Unit 1
Introduction to Traditional Financial Services
Q1) Define financial services. State the characteristics of financial services.
A1) Financial services refers to the monetary benefit or satisfaction derived from the services provided by financial service providers like Banks, Non- banking companies financial intermediaries, stock brokers, financial agents etc. Depending on the nature, financial services are categorized under two heads, namely;
a) Fund based financial services;
b) Fee based financial Services;
Characteristics of financial services
8. Financial services are perishable in nature. The users of financial service must receive the service at the spot of financial service providers.
Q2) State the functions of financial services. Highlight the problems faced by financial service sector in India.
A2) Functions of financial services
Merchant banking services facilitates the companies for proper utilisation of fund by providing them services like issue management, financial management etc.
2. Maintains liquidity:
It helps to maintain liquidity in the economy by connecting the potential investors and borrowers.
3. Better relation with customers:
Financial service providers always maintain better relation with customers by satisfying their priorities and protecting consumer interest.
4. Increases standard of living:
Hire purchase and consumer credit allows the people to purchase durable and luxuries goods on instalment basis. It facilitates increase in standard of living of people in the economy.
5. Promotes economic development:
It promotes economic development of a country by facilitating trade and industry, promoting savings and investment etc.
Problems in financial service sector
Some of the crucial challenges suffering by the financial service sector are-
The growing cybercrimes and fraud create challenges for banks sector to protect the customers from bank fraud, money laundering etc. The banks need to take precautionary measures to keep the customer’s wealth safely.
2. Changes in regulatory environment:
The regulatory environment of financial service sector is changing rapidly. It becomes quite challenging for financial service providers to cope up with such frequent changes.
3. Disbursement of information:
The financial service is information based. Thus it is quite challenging for financial service providers to provide reliable and valid information to the users by using appropriate source of communication.
4. Competition:
Financial service sector is facing stiff competition in the market due to mushrooming of institutions in every financial service sector. Each of the service providers must provide quality service and protect the interest of customer to survive in the market.
5. Changes in customer priorities:
Financial service sector is facing challenges for rapid changes in customer priorities. With the rapid changes in business environment and globalisation, the customers demand for a customised and innovative financial service which is a challenging task for the financial service provider.
Q3) What is financial market? Discuss in brief different constituents of financial market.
A3) Financial service market refers to the intangible market where money related assets are traded. It is a well regulated and organised market where different financial assets (money market instruments and capital market instruments) are traded both for short term and long term.
The financial service market mainly consist of money market and capital market
a) Money market: It refers to the financial market where near money assets are traded for short period i.e, less than one year or up-to 365 days. Different financial instruments traded under this market are Treasury bill, commercial paper, certificate of deposit, trade bills etc. it is regulated by the Reserve Bank of India.
This market can again be sub divided as-
1) Organisational structure- It consist of the following market
2) Institutional structure- It consist of the following institutions-
b) Capital market: It refers to the market where financial assets are traded for long period, i.e, for more than one year. Financial assets like shares, debentures, bond etc. are traded under this market. This market is regulated by the Securities and Exchange Board of India. This market is again sub-divided as-
Q4) Define bank. Discuss the functions of commercial bank.
A4) Banking companies refers to financial institutions which are banking in nature. Section 5(b) of Banking Regulation Act, 1949 defines “banking” means the accepting, for the purpose of lending or investment, of deposits of money from public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise.”
The bank provides variety of service to satisfy the customer needs. The functions of commercial bank are-
A) Primary functions: These are the traditional functions of commercial banks.
i) Acceptance of deposit: Banks accept deposit from the public under savings account, current account, recurring deposit account and fixed deposit account. Deposits of savings and current account are repayable on demand and deposit of recurring and fixed account is repayable on maturity.
ii) Lending of money: Banks lend money to the general public to satisfy their borrowing needs. Different types of lending facilities provided to the customers by banks are bank overdraft, discounting of bills, cash credit and term loans.
iii) Creation of credit: Banks create credit while lending money to the borrowers. When bank approve any loan of a customer, it opens a secondary/loan account in the name of the borrower and deposit (credit) the sanctioned loan amount. Thus banks create credit through its lending activities.
B) Secondary functions: Secondary functions of bank are grouped under two heads-
i) Agency functions: Bank acts as an agent for its customers. Some of the agency functions performed by banks are-
ii) General utility functions: Banker perform general utility functions to provide the customers retail and more convenient banking services. Some of the general utility functions performed by banks are-
Q5) Define NBFC. State the silent features of NBFC.
A5) The non-banking financial companies (NBFCs) are those institutions which are non-banking in nature. Reserve Bank of India defines that NBFC is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stock/bonds/debentures/securities issued by Government or local authority or other marketable securities of a nature like leasing, hire purchase, insurance business, chit business but does not include any institution whose principle business is that of agriculture activity, industrial activity, purchase or sale of goods (other than securities) or principle business of receiving deposits under any scheme or arrangement in one lump sum or in instalments by way of contributions or in any other manner, is also a non-banking financial company.
Some of the silent features of NBFCs are as-
Q6) Briefly discuss the classification of banks and NBFCs.
A6) Structure/classification of banking company
A) Scheduled Commercial banks: It refers to the banks established to facilitate trade and industry. It is again sub-divided as follow-
i) Public sector bank: It refers to the commercial banks where more than 50 per cent shares are held by the government. At present there are 12 public sector banks in India. It is again grouped as-
Some examples of public sector banks are State Bank of India, Punjab National bank, Union Bank of India etc.
ii) Private sector bank: It refers to the commercial banks where more than 50 per cent shares are owned by the private individuals. Some examples of private sector bans are Yes bank, ICICI, City bank, Federal bank etc.
iii) Foreign bank: It refers to the commercial bank which is operating in India but their head office is situated outside India. For example HSBC ban Ltd. Standard Chartered etc.
iv) Regional Rural Bank: RRBs are commercial banks established to operate at regional level of different states and to focus on the banking needs of rural masses. For example, Maharashtra Garmin bank, Assam Gramin Vikash bank etc.
B) Scheduled Co-operative bank: It refers to the bank established according to the co-operative principle and consumers are the owners of the bank. It provides normal banking services to its customers but it mainly focus on the agriculture and allied activities. It operates under three tier structure-
Different types of NBFCs operating in India are-
1) Housing finance companies: These types of NBFCs are engaged in extending loans against some mortgage for construction of house, flats, housing complex etc. For example: HDFC Ltd., DHFL etc.
2) Merchant banking companies: These types of NBFCs deals with corporate houses for providing services like issue management, portfolio management, financial management, tax planning, mergers and acquisition of companies etc. For example, J.P Morgan Chase, Goldman Sachs etc.
3) Stock exchanges: These types of NBFCs are engaged in purchase and sale of listed securities of different companies. For example, Bombay Stock Exchange, National Stock Exchange.
4) Brokering companies: These companies are engaged in brokering of securities by bringing together buyers and sellers of securities. For example, ICICI direct, Share Khan.
5) Venture capital fund companies: These NBFCs provide equity fund to highly risky projects related to sophisticated technology. For example, Nexus Venture Partners, Accel partners.
6) Nidhi Companies: Such NBFCs are engaged in borrowing and lending of fund in between members. For example: Mint Mutual Benefit Fund, Kumari Benefit Fund Ltd.
7) Insurance companies: These companies provide insurance services to its clients. Insurance is an agreement between insurance company/insurer and insured where insurer agreed to cover the losses of life/property of insured person on payment of premium. For example, LICI, SBI life insurance.
8) Chit fund companies: These NBFCs are engaged in rotating savings and credit among subscribers and borrowers under different schemes Guru Nanak Chit Fund Pvt. Ltd., MGK Chits Private Ltd.
9) Asset finance company: Such NBFCs are engaged in financing of physical assets such as automobiles, tractors and generator sets etc.
10) Investment companies: These NBFCs are engaged in acquisition of securities. For example, SBI mutual fund.
Q7) Define factoring. What are the different types of factoring.
A7) Factoring refers to selling of trade receivables (bills of exchange and promissory note) by the owner of business firm (client) to a factor (financial intermediary) to get immediate cash to manage short term finance for his business. Under this method of financing the trade receivables are sold at a discount to the factor. It has essential characteristics of-
Types of factoring
Depending on the nature of services provided by the factors, it is divides under the following heads-
1. Recourse and non-recourse factoring: Under recourse financing, the firm/client who get discounted bill from factor is not discharged from debt until and unless the factor recover the bill amount from the drawee. If the factor unable to recover the bill amount than the firm is liable to discharge the debt.
On the other hand, under non-recourse financing the firm/client is not liable for the debt to the factor if the amount of the trade bill is irrecoverable from the drawee.
2. Disclosed and undisclosed factoring: Under disclosed factoring, the firm mentions the name of factor in the invoice/bill asking the drawee to pay the debt amount to the factor.
In case of undisclosed factoring the name of the factor is not mentioned in the invoice/trade bill. Here the factor realises the debt from the drawee/debtor in the name of the firm.
3. Domestic and export factoring: Under domestic factoring, the parties involved in the factoring i.e, customer, client and factor are resident of the same country.
Under export factoring, the drawer and drawee both resided in different country.
4. Advance and maturity factoring: Under advance factoring, the factor advances money to the firm/client against uncollected trade receivables.
In case of maturity factoring, the banks collects the bills amount on maturity date from the payer and credit the collected amount in the respective account of client.
Q8) State the advantages and disadvantages of factoring.
A8) The factoring service is beneficial for traders. Some of the significant benefits of factoring are-
The factoring service also suffers from some the following disadvantages-
Q9) Write distinctions between factoring and forfaiting.
A9)
Basis of difference | Factoring | forfaiting |
| Duration of finance is short term. | Duration of finance may be both for short term and long term. |
2. Jurisdiction | Factoring service is provided both for domestic and foreign business. | Forfaiting is provided only to exporters. |
3. Recourse | It may be recourse and non-recourse. | It is always without recourse. |
4. Cost | Cost is borne by the seller. | Cost is borne by the forfeiter. |
5. Financing amount | Partial financing facility is extended. | Full financial facility is extended. |
6. Letter of credit | There is no requirement of letter of credit. | There is requirement for letter of credit. |
7. Risk | Risk can be transferred to the seller. | All risk is borne by the forfeiter. |
8. Contract | Contract is taken place between seller and factor. | Contract is taken place between exporter and forfeiter. |
9. Secondary market | It does not have secondary market. | It has secondary market. |
10. Goods | Trade receivables on ordinary goods. | Trade receivables on capital goods. |
Q10) Define bill discounting. Distinguish between bill discounting and factoring.
A10) Bill discounting is a method of extending short term credit by commercial banks to the traders against the bills of exchange. The commercial banks charges commission from the borrowers for the bill discounting process. There are three parties involved in bill discounting, namely,
Basis of difference | Factoring | Bill discounting |
| It involves total package of service including finance. | It involves financing only. |
2. Recourse | It is with or without recourse. | It is with recourse only. |
3. Financing method | It purchases the trade receivables or invoices. | It advances against the trade receivables. |
4. Volume | It involves individual transactions. | It involves provision of bulk finance. |
5. Balance sheet | It is a balance sheet item. | It is an off balance sheet item. |