Management of Financial Services 1.

1 Financial Services and Financial Markets

Lesson - 1

FINANCIAL SERVICES AND FINANCIAL MARKETS

1.0 Objective:
After studying this lesson, you shall be able:
* to understand the concept of Financial System.
* to know about the objectives of Financial System.
* to understand about Financial Market and its participants.
* to know about the concept of Financial Services and examine various types of Financial
Services.
Structure:
1.1 Financial System
1.2 Objectives of Financial System
1.3 Financial Markets
1.4 Participants in Financial Markets
1.5 Nature and Scope of Financial Services
1.5.1 Mutual Funds
1.5.2 Merchant Banking
1.5.3 Hire Purchase Financing
1.5.4 Housing Finance
1.5.5 Venture Capital
1.5.6 Portfolio Services
1.6 Leasing Finance
1.6.1 Factoring
1.6.2 Forfaiting
1.7 Credit Rating Services
1.8 Summary
1.9 Self Assessment Questions
1.10 Reference Books
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1.1 Financial System:

The financial system is the most important institutional and functional vehicle for economic
transformation. It is a set of interrelated activities and services working together to achieve some
predetermined purpose or goal. It includes different markets, the institutions, instruments, services
and mechanisms which influence the generation of savings, investment of capital and growth. Van
Horne defines the financial system as the purpose of financial markets to allocate savings efficiently
in an economy to ultimate users either for investment in real assets or for consumption. Robinson
defines financial system as “a link between savings and investment for the creation of new wealth
and to permit portfolio adjustment in the composition of the issuing wealth’. From the above defini-
tions, it may be said that the primary function of the financial system is the mobilisation of savings,
their distribution for industrial investment and stimulating capital formation to accelerate the process
of economic growth.
A financial system provides services that are essential in a modern economy. Financial
assets with attractive held, liquidity and risk characteristics encourage savings. By evaluating alter-
native investments and monitoring the activities of borrowers, financial intermediaries increase the
efficiency of resource use. Access to a variety of financial instruments enables an economic agent to
pool, price and exchange risks in the markets. Trade, the efficient use of resources, saving and risk
taking are the cornerstones of a growing economy. The financial system has been identified as the
most catalysing agent for growth of the economy, making it one of the key inputs of development.
Structure of the Finance System: The Indian Financial System is broadly classified into two
broad groups i.e., (1) Organised sector, (2) Unorganised Sector. The financial system is also divided
into users of financial services and providers. Financial institutions sell their services to households,
businesses and government. They are users of the financial services. The providers of financial
services are central bank, commercial banks, financial institutions, Money and capital markets,
non-banking institutions etc.,
Organised Financial System: The organised financial system comprises of an impressive
network of banks, other financial and investment institutions and a range of financial instruments
which together function in fairly developed capital and money markets. Short term funds are mainly
provided by the commercial and cooperative banking structure. About 85 percent of such banking
business is managed by twenty seven public sector banks. In addition to commercial banks, there
is the network of comparative banks and land development banks at state, district and block levels.
With around two third share in the total assets in the financial system, banks play an important role.
Of late, Indian banks have also diversified into areas of such as merchant banking, mutual funds,
leasing factoring and insurance etc.,
The organised financial system consists of the following sub systems:
* Banking System
* Cooperative System
* Development Banking
(i) Public Sector
(ii) Private Sector
* Money Markets
* Financial Companies/Institutions
 Management of Financial Services 1.3 Financial Services and Financial Markets

Over the years, the structure of financial institutions in India has developed and become
broad based with diversification.
Unorganised Financial System: The unorganised financial system comprises money lenders,
indigenous bankers, lending pawn brokers, landlords, traders etc., This part of the financial system
is not directly under the control of the Reserve Bank of India. There are a host of financial
companies, investment companies, chit funds etc., which are not regulated by the RBI or the
government in a systematic manner.
Organised Financial System:
Banking System: The structure the banking system is determined by two basic factors - eco-
nomic and legal. The development of the economy and the spread of banking habit calls for
increasing banking services. The RBI, the central bank of the country is at the top of the financial
system. The commercial banking system can be divided into four as given hereunder.
I. Public Sector Banks:
* State Bank of India State Bank group
Associate Banks 1+7
* 14 Nationalised Banks (1969)
* 6 Nationalised Banks (1980) 6-1 = 5
1 Bank merged with another bank.
* Regional Rural Banks (196) (Sponsored by Public Sector Banks)
II. Private Sector Banks:
* Old Private Banks
* Newly set up Private Banks
III. Foreign Banks & their Representative Offices:
IV. Cooperative Banks:
* State Cooperative Banks
* Central Cooperative Banks
* Primary Agricultural Credit Societies
* Urban Cooperative Banks
* Land Development Banks
Financial Systems and Development:
A financial system provides services that are essential in a modern economy. The Indian
financial system comprises of an impressive network of banks, other financial and investment
institutions offering wide range of products and services which together function in fairly developed
capital and money markets. As such, financial system has come to occupy an important role in the
process of economic development. The economic development of a country depends on its financial
structure. Investment is a precondition of economic growth. This is essential to sustain growth of
the economy. The more efficient composition of real wealth is obtained by the provision of financial
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assets which provide incentives to savers to hold a large part of their wealth in financial form. The
increasing rate of savings is correlated with the increase in the proportion of savings held in the form
of financial assets relative to tangible assets.
1.2 Objectives of Financial System:
The Indian financial system has been undergoing rapid changes particularly in relation to the
emerging financial liberalisation. In the process, it has undergone a radical transformation in its
structure and organisation. The main objectives of the financial system is to serve as an agent of
socio-economic development in various sectors viz., industry, agriculture and international trade.

Rapid Industrialisation

Support to Agriculture

Support to Trade
Speeding up economic growth

Rural Development

Entrepreneurial Development

Objectives of Financial System

Project Finance
Objectives of
Refinancing - Rediscounting
Financial
Systems
Development of Backward areas

Housing, Education, Health

Infrastructure

Liquidity

Price Control

Support to Institutions

Research and Development

Human Development

Eradication of Poverty
 Management of Financial Services 1.5 Financial Services and Financial Markets
The foremost task of any financial system is to accelerate the growth of the economy. Rapid
industrialisation even in the private sector has been referred to as providing additional employment
opportunity as well as higher production. Liquidity and Price Control motivate people to save and
invest in development and thereby develop various segments of the economy and create vast
employment opportunities, generate income, improve standard of living, eradicate poverty, ill health,
illiteracy and sustain economic development.
Role of the Financial System:
Financial systems provide payment services. They mobilise, savings and allocate credit.
The diverse services used in the financial system are by households, business and government
through an array of instruments like cheques, DDs, credit cards, bonds, stock, certificates,
commercial papers, Billing Exchange etc;. A financial system’s contribution to the economy
depends on the quantity and quality of its services and the efficiency with which it provides them.
Financial services make it cheaper and less risky to trade goods and services and to borrow and
lend.
Finance is the key to investment and growth. Providing saved resources to others with more
productive uses for them raises the income of saver and borrower alike. Without an efficient
financial system, lending can be both costly and risky. Self financed investment is one way to
overcome these difficulties but profitable investment opportunities may exceed the resources of the
individual enterprise. Investment by the public sector is another answer and the government mobilises
additional savings through tax system. When the economy is growing, financial arrangements need
to be augmented by commercial banks, financial institutions. In a diversified market based system,
the government retains a key role as prudential regulator to ensure sound development of financial
system through effective, functioning of financial institutions.
Financial Intermediaries:
Financial intermediaries are the institutions which collect savings from others, issuing in
return claims against themselves and use the funds thus acquired to purchase ownership or debt
claims. They play a very important role in the saving investment process by raising the level of
saving and investment and allocating more efficiently scare savings among most productive
investments. Financial institutions are grouped under five different categories as given hereunder.
(1) Banking System (Central Bank, Commercial Banks, Cooperative Banks, Regional Rural
Ranks)
(2) Depository Organisations (Mutual funds, Credit Unions etc.)
(3) Insurance Organisations (LIC, GIC, Postal Insurance, Pension Funds, Provident Funds
etc.)
(4) Development Banks and
(5) Other Institutions (Investment and Finance Companies, Stock Exchanges etc.)
The financial system in India has undergone rapid changes. The financial system should
facilitate the speedy growth of the economy. In recent years, the financial institutions are
concentrating more on the management of fund based resources as an effective means of
development. The changing environment of competition amongst different segments of the financial
system should call for more professionalism and good performance levels.
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1.3 Financial Markets:

Money, debt instruments and equities are called financial assets and they are claims against
present and future income. These claims are traded in financial markets. Although some securities
are traded directly between buyers and sellers after private negotiation, the major places for trading
securities are called financial markets. Financial markets perform a vital function of allocating the
wealth of the economy. Financial markets are the centres or arrangements that provide facilities for
buying and selling of financial claims and services. The participants on the demand and supply
sides of these markets are financial institutions, agents, brokers, dealers, borrowers, lenders, savers
and others who are interlinked by the laws, contracts and communication network.
Classification of Financial Markets:
The financial market comprises all banking and non banking financial institutions,
procedures, practices followed in these markets and financial instruments for facilitating the flow of
funds. The financial markets in an economy can be classified into:
(a) Primary and Secondary Markets and
(b) Money and Capital Markets.
a) Primary and Secondary Markets:
Primary market deals with the new issues of securities, while the market for existing claims
(financial assets) is known secondary market. In other/words, primary market deals with new
securities issued for the first time to the public and the secondary market deals in those securities
which have already been issued to the public. In the primary market, the brokers act as under
writers, managers, registrars and even merchant bankers to the new issues. In the secondary
market, the claims of long term nature of one year and above are traded both on spot and forward
basis. This trading imparts liquidity to investments and thus promotes saving and investment.
These claims can be converted into money at any time although at a loss of capital in various
degrees.
In the primary market, the government and corporate sector issue securities and raise
additional funds for investment purposes. In the secondary market, the existing securities change
hands from one owner to another owner and there is no additional flow of funds for further
investment. An active secondary market stimulates activity in the primary market. Thus, the level of
development in the secondary market determines the efficiency and growth of the primary market.
b) Money and Capital Markets:
Money Market is the place where short term claims (with a maturity period of one year or
less) are traded. The money market facilitates short term financing and assures liquidity of short
term financial assets. The money market is the central place for banking activities and is significant
in indicating changes in short term interest rates, monetary policy and availability of short term
credit. Money market assures borrowers that they can obtain short term funds quickly and it also
assures the lenders that they can convert their short term financial assets into cash. A well
developed money market is the basis for an effective monetary policy.
Capital market is a wider term and includes all operations in the new issues market (NIM)
and stock market. It is the market in which lenders and investors provide long term funds in
exchange for financial assets offered by borrowers or holders. The primary purpose of capital market
 Management of Financial Services 1.7 Financial Services and Financial Markets

is to direct the flow of savings into long term investments by development banks and other financial
institutions. There are two important aspects of capital market, namely, the raising of new capital in
the form of shares and debentures and trading in the securities already issued by companies. While
the first aspect is much more important from the point of view of economic growth, the second
aspect is also of considerable significance. However, the financial deregulation, development of new
instruments of money market and setting up of new subsidiaries of banks for undertaking financial
services have all aided in the deepening and widening of the capital market in India.
1.4 Participants in Financial Markets:
Financial Markets include money and capital markets. Money market an important segment
of the financial market has no geographical constraints and relates to all dealings in money and
monetary assets. The Indian money market is divided into organised and unorganised markets.
The unorganised money market consists of indigenous bankers and money lenders. The organised
money market in India consists of Reserve Bank of India, State Bank of India and its subsidiaries,
commercial banks, foreign banks, cooperative banks, regional rural banks, financial corporations, bill
market etc; The banking system is the most dominant force in the Indian money market and the RBI
being the central bank occupies the pivotal position in the money market as it has wide powers to
control money and credit through various credit instruments.
Participants in Money Market:
The participants and interconnecting participants in money market are presented in the charts
given hereunder.

Banks FIs
Banks, LIC RBI Banks Short Term Inter Corpo-
Corporate
UTI FIs rate Investment Market
RBI as lender Units
of last Resort

Trading Bill Commercial Corporate

Inter-Bank Sector
Market Bills Market

D & FH D & FH D & FH

D & FH - Discount and Finance Houses

Source: VA Avadhani, Marketing of Financial Services, Himalaya Publishing House, New Delhi,
2004, P-42.
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Inter Connecting
Participants in Money market

Discount of Inter Corporate

RBI as Inter-Bank
Finance Investment
Wender Market
House Market

Treasury Bills Market Commercial

Bills Market

Participation Certificates Banks

Certificate of Deposits and other Commerical Companies
paper

Discount Purchase Sale

Source: V,.A, Avadhani, Marketing of Financial Services, Himalaya Publishing House, New
Delhi, 2004, P- 42
The money market consists of a number of interrelated sub markets such as call marker,
bill market, treasury bill market, commercial paper market, certificates of deposit market etc.
Participants in the Capital Market:
Following are the participants in the capital market.
* Industrial Development Bank of India (IDBI) as Apex body
* Industrial Finance Corporation of India (IFCI)
* Industrial Credit & Instrument Corporation of India (ICICI)
* Small Industries Development Bank of India (SIDBI)
* Industrial Reconstruction Bank of India
* State Financial Corporations.
* State Industrial Development Corporations
 Management of Financial Services 1.9 Financial Services and Financial Markets
* Life Insurance Corporation of India (LIC)
* General Insurance Corporation (GIC)
* Unit Trust of India (UTI)
* Discount and Finance House of India (DFHI)
* Securities and Exchange Board of India (SEBI)
* Stock Holding Corporation of India (SHCI)
* National Stock Exchange of India (NSE)
* Over the counter Exchange of India (OTCEI)
* Credit Rating Institutions.
The Indian capital market has developed to a large extent due to various measures taken
over the years. Various institutions like SEBI, Stock Holding Corporation of India, over the Counter
Exchange of India and credit rating agencies have been set up to strengthen and expand the
securities market in the country and to provide various services to the investors and companies and
also to regulate stock exchanges so as to promote a healthy and orderly securities market. A
depository system has been introduced and dematerialised trading is picking up and computerised
one line trading between different markets is gathering momentum. All these steps are aimed to
achieve greater autonomy to corporates and better transparency for investors.
Financial Services:
Concept: Financial Services Sector refers to that sector which provides are facilities for the people
to put their money in various investment portfolios. There has been phenomenal growth in the
financial services sector during the last one decade. The growth of capital and money markets and
the fast pace of industrialisation have contributed to the development of financial services sector to a
greater extent. Financial services sector comprises financial institutions, commercial banks,
merchant bankers, brokerage houses and stock advisers. The expansion of financial services at a
very fast pace has left its impact on the financial services scenario in the country. In the last fifteen
years, coordinated efforts were being made to reorganise and restructure the financial services
industry. Such efforts were made by various committees set up by the government to look into
specific area of the financial sector. Prominent among these have been the Narasimham Committee
on financial sector reforms, the Pherwani Committee on reorganisation of stock exchanges, the
Dave Committee on mutual funds etc.
Elements of Financial Services Sector:
The financial services sector consists of three major elements:
(a) Instruments: which include issue of company shares, debentures, fixed deposit certificates,
Commercial papers etc.
(b) Market Players: Which include Banks, financial institutions, mutual funds, stock brokers etc.
(c) Regulatory Bodies and Specialised agencies : Which include the SEBI, Stock
exchanges, credit rating services,
DFHI, SHCI, OTCE of India, Venture
Capital companies etc;
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Constituents of Financial Services Sector: Following are the various constituents of financial
services sector in India.
1) Government: The central government is one of the most important constituents of the financial
services sector because of its regulating powers. It has extensive powers under the companies Act
1956, Capital Issues (control) Act and securities contract (Regulation) Act 1956.
2) Regulatory Agencies:
* SEBI - Securities Exchange Board of India
* CCI - Controller of Capital Issues
* RBI - Reserve Bank of India.
3) Financial Institutions:
* Commercial Banks
* Mutual Funds
* Stock Exchanges
* Merchant Bankers
* Portfolio Managers
* Stock Brokers
* Non Banking Financial Institutions (NBFI)
* Financial Consultants
4) Specialised Institutions:
* Discount and Finance House of India (DFHI)
* Stock Holding Corporation of India (SHCI)
* Over the Counter Exchange of India (OTCEI)
* Credit Rating Information Services of India Ltd. (CRISIL)
* Information and Investment Credit Rating Associates (IICRA)
1.5 Nature and Scope of Financial Services:
The nature and scope of financial services are very broad which cover not only the fund
based activities are: Mutual funds, Merchant Banking etc; Financial Services industry includes all
kinds of organisations which intermediate and facilitate financial transactions of both individuals and
corporate customers. In view of the development of industry and trade in the country, the financial
services sector had to introduce numerous services in recent years to cater to the requirements of
the industry. Following are different types of financial activities/services provided by various financial
agencies to suit different financial needs of the country.
1.5.1 Mutual Funds:
Mutual Fund is an institution which pools the savings of the community and invests in
various types of securities. Mutual fund units are investment vehicles that provide a means of
 Management of Financial Services 1.11 Financial Services and Financial Markets
participation in the stock market for people who have neither the time, nor the money, nor perhaps
the expertise to undertake direct investment in equities successfully. It offers the individual saver the
advantages of reasonable dividend and capital appreciation coupled with safety and liquidity. The
first mutual fund institution i.e., Unit Trust of India was set up in 1964. Later in nineties, many public
sector banks like SBI, Indian Bank, Bank of India, PNB, Canara Bank etc; and LIC GIC have launched
mutual funds. Subsequently, foreign mutual funds like ANG Grindlays, Standard chartered and
Private Sector mutual funds like Reliance, HDFC, ING Vysya, Tata Birla, Escorts etc; companies
have started their mutual fund agencies to mobilise resources in the country.
1.5.2 Merchant Banking:
Merchant Bank is defined as a kind of financial institution that provides variety of services
including investments, portfolio management, Corporate Counselling, under writing of the issue etc;.
Merchant banking in India is of recent origin. It has its beginning in India in 1967 when Grindlays
Bank established a division followed by Citi Bank in 1970. State bank of India started its Merchant
Banking Division in 1972. Later on ICICI set up their merchant banking division followed by many
nationalised banks and financial institutions. Some private companies have also launched Merchant
banking Consultancy Services in a big way. For example, J.M. Financial Consultants Champaklal
Investments and Financial consultancy, V.B. Desai Consultancy etc;. Following are the merchant
banking services.
* Project Counselling or Reinvestment Studies for investors
* Syndication of Loans and Project Finance.
* Issue Management
* Provision of Working Capital
* Foreign Currency Loans
* Portfolio Management for Non Residents
1.5.3 Hire Purchase Financing:
Hire purchase is a form of credit where goods are supplied after payment of a deposit with an
agreement to pay regular installments over a period of time. At the end of the hiring period, legal title
passes to the hirer on payment of a nominal sum. The hire purchase Act was enacted in 1972 which
provides for regulating various, rights and obligations of the owner (financier) and the hirer under a
hire purchase transaction. Commercial banks entered in the field of hire purchase later than the
private hire purchase financiers. Ever since nationalisation of bank, commercial banks have been
playing a dominant role in providing finance to road transport sector, which is a priority sector for the
purpose of their advances, while at the same time, hire purchase companies in the private sector
continued to grow because of the fast efficient and personalised services.
1.5.4 Housing Finance:
Housing in India has been one of the important economic activities which serves to fulfil
many of the plan objectives, providing shelter to the needy, raising the quality of life, creating
additional employment. Further, housing could lead to the generation of additional savings at all
levels. Easy access to institutional finance at affordable rates is an essential pre-requisite for
accelerating the tempo of housing activity. In the recent past, several private housing finance
 Centre for Distance Education 1.12 Acharya Nagarjuna University

companies were set up. The national Housing Bank (NHB) has been set up by the government of
India as an apex housing finance body to make funds available to provide refinance the commercial
banks, housing finance companies, cooperative housing housing finance companies etc; The NHB
has recognised 10 housing finance companies as being eligible for refinance facilities. The Housing
and Urban Development Corporation (HUDCO), Housing Development Finance Corporation (HDFC),
LIC and GIC have been very active in providing finance for housing facilities.
1.5.5 Venture Capital:
Venture capital is a new financial service, the emergence of which went towards developing
strategies to help a new class of new entrepreneurs to translate their business ideas into realities.
The capital provided to start a venture is known as venture capital. In particular, for a small
entrepreneur with zeal and dynamism but inadequate or lack of finance, venture capital of seed
capital is a boom making it a launching pad for financial growth. Venture capital is “equity support to
fund new concepts that involve a higher risk and at the same time have high growth and profit
potential”. Venture capital carries a high degree of risk, but the potential to generate a substantial
rate of return is high, if the project is viable.
The venture capital was originated in USA during the nineteenth and early twentieth
centuries. In 1987, the government of India announced guidelines for venture capital companies. In
1988, the first venture capital Company Technology Development and Information Company of India
(TDICI) was jointly set up by UTI and ICICI. The Technology Development Fund (TDF) set up by
IDBI, the Equity Development Scheme (EDS) set up by SBI Capital Markets Ltd and Canfina which
have been joined by India Investment Fund (IIF) Promoted by Grindlays Bank are some of the
venture capital institutions set up in India. In the Private Sector, Credit Capital Corporation (CCC)
started a venture capital company. Andhra Pradesh Industrial Development Corporation (APIDC)
and Gujarat Industrial Development Corporation (GIDC) too have started venture capital
subsidiaries.
1.5.6 Portfolio Services:
A new area in which financial services are rendered is portfolio services i.e., managing the
portfolios of individuals clients. SBI Personal Banking centres and Vysya Bank’s investors clubs are
the two good examples. These are also a few private investment advisers, who guide and help
individual investors and manage their portfolios. Portfolio Management service include:
* Guidance on purchase and sale of securities
* Handling of such transactions
* Advise on market conditions
* Safe custody of Documents
* Collection of earnings and dividends etc;
1.6 Leasing Finance:
A Lease is defined as a contract between lessor and a lessee for the hire of a specific asset
for a specified period of payment and for a specified rentals. It is an arrangement between two
parties, the leasing company and the user, whereby the former arranges to buy capital equipment
for the use of latter in accordance with the latter’s requirements and specifications. The
 Management of Financial Services 1.13 Financial Services and Financial Markets
consideration for the transaction is in the form of rentals paid by the lesser to the lessor, who,
however, remains the owner of the equipment over the agreed period. The rentals are
predetermined and payable at fixed intervals of time, according to the mutual convenience of both
the parties. A lese is a finance lease if it transfers substantially all the risks and rewards incident to
ownership. Lease rentals refer the payments in the form of interest on the lessor’s investment,
charges born by the lessor - repairs, insurance, maintenance etc; depreciation and servicing charges.
Types of Leases: Following are the different types of leases:
* Financial Lease
* Operating Lease
* Sale and Lease Back Leasing
* Cross Border Lease
* Leveraged Lease
* Specialised Service Lease
* Foreign to Foreign Lease
Leasing finance business was grown in countries like South Korea, Malaysia and Indonesia
and leasing is successful in these countries in mobilising and allocating scare financial resources,
while fulfilling the medium term and long term needs of their rapidly growing industry. In India, the
first leasing company was promoted by chidambaram group in 1973 at Madras. This was followed
by the 20th century leasing company in 1980 at Mumbai. Four other finance companies ie; Shetly
Investment and Finance, Motor and General Finance, Jayabharati Credit and Finance and Sundaram
Finance joined the stream in 1982. The number of leasing firms in India is about 4000, Equipment
leasing was being carried out by ICICI and IFCI which provide leasing for computerisation, exports,
expansion etc.
Leasing finance being helpful for the small and medium sized units has gained importance
with the increasing number of entrepreneurs. Leasing is accepted as an alternative source of
finance. The new industrial policy and other economic measures of the government, withdrawal of
investment allowance etc, have made leasing as a financing option. It plays an important role in the
financing of machinery, plant and equipment. Thus, alot of optimism has been brought about in the
leasing industry due to liberalisation. The need of the hour is to regulate it properly to maximise its
benefits to the stake holders. Development banks’ participation would bring respectability and
stability in the lease market as a result of which lease finance will be widely accepted as an
innovative instrument for the growth of entrepreneurship.
1.6.1 Factoring:
Factoring is defined as an out right purchase of credit approved accounts receivable with the
factor assuming bad debt losses. With the increase in the volume of production and sales, timely
collection and efficient management of receivables has assumed greater importance. Factoring
Companies specialise in financing inventories and receivables. Factoring offers a clear solution to
the problems created by working capital setting locked up in trade debts. It basically means
purchase of book debts of clients. In order to be an economically viable proposition, a factoring
agency has to build up a suitable infrastructure so as to ensure optimum efficiency in the working of
credit and collection departments so that the fixed costs are absorbed at low unit costs.
 Centre for Distance Education 1.14 Acharya Nagarjuna University

Factoring is thus an asset based method of financing as well as a specialised service being
the purchase of book debts of a company by the factor, thus releasing the capital tied up in accounts
receivables and providing financial accommodation to the company. The factor is an intermediary
between the supplier and customers who performs financing and debt collection services. Factoring
in one form or other is extended on a large scale in USA, UK and many European countries. The
varied services provided by the factors could benefit the large number of suppliers in India. The need
for factoring in India arises due to the limitations of the banking industry in the provision of finance,
credit protection or collection services. Moreover, an efficient system of receivables management for
the manufacturers is the need of the hour.
The RBI has already accepted the recommendations of Kalyana Sundaram Committee and
initiated on working out the details. SBI has floated its subsidiary to look after factoring service in
five zones of the country. Canara Bank has also floated a subsidiary in the southern region. Private
sector is being presently kept out of the factoring services. The establishment of SBI factors and
Commercial Services (P) Ltd. is a boom to Indian industries. It was set up by SBI in collaboration
with Small Industries Development Bank of India (SIDBI), Union Bank of India and State Bank of
Saurashtra in Feb 1991 to service the industry. Since the establishment of SBI Factors and
Commercial Services (P) Ltd, the sellers of the industrial products, particularly the manufacturers
have improved their cash flows through prepayment facilities, leading to increased sales, continuity
of suppliers and reduction in the cost of maintenance.
1.6.2 Forfaiting:
Forfaiting is a financial tool to exporters enabling them to convert their credit sales into cash
sales by discounting their receivables with an agency called A Forfaiter. It is also to work as Risk
Management tool to exporters because by selling the export receivables to the forfaiter, the exporter
is relieved of the political and commercial risks involved in international trade. Forfaiting is a source
of finance which enables exporters to get funds from the institution called forfaiter on transferring the
right to recover the debts from the importer. The exporter surrenders his right to receive payments in
future for immediate cash payments.
Forfaiting is a mechanism of financing exports carried as below:
* by discounting export receivables
* evidenced by bills of exchange or Promissory notes
* without recourse to the seller
* carrying medium to long term maturities
* on a fixed rate basis
Forfaiting is the non recourse discounting of export receivables. The most outstanding benefit of
forfaiting is its flexibility and it is gaining popularity because of limitations of the traditional sources of
export finance. Finance for exports needs to be fast, cheap and flexible and on all these counts,
forfaiting meets the bill. Over a period of time, forfaiting is likely to emerge as an alternative source
of trade finance especially for deferred exports.
1.7 Credit Rating Services:
Credit Rating is essentially giving an expert opinion by a rating agency on the relative
willingness and ability of the issuer of a debt instrument to meet the debt servicing obligation in time
 Management of Financial Services 1.15 Financial Services and Financial Markets
and in full. It is important to note that the company is not rated but the instrument, issued by the
company is rated for its capacity to service that instrument. Credit rating is an assessment of the
capacity of an issuer of debt security by an independent agency. A rating agency collects the
qualitative as well as quantitative data from a company which has to be rated and it assesses the
relative strength and capacity of company to honour its obligations contained in the debt instrument
through out the duration of the instrument. The methodology involved is the analysis of past
performance of the company and assessment of its prospects. If debt securities are rated
professionally and if such ratings enjoy widespread investor acceptance and confidence, a more
rational risk return trade off would be established in the capital market.
The ratings are expressed in code numbers which can easily be comprehended even by the
lay investors. The ratings are the quickest way of understanding a company’s financial standing
without going into the complicated financial reports. Credit rating is only a guidance to the investors
and not a recommendation to a particular debt instrument. Credit rating is a source of cost
information to investors. The collection, processing and analysis of relevant information is done by a
specialised agency which a group of investors can trust. A highly rated firm can enter the market
with great confidence. It also forewarns the management of the perception of risk in the market.
Ratings also encourage discipline among corporate borrowers to improve their financial structure
and performance to obtain better rating for their instruments.
The credit rating concept was started in USA in 1860. Subsequently, many countries have
evolved the credit rating of corporate firms. The Indian capital market has witnessed a tremendous
growth in late 80s and the member of companies borrowings directly from capital market has
increased and this has forced the industry for credit rating mechanism of the debt instruments
issued. Now, there are four credit rating agencies working in India: (1) Credit Rating Information
Services Ltd. (CRISIL-1988), (2) Investment Information and Credit Rating Agency of India (ICRA -
1991), (3) Credit Analysis and Research (CARE - 1993), (4) Duff Phelps Credit Rating Pvt. Ltd.
(DCR - India). Credit Rating agencies conduct a rating exercise at the request of a company. In
accordance with industry prace allover the world, the methodology involves an analysis of the past
performance of the company and assessment of its prospects. Already, more instruments and
bonds of banks and corporate companies have been covered under credit rating. The outlook for the
credit rating industry is said to be positive.
1.8 Summary:
The financial services sector in India is in a process of rapid transformation particularly after
the introduction of reforms in the financial sector. The main objective of the financial sector reforms
is to promote an efficient, competitive and diversified financial system in the country. At present,
numerous new financial intermediaries have started functioning with a view to extending multifashions
services to the investing public in the area of financial services. The emergence of various financial
institutions and regulatory bodies have transformed the financial services sector from being a
conservative industry to a very dynamic one. Further, the process of globalisation has paved the way
for the entry of innovative and sophisticated financial products into our country. Keeping in view of
the changed environment, the financial services industry in India has to play a very positive and
dynamic role in the years to come by offering many innovative products to suit the varied
requirements of the millions of the prospective investors spread throughout the country.
 Centre for Distance Education 1.16 Acharya Nagarjuna University

1.9 Self Assessment Questions:

1. What is financial system and explain its structure.
2. Discuss the objectives and role of Financial System.
3. Examine the concept of Financial Markets and explain their participants.
4. What are financial services and describe on the elements of Financial Service Sector.
5. Outline the Nature and Scope of Financial Services and discuss Mutual Funds and Housing
Finance.
6. Write short notes on:
a. Leasing Finance
b. Factoring
c. Credit Rating Services.
1.10 Reference Books:
1. Financial Markets And Services : Gordon E & Natarajan K, Himalaya Publishing House, Mumbai,
2000.
2. Marketing of Financial Services : V.A. Avadhani, Himalaya Publishing House, Mumbai, 2004.
3. The Indian Financial System : Vasant Desai, Himalaya Publishing House, Mumbai, 1999.

- Dr. V.K. BHASKARA RAO