Unit 3

Financial Services
Financial services are the economic services provided by the finance industry, which encompasses a broad
range of businesses that manage money, including credit unions, banks, credit-
card companies, insurance companies, accountancy companies, consumer-finance companies, stock
brokerages, investment funds, individual managers and some government-sponsored enterprises.

Characteristics of Financial Services

 Intangibility: Financial services are intangible. Therefore, they cannot be seen, touched. The
institutions offering financial services should have reputation and confidence of the customers.
They can build credibility and gain the trust of the customers by introducing innovating financial
services.
 Inseparability: Both production and supply of financial services have to be performed
simultaneously. Hence, there should be perfect understanding between the financial service
institutions and its customers.
 Perishability: Financial services also require a match between demand and supply. Services
cannot be stored. They have to be supplied when customers need them.
 Variability: In order to cater a variety of financial and related needs of different customers in
different areas, financial service organisations have to offer a wide range of products and services.
This means the financial services have to be tailor-made to the requirements of customers. The
service institutions differentiate their services to develop their individual identity.
 Dominance of human element: Financial services are dominated by human element. Thus,
financial services are labour intensive. It requires competent and skilled personnel to market the
quality financial products.

Functions of Financial Services

 Economic growth: The financial service industry mobilises the savings of the people, and
channels them into productive investments by providing various services to people in
general and corporate enterprises in particular. In short, the economic growth of any
country depends upon these savings and investments.
 Promotion of savings: The financial service industry mobilises the savings of the people
by providing transformation services. It provides liability, asset and size transformation
service by providing huge loan from small deposits collected from a large number of
people. In this way financial service industry promotes savings.
 Capital formation: Financial service industry facilitates capital formation by rendering
various capital market intermediary services. Capital formation is the very basis for
economic growth.
 Creation of employment opportunities: The financial service industry creates and
provides employment opportunities to millions of people all over the world.
 Contribution to GNP: Recently the contribution of financial services to GNP has been
increasing year after year in almost countries.
 Provision of liquidity: The financial service industry promotes liquidity in the financial
system by allocating and reallocating savings and investment into various avenues of
economic activity. It facilitates easy conversion of financial assets into liquid cash.

Types of Financial Services

Financial services are classified into two types: Fund based and fee based services
A. Asset/Fund Based Services
 Equipment leasing/Lease financing: A lease is an agreement under which a firm
acquires a right to make use of a capital asset like machinery etc. on payment of an agreed
fee called lease rentals. The person (or the company) which acquires the right is known as
lessee. He does not get the ownership of the asset. He acquires only the right to use the
asset. The person (or the company) who gives the right is known as lessor.
 Hire purchase and consumer credit: Hire purchase is an alternative to leasing. Hire
purchase is a transaction where goods are purchased and sold on the condition that
payment is made in instalments. The buyer gets only possession of goods. He does not get
ownership. He gets ownership only after the payment of the last instalment. If the buyer
fails to pay any instalment, the seller can repossess the goods. Each instalment includes
interest also.
 Bill discounting: Discounting of bill is an attractive fund based financial service provided
by the finance companies. In the case of time bill (payable after a specified period), the
holder need not wait till maturity or due date. If he is in need of money, he can discount
the bill with his banker. After deducting a certain amount (discount), the banker credits the
net amount in the customer’s account. Thus, the bank purchases the bill and credits the
customer’s account with the amount of the bill less discount. On the due date, the drawee
makes payment to the banker. If he fails to make payment, the banker will recover the
amount from the customer who has discounted the bill. In short, discounting of bill means
giving loans on the basis of the security of a bill of exchange.
 Venture capital: Venture capital simply refers to capital which is available for financing
the new business ventures. It involves lending finance to the growing companies. It is the
investment in a highly risky project with the objective of earning a high rate of return. In
short, venture capital means long term risk capital in the form of equity finance.
 Housing finance: Housing finance simply refers to providing finance for house building.
It emerged as a fund based financial service in India with the establishment of National
Housing Bank (NHB) by the RBI in 1988. It is an apex housing finance institution in the
country.
 Insurance services: Insurance is a contract between two parties. One party is the insured
and the other party is the insurer. Insured is the person whose life or property is insured
with the insurer. That is, the person whose risk is insured is called insured. Insurer is the
insurance company to whom risk is transferred by the insured. That is, the person who
insures the risk of insured is called insurer. Thus insurance is a contract between insurer
and insured. It is a contract in which the insurance company undertakes to indemnify the
insured on the happening of certain event for a payment of consideration. It is a contract
between the insurer and insured under which the insurer undertakes to compensate the
insured for the loss arising from the risk insured against.
 Factoring: Factoring is an arrangement under which the factor purchases the account
receivables (arising out of credit sale of goods/services) and makes immediate cash
payment to the supplier or creditor. Thus, it is an arrangement in which the account
receivables of a firm (client) are purchased by a financial institution or banker. Thus, the
factor provides finance to the client (supplier) in respect of account receivables. The factor
undertakes the responsibility of collecting the account receivables.
 Mutual fund: Mutual funds are financial intermediaries which mobilise savings from the
people and invest them in a mix of corporate and government securities. The mutual fund
operators actively manage this portfolio of securities and earn income through dividend,
interest and capital gains. The incomes are eventually passed on to mutual fund
shareholders. School of Distance Education Financial Services
Non-Fund Based/Fee Based Financial Services
 Merchant banking: Merchant banking is basically a service banking, concerned with
providing non-fund based services of arranging funds rather than providing them. The
merchant banker merely acts as an intermediary. Its main job is to transfer capital from
those who own it to those who need it. Today, merchant banker acts as an institution
 which understands the requirements of the promoters on the one hand and financial
institutions, banks, stock exchange and money markets on the other.
 Credit rating: Credit rating means giving an expert opinion by a rating agency on the
relative willingness and ability of the issuer of a debt instrument to meet the financial
obligations in time and in full. It measures the relative risk of an issuer’s ability and
willingness to repay both interest and principal over the period of the rated instrument. It
is a judgement about a firm’s financial and business prospects. In short, credit rating
means assessing the creditworthiness of a company by an independent organisation.
 Stock broking: Now stock broking has emerged as a professional advisory service. Stock
broker is a member of a recognized stock exchange. He buys, sells, or deals in
shares/securities. It is compulsory for each stock broker to get himself/herself registered
with SEBI in order to act as a broker. As a member of a stock exchange, he will have to
abide by its rules, regulations and bylaws.
 Custodial services: In simple words, the services provided by a custodian are known as
custodial services (custodian services). Custodian is an institution or a person who is
handed over securities by the security owners for safe custody. Custodian is a caretaker of
a public property or securities. Custodians are intermediaries between companies and
clients (i.e. security holders) and institutions (financial institutions and mutual funds).
There is an arrangement and agreement between custodian and real owners of securities or
properties to act as custodians of those who hand over it. The duty of a custodian is to
keep the securities or documents under safe custody. The work of custodian is very risky
and costly in nature. For rendering these services, he gets a remuneration called custodial
charges. Thus custodial service is the service of keeping the securities safe for and on
behalf of somebody else for a remuneration called custodial charges.
 Loan syndication: Loan syndication is an arrangement where a group of banks participate
to provide funds for a single loan. In a loan syndication, a group of banks comprising 10 to
30 banks participate to provid e funds wherein one of the banks is the lead manager.

Merchant Banking

The term merchant bank refers to a financial institution that conducts underwriting, loan
services, financial advising, and fundraising services for large corporations and high-net-
worth individuals (HWNIs). Merchant banks do not provide financial services to the
general public. Some of the largest merchant banks in the world include J.P. Morgan
Chase, Goldman Sachs, and Citigroup.
Functions (Services) of Merchant Bankers

Merchant banks have been playing an important role in procuring the funds for capital market for
the corporate sector for financing their operations.

 Corporate counseling: One of the important functions of a merchant banker is

corporate counseling. Corporate counseling refers to a set of activities undertaken
to ensure efficient functioning of a corporate enterprise through effective financial
management. A merchant banker guides the client on aspects of organizational
goals, vocational factors, organization size, choice of product, demand forecasting,
cost analysis, allocation of resources, investment decisions, capital and expenditure
management, marketing strategy, pricing methods etc.
 Project counseling: Project counseling relates to project finance. This involves the
study of the project, offering advisory services on the viability and procedural
steps for its implementation. Project counseling involves review of the project
ideas/project profile, Providing advice on procedural aspects of project
implementation, Conducting review of technical feasibility of the project on the
basis of the report prepared by own experts or by outside consultants etc
 Pre-investment studies: Another function of a merchant banker is to guide the
entrepreneurs in conducting pre-investment studies. It involves detailed feasibility
study to evaluate investment avenues to enable to decide whether to invest or not.
 Loan syndication: A merchant banker may help to get term loans from banks and
financial institutions for projects. Such loans may be obtained from a single
financial institution or a syndicate or consortium. Merchant bankers help corporate
clients to raise syndicated loans from commercial banks.
 Issue management: Issue management involves marketing or corporate securities
by offering them to the public. The corporate securities include equity shares,
preference shares, bonds, debentures etc. Merchant bankers act as financial
intermediaries. They transfer capital from those who own it to those who need it.
The security issue function may be broadly classified into two – pre-issue
management and post-issue management. The pre-issue management involves the
following functions: (a) Public issue through prospectus. (b) Marketing and
underwriting. (c) Pricing of issues.
 Portfolio management: Merchant bankers provide portfolio management service
to their clients. Today every investor is interested in safety, liquidity and
 profitability of his investment. But investors cannot study and choose the
appropriate securities. Merchant bankers help the investors in this regard. (a)
Undertaking investment in securities. (b) Collection of return on investment and
re-investment of the same in profitable avenues, investment advisory services to
the investors and other related services. (c) Providing advice on selection of
investments. (d) Carrying out a critical evaluation of investment portfolio. (e)
Securing approval from RBI for the purchase/sale of securities (for NRI clients).
(f) Collecting and remitting interest and dividend on investment.
 Foreign currency financing: The finance provided to fund foreign trade
transactions is called ‘Foreign Currency Finance’. The provision of foreign
currency finance takes the form of exportimport trade finance, euro currency loans,
Indian joint ventures abroad and foreign collaborations. The main areas that are
covered in this type of merchant activity are as follows: (a) Providing assistance
for carrying out the study of turnkey and construction contract projects. (b)
Arranging for the syndication of various types of guarantees, letters of credit, pre-
shipment credit, deferred post-shipment credit, bridge loans, and other credit
facilities. (c) Providing assistance in opening and operating bank accounts abroad.
(d) Arranging foreign currency loans under buyer’s credit scheme for importing
goods. (e) Arranging deferred payment guarantees under suppliers credit scheme
for importing capital goods. (f) Providing assistance in obtaining export credit
facilities from the EXIM bank for export of capital goods, and arranging for the
necessary government approvals and clearance. (g) Undertaking negotiations for
deferred payment, export finance, buyers credits, documentary credits, and other
foreign exchange services like packing credit, etc.
 Acceptance credit and bill discounting: Merchant banks accept and discount
bills of exchange on behalf of clients. Merchant bankers give loans to business
enterprises on the security of bill of exchange. For this purpose, merchant bankers
collect credit information relating to the clients and undertake rating their
creditworthiness.
 Venture financing: A merchant banker is to provide venture finance to projects. It
refers to provision of equity finance for funding high-risk and high-reward
projects.
 Lease financing: Leasing is another function of merchant bankers. It refers to
providing financial facilities to companies that undertake leasing. Leasing involves
letting out assets on lease for a particular period for use by the lessee.

Leasing

Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it
must pay a series of contractual, periodic, tax deductible payments. The lessee is the receiver
of the services or the assets under the lease contract and the lessor is the owner of the assets.
The relationship between the tenant and the landlord is called a tenancy, and can be for a fixed
or an indefinite period of time (called the term of the lease). The consideration for the lease is
called rent.

The advantages of leasing include

 Leasing helps to possess and use a new piece of machinery or equipment

without huge investment.
 Leasing enables businesses to preserve precious cash reserves.
 The smaller, regular payments required by a lease agreement enable businesses
with limited capital to manage their cash flow more effectively and adapt
quickly to changing economic conditions.
 Leasing also allows businesses to upgrade assets more frequently ensuring they
have the latest equipment without having to make further capital outlays.
 It offers the flexibility of the repayment period being matched to the useful life
of the equipment.
 It gives businesses certainty because asset finance agreements cannot be
cancelled by the lenders and repayments are generally fixed.
 However, they can also be structured to include additional benefits such as
servicing of equipment or variable monthly payments depending on a
business’s needs. h. It is easy to access because it is secured – largely or
entirely – on the asset being financed, rather than on other personal or business
assets.
 The rental, which sometimes exceeds the purchase price of the asset, can be
paid from revenue generated by its use, directly impacting the lessee's liquidity.
 Lease instalments are exclusively material costs.
  Using the purchase option, the lessee can acquire the leased asset at a lower
price, as they pay the residual or non-depreciated value of the asset.
 For the national economy, this way of financing allows access to state-of-the-
art technology otherwise unavailable, due to high prices, and often impossible
to acquire by loan arrangements.

Limitation of leasing

 It is not a suitable mode of project financing because rental is payable soon

after entering into lease agreement while new project generate cash only after
long gestation period.
 Certain tax benefits/ incentives/subsidies etc. may not be available to leased
equipments.
 The value of real assets (land and building) may increase during lease period.
In this case lessee may lose potential capital gain.
 The cost of financing is generally higher than that of debt financing.
 A manufacturer(lessee) who want to discontinue business need to pay huge
penalty to lessor for pre-closing lease agreement
 There is no exclusive law for regulating leasing transaction.

TYPES OF LEASE

 Financial lease Long-term, non-cancellable lease contracts are known as

financial leases. The essential point of financial lease agreement is that it
contains a condition whereby the lessor agrees to transfer the title for the asset
at the end of the lease period at a nominal cost. At lease it must give an option
to the lessee to purchase the asset he has used at the expiry of the lease. Under
this lease the lessor recovers 90% of the fair value of the asset as lease rentals
and the lease period is 75% of the economic life of the asset. The lease
agreement is irrevocable. Practically all the risks incidental to the asset
ownership and all the benefits arising there from are transferred to the lessee
who bears the cost of maintenance, insurance and repairs.
 Operational lease An operating lease stands in contrast to the financial lease
in almost all aspects. This lease agreement gives to the lessee only a limited
right to use the asset. The lessor is responsible for the upkeep and maintenance
of the asset. The lessee is not given any uplift to purchase the asset at the end
 of the lease period. Normally the lease is for a short period and even otherwise
is revocable at a short notice. Mines, Computers hardware, trucks and
automobiles are found suitable for operating lease because the rate of
obsolescence is very high in this kind of assets.
 Sale and lease back It is a sub-part of finance lease. Under this, the owner of
an asset sells the asset to a party (the buyer), who in turn leases back the same
asset to the owner in consideration of lease rentals. However, under this
arrangement, the assets are not physically exchanged but it all happens in
records only. The advantage of this method is that the lessee can satisfy
himself completely regarding the quality of the asset and after possession of
the asset convert the sale into a lease arrangement.
 Leveraged leasing Under leveraged leasing arrangement, a third party is
involved beside lessor and lessee. The lessor borrows a part of the purchase
cost (say 80%) of the asset from the third party i.e., lender and the asset so
purchased is held as security against the loan. The lender is paid off from the
lease rentals directly by the lessee and the surplus after meeting the claims of
the lender goes to the lessor. The lessor, the owner of the asset is entitled to
depreciation allowance associated with the asset.

 Full Payout Lease: A lease in which the lessor recovers, through the lease
payments, all costs incurred in the lease plus an acceptable rate of return,
without any reliance upon the leased equipment's future residual value.

 Conveyance type lease: The lease will be for a longer term with clear
intention of conveying the ownership of title of lessee.
 Cross Border Lease: Lease across national frontiersare called cross border
lease.
 Tax Lease: A lease wherein the lessor recognizes the tax incentives provided
by the tax laws for investment and ownership of equipment.
 Import Lease: The Company providing equipment for lease may be located in
a foreign country but the lessor and the lessee may belong to the same
country.
Mutual Funds

Mutual funds are investment vehicles which pools in small amount of funds from different
savers and investors and invest them into diversified portfolio to reduce the risk and
maximise the return.

Types of Mutual Funds

A. On the basis of Operation

Close ended funds: Under this type of fund, the size of the fund and its duration are fixed in advance.
Once the subscription reaches the predetermined level, the entry of investors will be closed. After the
expiry of the fixed period, the entire corpus is disinvested and the proceeds are distributed to the unit
holders in proportion to their holding.
Open-ended funds: This is the just reverse of close-ended funds. Under this scheme the size of the
fund and / or the period of the fund is not fixed in advance. The investors are free to buy and sell any
number of units at any point of time.
Interval Scheme: A type of close ended mutual funds that periodically offers to buy back a
percentage of outstanding shares from shareholders at pre-set intervals of three, six and twelve months
which is mentioned in the prospectus.
B. On the basis of return/ income
Income fund: This scheme aims at safety and generating regular and periodical income to the
members. Such funds are offered in two forms. The first scheme earns a target constant income at
relatively low risk. The second scheme offers the maximum possible income.
Growth fund: Growth fund offers the advantage of capital appreciation. It means growth fund
concentrates mainly on long run gains. It does not offers regular income. In short, growth funds aim at
capital appreciation in the long run. Hence they have been described as “Nest Eggs” investments or
long haul investments.
Balanced fund: This aims at providing a reasonable rate of return, protecting the value of the
investment and getting capital appreciation. Hence the investment is made in growth oriented
securities that are capable of appreciating in the long run.
C. On the basis of Investment
Equity fund: It mainly consists of equity based investments. It carried a high degree of risk. Such
funds do well in periods of favourable capital market trends.
Bond fund: It mainly consists of fixed income securities like bonds, debentures etc. It concentrates
mostly on income rather than capital gains. It carries lower risk. It offers secure and steady income.
But there is no chance of capital appreciation.
Balanced fund: It has a mix of debt and equity in the portfolio of investments. It aims at distributing
regular income as well as capital appreciation. This is achieved by balancing the investments between
the high growth equity shares and also the fixed income earning securities.
Other schemes
Taxation fund: This is basically a growth oriented fund. It offers tax rebates to the investors. It is
suitable to salaried people.
Index bonds: These are linked to a specific index of share prices. This means that the funds
mobilized under such schemes are invested principally in the securities of companies whose securities
are included in the index. The value of these index linked funds will automatically go up whenever
the market index goes up and vice versa.
Money market mutual funds: These funds are basically open ended mutual funds. They have all the
features of open ended mutual funds. But the investment is made is highly liquid and safe securities
like commercial paper, certificates of deposits, treasury bills etc. These are money market
instruments.
Off shore mutual funds: The sources of investments for these funds are from abroad. 10. Guilt
funds: This is a type of mutual fund in which the funds are invested in guilt edged securities like
government securities. It means funds are not invested in corporate securities like shares, bonds etc.

Objectives of Mutual Funds

 To mobilise savings of people.

 To offer a convenient way for the small investors to enter the capital and the money
market.
 To tap domestic savings and channelize them for profitable investment.
 To enable the investors to share the prosperity of the capital market.
 To act as agents for growth and stability of the capital market.
 To attract investments from the risk aversers.
 To facilitate the orderly development of the capital market.

Advantages (Importance) of Mutual Funds

 Mutual funds are growing all over the world. They are growing because of their
importance to investors and their contributions in the economy of a country. The
following are the advantages of mutual funds:
 Mobilise small savings: Mutual funds mobilize small savings from the investors by
offering various schemes. These schemes meet the varied requirements of the
 people. The savings of the people are channelized for the development of the
economy. In the absence of mutual funds, these savings would have remained idle.
 Diversified investment: Small investors cannot afford to purchase the shares of the
highly established companies because of high market price. The mutual funds
provide this opportunity to small investors. Even a very small investor can afford to
invest in mutual funds. The investors can enjoy the wide portfolio of the investments
held by the fund. It diversified its risks by investing in a variety of securities (equity
shares, bonds etc.) The small and medium investors cannot do this.
 Provide better returns: Mutual funds can pool funds from a large number of
investors. In this way huge funds can be mobilized. Because of the huge funds, the
mutual funds are in a position to buy securities at cheaper rates and sell securities at
higher prices. This is not possible for individual investors. In short, mutual funds are
able to give good and regular returns to their investors.
 Better liquidity: At any time the units can be sold and converted into cash.
Whenever investors require cash, they can avail loans facilities from the sponsoring
banks against the unit certificates.
 Low transaction costs: The cost of purchase and sale of mutual fund units is
relatively less. The brokerage fee or trading commission etc. are lower. This is due
to the large volume of money being handled by mutual funds in the capital market.
 Reduce risk: There is only a minimum risk attached to the principal amount and
return for the investments made in mutual funds. This is due to expert supervision,
diversification and liquidity of units.
 Professional management: Mutual funds are managed by professionals. They are
well trained. They have adequate experience in the field of investment. Thus
investors get quality services from the mutual funds. An individual investor would
never get such a service from the securities market
 Offer tax benefits: Mutual funds offer tax benefits to investors. For instance, under
section 80 L of the Income Tax Act, a sum of Rs. 10,000 received as dividend from
a mutual fund (in case of UTI, it is Rs. 13,000) is deductible from the gross total
income.
 Support capital market: The savings of the people are directed towards investments
in capital markets through mutual funds. They also provide a valuable liquidity to
the capital market. In this way, the mutual funds make the capital market active and
stable
 Promote industrial development: The economic development of any nation depends
upon its industrial advancement and agricultural development. Industrial units raise
funds from capital markets through the issue of shares and debentures. Mutual funds
supply large funds to capital markets. Besides, they create demand for capital market
instruments (share, debentures etc.). Thus mutual funds provide finance to industries
and thereby contributing towards the economic development of a country.
 Keep the money market active: An individual investor cannot have any access to
money market instruments. Mutual funds invest money on the money market
instruments.

Venture Capital
The term venture capital comprises of two words, namely, ‘venture’ and ‘capital’. The term
‘venture’ literally means a ‘course’ or ‘proceeding’, the outcome of which is uncertain (i.e.,
involving risk). The term capital refers to the resources to start the enterprise. Thus venture
capital refers to capital investment in a new and risky business enterprise. Money is
invested in such enterprises because these have high growth potential.

Methods or Modes of Venture Financing

Equity: All VCFs in India provide equity but generally their contribution does not exceed 49 per
cent of the total equity capital. Thus, the effective control and majority ownership of the firm remain
with the entrepreneur. They buy shares of an enterprise with an intention to ultimately sell them off
to make capital gains.
Conditional loan: It is repayable in the form of a royalty after the venture is able to generate sales.
No interest is paid on such loans. In India, VCFs charge royalty ranging between 2 and 15 per cent;
actual rate depends on the other factors of the venture, such as gestation period, cost-flow patterns
and riskiness.
Income note: It is a hybrid security which combines the features of both conventional loan and
conditional loan. The entrepreneur has to pay both interest and royalty on sales, but at substantially
low rates.
Conventional loan: Under this form of assistance, the enterprise is assisted by way of loans. On the
loans, a lower fixed rate of interest is charged, till the unit becomes commercially operational. When
the company starts earning profits, normal or higher rate of interest will be charged on the loan. The
loan has to be repaid as per the terms of loan agreement.
Other financing methods: A few venture capitalists, particularly in the private sector, have started
introducing innovative financial securities.
Stages of Venture Capital Financing
Venture capital takes different forms at different stages of a project. The various stages in the
venture capital financing are as follows:
1. Early stage financing: This stage has three levels of financing. These three levels are:
(a) Seed financing: This is the finance provided at the project development stage. A small amount of
capital is provided to the entrepreneurs for concept testing or translating an idea into business.
(b) Start up finance/first stage financing: This is the stage of initiating commercial production and
marketing. At this stage, the venture capitalist provides capital to manufacture a product.
(c) Second stage financing: This is the stage where product has already been launched in the market
but has not earned enough profits to attract new investors. Additional funds are needed at this stage
to meet the growing needs of business. Venture capital firms provide larger funds at this stage.
2. Later stage financing: This stage of financing is required for expansion of an enterprise that is
already profitable but is in need of further financial support. This stage has the following levels:
(a) Third stage/development financing: This refers to the financing of an enterprise which has
overcome the highly risky stage and has recorded profits but cannot go for public issue. Hence it
requires financial support. Funds are required for further expansion.
(b) Turnarounds: This refers to finance to enable a company to resolve its financial difficulties.
Venture capital is provided to a company at a time of severe financial problem for the purpose of
turning the company around.
(c) Fourth stage financing/bridge financing: This stage is the last stage of the venture capital
financing process. The main goal of this stage is to achieve an exit vehicle for the investors and for
the venture to go public. At this stage the venture achieves a certain amount of market share.

Advantages of Venture Capital

Venture capital has a number of advantages over other forms of finance. Some of them are:
1. It is long term equity finance. Hence, it provides a solid capital base for future growth.
2. The venture capitalist is a business partner. He shares the risks and returns.
3. The venture capitalist is able to provide strategic operational and financial advice to the company.
4. The venture capitalist has a network of contacts that can add value to the company. He can help
the company in recruiting key personnel, providing contracts in international markets etc.
5. Venture capital fund helps in the industrialization of the country.
6. It helps in the technological development of the country.
7. It generates employment.
8. It helps in developing entrepreneurial skills.
 9. It promotes entrepreneurship

Credit Rating

A credit rating is an evaluation method by credit agency regarding the ability and willingness an
entity (government, business, or individual) to fulfill its financial obligations. A credit rating
also signifies the likelihood a debtor will default. It is also representative of the credit
risk carried by a debt instrument – whether a loan or a bond issuance.

NEED FOR CREDIT RATING

• It is necessary in view of the growing number of cases of defaults in payment of interest

and repayment of principal sum borrowed.
• Maintenance of investor’s confidence, since defaults shatter the confidence of investors
in corporate instruments.
• Protect the interest of investors
• Motivate savers to invest in industry and trade.
OBJECTIVES OF CREDIT RATING

• The main objective is to provide superior and low cost info to investors for taking a
decision regarding risk return trade off, but it also helps to market participants in the
following ways:
• Improves a healthy discipline on borrowers
• Lends greater credence to financial and other representations
• Facilitates formulation of public guidelines on institutional investments
• Helps merchant bankers, brokers, regulatory authorities, etc., in discharging their
functions related to debt issues
• Encourages greater information disclosure, better accounting standards and improved
financial information (helps in investors protection)
• May reduce interest costs for highly rated companies
• Acts as a marketing tool
Credit Rating Agencies in India

 ONICRA Credit Rating Agency of India Ltd

 Credit Rating Information Services of India Ltd (CRISIL)
 Investment and Information and Credit Rating Agency of India (ICRA)
 Credit Analysis and Research Limited (CARE)
BENEFITS OF CREDIT RATING
 Easy Understandability of Investment Proposal: The rating agencies give rating symbols
to the instrument, which can be easily understood by investors. This helps them to
understand the investment proposal of an issuer company. For e.g. AAA (Triple A), given
by CRISIL for debentures ensures highest safety.
 Choice of Instruments: Credit rating enables an investor to select a particular
instrument from many alternatives available. This choice depends upon the safety or
risk of the instrument.
 Saves Investors Time and Effort: Credit ratings enable an investor to his save time and
effort in analyzing the financial strength of an issuer company. This is because the
investor can depend on the rating done by professional rating agency, in order to take
an investment decision. He need not waste his time and effort to collect and analyse
the financial information about the credit standing of the issuer company.
 Improves Corporate Image: Credit rating helps to improve the corporate image of a
company. High credit rating creates confidence and trust in the minds of the investors
about the company. Therefore, the company enjoys a good corporate image in the
market.
 Lowers Cost of Borrowing: Companies that have high credit rating for their debt
instruments will get funds at lower costs from the market. High rating will enable the
company to offer low interest rates on fixed deposits, debentures and other debt
securities. The investors will accept low interest rates because they prefer low risk
instruments. A company with high rating for its instruments can reduce the cost of
public issue to raise funds, because it need not spend heavily on advertising for
attracting investors.
 Wider Audience for Borrowing : A company with high rating for its instruments can get
a wider audience for borrowing. It can approach financial institutions, banks, investing
companies. This is because the credit ratings are easily understood not only by the
financial institutions and banks, but also by the general public.
 Good for Non-Popular Companies: Credit rating is beneficial to the non- popular
 companies, such as closely-held companies. If the credit rating is good, the public will
invest in these companies, even if they do not know these companies.
 Act as a Marketing Tool: Credit rating not only helps to develop a good image of the
company among the investors, but also among the customers, dealers, suppliers, etc.
High credit rating can act as a marketing tool to develop confidence in the minds of
customers, dealer, suppliers, etc.
 Helps in Growth and Expansion: Credit rating enables a company to grow and expand.
This is because better credit rating will enable a company to get finance easily for
growth and expansion
DEMERITS OF CREDIT RATING
 Possibility of Bias Exist: The information collected by the rating agency may be subject
to personal bias of the rating team. However, rating agencies try their best to provide
an unbiased opinion of the credit quality of the company and/or instrument. If not, they
will not be trusted.
 Improper Disclosure May Happen: The company being rated may not disclose certain
material facts to the investigating team of the rating agency. This can affect the quality
of credit rating.
 Impact of Changing Environment: Rating is done based on present and past data of the
company. So, it will be difficult to predict the future financial position of the company.
Many changes take place due to changes in economic, political, social, technological,
legal and other environments. All this will affect the working of the company being
rated. Therefore, rating is not a guarantee for financial soundness of the company.
 Problems for New Companies: There may be problems for new companies to collect
funds from the market. This is because a new company may not be in a position to
prove its financial soundness. Therefore, it may receive lower credit ratings. This will
make it difficult to collect funds from the market.
 Downgrading by Rating Agency: The credit-rating agencies periodically review the
ratings given to a particular instrument. If the performance of a company is not as
expected, then the rating agency will downgrade the instrument. This will affect the
image of the company.
 Difference in Rating: There are cases, where different ratings are provided by various
rating agencies for the same instrument. These differences may be due to many
 reasons. This will create confusion in the minds of the investor.

CREDIT RATING METHODOLOGY

 Information is collected and then analysed by a team of professionals in an agency.
 If necessary, meetings with top management suppliers and dealers and a visit to the
plant of proposed sites are arranged to collect additional data. This team of
professionals submits their recommendations to the rating committee.
 Committee discusses this report and then assigns rating.
 Rating assigned is then notified to the issuer and only on his acceptance, rating is
published.
 Assures confidentiality of information.
 Once the issuer decides to use and publish the rating, agency has to continuously
monitor it over the entire life of instrument, called surveillance.