Financial Services nd

2 EDITION

D r. R . S H A N M U G H A M

FINANCIAL SERVICES

FINANCIAL SERVICES Dr R. Shanmugham Former Professor of Management (Finance and Accounting) Bharathiar School of Management and Entrepreneur Development (BSMED) Bharathiar University Coimbatore, Tamilnadu

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EDITION

Financial Services Second Edition

Copyright © 2017 by Wiley India Pvt. Ltd., 4436/7, Ansari Road, Daryaganj, New Delhi-110002. Cover Image: Sergey Nivens/Shutterstock

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First Edition: 2009 Second Edition: 2017 ISBN: 978-81-265- 6407-1 ISBN: 978-81-265-8362-1 (ebk) www.wileyindia.com Printed at:



Preface to the Second Edition

The first edition of “Financial Services” received an overwhelming response from the teachers, ­students and practitioners for its simple and lucid style of presentation. It was found that the readers liked the hand-holding approach adopted in conveying the information in each chapter. The objectives of simplifying the regulatory provisions and avoiding the clutter of information on each topic have been achieved by the book. Encouraged by the positive response of the users of the book, we have launched the second ­edition of the book in your hands. This revised and enlarged edition of “Financial Services” contains certain value-adding features to benefit both academics and students as well as other users. Care has been taken to update the information to keep pace with the fast changing world of finance. The contents of the book have been checked as to their relevance to the topic on hand and each topic has been updated with information up to November 2016. Every chapter has been revisited and rewritten to capture the current developments at appropriate places. While revising, the author has retained the basic structure of presentation as in the first edition of the book which was well received by the users. Two new chapters – one on Microfinance Institutions and the other on Payment and Settlement Systems – have been added in this revised edition. The final chapter of the book, Other Financial Services, has been restructured and expanded to bring in Portfolio Management Services, Wealth Management Services and RTAs. Readers of the revised edition will find these new chapters academically enriching and a pleasant read in the book. A couple of charts have been added in this new edition to portray the concepts in an effective manner.

New to the Second Edition The following are the features that make this second edition distinct from the first one: 1. Chapters have been re-written wherever necessary to accommodate contemporary issues, regulations and recent data. 2. The Quiz (Practice Questions) at the end of every chapter containing multiple-choice, true or false, and fill in the blanks (fill-ins) questions would serve as good check-list for understanding the text. 3. We have added Short Answer Type questions to make students write a brief on the concepts and terms studied in the chapter. 4. The Discussion Forum is going to provide lead points for classroom seminars and debates. The topics are very carefully chosen to bring out an enlightening experience after the discussions. 5. The Edu-Sites part added in this edition is a useful information source to both the students and teachers.

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6. Further Reading section of each chapter has been revised and updated with recently published sources of information. 7. We have added two new chapters (Chapters 14 and 15) to cover the Microfinance Institutions and the Payment and Settlement Systems, respectively. 8. The contents of Chapter 13 on Other Financial Services in the first edition has been rearranged and enriched and brought under Chapter 16 in the Second edition. Portions relating to credit cards, debit cards, etc., have been shifted to Chapter 14 of the Second edition. 9. New Appendices have been added in select chapters to enable the readers to get a glimpse of the best practices adopted in the financial sector. The developments in the financial service industry make everyday headline news in the n­ ewspapers. All these developments have to be brought to the classroom by the teachers. For this purpose, “­Financial Services” would serve as a valuable tool. The authenticity of information presented in the book is evident from the sources cited for each table of data or the diagrams used for illustration. The uniqueness of the book is the presentation of international scenario vis-à-vis Indian financial system. To the academic community, the book has a wholesome treatment with the text supported by the quiz, brief answer questions, review questions, discussion forum and edu-sites. The concepts, terms, regulations and contemporary developments have been explained in the most student-friendly way. Enjoy reading the book.

Acknowledgements I acknowledge the efforts of Ms. Meenakshi Sehrawat, Executive Editor, and her team at Wiley India for bringing out this second edition of Financial Services. Ms. Sehrawat was very swift in her response to my e-mails and the comments received from her were valuable in improving the contents of the book. My s­ incere thanks to her for the coordination of the revision work. I gratefully acknowledge the help received from Ms Shanthakumari Ramanathan, Professor of Management, VIT Business School, VIT University, Vellore, for her contributions in enriching the contents of the second edition also. As usual, the students for whom I deliver lectures on Financial Services, Financial Markets, etc., have always been a source of strength for me because their participation and discussion on the topics enabled me to spot the areas to be highlighted. My thanks to all of them. Finally, my special thanks to my wife, daughter, son-in-law, and son for the support they have given me during the project. It is my hope that the second edition will receive the same appreciation from the users as the first one. The book has a precise but comprehensive presentation on the subject matter. It is possible that I might have missed certain finer points on the topics covered and therefore I am solely responsible for any error or omission in the text. The readers are welcome to point out the errors, if any, with their comments to my e-mail id. Thank you. Dr. R Shanmugham [email protected]



Preface to the First Edition

Financial Services is a book on the functioning and performance of the vibrant financial services s­ ector in India. The services sector contributes to the economic development of a country on a greater scale. The real sector needs the assistance of the services sector for growth. The developments in the B ­ anking, Financial Services, and Insurance (BFSI) sectors are considered important for the ­development of the economy. Sound banking system is important to mobilise savings of the p­ ublic and to finance the credit needs of the industry, apart from providing the payment and settlement mechanism in the economy. Similarly, insurance sector facilitates risk management in business firms. Other financial services serve as the catalysts for the growth of the real economy. This book deals with each of those services in a well-structured format. The need for a book of this nature was felt while this author was teaching this course for the MBA students for many years. No doubt, the existing books on the subject are very exhaustive and deals at length about various topics. However, most of them were found to be voluminous collection of material and at times gave a feeling of overload of information while reading. It is not simply the extent of material that is important but what matters is the way it is told to the readers. ­Therefore, keeping in mind the complexities of the topic and difficulties in comprehending the regulatory ­provisions regarding the financial services, this book adopts an easy-to-understand and easy-to-retain approach. The objective of the book is to take the reader along with the subject matter and not to allow any drift while reading. Financial Services contains chapters devoted to credit rating, factoring, venture capital, ­securitisation and depositories. The dynamic growth of the capital market in India has opened up the need for various services like merchant banking, stock broking and issue management. This book throws light on such financial services with a focus on the basic concepts, regulatory issues and the contemporary developments in the industry. The book contains 14 chapters that cover all the services with a clearly defined chapter goal for each chapter. The reader of the book will find that the subject matter is presented in a lucid, ­unambiguous way to enable the understanding of the content and retention of the same. Each ­chapter presents a summary of the topic in a nutshell to quickly grasp the points dealt with in the chapter. Key words at the end of each chapter capture the technical terms used in the chapter which serve as the focal area of learning. Visuals are the strengths of the book. Conceptual issues are reinforced with simple flow ­diagrams that capture the relevant process or the mechanism effectively. Tables have been inserted to p­ rovide statistical information as well as specific theoretical issues. One of the outstanding features of the book is the box items. Case studies, new concepts, topic-related news clippings, etc. have been ­presented in the boxes to add value to the content of the text. To the extent possible, recent data from various authentic sources have been presented in each chapter. The book is written in a style that touches upon the essentials and avoids unnecessary frills and overloading of information. Unlike the other comparative books on the subject, Financial Services

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avoids the clutter of too many sections and sub-sections in the text and the legal lingo relating to the Regulations. The book presents a review of the international scenario in specific financial services in addition to the discussion on the domestic set up.

Acknowledgements I acknowledge the support received from the start of this project from Mr Ananthakrishnan, ­Manager (Acquisitions) at Wiley India. He has encouraged me a lot to write a book of this kind for the benefit of management students. I am indebted to him for the motivation he provided during the execution of the project. The useful comments received from Ms Rakhee Das and her team at the Editorial Board of Wiley India is gratefully acknowledged. Ms Rakhee Das has painstakingly corrected my m ­ anuscript and has been patient enough to listen to the changes I have suggested to the edited copy of the book. She has done a great job to improve the quality of the book. I also thank Ms Sarah Rizvi (­Developmental Editor) and Mr Paras Bansal (Publisher), both from Wiley India, for effectively ­coordinating the project. I am indebted to Ms Shanthakumari Ramanathan, Assistant Professor of Management at PSG Institute of Management, Coimbatore, for her useful contributions in enriching the content of the book. The MBA students of Bharathiar School of Management and Entrepreneur ­Development (BSMED), Bharathiar University, Coimbatore, to whom I have taught all these years, deserve a special mention here because it is their interactions in the class that gave me newer insights on each topic in the book. The author has drawn information from several sources all of which are ­acknowledged in appropriate places in the book by indicating the source in the text, tables and ­figures. I am grateful to all those organisations, both government and private, for using the data and other relevant materials. Finally, I owe a lot to my family for their forbearance. My wife, my daughter and my son have been a constant source of support at all moments of this book project. For that, my special thanks to them. It is hoped that the book will make a refreshingly different reading for the readers. But it may not be completely error free. The author is responsible for any errors or omissions in the text. The readers are welcome to point out such errors and offer their suggestions to improve the content of the book. Please forward your comments to the author through e-mail. Thank you. Dr. R Shanmugham [email protected]



About the Author

Dr R. Shanmugham is a former Professor of Finance and Accounting in Bharathiar School of ­Management and Entrepreneur Development (BSMED), Bharathiar University, Coimbatore, Tamil Nadu. He is well known in the academic circles as one of the senior most professors in Finance area who has more than four decades of teaching and research experience at the university level. His doctoral research was about the decision-making process of retail investors in the capital market. His research papers on the investors’ behavior in both the Indian and foreign journals received wider acclaim from the academic community. Known for his skills in teaching finance for non-finance managers, he got appreciations from many participants in the teacher development and executive development programmes. Apart from authoring the current title of Financial Services, he has also written three books on Financial ­Management and Investment Management. The Government of Tamil Nadu has published his book on Financial Management in Tamil language through the Tamil Nadu State Council for Higher Education for the benefit of undergraduate and post-graduate students in various colleges and ­universities. The book received good response from the teachers and students. The author has served as Director of MBA Programme of National University of Rwanda (2002–2004) and as Director of Research and Consultancy, School of Finance and Banking, Rwanda (2006–2007). He has travelled widely for academic conferences in India and abroad. After his service in Bharathiar University, he continues his academic pursuits by writing books, guiding research, and delivering lectures on finance and investments.

Figure 1.1 Figure 1.2 Figure 1.3 Figure 2.1 Figure 5.1 Figure 5.2 Figure 6.1 Figure 7.1 Figure 8.1 Figure 8.2 Figure 9.1 Figure 9.2 Figure 9.3 Figure 10.1 Figure 11.1 Figure 11.2 Figure 11.3 Figure 11.4 Figure 11.5 Figure 12.1 Figure 12.2 Figure 13.1 Figure 13.2 Figure 13.3 Figure 14.1

List of Figures Financial Services in a Financial Supermarket Institutional Framework of Indian Financial System Structure of Indian Financial System Types of Capital Issues Mechanism of Factoring International Factoring [Picture Courtesy: FCI (www.fci.nl)] Credit Rating Process of CARE Ltd Securitisation Structure Business Plan Funnel Exit Strategies Participants in Depository System Dematerialisation Process Rematerialisation Process Structure of a Finance Lease Concept of Mutual Fund Structure of a Mutual Fund Types of Mutual Fund Schemes Components of Returns to Investors in Mutual Fund Schemes Mutual Fund Industry Average Assets under Management IRDAI’s Regulatory Framework Structure of Insurance Industry in India The NBFI Universe Classification of NBFCs Prudential Regulations of NBFCs (a) SHG-bank Linkage Model and (b) MFI Model

4 6 7 36 103 108 130 156 185 187 206 208 210 226 244 248 249 253 261 279 283 293 294 301 317



List of Tables

Table 1.1 Sectoral Composition of GVA (percentage share in GVA) 12 Table 2.1 Distinctions between Capital Market and Money Market 25 Table 2.2 Intermediaries in the Indian Securities market (select market participants) 48 Table 2.3 Resource Mobilisation by the Government and Corporate S­ ector in the Primary Market (2011–2015) (Rs. in billion) 49 Table 2.4 Secondary Market Performance in 2014–2016 (Rs. in billion) 50 Table 4.1 Select Investment Bankers 72 Table 4.2 Services Offered by an Investment Bank: The Case of Goldman Sachs 75 Table 4.3 Services Offered by Select Investment Banks: Indian Cases 76 Table 4.4 Issue Management Activities of Merchant Bankers 78 Table 4.5 Size of Public Issue and Number of Lead Managers 85 Table 5.1 Myths and Facts About Factoring 101 Table 5.2 Distinctions Between Bill Discounting and Factoring 102 Table 5.3 Factoring Volume in Various Continents (2015) 111 Table 5.4 Factoring Volume in Selected Countries (2015) 111 Table 6.1 CRAs Registered with SEBI 122 Table 6.2 Products/Instruments Requiring Mandatory Rating Before Issuance 124 Table 6.3 Product Portfolio of ICRA Ltd 125 Table 6.4 Standardised Credit Rating Symbols (Long-Term and Short-Term Debt ­Instruments)  127 Table 7.1 Trends in Structured Finance Issuances in India (Rs. in Crores) 167 Table 8.1 Industry-wise Cumulative Investments of SEBI Registered VCFs and FVCIs (as of December 2015) (Rs. in crores) 193 Table 9.1 Depository and Bank: A Comparison 204 Table 9.2 Progress of Dematerialisation at NSDL and CDSL (Listed and Unlisted Companies)215 Table 10.1 Comparative Features of Loan and Lease  224 Table 10.2 Lease – Hire-Purchase Distinctions 225 Table 10.3 PV of Lease Payments 233 Table 10.4 Computation of Interest Charges 234 Table 10.5 PV of Cash Flows in ‘Buy’ Option 234 Table 10.6 Cash Inflows and Outflows of a Lessor 235 Table 11.1 Select Exchange Traded Funds (ETFs) in India 252 Table 11.2 Resource Mobilisation by Mutual Funds (Rs. in crore) 260 Table 12.1 Milestones in the Indian Insurance Industry 272 Table 12.2 Select Life Insurance Products of LIC 274 Table 12.3 Number of Registered Insurers in India (as of 31.03.2016) 284

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List of Tables

Table 12.4 Level of Insurance Density and Insurance Penetration in India for Selected Years Table 13.1 Regulatory Framework for NBFCs: A Summary Table 13.2 NBFC Assets vs. Bank Assets (as a percentage to GDP) Table 16.1 Types of Membership: The case of NSE Table 16.2 Base Minimum Capital Requirement for Stock Brokers/Trading Members

285 303 308 363 364



List of Boxes

Box 1.1 Financial Turbulence in 2007–2008 14 Box 2.1 Shares with Differential Voting Rights (DVRs) 29 Box 2.2 ADRs, GDRs, FCCBs and IDRs 29 Box 2.3 IOSCO 34 Box 2.4 Role of SEBI in a Public Issue 35 Box 3.1 Activities of Primary Dealers 57 Box 3.2 STRIPS 62 Box 3.3 Debt Market: Its Impact on the Economy 63 Box 3.4 Gilt Funds 65 Box 4.1 Due Diligence 80 Box 4.2 Escrow Account 81 Box 4.3 The Goldman Sachs’ Business Principles 83 Box 5.1 Features of Factoring 104 Box 5.2 ECGC’s Non-recourse Maturity Export Factoring 106 Box 5.3 FCI 110 Box 6.1 Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999 (Regulation 13) Code of Conduct 137 Box 7.1 Securitisation: How it Works 152 Box 7.2 Securitisable Asset Pools 153 Box 7.3 Credit Enhancement: The National Housing Bank Case 157 Box 7.4 Securitisation: Citibank Case 159 Box 7.5 Securitisation in India: Milestones 166 Box 7.6 SLSDs (LSOs), CDOs, CLOs and CBOs 166 Box 8.1 Sectors Attracting Venture Capital 180 Box 8.2 Stages of Business Development and Financing 180 Box 8.3 Financing the Start-ups: Role of Angel Investing and Crowdfunding 182 Box 8.4 Deal Sourcing by ICICI Venture 184 Box 8.5 Post-Investment Process at ICICI Venture 186 Box 8.6 Exit Strategies of ICICI Venture186 Box 8.7 Venture Capital Organisations in India 191 Box 9.1 What an Investor can do with a Demat Account? 209 Box 9.2 Facilities Offered at NSDL 214 Box 10.1 Wet Lease: An Example 228 Box 11.1 Mutual Fund Lexicon 245 Box 11.2 Mutual Funds: Myths and Facts 247 Box 11.3 NAV Computation 258 Box 12.1 Insurance Myths 269

About the Book

New to the Second Edition

Financial Services is a book on the fast-growing financial services industry of India. The book discusses the institutions, instruments, markets, regulations, and various other financial services offered in the financial system. The dynamic growth of the financial markets and the fast-paced reforms have opened up the need for financial intermediation, insurance, payment and settlement, and a host of other financial services. This book covers all those services. Two new chapters, Chapter 14 on Microfinance Institutions and Chapter 15 on Payment and Settlement Systems have been added in this second edition.

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Two new chapters added — Chapter 14 on Microfinance Institutions and Chapter 15 on Payment and Settlement Systems

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Rewritten chapter objectives to accommodate contemporary issues, regulations and recent data (up to November 2016).

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New section containing Quiz comprising Multiple Choice Questions, True or False, and Fill Ins.

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Short Description Questions in addition to the earlier Review Questions.

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Discussion Forum that kindles student teacher interaction and a healthy debate on issues relevant to the chapter.

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Edu-sites added to facilitate students to supplement the contents of the chapter with additional inputs from web sources.

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Updated Further Reading section of each chapter with the materials published recently.

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New box items describing Shares with Differential Voting Rights, ADRs, GDRs , FCCBs, etc.

While presenting each topic, the book focuses on the basic concepts, structure of the industry, regulatory issues, and the contemporary developments. It attempts to simplify the detailed regulations in a capsule form to enable the readers to easily comprehend the provisions. The book is written in a style that touches on the essentials and avoids unnecessary frills and overloading of information on the topics. Unlike other books on the subject, Financial Services avoids the use of too many legal lingo relating to the regulations. The book adopts a hand-holding approach in delivering the contents of each chapter. Financial Services includes the current developments in the financial sector and brings to the attention of the readers the most recent performance trends based on information obtained from authentic data sources. The book captures the international scenario too at appropriate places to enable comparisons. The value-adding pedagogical features of the book would certainly be a boon to the readers.

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Role of SEBI in Capital Issues.

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Outlines of Red Herring Prospectus.

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New Tables on Regulatory Framework for NBFCs.

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New Appendices on: w Code of Conduct for Merchant Bankers (AMBI) w Financial Practices Code—NBFCs & MFIs w Securitisation Process at NHB w NVCA Definitions of Different Stages of Venture Capital Financing w Principles of Financial market Infrastructure (PFMI)

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