk of poor stock selection by the fund manager. The aspects
that are in favour of index funds are:
 low costs
 predictability
 diversification
All the index funds, which are currently in operation, are modelled either on
the Nifty or the Sensex. Several fund houses have launched passive index funds in
the past. Some of them are Franklin Templeton India Index fund (formerly Pioneer
ITI Index fund, offering both Sensex and Nifty Plans), UTI Nifty Index fund, UTI
Master Index fund and IDBI Principal Index fund.
These funds suffer because of tracking error. This error is the percentage
by which returns from the funds deviate from the underlying index. If the error is
positive, the funds generate higher returns than that of the index. One of the reasons
cited for the tracking error is the transaction cost. Index funds have to incur
brokerage and other costs to make changes in their portfolios in line with those in
the index. This results in increase in cost. Besides this, the lack of depth in the
Indian stock market also affects the index funds.
Investment management fee affects the return and recurring expenses such
as advertisement, investor communication costs and administration costs. Though
these expenses form a small portion of the returns each year, the compounding
effect over the years becomes quite significant.
It is felt that if the index funds could track down broad based market indices
such as S&P CNX 500 and BSE 200, it would help the investors to capture
Self-Instructional
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Classification of broad market trends more accurately. However, lack of liquidity of many small
Mutual Funds
and mid-cap stocks would result in high transaction costs.
Exchange traded funds (ETFs)
NOTES These are passively managed funds that track a particular index and have the
flexibility to trade like a common stock. These types of funds combine the attributes
of mutual funds with those of the stocks. Without large investment, an average
investor can have an entire range of index stocks. It is different from the index
funds where units are issued in return for cash and redeemed as per the net asset
value in cash. However, ETF issues units in lieu of shares and vice versa.
The ETFs are priced throughout the day. They can be bought and sold at
any time during a trading day just like a stock. The fund may either represent
market index or a specific industry sector or an international sector. An investor
can buy it on a margin. Short selling can be carried out. The expense ratio is similar
to the open end mutual funds. They range from 0.18 per cent of the value of the
fund to 0.84 per cent.
ETFs came into existence in the US in 1993. The first ETFs were based on
the S & P 500 and were popularly known as spiders. Presently, diamonds are the
other type of ETFs representing all thirty stocks in the Dow Jones Industrial Average
and traded in American stock exchange. The Benchmark Asset Management
Company (BAMC) has launched Nifty BeEs. It was listed on the capital market
segment of the NSE on 8 January 2002. Nifty BeEs tracks the Standard Poor
(S&P) CNX Nifty index. The minimum investment for taking the index exposure
through Nifty BeEs is just one unit (around 1/10 of the Nifty).
Balanced funds
These funds invest both in equity and fixed income securities. They are also called
‘income-cum-growth’ funds. They aim at regular income and capital appreciation.
They have the equity and debt portfolios to fulfil this objective. The portfolio beta
is less than one and the price of units does not rise in proportion to the aggregate
stock market price because of the debt component in the portfolio. Some of the
balanced funds are: Prudential ICICI Balanced fund, Kothari Balanced fund,
Alliance 95 fund and DSP Merrill Lynch Balanced fund. The performance of the
balanced funds differs due to the ratio of stocks to the fixed income securities that
varies from fund to fund and their different levels of exposure to individual sectors
like IT, media or telecom. The weightage of individual stock in funds differs. Hence,
an investor has to go through the portfolios before investing in the funds.
Money market funds or liquid funds
These funds were initiated during 1973 in the US when interest rates on short term
money market securities were high. They are also income funds and attempt to
provide current income and safety of principal by investing in short term securities
such as treasury bills, bank certificates of deposits, bank acceptances, commercial
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papers and inter bank call money. Returns on these schemes fluctuate much less Classification of
Mutual Funds
as compared to the other funds. These funds are appropriate for corporate and
individual investors to invest their surplus cash for a short period.
Gilt funds NOTES
These are also known as G-Sec funds. These invest in the Government of India
securities, and have gained popularity in the Indian market. The Securities Exchange
Board of India has issued new guidelines in 2002 with an aim to provide better
checks and balances for the mutual funds. The following are the salient features of
the new requirements:
 Mutual funds have to reconcile their balance with the monthly RBI report
 Internal audit, continuous checks by the auditors and reports to audit
committees form a part of the requirements
 The same report must also be placed before the boards of the asset
management company and the trustee company
 Mutual funds will have to submit a compliance certificate to the RBI on a
quarterly basis, indicating their adherence to the norms
 Public debt offices of the RBI will issue monthly statements to mutual funds
maintaining SGL/CSGL accounts
Growth funds
The main objective of these funds is to provide capital appreciation over medium
to long term. They invest a major portion of their collected money in equity. This
makes them prone to risk. As per their preference, the investors may either choose
the option of dividend or the option of capital appreciation. Investors have to
specify their choice while applying for units. However, if they want to change at a
later date, they are permitted to do so. The year 1999–2000 was one of the best
periods for growth funds in the Indian market. Fresh sales by growth schemes
were about 1000 crore. Growth funds outperform bench mark index in bull phase
and underperform in bearish times. Another common problem cited by the fund
managers is that investors put more money when the NAVs are high and sell when
NAVs are low, making the managers busier in redemption than in managing the
funds.
Income/Debt-oriented funds
The objective of these funds is to provide regular and steady income to investors.
A major part of the funds corpus is invested in fixed-income securities such as
bonds, corporate debentures, government securities and money market instruments.
The scope for capital appreciation is limited in these schemes. These funds carry
only modest risks as compared to equity funds.
The NAVs of debt funds are affected because of change in interest rate in
the country. If the interest rates increase, NAVs of such funds are likely to fall in
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Classification of the short run and vice-versa. For instance, debt funds lost heavily in July 2000,
Mutual Funds
when the RBI raised the interest rate to defend the rupee. Thus, the debt funds are
prone to risk because of changes in the rate of interest. The NAV is calculated
based on the market price and not just the income earned from holding from the
NOTES bonds. The NAV fluctuates with the volatility of the bond prices.
Like all instruments, the bond price is based on demand and supply. This
means that the bond prices will fall when supply is relatively more than the demand.
This happens when rupee is falling sharply against the dollar or when the call rates
are very high. During this period, banks generate resource by selling the bonds.
The excessive supply of bonds in the market pulls down the price.
Fall in the prices of bonds leads to fall in NAVs of the debt funds. Thus the
debt funds are also prone to market risk. However, long-term investors prefer
these funds. Some of the debt funds/income funds include Birla Income Plus,
Prudential ICICI Income plan, SBI LiquiBond, UTI Bond fund and DSP Merrill
Lynch Bond fund.
Reinvestment risk is defined as the risk of having to reinvest the intermediate
cash flows (coupon payments at a lower interest rate). In falling interest climate,
the mutual funds may earn a lower return by reinvesting the coupon payment. To
understand this, the funds should provide two distinct NAVs—one inclusive of the
coupon payments, and other exclusive of the coupons. This would give an idea
about the reinvestment risk to the investors.
Sector specific funds
These funds/schemes invest in securities of those sectors or industries specified in
the offer documents, e.g., information technology, pharmaceuticals, fast moving
consumer goods (FMCG) and petroleum, etc. The returns on these funds depend
on the performance of these sectors. Since they are investing in a particular sector,
the risk is high as compared to the other funds. The performance of the sector
should be closely followed in order to take the entry and exit decisions.
A complaint often levelled against these funds is that they invest in sectors
other than the ones suggested by their name. This is because most offer documents
spell out the investment strategy in vague terms and this allows the funds to move
away completely from the nature of the scheme as indicated by its name. For
example, Tata Core sector fund was designed to invest in the core sector (steel,
cement, power and infrastructure) in 1999, but it shifted out of cyclicals into
technology stocks. By Nov 1999, 71 per cent of its assets were invested in
technology stocks.
Tax saving schemes
These schemes provide tax rebates to the investors under the supervision of the
Income Tax Act 1961. The government offers tax incentives for investment in
specified avenues. Equity linked savings schemes and pension schemes offered
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by mutual funds offer tax benefits. These schemes resemble the equity-oriented Classification of
Mutual Funds
schemes and invest mostly in equities.
Load and no load funds
In load funds, a fee is charged for the entry and exit. The charge is a percentage of NOTES
NAV. Whenever an investor buys or sells units in the fund, he has to pay a charge.
If the entry as well as exit load is one per cent to buy a unit worth 10, he has to
pay 10.10. Likewise if he sells a unit, he will get 9.90 per unit. The load factor
affects the return and the investor has to consider the load factor before investing
in a mutual fund.
No load funds do not charge a fee for entry or exit. No additional charges
are levied on the purchase or sale of units. However, SEBI regulations allow no
load funds to hike the investment management fees by up to one per cent per
annum until they recover their initial expenses.
Check Your Progress

1. How does the SEBI Mutual Fund Regulations, 1993 defines mutual fund?
2. State some of the aspects which are in favour of index funds.
3. What is the main objective of growth funds?
10.3 FACTORING: MECHANISM AND TYPES OF

FACTORING
Factoring is a type of financial service provided by specialist organizations. In

factoring, a financial institution (factor) buys the debts or accounts receivables of
a company (client) and pays up to 80 per cent (rarely up to 90 per cent) of the
amount immediately to credit sales, once agreement with the factor is entered into.
The factoring company pays the remaining amount (the balance 10 per cent or 20
per cent) to the client when the collections are made from debts. Factoring is a
great boon to firms that sell on a credit basis as the collection of receivables poses
a problem to them. Several small and medium-sized organizations cannot afford
to have a separate credit department. For such organizations, factoring is ideal, as
factors play an important role in the collection of debts and other services connected
with credit management. As this is a specialist organization that provides factoring
services, even big organizations too may prefer to avail of their services from the
cost-benefit analysis viewpoint.
A factor is an institution that offers credit against receivables and provides
managerial services relating to management of debts arising from credit sales.
Factoring is a financial innovation that provides financial and managerial support
to a client.
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Classification of The factoring business is defined as ‘the business of acquisition of receivables
Mutual Funds
of an assignor by accepting assignment of such receivables or financing, whether
by way of making loans or advances or in any other manner against the security
interest over any receivables’. However, the credit facilities provided by banks in
NOTES the ordinary course of business against the security of receivables and any activity
undertaken as a commission agent or otherwise for sale of agricultural produce or
goods of any kind whatsoever and related activities are expressly excluded from
the definition of factoring business. The Factoring Act has laid down the basic
legal framework for factoring in India.
Factoring is an arrangement under which a financial institution (called a factor)
undertakes the task of collecting the book debts of its client in return for a service
charge. Factoring involves the sale of receivables to a specialized firm, called
factors. Factors collect receivables and also advance cash against receivables to
solve the client firm’s liquidity problem. They charge interest on the amount advanced
for providing their services and charge a commission for other services.
Management services, which relate to maintenance of a sales ledger, the collection
of book debts (accounts receivable), rendering advisory services to their clients
and protection from bad debts, are also provided by factors. The factoring institution
eliminates the client’s risk of bad debts by taking over the responsibility of book
debts due to the client. The factoring institution advances a proportion of the value
of book debts of the client immediately, and the balance on the realization of book
debts.
The factoring service is more comprehensive, compared to a cash credit
limit from a bank or the discounting of bills. A bank looks at the total assets of a
borrower while a factor considers only the book debts.
Factoring differs from a bank loan. The emphasis in factoring is on the value
of the receivables (essentially a financial asset), whereas a bank focuses more on
the value of the borrower’s total assets.
Parties in Factoring
There are three parties involved in a factoring transaction:
 The buyer of the goods
 The seller of the goods
 The factor, i.e., financial institution
Under the Factoring Regulation Act, 2011, the factor is referred to as the
‘assignee’, the industry selling the accounts receivable to the factor as the ‘assignor’,
and the person liable to the industry as the ‘debtor’.
Factoring Services
The purchase of receivables is fundamental to the functioning of factoring. The
following basic services are provided in factoring:
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 Financial accommodation Classification of
Mutual Funds
 Sales ledger administration and credit management
 Credit collection
 Protection to seller against default and bad-debt losses of buyers NOTES
Credit sales are common in most businesses. Factoring involves the
outsourcing of debt collection along with the option of bearing risk for bad debts.
Bad debts eat the profitability of business. Factoring provides an option to cover
the default risk that may arise in respect of credit sales to business organizations.
Factoring Procedure
Normally, the credit evaluation of potential buyers, the maintenance of a sales
ledger, follow-up with debtors and collections from them are handled by a separate
credit department in an organization; its role is vital in improving liquidity and
profitability. The maintenance of a separate department is expensive; moreover,
this department may not have the professional expertise that is normally available
with an exclusive organization, such as a factoring agency, which specializes only
in this type of activity.
In factoring, receivables created out of the sale of goods or services are
sold to a factor. To benefit from professional expertise and receive services in a
cost effective manner, organizations may avail of factoring services.
The agreement between the supplier and the factor specifies the factoring
procedure and spells out the detailed conditions between the two parties.
To perform the functions of credit evaluation and collection for a large number
of clients, a factor may maintain a credit department with specialists on the staff.
Once the factor has purchased a firm’s receivables, receivables disappear from
the balance sheet of the supplier and ownership rests with the factor.
The factoring procedure is as follows:
 The buyers’ creditworthiness is appraised by the factor, based on market
assessment, and the factor then fixes credit limits for potential buyers of
the client to whom goods are sold or services provided on credit.
 Once the factor is satisfied about the customer’s creditworthiness and
agrees to buy receivables, the client firm dispatches goods to the buyers
and sends a copy to the factor.
 The sales documents given to buyers contain the instruction to make the
payment to the factor directly.
 The factor remits the agreed amount to the client.
 Once the full amount is collected from debtors, the balance invoice amount
is paid, after deducting interest and commission as per the terms of
agreement.
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Classification of  Factoring may be on recourse basis, where the risk of bad debts is
Mutual Funds
borne by the client firm or on a non-recourse basis where the risk of
bad debts is borne by the factor.
 When the factor assumes the responsibility for bearing loss and the risk
NOTES
of bad debts, the service charges would increase, compared to a situation
where losses due to bad debt are borne by the client.
Fig. 10.1 Factoring Process
Types of Factoring
Different types of factoring are:
 Disclosed and undisclosed factoring
 Recourse and non-recourse factoring
Disclosed factoring: Disclosed factoring means that the customer (i.e.,
the debtor), who is liable to make the payment to the client on credit sales, must
be informed by way of intimation in writing that receivables from the customer are
being factorized. Prior to the commencement of the Factoring Act 2011, the
assignment of receivables was governed by the Transfer of Property Act 1882,
which does not make prior notice to the debtor compulsory before the assignment
of receivables. Thus, it was open to the parties to decide whether they wanted to
undertake disclosed or undisclosed factoring. However, as per the provisions of
the Factoring Act 2011, prior notice to the debtor is now mandatory for the
assignment of receivables to the factor.
Factoring, as envisaged under the Factoring Act, must be disclosed factoring.
Earlier, it was open to the parties to decide. Prior notice to the debtor before the
assignment of receivables has become mandatory now under the Factoring
Regulation Act 2011. Disclosed factoring can either be on recourse or non-recourse
basis.
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150 Material
Undisclosed factoring: In undisclosed factoring, a seller’s customers are Classification of
Mutual Funds
not notified of the factoring arrangement. Sales ledger administration and collection
of debts are undertaken by the client (seller). In this type, factoring is limited to the
provision of finance by the factor—no other services are provided. Factoring
services, such as undisclosed factoring, are confidential in nature, as the debtors NOTES
are not aware of the factoring arrangement. This practice is not possible now.
Recourse factoring: In recourse factoring, if buyers do not pay the amount
on maturity, the factor recovers the amount from the client (seller) as the buyer has
paid an advance to the seller at the time of credit sales reporting. Recourse factoring
is offered at a lower cost since the risk to the factor is low. This is the most
common type of factoring and very popular in the UK and US, where factoring is
advanced.
In recourse factoring, the factor does not take on the risk of bad debts. Put
another way, the factor reclaims its money from the client if the customer (buyer)
does not pay the debt.
Example: The factoring agreement requires payment to be made within
three months. It also states that 80 per cent of each invoice will be advanced. On
30 April 2012, an invoice for 1,000,000 is issued and the factor advances 80,000
immediately. On 31 July, if the buyer has defaulted in payment, 80,000 must be
repaid to the factor. There is no refund of the factoring fees relating to the debt.
Non-recourse factoring: In non-recourse factoring, the factor undertakes
the risk of bad debts from customers. This is an advantageous situation for the
client who is burdened with the risk of bad debts. Non-recourse factoring is popular
in developing countries, including India.
In non-recourse factoring, the factor takes on the risk of bad debts. The
factor accepts specified risks of the debtor’s failure to pay, but it does not insure
against debts that are unpaid because of genuine disputes. Non-recourse factoring
is more expensive than recourse factoring, because in the former, the factor accepts
the risk of bad debts.
A factor’s commission depends on the services provided including
acceptance of risk for bad debts or otherwise.
10.4 CASH MANAGEMENT: MEANING,

IMPORTANCE AND OBJECTIVES
Cash management is concerned with the managing of: (i) cash flows into and out
of the firm, (ii) cash flows within the firm, and (iii) cash balances held by the firm
at a point of time by financing deficit or investing surplus cash. It can be represented
by a cash management cycle as shown in Figure 10.2.
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Classification of
Mutual Funds
NOTES
Fig. 10.2 Cash Management Cycle
Management of cash is also important as it is difficult to predict cash flows

accurately, particularly the inflows, and there is no perfect agreement between the
inflows and outflows of cash. Sometimes, cash outflows will exceed cash inflows
(as payments for taxes, dividends or seasonal inventory build up), while at other
times, cash inflow will be more than cash payments (as there may be large cash
sales and debtors may be realized in large sums promptly). Management of cash is
also critical since cash constitutes the smallest portion of the total current assets,
yet the management’s precious time is devoted in managing it. A lot of innovations
have been done in cash management techniques recently. An obvious aim of the
firm these days is to manage its cash affairs in such a way as to keep cash balance
at a minimum level and to invest the surplus cash in profitable investment
opportunities.
A firm should chart out strategies concerning the facets of cash management,
which are as follows:
 Cash planning: Cash inflows and outflows must be drawn out to project
cash surplus or deficit for each part of the planning period, and for this
purpose, a cash budget must be prepared.
 Managing the cash flows: The management of a firm should ensure
proper and uninterrupted flow of cash. The cash inflows should be
accelerated, while the cash outflows should be slowed down as far as
possible.
 Optimum cash level: The firm must take a decision regarding the suitable
level of cash balances. The cost of excess cash and danger of cash
deficiency need to be compared to figure out the appropriate level of
cash balances. The firm should decide about the division of such cash
balance between alternative short-term investment opportunities such
as bank deposits, marketable securities or inter-corporate lending.
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The ideal cash management system will depend on the firm’s products, Classification of
Mutual Funds
organization structure, competition, culture and options available. The task is
complex, and decisions taken can affect important areas of the firm. For example,
to improve collections if the credit period is reduced, it may affect sales. However,
in certain cases, even without fundamental changes, it is possible to significantly NOTES
reduce cost of cash management system by choosing the right bank and controlling
the collections properly.
Motives for Holding Cash
Just like the motives for holding inventory the firm’s need to hold cash may be
attributed to the following three motives:
 The transactions motive
 The precautionary motive
 The speculative motive
1. Transaction motive: The transactions motive requires a firm to hold cash to
conduct its business in the ordinary course. The firm needs cash primarily to make
payments for purchases, wages and salaries, other operating expenses, taxes,
dividends, etc. The need to hold cash would not arise if there were perfect
synchronization between cash receipts and cash payments, i.e., enough cash is
received when the payment has to be made. But cash receipts and payments are
not perfectly synchronized. For those periods, when cash payments exceed cash
receipts, the firm should maintain some cash balance to be able to make required
payments. For transactions purpose, a firm may invest its cash in marketable
securities. Usually, the firm will purchase securities whose maturity corresponds
with some anticipated payments, such as dividends, or taxes in the future. Notice
that the transactions motive mainly refers to holding cash to meet anticipated
payments whose timing is not perfectly matched with cash receipts.
2. Precautionary motive: The precautionary motive is the need to hold cash
to meet contingencies in the future. It provides a cushion or buffer to withstand
some unexpected emergency. The precautionary amount of cash depends upon
the predictability of cash flows. If cash flows can be predicted with accuracy, less
cash will be maintained for an emergency. The amount of precautionary cash is
also influenced by the firm’s ability to borrow at short notice when the need arises.
Stronger the ability of the firm to borrow at short notice, the lesser the need for
precautionary balance.
3. Speculative motive: The speculative motive relates to the holding of cash
for investing in profit-making opportunities as and when they arise. The opportunity
to make profit may arise when security prices change. The firm will hold cash,
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Classification of when it is expected that interest rates will rise and security prices will fall. Securities
Mutual Funds
can be purchased when the interest rate is expected to fall; the firm will benefit by
the subsequent fall in interest rates and increase in security prices. The firm may
also speculate on materials’ prices. If it is expected that materials’ prices will fall,
NOTES the firm can postpone materials’ purchasing and make purchases in future when
price actually falls. Some firms may hold cash for speculative purposes.
Cash Planning
Cash flows are inseparable parts of the business operations of firms. A firm needs
cash to invest in inventory, receivable and fixed assets and to make payment for
operating expenses in order to maintain growth in sales and earnings. It is possible
that the firm may be making adequate profits but may suffer from the shortage of
cash as its growing needs may be consuming cash very fast. The ‘cash-poor’ position
of the firm can be corrected if its cash needs are planned in advance. At times, a firm
can have excess cash with it if its cash inflows exceed cash outflows. Such excess
cash may remain idle. Again, such excess cash flows can be anticipated and properly
invested if cash planning is resorted to. Cash planning is a technique to plan and
control the use of cash. It helps to anticipate the future cash flows and needs of the
firm and reduces the possibility of idle cash balances (which lowers firm’s profitability)
and cash deficits (which can cause the firm’s failure).
Cash planning protects the financial condition of the firm by developing a
projected cash statement from a forecast of expected cash inflows and outflows for
a given period. The forecasts may be based on the present operations or the
anticipated future operations. Cash plans are very crucial in developing the overall
operating plans of the firm.
Cash planning may be done on daily, weekly or monthly basis. The period
and frequency of cash planning generally depends upon the size of the firm and
philosophy of management. Large firms prepare daily and weekly forecasts.
Medium-sized firms usually prepare weekly and monthly forecasts. Small firms
may not prepare formal cash forecasts because of the non-availability of information
and small-scale operations. However, if the small firms prepare cash projections,
it is done on monthly basis.
Cash Forecasting and Budgeting
Cash budget is the most significant device to plan for and control cash receipts
and payments. A cash budget is a summary statement of the firm’s expected cash
inflows and outflows over a projected time period. It gives information on the
timing and magnitude of expected cash flows and cash balances over the projected
period. This information helps the financial manager to determine the future cash
needs of the firm, plan for the financing of these needs and exercise control over
the cash and liquidity of the firm.
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The time horizon of a cash budget may differ from firm to firm. A firm whose Classification of
Mutual Funds
business is affected by seasonal variations may prepare monthly cash budgets.
Daily or weekly cash budgets should be prepared for determining cash requirements
if cash flows show extreme fluctuations. Cash budgets for a longer intervals may
be prepared if cash flows are relatively stable. NOTES
Cash forecasts are needed to prepare cash budgets. Cash forecasting
may be done on short-or long-term basis. Generally, forecasts covering periods
of one year or less are considered short-term forecasts and those extending beyond
one year are considered long-term forecasts.
1. Short-term cash forecasts
It is comparatively easy to make short-term cash forecasts. The important functions
of carefully developed short-term cash forecasts are as follows:
 To determine operating cash requirements
 To anticipate short-term financing
 To manage investment of surplus cash
Short-run cash forecasts serve many other purposes. For example, multi-
divisional firms use them as a tool to coordinate the flow of funds between their
various divisions as well as to make financing arrangements for these operations.
These forecasts may also be useful in determining the margins or minimum balances
to be maintained with banks. Still other uses of these forecasts are as follows:
 Planning reductions of short- and long-term debt
 Scheduling payments in connection with capital expenditures
programmes
 Planning forward purchases of inventories
 Checking accuracy of long-range cash forecasts
 Taking advantage of cash discounts offered by suppliers
 Guiding credit policies
2. Short-term forecasting methods
Two most commonly–used methods of short-term cash forecasting are as follows:
 The receipt and disbursements method
 The adjusted net income method
The receipts and disbursements method is generally employed to forecast
for limited periods, such as a week or a month. The adjusted net income method,
on the other hand, is preferred for longer durations, ranging between a few months
to a year. Both methods have their pros and cons. The cash flows can be compared
with budgeted income and expense items if the receipts and disbursements approach
is followed. On the other hand, the adjusted income approach is appropriate in
showing a company’s working capital and future financing needs.
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Classification of 10.4.1 ST/MT Funding
Mutual Funds
External funds available for a period of one year or less are called short-term
finance. In India, short-term funds are used to finance working capital. Two most
NOTES significant short-term sources of finance for working capital are trade credit and
bank borrowing.
Short-term Sources of Finance
External funds available for a period of one year or less are called short-term
finance. Two most significant short-term sources of finance for working capital
are trade credit and bank borrowing. Let us go through the short-term sources of
finance.
Trade Credit
Trade credit refers to the credit that a customer gets from suppliers of goods in
the normal course of business. In practice, the buying firms do not have to pay
cash immediately for the purchases made. This deferral of payments is a short-
term financing called trade credit. It is a major source of financing for firms. In
India, it contributes to about one-third of the short-term financing. Particularly,
small firms are heavily dependent on trade credit as a source of finance since they
find it difficult to raise funds from banks or other sources in the capital markets.
Trade credit is mostly an informal arrangement, and is granted on an open
account basis. A supplier sends goods to the buyer on credit which the buyer
accepts, and thus, in effect, agrees to pay the amount due, as per sales the terms
in the invoice. However, he does not formally acknowledge it as a debt; he does
not sign any legal instrument. Once the trade links have been established between
the buyer and the seller, they have each other’s mutual confidence, and trade
credit becomes a routine activity which may be periodically reviewed by the supplier.
Open account trade credit appears as sundry creditors (known as accounts
payable in USA) on the buyer’s balance sheet.
Trade credit may also take the form of bills payable. When the buyer signs
a bill—a negotiable instrument—to obtain trade credit, it appears on the buyer’s
balance sheet as bills payable. The bill has a specified future date, and is usually
used when the supplier is less sure about the buyer’s willingness and ability to pay,
or when the supplier wants cash by discounting the bill from a bank. A bill is formal
acknowledgement of an obligation to repay the outstanding amount. In USA,
promissory notes—a formal acknowledgement of an obligation with a promise
to pay on a specified date—are used as an alternative to the open account, and
they appear as notes payable in the buyer’s balance sheet.
Bank Finance for Working Capital
Banks are the main institutional sources of working capital finance in India. After
trade credit, bank credit is the most important source of financing working capital
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requirements. A bank considers a firm’s sales and production plans and the desirable Classification of
Mutual Funds
levels of current assets in determining its working capital requirements. The amount
approved by the bank for the firm’s working capital is called credit limit. Credit
limit is the maximum amount of funds which a firm can obtain from the banking
system. In the case of firms with seasonal businesses, banks may fix separate NOTES
limits for the peak level credit requirement and normal, non-peak level credit
requirement indicating the periods during which the separate limits will be utilized
by the borrower. In practice, banks do not lend 100 per cent of the credit limit;
they deduct margin money. Margin requirement is based on the principle of
conservatism and is meant to ensure security. If the margin requirement is 30 per
cent, bank will lend only up to 70 per cent of the value of the asset. This implies
that the security of bank’s lending should be maintained even if the asset’s value
falls by 30 per cent.
Forms of Bank Finance
A firm can draw funds from its bank within the maximum credit limit sanctioned. It
can draw funds in the following forms: (a) overdraft, (b) cash credit, (c) bills
purchasing or discounting, and (d) working capital loan.
Overdraft: Under the overdraft facility, the borrower is allowed to withdraw
funds in excess of the balance in his current account, up to a certain specified limit,
during a stipulated period. Though overdrawn amount is repayable on demand, it
generally continues for a long period by annual renewals of the limits. It is a very
flexible arrangement from the borrower’s point of view since he can withdraw and
repay funds whenever he desires within the overall stipulations. Interest is charged
on daily balances—on the amount actually withdrawn—subject to some minimum
charges. The borrower operates the account through cheques.
Cash credit: The cash credit facility is similar to the overdraft arrangement. It is
the most popular method of bank finance for working capital in India. Under the
cash credit facility, a borrower is allowed to withdraw funds from the bank upto
the sanctioned credit limit. He is not required to borrow the entire sanctioned
credit at once, rather, he can draw periodically to the extent of his requirements
and repay it by depositing surplus funds in his cash credit account. There is no
commitment charge; therefore, interest is payable on the amount actually utilized
by the borrower. Cash credit limits are sanctioned against the security of current
assets. Though funds borrowed are repayable on demand, banks usually do not
recall such advances unless they are compelled by adverse circumstances. Cash
credit is a most flexible arrangement from the borrower’s point of view.
Purchase or discounting of bills: Under the purchase or discounting of bills, a
borrower can obtain credit from a bank against its bills. The bank purchases or
discounts the borrower’s bills. The amount provided under this agreement is
covered within the overall cash credit or overdraft limit. Before purchasing or
discounting the bills, the bank satisfies itself as to the creditworthiness of the drawer.
Though the term ‘bills purchased’ implies that the bank becomes owner of the
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Classification of bills, in practice, bank holds bills as security for the credit. When a bill is discounted,
Mutual Funds
the borrower is paid the discounted amount of the bill (viz., full amount of bill
minus the discount charged by the bank). The bank collects the full amount on
maturity.
NOTES
Letter of credit: Suppliers, particularly the foreign suppliers, insist that the buyer
should ensure that his bank will make the payment if he fails to honour its obligation.
This is ensured through a letter of credit (L/C) arrangement. A bank opens an L/C
in favour of a customer to facilitate his purchase of goods. If the customer does
not pay to the supplier within the credit period, the bank makes the payment under
the L/C arrangement. This arrangement passes the risk of the supplier to the bank.
Bank charges the customer for opening the L/C. It will extend such facility to
financially sound customers. Unlike cash credit or overdraft facility, the L/C
arrangement is an indirect financing; the bank will make payment to the supplier on
behalf of the customer only when he fails to meet the obligation.
Working capital loan: A borrower may sometimes require ad hoc or temporary
accommodation, in excess of the sanctioned credit limit, to meet unforeseen
contingencies. Banks provide such accommodation through a demand loan
account or a separate non-operable cash credit account. The borrower is
required to pay a higher rate of interest above the normal rate of interest on such
additional credit.
Long-term/Medium-term Sources of Finance
Long-term sources of finance are those that are needed over a longer period of
time - generally over a year. The reasons for needing long-term finance are generally
different to those relating to short term finance. Long term finance may be needed
to fund expansion projects or buy new premises. It is important to remember that
in most cases, a firm will not use just one source of finance but a number of
sources. There might be a dominant source of funds but when you are raising
hundreds of millions of pounds it is unlikely to come from just one source. Let us
go through the various long-term source of finance.
1. Shares
Ordinary shares (referred to as common shares in the US) represent the ownership
position in a company. The holders of ordinary shares, called shareholders (or
stockholders in the US), are the legal owners of the company. Ordinary shares are
the source of permanent capital since they do not have a maturity date. For the
capital contributed by shareholders by purchasing ordinary shares, they are entitled
to dividends. The amount or rate of dividend is not fixed; the company’s board of
directors decides it. An ordinary share is, therefore, known as a variable income
security. Being the owners of the company, shareholders bear the risk of ownership;
they are entitled to dividends after the income claims of others have been satisfied.
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Similarly, when the company is wound up, they can exercise their claims on assets Classification of
Mutual Funds
after the claims of other suppliers of capital have been met.
2. Debentures
A debenture is a long-term promissory note for raising loan capital. The firm promises NOTES
to pay interest and principal as stipulated. The purchasers of debentures are called
debenture holders. An alternative form of debenture in India is bond. Mostly public
sector companies in India issue bonds. In the USA, the term debenture is generally
understood to mean the unsecured bond.
3. Venture Capital Financing: Concept
Venture capital (VC) is a significant financial innovation of the twentieth century.
It is generally considered as a synonym of risky capital. Venture capital finance is
often thought of as ‘the early stage financing of new and young enterprises seeking
to grow rapidly.’ It usually implies an involvement by the venture capitalist in the
management of the client enterprises. It has also come to be associated with the
financing of high and new technology based enterprises. The conventional financiers
generally support proven technologies with established markets. Venture capital
focuses on high technology, but it is not a necessary condition for venture financing.
According to Pratt:
There is a popular misconception that high-technology is the principal driving
factor behind the investment decision of a US venture capitalist. Only a small minority
of venture capital investments are in new concepts of technology where potential
technical problems add a significant amount of risk to the new business development.
There is, however, no doubt that young, high-tech companies would look
forward to the venture capitalists for making risky capital available to them. In
broad terms, venture capital is the investment of long-term equity finance where the
venture capitalist earns his return primarily in the form of capital gains. The underlying
assumption is that the entrepreneur and the venture capitalist would act together in
the interest of the enterprise as ‘partners’. The true venture capital finances any
risky idea. In fact, venture capital can prove to be a powerful mechanism to
institutionalize innovative entrepreneurship. It is a commitment of capital for the
formation and setting up of small-scale enterprises specializing in new ideas or new
technologies. The venture capitalist focuses on growth; he would like to see small
business growing into larger ones.
Check Your Progress

4. State the parties involved in factoring.
5. What are the three motives for holding cash?
6. Why are cash forecasts needed?
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Classification of
Mutual Funds 10.5 ANSWERS TO CHECK YOUR PROGRESS
QUESTIONS
NOTES 1. The SEBI Mutual Fund Regulations, 1993 defines mutual fund as ‘a fund
through sale of units to the public, under one or more schemes, for investing
in securities in accordance with the regulations’.
2. The aspects that are in favour of index funds are:
 Low costs
 Predictability
 Diversification
3. The main objective of growth funds is to provide capital appreciation over
medium to long term. They invest a major portion of their collected money
in equity. This makes them prone to risk. As per their preference, the investors
may either choose the option of dividend or the option of capital appreciation.
4. There are three parties involved in a factoring transaction:
 The buyer of the goods
 The seller of the goods
 The factor, i.e., financial institution
5. The following basic services are provided in factoring:
 Financial accommodation
 Sales ledger administration and credit management
 Credit collection
 Protection to seller against default and bad-debt losses of buyers
6. Cash forecasts are needed to prepare cash budgets. Cash forecasting may
be done on short-or long-term basis. Generally, forecasts covering periods
of one year or less are considered short-term forecasts and those extending
beyond one year are considered long-term forecasts.
10.6 SUMMARY
 Mutual fund is a mechanism for pooling resources by issuing units in securities

to the investors and investing funds in accordance with the objectives
disclosed in the offer document. A mutual fund is a corporation, trust or
partnership, which manages the collected money with the help of professional
expertise.
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 The SEBI Mutual Fund Regulations, 1993 defines mutual fund as ‘a fund Classification of
Mutual Funds
through sale of units to the public, under one or more schemes, for investing
in securities in accordance with the regulations’.
NOTES
 A mutual fund scheme can be classified into close ended or open ended
depending on its maturity period.
 Gift funds are also known as G-Sec funds. These invest in the Government
of India securities, and have gained popularity in the Indian market. The
Securities Exchange Board of India has issued new guidelines in 2002 with
an aim to provide better checks and balances for the mutual funds.
 The main objective of growth funds is to provide capital appreciation over
medium to long term. They invest a major portion of their collected money
in equity. This makes them prone to risk. As per their preference, the investors
may either choose the option of dividend or the option of capital appreciation.
Investors have to specify their choice while applying for units.
 Sector specific funds/schemes invest in securities of those sectors or industries
specified in the offer documents, e.g., information technology,
pharmaceuticals, fast moving consumer goods (FMCG) and petroleum,
etc.
 The returns on these funds depend on the performance of these sectors.
Since they are investing in a particular sector, the risk is high as compared
to the other funds.
 Factoring is a type of financial service provided by specialist organizations.
In factoring, a financial institution (factor) buys the debts or accounts
receivables of a company (client) and pays up to 80 per cent (rarely up to
90 per cent) of the amount immediately to credit sales, once agreement
with the factor is entered into.
 Factoring is an arrangement under which a financial institution (called a factor)
undertakes the task of collecting the book debts of its client in return for a
service charge. Factoring involves the sale of receivables to a specialized
firm, called factors.
 Normally, the credit evaluation of potential buyers, the maintenance of a
sales ledger, follow-up with debtors and collections from them are handled
by a separate credit department in an organization; its role is vital in improving
liquidity and profitability.
 Cash management is concerned with the managing of: (i) cash flows into
and out of the firm, (ii) cash flows within the firm, and (iii) cash balances
held by the firm at a point of time by financing deficit or investing surplus
cash.
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Classification of  Management of cash is also important as it is difficult to predict cash flows
Mutual Funds
accurately, particularly the inflows, and there is no perfect agreement between
the inflows and outflows of cash.
 Cash budget is the most significant device to plan for and control cash
NOTES
receipts and payments. A cash budget is a summary statement of the firm’s
expected cash inflows and outflows over a projected time period. It gives
information on the timing and magnitude of expected cash flows and cash
balances over the projected period.
 Cash forecasts are needed to prepare cash budgets. Cash forecasting may
be done on short-or long-term basis. Generally, forecasts covering periods
of one year or less are considered short-term forecasts and those extending
beyond one year are considered long-term forecasts.
 Trade credit refers to the credit that a customer gets from suppliers of goods
in the normal course of business. In practice, the buying firms do not have
to pay cash immediately for the purchases made. This deferral of payments
is a short-term financing called trade credit. It is a major source of financing
for firms.
10.7 KEY WORDS
 Exchange-traded fund: An exchange-traded fund is an investment fund

traded on stock exchanges, much like stocks. An ETF holds assets such as
stocks, commodities, or bonds and generally operates with an arbitrage
mechanism designed to keep it trading close to its net asset value, although
deviations can occasionally occur.
 Factoring: Factoring is a financial transaction and a type of debtor finance
in which a business sells its accounts receivable to a third party at a discount.
A business will sometimes factor its receivable assets to meet its present
and immediate cash needs.

EXERCISES
1. What are load and no load funds?
2. Write a short note on factoring services.
3. What are the different short-term sources of finance?
4. State the different forms of bank finance.
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Long-Answer Questions Classification of
Mutual Funds
1. Describe the different types of mutual funds.
2. Discuss the procedure of factoring.
3. Explain the methods of factoring. NOTES
4. Analyse the meaning and importance of cash management.

5. Describe the long-term sources of finance.

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Cash Flow Cycle
BLOCK - IV
LRR AND CRR
NOTES
UNIT 11 CASH FLOW CYCLE
Structure
11.0 Introduction
11.1 Objectives
11.2 Cash Flow Budgeting and Forecasting
11.3 Securitization
11.3.1 Term Loans
11.4 Capital Budgeting
11.5 Profit and Cost Centre
11.7 Summary
11.8 Key Words
11.0 INTRODUCTION
In the previous unit, you learnt about how mutual funds are classified. In this unit,
the discussion will turn towards cash flow cycle. In a business, cash flow cycle
attempts to measure the time it takes a company to convert its investment in inventory
and other resource inputs into cash. In other words, the calculation measures how
long cash is tied up in inventory before the inventory is sold and cash is collected
from customers. Just like any other business, the cash flow is extremely important
for banks to maintain their working capital. This unit will discuss cash flow
budgeting, forecasting, cost and profit centre and capital budgeting in detail.
11.1 OBJECTIVES

 Explain cash flow forecasting
 Describe the ways in which a banker secures his advances
 Discuss capital budgeting, cost and profit centre
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Cash Flow Cycle
11.2 CASH FLOW BUDGETING AND
FORECASTING
Three basic principles are followed in forecasting project cash flow: (a) relevant NOTES
or incremental cash flow principle, (b) ‘independent of financing’ principle, (c)
long-term fund principle.
The relevant or incremental cash flow principle
Only those cash flows, which are relevant to making investment decisions, should
be considered in estimating project cash flows. A net change in a firm’s cash flow
due to acceptance of a project is relevant in making decision. An acceptance of a
new project may cause changes in the fixed assets and working capital, and in the
operating cash flows. An acceptance of a project of one department may affect
cash flows of other departments, which is relevant for the project. For example, a
powder detergent company sets up a plant for manufacturing liquid detergents. It
may result in a loss of sales of powder detergent due to cannibalization effect.
Therefore, it is relevant to the liquid detergent project. Some points related to the
relevant cash flow principle are explained later in this section. But those readers
who want to read in detail about relevant cash flow are advised to read a suitable
book on management accounting.
The ‘independent of financing’ principle
Investment and financing decisions are considered to be completely independent
of each other, according to this principle. Therefore, interest expense together
with tax savings on it is not considered as part of project cash flow. Project cash
flow is calculated as per Equation 11.1.
Project cash flow = PAT + Depreciation ± Working capital change +
Interest × (1 - t) (11.1)
Interest on debt, together with a tax shield is added back to the net profit
for calculating the yearly cash flow of the project. Repayment of the principal sum
of loan is not considered as project cash flow. According to the same logic dividend
payment by the firm is not considered as part of the project cash flow. Project
cash flow is discounted by a discount rate, which comprises the interest, tax shield
on interest and dividend components related to financing of a project. Therefore,
it is excluded from the project cash flow.
The long-term funds principle
This principle is rather an exception to the previous principle of ‘independence of
financing’. Only long term financing is kept separate from the project cash flow.
Long term financing is necessary for investment in fixed assets and permanent
portion of working capital. Short term fluctuation in working capital and its financing
are combined with the project cash flow. Therefore, the working capital loan
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Cash Flow Cycle schedule and its interest schedule are prepared and the cash flows associated with
it is included in the project cash flow.
Salient Points about Basic Principles
NOTES The principle of relevant cash flow can be easy to understand after the perusal of
pertinent issues. Some of these issues are enumerated below:
Incremental cash flow
This is the basic principle; only the incremental cash flow is relevant to a project.
Some important points to be remembered are:
(a) Sunk costs are not relevant: Costs incurred in the past are historical
cost. A part of historical cost is realizable, which is relevant. The remaining
part, which cannot be realized, is a sunk cost. The sunk portion of historical
cost is not relevant. For example, in a replacement project, a new machine
is bought and the old one is discarded. The book value (say 5,000) of an
old machine is the ‘historical cost’. If this old machine can be sold at say
1,000 then 4,000 is unrealizable and therefore ‘sunk’ but 1,000 is
realizable and therefore ‘relevant’ or ‘incremental’ or ‘future’ or ‘opportunity’
cash flow. This cash flow will occur if the replacement project is accepted,
and therefore 1,000 is a part of the project cash flow.
(b) Overheads may not be relevant: If a firm’s overheads are unlikely to
change with the acceptance of a particular investment plan, then it is irrelevant
irrespective of policy of overhead allocation. But, if some overheads are
likely to change with the acceptance of a project then amount of change is
a relevant cash flow.
(c) Any cost can be relevant or irrelevant: No particular cost is automatically
relevant or otherwise. Therefore, costs classified into direct cost and indirect
costs (or overheads), or variable costs and fixed costs cannot be generalized
as either relevant or irrelevant costs. Only future cash flows are relevant,
irrespective where they occur in the whole organization.
(d) The project cash flow may occur anywhere in the firm: It often happens
that the acceptance of a proposed project may have effects somewhere in
the firm. Any cash flow that occurs anywhere in the firm as a result of the
acceptance of a project is the ‘project cash flow’. For example, if a firm
builds a new division for the production of a new product and as a result if
the sales of one of the existing division are expected to reduce then the
expected loss of cash flow from the existing division is the cash flow of the
project of building a new division.
Salvage value must be considered
The salvage value of assets on the date of project termination must be included as
the terminal cash flow, which becomes the part of project cash flow. The tax
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implications on salvage value are also considered. Similarly, if the acceptance of Cash Flow Cycle
an investment plan requires the salvaging of some assets held now, then that salvage
value is considered as cash inflow in the initial period.
Working capital must be considered NOTES
Working capital is the net investment in circulating assets (like cash, raw material,
semi finished goods, finished goods and receivables) minus current liabilities (like
accounts payables and other payables). In most cases capital investment proposals
require an additional (incremental) working capital, without which wheels of fixed
assets cannot operate.
Any increase (decrease) in the core or permanent (or core) working capital
is an initial cash outflow (inflow). This core working capital is held through the
project life (no effect on operating cash flow), and upon the termination of the
project the working capital change back to original and therefore result into the
decrease (increase) of the working capital, incurring cash inflow (outflow) as the
terminal cash flow. That means the change in working capital affects initial cash
flow as well as terminal cash flow, but with opposite sign (inflow vs. outflow).
However, note that as per the ‘long-term funds principle’ fluctuating working
capital requirements during the life of the project, together with its source of funds
and cost of funds, is considered as the part of operating cash flow of the project.
Tax implications
Incremental tax is usually a largest single component in cash flow estimates. The
government provides incentives and disincentives for investment in selected areas
of business and location. Central and State tax structure (direct and indirect both)
must be appropriately considered at a realistic level. A realistic level means the
extent to which it can be availed to a firm.
Cash Flow Classification
Cash flow can be classified from various angles as below:
1. Timing of occurrence basis
2. Type of cash flow
3. Pattern of cash flow
4. Inter-dependence basis
Timing of occurrence basis
Project cash flow is usually classified into three parts on the basis of the timing of
occurrence; namely, (a) initial cash flow, (b) operating cash flow and (c) terminal
cash flow.
(a) Initial cash flow It is the cash flow of the capital type, which is usually an
outflow for a typical project1. This cash flow would remain invested for the
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Cash Flow Cycle life of the project, during which it would generate operating cash flow as
return. All capital assets, pre-operative expenditure, preliminary expenditure,
as well as core working capital are included in the initial cash flow.
(b) Operating cash flow The Operating cash flow starts coming in once the
NOTES
project is commissioned and the initial teething problems are over. The
operating cash flow is generated from regular cash receipts and cash
payments during routine operations. Tax implications are also considered
here.
(c) Terminal cash flow The terminal cash flow is important for the internal
evaluation of projects. At the end of the project life, salvage value is received
and working capital is recovered in cash. These items together with tax
implications, if any, form part of the terminal cash flow.
Types of cash flow
Cash flows are also classified three groups on the basis of the type. These groups
are (a) absolute cash flow, (b) relative cash flow and (c) incremental cash flow.
(a) Absolute cash flow It occurs in the case of green field projects, because
all the cash flows of such projects are incremental over zero. Any investment,
which does not change the existing assets, is likely to have absolute cash
flow. For example, if a new business is set up, all the cash flows of that
business is absolute cash flow because they occur additionally over no existing
cash flows.
(b) Relative cash flow occurs when two mutually exclusive investment
alternatives are evaluated. The difference in the cash flow of the two
alternatives is termed as the relative cash flow. If a company wants to add
a new machine in its shop floor, and two alternative machines are evaluated,
then the cash flow estimates of both alternative machines give a relative
cash flow on comparison.
(c) Incremental cash flow is obtained when an investment proposal is meant
for replacement of some existing assets. Modernization, new product
development, replacement of machine and such investment opportunities
involve the projection of incremental cash flow. The excess of cash flow
from the proposed investment plan over that of existing alternative is called
the incremental cash flow.
The classification of cash flow on these lines follows the same basic principles
of cash flow projection. The awareness of this classification would change the
context of understanding. One has to be careful, particularly in the incremental
cash flow, as a mechanical process of evaluation may lead to a wrong decision.
An investment option involving incremental cash flow may not have an investment
pattern, but may have a financing pattern. The divestment option would generate
financing pattern, which can be accepted if IRR is less than discount rate, which is
just opposite to the IRR-based decision rule.
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Table 11.1 Summary List of Cash Flow Classification Cash Flow Cycle
Timing of Types of Pattern of Interdependence

Occurrence basis Cash Flow Cash Flow basis
Initial investment Absolute cash flow Investment vs. Independent
Financing pattern Dependent NOTES
Operating cash flow Relative cash flow Other patterns; Dependent on;
Terminal cash flow Incremental cash flow * conventional vs. * Other cash flow
non-conventional streams
* Annuity * Cash flow of previous
* Mixed period
Perfectly correlated
Partially correlated
Pattern of cash flow

Cash flow pattern are described in two ways:
(a) Investment vs financing pattern In the investment pattern of cash flow,
an outflow occurs initially followed by a stream of inflow, whereas in financing
pattern the initial inflow occurs followed by a stream of outflow. For example,
Y0 Y1 Y2 Y3 Yn
Investment pattern  -1000 +200 +300 +400 + 300
Financing pattern  +1000 -200 -300 -400 -300
Initial and subsequent signs of cash flow create the distinction of investment
and financing pattern of cash flow.
(b) Other patterns The timing of cash flow gives the following patterns:
 Conventional vs. non-conventional cash flow: In the conventional cash
flow either initial inflow is followed by outflow, or initial outflow is
followed by inflow; and sign changes only once in the cash flow stream
over the time line. In the non-conventional cash flow, inflows and the
outflows occur alternatively though not with regularity and sign changes
more than once during the period of cash flows.
 Annuity cash flow: The annuity cash flow implies that the subsequent
series of cash flow (inflow in case of the investment pattern, and outflow
in case of the financing pattern) is uniform in amount.
Table 11.2 Examples of various patterns of cash flows
Y0 Y1 Y2 Y3 Y4 Yn
Conventional  (a) -1000 +200 +300 +400 +450 +300
or (b) +1000 -200 -300 -400 -450 -300
Non conventional ® -1000 +500 +300 -400 +500 +300
Annuity  (c) -1000 +300 +300 +300 +300 +300
or (d) +1000 -300 -300 -300 -300 -300
Mixed  -1000 +500 +300 +100 +300 +200
Mixed cash flow: It is the opposite of annuity cash flow. An uneven stream
of cash flow is called a mixed cash flow. Table 11.2 gives examples of each of
these patterns. A conventional stream can be either in annuity form or in mixed
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Cash Flow Cycle It is essential to know the pattern in which cash is received from investments
so that terms for the funds for financing of the project can be suitably determined.
The cost of funds usually comes down where project cash flow matches in terms
of amount and timing with the capital servicing commitments. A mismatch between
NOTES the two may require further funds for bridging the gap and increase the cost of
project.
Interdependence basis
This classification is applied to risky cash flow. Cash flows may be independent or
inter-dependent. Cash flow can be inter-dependent in two ways: (a) different
streams of cash flow during a single period may be dependent on each other, and
(b) cash flow of two different periods may be dependent on each other. The price
of raw material and price of output, quality cost and price of output, price of
product and sales quantity are dependent on each other. They are examples of the
former type of inter-dependence. Whereas, in case of a new product launch the
cash flow of the first year of commissioning will depend on the project completion
time, in the case of a research project the cash flow estimate in, say, year-3 will
depend upon the actual cash flow of year-2. Inter-dependence of cash flow may
change the risk profile of the complete cash flow stream of the project.
If cash flows are related then they may be in (a) perfect correlation, either
positive or negative, or (b) partial correlation, either positive or negative. Since
risk is an important element in the endeavour to attain the objective of shareholder
wealth maximization the interdependence of cash flow assumes greater significance
in investment analysis.
Electronic cash management refers to the set of procedures and practices of
integrated management of cash with the developments in the technologies of the
information. Electronic cash management systems are becoming popular with
companies as they help deter fraud. This is because electronic cash management
solutions deter money handlers from pocketing money, they provide a proper
paper trail throughout the entire process as well as they provide easy access to
oversight.
11.3 SECURITIZATION
A banker secures the advances by means of:

(a) Lien
(b) Pledge
(c) Mortgage
(d) Hypothecation
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Banker’s Lien Cash Flow Cycle
Legal aspects relating to ‘Banker’s Lien’ have already been discussed in detail in
the chapter ‘Banker and Customer’ under the heading ‘Banker’s Lien’. Reader’s
attention is invited to that section. It may briefly be repeated here that a lien is a NOTES
right to retain properties belonging to the debtor until he has discharged the debt
due to the retainer of the properties. A banker’s lien is a general lien, which confers
a right to retain properties in respect of any general balance due by the debtor to
the banker. Bankers have a general lien on all securities deposited with the bankers
in their capacity as bankers by a customer unless there be an express contract or
circumstances that show an implied contract inconsistent with the lien as has been
held in Brandao vs Barnett. In the case of lien, banker’s right of sale extends to
only fully negotiable securities. As far as such securities as concerned, the banker
may exercise his right of sale after serving reasonable notice to the customer. In
the case of securities other than fully negotiable securities, the banker is well advised
to realize them only after getting sanction from a Court of Law.
Pledge
A pledge is a contract whereby an article is deposited with a lender or a promise
as security for the repayment of a loan or performance of a promise. To complete
a contract of pledge, delivery of the goods to the banker is necessary. Delivery of
the documents of title relating to the goods, or the key of the godown where the
goods are stored, may be sufficient to create a valid pledge. Strictly speaking,
where no possession is given, it is known as ‘hypothecation’, which is elaborated
in the next section. Legal aspects relating to pledges in this section cover ‘documents
of title’ also.
It has been observed in Shatzadi Begum Saheba and others vs Girdharilal
Sanghi and others that there are three essential features of a pledge, namely:
(a) there must be a bailment of goods, i.e., delivery of goods;
(b) the bailment must be by way of security and
(c) the security must be for payment of a debt or performance of a
promise.
A pledge gives the pledgee no right of ownership. But under Section 173 of
the Indian Contract Act, he gets a special interest to retain possession even against
the true owner until the payment of the debt, and any other expenses incurred in
respect of the possession or preservation of the goods. In case of a pledge a
special interest and not the special property is transferred to the pledge who is
impliedly authorized to sell the goods pledged in case of default in accordance
with the provisions of the Contract Act as has been held in Kunhunni Elaya
Nayar vs Krishna Pattar. The pledgee’s right of disposition is governed by the
terms of the pledge and is limited to the recovery of the amount due under the
pledge as has been held in the above referred case of Shatzadi Begum Saheba
and others vs Girdharilal Sanghi and others.
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Cash Flow Cycle Mortgage
Section 58 of the Transfer of Property Act defines a ‘mortgage’ thus:
‘A mortgage is the transfer of an interest in a specific immovable property
NOTES for the purpose of securing the payment of money advanced or to be advanced by
way of loan, an existing or future debt, or the performance of an engagement
which may give rise to pecuniary liability.’
In terms of the above definition, the essentials of a mortgage are:
1. There must be a transfer of interest in an immovable property.
2. The immovable property must be a specific one.
3. The consideration of a mortgage may be either money advanced or to
be advanced by way of a loan, or the performance of a contract.
What is ‘Immovable Property’?
When the banker is securing the advances on the security of collaterals, the point
whether a particular collateral is a movable property or an immovable property
assumes significance. It may be recalled here that a mortgage can be created only
by a transfer of interest in an immovable property. Besides, this point is relevant
for determining the period of limitation for a suit for declaration of the title to the
property, or for recovery of possession of the property. If the property is a movable
property, then such a suit is required to be filed within three years. But if it is an
immovable property, then such a suit can be filed within twelve years.
In Ramadev Panigrahi vs Smt Manorama Raj, the question whether
machinery embedded or installed in the earth, by constructing foundations for the
purpose, was movable or immovable came up for consideration. The High Court
the statutory definitions of the terms ‘movable property’ and ‘immovable property’
and stated that movable property would become immovable property if it was
attached to the earth or permanently fastened to anything attached to the earth.
The enquiry should not be whether the attachment is direct or indirect; but what
the nature and character of the attachment and the intention and object of such
attachment were. The High Court considered several English and Indian decided
cases on the subject and felt that the tests enunciated by these cases to determine
the character and nature of the property were:
(a) What was the intendment, object and purpose of installing the
machinery—whether it was the beneficial enjoyment of the building,
land or structure, or the enjoyment of the very machinery?
(b) The degree and manner of attachment or annexation of the machinery
to the earth.
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In order to determine the intendment, object and purpose of installing the Cash Flow Cycle
machinery, the High Court observed:

‘Where the machinery and the building or land on which it is installed
are owned by one and the same person normally it should be inferred,
unless the contrary is proved, that the object and purpose of installing NOTES
the machinery is to have beneficial enjoyment of the entire building or
land but not the sole enjoyment of the very machinery itself. However,
where the machinery imbedded or installed and the building or land
belong to two different persons, the intendment and object of the
person who is in possession and enjoyment of the property in installing
or annexing the machinery must normally be presumed, until the
contrary is proved, to be to exploit the benefit of machinery alone, as
he is not interested in the building or land.’
Thus, it has to be inferred that the object and purpose of installation of the
machinery by a lessee or a tenant in possession of a building, factory or land, was
for the beneficial enjoyment of the very machinery during the period of lease or
tenancy and not for making any permanent improvement of the building, factory or
land, as the case may be. Again, where the building in which machinery has been
installed was not a pucca or permanent one, but was only a temporary shed, the
intention and purpose of the owner could only be the beneficial enjoyment of the
very machinery but not the building.
Hypothecation—Mortgage of Movables
A ‘mortgage of movables’ may be defined as a transfer, by way of security of the
general ownership of the chattel, subject to the equity of redemption of the
mortgagor. Mortgage of movables can be made by mere parole and without transfer
of possession. However, a subsequent mortgagee with possession, in the absence
of notice of the previous mortgage, will get priority over a prior mortgage without
possession. In the strict sense, the term ‘mortgage’ is used only in connection
with immovables. In the case of movables, the terms ‘pledge’ and ‘hypothecation’
are used generally. Where a mortgage of movables is created by delivery of
possession of goods, it is known as a ‘pledge’, and where no possession is given
it is known as ‘hypothecation’.
Letter of Hypothecation
In the case of hypothecation, a document known as ‘Letter of Hypothecation’ is
executed. This document details the terms under which the relevant goods are
hypothecated. Briefly, the following are the main contents of the letter of
hypothecation:
(a) affirmation by the borrower that the goods are free from encumbrances,
that further encumbrances will not be created on them and that he is the
absolute owner of the goods;
(b) undertaking by the borrower that proceeds arising from the sale of the
hypothecated goods will be utilized for the repayment of the advance;
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Cash Flow Cycle (c) undertaking by the borrower to meet all expenses relating to the safe custody
of the hypothecated goods and that sufficient margin acceptable to the banker
will be maintained at all times; and
(d) provision to the effect that the banker has the right to take possession of the
NOTES
hypothecated goods and to realize them in the event of the borrower making
default in the repayment of the advance.
11.3.1 Term Loans
Term loans are short-term loans offered to businesses for capital expenditure and
expansion among others. Generally having a tenor up to 5 years, these loans are
tailor-made to suit the various financial needs of businesses. Minimal documentation,
quick disbursal of funds, and flexibility in repayment are some of the major benefits
of these loans.
MT and LT Funding
We have already discussed the various sources of medium and long-term funding
in the previous unit.
11.4 CAPITAL BUDGETING
The investment decisions of a firm are generally known as the capital budgeting,
or capital expenditure decisions. A capital budgeting decision may be defined
as the firm’s decision to invest its current funds most efficiently in the long-term
assets in anticipation of an expected flow of benefits over a series of years. The
long-term assets are those that affect the firm’s operations beyond the one-year
period. The firm’s investment decisions would generally include expansion,
acquisition, modernization and replacement of the long-term assets. Sale of a
division or business (divestment) is also as an investment decision. Decisions like
the change in the methods of sales distribution, or an advertisement campaign or a
research and development programme have long-term implications for the firm’s
expenditures and benefits, and therefore, they should also be evaluated as investment
decisions. It is important to note that investment in the long-term assets invariably
requires large funds to be tied up in the current assets such as inventories and
receivables. As such, investment in fixed and current assets is one single activity.
The following are the features of investment decisions:
 The exchange of current funds for future benefits
 The funds are invested in long-term assets
 The future benefits will occur to the firm over a series of years
It is significant to emphasize that expenditures and benefits of an investment
should be measured in cash. In the investment analysis, it is cash flow, which is
important, and not the accounting profit. It may also be pointed out that investment
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decisions affect the firm’s value. The firm’s value will increase if investments are Cash Flow Cycle
profitable and add to the shareholders’ wealth. Thus, investments should be

evaluated on the basis of a criterion, which is compatible with the objective of the
Shareholder Wealth Maximization. An investment will add to the shareholders’
wealth if it yields benefits in excess of the minimum benefits, as per the opportunity NOTES
cost of capital.
11.5 PROFIT AND COST CENTRE
For the purpose of ascertaining cost, the whole organization is divided into small
parts or sections. Each small section is treated as a cost centre of which cost is
ascertained. A cost centre is defined by CIMA, London as ‘a location, person,
or item of equipment (or group of these), for which costs may be ascertained
and used for the purpose of control.’ Thus, a cost centre refers to a section of
the business to which costs can be charged. It may be a location (a department,
a sales area), an item of equipment (a machine, a delivery van), a person
(a salesman, a machine operator) or a group of these (two automatic machines
operated by one workman). The main purpose of ascertaining the cost of a cost
centre is control of cost.
Cost centres are primarily of two types:
(a) Personal cost centre—which consists of a person or a group of
persons.
(b) Impersonal cost centre—which consists of a location or an item of
equipment or group of these.
From a functional point of view, cost centres may be of the following two
types:
(a) Production cost centre: These are those cost centres where actual
production work takes place. Examples are, weaving department in a
textile mill, melting shop in a steel mill and cane crushing shop in a
sugar mill.
(b) Service cost centre: These are those cost centres which are ancillary
to and render services to production cost centres. Examples of service
cost centres are power house, tool room, stores department, repair
shop and canteen.
A cost accountant sets up cost centres to enable himself to ascertain the
costs he needs to know. A cost centre is charged with all the costs that relate to it,
e.g., if a cost centre is a machine, it will be charged with the costs of power, light,
depreciation and its share of rent, etc. The purpose of ascertaining the cost of a
cost centre is cost control. The person in charge of a cost centre is held responsible
for the control of cost of that centre.
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Cash Flow Cycle Profit Center
A profit center is a section of a company treated as a separate business. Thus
profits or losses for a profit center are calculated separately.
NOTES Business organizations may be organized in terms of profit centers where
the profit center’s revenues and expenses are held separate from the main company’s
in order to determine their profitability. Usually different profit centers are separated
for accounting purposes so that the management can follow how much profit each
center makes and compare their relative efficiency and profit. Examples of typical
profit centers are a store, a sales organization and a consulting organization whose
profitability can be measured.
A profit center manager is held accountable for both revenues, and costs
(expenses), and therefore, profits. What this means in terms of managerial
responsibilities is that the manager has to drive the sales revenue generating activities
which leads to cash inflows and at the same time control the cost (cash outflows)
causing activities.
This makes the profit center management more challenging than cost center
management. Profit center management is equivalent to running an independent
business because a profit center business unit or department is treated as a distinct
entity enabling revenues and expenses to be determined and its profitability to be
measured.
Peter Drucker originally coined the term profit center around 1945. He
later recanted, calling it ‘One of the biggest mistakes I have made.’ He later asserted
that there are only cost centers within a business, and ‘The only profit center is a
customer whose cheque hasn’t bounced.’
Cost Unit
“Cost unit is a form of measurement of volume of production or service. This unit
is generally adopted on the basis of convenience and practice in the industry
concerned.” CAS-I.
A cost unit is defined by CIMA, London as a ‘unit of product or service
in relation to which costs are ascertained.’ For example, in a sugar mill, the
cost per tonne of sugar may be ascertained, in a textile mill the cost per metre of
cloth may be ascertained. Thus ‘a tonne’ of sugar and ‘a metre’ of cloth are cost
units. In short, cost unit is unit of measurement of cost.
All sorts of cost units are adopted, the criterion for adoption being the
applicability of a particular cost unit to the circumstances under consideration.
Broadly, cost units may be of two types as explained below:
(i) Units of production, e.g., a ream of paper, a tonne of steel or a
metre of cable.
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(ii) Units of service, e.g., passenger miles, cinema seats or consulting Cash Flow Cycle
hours.
The cost units and cost centres should be those which are natural to the
business and which are readily understood and accepted by all concerned.
NOTES
Cost Object
Cost object may be defined as ‘anything for which a separate measurement of
cost may be desired.’ A cost accountant may want to know the cost of a particular
‘thing’ and such a ‘thing’ is called a cost object. A cost object may be a product,
service, activity, department or process, etc.
Planning and Control
Financial planning and control defines as a combination of strategies it supports
the entire financial management process for an organization. The process begins at
financial planning, many times in the form of cash flow and forecasting balance
sheet. This information will be use of various reasons, in order to calculate your
business ratios and financial indicators as a basis for the calculation otherwise in
order to illustrate risk calculation or repayment purposes.
Check Your Progress

1. What is working capital?
2. What are the ways of classifying cash flow?
3. What is a pledge?
4. What is profit centre?

QUESTIONS
1. Working capital is the net investment in circulating assets (like cash, raw
material, semi-finished goods, finished goods and receivables) minus current
liabilities (like accounts payables and other payables). In most cases capital
investment proposals require an additional (incremental) working capital,
without which wheels of fixed assets cannot operate.
2. Cash flow can be classified from various angles as below:
(i) Timing of occurrence basis
(ii) Type of cash flow
(iii) Pattern of cash flow
(iv) Inter-dependence basis
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Cash Flow Cycle 3. A pledge is a contract whereby an article is deposited with a lender or a
promise as security for the repayment of a loan or performance of a promise.
To complete a contract of pledge, delivery of the goods to the banker is
necessary.
NOTES
4. A profit center is a section of a company treated as a separate business.
11.7 SUMMARY
 Three basic principles are followed in forecasting project cash flow: (a)
relevant or incremental cash flow principle, (b) ‘independent of financing’
principle, (c) long-term fund principle.
 The salvage value of assets on the date of project termination must be
included as the terminal cash flow, which becomes the part of project cash
flow. The tax implications on salvage value are also considered.
 Incremental tax is usually a largest single component in cash flow estimates.
The government provides incentives and disincentives for investment in
selected areas of business and location. Central and State tax structure
(direct and indirect both) must be appropriately considered at a realistic
level.
 Project cash flow is usually classified into three parts on the basis of the
timing of occurrence; namely, (a) initial cash flow, (b) operating cash flow
and (c) terminal cash flow.
 Electronic cash management refers to the set of procedures and practices
of integrated management of cash with the developments in the technologies
of the information.
 A banker secures the advances by means of:
(a) Lien
(b) Pledge
(c) Mortgage
(d) Hypothecation
 A capital budgeting decision may be defined as the firm’s decision to invest
its current funds most efficiently in the long-term assets in anticipation of an
expected flow of benefits over a series of years.
 A cost centre refers to a section of the business to which costs can be
charged. It may be a location (a department, a sales area), an item of
equipment (a machine, a delivery van), a person (a salesman, a machine
operator) or a group of these (two automatic machines operated by one
workman). The main purpose of ascertaining the cost of a cost centre is
control of cost.
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 Cost object may be defined as ‘anything for which a separate measurement Cash Flow Cycle
of cost may be desired.’
11.8 KEY WORDS NOTES

 Cost Unit: It is a form of measurement of volume of production or service.
This unit is generally adopted on the basis of convenience and practice in
the industry concerned.
 Capital Budgeting: It is the planning process used to determine whether
an organization’s long term investments such as new machinery, replacement
of machinery, new plants, new products, and research development projects
are worth the funding of cash through the firm’s capitalization structure
 Mortgage: It is a legal agreement by which a bank, building society, etc.
lends money at interest in exchange for taking title of the debtor’s property,
with the condition that the conveyance of title becomes void upon the payment
of the debt.
 Hypothecation: It is the practice where a debtor pledges collateral to
secure a debt or as a condition precedent to the debt, or a third party
pledges collateral for the debtor.

EXERCISES
1. What is a banker’s lien?
2. What is capital budgeting?
3. What are the two types of cost centres?
Long-Answer Questions
1. Discuss the principles for forecasting cash flow.
2. Describe the various types of cash flow.
3. Examine how a banker secures his advances.

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Cash Flow Cycle Acharya S.C. and A. K. Mohanty. Operational Analysis of Regional Rural
NOTES
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Liquidity Management
UNIT 12 LIQUIDITY MANAGEMENT

Structure NOTES
12.0 Introduction
12.1 Objectives
12.2 Objectives and Sources
12.3 Contingency Plans
12.5 Summary
12.6 Key Words
12.0 INTRODUCTION
In the previous unit, you learnt about cash flow budgeting, forecasting, capital
budgeting and cash management.
Liquidity means the capacity to meet one’s financial commitments. Banks
are often evaluated on their liquidity, or their ability to meet cash and collateral
obligations without incurring substantial losses. Liquidity management then describes
the effort of bank managers to decrease liquidity risk exposure. This unit will discuss
the objectives and sources of liquidity management. It will also discuss contingency
plans, maturity ladder, information and internal control.
12.1 OBJECTIVES

 Describe the objectives and sources of liquidity management
 Discuss contingency plans and maturity ladder
12.2 OBJECTIVES AND SOURCES
Liquidity refers to a company’s cash position and its ability to meet obligations
when due. A key role of all cash managers in ensuring liquidity is the daily monitoring
of working capital and to optimally manage the company’s resources by accelerating
inflows and controlling outflows. If there is an excess of cash in the daily position,
the cash manager has to determine the best use for that surplus. If there is a deficit,
the cash manager must find a source of funds.
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Liquidity Management There are three major sources and uses of liquidity. The sources are:
1. Business flows: Cash generated by the business
2. Internal sources: Cash on deposit or invested in liquid instruments
NOTES 3. External sources: Cash raised from sources such as the Commercial
Paper market or from banks
The uses are:
1. Business flows: Outflows generated by the business
2. Internal uses: Investments or purchase of assets
3. External uses: Repayment of debt
Maturity Concerns
Liquidity problems arise on account of the mismatches in the timing of inflows and
outflows. Per se, the liabilities being the sources of funds are inflows while the
assets being application of funds are outflows. However, in the context of liquidity
risk management, we need to look at this issue from the point of maturing liabilities
and maturing assets; a maturing liability is an outflow while a maturing asset is an
inflow. The need for liquidity risk management arises on account of the mismatches
in maturing assets and maturing liabilities.
Cash forecasting is used to estimate the liquidity position of the company for periods
ranging from the current day up to one year. Short-term forecasts (0 - 3months)
are used primarily for managing liquidity. Operational forecasts (1 – 12 months)
are used for medium term working capital and financing requirements. The long-
term forecasts (1 – 5 years) are used for planning strategic financial goals. Some
of the forecasting methods used by cash managers are:
 Cash Budgeting
 The Distribution Method
 Cash Modelling
A maturity ladder refers to a strategy of purchasing equal amounts of bonds maturing
at equal intervals, for example every six months or every year. This is also called
laddering maturities.
Strategy
When interest rates are low, it pays to keep maturities short in order to take
advantage of future rate increases. When interest rates are high, it pays to go with
the longest maturities to lock in the high rates before they drop. An investor with a
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ladder can apply this strategy as his bonds mature one by one. If no changes in Liquidity Management
interest rates have occurred, he can reinvest the maturing bond into a new one that
matures after the last bond in the ladder.
NOTES
12.3 CONTINGENCY PLANS
A contingency funding plan (CFP) is, at its core, a liquidity crisis management
instrument. The document is prepared as a directive for a future emergency and
stands ready to be referenced, someday, as a response plan and potential forecast
of how a distant liquidity event may unfold. But then, the scenarios presented in
the CFP may not occur. The next liquidity crisis may be an event that not a single
bank management team could have ever imagined. After all, clairvoyance is not
typically listed as a required banking skill.
Luckily, the objective of the contingency planning process is not to predict
the future. Rather, the CFP’s great value lies in its utility both as a crisis management
document and a regular deep dive into the bank’s liquidity profile. As an assessment
tool, the contingency planning process provides additional insight into the community
bank’s liquidity strengths and weaknesses beyond the bank’s normal reporting
activities. In this role, the CFP serves as a comprehensive evaluation, similar to a
person’s annual health examination, which complements ongoing asset/liability
monitoring. This endeavour can provide new risk mitigation knowledge that
management can use to protect the bank both in an emergency and in the day-to-
day competitive arena.
Netting
Netting entails offsetting the value of multiple positions or payments due to be
exchanged between two or more parties. It can be used to determine which party
is owed remuneration in a multiparty agreement. Netting is a general concept that
has a number of more specific uses, specifically in financial markets.
Netting is used in trading, where an investor can offset a position in one
security or currency with another position either in the same security or another
one. The goal in netting is to offset losses in one position with gains in another. For
example, if an investor is short 40 shares of a security and long 100 shares of the
same security, he is net long 60 shares.
Also, when a company files for bankruptcy, parties tend to net the balances
owed to each other. This is also called a set-off clause or set-off law. That is, a
company doing business with a defaulting company will offset any money they
owe the defaulting company with money that’s owed them. The remainder
represents the total amount owed by them or to them, which can be used in
bankruptcy proceedings.
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Liquidity Management Companies can also use netting to simplify third-party invoices, ultimately
reducing multiple invoices into a single one. For example, several divisions in a
large transport corporation purchase paper supplies from a single supplier, but the
paper supplier also uses the same transport company to ship its products to others.
NOTES By netting how much each party owes the other, a single invoice can be created
for the company that has the outstanding bill. This technique can also be used
when transferring funds between subsidiaries.
Information and Internal Control
A system of effective internal controls is a critical component of bank management
and a foundation for the safe and sound operation of banking organisations. A
system of strong internal controls can help to ensure that the goals and objectives
of a banking organisation will be met, that the bank will achieve long-term
profitability targets, and maintain reliable financial and managerial reporting. Such
a system can also help to ensure that the bank will comply with laws and regulations
as well as policies, plans, internal rules and procedures, and decrease the risk of
unexpected losses or damage to the bank’s reputation.
Check Your Progress

1. What is liquidity?
2. Why does the need for liquidity risk management arise?
3. What does netting entail?

QUESTIONS
1. Liquidity refers to a company’s cash position and its ability to meet obligations
when due.
2. The need for liquidity risk management arises on account of the mismatches
in maturing assets and maturing liabilities.
3. Netting entails offsetting the value of multiple positions or payments due to
be exchanged between two or more parties.
12.5 SUMMARY
 A key role of all cash managers in ensuring liquidity is the daily monitoring
of working capital and to optimally manage the organization’s resources by
accelerating inflows and controlling outflows.
 Liquidity problems arise on account of the mismatches in the timing of inflows
and outflows.
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 Cash forecasting is used to estimate the liquidity position of the company Liquidity Management
for periods ranging from the current day up to one year.

 Short-term forecasts (0 - 3months) are used primarily for managing liquidity.
Operational forecasts (1 – 12 months) are used for medium term working
NOTES
capital and financing requirements. The long-term forecasts (1 – 5 years)
are used for planning strategic financial goals.
 A contingency funding plan (CFP) is, at its core, a liquidity crisis management
instrument. The document is prepared as a directive for a future emergency
and stands ready to be referenced, someday, as a response plan and potential
forecast of how a distant liquidity event may unfold.
 Netting is used in trading, where an investor can offset a position in one
security or currency with another position either in the same security or
another one. The goal in netting is to offset losses in one position with gains
in another.
 A system of effective internal controls is a critical component of bank
management and a foundation for the safe and sound operation of banking
organisations.
 A system of strong internal controls can help to ensure that the goals and
objectives of a banking organisation will be met, that the bank will achieve
long-term profitability targets, and maintain reliable financial and managerial
reporting.
12.6 KEY WORDS
 Maturity Ladder: It refers to a strategy of purchasing equal amounts of

bonds maturing at equal intervals, for example every six months or every
year.
 Cash Budgeting: It is an estimation of the cash inflows and outflows for a
business over a specific period of time.

EXERCISES
1. What are the sources of liquidity?
2. State the uses of liquidity.
Long-Answer Questions
1. Discuss cash forecasting.
2. Describe the role of contingency plans in liquidity management.
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Liquidity Management

NOTES and Management. Gurgaon: Partridge Publishing.
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186 Material
Regulation, Supervision
UNIT 13 REGULATION, and Compliance
SUPERVISION AND
NOTES
COMPLIANCE
Structure
13.0 Introduction
13.1 Objectives
13.2 Need and Significance of Internal and External Audit
13.4 Summary
13.5 Key Words
13.0 INTRODUCTION
The purpose of the work of the auditors is to enable them to express an opinion as
to whether the accounts presented show a true and fair view. It is the sacred duty
of an auditor to extend his procedures even at the slightest indication of the existence
of fraud or error which may result in material misstatement so that he can confirm
or dispel his suspicions. According to the observations made by the International
Auditing Practices Committee: ‘The responsibility for the prevention and detection
of fraud and errors rests with management through the implementation and continued
operation of an adequate system of internal control. Such a system reduces but
does not eliminate the possibility of fraud or error.’ It continues to state that the
object of an audit is to enable the auditor to express an opinion on the financial
statements subjected to his audit. In this unit, we will learn about the meaning of
audit, with especial focus on internal and external audit.
13.1 OBJECTIVES

 Discuss the need of internal and external auditing
 Describe the significance of internal and external auditing
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Material 187
and Compliance 13.2 NEED AND SIGNIFICANCE OF INTERNAL
AND EXTERNAL AUDIT
NOTES According to Montgomery, a prominent American accountant

“Auditing is a systematic examination of the books and records of a
business or other organisation, in order to ascertain or verify, and to
report upon the facts regarding its financial operations and the results
thereof.”
According to Spicer and Pegler
“An audit may be said to be such an examination of the books, accounts
and vouchers of a business, as will enable the auditor to report whether
he is satisfied that the balance sheet is properly drawn up, so as to
give a true and fair view of the state of affairs of the business, and
that the profit and loss account gives a true and fair view of the profit
or loss for the financial period, according to the best of the information
and explanations given to him, and as shown by the books; and if not,
to report in what respects he is not satisfied.”
Ronald Irish states
“Auditing in its modern concept, is a scientific and systematic
examination of books, vouchers and other financial and legal records
in order to verify and report upon the facts regarding the financial
condition disclosed by the balance sheet and the net income revealed
by the profit and loss account.”
An Introduction to Indian Government Accounts and Audit considers audit as an
instrument of financial control. It continues to state that
“It (audit) acts as a safeguard on behalf of the proprietor (whether an
individual or a group of persons) against extravagance, carelessness
or fraud on the part of the proprietor’s agents or servants in the
realisation and utilisation of his money or other assets, and it ensures
on the proprietor’s behalf that the accounts maintained truly represent
facts and that expenditure has been incurred with due regularity and
propriety.”
According to L.R.Dicksee
“An audit is an examination of accounting records undertaken with a
view to establishing whether they correctly and completely reflect
the transactions to which they purport to relate. In some instances it
may be necessary to ascertain whether the transactions themselves
are supported by proper authority.”
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L.R.Howard describes an audit as Regulation, Supervision
and Compliance
“An examination by an auditor of the evidence from which the final
revenue accounts and balance sheet of an organisation have been
prepared, in order to ascertain that they present a true and fair view
of the summarised transactions for the period under review and of NOTES
the financial state of the organisation at the end date, thus enabling the
auditor to report thereon.”
Preface to International Auditing Guidelines of the International Federation of
Accountants describes an audit as
“the independent examination of financial information of any entity,
whether profit oriented or not, and irrespective of its size or legal
form, when such an examination is conducted with a view to expressing
an opinion thereon.”
The Institute of Chartered Accountants in England and Wales in its ‘statement
on Auditing’ has stated that the essential features of an audit are
(a) to make a critical review of the system of book keeping, accounting
and internal control;
(b) to make such tests and enquiries as the auditors consider necessary to
form an opinion as to the reliability of the records as a basis for the
preparation of accounts;
(c) to compare the profit and loss account and the balance sheet with the
underlying records in order to see whether they are in accordance
therewith;
(d) to make a critical review of the profit and loss account and the balance
sheet in order that a report may be made to the members stating
whether, in the opinion of the auditors, the accounts are presented
and the items are described in such a way that they show not only a
true but also a fair view and give in the prescribed manner the
information required by the Act.
The features covered by (d) above are subsequently explained in more
clear terms as follows:
...In addition, the auditors will make a critical review of the profit and loss
account and the balance sheet in relation to the following matters:
(a) whether the accounts have been prepared on sound accounting
principles consistent with those applied in the previous period; the
distinction between capital and revenue is particularly important to
prevent the overstatement of profits by charging revenue expenditure
to capital or their understatement by charging capital expenditure to
revenue;
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Material 189
Regulation, Supervision (b) the items in the balance sheet with particular reference to the basis on
and Compliance
which they are stated and:
(i) the existence, ownership and proper custody of assets,
NOTES (ii) the existence of liabilities,
(iii) their relation to the corresponding items at the end of the previous
year, and where necessary, earlier years,
(iv) the suitability of the descriptions used,
(v) an adequate disclosure of information;
(c) the items in the profit and loss account with particular reference to
adequate description, disclosure of information and the significance
of variations as compared with previous periods;
(d) compliance with the requirements of the Act.
The purpose of the work of the auditors is to enable them to express an
opinion as to whether the accounts presented show a true and fair view. The
purpose should govern their whole approach and if with respect to any material
they are unable to satisfy themselves, it will be their duty to include appropriate
reservations in their report, to the extent, if necessary, of stating that they are not
able to express the opinion that the accounts show a true and fair view.
The above definitions and observations throw light on the objectives and scope of
an audit. The primary objectives of an audit is to enable the auditor to express an
opinion on the financial statements which have been subject to such audit. This
opinion is then embodied in what is known as “audit report”, addressed to those
interested parties who commissioned the audit, or to whom the auditor is
responsible under the relevant statute. It may be noted here that the terminology
used in different countries by the auditor in expressing his opinion varies. The
actual wording used reflects concepts determined by local legislation, by rules
issued by professional bodies, or by the development of general practice within
the country. Phrases often used to reflect these concepts are: “present fairly in
accordance with generally accepted accounting principles”, “give a true and fair
view”, and “in conformity with the law”. In expressing the opinion, the auditor has
to carry out such procedures and take such steps as designed to obtain reasonable
assurance that the financial statements are properly stated in all material respects.
It is true that there are certain inherent limitations present in any kind of examination
where the person carrying out his examination will have to use his judgment. Also,
much of the evidence available to auditors is persuasive rather than conclusive in
nature. Hence there is an unavoidable risk that even some material misstatements
may remain undiscovered, and absolute certainty in auditing is rarely attainable.
However, it is the sacred duty of an auditor to extend his procedures even at the
slightest indication of the existence of fraud or error which may result in material
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misstatement so that he can confirm or dispel his suspicions. And wherever it is Regulation, Supervision
and Compliance
not possible to give an affirmative opinion whether or not the financial statements
give a true and fair view, the auditor has to express a qualified opinion or disclaimer
of opinion, as appropriate. Constraints on the scope of the audit of financial
statements that impair the auditor’s ability to express an unqualified opinion on NOTES
such statements should also be set out in the audit report, making it clear in what
respect and to what extent the financial statements are considered to be misstated.
Thus the opinion expressed by the auditor helps to establish the extent of
credibility of the financial statements. Of course, such an opinion should not be
construed as an assurance as to the future viability of the organisation or as to the
efficiency or effectiveness with which the management has conducted the affairs of
that unit.
Scope of an Audit
The scope of an audit is dependent on the terms of agreement between the auditor
and the client and on statutory requirements and the requirements of the relevant
professional bodies. A properly conducted audit is organised to cover adequately
all aspects of the organisation as far as they are relevant to the financial statements
subject to examination. The auditor has to ensure that information contained in the
underlying accounting data and other source data is reliable and sufficient as the
basis for the preparation of the financial statements. To achieve this the auditor
makes a study and evaluation of accounting system and the related internal controls
on which he intends to rely, and tests these internal controls to decide on the
nature, extent and timing of other audit procedures. This is reinforced by carrying
out such other tests, enquiries and other verification procedures of accounting
transactions and account balances as are considered appropriate in the
circumstances of each case.
As to the point whether the relevant information is properly communicated,
the auditor bases his opinion by:
(i) comparing the financial statements with the underlying accounting
records and other source data to see whether they properly summarise
the transactions and events recorded therein; and
(ii) considering the judgments that management has made in preparing
the financial statements; accordingly he assesses the selection and
consistent application of accounting policies, the manner in which the
information has been classified, and the adequacy of disclosure.
It may be noted in this connection that the auditor is not responsible for the
preparation of the financial statements on which he has to form and express an
opinion. This is the responsibility of the management of the particular organisation
concerned which, inter alia, also covers the maintenance of adequate accounting
records and internal controls, the selection and application of appropriate accounting
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Regulation, Supervision policies and the safeguarding of the assets of the organisation. As observed by the
and Compliance
Council of Chartered Accountants in England and Wales, the directors are
responsible for the accounts and financial control of a company. Their statutory
duties include responsibility for ensuring the maintenance of adequate records and
NOTES the preparation of annual accounts showing a true and fair view required by the
Act. They are responsible for safeguarding the assets of the company and are not
entitled to rely upon the auditor to protect them from any shortcomings in carrying
out their responsibilities. The Research Committee of the Institute of Chartered
Accountants of India has specifically stated that the duty of safeguarding the assets
of a company is primarily that of the management, and the auditor is entitled to rely
upon the safeguards and internal controls instituted by the management. Of course,
in forming and expressing professional opinion on the financial statements the auditor
has his own independent responsibility. This responsibility is heavy and cannot be
discharged without a full realisation of the professional skill and judgment which
need to be exercised in carrying out his duties. If the directors have not carried
out their duty properly this will have a material bearing on the terms of the audit
report and may well involve the auditor in extensive checking; but it is not his
function to act as a substitute for proper management control.
The advantages of an audit are as follows:
1. Detection and prevention of errors and frauds
It has already been mentioned that incidental to the primary objective, an
audit facilitates the detection and prevention of fraud and errors.
In this connection a brief mention of the various types of errors and frauds
would be enlightening. Errors may be classified into:
(a) An ERROR OF OMISSION arises from omitting to record a
transaction fully or partially in the book of accounts. The omission to
record a sales invoice while writing up the sales book is an example.
Partial omission by recording only one aspect of the transaction will
affect the balancing of the trial balance and hence can easily be
detected. On the other hand, complete omission will not affect the
arithmetical accuracy of the trial balance.
(b) An ERROR OF COMMISSION arises as a result of recording a
transaction incorrectly, either partially or wholly. For instance, posting
an incorrect amount to the ledger. Where the transaction is wholly
incorrectly recorded, the trial balance may not be affected. Where
the recording is only partially incorrect, it will affect the arithmetical
accuracy of the trial balance.
(c) An ERROR OF PRINCIPLE arises from the failure to observe
fundamental principles of accounting in recording the transactions.
Incorrect allocation of expenditure between capital and revenue,
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incorrect bases of valuation of current assets and fixed assets, incorrect Regulation, Supervision
and Compliance
adjustment of prepaid expenses and accrued income, incorrect
provision for depreciation, etc. are some of the examples of errors of
principle. Such errors will not affect the arithmetical accuracy of the
trial balance. They are, however, often serious in the sense that they NOTES
may affect the true and fair view of the financial statements.
(d) An ERROR OF DUPLICATION arises from recording a transaction
twice and posting the same twice to the ledger. Such errors do not
affect the arithmetical accuracy of the trial balance.
(e) A COMPENSATING ERROR arises from an error being offset by
another error or errors. Such errors also do not affect the arithmetical
accuracy of the trial balance.
Fraud may involve either misappropriation of money, goods or any property;
or falsification of accounts not involving any misappropriation as such.
Examples of the former include:
(i) entering fictitious credit notes;
(ii) writing off good debts as bad;
(iii) failure to record all cash received;
(iv) entering higher discounts than was actually allowed;
(v) inclusion of fictitious payments;
(vi) wages defalcation;
(vii) under invoicing; etc.
Examples of the latter include:
(i) overvaluation or undervaluation of stock in trade and work in progress;
(ii) over provision or under provision for depreciation and bad debts;
(iii) treating revenue items as capital and vice versa;
(iv) ante dating or post dating of purchase invoices and sales invoices, etc.
The object of the latter type of fraud is not immediate misappropriation of
money as such. The object is usually to show a different picture of the
earning capacity and the state of affairs of the business than what actually is
the case. For instance, a higher profit may be shown through the falsification
of accounts with the following objectives:
(i) increasing the remuneration payable to the people at the top where
such remuneration is expressed as a percentage of net profits;
(ii) obtaining credit facilities by showing a rosy picture of the business;
(iii) maintaining the confidence of the shareholders in the management;
(iv) declaring higher dividends in order to facilitate the sale of securities of
the company at higher prices; etc.
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Regulation, Supervision On the other hand a lower profit may be shown through falsification of
and Compliance
accounts with the following objectives:
(i) misleading trade competitors about the state of the business;
NOTES (ii) facilitating tax evasion;
(iii) declaring lower dividends in order to facilitate the purchase of the
securities of the company at low prices; etc.
Besides facilitating the detection and prevention of fraud and errors, the
following advantages also arise from subjecting financial statements to an
independent audit:
2. In the case of large organisations, the interests of many parties are protected.
For example, in the case of limited companies the interests of shareholders,
who do not take part in the day to day management of the companies and
who thereby are divorced from management, are protected. In addition,
as mentioned earlier, audited accounts helps to establish the credibility of
annual accounts. As a result even in cases where accounts have not been
specifically prepared for use by third parties, it would be possible for them
to make use of such accounts in order to take decisions based on them. It
is with these objectives that statutory provisions are in force for the
compulsory audit of accounts by suitably qualified auditors in many cases.
3. Audited accounts will be more acceptable to banks and other financial
institutions in extending financial accommodation.
4. Audited accounts will carry greater authority for tax assessment by tax
authorities.
5. In the case of partnership organisations audited accounts will help in avoiding
disputes between the partners especially where profit sharing arrangements
are complex. So also, the admission of a new partner or the death,
retirement, etc. of an existing partner or the sale of the business as a going
concern may require revaluation of assets and liabilities and the computation
of goodwill. In such cases, audited accounts will be a more suitable basis.
On the basis of nature of work undertaken, audit may be classified into following
sections:
Private audit
Although there is no statutory provision for the audit of the accounts of individuals
and partnership firms, the advantages arising from subjecting the accounts to an
independent examination of properly qualified persons have already been pointed
out. A point of importance to be noted in this connection is that the duties, rights
and responsibilities of an auditor undertaking such a work are not defined statutorily.
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As indicated earlier, the accountant, in many cases, may be required to write up Regulation, Supervision
and Compliance
the accounts besides being required to carry out an audit. The client may not be
fully aware of the distinction between the work of an accountant in doing the
accounting work and in carrying out the work of audit and the full implications of
each. Consequently it is quite possible that the client and the accountant might NOTES
have quite different ideas in mind as to the nature and purpose of the appointment
of the accountant. Besides, the client might have, on the grounds of expenses or
otherwise, limited the scope of work to be done; it is also dependent on the records
maintained by the client. These could have far reaching consequences which may
involve issues of negligence and breach of trust on the part of the auditor.
This indicates the necessity of getting the terms of appointment defined in
writing whenever an auditor is taking up an appointment in respect of a private
audit. The rights, duties and responsibilities of the auditor together with the nature
and scope of work should be clearly specified. Even where the auditor is appointed
to carry out work in accordance with the rules and regulations of an entity, as in
the case of clubs, charitable organisations, etc., it would be advisable to obtain a
letter of engagement, the details of which are discussed in detail elsewhere.
In those cases where a practising accountant is appointed only to prepare
the accounts and not in the capacity of an auditor, the position should be made
clear either by means of a note placed at the foot of the accounts or by means of
a separate covering letter accompanying the accounts in which it should be stated:
(i) the source or sources of information from which the accounts have
been prepared; and
(ii) that an audit or verification of assets and liabilities has not been carried
out.
When the information is given in a covering letter accompanying the accounts,
the accounts should include a specific statement referring to the covering letter.
Audit under statute
In many cases the relevant statutes will specify detailed provisions relating to the
appointment, remuneration, removal, rights, duties, responsibilities, etc. of auditors
for the independent audit of the financial statements of the undertakings covered
by the respective statutes. For instance, the Companies Act contains such provisions
relating to company audit. In such cases the position of the auditor is clear and
any restrictions on his work specified in the statues concerned will be ultra vires.
Thus the main difference between private audits and statutory audits arises from
the fact that while in the former case the scope of the audit may be determined as
narrowly or as broadly as the client wishes, according to his requirements, in the
case of statutory audits their scope and depth are largely determined by the
governing legislation, which neither the directors nor the members of the client
organisation or other persons have authority to restrict.
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Regulation, Supervision Internal audit
and Compliance
As the every name implies, this is an examination carried out by the employees
specially appointed for the purpose by an organisation. It is defined as an appraisal
NOTES activity, independent of other activities, within an organisation, for the review of
operations, as a service to all levels of management. It differs from an independent
audit, otherwise known as external audit, in scope, approach, responsibility and
independence.
On the basis of the methods of approach to work, audit may be classified
into:
I. Final audit or completed audit: A final audit, otherwise known as completed
audit, is one that is carried through to completion in one continuous session.
Normally it is commenced immediately after the end of the accounting period. In
certain cases it is commenced towards the end of the accounting period but
completed after the end of such period.
Advantages
1. The expenses involved is considerably less and hence this type of audit is
suitable for small organisations.
2. Since work is carried through completion in one session, possibilities of
alteration of figures after the completion of work up to a certain stage can
be eliminated.
3. As an extension to the above, it obviates the necessity of taking down notes
and balances on the completion of work at each stage for subsequent
comparison.
4. It facilitates the drawing up of a more simplified time table for audit assistants.
Disadvantages
1. In the case of large organisations it would not be practicable to have a
completed audit because of the large volume of work to be done. This
would mean undue delay in the presentation of final accounts.
2. Where there are a number of clients whose accounting dates are the same,
the pressure of work will be heavy. This may cause delay in the completion
of work.
3. Limitation in time for the completion of work may lead the audit staff
overlooking some of the detailed aspects.
II. Continuous Audit: In the case of a continuous audit, work of audit is carried
out throughout the accounting period by the audit staff engaged continuously on
the audit.
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Advantages Regulation, Supervision
and Compliance
1. Since the audit staff are engaged in the work continuously, fraud and errors
are detected sufficiently early with the result that the amount of defalcations,
irregularities and errors will be less than would be the case otherwise. NOTES
2. It is possible to carry out a more detailed checking. Such detailed checking
reveals more about the functioning or malfunctioning of the client’s system
of accounting and related internal controls.
3. The work of audit assistants can be arranged more effectively, giving due
consideration to the pressure of work in different client organisations.
4. It acts as a moral check on client staff in that they will give particular
importance to keep the work uptodate because of the frequent visits by the
auditor.
5. Continuous engagement on the work enables the auditor to understand better
the technical details of the client organisation.
6. Since most of the detailed checking will be over by the end of the accounting
period, it facilitates the completion of final work more quickly with the result
that the final accounts can be presented without much delay after the end of
the financial year.
7. Because of the constant contact which the audit staff have with the work,
audit programmes can be reviewed according to the developing
circumstances.
8. Wherever possible and feasible, closer cooperation and coordination of
work between the external auditor and internal auditor can be achieved.
Disadvantages
1. There are possibilities of the client staff altering the figures either innocently
or fraudulently once the auditor has completed checking a part of the work.
2. Periodical checking of the books and records may cause inconvenience to
the client staff through interruption of their work.
3. Similarly, attendance by audit staff at intervals may lead to their failure to
follow up unfinished work during the previous visit.
4. Audit staff will find it necessary to maintain detailed notes on accounts and
balances, especially in respect of unfinished work during any visit.
5. There is the danger that the audit staff might lose the impartiality of outlook
when they are allowed to remain on a continuous audit over a long period
of time because of the possibility that they tend to regard themselves as a
part of client staff.
6. It is an expensive system of audit.
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Regulation, Supervision In spite of the above disadvantages, big business organisations generally
and Compliance
prefer continuous audit. This is all the more so in the case of organisations which
require their final accounts to be presented immediately after the end of the
accounting period.
NOTES
Certain precautions may be taken to overcome most of the disadvantages
mentioned above. The client staff should be given strict instructions that no
alteration, however, genuine it may be, should be made once the auditor has
examined the books and records and that, if necessary, rectification of an error
should be made only through an adjusting entry. The auditor should use special
ticks while passing altered figures. When ticking an altered figure, the amount
should be inserted in ink in small figures to prevent any misunderstanding as to the
figure which has been accepted. Similarly, client staff should be instructed to enter
periodical totals in ink or in any other permanent form to guard against alteration.
Inconvenience to the client staff can be avoided to a great extent through a
judicious selection of work completed up to a particular date.
Proper follow up by the audit staff can be ensured through extensive note
taking, properly planned audit programmes and proper supervision. The audit
working papers should include:
(a) notes of important totals taken from the books of account up to the
stage to which they have been checked;
(b) details of any alterations that have been made in figures checked earlier;
(c) details of transactions which appear to be unusual or exceptional and
which therefore call for special treatment;
(d) notes of any verification tests carried out; and
(e) particulars of errors discovered.
The audit programme should be so drafted as to show clearly:
(a) the work to be done during the course of each quarter or month; and
(b) the work to be performed at the final stages.
III. Interim audit: This is an audit conducted in between two final audits. The
object may be to complete detailed procedural or vouching tests with a view to
assisting the speeding up of the final audit, or to make available interim results to
the management to declare an interim dividend through the preparation of interim
accounts. It is important to note in this connection that an interim audit does not
take into account such matters as verification of assets and liabilities, provision for
depreciation, bad debts, etc.
Advantages
1. It enables the management to get an idea about the overall performance of
the organisation periodically.
2. It facilitates the discovery of errors and frauds sooner.
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3. It aids the completion of the final audit without much delay. Regulation, Supervision
and Compliance
4. It facilitates the declaration of interim dividends.
5. It acts as a moral check on the client staff in keeping the work uptodate.
Disadvantages NOTES
The main disadvantage is, as in the case of a continuous audit, the possibility of
alteration of figures after the same have been passed by the auditor. The precautions
enumerated in connection with a continuous audit are applicable in this case also.
IV. Partial audit: Partial audit is one which covers only a part of the accounts.
For instance, a sole trader may require his cash book to be audited without involving
any verification or valuation of assets or liabilities. As already indicated, partial
audits should be undertaken only after getting the terms of such assignments clearly
in writing as otherwise the auditor may be held liable for work which he was not
supposed to do.
V. Procedural audit or systems audit: This is in fact a part of the audit work as
a whole. It is an examination, assessment and review of the internal control
procedures and records of an entity with a view to ensuring their reliability as a
basis for the preparation of its final accounts. In other words, it consists of those
audit steps which are designed to test whether the procedures laid down are in
fact being followed, thus establishing independently the accuracy of the information
supplied by the client staff. As observed by Skinner and Anderson, the system
audit approach attempts to ‘explore inside the system and discover exactly how it
produces results. If the mechanics of the system were analysed intensively and
detailed survey showed it to be designed with appropriate control, checks and
balances to forestall errors, then this too would be a good indication that the
results produced by the system were accurate.’ The increased attention given by
auditors to the internal control procedures existing in the client organisation has
naturally resulted in the increased importance of procedural audit. More about
this is dealt in the chapter “Internal Control”.
VI. Balance sheet audit: Balance sheet audit operates in the opposite direction
to audit procedures normally carried out. It commences with a detailed examination
of the draft balance sheet and works back to the books of original entry and their
documentary evidence. This type of audit need not necessarily be considered as
strange in view of the fact that every single transaction has a direct effect on the
balance sheet.
Balance sheet audit is of more recent origin and is popular in the United
States of America. It is appropriate under the following circumstances:
 Where the client organisation is very large with a complex economic
unit employing qualified accounting staff and having an internal audit
department.
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Regulation, Supervision  Where the auditor has acted in that capacity for the client organisation
and Compliance
during the last few years.
 Where the internal control system in operation is efficient and effective
in every material aspects, this having been proved to the entire satisfaction
NOTES
of the auditor.
 Where an interim audit has already covered basic tests of routine
procedures in each department of the client organisation.
Following is given a broad outline of the procedures to be followed in the
case of a balance sheet audit.
 Verify all assets and liabilities, with special reference to documents of
title, agreements, correspondence and valuation.
 Examine the minute books, noting carefully any matters of importance
relating to the accounts and the balance sheet items, e.g., capital
commitments, pending law suits, capital and loan issues, etc.
 Compare each item in the balance sheet with the corresponding item
for the previous year and ascertain the reason for any material variations
and their effect on the profits for the year.
 Compare the profit and loss account with that for the previous year
and ascertain the reasons for any material variations.
 Examine whether variations for wages, materials consumed and other
variable expenses are fairly consistent with the variation in turnover.
Ascertain the quantities of turnover where the monetary value thereof
has been affected by price or other variations.
 Verify the quantitative details of purchases, production, turnover, and
opening and closing stock.
 Ascertain the reasons for any material variations in the rate of gross
profits.
 Compare the values of stock on hand with those adopted for insurance
purpose.
 Examine transactions of an exceptional nature and items of non
recurring nature such as exceptional profits, capital profits, etc. These
may have resulted in charges or credits of a material amount to the
profit of the period under review.
 Compare the values of stock on hand with the cost of turnover,
ascertaining the reason for any material variations in this ratio, which
indicates the average rate of stockturn during the period.
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 Consider the changes in the position disclosed by the balance sheet. Regulation, Supervision
and Compliance
For instance, does this reveal increased liquidity, a proportionate
reduction in capital or long term liabilities, or increase in fixed assets?
 Examine the schedules showing the composition of each item in the
NOTES
balance sheet. Study the changes comparing them with the schedules
relating to the previous year.
 Examine the values placed on the current assets, with particular
reference to the basis of valuation of stock and work in progress.
 Ascertain any material variation in current assets as compared with
the previous year. Accounting ratios may be usefully applied in this
regard. For example, if the debtors-turnover ratio indicates that the
customers are taking longer period to settle their accounts, particular
attention should be paid to the provision for bad and doubtful debts.
Similarly possibility that remittances have not been accounted for should
be considered.
 Scrutinise the schedules for provisions, accruals and prepayments,
comparing them with those for the previous period and enquiring into
any material variations.
 Ascertain whether the provisions made for depreciation are reasonable
and the amounts set aside for the increased cost of replacement are
reasonable.
 Consider the effect of any changes in the basis of accounting on material
variation in profits.
 Examine the nature and amount of contingent liabilities and
commitments for capital expenditure not provided for in the accounts.
 Consider any forward contracts for forward purchases or sales,
ascertaining whether any provision for losses is required at the balance
sheet date.
 Examine the statement of sources and application of funds, comparing
it with that of the previous year.
 Where appropriate, compare the accounts concerned with the figures
shown by certificates and returns made to trade associations, insurance
companies and Government departments in respect of wages and
salaries paid, declarations for insurance purposes, returns to the
customs and excise authorities and similar documents.
 Examine all remaining balance sheet items ascertaining that these are
in order in the light of the prevailing audit requirements.
 Ascertain that all statutory requirements have been complied with in
every detail.
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Regulation, Supervision VII. Social audit or social responsibility audit: Social audit takes into
and Compliance
consideration the relationship of an entity’s activities in relation to its employees,
the community in general, and the customers in the context of social considerations.
The concept of social audit arises from the modern conception that an entity owes
NOTES certain duties, besides it duties to the shareholders who have put their capital in
the entity, towards the employees who are putting their labour and their lives into
the business, and towards its customers and the general public. As Lord Denning
has observed:
“................the directors of a great company should owe a duty to
those who are employed by the company to see that their conditions
of service are proper. They should owe a duty to the consumers, to
the people to whom the goods are supplied, a public duty perhaps,
not to expect excessive prices. They should owe a duty also to the
community in which they live, not to make the place of production
hideous or a nuisance to those who live around.”
In relation to employees, social audit will ascertain, assess and review
whether the people who put their labour and lives into the company get fair wages,
continuity of employment, and a recognition of their right to their jobs, as well as
recreation and welfare facilities, retirement arrangements, etc.
In relation to the general public, social audit will take into consideration the
question of environment, pollution, ecology, and other factors of the entity’s activities
in the light of their immediate and long term effects. Other considerations involving
the welfare of the general public who are affected by the operations and actions of
the entity will also be reviewed under social audit.
In relation to the customers, social audit will take into consideration such
factors as the entity’s pricing policy, maintenance of quality control, methods of
redressing the grievances of the customers, honesty in advertising, etc.
VIII. Operational audit: Operational audit is concerned with the operating
propriety and efficiency of the functional areas of an organisation. It takes into
consideration (i) inefficient operations both from the time and cost angles; and (ii)
wastage of resources through lack of propriety in expenses. It is aimed at improving
the profitability of the organisation and simultaneously at achieving the other
organisational objectives.
IX. Management audit: This is a total audit of every area of operation of an
organisation with a view to identifying the inefficiencies and/or ineffectiveness of
the management and setting up criteria for efficiency. According to the Association
of Consulting Management Engineers Inc., U.S.A.:
“Just as the public accountant examines the books and records of a
company, the management auditors study a business as a whole. They
consider its policies, organisation, operating methods, financial
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procedures and physical facilities and report on its overall position. Regulation, Supervision
and Compliance
Whereas the accounting audit is concerned with past transactions
and (operational audit) with the present conditions, management audit
studies the present and looks into the future.”
Again, William P. Leonard defines management audit as NOTES
“a comprehensive and constructive examination of an organisational
structure of a company, institution or branch of a Government or
any component thereof, such as a division or department, and its
plans and objectives, its means of operation, and its use of human and
physical facilities.”
In short, management audit is an investigation to ascertain whether every
level of management and staff is functioning at its optimum, and a set of
recommendations is issued to the management after the review, keeping it alert
against internal and external changes which may have a bearing on the growth
plans of the organisation.
X. Cost audit: Cost audit involves an examination of the cost records and cost
performance of an organisation just as financial audit is concerned with the financial
records and performance. The Institute of Cost and Management Accountants,
U.K. defines it as the verification of cost accounts and a check on adherence to
cost accounting plan. Thus cost audit is an examination of the cost accounting
records to ensure that the cost statements are properly drawn up so as to show a
true and fair view of the cost of production and marketing of various goods dealt
with by the organisation.
XI. Special audit under the companies act: In terms of section 233A of the
Indian Companies Act, the Central Government is empowered to order a special
audit of the accounts of a company for a specified period where it is of the opinion
that -
(a) the affairs of the company are not being managed in accordance with sound
business principles or prudent commercial principles; or
(b) any company is being managed in a manner likely to cause serious injury or
damage to the interests of the trade, industry or business to which it pertains;
or
(c) that the financial position of any company is such as to endanger its solvency.
Special audit under the Act is conducted by professionally qualified
accountants in the same manner as any company audit with the main difference
that the special auditor submits his report to the Central Government instead of to
the shareholders as in the case of a company auditor in the ordinary course. On
receipt of the report, the Central Government shall take such action as is necessary.
But if the Government does not take any action on the report within four months
from the date of its receipt, it shall send a copy of the report with its comments to
Self-Instructional
Material 203
Regulation, Supervision the company concerned for circulation among the members. The expense of this
and Compliance
kind of audit including the remuneration to the special auditor, as determined by
the Central Government, shall be paid by the company.
NOTES
Check Your Progress
1. What is the primary objective of an audit?
2. In which kind of audit, the terms of appointment of an auditor need to be
defined in writing?
3. What is the main difference between private audits and statutory audits?
4. Define internal audit.

QUESTIONS
1. The primary objective of an audit is to enable the auditor to express an

opinion on the financial statements, which have been subject to such audit.
2. In private audit, the terms of appointment of an auditor need to be defined
in writing.
3. The main difference between private audits and statutory audits arises from
the fact that while in the former case the scope of the audit may be determined
as narrowly or as broadly as the client wishes, according to his requirements,
in the case of statutory audits their scope and depth are largely determined
by the governing legislation, which neither the directors nor the members of
the client organisation or other persons have authority to restrict.
4. An internal audit is defined as an appraisal activity, independent of other
activities, within an organisation, for the review of operations, as a service
to all levels of management.
13.4 SUMMARY
 The purpose of the work of the auditors is to enable them to express an

opinion as to whether the accounts presented show a true and fair view.
 The primary objective of an audit is to enable the auditor to express an
opinion on the financial statements, which have been subject to such audit.
Self-Instructional
204 Material
This opinion is then embodied in what is known as ‘audit report’, addressed Regulation, Supervision
and Compliance
to those interested parties who commissioned the audit, or to whom the
auditor is responsible under the relevant statute.
 The scope of an audit is dependent on the terms of agreement between the
NOTES
auditor and the client and on statutory requirements and the requirements
of the relevant professional bodies.
 On the basis of nature of work undertaken, audit may be classified into
private audit, internal audit, and audit under statute.
 On the basis of the methods of approach to work, audit may be classified
into: final audit or completed audit; continuous audit; interim audit; partial
audit; procedural audit or systems audit; balance sheet audit; social audit;
operational audit; management audit; cost audit; and special audit under the
Companies Act.
13.5 KEY WORDS
 Statute: It is a written law passed by a legislative body.

 Audit: It is to conduct an official financial inspection of (a company or its
accounts).

EXERCISES

1. What are the essential features of an audit according to the Institute of
Chartered Accountants in England and Wales?
2. How would you describe the scope of an audit?
3. Why should an auditor’s role be defined in case of the private audit?
1. Describe the various meanings of audit in detail.
2. Discuss the classification of an audit on the basis of methods of approach to
work.
3. Explain the advantages of an audit.
Self-Instructional
Material 205
and Compliance 13.7 FURTHER READINGS

NOTES and Management. Gurgaon: Partridge Publishing.
Self-Instructional
206 Material

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ALAGAPPA UNIVERSITY

[Accredited with ‘A+’ Grade by NAAC (CGPA:3.64) in the Third Cycle

"The copyright shall be vested with Alagappa University"

Vikas® is the registered trademark of Vikas® Publishing House Pvt. Ltd.

BLOCK - I: BASICS OF RURAL BANKING

BLOCK - II: RURAL BANKING FEATURES

Unit 6: Management of Post-issue Activities – Processing of Aata – Unit 6: Management of

BLOCK - III: VENTURE CAPITAL AND MISCELLANEOUS

Rural banking refers to providing banking services to individuals living in rural

BASICS OF RURAL BANKING

A rural bank can be defined as rural financial institution/ cooperative/ community

After going through this unit, you will be able to:

Check Your Progress

Public issue of corporate securities as a source of financing projects has gained

Check Your Progress

1.4 ANSWERS TO CHECK YOUR PROGRESS

1. The objective of the Swarnjayanti Gram Swarozgar Yojana (SGSY) is to

1.6 KEY WORDS

 Underwriting: It is the process through which an individual or institution

1.7 SELF ASSESSMENT QUESTIONS AND

Short Answer Questions

Ram Jitendra. 2015. Regional Rural Banks of India: Evolution, Performance

UNIT 2 GROWTH OF RURAL Banking in India

After going through this unit, you will be able to:

2.2 MEANING, IMPORTANCE AND IMPLICATION

Rural development has to play a vital role in the overall socio-economic

2.3 NEED FOR CONTROL: TYPES, SCOPE AND

Control is the fundamental management function. It signifies the measurement and

Check Your Progress

2.4 ANSWERS TO CHECK YOUR PROGRESS

 Rural development has to play a vital role in the overall socio-economic

2.6 KEY WORDS

 Scrips: It is a provisional certificate of money subscribed to a bank or

2.7 SELF ASSESSMENT QUESTIONS AND

Short Answer Questions

2.8 FURTHER READINGS

Ram Jitendra. 2015. Regional Rural Banks of India: Evolution, Performance

UNIT 3 PROJECT RELATED of a Rural Banker

After going through this unit, you will be able to:

The appraisal of a project involves a thorough investigation into the project by a

3.3 CORPORATE COUNSELLING

Corporate counselling refers to the activities performed by the merchant banks to

Individual objectives are related to the employees of the organization. As employees

3.4 LOAN SYNDICATION: MEANING AND SCOPE

A syndicated loan is an essential source of debt financing for corporate loan

3.5 ANSWERS TO CHECK YOUR PROGRESS

1. The sources of finance are the following:

 The appraisal of a project involves a thorough investigation into the project

3.7 KEY WORDS

 Project appraisal: It is an independent examination of the project concerned

3.8 SELF ASSESSMENT QUESTIONS AND

Short Answer Questions

1. Discuss the various steps involved in project appraisal.

3.9 FURTHER READINGS

Ram Jitendra. 2015. Regional Rural Banks of India: Evolution, Performance

After going through this unit, you will be able to:

4.3 MANAGEMENT OF PRE-ISSUE ACTIVITIES

Check Your Progress

4.4 ANSWERS TO CHECK YOUR PROGRESS