BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

CLASS- BBA 3 YEAR

SUBJECT- MERCHANT BANKING AND FINANCIAL SERVICES

MAJOR SUBJECT (FINANCE)

UNIT-2
• Financial Services: Meaning and Definition
• Role of Financial Services in a financial system
• Leasing: Meaning and features.
• Introduction to equipment leasing
• Types of Leases
• Evolution of Indian Leasing Industry
• Legal Aspects of Leasing: present Legislative Framework.
• Hire purchase: concept and characteristics of Hire purchase.
• Difference between hire purchase and leasing

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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

1. Financial Services: Meaning and Definition

Financial services encompass a wide range of activities that involve the management of money
and assets. They are essential for individuals, businesses, and economies to function smoothly.

Definition: Financial services are the provision of economic services to individuals, businesses,
and governments. These services include but are not limited to:
• Banking: Offering various financial products like savings accounts, checking accounts, loans, and
mortgages.
• Insurance: Providing protection against financial losses due to unforeseen events such as
accidents, illness, or property damage.
• Investment: Helping individuals and organizations grow their wealth through stocks, bonds,
mutual funds, and other financial instruments.
• Retirement planning: Assisting individuals in saving for their retirement through pension plans,
annuities, and other retirement vehicles.
• Wealth management: Providing comprehensive financial planning and investment advice to high-
net-worth individuals and families.
• Financial technology (FinTech): Using technology to deliver financial services more efficiently and
accessibly.

Key Characteristics of Financial Services:

• Risk management: Assessing and mitigating risks associated with financial transactions.
• Intermediary role: Acting as a middleman between borrowers and lenders, buyers and sellers.
• Regulatory oversight: Operating within a framework of laws and regulations to protect consumers
and maintain market stability.
• Innovation: Continuously adapting to technological advancements and changing market needs.
Importance of Financial Services:
• Economic growth: Financial services play a crucial role in facilitating investment,
entrepreneurship, and economic development.
• Financial inclusion: Providing access to financial services to underserved populations can improve
their quality of life and reduce poverty.
• Risk management: Financial services help individuals and businesses manage risk and protect
their assets.
• Innovation: The financial services industry is a major driver of technological innovation.

The Role of Financial Services in a Financial System

Financial services are the backbone of a modern financial system. They provide the essential
infrastructure that enables individuals, businesses, and governments to manage their finances
effectively. Here are some key roles played by financial services:

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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

1. Facilitation of Economic Activity:

• Capital Allocation: Financial services help channel funds from savers to borrowers, ensuring that
capital is allocated efficiently to productive investments.
• Risk Management: By offering insurance and other risk management products, financial services
help businesses and individuals mitigate potential losses, encouraging them to take calculated
risks.
• Payment Systems: Financial institutions provide payment systems that facilitate transactions
between buyers and sellers, both domestically and internationally.

2. Promotion of Economic Growth:

• Investment: Financial services encourage investment by providing a variety of investment options,
such as stocks, bonds, and mutual funds.
• Entrepreneurship: By providing access to financing, financial services support the growth of new
businesses and entrepreneurship.
• Innovation: Financial institutions often play a role in funding research and development, fostering
innovation and technological advancements.

3. Financial Inclusion:
• Access to Financial Services: Financial services help to expand access to financial products and
services, particularly for underserved populations.
• Poverty Reduction: By providing financial tools and resources, financial services can help
individuals and communities escape poverty.

4. Market Stability:
• Regulation: Financial regulators play a crucial role in ensuring the stability and integrity of the
financial system.
• Risk Management: Financial institutions are required to implement risk management practices to
prevent systemic crises.
• Consumer Protection: Financial regulations protect consumers from fraud, abuse, and unfair
practices.

5. Economic Development:
• Infrastructure Investment: Financial services can support the development of essential
infrastructure, such as transportation, energy, and telecommunications.
• Foreign Investment: Financial institutions can attract foreign investment, bringing capital and
expertise to developing economies.
In conclusion, financial services play a vital role in the functioning of a modern economy. By
providing essential services such as capital allocation, risk management, payment systems, and
financial inclusion, they contribute to economic growth, stability, and development.

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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

2. Leasing: Meaning and features.

Leasing is a financial arrangement where one party (the lessor) grants another party (the lessee)
the right to use an asset for a specified period of time in exchange for periodic payments. This
arrangement is often structured as a long-term rental agreement.

Key Features of Leasing:

• Ownership: The lessor retains ownership of the asset, while the lessee has the right to use it.
• Periodic Payments: The lessee makes regular payments to the lessor, typically known as lease
payments.
• Term: The lease agreement specifies the duration of the lease, which can range from a few months
to several years.
• Residual Value: The estimated value of the asset at the end of the lease term is known as the
residual value.
• Maintenance: The lease agreement may outline who is responsible for maintenance and repairs
during the lease term.
• Purchase Option: In some cases, the lessee may have the option to purchase the asset at the end
of the lease term for a predetermined price.

Types of Leases:
• Operating Lease: A short-term lease where the lessee does not acquire ownership rights at the
end of the lease term.
• Financial Lease: A long-term lease where the lessee essentially acquires the asset's economic
benefits.
• Sale-Leaseback: A transaction where a company sells an asset to a lessor and then leases it back.

Benefits of Leasing:
• Preservation of Capital: Leasing can help a company conserve capital by avoiding upfront asset
purchases.
• Tax Advantages: Leasing can offer tax benefits, as lease payments may be deductible as business
expenses.
• Flexibility: Leases can be tailored to meet specific needs, including term length, payment
schedules, and maintenance responsibilities.
• Access to Newer Assets: Leasing can provide access to newer, more efficient assets without the
need for a large upfront investment.

Disadvantages of Leasing:
• Higher Total Cost: Over the long term, leasing may result in higher total costs compared to outright
ownership.
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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

• Limited Ownership Rights: Lessees do not have the same ownership rights as outright owners.
• Restricted Use: Lease agreements may place restrictions on how the asset can be used.
In summary, leasing is a versatile financial arrangement that can offer both benefits and
drawbacks. By understanding the key features and types of leases, businesses can make informed
decisions about whether leasing is the right option for their specific needs.

3. Types of Leasing

Leasing can be categorized into several types based on the terms and conditions of the agreement.
Here are some of the most common types:

1. Operating Lease
• Definition: A short-term lease where the lessee does not acquire ownership rights at the end of
the lease term.
• Characteristics:
o Typically covers a portion of the asset's useful life.
o Lease payments are considered operating expenses.
o The lessor retains ownership and bears the risk of obsolescence.
• Example: A company leases a copier machine for a few years. At the end of the lease, the company
returns the copier to the lessor.

2. Financial Lease
• Definition: A long-term lease where the lessee essentially acquires the asset's economic benefits.
• Characteristics:
o Covers most of the asset's useful life.
o Lease payments are treated as debt payments.
o The lessee assumes the risk of obsolescence.
o The lessee may have the option to purchase the asset at a nominal price at the end of the
lease.
• Example: A company leases a truck for five years. At the end of the lease, the company can
purchase the truck for a nominal fee.

3. Sale-Leaseback
• Definition: A transaction where a company sells an asset to a lessor and then leases it back.
• Characteristics:
o Can be either an operating or financial lease.
o Allows the company to raise capital by selling the asset.
o The company continues to use the asset as a lessee.
• Example: A company sells its factory building to a lessor and then leases it back.

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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

4. Leveraged Lease
• Definition: A lease where the lessor borrows funds to purchase the asset and then leases it to the
lessee.
• Characteristics:
o Involves multiple parties: the lessor, the lessee, and a lender.
o The lessor uses debt financing to acquire the asset.
o The lease payments help the lessor repay the debt.
• Example: A leasing company borrows money from a bank to purchase a fleet of cars and then
leases them to a rental car company.

5. Reverse Lease
• Definition: A lease where the lessee sells an asset to the lessor and then leases it back.
• Characteristics:
o Similar to a sale-leaseback but with the roles reversed.
o Can be used to transfer risk to the lessor.
• Example: A company sells its old equipment to a lessor and then leases it back.

4. Introduction to Equipment Leasing

Equipment leasing is a financial arrangement where one party (the lessor) grants another party
(the lessee) the right to use a piece of equipment for a specified period of time in exchange for
periodic payments. This arrangement is often structured as a long-term rental agreement.

Key Features of Equipment Leasing:

• Ownership: The lessor retains ownership of the equipment, while the lessee has the right to use
it.
• Periodic Payments: The lessee makes regular payments to the lessor, typically known as lease
payments.
• Term: The lease agreement specifies the duration of the lease, which can range from a few months
to several years.
• Residual Value: The estimated value of the equipment at the end of the lease term is known as
the residual value.
• Maintenance: The lease agreement may outline who is responsible for maintenance and repairs
during the lease term.
• Purchase Option: In some cases, the lessee may have the option to purchase the equipment at
the end of the lease term for a predetermined price.

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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

Benefits of Equipment Leasing:

• Preservation of Capital: Leasing can help a company conserve capital by avoiding upfront
equipment purchases.
• Tax Advantages: Leasing can offer tax benefits, as lease payments may be deductible as business
expenses.
• Flexibility: Leases can be tailored to meet specific needs, including term length, payment
schedules, and maintenance responsibilities.
• Access to Newer Equipment: Leasing can provide access to newer, more efficient equipment
without the need for a large upfront investment.

Disadvantages of Equipment Leasing:

• Higher Total Cost: Over the long term, leasing may result in higher total costs compared to outright
ownership.
• Limited Ownership Rights: Lessees do not have the same ownership rights as outright owners.
• Restricted Use: Lease agreements may place restrictions on how the equipment can be used.
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5. Legal Aspects of Leasing: present Legislative Framework.

Leasing, as a contractual agreement where one party (the lessor) allows another party (the lessee)
to use an asset for a specified period in exchange for periodic payments, is governed by a
combination of general contract law, property law, and specific leasing laws. The legislative
framework varies across countries but follows some common principles globally. Here's a detailed
explanation of the legal aspects of leasing, focusing on India's legislative framework as a
representative example.
1. General Contract Law (Indian Contract Act, 1872)
• Essentials of a Contract: Leasing is a contractual agreement, so all essential elements of a valid
contract under the Indian Contract Act, 1872 must be met:
o Offer and Acceptance: Mutual consent between lessor and lessee.
o Lawful Consideration: Periodic lease payments made by the lessee.
o Free Consent: Both parties should enter the contract freely, without coercion, undue
influence, or fraud.
o Competency of Parties: Both lessor and lessee must be legally capable of entering into the
contract (i.e., must be of legal age, sound mind, etc.).
o Lawful Object: The object or purpose of the lease must be lawful.
• Contract Enforcement: If the terms of the lease are violated, the aggrieved party can seek legal
recourse as per the Contract Act’s provisions.

2. Transfer of Property Act, 1882 (For Immovable Property Leases)

• Chapter V of the Transfer of Property Act, 1882 deals specifically with leases of immovable
property.

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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

• Lease Definition: Under Section 105, a lease is defined as the transfer of the right to enjoy
immovable property for a specified time or perpetuity in exchange for rent or any other
consideration.
• Key Provisions:
o Duration and Commencement of Lease: The lease term and commencement should be
clearly stated.
o Rights and Liabilities of Lessor and Lessee:
▪ The lessor must ensure the lessee's peaceful possession of the leased property.
▪ The lessee must pay rent as agreed and not misuse or damage the property.
o Termination: A lease can be terminated by the efflux of time, a breach of conditions, or
mutual agreement between the parties.
o Renewal of Lease: The lease may include a renewal clause, allowing the lessee to extend
the term upon meeting specified conditions.

3. Registration Act, 1908

• Leases of immovable property for a period exceeding one year must be registered under the
Registration Act, 1908.
• Section 17: Stipulates that non-registered leases exceeding one year are not admissible as
evidence in court.
• Section 107 of the Transfer of Property Act: Leases of immovable property from year to year, or
for any term exceeding one year, must be made through a registered deed.

4. Stamp Duty Laws

• Stamp duty is payable on lease agreements based on the tenure of the lease and the
rent/consideration involved.
• Indian Stamp Act, 1899 (as amended by state laws): The applicable stamp duty varies by state.
Failure to properly stamp the lease agreement can render it inadmissible as evidence in court.
• The amount of stamp duty also depends on whether the lease is for a residential, commercial, or
industrial property.

5. Rent Control Laws (For Residential and Commercial Leases)

• India has Rent Control Acts enacted by individual states to regulate rent and protect the rights of
tenants, particularly in urban areas. These laws were primarily introduced to prevent arbitrary
eviction and exorbitant rent increases.
• Key Features:
o Fair Rent: Rent control laws ensure that the rent charged is fair and reasonable.
o Eviction Protection: Tenants cannot be evicted except for certain specified reasons, such
as non-payment of rent, violation of lease terms, or the landlord’s need to occupy the
property for personal use.
o Rent Increase Restrictions: Landlords are typically restricted from increasing rent
arbitrarily. The law mandates certain conditions under which rent can be increased.
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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

• Example: The Delhi Rent Control Act, 1958 and similar state-specific laws provide comprehensive
guidelines on tenant rights, rent control, and dispute resolution.

6. Income Tax Act, 1961

• Tax Treatment of Leasing:
o The rent received by the lessor from leasing is considered taxable income under the
Income from House Property or Business Income, depending on the nature of the leasing
business.
o Depreciation: The lessor can claim depreciation on the leased asset if it is part of a
business.
o For financial leases, the lessee may treat the lease payments as operating expenses, but
this varies based on the type of lease (operating or finance lease).

7. Goods and Services Tax (GST) Act, 2017

• Applicability of GST: Lease transactions, both for immovable and movable property, attract GST
in India.
o Commercial Leases: GST is applicable to the rent paid for leasing commercial properties.
o Residential Leases: Residential leases used for personal purposes are exempt from GST.
However, if the property is leased for commercial purposes, GST is applicable.
• The GST rate for leasing services generally ranges between 12% to 18%, depending on the nature
of the lease and the asset involved.

8. Specific Laws for Equipment Leasing (Movable Property)

• Leasing of movable assets like machinery, vehicles, or equipment is governed by the Indian
Contract Act, 1872 and sector-specific regulations, if applicable.
• Equipment leases often resemble financing arrangements and may be treated similarly to loans
for tax purposes.
• Under the Companies Act, 2013, financial leasing companies and Non-Banking Financial
Companies (NBFCs) providing leasing services are subject to regulations by the Reserve Bank of
India (RBI).

9. SEBI (Securities and Exchange Board of India) Regulations

• In cases where a lease is part of a securitization deal or a financial instrument listed on stock
exchanges, the lease transaction may come under the purview of SEBI regulations.

10. Dispute Resolution

• Lease disputes may arise over rent payments, eviction, lease terms, or repairs. Such disputes can
be resolved through:
o Civil Court: Regular courts handle most lease disputes under contract law and property
law.
o Rent Control Tribunals: Special tribunals handle disputes arising under rent control laws.
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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

o Arbitration: Many commercial leases include an arbitration clause for resolving disputes
without going to court.

6. Hire Purchase: Concept and Characteristics

Concept of Hire Purchase

Hire Purchase (HP) is a type of financial arrangement where an individual (the hirer) agrees to
acquire an asset by paying an initial deposit and then making periodic payments (instalments).
Under a hire purchase agreement, the ownership of the asset is transferred to the hirer only after
the final instalment is paid. Until then, the ownership remains with the financier or seller, and the
hirer merely has possession and the right to use the asset.
Hire purchase is typically used for the acquisition of high-value assets like automobiles, machinery,
and other equipment. It is popular in personal finance and small-scale businesses because it
enables the hirer to use the asset while spreading the cost over time.

Key Characteristics of Hire Purchase

1. Transfer of Ownership
o Ownership of the asset is not transferred immediately to the hirer. The financier (or seller)
retains ownership until the full payment is made, including interest, if applicable. After
the final instalment is paid, the title is transferred to the hirer.
2. Right to Use the Asset
o Even though the hirer does not initially own the asset, they have the right to use it from
the moment the hire purchase agreement is signed and the first payment is made. This is
distinct from a lease where ownership never transfers.
3. Payment in Instalments
o The purchase price is paid in instalments over a specified period, usually monthly. Each
instalment consists of two components:
▪ A principal portion, which reduces the outstanding amount owed.
▪ An interest portion, which represents the cost of borrowing.
4. Option to Purchase
o At the end of the hire purchase term, the hirer is given the option to purchase the asset
outright, which is usually done by paying a nominal fee (called a purchase option fee). The
hirer can also choose to return the asset without buying it, depending on the agreement.
5. Down Payment or Deposit
o The hirer typically makes an initial down payment or deposit at the start of the agreement,
which reduces the total amount to be financed through instalments.
6. Ownership Risk and Responsibility
o While the financier retains ownership, the hirer bears the risk of damage or loss of the
asset during the hire period. The hirer is also responsible for maintaining and insuring the
asset.
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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

7. Right to Repossession
o If the hirer defaults on the instalments, the financier has the right to repossess the asset.
Since the ownership remains with the financier, the process of repossession is more
straightforward compared to a loan situation where the borrower already owns the asset.
8. Cost Implication
o Hire purchase often results in a higher overall cost than purchasing the asset outright
because it includes interest charges spread over the instalment period. This total cost is
typically higher than the asset’s cash price.
9. Legal Framework
o In many countries, hire purchase agreements are regulated under consumer protection
laws. In India, for example, hire purchase transactions are governed by the Hire Purchase
Act, 1972, although this law has not been fully enforced in all states.

Advantages of Hire Purchase

• Spread Payment: The hirer doesn’t need to pay the full price upfront, making it easier to acquire
expensive assets.
• Immediate Use: The hirer can use the asset while paying for it, which is especially useful for
businesses or individuals who need the asset to generate income.
• Ownership Opportunity: At the end of the term, the hirer can own the asset outright.

Disadvantages of Hire Purchase

• Higher Total Cost: Due to interest charges, the hirer often pays more in the long run compared to
paying the full price upfront.
• Repossession Risk: If the hirer defaults, they risk losing the asset and the money already paid
towards it.
• No Ownership Until Final Payment: The hirer doesn’t own the asset until the final instalment,
which limits their ability to sell or modify it.

7. Difference Between Hire Purchase and Leasing

Hire Purchase (HP) and Leasing are both financial arrangements that allow individuals or
businesses to use assets without paying the full amount upfront. However, they have fundamental
differences in terms of ownership, payment structure, and legal nature. Below are the key
differences:
Aspect Hire Purchase Leasing

Ownership transfers to the

hirer after the final Ownership remains with the
Ownership instalment is paid. The hirer lessor throughout the lease term.
has the option to buy the The lessee never owns the asset.
asset.
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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

Aspect Hire Purchase Leasing

A purchase agreement A rental agreement where the

Nature of lessee rents the asset without the
where the hirer intends to
Agreement intention to own it.
own the asset after
completing the payment.

The payments are Payments are considered rental

Payment instalments towards charges for using the asset. They
Structure purchasing the asset may be periodic without leading
(includes interest and to ownership.
principal).
Lease agreements can be short-
Typically involves longer term or long-term, depending on
Duration periods, as the hirer the type of lease (operating or
eventually owns the asset. finance lease).

Ownership is transferred to Ownership never transfers to the

Ownership the hirer after paying all lessee. The asset remains with the
Transfer instalments, often with a lessor even after the lease ends.
nominal fee.
The lessee can deduct lease
The hirer can claim payments as a business expense,
depreciation benefits once but cannot claim depreciation.
Tax Benefits
ownership is transferred, Depreciation benefits go to the
and interest paid can be lessor.
deductible.
Maintenance responsibilities
Usually, the hirer is depend on the lease agreement
Maintenance
responsible for maintenance but are typically the lessor’s
and Repairs
once the agreement is in responsibility in operating leases.
place.
Early termination is generally
If the hirer defaults or more flexible, especially in an
Early
terminates early, the lessor operating lease, but penalties may
Termination
can repossess the asset, and still apply.
a penalty may be charged.

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BBA 3 YEAR MERCHANT BANKING AND FINANCIAL SERVICES UNIT-2

Aspect Hire Purchase Leasing

Considered a capital Considered an operating expense

Capital vs. expenditure because the for the lessee, especially in
Operating asset will eventually belong operating leases.
to the hirer.
Lessee uses the asset for a fixed
Hirer uses the asset during period without owning it. At the
Use of Asset the instalment period and end of the lease, the asset is
eventually owns it. returned or renewed.

The financier can repossess The lessor can take back the asset
Repossess at the end of the lease term or in
the asset if the hirer defaults
Rights case of non-payment.
on payments.

Appears on the balance Operating leases do not appear as

Financial liabilities, but finance leases can
sheet as an asset (after
Statement be capitalized on the lessee's
ownership) and liability
Impact balance sheet.
(loan).
Conclusion
• Hire Purchase is primarily for people or businesses that wish to own the asset after a series of
instalment payments, making it more akin to a purchase over time.
• Leasing is more like a rental agreement where the lessee uses the asset but does not intend to
own it, offering more flexibility but with no transfer of ownership.

IMPORTANT QUESTIONS OF UNIT

1. Write Financial Services its Meaning and Role of Financial Services in a financial system
2. What is Leasing: Meaning and features and types?
3. What is Hire purchase its concept and characteristics and Difference between hire
purchase and leasing

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