Financial Services

Introduction
Financial services refer to services provided by the finance industry. The finance industry encompasses a broad
range of organizations that deal with the management of money. Among these organizations are banks, credit
card companies, insurance companies, consumer finance companies, stock brokerages, investment funds and
some government sponsored enterprises.

10.1 Concept of Financial Services

Financial services can be defined as the products and services offered by institutions like banks of various kinds
for the facilitation of various financial transactions and other related activities in the world of finance like loans,
insurance, credit cards, investment opportunities and money management as well as providing information on
the stock market and other issues like market trends.
Notes The Gramm-Leach-Bliley Act enacted in the late 1990s brought the term financial services into prominence when it repealed earlier
laws which forbade a bank or any financial institution from venturing into fields like insurance and investment. The result was the merger of
many organizations offering the above mentioned services under one banner giving rise to a new type of banking popularly known as
Commercial Banking and a number of organizations like Citibank came into existence purely as service providers.
The Finance services industry though a highly profitable Industry with respect to earnings does not count for a
large share of the market and also employs a lesser number of people as compared to some of the other
Industries. Some of the major service providers and commercial banks in this field are:
1. Citibank
2. HSBC
3. Standard Chartered
4. Citigroup
5. Merrill Lynch
6. Morgan Stanley
7. ING (Investment)
8. American Express (Credit Card)
9. VISA (Credit Card)
10. Allianz (Insurance)

10.2 Role of Financial Services

During the last decade, there has been a broadening and deepening of financial markets. Several new instruments
and products have been introduced. Existing sectors have been opened to new private players. This has given a
strong impetus to the development and modernization of the financial sector. New players have adopted
international best practices and modern technology to offer a more sophisticated range of financial services to
corporate and retail customers. This process has clearly improved the range of financial services and service
providers available to Indian customers. The entry of new players has led to even existing players upgrading
their product offerings and distribution channels. This continued to be witnessed in 2002-03 across key sectors
like commercial banking and insurance, where private players achieved significant success.
These changes have taken place against a wider systemic backdrop of easing of controls on interest rates and
their realignment with market rates, gradual reduction in resource pre-emption by the government, relaxation
of stipulations on concessional lending and removal of access to concessional resources for financial institutions.
Over the past few years, the sector has also witnessed substantial progress in regulation and supervision.
Financial intermediaries have gradually moved to internationally acceptable norms for income recognition, asset
classification, and provisioning and capital adequacy.
This process continued in 2002-03, with RBI announcing guidelines for risk-based supervision and consolidated
supervision. While maintaining its soft interest rate stance, RBI cautioned banks against taking large interest rate
risks, and advocated a move towards a floating rate interest rate structure.
The past decade was also an eventful one for the Indian capital markets. Reforms, particularly the establishment
and empowerment of Securities and Exchange Board of India (SEBI), market- determined prices and allocation
of resources, screen-based nationwide trading, dematerialisation and electronic transfer of securities, rolling
settlement and derivatives trading have greatly improved both the regulatory framework and efficiency of
trading and settlement. On account of the subdued global economic conditions and the impact on the Indian
economy of the drought conditions prevailing in the country, 2002-03 was a subdued year for equity markets.
Despite this, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) ranked third and sixth
respectively among all exchanges in the world with respect to the number of transactions. The year also
witnessed the grant of approval for setting up of a multi-commodity exchange for trading of various commodities.
In the midst of these positive developments, a key issue that continues to impact the Indian financial sector
adversely is that of asset quality and consequent pressure on capital. The liberalisation and globalisation of the
Indian economy led to a process of restructuring and consolidation across several sectors of the economy. Several
units that were set up in a protectionist environment became unviable in the new paradigm of competition in the
global market place. Volatility in global commodity prices has a major impact on Indian companies.
This has led to non-performing loans and provisioning for credit losses becoming a key area of concern for the
Indian financial system. The NPA problem in India, viewed in the context of comparison with other Asian
economies, does not pose an insoluble systemic problem; at 8% of GDP, the NPA levels are significantly lower
than the levels of 30-40% seen in other Asian economies. The key problems in India have been the inability of
banks to quickly enforce security and access their collateral, and the capital constraints in recognising large loan
losses. Recent measures taken by the Government have attempted to address both these problems. The
Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act
creates a long-overdue framework for resolving the distressed credit problem in India, by providing legal support
to the resolution process and thereby encourages the flow of capital into this specialised sector. The proposal for
swapping high-yield Government securities held by banks into lower-yield securities, thereby realising mark-to-
market gains and utilising the same to make additional provisions, would also strengthen the balance sheets of
banks.
During the year the RBI operationalised the corporate debt restructuring forum, which has a made significant
progress in building lender consensus on restructuring. The next major initiative would be the operationalisation
of an asset reconstruction company, and the development of a market for distressed credit similar to those in
other countries.
The increasing disintermediation in the corporate credit market, slowdown in creation of new capital assets as
companies focus on improving existing capacity utilisation and improving working capital efficiency of Indian
corporates has led to lower demand for credit from the corporate sector in the past two years. This has been
replaced by the huge retail finance opportunity. Existing low penetration levels, increasing affordability of credit
and rising income levels have led to a growing demand for retail credit. This has been strengthened by the tax
incentives for acquiring residential property, leading to a particularly high growth in housing finance. Going
forward, the infrastructure, retail and small and medium enterprise segments would provide large growth
opportunities, while the manufacturing sector is expected to continue its consolidation phase, with selective
additions to capacity. However, success in these segments presents several challenges. Retail and SME banking
requires extremely effective distribution systems that are capable of offering flexibility and convenience to the
customer, while maintaining cost-efficiency for banks. At the same time, banks need to put in place high-quality
credit modelling and data mining systems. This is essential to appropriately assess and price risk and allocate
capital in a manner that would optimise risk-adjusted returns. The Indian financial system would also witness
greater activity in the debt markets, as originators of credit increasingly seek to proactively manage their
portfolios by structuring and selling down loan portfolios to entities that have capital to deploy but lack the
origination and structuring capabilities.
India has made considerable progress in the post-1991 period. The country's macroeconomic fundamentals have
improved and external vulnerability has been sharply reduced. Reforms in the financial sector have
appropriately addressed the pre-1991weaknesses in the sector and improved its competitive strength
domestically as well as globally. Individual players now need to adopt proactive competitive strategies that will
enable them to capture the emerging opportunities. Exposure to global practices has made the Indian customer
more discerning and demanding.

There has been a clear shift towards those entities that are able to offer products and services in the most
innovative and cost-efficient manner. The financial sector will need to adopt a customer- centric business focus.
It will also have to create value for its shareholders as well as its customers, competing for the capital necessary
to fund growth as well as for customer market share.
10.4 Emerging Trends in Financial Services

Every industry undergoes periodic changes and, in that context, the financial services industry is certainly not an
exception. The only exception is that changes in the financial services industry have occurred more rapidly as
compared to other industries, the most probable reason being its dynamic nature. Emerging trends in the
financial services industry provide a definitive clue to the ongoing changes and here are some of those to help
you get a better understanding:

Increased Automation
With rapid advancements in Information Technology and allied systems and processes, the financial services
industry has witnessed increased automation over the years. Financial projects are still managed under the
watchful eyes of highly qualified professionals, but the actual processing and transacting is being done by
automated software systems. It is certainly a positive development because automated systems eliminate the
chances of human errors and inaccuracies and also allow firms to handle large financial projects with veritable
ease.

Diminishing Size Limitations

At the beginning, financial services outsourcing was embraced mostly by business heavyweights such as
Goldman Sachs, Lehman Brothers, Morgan Stanley, Citi Group etc. Things however have changed over the years
as can be seen from the dramatic increase in the number of Small & Medium Enterprises (SMEs) hiring financial
outsourcing services. Business size is no longer a criterion for choosing financial services outsourcing, something
that is good news for both SMEs and small outsourcing service providers that cater to niche market segments.

Rapidly Expanding Wider Presence

There was a time when financial services were limited to a few advantageous geographical locations like Mumbai.
However, due to rising demand for financial services, other locations like countries such as Ahmedabad, New
Delhi, Chandigarh, Kolkata, etc., have also started offering financial services. It signifies that financial services
industry now enjoys a wide presence and is not limited to a few regional pockets. And that is good because
businesses now have a lot more options to choose from.

Introduction of Web Technology

Predicting the future is never easy, but in the use of web technology for the financial services industry, there are
a number of trends and technologies that are in their early stages and show significant promise for the sector.
In addition, websites can offer dialog-based or even voice-based assistance for users of the site. This is will make
it much easier to service complex financial products online to both consumers and to agents.
Finally, with the ubiquity of mobile phones and the increasing market penetration, more and more information
and communication will be channelled through these routes. To manage this effectively, it is important to choose
a content management solution that will allow these channels to be used without the need for complex and time-
consuming reuse of information.
Wireless networking has lead to the market place being flooded with all sorts of new internet appliances, mobile
devices and gadgets that provide users a low-cost alternative to PCs.
Handhelds, PDAs, Smartphones, Blackberries, Tablet PCs, Notebooks/Laptops name just a few of the options now
available and manufacturers are continually trying to launch new devices in an attempt to provide the right
hybrid device that sits somewhere between the Smartphone and the PDA. This trend is likely to continue for the
foreseeable future.

10.5 Nature of Financial Services

Consumers of this sector are often key decision makers — investors, corporate executives, investment fund
managers, or members of the public—who need time-critical support for determining actions and strategies.
Thus, the financial publishing industry directly supports homeowners in choosing a mortgage, investors in
choosing stocks, and corporate executives in providing the information they need to manage their organizations.
Accuracy, legal validity, predictability, and timely publication are also crucial in financial services.

The industry also is experiencing a growing demand for customized, personalized services. Financial institutions
that can quickly create personalized knowledge products have a competitive advantage.
Information offered by the financial services industry tends to have the following characteristics:
1. Financial data tends to be very personal in nature. Customers of financial information are generally very
particular about the exact types of information that they personally need.
2. Financial data must be accessible. Users must be able to find the information they need quickly.
3. Financial data must be accurate. Mistakes can lead to incorrect or misguided decision-making, with
potentially dire results.
The financial services industry is very competitive. Since financial information is considered a commodity, many
consumers seek out companies that can provide easy access to that information.

Example: A company without a Web portal is at a competitive disadvantage, since consumers of financial
data now expect the option of obtaining their information from the Web.
Therefore, the business challenges facing the financial services industries include:
1. Providing personalized and customized on-demand information
2. Meeting competitive pressures to create new, distinctive, and high-value information products
3. Delivering accurate information that is current and readily available Solution requirements and
components Solution requirements.
Financial services companies distribute large numbers of documents, each containing a high density of raw
financial data that is extremely important for supporting financial-based decisions. Consumers of this
information are often key decision-makers who need time-critical support for determining actions and strategies.

Example: The financial publishing industry directly supports homeowners in choosing a mortgage, investors
in choosing stocks, and corporate CEOs in managing their organisations.
Financial services sector requires an infrastructure that supports the creation of accurate, legally valid
documents in a predictable and timely manner. Finally, the financial services institutions that can quickly create
customized financial products, reports and other personalized knowledge products have a competitive
advantage over other financial services institutions.

10.6 Types of Financial Services

Out of the varied financial services that the financial market offers, the most important ones are discussed under:

Banking Services
The primary operations of banks include:
1. Keeping money safe while also allowing withdrawals when needed
2. Issuance of checkbooks so that bills can be paid and other kinds of payments can be delivered by post
3. Provide personal loans, commercial loans, and mortgage loans (typically loans to purchase a home,
property or business)
4. Issuance of credit cards and processing of credit card transactions and billing
5. Issuance of debit cards for use as a substitute for checks
6. Allow financial transactions at branches or by using Automatic Teller Machines (ATMs)
7. Provide wire transfers of funds and electronic fund transfers between banks
8. Facilitation of standing orders and direct debits, so payments for bills can be made automatically
9. Provide overdraft agreements for the temporary advancement of the bank's own money to meet monthly
spending commitments of a customer in their current account
10. Provide charge card advances of the bank's own money for customers wishing to settle credit advances
monthly.
11. Provide a check guaranteed by the bank itself and prepaid by the customer, such as a cashier's check or
certified check
 12. Notary service for financial and other documents.

Other Types of Bank Services

1. Private banking - Private Banks provide banking services exclusively to high net worth individuals. Many
financial services firms require a person or family to have a certain minimum net worth to qualify for
private banking services. Private banks often provide more personal services, such as wealth
management and tax planning, than normal retail banks.
2. Capital market bank - bank that underwrite debt and equity, assist company deals (advisory services,
underwriting and advisory fees), and restructure debt into structured finance products.
3. Bank cards - include both credit cards and debit cards. Bank of America is the largest issuer of bank cards.
4. Credit card machine services and networks - companies which provide credit card machine and payment
networks call themselves "merchant card providers".

Foreign Exchange Services

Foreign exchange services are provided by many banks around the world. Foreign exchange services include:
1. Currency Exchange - where clients can purchase and sell foreign currency banknotes
2. Wire Transfer - where clients can send funds to international banks abroad
3. Foreign Currency Banking - banking transactions are done in foreign currency.

Investment Services
1. Asset management: The term usually given to describe companies which run collective investment funds.
2. Hedge fund management: Hedge funds often employ the services of "prime brokerage" divisions at major
investment banks to execute their trades.
3. Custody services: Custody services and securities processing is a kind of 'back-office' administration for
financial services. Assets under custody in the world was estimated to $65 trillion at the end of 2004.

Insurance Services
1. Insurance brokerage: Insurance brokers shop for insurance (generally corporate property and casualty
insurance) on behalf of customers. Recently a number of websites have been created to give consumers
basic price comparisons for services such as insurance, causing controversy within the industry.
2. Insurance underwriting: Personal lines insurance underwriters actually underwrite insurance for
individuals, a service still offered primarily through agents, insurance brokers, and stock brokers.
Underwriters may also offer similar commercial lines of coverage for businesses. Activities include
insurance and annuities, life insurance, retirement insurance, health insurance, and property & casualty
insurance.
3. Reinsurance: Reinsurance is insurance sold to insurers themselves, to protect them from catastrophic
losses.

Other Financial Services

1. Intermediation or advisory services: These services involve stock brokers (private client services) and
discount brokers. Stock brokers assist investors in buying or selling shares.
2. Primarily internet-based companies are often referred to as discount brokerages, although many now
have branch offices to assist clients. These brokerages primarily target individual investors. Full service
and private client firms primarily assist execute trades and execute trades for clients with large amounts
of capital to invest, such as large companies, wealthy individuals, and investment management funds.
3. Private equity: Private equity funds are typically closed-end funds, which usually take controlling equity
stakes in businesses that are either private, or taken private once acquired. Private equity funds often use
leveraged buyouts (LBOs) to acquire the firms in which they invest. The most successful private equity
funds can generate returns significantly higher than provided by the equity markets.
4. Venture capital: Venture capital is a type of private equity capital typically provided by professional,
outside investors to new, high-potential-growth companies in the interest of taking the company to an
IPO or trade sale of the business.
5. Angel investment: An angel investor or angel (known as a business angel or informal investor in Europe),
is an affluent individual who provides capital for a business start-up, usually in exchange for convertible
 debt or ownership equity. A small but increasing number of angel investors organize themselves into
angel groups or angel networks to share research and pool their investment capital.
6. Conglomerates: A financial services conglomerate is a financial services firm that is active in more than
one sector of the financial services market e.g. life insurance, general insurance, health insurance, asset
management, retail banking, wholesale banking, investment banking, etc. A key rationale for the
existence of such businesses is the existence of diversification benefits that are present when different
types of businesses are aggregated i.e. bad things don't always happen at the same time. As a
consequence, economic capital for a conglomerate is usually substantially less than economic capital is
for the sum of its parts.
 Merchant Banking
Introduction
In banking, a merchant bank is a financial institution primarily engaged in offering financial services and advice
to corporations and to wealthy individuals. The term can also be used to describe the private equity activities of
banking. The chief distinction between an investment bank and a merchant bank is that a merchant bank invests
the banks own capital in a client company whereas an investment bank purely distributes (and trades) the
securities of that company in its capital raising role. Both merchant banks and investment banks provide fee
based corporate advisory services including in relation to mergers and acquisitions.

14.1 Meaning
A merchant bank can be defined as a bank that deals mostly in (but is not limited to) international finance, long-
term loans for companies and underwriting. Merchant banks do not provide regular banking services to the
general public.
Their knowledge in international finances make merchant banks specialists in dealing with multinational
corporations.

14.2 Role
In the past the role of the merchant banker was to arrange the necessary capital and ensure that the transaction
would be implemented i.e. a financial intermediary facilitating the flow of capital among the concerned parties.
But today, a merchant banker plays multiple roles which include those of an entrepreneur, a management
advisor, an investment banker, and a transaction broker.
This shows that the breadth and depth of a merchant bankers activity has changed over the years.
A merchant bank deals with the commercial banking needs of international finance, long term company loans,
and stock underwriting. A merchant bank does not have retail offices where one can go and open a savings or
checking account. A merchant bank is sometimes said to be a wholesale bank, or in the business of wholesale
banking. This is because merchant banks tend to deal primarily with other merchant banks and other large
financial institutions.
The most familiar role of the merchant bank is stock underwriting. A large company that wishes to raise money
from investors through the stock market can hire a merchant bank to implement and underwrite the process.
The merchant bank determines the number of stocks to be issued, the price at which the stock will be issued, and
the timing of the release of this new stock. The merchant bank files all the paperwork required with the various
market authorities, and is also frequently responsible for marketing the new stock, though this may be a joint
effort with the company and managed by the merchant bank. For really large stock offerings, several merchant
banks may work together, with one being the lead underwriter.
Merchant bankers offer customised solutions to solve the financial problems of their clients. Advice is sought in
areas of financial structuring. Merchant bankers study the working capital practices that exist within the
company and suggest alternative policies. They also advise the company on rehabilitation and turnaround
strategies, which would help companies to recover from their current position. They also provide advice on
appropriate risk management strategies like hedging strategies.
These financial intermediaries arrange loans, for their clients, by analysing their cash flow pattern, so that the
terms of borrowing meet the clients cash requirements. They also offer assistance in loan documentation
procedures.
Merchant bankers assist the management of the client company to successfully restructure various activities,
which include mergers and acquisitions, divestitures, management buyouts, joint venture among others. They
also play a lead role to help companies achieve the objectives of these restructuring strategies, the merchant
banker participates in different activities at various stages which include understanding the objectives behind
the strategy (objectives could be either to obtain financial, marketing, or production benefits), and help in
searching for the right partner in the strategic decision and financial valuation of the proposal.
14.3 Functions
Merchant Banks are popularly known as "issuing and accepting houses". They offer a package of financial
services. Unlike in the past, their activities are now primarily non-fund based. One of the basic requirements of
merchant banks is highly professional staff with skills and worldwide contacts. The basic function of merchant
banks is marketing corporate and other securities, that is guaranteeing sales and distribution of securities.

All the aspects – origination, underwriting and distribution of the sale of industrial securities are handled by
them. They are experts and good judges of the type, timing and terms of issues and make them acceptable to
investors under prevailing preferences and market conditions, and at the same time afford the borrowing
company, flexibility and freedom that it needs to meet possible future contingencies. They guarantee the success
of issues by underwriting them. They also provide all the services related to receiving applications, allotment,
collecting money, sending share certificates and so on.

The merchant banker normally does not assume all the risk himself while underwriting the issue. Merchant
banks offer services also to investors. The range of activities offered by merchant banks is much wider than
sponsoring public issues of industrial securities. They offer project finance, syndication of credit, corporate
advisory services, mutual fund investments, investment management etc. Let us go through the most important
services of Merchant Banks.

Project Counselling
Project counselling includes preparation of project reports, deciding upon the financing pattern to finance the
cost of the project and appraising the project report with the financial institutions or banks. It also includes filling
up of application forms with relevant information for obtaining funds from financial institutions and obtaining
government approval.

Issue Management
Management of issue involves marketing of corporate securities viz. equity shares, preference shares and
debentures or bonds by offering them to public. Merchant banks act as an intermediary whose main job is to
transfer capital from those who own it to those who need it. After taking action as per SEBI guidelines, the
merchant banker arranges a meeting with company representatives and advertising agents to finalise
arrangements relating to date of opening and closing of issue, registration of prospectus, launching publicity
campaign and fixing date of board meeting to approve and sign prospectus and pass the necessary resolutions.
Pricing of issues is done by the companies in consultant with the merchant bankers.

Underwriting of Public Issue

Underwriting is a guarantee given by the underwriter that in the event of under subscription, the amount
underwritten would be subscribed by him. Banks/Merchant banking subsidiaries cannot underwrite more than
15% of any issue.

Managers, Consultants or Advisers to the Issue

The managers to the issue assist in the drafting of prospectus, application forms and completion of formalities
under the Companies Act, appointment of Registrar for dealing with share applications and transfer and listing
of shares of the company on the stock exchange. Companies can appoint one or more agencies as managers to
the issue.

Portfolio Management
Portfolio refers to investment in different kinds of securities such as shares, debentures or bonds issued by
different companies and government securities. Portfolio management refers to maintaining proper
combinations of securities in a manner that they give maximum return with minimum risk.
Advisory Service relating to Mergers and Takeovers
A merger is a combination of two companies into a single company where one survives and other loses its
corporate existence. A takeover is the purchase by one company acquiring controlling interest in the share capital
of another existing company. Merchant bankers are the middlemen in setting negotiation between the two
companies.

Off Shore Finance

The merchant bankers help their clients in the following areas involving foreign currency.
1. Long term foreign currency loans
2. Joint ventures abroad
3. Financing exports and imports
4. Foreign collaboration arrangements

Non-resident Investment
The services of merchant banker includes investment advisory services to NRI in terms of identification of
investment opportunities, selection of securities, investment management, and operational services like
purchase and sale of securities.

Loan Syndication
Loan syndication refers to assistance rendered by merchant bankers to get mainly term loans for projects. Such
loans may be obtained from a single development finance institution or a syndicate or consortium. Merchant
bankers help corporate clients to raise syndicated loans from banks or financial institutions.

Corporate Counselling
Corporate counselling covers the entire field of merchant banking activities viz. project counselling, capital
restructuring, public issue management, loan syndication, working capital, fixed deposit, lease financing
acceptance credit, etc.

SEBI Guidelines regarding Merchant Banking

1. Without holding a certificate of registration granted by the Securities and Exchange Board of India, no
person can act as a merchant banker.
2. Only a body corporate other than a non-banking financial company shall be eligible to get registration as
merchant banker.
3. The categories for which registration may be granted are given below:
(a) Category I: to carry on the activity of issue management and to act as adviser, consultant, manager,
underwriter, portfolio manager.
(b) Category II: to act as adviser, consultant, co-manager, underwriter, portfolio manager.
(c) Category III: to act as underwriter, adviser or consultant to an issue.
(d) Category IV: to act only as adviser or consultant to an issue.
4. The capital requirement depends upon the category. The minimum net worth requirement for acting as
merchant banker is given below:
(a) Category I - 5 crores
(b) Category II - 50 lakhs
(c) Category III - 20 lakhs
(d) Category IV - Nil.
5. An application should be submitted to SEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992.
SEBI shall consider the application and on being satisfied issue a certificate of registration in Form B of
the SEBI (Merchant Bankers) Regulations, 1992.
 6. Rs. 5 lakhs which should be paid within 15 days of date of receipt of intimation regarding grant of
certificate.
7. The validity period of certificate of registration is three years from the date of issue.
8. For renewal, three months before the expiry period, an application should be submitted to SEBI in Form
A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall consider the application and on being
satisfied renew certificate of registration for a further period of 3 years.
9. 2.5 lakhs which should be paid within 15 days of date of receipt of intimation regarding renewal of
certificate.
10. The person whose registration is not current shall not carry on the activity as merchant banker from the
date of expiry of validity period.
14.1 Underwriting Services in India
The word "underwriter" is said to have come from the practice of having each risk-taker write his or her name
under the total amount of risk that he or she was willing to accept at a specified premium. In a way, this is still
true today, as new issues are usually brought to market by an underwriting syndicate in which each firm takes
the responsibility (and risk) of selling its specific allotment.
Thus underwriting can be understood as the process by which investment bankers raise investment capital from
investors on behalf of corporations and governments that are issuing securities (both equity and debt). It is also
the process of issuing insurance policies.
Underwriting of capital issues has become very popular due to the development of the capital market and special
financial institutions. The lead taken by public financial institutions has encouraged banks, insurance companies
and stock brokers to underwrite on a regular basis. The various types of underwriters differ in their approach
and attitude towards underwriting:
1. Development banks like IFCI, ICICI and IDBI: They follow an entirely objective approach. They stress
upon the long-term viability of the enterprise rather than immediate profitability of the capital issue.
They attempt to encourage public response to new issues of securities.
2. Institutional investors like LIC and AXIS: Their underwriting policy is governed by their investment
policy.
3. Financial and development corporations: They also follow an objective policy while underwriting
capital issues.
4. Investment and insurance companies and stock-brokers: They put primary emphasis on the short term
prospects of the issuing company as they cannot afford to block large amount of money for long periods
of time.
To act as an underwriter, a certificate of registration must be obtained from Securities and Exchange Board of
India (SEBI). The certificate is granted by SEBI under the Securities and Exchanges Board of India
(Underwriters) Regulations, 1993. These regulations deal primarily with issues such as registration, capital
adequacy, obligation and responsibilities of the underwriters. Under it, an underwriter is required to enter into
a valid agreement with the issuer entity and the said agreement among other things should define the
allocation of duties and responsibilities between him and the issuer entity. These regulations have been further
amended by the Securities and Exchange Board of India (Underwriters) (Amendment) Regulations, 2006.

Summary
 Merchant Banking is an important service provided by a number of financial institutions that helps in
the growth of the corporate sector which ultimately reflects into the overall economic development of
the country.
 The activities of the merchant banking in India is very vast in nature of which includes the management
of the customers securities, management of the portfolio, the management of projects and counseling
as well as appraisal, the management of underwriting of shares and debentures, the circumvention of
the syndication of loans and management of the interest and dividend, etc .
 Merchant banks were expected to perform several functions like issue management, underwriting,
portfolio management, loan syndication, consultant, advisor and host of other activities.
 SEBI was also made all powerful to regulate the activities of merchant banks in the best interest of
investors and economy.
 Apart, merchant banking was the necessity of banks themselves which were in need of non-fund based
income so as to improve their profitability margins by all means in the changed economic scenario.
 Unit 9: Mutual Funds
Mutual Funds
Introduction
According to Chapter 1, Securities and Exchange Board of India (Mutual Funds) Regulations, December 9, 1996,
a "mutual fund" means a fund established in the form of a trust to raise money through the sale of units to the
public or a section of the public under one or more schemes for investing in securities, including money market
instruments. They raise money by selling shares of the fund to the public, much like any other type of company
can sell stock in itself to the public. Mutual funds then take the money they receive from the sale of their shares
(along with any money made from previous investments) and use it to purchase various investment vehicles,
such as stocks, bonds and money market instruments.
In return for the money they give to the fund when purchasing shares, shareholders receive an equity position in
the fund and, in effect, in each of its underlying securities. For most mutual funds, shareholders are free to sell
their shares at any time, although the price of a share in mutual fund will fluctuate daily, depending upon the
performance of the securities held by the fund. Benefits of mutual funds include diversification and professional
money management. Mutual funds offer choice, liquidity, and convenience, but charge fees and often require a
minimum investment.
There are many types of mutual funds, including aggressive growth fund, asset allocation fund, balanced fund,
blend fund, bond fund, capital appreciation fund, open fund, clone fund, closed fund, crossover fund, equity fund,
fund of funds, global fund, growth fund, growth and income fund, hedge fund, income fund, index fund,
international fund, money market fund, municipal bond fund, prime rate fund, regional fund, sector fund,
specialty fund, stock fund, and tax-free bond fund.

9.1 Unit Trust of India

Unit Trust of India was created by the UTI Act passed by the Parliament in 1963. For more than two decades, it
remained the sole vehicle for investment in the capital market by the Indian citizens.
The Indian Government were allowed public sector banks in mid- 1980s to open mutual funds. The real vibrancy
and competition in the MF industry came with the setting up of the Regulator SEBI and its laying down the MF
Regulations in 1993. UTI maintained its pre-eminent place till 2001, when a massive decline in the market indices
and negative investor sentiments after Ketan Parekh scam created doubts about the capacity of UTI to meet its
obligations to the investors. This was further compounded by two factors; namely, its flagship and largest scheme
US 64 was sold and re-purchased not at intrinsic NAV but at artificial price and its Assured Return Schemes had
promised returns as high as 18% over a period going up to two decades..!!
Fearing a run on the institution and possible impact on the whole market Government came out with a rescue
package and change of management in 2001. Subsequently, the UTI Act was repealed and the institution was
bifurcated into two parts. UTI Mutual Fund was created as a SEBI registered fund like any other mutual fund. The
assets and liabilities of schemes where Government had to come out with a bail-out package were taken over
directly by the Government in a new entity called Specified Undertaking of UTI, SUUTI. SUUTI holds over 27%
stake Axis Bank. In order to distance Government from running a mutual fund the ownership was transferred to
four institutions; namely SBI, LIC, BOB and PNB, each owning 25%. Certain reforms like improving the salary
from PSU levels and affecting a VRS were carried out UTI lost its market dominance rapidly and by end of 2005,
when the new shareholders actually paid the consideration money to Government its market share had come
down to close to 10%!
A new board was constituted and a new management inducted. Systematic study of its problems role and
functions was carried out with the help of a reputed international consultant. Fresh talent was recruited from the
private market, organizational structure was changed to focus on newly emerging investor and distributor
groups and massive changes in investor services and funds management carried out. Once again UTI has emerged
as a serious player in the industry. Some of the funds have won famous awards, including the Best Infra Fund
globally from Lipper. UTI has been able to benchmark its employee compensation to the best in the market, has
introduced Performance Related Payouts and ESOPs.
The UTI Asset Management Company has its registered office at: UTI Tower, Gn Block, Bandra - Kurla Complex,
Bandra (East), Mumbai - 400 051. It has over 70 schemes in domestic MF space and has the largest investor base
of over 9 million in the whole industry. It is present in over 450 districts of the country and has 100 branches
called UTI Financial Centres or UFCs. About 50% of the total IFAs in the industry work for UTI in distributing its
 Unit 9: Mutual Funds
products! India Posts, PSU Banks and all the large Private and Foreign Banks have started distributing UTI
products.
The total average Assets Under Management (AUM) for the month of June 2008 was 530 billion and it ranked
fourth. In terms of equity AUM it ranked second and in terms of Equity and Balanced Schemes AUM put together
it ranked FIRST in the industry. This measure indicates its revenue- earning capacity and its financial strength.
Besides running domestic MF Schemes UTI AMC is also a registered portfolio manager under the SEBI (Portfolio
Managers) Regulations. It runs different portfolios for is HNI and Institutional clients. It is also running a Sharia
Compliant portfolio for its Offshore clients. UTI tied up with Shinsei Bank of Japan to run a large size India-centric
portfolio for Japanese investors.
For its international operations UTI has set up its 100% subsidiary, UTI International Limited, registered in
Guernsey, Channel Islands. It has branches in London, Dubai and Bahrain. It has set up a Joint Venture with
Shinsei Bank in Singapore. The JV has got its license and has started its operations.
In the area of alternate assets, UTI has a 100% subsidiary called UTI Ventures at Banglore. This company runs
two successful funds with large international investors being active participants. UTI has also launched a Private
Equity Infrastructure Fund along with HSH Nord Bank of Germany and Shinsei Bank of Japan.

9.2 Types of Mutual Funds

Most funds have a particular strategy they focus on when investing. For instance, some invest only in Blue Chip
companies that are more established and are relatively low risk. On the other hand, some focus on high-risk start
up companies that have the potential for double and triple digit growth. Finding a mutual fund that fits your
investment criteria and style is important.

Types of mutual funds are:

Value stocks: Stocks from firms with relative low Price to Earning (P/E) Ratio, usually pay good dividends. The
investor is looking for income rather than capital gains.
Growth stock: Stocks from firms with higher low Price to Earning (P/E) Ratio, usually pay small dividends. The
investor is looking for capital gains rather than income.
Based on company size, large, mid, and small cap: Stocks from firms with various asset levels.
Income stock: The investor is looking for income which usually come from dividends or interest. These stocks
are from firms which pay relative high dividends. This fund may include bonds which pay high dividends. This
fund is much like the value stock fund, but accepts a little more risk and is not limited to stocks.
Index funds: The securities in this fund are the same as in an Index fund. The number and ratios or securities are
maintained by the fund manager to mimic the Index fund it is following.
Enhanced index: This is an index fund which has been modified by either adding value or reducing volatility
through selective stock-picking.
Stock market sector: The securities in this fund are chosen from a particular marked sector such as Aerospace,
retail, utilities, etc.
Defensive stock: The securities in this fund are chosen from a stock which usually is not impacted by economic
down turns.
International: Stocks from international firms.
Real estate: Stocks from firms involved in real estate such as builder, supplier, architects and engineers, financial
lenders, etc.
Socially responsible: This fund would invests according to non-economic guidelines. Funds may
make investments based on such issues as environmental responsibility, human rights, or
religious views. For example, socially responsible funds may take a proactive stance by selectively
investing in environmentally-friendly companies or firms with good employee relations.
Therefore the fund would avoid securities from firms who profit from alcohol, tobacco, gambling,
pornography etc.
Balanced funds: The investor may wish to balance his risk between various sectors such as asset
size, income or growth. Therefore the fund is a balance between various attributes desired.
Tax efficient: Aims to minimize tax bills, such as keeping turnover levels low or shying away from
companies that provide dividends, which are regular payouts in cash or stock that are taxable in
the year that they are received. These funds still shoot for solid returns; they just want less of
them showing up on the tax returns.
Convertible: Bonds or Preferred stock which may be converted into common stock.
Junk bond: Bonds which pay higher that market interest, but carry higher risk for failure and are
rated below AAA.
Mutual funds of mutual funds: This funds that specializes in buying shares in other mutual funds
rather than individual securities.
Open ended: A type of mutual fund that does not have restrictions on the amount of shares the
fund will issue. If demand is high enough, the fund will continue to issue shares no matter how
many investors there are. Open-end funds also buy back shares when investors wish to sell.
Closed ended: This fund has a fixed number of shares. The value of the shares fluctuates with the
market, but fund manager has less influence because the price of the underlining owned
securities has greater influence.
Exchange traded funds (ETFs): Baskets of securities (stocks or bonds) that track highly
recognized indexes. Similar to mutual funds, except that they trade the same way that a stock
trades, on a stock exchange.

9.3 Significance of Mutual Funds

Mutual funds have emerged as the best in terms of variety, flexibility, diversification, liquidity as
well as tax benefits. Besides, through MFs investors can gain access to investment opportunities
that would otherwise be unavailable to them due to limited knowledge and resources.
MFs have the capability to provide solutions to most investors' needs, however, the key is to do
proper selections and have a process for monitoring.
1. Diversification: The best mutual funds design their portfolios so individual investments
will react differently to the same economic conditions. For example, economic conditions
like a rise in interest rates may cause certain securities in a diversified portfolio to
decrease in value. Other securities in the portfolio will respond to the same economic
conditions by increasing in value. When a portfolio is balanced in this way, the value of the
overall portfolio should gradually increase over time, even if some securities lose value.
2. Professional management: Most mutual funds pay topflight professionals to manage
their investments. These managers decide what securities the fund will buy and sell.
3. Regulatory oversight: Mutual funds are subject to many government regulations that
protect investors from fraud.
4. Liquidity: It's easy to get your money out of a mutual fund. Write a check, make a call, and
you've got the cash.
5. Convenience: You can usually buy mutual fund shares by mail, phone, or over the Internet.
 6. Low Cost: Mutual fund expenses are often no more than 1.5 percent of your investment.
Expenses for Index Funds are less than that, because index funds are not actively managed.
Instead, they automatically buy stock in companies that are listed on a specific index:
(a) Transparency
(b) Flexibility
(c) Choice of schemes
(d) Tax benefits
(e) Well regulated

9.4 SEBI and Mutual Funds

To protect the interest of the investors, SEBI formulates policies and regulates the mutual funds.
It notified regulations in 1993 (fully revised in 1996) and issued guidelines from time to time. MF
either promoted by public or by private sector entities including one promoted by foreign entities
are governed by these Regulations. As a result, the Indian mutual fund industry witnessed robust
growth and stricter regulation from SEBI since 1996.

Guidelines for Selling and Marketing Mutual Funds

Investors can purchase and sell mutual fund units through various types of intermediaries -
individual agents, distribution companies, national/regional brokers, banks, post offices etc. as
well as directly from Asset Management Companies (AMCs), including the Unit Trust of India
Investors of Mutual Funds can be broadly classified into three categories:
1. Those who want product information, advice on financial planning and
investment strategies.
2. Those who require only a basic level of service and execution support i.e.
delivering and collecting application forms and cheques, and other basic
paperwork and post sale activities.
3. Those that prefer to do it all themselves, including choice of investments as well
as the process/paperwork related to investments.
To cater to different types of investors, the Mutual Fund industry comprising of AMCs and
intermediaries at present offers the following two levels of services:

Value Added Services

This includes product information and advice on financial planning and investment strategies.
The advice encompasses analyzing an investor's financial goals depending upon the segment of
investor, assessing his/her resources, determining his/her risk bearing capacity/preference and
then using this information to recommend an asset allocation/specific investment/s that are in
tandem with the investor's needs. Investors may also receive information on taxation, estate
planning and portfolio rebalancing to remain aware about the changes/developments in market
conditions and adjust the portfolios from time to time according to their needs. In such advisory
services, the emphasis is on building an ongoing relationship with the investor/s. In India, given
that mutual funds are relatively new, there is a low level of awareness amongst investors about
the working and benefits of Mutual Funds. Also, very few investors take an organized approach
to financial planning. Therefore, it is clear that the vast majority of investors would benefit
significantly from the value-added services enumerated above.

Basic Services
This includes providing the basic information on schemes launched to investors, assisting them
in filling application forms, submission of application forms along with cheques at the respective
office/s, delivering redemption proceeds and answering scheme related queries investor/s may
have. What investors receive here is convenience and access to mutual funds through agents and
employees of brokers who visit them and facilitate the paperwork related to investment.
These services are also given through the branches and front office staff of AMCs and
intermediaries. These are transaction-oriented service where investors make the investment
decisions themselves, and rely on the AMC and intermediary mostly for execution and logistics
support.

Summary
 Mutual funds can be described as open-ended funds operated by an investment company
which raises money from shareholders and invests in a group of assets, in accordance
with a stated set of objectives.
 In return for the money they give to the fund when purchasing shares, shareholders
receive an equity position in the fund and, in effect, in each of its underlying securities.
 For most mutual funds, shareholders are free to sell their shares at any time, although the
price of a share in a mutual fund will fluctuate daily, depending upon the performance of
the securities held by the fund. Benefits of mutual funds include diversification and
professional money management.
 There are many types of mutual funds like Value stocks, Growth stock, Based on company
size, large, mid, and small cap, Income stock, Index funds, Enhanced index, Stock market
sector, Defensive stock, International, Real estate, Socially responsible, Balanced funds,
Tax efficient, Convertible, Junk bond, Mutual funds of mutual funds, Closed end, Exchange
traded funds, etc.
 Mutual funds have emerged as the best in terms of variety, flexibility, diversification,
liquidity as well as tax benefits.
 Besides, through MFs investors can gain access to investment opportunities that would
otherwise be unavailable to them due to limited knowledge and resources.
 MFs have the capability to provide solutions to most investors' needs, however, the key is
to do proper selections and have a process for monitoring
 Venture capital

Introduction
Venture capital is a post-war phenomenon in the business world mainly developed as a sideline
activity of the rich in USA. The concept, thus, originated in USA in 1950s when the capital magnets
like Rockfeller Group financed the new technology companies.
The concept became popular during 1960s and 1970s when several private enterprises started
financing highly risky and highly rewarding projects. To denote the risk and adventure and some
element of investment, the generic term "Venture Capital" was developed. The American
Research and Development was formed as the first venture organization which financed over 100
companies and made profit over 35 times its investment. Since then venture capital has grown'
vastly in USA, UK, Europe and Japan and has been an important contribution in the economic
development of these countries.
Of late, a new class of professional investors called venture capitalists has emerged whose
specialty is to combine risk capital with entrepreneurs management and to use advanced
technology to launch new products and companies in the market place.
Undoubtedly, it is the venture capitalist's extraordinary skill and ability to assess and manage
enormous risks and extort from them tremendous returns that has attracted more entrants.
Innovative, hi-tech ideas are necessarily risky. Venture capital provides long-term start-up costs
to high risk and return projects. Typically, these projects have high mortality rates and therefore
are unattractive to risk averse bankers and private sector companies.
Venture capitalist finances innovation and ideas, which have potential for high growth but are
unproven. This makes it a high risk, high return investment. In addition to finance, venture
capitalists also provide value-added services and business and managerial support for realizing
the venture's net potential.

16.1 Meaning of Venture Capital

Venture Capital has emerged as a new financial method of financing during the 20th century.
Venture capital is the capital provided by firms of professionals who invest alongside
management in young, rapidly growing or changing companies that have the potential for high
growth. Venture capital is a form of equity financing especially designed for funding high risk and
high reward projects.
There is a common perception that venture capital is a means of financing high technology
projects. However, venture capital is investment of long term finance made in:
1. Ventures promoted by technically or professionally qualified but unproven
entrepreneurs, or
2. Ventures seeking to harness commercially unproven technology, or
3. High risk ventures.
The term 'venture capital' represents financial investment in highly risky project with the
objective of earning a high rate return. While the concept of venture capital is very old the recent
liberalisation policy of the government appears to have given fillip to the venture capital
movement in India. In the real sense, venture capital financing is one of the most recent entrants
the Indian capital market. There is a significant scope for venture capital companies in our
country because of increasing emergence of technocrat entrepreneurs who lack capital to be
risked.
These venture capital companies provide the necessary risk capital to the entrepreneurs so as to
meet the promoters' contribution as required by the financial institutions. In addition to
providing capital, these VCFs (Venture Capital firms) take an active interest in guiding the
assisted firms.
A young, high tech company that is in the early stage of financing and is not yet ready to make a
public offer of securities may seek venture capital. Such a high risk capital is provided venture
capital funds in the form of long-term equity finance with the hope of earning a high rate of return
primarily in form of capital gain. In fact, the venture capitalist acts as a partner with the
entrepreneur.
Thus, a Venture Capitalist (VC) may provide the seed capital unproven ideas, products,
technology oriented or start up firms. The venture capitalists may also invest in a firm that unable
to raise finance through the conventional means.

16.2 Features of Venture Capital

"Venture Capital combines the qualities of a banker, stock market investor and entrepreneur in
one."
The main features of venture capital can be summarised as follows:
 High Degrees of Risk: Venture capital represents financial investment in a highly risky
project with the objective of earning a high rate of return.
 Equity Participation: Venture capital financing is, invariably, an actual or potential equity
participation wherein the objective of venture capitalist is to make capital gain by selling
the shares once the firm becomes profitable.
 Long-term Investment: Venture capital financing is a long term investment. It generally
takes a long period to encash the investment in securities made by the venture capitalists.
 Participation in Management: In addition to providing capital, venture capital funds
take an active interest in the management of the assisted firms. Thus, the approach of
venture capital firms is different from that of a traditional lender or banker. It is also
different from that of a ordinary stock market investor who merely trades in the shares
of a company without participating in their management. It has been rightly said, "venture
capital combines the qualities of banker, stock market investor and entrepreneur in one".
 Achieve Social Objectives: It is different from the development capital provided by
several central and state level government bodies in that the profit objective is the motive
behind the financing. But venture capital projects generate employment, and balanced
regional growth indirectly due to setting up of successful new business.
 Investment is Liquid: A venture capital is not subject to repayment on demand as with
an overdraft or following a loan repayment schedule. The investment is realised only
when the company is sold or achieves a stock market listing.
It is lost when the company goes into liquidation.

16.3 Techniques of Venture Capital

Venture capital firms usually recognise the following two main stages when the investment could
be made in a venture namely:
1. Early Stage Financing:
a. Seed Capital & Research and Development Projects
b. Start Ups
c. Second Round Finance
2. Later Stage Financing:
(a) Development Capital
(b) Expansion Finance
(c) Replacement Capital
(d) Turn Arounds
(e) Buy Outs.

Early Stage Financing

This stage includes the following:
1. Seed Capital and R&D Projects: Venture capitalists are more often interested in
providing seed finance i. e. making provision of very small amounts for finance needed to turn
into a business. Research and development activities are required to be undertaken before a
product is to be launched. External finance is often required by the entrepreneur during the
development of the product. The financial risk increases progressively as the research phase
moves into the development phase, where a sample of the product is tested before it is finally
commercialised "venture capitalists/firms/funds are always ready to undertake risks and make
investments in such R & D projects promising higher returns in future.
2. Start Ups: The most risky aspect of venture capital is the launch of a new business after
the research and development activities are over. At this stage, the entrepreneur and his products
or services are as yet untried. The finance required usually falls short of his own resources. Start-
ups may include new industries/businesses set up by the experienced persons in the area in
which they have knowledge. Others may result from the research bodies or large corporations,
where a venture capitalist joins with an industrially experienced or corporate partner. Still other
start-ups occur when a new company with inadequate financial resources to commercialise new
technology is promoted by an existing company.
3. Second Round Financing: It refers to the stage when product has already been launched
in the market but has not earned enough profits to attract new investors. Additional funds are
needed at this stage to meet the growing needs of business. Venture Capital Institutions (VCIs)
provide larger funds at this stage than at other early stage financing in the form of debt. The time
scale of investment is usually three to seven years.

Later Stage Financing

Those established businesses which require additional financial support but cannot raise capital
through public issue approach venture capital funds for financing expansion, buyouts and
turnarounds or for development capital.
1. Development Capital: It refers to the financing of an enterprise which has overcome the
highly risky stage and have recorded profits but cannot go public, thus needs financial support.
Funds are needed for the purchase of new equipment/plant, expansion of marketing and
distributing facilities, launching of product into new regions and so on. The time scale of
investment is usually one to three years and falls in medium risk category.
2. Expansion Finance: Venture capitalists perceive low risk in ventures requiring finance
for expansion purposes either by growth implying bigger factory, large warehouse, new factories,
new products or new markets or through purchase of exiting businesses. The time frame of
investment is usually from one to three years. It represents the last round of financing before a
planned exit.
3. Buy Outs: It refers to the transfer of management control by creating a separate business
by separating it from their existing owners. It may be of two types.
(a) Management Buyouts (MBOs): In Management Buyouts (MBOs) venture capital
institutions provide funds to enable the current operating management/ investors to acquire an
existing product line/business. They represent an important part of the activity of VCIs.
(b) Management Buyins (MBIs): Management Buy-ins are funds provided to enable
an outside group of manager(s) to buy an existing company. It involves three parties: a
management team, a target company and an investor (i.e. Venture capital institution). MBIs are
more risky than MBOs and hence are less popular because it is difficult for new management to
assess the actual potential of the target company. Usually, MBIs are able to target the weaker or
under-performing companies.
4. Replacement Capital: Another aspect of financing is to provide funds for the purchase of
existing shares of owners. This may be due to a variety of reasons including personal need of
finance, conflict in the family, or need for association of a well known name. The time scale of
investment is one to three years and involve low risk.
5. Turnarounds: Such form of venture capital financing involves medium to high risk and a
time scale of three to five years. It involves buying the control of a sick company which requires
very specialised skills. It may require rescheduling of all the company's borrowings, change in
management or even a change in ownership. A very active "hands on" approach is required in the
initial crisis period where the venture capitalists may appoint its own chairman or nominate its
directors on the board.
In nutshell, venture capital firms finance both early and later stage investments to maintain a
balance between risk and profitability. Venture capitalists evaluate technology and study
potential markets besides considering the capability of the promoter to implement the project
while undertaking early stage investments. In later stage investments, new markets and record
of the business/entrepreneur is closely examined.

Summary
 Venture capital is the capital provided by firms of professionals who invest alongside
management in young, rapidly growing or changing companies that have the potential
for high growth.
 Venture capital is a form of equity financing especially designed for funding high risk and
high reward projects.
 A Venture Capitalist (VC) may provide the seed capital unproven ideas, products,
technology oriented or start up firms.
 The venture capital involves high degrees of risk.
 Venture capital financing is an actual or potential equity participation wherein the objective
of venture capitalist is to make capital gain by selling the shares once the firm becomes
profitable.
 Venture capital financing is a long term investment. It generally takes a long period to
encash the investment in securities made by the venture capitalists.
 Venture capital funds take an active interest in the management of the assisted firms.
 Venture capital projects generate employment, and balanced regional growth indirectly
due to setting up of successful new business.
 Venture capital firms usually recognise the following two main stages when the investment
could be made in a venture namely Early Stage Financing and Later Stage Financing.
 In India the Venture Capital plays a vital role in the development and growth of innovative
entrepreneurships