UNIT V INSURANCE AND OTHER FEE BASED FINANCIAL SERVICES

Insurance Act,1938 – IRDA – Regulations – Products and services – Venture Capital

Financing– Bill discounting –factoring – Merchant Banking –Role of SEBI

The Insurance Act of 1938 is a significant piece of legislation in India that governs the business
of insurance in the country. It has undergone amendments over the years to adapt to the changing
dynamics of the insurance industry.
Objective:
The primary objective of the Insurance Act, 1938, is to regulate the business of insurance in
India and ensure the protection of the interests of policyholders.

Regulatory Authority:
The act establishes the regulatory authority for insurance in India, initially known as the
Controller of Insurance and later replaced by the Insurance Regulatory and Development
Authority (IRDA) after the enactment of the IRDA Act in 1999.

Licensing and Registration:

The Act mandates that any entity wishing to carry on the business of insurance in India must
obtain a license from the regulatory authority. It outlines the eligibility criteria and conditions for
obtaining and maintaining a license.

Solvent and Prudent Conduct:

Insurance companies are required to conduct their business in a solvent and prudent manner to
safeguard the interests of policyholders. The act provides guidelines for the financial
management and operations of insurance companies.

Insurance Products and Policies:

The Act prescribes the terms and conditions for insurance policies, including premium rates,
policy terms, and other features. It outlines the requirements for policy documentation,
disclosure, and communication with policyholders.
Investments:
The Act specifies the types of investments that insurance companies can make to ensure the
safety and stability of policyholder funds. It sets limits on investments in various asset classes
and prescribes prudential norms for investment management.

Appointment of Agents and Intermediaries:

The Act regulates the appointment and functioning of insurance agents and intermediaries. It
outlines the qualifications and code of conduct for insurance agents.

Investigation and Inspection:

The regulatory authority has the power to investigate and inspect the affairs of insurance
companies to ensure compliance with the provisions of the Act.
It can take corrective measures, including issuing directions and imposing penalties.

Policyholder's Interests:
The Act emphasizes the protection of policyholders' interests and outlines mechanisms for the
redressal of grievances. It mandates the creation of the policyholder's protection fund to meet the
claims of policyholders in case of insolvency of an insurance company.
Amendments:
The Insurance Act has undergone several amendments to keep pace with the evolving insurance
landscape and address emerging challenges. The establishment of the Insurance Regulatory and
Development Authority (IRDA) in 1999 was a significant development that shifted the
regulatory framework from a government department to an independent regulatory authority.

Recent Changes:
Subsequent amendments to the Act may have introduced changes in areas such as digital
transactions, innovative insurance products, and corporate governance.
 IRDAI -REGULATIONS FOR INSURANCE
The Insurance Regulatory and Development Authority of India (IRDAI) was established in 1999
as an autonomous regulatory body entrusted with the task of overseeing and fostering the
development of the insurance sector within the country.

 Licensing and Registration:

IRDAI plays a pivotal role in the issuance of licenses to insurance companies, intermediaries,
and agents. Before obtaining approval, entities undergo a thorough assessment of eligibility
and compliance with regulatory standards. A comprehensive registry is maintained by
IRDAI, encompassing all insurers, intermediaries, and other entities involved in the
insurance sector.

 Product Approval Process:

Insurance companies are required to seek prior approval from IRDAI for the introduction of
new insurance products. This approval process involves a meticulous review of the product
features, terms, and conditions to ensure alignment with the regulatory guidelines set forth by
IRDAI.

 Policyholder Protection:
A core aspect of IRDAI's mandate is to establish rules and guidelines to safeguard the
interests of policyholders. This includes ensuring fair treatment, transparent disclosure of
information, and the expeditious settlement of claims. Additionally, IRDAI oversees the
establishment and effectiveness of grievance redressal mechanisms within insurance
companies and intermediaries.

 Financial Stability and Solvency:

IRDAI sets stringent guidelines to ascertain the financial soundness of insurance companies.
These guidelines encompass capital adequacy norms and various financial parameters, all
aimed at ensuring the solvency and stability of insurers operating within the Indian insurance
market.

 Investment Regulations:
To strike a balance between risk and return, IRDAI regulates the investment activities of
insurance companies. This includes specifying the types of assets in which insurers can
invest and setting limits for each category, thereby contributing to the overall financial health
of the insurance industry.
 Reinsurance Framework:
The reinsurance business is subject to IRDAI regulations, which delineate guidelines for the
ceding of insurance business to reinsurers, both domestic and foreign. These regulations
contribute to the effective management of risk within the insurance ecosystem

 Market Conduct and Ethics:

IRDAI is committed to promoting fair business practices within the insurance industry. It
issues codes of conduct and ethical guidelines for insurance companies and intermediaries.
Regular monitoring ensures compliance with these codes, and corrective actions are taken
when necessary to maintain the integrity of the market.

 Technology and Digital Initiatives:

Recognizing the evolving landscape, IRDAI actively encourages the adoption of technology
in the insurance sector. The regulatory body sets guidelines for digital insurance platforms
and Insur-Tech companies, fostering innovation while ensuring the security and reliability of
digital processes.

 Health Insurance Regulations:

Specific regulations are in place for the health insurance segment. IRDAI addresses aspects
such as standardization of health insurance products, portability, and the formulation of
effective claim settlement procedures.

 Risk Management and Compliance:

Insurance companies are mandated to establish robust risk management frameworks,
ensuring compliance with various regulations related to corporate governance, anti-money
laundering, and fraud prevention. IRDAI's oversight ensures the stability and ethical conduct
of insurers within the industry.

INSURANCE PRODUCTS
Life Insurance Products:
 Term Life Insurance:
Term life insurance offers coverage for a specified duration, providing a pure death benefit
without accumulating cash value. It serves as a reliable tool for income protection and meeting
specific financial obligations, such as mortgage coverage.
 Whole Life Insurance:
Whole life insurance ensures lifelong coverage and includes a cash value component. Premiums
remain constant throughout the policy, and the policyholder benefits from both the death benefit
and the cash value accumulation. It is often used for long-term savings and estate planning.
  Universal Life Insurance:
Universal life insurance offers flexible coverage with an adjustable premium. The cash value
component is linked to market interest rates, allowing policyholders to participate in investment
gains. This type of insurance is commonly chosen for its investment potential and estate planning
purposes.

Health Insurance Products:

 Individual Health Insurance:
Individual health insurance provides coverage for medical expenses incurred by a single person.
With customizable coverage options, premiums are determined based on individual health
factors, offering personalized protection against healthcare costs.
 Family Health Insurance:
Family health insurance extends coverage to all family members. Offering comprehensive
protection for the entire household, it is a practical solution for families seeking collective health
coverage. This type of insurance ensures that the health needs of every family member are
addressed.
 Critical Illness Insurance:
Critical illness insurance pays a lump sum in the event of specific severe illnesses. As standalone
coverage, it complements regular health insurance by providing financial support during critical
health conditions. Policyholders can use the lump sum to cover treatment costs or other financial
obligations.

Property Insurance Products:

 Home Insurance:
Home insurance protects against damage or loss to residential properties. It encompasses
coverage for the structure itself and personal belongings inside the home. Often a requirement
for mortgage approval, home insurance provides homeowners with financial security in the face
of unexpected events.
 Commercial Property Insurance:
Commercial property insurance safeguards business premises and assets. Covering buildings,
inventory, and equipment, this insurance type is essential for business continuity. It ensures that
businesses are protected against potential financial losses resulting from damage or loss of
commercial property.

Auto Insurance Products:

 Comprehensive Coverage:
Comprehensive coverage in auto insurance protects against various non-collision events, such as
theft, vandalism, or natural disasters. It provides a comprehensive shield for the insured vehicle,
covering repair or replacement costs resulting from unforeseen events.
 Liability Coverage:
Liability coverage is a fundamental component of auto insurance, covering bodily injury and
property damage caused to others. Mandatory in many jurisdictions, it ensures that individuals
have financial protection and legal coverage in the event of an accident.
 Collision Coverage:
Collision coverage in auto insurance addresses damages to the insured vehicle resulting from
collisions. It covers the costs of repairing or replacing the vehicle, providing a financial safety
net for vehicle owners.

Liability Insurance Products:

 Professional Liability Insurance:
Professional liability insurance protects professionals against claims of negligence or errors and
omissions in their services. It covers legal defense costs and settlements, offering a safeguard for
professionals in fields such as medicine, law, or consulting.
 General Liability Insurance:
General liability insurance provides businesses with protection against third-party claims,
including bodily injury and property damage. A standard risk management tool, it ensures that
businesses can operate with financial security, even in the face of unforeseen liabilities.

Specialty Insurance Products:

 Cyber Insurance:Cyber insurance protects against the risks and financial consequences of
cyber threats and data breaches. With coverage for data recovery, legal costs, and other
related expenses, it is crucial for businesses that handle sensitive data.
 Event Cancellation Insurance: Event cancellation insurance covers financial losses
incurred due to the cancellation of planned events. Providing protection against unforeseen
circumstances, it is a valuable tool for event organizers and hosts, offering financial security
in the face of unexpected disruptions.

INSURANCE SERVICES
Underwriting Services:
Underwriting is a fundamental insurance service involving the assessment of risks associated
with insuring a particular individual or entity. Insurance companies use underwriting to
determine the premium rates and coverage eligibility for policyholders. This process involves
evaluating factors such as the applicant's health, age, lifestyle, and the nature of the insured
property. Through underwriting, insurers aim to maintain a balanced risk portfolio and ensure
that the premiums accurately reflect the level of risk associated with the coverage.

Claims Processing:
Claims processing is a critical aspect of insurance services, involving the procedures followed
when a policyholder files a claim. Insurance companies carefully assess the validity of claims,
investigating the circumstances surrounding the loss or event covered by the policy. Timely and
accurate claims processing is essential to fulfill the insurer's obligation to provide financial
compensation to the policyholder. Insurers strive to streamline this process to enhance customer
satisfaction and maintain trust in the insurance industry.

Risk Management Services:

Risk management is a comprehensive service provided by insurance companies to identify,
assess, and mitigate risks. Insurers work closely with policyholders to develop strategies that
minimize the impact of potential adverse events. This involves a thorough analysis of the
policyholder's unique risk profile and the implementation of measures to reduce or transfer
identified risks. Effective risk management services contribute to the financial stability of both
the insurer and the insured, promoting a proactive approach to handling uncertainties.
Premium Calculation:
Premium calculation is a service that determines the amount of premium a policyholder must pay
for insurance coverage. Insurers consider various factors, including the insured's age, health
condition, occupation, and the type of coverage required. Actuarial methods and statistical
models are often employed to assess the likelihood of claims and set appropriate premium rates.
Transparent and fair premium calculations are crucial for maintaining the affordability of
insurance products and ensuring that policyholders receive adequate coverage for the premiums
paid.

Actuarial Services:
Actuarial services in the insurance industry involve the application of statistical and
mathematical methods to assess risk and uncertainty. Actuaries play a crucial role in determining
premium rates, policy reserves, and other financial aspects of insurance products. By analyzing
past data and predicting future trends, actuaries contribute to the financial stability of insurance
companies. Actuarial expertise is particularly important in life insurance and pension planning,
where long-term financial commitments require accurate risk assessment and financial modeling.

Policy Renewals:
Policy renewals are a standard insurance service wherein policyholders have the option to renew
their insurance coverage after the expiration of the policy term. Insurers often offer flexible
renewal options, allowing policyholders to update coverage levels, adjust premiums, or make
changes to their policies as needed. Effective communication during the renewal process is
crucial for insurers to keep policyholders informed about any changes in terms, conditions, or
premium rates, fostering a long-term relationship with customers.

Customer Service:
Customer service is a comprehensive service provided by insurers to address policyholder
inquiries, concerns, and general assistance. It encompasses various channels, including phone
support, online platforms, and in-person interactions. Responsive and efficient customer service
is essential for building trust, ensuring customer satisfaction, and retaining policyholders.
Insurers often invest in technology and training to enhance the overall customer experience, from
purchasing policies to filing claims and accessing policy information. Good customer service is a
key factor in establishing a positive reputation within the insurance industry.

VENTURE CAPITAL FINANCING

Venture Capital (VC) financing is a form of funding provided by professional investors to early-
stage and high-potential startups and companies in exchange for equity or ownership stakes. This
funding model is designed to support innovative ventures that may have high growth potential
but lack access to traditional forms of financing.

Characteristics of Venture Capital financing:

 High Risk-High Reward: Venture capital (VC) financing is characterized by its inherent risk
and potential for high returns. Startups and early-stage companies seeking VC funding often
lack a proven track record, making these investments inherently risky. However, venture
capitalists are attracted to the potential for substantial returns if the company succeeds and
achieves significant growth.
 Equity Investment: Venture capital involves the exchange of capital for equity ownership in
the company. Unlike traditional loans, where businesses repay borrowed funds with interest,
VC investors become partial owners of the business. This alignment of interests encourages
investors to actively support and mentor the entrepreneurs they fund.
 Long-Term Investment Horizon: Venture capitalists typically have a longer investment
horizon compared to traditional lenders. They understand that startups may take several years
to become profitable or achieve an exit event, such as an initial public offering (IPO) or
acquisition. This patient approach distinguishes venture capital from other forms of
financing.
 Active Involvement: Beyond providing capital, venture capitalists often play an active role in
the companies they invest in. This involvement may include participating in strategic
decision-making, offering mentorship to the management team, and leveraging their
networks to help the company grow. This hands-on approach distinguishes venture capital
from passive forms of investment.
 Focus on Innovation and Technology: Venture capital is prominently associated with
funding innovative and technology-driven companies. Investors seek opportunities in sectors
with high growth potential, such as biotechnology, artificial intelligence, and clean energy.
 This focus on innovation aligns with the expectation of significant returns resulting from
disruptive technologies or business models.
 Exit Strategies: Venture capitalists look for clear exit strategies to realize returns on their
investments. Common exit routes include IPOs, where the company goes public, and
acquisitions by larger corporations. The successful exit of a portfolio company allows
venture capitalists to monetize their equity stake and generate returns for their fund.
 Portfolio Diversification: VC firms typically manage a portfolio of investments rather than
concentrating on a single company. This diversification strategy helps mitigate the risks
associated with startup investments. While some companies in the portfolio may fail,
successful exits from others can offset losses and contribute to the overall profitability of the
venture capital fund.
 Due Diligence Process: Before making an investment, venture capitalists conduct thorough
due diligence to assess the viability and potential risks of a startup. This process involves
scrutinizing the business model, market opportunity, competitive landscape, and the
capabilities of the founding team. Rigorous due diligence helps investors make informed
decisions and manage risks effectively.
 Cyclical Nature of Investments: The venture capital industry is sensitive to economic cycles
and market conditions. During periods of economic growth and optimism, VC funding tends
to increase, while during economic downturns, funding may become more conservative. This
cyclical nature reflects the broader risk appetite in the financial markets.
 Strategic Value Addition: Beyond financial support, venture capitalists bring strategic value
to their portfolio companies. This can include expertise in scaling operations, access to
industry networks, and guidance on navigating challenges. The symbiotic relationship
between investors and entrepreneurs enhances the overall success potential of the funded
startups.

Stages of Venture Capital Financing:

 Seed Stage:
The seed stage is the initial phase of venture capital financing. At this point, the startup is
typically in its infancy, often at the ideation or prototype stage. Funding is used for market
research, product development, and building a founding team. Investors in this stage are known
as seed investors or angel investors.

 Early Stage (Series A and Series B):

In the early stage, the startup has progressed beyond the initial concept, showing potential for
growth. Series A financing is the first significant round of financing from venture capitalists. It is
used to scale operations, expand market reach, and improve the product. Series B funding
follows, supporting the company in achieving market fit, enhancing infrastructure, and
increasing customer acquisition.

 Expansion Stage (Series C and Beyond):

At the expansion stage, the startup aims to scale its operations and capture a larger market share.
Series C, D, and subsequent rounds provide capital for geographic expansion, product
diversification, and potential mergers and acquisitions. Companies at this stage are expected to
demonstrate strong revenue and user growth.

 Mezzanine or Late Stage:

Mezzanine financing, also known as late-stage financing, occurs when the startup is preparing
for an initial public offering (IPO) or a significant exit event. Investors in this stage are often
institutional investors, hedge funds, or private equity firms. The funding is used for final scaling,
optimizing financials, and strategic initiatives before going public.

 Bridge Financing:
Bridge financing, or bridge rounds, may occur between major financing rounds. It provides
short-term capital to address funding gaps, allowing startups to continue operations while
securing additional funding. Bridge financing is often used when a startup is close to achieving
significant milestones but needs additional runway.

 Exit Stage:
The exit stage is not a funding round but represents the point at which venture capitalists and
early investors exit their investments. Common exit strategies include Initial Public Offerings
(IPOs), where the company goes public on a stock exchange, and acquisitions, where a larger
company acquires the startup. These exits provide returns to investors.

 Post-Investment Support:
Throughout all stages, venture capitalists provide more than just capital. They offer mentorship,
industry expertise, and valuable networks to help startups navigate challenges and maximize
their growth potential. This support is crucial in building a successful and sustainable business.

 Risks and Rewards:

While venture capital financing offers significant opportunities for growth, it comes with
inherent risks. Investors bear the risk of a startup failing, but the potential rewards, especially in
successful exits, can be substantial. Startups, on the other hand, gain access to critical funding
and expertise, but they must meet the expectations and milestones set by their investors.

Challenges and Risks in Venture Capital Financing:

High Failure Rate:
Venture capital financing inherently involves a high level of risk, as startups, particularly at the
early stages, face significant uncertainty and challenges. The failure rate among startups is
substantial, and many ventures funded by venture capitalists may not achieve the expected
success. Factors such as market dynamics, competition, and unforeseen challenges can contribute
to the failure of these businesses, leading to financial losses for venture capitalists.

Liquidity Concerns:
One of the notable challenges in venture capital financing is the lack of liquidity. Unlike publicly
traded stocks, venture capital investments are illiquid, meaning that investors may have limited
opportunities to sell or divest their holdings. This lack of liquidity can be especially challenging
for investors, as returns on their investments are realized only when portfolio companies undergo
successful exits, such as through acquisitions or initial public offerings (IPOs). The extended
timeline to achieve liquidity can impact the overall performance of a venture capital fund.
Market Volatility:
The success of venture capital investments is closely tied to the overall economic environment
and market conditions. Economic downturns or fluctuations can adversely affect the valuation
and success of portfolio companies. Market volatility can impact consumer spending, corporate
budgets, and investor confidence, influencing the financial health and growth prospects of
startups. Venture capitalists need to navigate these uncertainties and adapt their strategies to
mitigate the impact of market dynamics on their portfolio.

Operational Risks:
Beyond market-related risks, venture capitalists also face operational risks associated with the
management and execution of their investment strategy. This includes risks related to the
selection and oversight of portfolio companies, the effectiveness of the management teams in
these companies, and the ability to implement growth strategies successfully. Operational
challenges within portfolio companies, such as issues with product development, scaling
operations, or strategic missteps, can pose significant risks to the overall success of a venture
capital fund.

Exit Challenges:
While the goal of venture capital financing is to achieve profitable exits, the process of exiting an
investment can be complex and challenging. External factors such as market conditions, industry
trends, and the overall economic climate can impact the feasibility and timing of exits.
Additionally, achieving the desired valuation for a portfolio company during an exit can be a
formidable task. Delays in exits or difficulties in finding suitable acquirers can affect the returns
realized by venture capitalists.

Regulatory and Compliance Risks:

The regulatory landscape can pose challenges for venture capitalists, especially as it evolves over
time. Changes in regulations related to investment, securities, or taxation can impact the
structuring and execution of venture capital deals. Compliance with legal requirements and
adherence to industry standards are essential, and any failure in this regard can lead to legal and
reputational risks. Staying abreast of regulatory changes and ensuring compliance is a continuous
challenge in the dynamic field of venture capital.

Dependency on External Factors:

Venture capital financing is often influenced by external factors beyond the control of investors
or portfolio companies. Global events, geopolitical tensions, and macroeconomic shifts can have
cascading effects on the investment landscape. The interdependence of the global economy
means that venture capitalists must navigate a landscape influenced by factors outside their
immediate purview, adding a layer of complexity to their risk management strategies.

BILL DISCOUNTING
Bills discounting, also known as bill discounting or invoice discounting, is a financial
practice where a business can raise immediate funds by selling its trade receivables or bills of
exchange to a financial institution or another party. This method allows companies to expedite
their cash flow by converting invoices that are due for payment at a later date into immediate
cash. Bill discounting is book debt financing. This is done by commercial banks.
When goods are sold on credit, the receivables or book debts are created. The supplier or
seller of goods draws a bill of exchange on the buyer or debtor for the invoice price of the goods
sold on credit. It is drawn for a short period of 3 to 6 months. Sometimes it is drawn for 9
months. After drawing the bill, the seller hands over the bill to the buyer. The buyer accepts the
same. This means he binds himself liable to pay the amount on the maturity of the bill. After
accepting the bill, the buyer (drawee) gives the same to the seller (drawer). Now the bill is with
the drawer. He has three alternatives. One is to retain the bill till the due date and present the bill
to the drawee and receive the amount of the bill. This will affect the working capital position of
the creditor. This is because he does not get immediate payment. The second alternative is to
endorse the bill to any creditors to settle the business obligation. The third or last alternative is to
discount the bill with his banker. This means he need not wait till the due date. If he is in need of
money, he can discount the bill with his banker. The banker deducts certain amount as discount
charges from the amount of the bill and balance is credited in the customer’s (drawer’s or
holders) account. Thus the bank provides immediate cash by discounting trade bills. In other
words, the banker advances money on the security of bill of exchange. On the due date, the
banker presents the bill to the drawee and receives payment. If the drawee does not make
payment, the drawer has to make payment to the banker. Here the bank is the financier. It renders
financial service. In short, discounting is a financial service.

Advantages of Bill Discounting/Bill Financing

1. It offers high liquidity. The seller gets immediate cash.
2. The banker gets income immediately in the form of discount.
3. Bills are not subject to any fluctuations in their values.
4. Procedures are simple.
5. Even if the bill is dishonored, there is a simple legal remedy. The banker has to simply note
and protest the bill and debit in the customer’s account.
6. The bills are useful as a base for the maintenance of reserve requirements like CRR and SLR.

FACTORING
Factoring, also known as accounts receivable financing or invoice factoring, is a financial
arrangement where a business sells its accounts receivable (invoices) to a third-party financial
institution, known as a factor. This enables the business to receive immediate cash, improving its
cash flow without waiting for customers to pay their invoices.

Process of Factoring (Factoring Mechanism)

The firm (client) having book debts enters into an agreement with a factoring
agency/institution. The client delivers all orders and invoices and the invoice copy (arising from
the credit sales) to the factor. The factor pays around 80% of the invoice value (depends on the
price of factoring agreement), as advance. The balance amount is paid when factor collects
complete amount of money due from customers (client’s debtors). Against all these services, the
factor charges some amounts as service charges. In certain cases the client sells its receivables at
discount, say, 10%. This means the factor collects the full amount of receivables and pays 90%
(in this case) of the receivables to the client. From the discount (10%), the factor meets its
expenses and losses. The balance is the profit or service charge of the factor.
Thus there are three parties to the factoring. They are the buyers of the goods (client’s
debtors), the seller of the goods (client firm i.e. seller of receivables) and the factor. Factoring is
afinancial intermediary between the buyer and the seller.
Features (Nature) of Factoring
From the following essential features of factoring, we can understand its nature:
1. Factoring is a service of financial nature. It involves the conversion of credit bills into cash.
Account receivables and other credit dues resulting from credit sales appear in the books of
account as book credits.
2. The factor purchases the credit/receivables and collects them on the due date. Thus the risks
associated with credit are assumed by the factor.
3. A factor is a financial institution. It may be a commercial bank or a finance company. It offers
services relating to management and financing of debts arising out of credit sales. It acts as a
financial intermediary between the buyer (client debtor) and the seller (client firm).
4. A factor specialises in handling and collecting receivables in an efficient manner.
5. Factor is responsible for sales accounting, debt collection, credit (credit monitoring),
protection from bad debts and rendering of advisory services to its clients.
6. Factoring is a technique of receivables management. It is used to release funds tied up in
receivables (credit given to customers) and to solve the problems relating to collection, delays
and defaults of the receivables.

Functions of a Factor
Factor is a financial institution that specialises in buying accounts receivables from business
firms. A factor performs some important functions. These may be discussed as follows:
1. Provision of finance: Receivables or book debts is the subject matter of factoring. A factor
buys the book debts of his client. Generally a factor gives about 80% of the value of receivables
as advance to the client. Thus the nonproductive and inactive current assets i.e. receivables are
converted into productive and active assets i.e. cash.
2. Administration of sales ledger: The factor maintains the sales ledger of every client. When the
credit sales take place, the firm prepares the invoice in two copies. One copy is sent to the
customers. The other copy is sent to the factor. Entries are made in the ledger under open-item
method. In this method each receipt is matched against the specific invoice. The customer’s
account clearly shows the various open invoices outstanding on any given date. The factor also
gives periodic reports to the client on the current status of his receivables and the amount
received from customers. Thus the factor undertakes the responsibility of entire sales
administration of the client.
3. Collection of receivables: The main function of a factor is to collect the credit or receivables
on behalf of the client and to relieve him from all tensions/problems associated with the credit
collection. This enables the client to concentrate on other important areas of business. This also
helps the client to reduce cost of collection.
4. Protection against risk: If the debts are factored without resource, all risks relating to
receivables (e.g., bad debts or defaults by customers) will be assumed by the factor. The factor
relieves the client from the trouble of credit collection. It also advises the client on the
creditworthiness of potential customers. In short, the factor protects the clients from risks such as
defaults and bad debts.
5. Credit management: The factor in consultation with the client fixes credit limits for approved
customers. Within these limits, the factor undertakes to buy all trade debts of the customer.
Factor assesses the credit standing of the customer. This is done on the basis of information
collected from credit relating reports, bank reports etc. In this way the factor advocates the best
credit and collection policies suitable for the firm (client). In short, it helps the client in efficient
credit management.
6. Advisory services: These services arise out of the close relationship between a factor and a
client. The factor has better knowledge and wide experience in the field of finance. It is a
specialised institution for managing account receivables. It possesses extensive credit
information about customer’s creditworthiness and track record. With all these, a factor can
provide various advisory services to the client. Besides, the factor helps the client in raising
finance from banks/financial institutions.

Advantages of Factoring
A firm that enters into factoring agreement is benefited in a number of ways. Some of the
important benefits of factoring are summarised as follows:
1. Improves efficiency: Factoring is an important tool for efficient receivables management.
Factors provide specialised services with regard to sales ledger administration, credit control etc.
Factoring relieves the clients from botheration of debt collection.
2. Higher credit standing: Factoring generates cash for the selling firm. It can use this cash for
other purposes. With the advance payment made by factor, it is possible for the client to pay off
his liabilities in time. This improves the credit standing of the client before the public.
3. Reduces cost: The client need not have a special administrative setup to look after credit
control. Hence it can save manpower, time and effort. Since the factoring facilitates steady and
reliable cash flows, client can cut costs and expenses. It can avail cash discounts. Further, it can
avoid production delays.
4. Additional source: Funds from a factor is an additional source of finance for the client.
Factoring releases the funds tied up in credit extended to customers and solves problems relating
to collection, delays and defaults of the receivables.
5. Advisory service: A factor firm is a specialised agency for better management of receivables.
The factor assesses the financial, operational and managerial capabilities of customers. In this
way the factor analyses whether the debts are collectable. It collects valuable information about
customers and supplies the same for the benefits of its clients. It provides all management and
administrative support from the stage of deciding credit extension to the customers to the final
stage of debt collection. It advocates the best credit policy suitable for the firm.
6. Acceleration of production cycle: With cash available for credit sales, client firm’s liquidity
will improve. In this way its production cycle will be accelerated.
7. Adequate credit period for customers: Customers get adequate credit period for payment of
assigned debts.
8. Competitive terms to offer: The client firm will be able to offer competitive terms to its
buyers. This will improve its sales and profits.

Limitations of Factoring:
The main limitations of factoring are outlined as below:
1. Factoring may lead to over-confidence in the behaviour of the client. This result in overtrading
or mismanagement.
2. There are chances of fraudulent acts on the part of the client. Invoicing against non-existent
goods, duplicate invoicing etc. are some commonly found frauds. These would create problems
to the factors.
3. Lack of professionalism and competence, resistance to change etc. are some of the problems
which have made factoring services unpopular.
4. Factoring is not suitable for small companies with lesser turnover, companies with speculative
business, companies having large number of debtors for small amounts etc.
5. Factoring may impose constraints on the way to do business. For non - recourse factoring most
factors will want to pre- approve customers. This may cause delays. Further, the factor will apply
credit limits to individual customers.

MERCHANT BANKING
According to Random house Dictionary, “Merchant bank is an organization that
underwrites securities for corporations, advises such clients on mergers and is involved in the
ownership of common ventures. These organizations are sometimes banks which are not
merchants and sometimes merchants who are not banks and sometimes houses which are neither
merchants nor banks”.
“any person who is engaged in the business of issue management either by making
arrangements regarding selling, buying or subscribing to securities as manager, consultant,
advisor or rendering corporate advisory service in relation to such issue management”.
A merchant bank also can be defined as, a financial institution conducting money market
activities and lending, underwriting and financial advice, and investment services whose
organisation is characterised by a high proportion of professional staff able to approach problems
in an innovative manner and to make and implement decisions rapidly.

MERCHANT BANKING IN INDIA

Merchant banking activity was formally initiated into the Indian capital market by Grindlays
Bank in 1967. Grindlays which started with management of capital issues recognized the needs
of emerging class of entrepreneurs for diverse financial services ranging from production
planning and system design to market research. Then it also provided management consultancy
services to large and medium sized companies.

Following Grindlays Bank, City bank set up its merchant banking division in 1970. They took up
the task of assisting new entrepreneurs and existing units in the evaluation of new projects &
raising funds through borrowing and issue of equity. Management consultancy services were
also offered
Consequences to the recommendations of Banking commission in 1972, that Indian Banks
should start merchant Banking services, state bank of India started the Merchant banking
Division in 1972. In the Initial years the SEBI’s objective was to render corporate advice and
assistance to small and medium entrepreneurs.

Merchant Bank activities are regulated by (a) Guidelines of SEBI and Ministry of Finance, (b)
Companies Act, 1956, (c) Listing Guidelines of Stock Exchanges & (d) SEBI Act, 1956.

The commercial banks that followed State Bank of India in setting up merchant banking units
were Central Bank of India, Bank of India and Syndicate Bank in 1977; Bank of Baroda,
Standard Chartered Bank and Mercantile Bank in 1978; and United Bank of India, United
Commercial Bank, Punjab National Bank, Canara Bank and Indian Overseas Bank in late
seventies and early ‘80s. Among the development banks, ICICI started merchant banking
activities in 1973, followed by IFCI (1986) and IDBI (1991).

FUNCTIONS OF MERCHANT BANKER (OR) SERVICES RENDERED BY

MERCHANT BANK

 Corporate Counselling: Set of activities undertaken to ensure efficient running of a

corporate enterprise.
 Project Counselling: It offers advisory assistance on the viability and procedural steps for
its implementation.
 Pre-investment studies: To evaluate alternative avenues of Capital Investment in terms of
growth and profit prospect.
 Capital Restructuring: Restructuring capital base, diversify operations, merger,
amalgamation, and change in business status.
 Credit Syndication & Project Finance: Raising Indian and Foreign currency loans.
 Issue Management & Underwriting: Management of the public issue of corporate
securities.
 Portfolio Management: Making decision relating to investment.
 Working Capital Finance: The finance required for day-to-day activities expenses of an
enterprise.
 Acceptance credit & Bill Discounting: Activities relating to the acceptance and discounting
of Bills of exchange ie, collecting credit information and rating the credit worthiness.
 Mergers, Amalgamation and Takeovers: MB Arranges for negotiating Merger and
acquisition
 Venture Capital: High risk and high reward projects and Merchant banker funds this type of
high technology and high risk projects.
 Lease Financing: Finance facilities are provided for leasing is called Lease financing.
 Foreign Currency Finance: Finance provided to fund foreign trade transactions.
 Fixed Deposit Broking: Computing the amount that could be raised by a company in the
form of deposits from the public, Drafting of advertisement for the same.
 Mutual Funds: Mobilizing the savings of innumerable investors for channelizing them into
productive investment.
 Relief to sick industries: Rejuvenating old lines by appraising their technology and process,
assessing their requirement, and restructuring their capital base.
 Project Appraisal: Evaluation of industrial projects in terms of technology raw materials,
production capacity and location.
CODE OF CONDUCT FOR MERCHANT BANKERS:

 To prevent the interest of the investors

 To maintain high standard of integrity
 To fulfil his obligation in a prompt, ethical and professional manner
 He shall always exercise Due diligence
 Redress the grievance of the investor
 Ensure adequate disclosure
 Ensure that the investors are provided with true and adequate information.
 He should not discriminate amongst the clients
 He shall avoid conflict of interest
 He shall render the best possible advice
 He shall not divulge to anybody
 Shall not indulge in any unfair competition
 He shall maintain long term length relationship
 He shall have internal control procedures
 He shall maintain an appropriate level of knowledge
 He shall ensure that the board is promptly informed.
 He shall provide adequate freedom and powers to its compliance officer
 He shall develop its own internal code of conduct
 He shall ensure good corporate policies
 He shall be responsible for any act or omission
 He shall ensure that it has adequate resources
 THE ROLE OF SEBI IN MERCHANT BANKING IN INDIA
 Regulation and Oversight:
o SEBI regulates merchant bankers and their activities to ensure fair practices and
protect the interests of investors.
o It issues guidelines and regulations pertaining to merchant banking activities to
maintain the integrity of the securities market.
 Registration and Compliance:
o SEBI mandates that entities involved in merchant banking activities register with the
regulatory authority.
o Merchant bankers are required to comply with SEBI regulations and guidelines, and
SEBI has the authority to take enforcement actions against those who violate the
rules.
 Issue Management:
o SEBI is involved in the regulation of the issuance of securities, including initial
public offerings (IPOs) and rights issues.
o Merchant bankers are required to adhere to SEBI guidelines regarding the pricing,
disclosure, and other aspects of securities offerings.
 Investor Protection:
o SEBI works to protect the interests of investors by ensuring that merchant bankers
provide accurate and adequate information to the investors.
o It sets guidelines for disclosures and transparency in the merchant banking process to
facilitate informed decision-making by investors.
 Market Development:
o SEBI contributes to the development and growth of the securities market by
formulating policies that encourage healthy competition and innovation in merchant
banking services.
 Continuous Monitoring and Surveillance:
o SEBI conducts regular monitoring and surveillance of merchant banking activities to
identify and address any potential market abuses or irregularities.
 Capacity Building:
o SEBI may engage in initiatives to enhance the skills and capabilities of merchant
bankers through training programs and other capacity-building measures.
 Policy Formulation:
o SEBI formulates policies related to merchant banking in consultation with market
participants, industry stakeholders, and the government.

RECENT DEVELOPMENTS AND CHALLENGES AHEAD OF MERCHANT

BANKING
The progress of any economy mainly depends on the efficient financial system of the
country. Indian economy is no exception of this. This importance of the financial sector reforms
affirms an effective means for solving the problems of economic, financial and social in India
and elsewhere in the developing nations of the world. The progress of the securities Industry of
any country depends mainly on the flow of funds. Infact, Capital generation is the lifeblood of
the capital market without which the health and soundness of the financial system cannot be
geared up and for which well-developed capital market as well as money market is essential.
In recent years, there has been a considerable widening and deepening of the Indian
financial system, of which banking is a significant component. With greater liberalisation, the
financial system has come to play a much larger role in the allocation of resources than in the
past and its role in future can be expected to be much larger than at present. The growing role of
the financial sector in the allocation of resources has significant potential advantages for the
efficiency with which our economy functions.