4 - 5 - Financial Services and Banking.pdf

FAC241 - BANKING, Monsoon 2024 4 - 5 FINANCIAL SERVICES AND BANKING Learning Objectives: LO1 – To develop an understanding of financial services LO2 – New financial services LO3 – Banking as a...

FAC241 - BANKING, Monsoon 2024 4 - 5 FINANCIAL SERVICES AND BANKING Learning Objectives: LO1 – To develop an understanding of financial services LO2 – New financial services LO3 – Banking as a key financial service FINANCIAL SERVICES All types of activities, which are of financial nature, could be brought under the term “financial services”. The term means “mobilizing and allocating savings”. Thus, it includes all activities involved in the transformation of savings into investment. The financial services can also be called financial intermediation. Financial intermediation is a process by which funds are mobilised from a large number of savers and make them available to all those who are in need of them, particularly to corporate customers. Thus, the financial services sector is a key area, and it is very vital for industrial developments. A well-developed financial services industry is absolutely necessary to mobilise the savings and to allocate them to various investable channels, and thereby to promote industrial development in a country. 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 1 Hetal Jhaveri, AMSOM, Ahmedabad University  FAC241 - BANKING, Monsoon 2024 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. FUNCTIONS OF FINANCIAL SERVICES  Facilitating transactions (exchange of goods and services) in the economy.  Mobilizing savings (for which the outlets would otherwise be much more limited).  Allocating capital funds (notably to finance productive investment).  Monitoring managers (so that the funds allocated will be spent as envisaged).  Transforming risk (reducing it through aggregation and enabling it to be carried by those more willing to bear it). CLASSIFICATION OF FINANCIAL SERVICES The financial intermediaries in India are traditionally classified into two: 1. Capital market intermediaries 2. Money market intermediaries The capital market intermediaries consist of the term-lending, and the investing institutions which mainly provide long-term funds. On the other hand, the money market consists of commercial banks, cooperative banks and other agencies which supply only short term funds. SCOPE OF FINANCIAL SERVICES Financial services cover a wide range of activities. They can be broadly classified into two, namely: 1. Traditional Activities Traditionally, the financial intermediaries have been rendering a wide range of services encompassing both capital and money market activities. They can be grouped under two heads, viz. i. Fund based activities and ii. Non-fund based activities i. Fund based activities: The traditional services which come under fund based activities are the following:  Underwriting or investment in shares, debentures, bonds, etc. of new issues (primary market activities).  Dealing in secondary market activities.  Participating in money market instruments like commercial papers, certificate of deposits, treasury bills, discounting of bills etc.  Involving in equipment leasing, hire purchase, venture capital, seed capital etc.  Dealing in foreign exchange market activities. Non fund based activities 2 Hetal Jhaveri, AMSOM, Ahmedabad University  FAC241 - BANKING, Monsoon 2024 ii. Non fund based activities: Financial intermediaries provide services on the basis of non- fund activities also. This can be called ‘fee based’ activity. Today customers, whether individual or corporate, are not satisfied with mere provisions of finance. They expect more from financial services companies. Hence a wide variety of services, are being provided under this head. They include:  Managing the capital issue i.e. management of pre-issue and post-issue activities relating to the capital issue in accordance with the SEBI guidelines and thus enabling the promoters to market their issue.  Making arrangements for the placement of capital and debt instruments with investment institutions.  Arrangement of funds from financial institutions for the clients project cost or his working capital requirements.  Assisting in the process of getting all Government and other clearances. 2. Non-traditional Activities Beside the above traditional services, the financial intermediaries render innumerable services in recent times. Most of them are in the nature of non-fund based activity. In view of the importance, these activities have been in brief under the head ‘New financial products and services’. However, some of the non-traditional services provided by them are given in brief here under.  Rendering project advisory services right from the preparation of the project report till the raising of funds for starting the project with necessary Government approvals.  Planning for M&A and assisting for their smooth carry out.  Guiding corporate customers in capital restructuring.  Acting as trustees to the debenture holders.  Recommending suitable changes in the management structure and management style with a view to achieving better results.  Structuring the financial collaborations/joint ventures by identifying suitable joint venture partners and preparing joint venture agreements.  Rehabilitating and restructuring sick companies through appropriate scheme of reconstruction and facilitating the implementation of the scheme.  Hedging of risks due to exchange rate risk, interest rate risk, economic risk, and political risk by using swaps and other derivative products.  Managing in-portfolio of large Public Sector Corporations.  Undertaking risk management services like insurance services, buy-back options etc.  Advising the clients on the questions of selecting the best source of funds taking into consideration the quantum of funds required, their cost, lending period etc.  Guiding the clients in the minimization of the cost of debt and in the determination of the optimum debt-equity mix.  Promoting credit rating agencies for the purpose of rating companies which want to go public by the issue of debt instrument. 3 Hetal Jhaveri, AMSOM, Ahmedabad University  FAC241 - BANKING, Monsoon 2024  Undertaking services relating to the capital market, such as 1)Clearing services, 2)Registration and transfers, 3)Safe custody of securities, 4)Collection of income on securities.  Promoting credit-rating agencies for the purpose of rating companies which want to go public by the issue of debt instruments. FUND-BASED  FACTORING: It refers to managing the process of sales ledger by financial service company. It’s an arrangement under which financial intermediary assumes credit risk in the collection of book debts for its clients. A factor provides credit information, collects debts, monitors sales ledgers, and provides finance against debts.  FORFAITING: It’s a technique by which forfaitor (Financing Agency) discounts an export bill and pay ready cash to the exporter who can concentration the export front without bothering about the collection of export bills. The exporter is protected against the risk of non-payment of debts by the importers.  LEASING: A lease is a contract outlining the terms under which one party agrees to rent property owned by another party. It guarantees the lessee, the tenant, use of an asset and guarantees the lessor, the property owner or landlord, regular payments from the lessee for a specified number of months or years. Both the lessee and the lessor face consequences if they fail to uphold the terms of the contract.  HIRE PURCHASE: An arrangement for buying expensive consumer goods, where the buyer makes an initial down payment and pays the balance plus interest in installments. The ownership of the merchandise is transferred to the buyer after all the payments have been made.  SECURITIZATION: Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming them into a security. Eg. A bank converts the loans given into marketable securities (a kind of secured debentures). Sells those debentures to investors and raises fresh funds so that it can give more loans.  MUTUAL FUNDS: A mutual fund is an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus. 4 Hetal Jhaveri, AMSOM, Ahmedabad University  FAC241 - BANKING, Monsoon 2024  INSURANCE: An arrangement by which a company or the state undertakes to provide a guarantee of compensation for specified loss, damage, illness, or death (risk) in return for payment of a specified premium.  VENTURE CAPITAL: Venture capital is financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. For startups without access to capital markets, venture capital is an essential source of money. Risk is typically high for investors, but the downside for the startup is that these venture capitalists usually get a say in company decisions.  FOREX: Any services related to foreign exchange. Some such services include –  Buying & selling foreign currencies  Foreign currency loans  Foreign currency deposits / accounts  FOREX cards for travelers  Inward and outward remittances (export – import)  Export credit  Trading in international currencies  Trading in currency derivatives FEE-BASED  MERCHANT BANKING: It’s a financial intermediary who helps to transfer capital from those who possess it to those need it. Merchant banking includes wide range of activities i.e. management of customers securities, portfolio management, project counseling and appraisal, underwriting of shares and debentures, acting as banker for refund orders, handling interest and dividend warrants etc. Merchant banker renders a host of services to corporate and promotes industrial growth.  UNDERWRITING: An insurance, giving a risk cover to the issuers of securities to get minimum subscription for the securities issued. Turns into fund-based facility if the underwriter is not able to get the minimum committed subscription for the issuer.  STOCK BROKING: The business or service of buying and selling goods or assets for others. The broker charges a fee for the services / acting as an intermediary.  LOAN SYNDICATION: Loan arranged by a bank called lead manager for a borrower who is usually a large corporate customer or a government department. The other banks who are willing to lend can participate in the loan by contributing an amount suitable to their own lending policies. Since single bank can’t provide huge sum of loan, a number of banks join together and form a syndicate. It also enables the members of the syndicate to share the credit risk associated with a particular loan among themselves. This is otherwise referred as “Consortium Financing”. 5 Hetal Jhaveri, AMSOM, Ahmedabad University  FAC241 - BANKING, Monsoon 2024  CUSTODIAL SERVICES: A custodian is a financial institution that holds customers' securities for safekeeping to minimize the risk of their theft or loss. A custodian holds securities and other assets in electronic or physical form. Since they are responsible for the safety of assets and securities that may be worth hundreds of millions or even billions of dollars, custodians generally tend to be large and reputable firms.  CREDIT RATING: The business or service of buying and selling goods or assets for others. The broker charges a fee for the services / acting as an intermediary.  CORPORATE ADVISORY SERVICES: Corporate finance advisory means the advisory services that are provided to the various corporate bodies about the financial aspect of their operations. These services may be provided by the advisory boards of the companies or by professional bodies who deal in such services.  INVESTMENT MANAGEMENT: Professional asset management of various securities, including shareholdings, bonds, and other assets, such as real estate, to meet specified investment goals for the benefit of investors.  LETTER OF CREDIT (L/C): A letter of credit is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. BANKING A bank is a financial institution which deals with deposits and advances and other related services. It receives money from those who want to save in the form of deposits and it lends money to those who need it. Oxford Dictionary defines a bank as "an establishment for custody of money, which it pays out on customer's order." CHARACTERISTICS / FEATURES OF A BANK 1. Dealing in Money Bank is a financial institution which deals with other people's money i.e. money given by depositors. 2. Individual / Firm / Company A bank may be a person, firm or a company. A banking company means a company which is in the business of banking. 3. Acceptance of Deposit A bank accepts money from the people in the form of deposits which are usually repayable on demand or after the expiry of a fixed period. It gives safety to the deposits of its customers. It also acts as a custodian of funds of its customers. 6 Hetal Jhaveri, AMSOM, Ahmedabad University  FAC241 - BANKING, Monsoon 2024 4. Giving Advances A bank lends out money in the form of loans to those who require it for different purposes. 5. Payment and Withdrawal A bank provides easy payment and withdrawal facility to its customers in the form of cheques and drafts; it also brings bank money in circulation. This money is in the form of cheques, drafts, etc. 6. Agency and Utility Services A bank provides various banking facilities to its customers. They include general utility services and agency services. 7. Profit and Service Orientation A bank is a profit seeking institution having service oriented approach. 8. Ever increasing Functions Banking is an evolutionary concept. There is continuous expansion and diversification as regards the functions, services and activities of a bank. 9. Connecting Link A bank acts as a connecting link between borrowers and lenders of money. Banks collect money from those who have surplus money and give the same to those who are in need of money. 10. Banking Business A bank's main activity should be to do business of banking which should not be subsidiary to any other business. 11. Name Identity A bank should always add the word "bank" to its name to enable people to know that it is a bank and that it is dealing in money. TYPES OF BANKS Central Bank: A central bank is an independent national authority that conducts monetary policy, regulates banks, and provides financial services including economic research. Its goals are to stabilize the nation's currency, keep unemployment low and prevent inflation. Commercial Banks: A bank dealing with general public, accepting deposits from making loans to large numbers of households and firms. Through the process of accepting deposits and lending, commercial banks create credit in the economy. Commercial banks are of three types: 7 Hetal Jhaveri, AMSOM, Ahmedabad University  FAC241 - BANKING, Monsoon 2024 (I) Public Sector Banks: Public sector bank is a bank in which the government holds a major portion of the shares. Say for example, SBI is public sector bank, the government holding in this bank is 58.60%. Similarly PNB is a public sector bank, the government holds a stake of 58.87%. Usually, in public sector banks, government holdings are more than 50 per cent. Public sector banks are classified into two categories further- 1. Nationalized Banks 2. State Bank and its Associates. In nationalized banks the government control and regulates the functioning of the banking entity. Some examples are SBI, PNB, BOB, OBC, Allahabad Bank etc. However, the government keeps reducing the stake in PSU banks as and when they sell shares. So to that extent they can also become minority shareholders in these banks. (II) Private Sector Banks: In these banks, most of the equity is owned by private bodies, corporations, institutions or individuals rather than government. These banks are managed and controlled by private promoters. (III) Foreign Banks: These are registered banks with their headquarters in a foreign country but operate their branches in our country. Development Banks: A development bank may, thus, be defined as a financial institution concerned with providing all types of financial assistance (medium as well as long term) to business units, in the form of loans, underwriting, investment and guarantee operations, and promotional activities — economic development in general, and industrial development, in particular. Cooperative Banks: Co-operative banks are organized under the provisions of the Co- operative Societies law of the state. These banks were originally set up in India to provide credit to the farmers at cheaper rates. However, the co-operative banks function also in the urban sectors. Specialised Banks: The specialised banks engage themselves in some specific area or activity. Some are as follows: Export Import Bank of India (EXIM Bank): Such banks provide long term financial assistance to the exporters and importers. National Bank for Agricultural and Rural Development (NABARD): This bank was established in 1982 in India in view of providing the rural credit to the farmers. Actually, it is an apex institution which co-ordinates the functioning of different financial institutions working in the field of rural credit. NABARD has been making continuous efforts through its micro-finance programme or improving the access of the rural poor to formal institutional credit. The self-help group (SHG) – Bank linkage programme was introduced in 1992 as a mechanism to provide financial services to the rural poor people on a sustainable basis. ***** 8 Hetal Jhaveri, AMSOM, Ahmedabad University