FINANCIAL SERVICES AND INSTITUTIONS

MBA (FINANCE) Paper 4.23

MBA PAPER 4.23 FINANCIAL SERVICES AND INSTITUTIONS SYLLABUS UNIT 1 Financial Services: Concept And Scope of Financial Services Functions Concerning Public and Private Placement of Capital Issue: Lead Management Issue Pricing And Promotion Disclosure Norms Issue Underwriting Collecting Banker SEBI Regulations Regarding Lead Managers And Merchant Banking Functionaries. UNIT 2 Mutual fund Services Concept, Need and Scope MFs in India: Types of schemes Performance portfolio performance Evaluation Measures-Regulations Regarding Mutual Funds UNIT 3 Credit Rating Objectives Institutions: CRISIL ICRA CARE Debt and Deposit Rating and equity Rating Procedures Reading Different Grades of Rating International Credit Rating Institutions UNIT 4 Role of UTI and LIC as Investment Institutions Portfolio Management Services: Concept and Need Services of NBFC to investors. UNIT 5 Development Financial Institution Role on functions of IDBI, IFC, and IRBI RBI and Management of Gilt Securities Market UNIT 6 Stock Exchanges: Role and Organisation of BSE and NSE OTCEI SEBI and Stock Exchanges.

Contents UNIT I 1. Financial Markets and Financial Services 2. Raising of Capital / Issue of Shares UNIT II 3. Mutual Funds UNIT III 4. Credit Rating Services UNIT IV 5. Unit Trust of India 6. Life Insurance Corporation 7. Portfolio Management 8. Services Provided by NMFCs UNIT V 9. IDBI 10. IFCI & IRBI 11. RBI & Management of Gilt Securities Market UNIT VI 12. Stock Exchanges in India 13. Securities and Exchange Board of India

Lesson 1
Financial Markets and Financial Services Objective Reading this lesson the student will be in a position to understand the concept and types of Financial Services, Major Categories of Financial Services, Analysis of Categories of Financial Services, Financial Innovations. Contents Meaning of Financial Services Types of Financial Services Major Categories of Financial Services Analysis of Categories of Financial Services Global Integration of Financial Services Financial Innovations

Introduction Financial system is a set of complex and closely interlinked financial institutions markets, services, Practices, Instruments and Procedures. The financial system of any country comprise of specialized and non-specialized financial institutions, of organized and unorganized financial instruments and services that enable transfer of funds. While financial institutions are business organizations that. act as mobilizes and depositors of savings, financial markets are the arrangements that provide facilities for buying and selling of financial claims and services. Financial markets are sometimes classified are primary and secondary markets. The Participants of the demand and supply sides of these markets are financial institutions, agents, dealers, brokers and others who are inter-linked by the laws, contracts and covenants. The efficient financial markets are characterized by the absence of information based gain, by correct valuation of assets, by maximization of convenience and minimization of transaction costs and by maximization of marginal efficiency of capital. Financial markets today unfold a higher degree of integration, with large amounts \of capital flowing across borders to take advantage of slightest perceived financial benefits. Gross capital flows among industrial countries are also much larger not than a decade ago. The Indian economy has moved away from a highly regulated and controlled regime to a liberalized one governed by the market forces in allocation of resources for economic growth and development. With the changes taking place in he real sector of the economy, the financial system in India is also in the process of rapid transformation. The Financial services have a crucial role to play in this process of reforms in the financial sector. In India, the role of financial services industry has assumed great significance during the decade that witnessed phenomenal growth and changes in money market, capital market and foreign exchange market. On account of deregulation and liberalized economic and legal environment and emergence of new financial instruments in capital and money markets, the utility of financial services industry has further increased to its users. Meaning of Financial Services A Financial Services is any service of financial nature offered by financial service supplier of a member nation. Types of Financial Services Besides traditional commercial and co-operative banks financial services include non-banking financial companies like investment companies, hire-purchase and leasing companies, housing finance Companies, mutual funds, Venture Capital funds, Portfolio managers, Foreign Institutional Investors, merchant bankers, under writers, Stock brokers custodians and depositories. In last decade, a number of non-banking specialized financial institutions like Mutual Funds, Venture Capital Funds, Credit rating agencies like CRISIL, CARE, ICRA, Equity Research, Credit Cards, Factoring. Merchant banking organisatoins have commenced functioning in India to extend multifarious services in the area of financial services. Financial services also include technical and economic consultancy, stockholding, discounting and re-discounting, refinancing underwriting, funds transfer, safe deposit vaults, loan syndicating and managing capital issues. Gross Capital outflows from the main industrial countries came to about $850 billion in 1993, compared with an average of about $500 billion during 1985-93 and about $100 billion in the first half of the 1980s. Major Categories of Financial Services

Financial Services could be grouped into five major categories as enumerated below: Creating of Financial Instruments Security transactions Payment Services Risk management Other Financial Services

Analysis of Categories of Financial Services Financial Instruments otherwise known as Financial Claims, are created through different contracts. The second category include Financial Services fund. Organizations provide services to assist the development of security transactions both in Primary and Secondary markets. The third category include payment services which assist in settling debts without the direct exchange of cash and instruments used include cheques, Demand drafts, credit cards, travellers cheques and so forth. The fourth category of financial services namely risk management products permit the investors to manage the risk associated with unexpected movement with interest rates and security prices. Finally, the last residual category of financial services which include derivative financial instruments financial future contracts that are entered into with a view to providing for risk transfer. The development of financial assets of economic entities is an indicator of growth of financial services. The assets of these institutions have gone from Rs. 63,637 covers at the end of March 1981 to Rs. 4,95,099 crores at the end of March 1993, thus registering a compound annual growth of 18.6 percent. Integration The term integration refers to the establishment of close connections or effective linkages between different constituents and between different parts of the financial system. Financial integration is the opposite of the maturity wise, geographical, institutional, seasonal, instrumental, segmentation or Compartmentalization of the financial markets. The integration process has helped the financial markets both at national and international levels to enhance their efficiency and it has also facilitated in globalization of financial services. The flow of foreign capital from the industrialized countries to the developing countries has been the significant outcome of this integration process. Global Integration of Financial Markets In terms of international trade and financial flows, Indian economy is to a very great extent an open economy, though the extent of its openness may not be as great as in countries like USA, UK, Germany, Japan, Philippines. The foreign exchange markets are cleared at a conversion price, i.e. at the exchange rate. The foreign exchange rates are an important part of financial analysis. Though the exchange rate is apparently determined by the supply of and demand for foreign exchange, the complex forces of exports and imports lie behind the whole process of exchange rate determination. The international aspects of savings and investments flows are reflected in the volume of capital flows between nations. The world economy has witnessed significant changes in recent years. India has already opened up its economic frontiers and presently expects increasing gains from the new world trade order and the world finance system. Since 1990, the global economy has emerged very swiftly requiring significant changes. The openness of the economy is also apparent in the projections of the Eight Plan. While exports are expected to grow by 13.6% p.a. in volume terms to reach a level of US $33.55 billion by the year 1996-97, imports are projected to increase by 8.4% in volume terms. The trade policy reforms have been made part of overall reform process for he realization of aforesaid objectives. The GATT played a significant role in facilitating the rapid expansion in global trade through a succession of rounds which culminated in the Uruguay Round and resulted in the transformation of GATT into World Trade Organisatoin. The Uruguay Round has been the most ambitious and comprehensive multilateral trade negotiations in history. During the 1996-1994, international transaction sin good and non-factor services as a proportion of GDP enhance from 33% to 43% for the developing world as a whole. The General Agreement on Trade in services is the first multilaterally agreed and legally enforceable rules to cover international trade in services. Share of services in global trade has increased to over 22% in 1994 against 15% in 1980. The way the Indian Corporate sector reacted to the domestic liberalization process as well as to the Uruguay Round results disclose that a large segment is quite conscious that this liberalization process is desirable, possibly also irreversible and the world trade liberalization through the Uruguay Round can be a position factor that will facilitate the adjustments needed to be done at the corporate level in response to the domestic reforms process. Thus global integration of financial markets resulted from de-regulatory measures, technological and information explosion and financial innovations. The Indian Corporate Sector has appreciated the concept of globalization of

economyand have been initiating measures to emerge as Indian multinationals. The measures include improved quality products, establishment of overseas distribution and marketing channels, capacity utilization, cost consciousness, strategic alliances for both domestic and international operations and so forth. Financial Innovations Financial innovation can be variously defined as the introduction of new financial instrument or service or practice, or introducing new uses of funds, or finding out new sources of funds, or introducing new process or techniques to handle day-to-day operations, or carrying out a new organisatoin all these changes being on the parts of existing financial institutions. In addition, the emergence and its spectacular growth of new financial institutions and markets is also part of financial innovation. Financial innovations encompass wide ranging changes in the financial system and they also have wide ranging effects. They lead to the broadening deepening, diversification, structural transformation internationalization and sophistication of the financial system. They result in the financialization of the economy whereby financial assets to total assets ratio tends to increase. Changes in the financial market during the Nineteen witnessed considerable amount of financial innovations. They are generally the outcome of the changing needs for financial services and the availability of new technology to provide them. There are continuous efforts to innovate and serve the financial consumers and this brings about new products for consumers, new functions of financial institutions and call for changes in the strategies of regulating agencies. Financial innovations improve market integration and the efficiency of international financial markets by bringing about structural changes and by offering broader and more flexible range of instruments. This results in improved allocations would strengthen global financial intermediaries and would provide hedge exposure to risk associated fluctuation in many financial parameters through a variety of techniques. A number of companies have come out with new financial instruments in the recent years. The innovative corporate new financial instruments include zero interest bonds, deep discount bonds, partially convertible debentures, zero coupon convertible note, Debt for equity swap and so forth.

Lesson 2 Raising of Capital/Issue of Shares Objective Reading his lesson the students will be in a position to understand the various notes of rising of capital form public, SEBI Guidelines for issue of shares to the Public, Public Issue by Unlisted Companies (Other than a banking company), Pricing of Issue, Public Issue by listed companies, Promoters Contribution, Meaning of Book Building, underwriting, SEBI guidelines for Underwriting, SEBI Regulations regarding Lead Managers and Merchant Banking Functionaries, Lead Managers Obligation. Contents Raising of capital /Issue of shares SEBI Guidelines for issue of share to the Public (IPOs) Public Issue by Unlisted Companies (Other than a banking company) Exemption from Eligibility Norms Pricing of Issue Public Issue by listed companies Promoters Contribution Meaning of Book Building Meaning of underwriting Firm underwriting Agreement between Underwriter and Client Company Underwriters General Responsibilities SEBI guidelines As per SEBI Guidelines, 2000 Merchant Banking Role of Merchant Bankers Services Rendered by Merchant Banks Merchant Banking in India SEBI Regulations regarding Lead Managers and Merchant Banking Functionaries Lead Managers Obligation

Companies limited by shares have to issue shares to rise the necessary capital for their operations. Issue of shares may be made in 3 ways: 1. By private placemen of shares; 2. By allotting entire shares to an Issue House, which in turn, offer the shares for sale to the public; and 3. By inviting the public to subscribe for shares in the company through a prospectus. Private placement of shares A Private Company limited by shares is prohibited by the Act and the Articles from inviting the public for subscription of shares or debentures. It also need not file a statement in lieu of prospectus. Its shares are issued privately to a small number of persons known to the promoters or related to them by family connections. A public Company can also rise its capital by placing the shares privately and without inviting the public for subscription of its shares or debentures. In this kind of arrangement, an underwriter or a broker finds persons, normally his clients who wish to buy the shares, i.e., to place them. Since no public offer is made for shares, there is no need to issue any prospectus. However, under section 70 of the Act, such a company is required to file with the Registrar a statement in lieu of prospectus at least 3 days before making allotment of any shares or debentures.

As per the guidelines issued by SEBI, private placement by a public company of its shares should not be made by subscription of shares from unrelated investors through any kind of market intermediates. This means promoters shares should not be contributed by subscription of those shares by unrelated investors through brokers, merchant bankers, etc. however, subscription of such shares by friends, relative and associates is allowed. By an offer for sale Under this arrangement, the company allots or agrees to allot shares or debentures at a price to a financial institution or an Issue-House for sale to the public. The Issue-House publishes a document called an offer for sale, with an application form attached, offering to the public shares or debentures for sale at a price higher than what is paid by it or at par. This document is deemed to be a prospectus [Section 64(1)]. On receipt of applications from the public, the Issue-House renounces the allotment of the number of shares mentioned in the application in favour of the applicant purchase who becomes a direct allottee of the shares. By inviting public through prospectus This is the most common method by which a company seeks to raise capital from the public. The company invites offers from members of the public to subscribe for the shares or debentures through prospectus. An investor is expected to study the prospectus and if convince about the prospectus of the company, may apply for shares. Issue of shares to existing shareholders Further capital is also raised by issue of rights shares to the existing shareholders (section 81). In this, case, the shares are allotted to the existing equity shareholders in proportion to their original shareholding, e.g., one share against every two shares held by a member. Public Issue of Shares Public Issue of shares means the selling or marketing of shares for subscription by the public by issue of prospectus. For raising capital from the public by the issue of shares or debentures, a public company ahs to comply with the provisions of the Companies Act, the Securities Contracts (Regulation) Act, 1956 including the Rules made thereunder and the guidelines and instructions issued by he concerned Government authorities, the Stock Exchange and the Securities and Exchange Board of India (SBI), etc. Management of a public issue involves coordination of activities and cooperation of a number of agencies such as manages to the issue, underwriters, brokers, registrars to the issue, solicitor/legal advisors, printers, publicity and advertising agents, financial institutions, auditors and other Government/statutory agencies such as Registrar of Companies, Reserve Bank of India, Stock Exchange, SEBI etc. Before discussing he procedure for issue of shares, it is advisable to first understand the guidelines issued by SEBI with regard to issue of shares termed as Guidelines for Disclosure and Investor Protection. SEBI Guidelines for Issue of Shares to the Public [IPOS] SEBI guidelines, 2000 require companies to comply with the following requirements in case of issue to the public (IPOs): 1. The appointment of Category 1 Merchant Banker to manage an issue shall be compulsory. 2. Registrar to Issue must be appointed. 3. Partly paid shares must either be made fully paid or forfeited. 4. The company shall not make public issue where it has been prohibited by the SEBI (Board) 5. Draft offer document (prospectus) shall be filed with the SEBI at least 21 days before filing of the prospectus with Registrar of Companies. 6. The draft offer document filed with the SEBI shall be made public for a period of 21 days from the date of filing the offer document with the SEBI. 7. The lead merchant banker shall. While filing the draft document with the SEBI also file the draft offer document with the stock exchanges where the securities are proposed to be listed; Make copies of draft offer document available to the public Shall made ten (10) copies of the draft offer document available to the dealing office of the SEBIU, three (3) copies to the Primary Market Department, SEBI, Head Office and 25 copies to the stock exchange(s) where the issue is proposed to be listed.

The lead merchant banker shall submit the draft offer document on a computer floppy to the dealing office of the Board and to the Primary Market Department, SEBI, Head Office; Obtain and furnish to the SEBI, an in-principle approval of the stock exchanges for listing of the securities within 15 days of filing of the draft offer document with the stock exchange(s)

8. The company shall carry out the changes suggested by SEBI before filing of prospectus with Registrar of Companies. Public Issue by Unlisted Companies (Other than a Banking Company) An unlisted company shall be allowed to make a public issue subject to the following conditions: 1. It must have a tract record of distributable profits in terms of section 205 of the Companies Act, 1956 (i.e. ability to pay dividends) for at least 3 out of immediately preceding 5 years; 2. It must have a minimum pre-issue net worth of not less than Rs. 1 crore in 3 out of preceding 5 years and also in immediately preceding 2 years. Three years out of immediately preceding five years, shall mean that at least three (3) audited accounts for a period of not less than thirty six (36) months are available for computation of the minimum tract record of three (3) years of distributable profits. 3. The issue size must not exceed 5 times its pre-issue net worth as per the last available audited accounts either at the time of filing offer documents with SEBI or at the time of opening of issue. In case a company does not satisfy the aforesaid requirements or the issue size exceeds five times its pre-issue net worth as per last available audited accounts, it can make a public issue only through book-building subject to at least 60% of the issue being allotted to Qualified Institutional Buyers (QIBs) failing which full subscription monies must be refunded. Qualified Institutional Buyer shall mean Public financial institutions as defined in section 4A of the Companies Act, 1956, Scheduled commercial banks; Mutual funds; Foreign institutional investors registered with SEBI; Multilateral and bilateral development financial institutions; Venture capital funds registered with SEBI.

4. The company shall enter into agreements with all the depositories for dematerialization of securities. However, the investors shall have an option to receive allotment of securities through any of the depositories. Exemption from Eligibility Norms The eligibility norms for making a public issue as noted above shall not be applicable in case of.

1. a banking company including a Local Area Bank (hereinafter referred to as Private Sector Banks) set up
under sub-section (c) of section 5 of the Banking Regulation Act, 1949, and which has received licence from the Reserve Bank India, or

2. a corresponding new bank set up under the Banking Companies (Acquisition and Transfer of Undertaking)
Act. 1970, Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980, State Bank of India Act, 1955 and State Bank of India (Subsidiary Banks) Act, 1959 (herein-after referred to as public sector banks), 3. an infrastructure company; whose project has been appraised by a Public Financial Institution or Infrastructure Development Finance Corporation (IDFC) or Infrastructure Leasing and Financing Services Ltd. (IL&FS) and not less than 596 of the project cost is financed by any of the institution referred to in sub-clause (a) jointly or severally, irrespective of whether they appraise the project or not, by way of loan or subscription to equity or a combination of both.

Pricing of Issue Fee pricing has been allowed under SEBI Guidelines, 2000. In other words, every company, which is entitled to make a public issue, shall be free to offer its public issue either at par or at a premium. Issuer company can mention price band of 20% (cap in the price band should not be more than 20% of the floor price) in the offer document filed with the Board and actual price can be determined at a later date before filing of the offer document with the ROC. When the Board of directors has been authorized to determine the offer price within a specified price band, such price shall be determined by a resolution to be passed by the Board of Directors. Differential pricing

1. Any unlisted company or a listed company making a public issue of equity shares or securities convertible at
a later date into equity shares, may issue such securities to applicants in the firm allotment category at a p[rice different from the price at which the net offer to the public is made provided that the price at which the security its being offered to the applicants in firm allotment category is higher than the price at which securities are offered to public. The net offer to the public means the Indian public and does not include firm allotments or rese4rvations or promoters contributions. 2. A listed company making a composite issue of capital may issued securities at differential prices in its public and rights issue. 3. In the public issue which is part of a composite issue, differential pricing as per (i) above is also permissible 4. Justification for the price difference shall be given in the offer document. A banking company shall be allowed to make a public issue at a price approved by the Reserve Bank of India. Public Issue by Listed Companies A listed company shall be free to make a public issue. However, it the net worth of the company becomes more than 5 times the net worth prior to the issue, it shall be allowed only through book building subject to at least 60% of the issue being allotted to Qualified Institutional Buyers (QIBs) failing which full subscription monies must be refunded. A listed company which has changed its name so as to indicate that it is a company in the information technology sector during a period of three years prior to filing of offer document with the SEBI, shall comply with the requirements of unlisted companies, before it can make a public issue of equity shares or securities convertible at a later date into equity shares. A listed company shall be allowed free pricing of its issue. Denomination of shares The companies, which have already issued shares in the denomination of Rs. 10 or Rs. 100, may change the standard denomination of the shares by splitting or consolidating the existing shares. The companies proposing to issue shares in any denomination or changing the standard denomination shall comply with the following: The shares shall not be issued in the denomination of decimal of a rupee; The denomination of the existing shares shall not be altered to a denomination of decimal of a rupee; At any given time there shall be only one denomination for the shares of the company; The companies seeking to change the standard denomination may do so after amending the Memorandum and Articles of Association, if required; The company shall adhere to the disclosure and accounting norms specified by the SEBI from time to time.

Promoters Contribution 1. Unlisted company The promoters contribution shall be at least 20 percent of the post issue capital. 2. Listed company The promoters contribution shall be: At least 20 percent of the proposed public issue; or Shall not fall below 20 percent of the post issue capital.

3. In case of composite issues of listed companies, rights issue component of the composite issue shall be excluded while calculating the post issue capital. 4. Private placement of promoters through market Intermediaries shall not be allowed.

5. Promoters contribution shall be at the same price as applicable to the investing public. 6. Minimum amount to be contributed by each promoter shall not be less than Rs. 25,000 per application. This limit shall also apply to contributions made by business associated such as dealers and distributors. However, in case of contributions made by firms or body corporate not being business associates, the minimum contribution shall be Rs. 1,00,000. 7. In case of listed as well as unlisted companies:

Promoters must bring in the full amount of their contribution (including premium at least one day before the issue opens which shall be kept in an escrow account with a Scheduled Commercial Bank and the said contribution/amount shall be released to the company along with the public issue proceeds). Where promoters contribution exceeds Rs. 100 crores, they shall bring Rs. 100 crores before opening of the issue and the balance on pro rata basis in advance before calls are made on public. The companys Board shall pass a resolution allotting the shares or convertible instruments to promoters against the monies received. A copy of the resolution along with a Chartered Accountants Certificate certifying that the promoters contribution has been brought in shall be filed with the SEBI before opening of the issue. The certificate of the Chartered Accountants shall also be accompanied by a list of names and addresses of friends, relatives and associates who have contributed to the promoters quota along with the amount of subscription made by each of them. Promoters shall not acquire shares through private placements either directly or through any intermediary. Reservations for allotment on firm/preferential basis for various categories together with promoters contribution must not exceed 75% of the total issue amount. Reservation on competitive basis can be made in a public issue to the following categories Category of persons

S. No.

Reservations and firm allotment

1. Permanent employees (including working directors) of the company and in the case of a new company, the permanent employees of the promoting companies. 2. Shareholders of the promoting companies in the case of the a new company and shareholders of group companies in the case of an existing company. 3. Indian mutual funds 4. Foreign institutional investors (including non-resident Indians and overseas corporate bodies) 5. Indian and multilateral development institutions 6. Scheduled banks. S. No. 2. Indian mutual funds 3. Foreign Institutional Investors (including non-resident Indians and overseas corporate bodies) 4. Permanent/regular employees of the issuer company 5. Scheduled banks. Reservations in favour of employees shall not exceed 1096 of the issue. Reservations in favour of shareholders and lead merchant bankers must not exceed 10% and 5% respectively. In case promoting companies are designated financial institutions / State and Central Financial Institutions, the employees and the shareholders of such promoting companies shall not be eligible for the said reservations. The allotments to the reserved category(ies) shall be subject to a lock-in period of one year. Firm allotment in public issues can be made to the following: Category at persons

1. Indian and multilateral development financial institutions

Minimum application The minimum number of shares for which application shall be allowed to be made has been fixed at 200 shares of the face value of Rs. 10 each. In case of issue at a premium, the minimum amount payable (on application, allotment and calls) shall not be less than Rs. 2,000. Minimum application money The minimum application money to be paid by an applicant along with the application shall not be less than 25% of the Issue price. Further, the minimum number of instrument for which an application has to be made shall not be less than the tradeable lot. Minimum tradeable lot The minimum tradeable lot, in case of shares of face value of Rs. 10 each, shall, at the option of the issuer/offerer, be fixed on the basis of offer price as given below: Provided that the maximum tradeable lot in any case shall not exceed 100 shares. Offer price per shares Up to Rs. 100 Rs. 101 Rs. 400 More than Rs. 400 Minimum tradable lot 100 shares 50 shares 10 shares

Share application form to seek permanent account number In respect of application for the value of Rs. 50,000 or more, the application(s) shall mention his/her/their permanent account number /GIR number and income-tax circle/ward, district or the fact of non-allotment of PAN/GIR number as the case may be. Applications not complying with these provisions are liable to be rejected. Closure of Issue Issue must be kept open for at least 3 working days and not more than 10 working days. However, public issues made by infrastructure companies may be kept open up to 21 working days. Minimum subscription The following statements shall appear in the prospectus:

1. For non-underwritten Public issues: If the company does not receive the minimum subscription of 90% of the
issued amount on the date of closure of the issue or if the subscription level falls below 90% after the closure of issue on account of cheques having being returned unpaid or withdrawal of applications, the company shall forthwith refund the entire subscription amount received. If there is a delay beyond 8 days after the company becomes liable to pay the amount, the company shall pay interest as per section 73 of Companies Act, 1956.

2. For Underwritten Public Issues: If the company does not receive the minimum subscription of 90% of the net
offer to public including devolvement of Underwriters within 60 days from the date of issue, the company shall forthwith refund the entire subscription amount received. If there is a delay beyond 8 days after the company becomes liable to pay the amount, the company shall pay interest prescribed under section 73 of the Companies Act, 1956. 3. For composite Issues:

The Lead Merchant Banker shall ensure that the requirement of minimum subscription is satisfied both jointly and severally, ie., independently for both rights and public issues. If the company does not receive the minimum subscription in either of the issues, the company shall refund the entire subscription received.

The aforesaid requirements of 90% minimum subscription will not be relevant in case of offer for sale of securities (i.e. the management offering their shareholdings through public offer with a view to convert a closely held company into a widely held company). The requirement of 90 per cent subscription for issue of capital by an infrastructure company shall not be mandatory if disclosures are made in the prospectus regarding the alternate sources of funding. The lead manager shall verify and confirm the same as part of his due diligence.

Over-subscription No retention of over-subscription shall be allowed except to the extent of maximum 10% necessitated by approximation while making proportionate allotment. Allotment to be on proportionate basis In case of over-subscription, the allotment shall be on proportionate basis subject to a minimum of 50% of the net public offer to be reserved for allotment to individuals applying for 1,000 or less shares. SEBI in this regard has clarified that reservation in favour of small investors ahs to be a minimum of 50%. It means that if the category of individual applicants up to 1,000 shares would have got 70 per cent of the public offer in accordance with proportionate formula, they would get 70% and not 50%. On the other hand, if they are entitled to only 30% as per the formula, they would be given 50% of the net offer to the public. Issue to be made fully paid up Issue must be made fully paid up within 12 months except where the total issue size exceeds Rs. 500 crores. If the investor fails to pay call money within 12 months, as aforesaid, the subscription money already paid may be forfeited. Refund of over-subscription All monies in excess of the application money on shares allotted must be repaid forthwith without interest. Section 73(2A) provides that if such money is not repaid within 8days from the day the company becomes liable to pay, the company and very director of the company, who is an officer in default, shall be jointly and severally liable to repay the same with interest @ 15% p.a. There shall be no escape from payment of interest irrespective of circumstances. Refund orders/shares or debentures certificates Refund orders of the value over Rs. 1,500 and shares/debentures certificates shall be sent by registered post only. Safety net or buy-back arrangement Where any safety net scheme or buy-back arrangement is proposed, it must be ensured that: The safety net scheme or buy-back arrangement has been finalized in advance and disclosed in the prospectus; The facility can be made available only to original allottees who are persons resident in India; The facility is limited up to a maximum of 1000 shares per allottee; The offer must be kept open for a period of at least six months from the last date of dispatch of securities; The financial capacity of the person (viz., promoters, directors or merchant bankers) making available such facility must have been disclosed in the draft prospectus; and No buy-back or stand-by or similar arrangements are allowed with the persons for whom securities are reserved for allotment on firm basis.

Other requirements

Updation of offer document: The lead merchant banker shall ensure that the particulars as per audited statements contained in the offer document are not more than 6 months old from issue opening date. In respect of a Government company making public issue, the auditors report in the prospectus shall not be more than six months old as on the date of filing of the prospectus with the Registrar of Companies or the Stock exchange as the case may be. Compliance Officer to be appointed by lead merchant banker: The lead merchant banker shall appoint a senior officer as Compliance Officer to ensure that all rules, regulations, guidelines, notifications, etc. issued by the Board, the Government of India, and other regulatory authorities in various maters and provide necessary guidance and also ensure compliance internally. The Compliance Officer shall also ensure that observations made/deficiencies pointed out by the Board do not recur. Incentive to prospective shareholders: The issuer shall not offer any incentives to the prospective investors by way of medical insurance scheme, lucky draw, prizes. etc. Requirement of monitoring agency: In case of issue exceeding Rs. 500 crores, the issuer shall make arrangements for the use of proceeds, of the issue to be monitored by one of the financial institutions. A copy

of the monitoring report as per the format specific in Schedule XIX of SEBI guidelines, shall be filled with the Board by the said monitoring agency, on a half-yearly basis, till the completion of project, for the purposes of record.

Option to receive securities in dematerialized form: The lead merchant banker shall incorporate a statement in the offer document and in the application form to the effect that the investors have an option to either receive securities in the form of physical certificates or hold them in a dematerialized form.

Meaning of Book Building SEBI has allowed book building as an alternative to firm allotment. Under the process of book building prospective buyers make offers to purchase specified number of shares at a particular price. SEBI Guidelines, 2000 define book building to mean a process undertaken by which demand for the securities proposed to be issued by a body corporate is elicited and built-up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memoranda or offer document. In case the issuer chooses to issue securities through book building, it must follow the SEBI guidelines in this regard. 75% of Book Building Process [w.e.f. 27-1-2000] In an issue of securities to the public through a prospectus the option for 75% book building shall be available to the issuer company subject to the following: Issue of securities through book building shall be separately indicated as placement portion category and the securities available to the public should be identified as net offer to the public. At least 25% of the issue must be offered to the public. Underwriting shall be mandatory for the net offer to the public portion. Draft prospectus containing all information except the price shall be filed with SEBI. One of the lead merchant banker shall be nominated as a Book Runner and his name mentioned in the prospectus. The draft prospectus indicating the price band may be circulated by the Book Runner to the institutional buyer who are eligible for firm allotment and to the intermediaries eligible to act as underwriters inviting offers for subscribing to the securities. The institutional buyers and underwriters shall intimate to the Book Runner orders received by them as well as the securities they are willing to subscribe alongwith the relevant price. The Book Runner will keep a record of the same. The Book Runner and the issue company shall determine the price at which the securities shall be offered to the public. The issue price for the placement portion and offer to the public shall be the same. On determination of the issue price, the underwriter shall enter into an underwriting agreement with the issuer company indicating the number of securities the underwriter shall subscribe to. The Book Runner may require the underwriters to bring in advance monies with respect to the net offer to the public. Within tow days of determination of the price, the prospectus shall be filed with ROC. Two separate accounts for collection of application money, viz., for placement portion and net offer to the public shall be opened. The institutional buyers and underwriters shall pay the application money on the securities proposed to be allotted to them one day prior to the opening of the issue to the public. Allotment for the private placement portion shall be made on the second day from the closure of the issue. Allotment of securities under the public category shall be made as per the Guidelines. In case of under subscription in any category, spillover shall be permissible. The Book Runner and other intermediaries associated with the book building process shall maintain records of the book building process. SEBI will have the right to inspect such records.

Underwriting Meaning of underwriting According to Palmer, underwriting is an expression used in company matters signifying a contract by which a person (known as the underwriter) agrees (usually for a commission) that if the shares, debentures, or debenture stock about to be offered for subscription or some specified proportions thereof, are not, within a specified time, taken up by the public, or by that section of the public to which they are to be offered, he will himself take them up and pay for what the public do not take up or some specified proportions thereof. SEBI Guidelines, 2000 define underwriting; to mean an agreement with or without conditions to subscribe to the securities of a body corporate when the existing shareholders of such body corporate or the public do not subscribe to the securities offered to them. Firm underwriting When an underwriter desires to take in a firm way, the whole or a portion of the number of shares he has underwritten, the effect will be that an allotment of that number would be made to him irrespective of whether the issue is over or undersubscribed. To the underwriter who takes on firm basis a given number of shares will be, so far as the rest of the shares are concerned, in the same position as other underwriters. The underwriting business has flourished with the boom in the primary market. In 1993-94, the total amount raised through public offerings was about Rs. 12,500 crores from 770 issues. During 1993-94, primary market raised about Rs. 27.000 crores from 1100 issues. Till 1993-94, devolvements on issues or under subscriptions were a rare exception. Chambal Fertilizers made a history with only 33 percent subscription. The situation worsened in first half 1995 with the under subscription going down to as low as less than one per cent. Some recent examples of under subscriptions are M.S Shoes, Bhushan Steels, Malvika Steels, TCI Finance, Kothari Global, Niwas Spinning, Pitte Cement, Pal Peugeot, Pashupati Fabs, Metropoli Overseas, Parasrampuria synthetics, BSM Knitfab, Elque Polyesters etc. The Stock market and primary markets have been weak since March, 1995 and there were several cases of devolved issues. Promoters were found using the following strategies to avoid devolving of issues: Engineering dummy applications during first 2-3 days of issues and looking to the response, brokers advise investors to subscribe. Convincing brokers to subscribe, promising to buy back their shares at a premium after a particular period. Borrowing money through a front, who uses the funds to apply for shares, Devolvement is avoided and the promoters return the loans from the amount collected.

In case of devolved issues, the medium term impact on the share prices will be negative because underwriters will look out for a exit route. Underwriting which is safety net for the promoters on one hand and a major source of income for underwriters, is now at cross roads. The reasons which can be attributed to this declining business is SEBI guidelines to make underwriting optional and the declining capital market conditions. Presently, good issues and confident promoters do not go for underwriting to save on costs. in the CCI era, almost all issues used to get oversubscribed and devolvements were rare. Free pricing introduced in 1992 has led to flood of new issues, bunching of issues, issues by finance companies and NBFCs, poor quality issues and dull market conditions, especially since last two years. Underwriters have formed an association known as Stock Brokers Underwriters Association (SUA) to fight for their common causes. Underwriters make a commitment to get the underwritten issue subscribed either by others or by themselves. They agree to take up unsubscribed portion of the issue. They render this service for a commission agreed upon between the issuing company and the underwriter subject to the ceiling under the Companies Act. Underwriting services are available from brokers, investments companies, commercial banks and term lending institutions. The quality of service rendered by them differ greatly. Underwriting of issues is not obligatory after April 1995. However, they continue to be an important element in the development of primary market: because they ensure success of the Issue and render other related services. Underwriters are appointed by the issuing company in consultation with the merchant bankers / lead managers. They have to testify that in their opinion, the underwriters assets are adequate to meet their obligations. A statement to this effect is alos to be incorporated in the prospectus.

Registration with SEBI Only such person (an individual, firm or a company) who has obtained certificate of registration from SEBI, can act as an underwriter. Merchant bankers and stock brokers already having a valid certificate of registration from SEBI do not require a separate registration from SEBI for working as underwriters. Conditions for granting registration Before granting certificate of registration, SEBI satisfies itself that the applicant: Has the necessary infrastructure like adequate office space, equipment and manpower to effectively functions and discharge his duties. Has past experience in underwriting or has in employment at least two persons with experience in underwriting. Meets capital adequacy requirements of net worth of not less than Rs lakh. The applicant (director, principal officer or partner) has not been convicted of an offence involving moral turpitude or found guilty of any economic offence. Undertakes to fulful obligations under the SEBI Act, Rules and Regulations. Undertakes to abide by the prescribed code of conduct, and Pays the prescribed fee for grant of registration certificate and for its renewal, which is Rs. 2 Lakh for the first and the second years from the Initial grant of certificate and Rs. 20,000 per annum subsequently for keeping the certificate in force or for its renewal. Certificate of registration can be suspended by SEBI in case of failure to pay the fee.

Agreement between Underwriter and Client company There has to be an agreement between the underwriter and the issuing company. Among other relevant matters, the agreement specifically includes the following: The period during which the agreement will remain in force. The amount of underwriting obligation, He maximum period within which the underwriter will have to subscribe to the offer after being intimated by or on behalf of the issuing company. The rate and amount of commission/brokerage chargeable by the underwriter, within the limits imposed by the Companies Act, and Any other details regarding the arrangements made by the underwriter for fulfilling the underwriting obligations.

Underwriters General Responsibilities In addition to other responsibilities under SEBI Act rules and regulations, and those arising from valid agreement with the issuing company, an underwriter has the following general responsibilities. Cannot derive any other or indirect benefit from underwriting the issue except receiving the underwriting commission at the agreed rate, the ceiling for which is 5 per cent in case of underwriting of shares and 2.5 per cent in case of debentures. Cannot take up total underwriting obligation, at any point of time under all underwriting agreements, exceeding twenty times his net worth, and Subscribe for securities under the agreement within 45 days of the receipt of intimation from the issuing company.

SEBI Guidelines As Per SEBI Guidelines, 2000 1. Underwriting shall be optional. 2. The lead merchant banker shall satisfy themselves about the ability of the underwriters to discharge their underwriting obligations.

3. The lead merchant banker shall: Incorporate a statement in the offer document to the effect that in the opinion of the lead merchant banker, the underwriters assets are adequate to meet their underwriting obligations; Obtain Underwriters written consent before including their names as underwriters in the final offer document.

4. In respect of every underwritten issue, the lead merchant banker(s) shall undertake a minimum underwriting obligation of 5% of the total underwriting commitment or Rs. 25 lacs whichever is less. 5. The outstanding underwriting commitments of a merchant banker shall not exceed 20 times its networth at any point of time. 6. In respect of an underwritten issue, the lead merchant banker shall ensure that the relevant details of underwriters are included in the offer document. Underwriting commission Section 76 permits the payment of underwriting commission subject to the compliance of the following conditions:

It should be authorized by the Article of the company. An authority in the memorandum is not sufficient. The commission payable should not exceed 5 percent in the case of shares and 2 per cent in the case of debentures. Any lesser amount may be prescribed by the Articles and if it is so prescribed, it is the amount prescribed in the Articles that shall be payable as the underwriting commission by way of maximum. Underwriting commission may be paid in cash or kind or as lump sum or by way of percentage but in no case can it go beyond the statutory limits of 5 percent or 2% percent as the case may be. However, if he articles authorizes payment by a certain percentage, a lump sum payment cannot be made. Underwriting commission should be disclosed in the prospectus or statement in lieu of prospectus, as the case may be, or in a statement filed with the Registrar before the payment of the commission. However, the requirement of disclosure is relevant to the main underwriting agreement only; it does not cover subunderwriting agreements. The number of shares or debentures which persons have agreed to subscribe absolutely or conditionally should also be disclosed as in (iv) above A copy of the contract relating to the payment of the commission should be delivered to the Registrar.

Sub-underwriting The underwriting usually chooses to spread his risk by using sub-underwriters who agree to take certain number of shares for which they receive a commission. The liability of sub-underwriter is contingent upon: The number of shares subscribed by the public; The intimation by the underwriters to the sub-underwriter that the latter shall subscribe or procure subscriptions.

A sub-underwriting letter authorizing an underwriter to apply for shares for a valuable consideration, if the offer is accepted by the underwriter, amounts to an authority coupled with interest and is irrevocable. Merchant Bankers Definition of Merchant Banker The Notification of the Ministry of Finance defines a merchant banker as, any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory service in relation to such issue management. Role of Merchant Bankers Merchant Banker is the most important link between a company receiving funds and the investors. The role of Merchant banker is that of a catalyst in the process of converting formulation of projects into industrial ventures. They provide fund-based and fee-based services. The primary merchant banking functions are as under. 1. The provide long-term source of funds required by industries/trade/commerce for investment. The merchant banker primarily came into being as corporate counselors for restructuring base of capital, thereafter for issue management and underwriting of the same.

2. Project counselling which includes credit syndication and the working capital. 3. Capital structuring. 4. Portfolio management. Their accountal for activities connected with an issue right upto the allotment of shares. They have to certify the statement in the prospectus to the SEBI. Penalty points are awarded to the merchant banker who do not comply with the stipulated conditions. Services Rendered by Merchant Banks The working of merchant banking agencies and subsequent units formed to offer merchant banking services has shown that merchant banks are rendering diverse services and functions, such as organizing and extending finance for investment in projects, assistance in financial management, acceptance holes business, raising Euro-dollar loans and issue of foreign currency bonds, financing of local authorities, financing export of capital goods, ships, hydropower installation, railways, financing of hire-purchase transactions, equipment leasing, mergers and takeovers, valuation of assets, investment management and promotion of investment trusts. Not all merchant banks offer all these service. Different merchant bankers specialize in different services. Merchant banking in India Merchant banking activity was formally initiated into the Indian capital markets when Grindlays Bank received the licence from Reserve Bank in 1967. Grindlays which started with management of capital issue, recognized the needs of emerging class of entrepreneurs for diverse financial services ranging from production planning and systems design to market research. Apart from meeting specially the needs of small scale units, it provided management consultancy services to large and medium sized companies. following Grindlays Bank, Citibank set up its merchant banking division in 1970. The division took up the task of assisting new entrepreneurs and existing units in the evaluation of new projects and raising funds through borrowing and issue of equity. Management consultancy services were also offered. Consequent to the recommendations of Banking Commission in 1972, that Indian banks should start merchant banking services as part of their multiple services which banks could offer their clients. State Bank of India started the Merchant Banking Division in 1972. In the initial years the SBIs objective was to render corporate advice and assistance to small and medium entrepreneurs. The commercial banks that followed State Bank of India were Central Bank of India, Bank of India and Syndicate Bank in 1977; Bank of Baroda, Standard Chartered Bank and Mercantile Bank in 1978; and United Bank of India, United Commercial Bank, Punjab National Bank, Canara Bank and Indian Overseas Bank in the late seventies and early 80s followed by IFCI (1989) and IDBI (1991), Merchant banking activities are regulated by (1) Guidelines of SEBI and Ministry of Finance, (2) Companies Act, 1956 and (3) Listing Guidelines of Stock Exchange and (4) Securities Contracts (Regulation) Act, 1956. SEBI (Merchant Bankers) Rules and Regulations, 1992 Merchant Banking in India is governed by the SEBI (Merchant Bankers) Rules 1992 and SEBI (Merchant Bankers) Regulations 1992. Under these Rules & Regulations, the registration of Merchant Bankers with SEBI is compulsory. The regulations provide for the registration of four categories of Merchant Bankers. Under the first category, bankers can act as an issue manager, adviser, consultant, underwriter and portfolio manager. Under the second category, he can act as an adviser, consultant, co-manager, underwriter and portfolio manager. In the third category, he can act as an underwriter, adviser and consultant and in the fourth category he could act only as an adviser or consultant to an issue. The Merchant Bankers are required to fulfil the capital adequacy requirements which are Rs. 5 crore, Rs. 50 lakh, Rs. 20 lakh for the first three categories of Merchant Bankers, respectively. As category four Merchant Bankers are authorizes to act as consultant or advisers to an issue, no capital adequacy requirements has been prescribed. The Code of Conduct specified that every merchant banker should observe high standards of integrity and fairness in his dealings with clients and other Merchant Bankers. Merchant Bankers are required to take adequate steps for allotment of securities and refund of application money without delay and not indulge in price rigging and manipulation. To ensure transparency and accountability, SEBI has advised Merchant Bankers to enter into agreements with corporate bodies setting out their mutual rights, liabilities and obligations relating to an issue particularly on disclosures, allotment and refund, maintenance of books of accounts, and submission of half yearly report to SEBI. The regulations stipulate that all issue should be managed by atleast one Merchant Banker functioning as a lead manager.

Number of lead managers The number of lead manages depends on the size of the pubis issue. The guidelines stipulate that for an issue upto Rs. 50 crores/ the number of lead managers should not exceed two, for issues between Rs. 50-100 crores maximum of three, for issues between Rs. 100-200 crores, four, for issue above Rs. 200 crores but less than Rs. 400 crores, five and for issues above Rs. 400 crores, five or as may be agreed by SEBI. Responsibilities of lead manager Lead managers should not agree to manage any issue unless his responsibilities relating to the issue mainly disclosures, allotment and refund are clearly defined. A statement specifying such responsibilities should be furnished to SEBI. Underwriting obligation Lead merchant banker in Category I should accept a minimum underwriting obligation of five per cent of the total underwriting commitment or Rs. 25 lakhs whichever is less. The lead Merchant Banker is responsible for verification of contents of a prospectus or the letter of offer in respect of an issue and is required to submit to SEBI, a due diligence certificate confirming that the disclosures made in the draft prospectus are true, fair and adequate to enable to investor to make a well informed decision. The lead manager undertaking the responsibility for refunds on allotment of securities would continue to be associated with the issue till the subscribers have received the shares or excess application money. The regulations provide for a procedure for inspection of Merchant Bankers for SEBI. Under these regulations, SEBI will be empowered to suspend a registration of a merchant banker in case he furnishes wrong or false information, fails to resolve the complaints of investors, indulges in price rigging or fails to maintain capital adequacy requirement. In case of deliberate manipulation or price rigging or cornering activities or deterioration in the financial position, the Board is empowered to cancel the registration of the Merchant Banker. The penalty of suspension or cancellation of registration can be imposed by the SEBI only after holding an inquiry and giving sufficient opportunity to the Merchant Banker of being heard. SEBI Guidelines for Merchant Bankers SEBI has issued a number of general instructions to authorized Merchant Bankers. These have been consolidated and codified in the form of a Circular issue by the SEBI. All registered Merchant Bankers are required to ensure compliance with the instructions contained in the Compendium, which particularly deals with the following matters: 1. Registration 2. Pre-Issue Obligations: Memorandum of Understanding Inter se allocation of responsibilities Submission of Draft Offer Documents Disclosures Application form Front, Outer Cover page Payment to other intermediaries Despatch of Issue Material Certificate relating to Promoters contribution.

3. Underwriters 4. Advertisements 5. Post Issue Obligations 6. General 7. Capital Structure

Submission of due diligence certificate A due diligence certificate about verification of contents of prospectus or the letter of an offer in respect of an issue and the reasonableness of the views excessed therein should be submitted to SEBI atleast two weeks prior to the opening of an issue by the lead merchant banker. Documents to be submitted to SEBI by lead Manager The lead manager should submit to SEBI, (a) Particular of the issue, draft prospectus or letter of offer, (b) Any other literature intended to be circulated to the investors including the shareholder and (c) Such other documents relating to prospectus or letter of offer as the case may be. These documents should be furnished at least two weeks before filing the draft prospectus or letter of offer with ROC or with Regional Stock Exchange. The lead manager has to ensure that modifications suggested by SEBI are incorporated. The lead manager undertaking the responsibility for refunds or allotment of securities in respect of any issue should continue to be associated with the issue till the subscribers have received share certificate or refund of excess application money. Insider trading Merchant bankers either directly or indirectly are prohibited from entering into any transaction in securities on the basis of unpublished price sensitive information. Acquisition of shares Merchant Bankers should submit to SEBI particulars of any transaction for acquisition of securities of a company whose issue is managed by them within 15 days from the date of entering into such transaction. Disclosures As and when required by SEBI, merchant banker has to disclose his, (a) Responsibilities with regard to the management of the issue, (b) Any change in information furnished which have a bearing on the certificate granted, (c) The names of the companies whose issue he has managed, (d) Breach of capital adequacy and (e) His activities as a manager, underwriter, consultant or adviser to an issue. SEBI Regulations Regarding Lead Managers And Merchant Banking Functionaries Lead Managers obligation As per SEBI, the Lead Managers will have to fulfil the following obligations: 1. To enter into a Memorandum of Understanding with the Company in the format given in appendix setting out their mutual rights, liabilities and obligations relating to the issue. 2. To ensure that the offer documents comply with all requirements as per the Companies Act, 1956, SEBI Guidelines and other relevant Notifications of the Government. 3. To furnish the due diligence Certificate in the prescribed format along with the draft offer documents. 4. To furnish to SEBI along with the draft offer document the following undertakings/certificates: a. An undertaking form The Chief Executive Officer of the Company that the complaints received In respect of the issue which would be attended to expeditiously and satisfactorily The Company Secretary that the Company will get the instruments of the proposed issue listed within the prescribe time period and would take necessary steps in time for the purpose.

The Company Secretary that the Company would apply in advance for the listing of the shares which would be generated by the conversion of Debentures/ Bonds (wherever applicable) The Company that the requisite funds for the purpose of dispatching refund orders / allotment letters / certificates by registered post will be made available to the Registrars to the Issue.

b. An undertaking from the Issue that the Promoters contribution, including premium, in full will be brought in advance before the issue opens. c. Certificate signed by the Company Secretary confirming the following: i. All refund orders against the previous issues have been dispatched to the applicants ii. All shares/debentures certificates have been dispatched to the allottees; and iii. The instrument(s) has been listed on the Stock Exchanges mentioned in the concerned offer documents. iv. An undertaking from the Lead Manager to get the issue fully under written to the extent of offer to the public and to include details thereof in the final prospectus. 5. To independently assess the capability and capacity of the various intermediaries to handle the issue and ensure that they are registered with SEBI. Where the Lead manager is the sole/one of the lead managers of an issue, he cannot act as Registrar to the said issue. Where the issuer of a capital is a registered Registrar to an Issue, the issuer will have to appoint on outside Registrar to process its issue. To ensure that the number of co-managers to an issue does not exceed the number of lead managers to the said issue and that number of advisors to the issue is only one.

6. To ensure that Bankers to the issue are appointed in the mandatory collection centres per Ministry of
Finance, Stock Exchange Division Guidelines. No. F. 1/36/SE/90 dated July 11, 1990. To ensure that wider proper and equitable distribution of public issue material takes place to avoid complaints of inadequate supply of such material from Stock Exchanges, brokers, under-writers etc.

7. To furnish to SEBI a certificate from a Chartered Accountant/Company Secretary in practice to the effect that
the promoters contribution including premium in its entirely has been brought in advance before the public issue opens. This certificate should be forwarded at least one dye prior to the date of opening of the issue accompanied by a list of names and addresses of friends, relatives and associates who have contributed to the promoters quota along with the amount of subscription made by each of them. 8. To accept a minimum underwriting obligation of 5 percent of the total underwriting commitment (of the issue) or Rs. 25 lakhs whichever is less. The outstanding underwriting commitments of the merchant banker shall not exceed 5 times his net worth at any pint of time. 9. To satisfy himself that the issue is fully subscribed before announcing closure of the issue. 10. To exercise due caution while finalizing the underwriting arrangement keeping in view the tract record of underwriters in meeting their commitments in the devolved issues managed by the lead manager. 11. To ensure that the underwriting obligations are carried out in the following manner: The Company shall within 30 days after the date of closure of subscription list communicate in writing to the Under-writer, the total number of shares/ debentures remaining unsubscribed, the number of shares/debentures required to be taken up by the underwriter of subscription to be procured thereof by the underwriter. The company shall make available to the Underwriter the manner of computation of underwriting obligation and also furnish a certificate in support of such computation from the Companys Auditors. The underwriter on being satisfied about the extent of devolvement of the underwriting obligation, shall immediately and in any case not later than 30 days after receipt of the communication under sub-clause (a) above, make or procure the applications to subscribe to the shares/debentures and submit the same together with the application moneys to the company.

In the even of failure of the underwriter to make the application to subscribe to the shares as required under clause (iii) above, the company shall be free to make arrangement(s) with one or more persons to subscribe to such shares without prejudice to the rights of the company to take such measures and proceedings as may be available to it against the Underwriter including the right to claim damages for any loss suffered by the Company by reason of failure on the part of the part of the underwriter to subscribe to the shares as aforesaid.

12. To ensure that the issuers relate an advertisement giving details relating to over subscription, basis of allotment, number, value and percentage of applications received alongwith stock-invest, number, value and percentage of successful allottees who have applied through stock invest, date of completion of refund orders, date of dispatch of certificates, date of completion of dispatch of cancelled stock invests directly to the investors by the Registrars and date of filing of listing application This advertisement should be released within 10 days from the date of completion of the various activities. 13. To confirm to SEBI within 7 days from the date of closure of the issue that the issue is subscribed to the extent of atleast 90 percent. 14. To ensure compliance report of 45 days and 90 days. Respectively submitted by the issuer. 15. To maintain close co-ordination with the Registrars to the Issue and ensure, compliance of all stipulations relating to the Issue. 16. Where there is reservation for NRIs in public issue, to ensure that copies of the prospectus with application forms are sent to the Indian Investment Centre, New Delhi. 17. To ensure compliance by the Registrars to an Issue in respect of handling of applications accompanied by stock invest.

18. Lead managers should note that if the offer documents modified in the light of SEBIs observations and duly
highlighting the changes made are not received by SEBI with 30 days from the date of conveying its observations (in writing or through discussions), the file will be treated as closed at SEBI. The Lead Managers will have to refile the documents afresh. 19. To ensure necessary compliance by the issuer with the Companies Act requirements with regard to appointment of whole time. Company Secretaries before filing of offer documents with Registrar of Companies. 20. To ensure that capital structure is presented as follows in the offer documents: Number of instruments, description, aggregate nominal value and Issue amount should be given in that order. Present issue offer document should be net of promoters contribution in present issue plus offer through offer document. Offer through offer document should be net of promoters contribution but inclusive of reservations/firm allotments to permitted reserved categories. Percentage of reservation permitted reserved categories should be reckoned only with reference to the offer document (i.e. amount offered to the public through the offer documents. Net offer to the public will be the offer made to Indian public excluding reservations/ firm allotments. If any firm allotment has been made to any person(s) in the specified categories, no further application from that person(s) [excepting persons from employees category] should be entered. Similarly, where reservation ahs been made to specific category(ies), person(s) belonging to that category(ies) [except employees and shareholders categories] should not make application in the public offer category. Where reservations have been made to shareholders of group companies, name of group companies whose share-holders are covered should be disclosed in the offer document. Such information should also be contained in the Memorandum 2A. An applicant in the public category can make an application for that number of securities only which is offered to the public. Similarly, in the case of reserved categories, no single applicant in the reserved category can make an application for a number of securities which exceeds the reservation. Notes under capital structure relating to promoters contribution and lock-in-period should clearly state the date of allotment, number of instruments, face value. Issue price, percentage to total and date upto which

locked in, together with a statement that the same has been brought in, in multiples of specified minimum lot and from persons falling within the definition of promoters as per SEBI guidelines. Further, eligible shares issued last to the core promoters should be locked in first for a period of 5 years. In case the already issued capital includes shares issued for consideration other than cash, complete details about the manner in which such shares were issued should be incorporated immediately after the capital structure presentation.

21. In the case of unlisted companies going public for the first time, bonus shares issued to the promoters out of free reserves built out of the genuine profits or share premium collected in cash only will be allowed to be included for the puroses of reckoning minimum promoters contribution. In other words, where such bonus shares have been issued out of revaluation reserve or reserves without accrual of cash resources during the preceding 3 accounting years, the same will not be considered eligible for reckoning promoters contribution. In case of all companies (including partnership firms converted into companies and going public), where shares (other than by way of bonus) have been issued to the promoters for consideration other than cash during the preceding 3 accounting years the same will be reckoned for promoters contribution only if they satisfy the following. No revaluation of assets is involved in such a transaction The shares have been issued only at the same price at which the public issue is proposed.

The lead managers should ensure that in the case of first public issue by an existing unlisted or new company, the promoters partake to the required extent in each class of securities which are offered to the public and that an offer to the public is made to the minimum required extent of each class of securities which are sought to be listed, in terms of rule 19(2) (b) of Securities Contracts (Regulation) Rules.

Lesson 3 Mutual Funds Objective Reading this lesson the students will be in position to understand the concept of objectives of Mutual Funds, Mutual Funds in India, Phases of Development, Structure of Indian Mutual Funds, Types of Schemes, Regulations regarding Mutual Funds, Merits of Mutual Funds and Limitations. Contents Mutual Funds Objectives Worlds Leading Mutual Fund Operations Mutual Funds in India Private sector mutual funds Registration of Mutual Funds Phases of Development Structure of Indian Mutual Funds Types of Schemes Performance of Mutual Funds Regulation regarding Mutual Funds Merits of Mutual Funds Limitations

In India, mutual fund came into being through the Unit Trust of India. UTI came into existence in 1964 and pioneered the concept of units in India. However, the first mutual fund scheme in the real sense of the term had to wait until 1986 when UTI introduced the Master Share. The response from the investors was splendid and its success heralded the birth of other mutual funds. Now mutual funds are operated by public sector organisation like the State Bank of India, PNB, Canara Bank, Bank of India, Indian Bank, LIC, GIC, ICICI and IDBI through their wholly owned subsidiaries and also by private sector operators such as the Alliance Capital, 20th Century finance etc. The latest entrant is the IDBI with a novel feature of safety net, whereby the original subscribers are assumed of protection of face capital value, in the case of the scheme faltering. There are about 20 operators, providing as many as 250 schemes. 50 schemes are quoted in stock exchanges, 90 schemes are repurchased while the rest are neither traded in stock exchange nor repurchased. Mutual funds are subject to stock market fluctuations, which is turn are caused by several factors. Objectives The objectives of mutual funds are: To provide an investment opportunity for the investors, especially the small income group of people to participate in the growing corporate securities market though not directly, but in an indirect manner. To provide a return that is more than bank deposit rate, to the subscribers without corresponding rise in the level of risk. To mobilize the savings of the public and channel them into productive investments. To provide for different investment objectives like current return, capital appreciation, tax benefit or a mixture of these and

To strengthen the capital market by adding the mutual and dimension to the same.

Worlds Leading Mutual Fund According to U.S. News and world report, Indias largest mutual fund. Unit Trust of India is far behind worlds leading mutual funds as is revealed from the following statistics. Mutual Fund Fidelity Vanguard Merrill Lynch American Funds Franklin Templeton Unit Trust of India Assets ($ in billion) 295.0 132.0 114.2 102.0 56.3 20.0 No. of Schemes 210 90 128 28 102 59 Expenses ratio (%) 1.20 0.30 0.40 0.80 0.80 0.54

Italy recorded a growth of 200% in Mutual Fund industry during 1980s and 1990s, Japan 600%, U.K. 350% and Germany about 320%. M.F. industry has also shown good growth in countries like Canada, South Africa, Mexico and Australia. In developed countries, hardly any direct investment take place since Mutual Funds dominate the scene and the level of institutionalization is very high.The Mutual Fund industry in U.S.A. is 70 years old. Mutual funds in developed nations are a parallel investment instrument to banks, offering near identical security, with assured higher returns. The first American Mutual Fund to hit the Indian Market was Morgan Stanley in January, 1994. In just 72 hours, Morgan Stanley mopped up Rs. 900 crores and retained it fully as against its announcement that it would retain Rs. 300 crores on a first come first serve basis. Internationally, mutual Funds have been in a position to ensure acceptable returns and sustain level performances. Investments in mutual funds, commodity funds and pension funds have been on rise all over the world. All investments are routed through mutual funds. American Mutual Funds have about $ 2 trillion savings from about 40 million Americans. American Mutual Funds declare as much of information as possible. For example, Mutual Funds are required to make public their correspondence with companies they have invested in. Declaration of quarterly results, display of portfolio on a quarterly basis to investors and daily computation of net asset values are the other major disclosures. The funds discuss their country weightings for the second quarter and their view of the stock market. By defining their investments policies they intend to let the investor know his risks. American Mutual Funds also engage in practice of trading on the margins, which involved a number of trades in any scrip daily and over a month, by making a small down payment of the total cost of investment. The gains are taken and losses replenished. The other area of investment is asset backed derivatives like mortgage backed securities. Such practice can lead to collapse of a fund any time.In US, John Hanwcks Mutual Fund prospectuses are detailed, often running to 32 pages but written in language understandable to an average investor. Its prospectuses contain an easy-to-understand section explaining a funds risks and bar charts to show how fund performs in different markets. It accurately and succinctly describe the risks and the investment strategies of its funds. Assets of few Leading Mutual Funds World Wide Funds Unit Trust of India Franklin/Templeton American Funds Men-ill Lynch Vanguard Fidelity Asset ($ billion) 20.00 56.3 102.00 114.2 132.00 295.0 No. of Schemes 59 102 28 128 90 210

The above data reveals that whereas Fidelity alongwith Merrill Lynch of US accounts for US $ 409.20 billion. Unit Trust of India having history of over 30 years just manages assets worth US $ 20 billion only.

Operations The mutual fund operation works this way. The mutual fund management designs a scheme with specified goal, viz, income, growth, tax off or mixture of these and floats the scheme after meeting the legal formalities thereto. The public are invited to subscribe to the scheme. Baring a handful of schemes, all other schemes just require a minimum exposure of Rs. 500, at present, per application. So many can participate in mutual fund schemes unlike public issues of shares requiring minimum exposure of Rs. 5000. The collected sum is invested, on behalf of the subscribers to the schemes, by there fund managers in corporate, money market and other securities. The capital gains realized by dealing in the securities and interest and dividend earned from the scrips are distributed or reinvested after meeting fund expenditures, subject to the nature of the fund. In an income scheme major portion of earnings is distributed as dividend on the units of the funds, while in the case of growth scheme, the earnings are mostly ploughed back. Mutual Funds in India In India, the only mutual fund operating for a long time since 1964 was the Unit Trust of India (UTI). It is an openended mutla fund, whose units can be sold and repurchased at any time. It is in the public sector enjoying a monopoly position and some unique tax benefits such as exception from income-tax of its entire income. UTI was alone in the field until 1987. Mutual Funds have been established since 1987 by the public sector banks following an amendment to the Banking (Regulations) Act in 1983, which empowered the RBI to permit the banks to carry on non-banking business such as leasing, mutual funds etc under section 6 of this Act. The growth of the mutual fund industry in India was very slow till the end of the 1980s, primarily due to government controls and over regulations of the financial services industry. Severe entry barriers restricted the growth of the mutual fund industry in terms of number of players, mobilization of savings and creating of assets. This was the Scenario till 1986-87. The mutual fund market in India was solely controlled by a single institution, namely Unit Trust of India which was formed by the Government of India under an Act of parliament. UTI commenced operations in July 1964, with a view to encourage savings and investment and participation in the income, profits and gains accruing to the corporation from the acquisition, holding, management and disposal of securities.Today there are three different types of players operating in the Indian market. UTI, non-UTI, Public Sector Mutual Funds and private sector mutual funds (including foreign mutual funds). Private sector mutual funds Performance of existing mutual funds promoted by nationalized banks had been viewed with interest and with the entry of private sector mutual funds, this industry is all set for explosion. Government allowed entry of private mutual funds in the country in 1992 buy none of the private mutual funds has commenced operations yet although SEBI has cleared a number of private mutual funds. The following have launched their mutual funds so far Kothari Pioneer Mutual Fund 20th Century Mutual Fund ICICI Mutual Fund IDBI Mutual Fund Morgan Stanley Growth Fund Alliance 1995 GIC Mutual Fund JM Mutual Fund SRF Mutual Fund Biria Mutual Fund ITC Threadneedle Mutual Fund IDBI Mutual Fund Templeton Mutual Fund Jardine Fleming Mutual Fund

Entry of private mutual funds has encouraged competition in the financial sector and improved the existing investment climate, both qualitatively and quantitatively. Many more companies, which have announced MF activities, are companies with proven tract record. The entry of private M.F. will also ensure better accounting standards, policies, disclosures and transparency in accounts and operations. Registration of Mutual Fund All mutual funds are required to obtain a certificate of registration from SEBI. The application shall be made by the sponsor in Form A alongwith a fee of Rs. 25,000. The application should be complete in all respects and must conform to the instructions specified in the form. The sponsor may be required to furnish further information or clarification or to appear personally before the Board, The Board shall consider the following aspects, before granting the certificate. The sponsor has a sound track record and experience of at least 5 years, professional competence, financial soundness and general reputation of fairness and integrity. Mutual Fund is in the form of a Trust and managed by an Asset Management Company (AMC) with a custodian to keep custody of the securities. Sponsor contributes at least 40% to the net worth of the AMC, and The sponsor or any of its directors or the principal officer of the mutual fund has not been convicted of an offence.

If the board is satisfied, it shall grant a certificate in From B, subject to certain terms and conditions. The Mutual Fund shall pay the registration free of Rs. 25 lakhs. Besides, an annual service fee of Rs. 2.5 lakhs shall be payable for every financial year following the year of registration. If the mutual fund fails to pay the annual fee, the Board may prohibit it form launching an new scheme till the fees is remitted. If the applicant does not satisfy the requirement of registrations, the Board shall reject the application and communicate the order of rejection to the applicant. Appointment of a trustee A Mutual Fund shall be constituted as a trust under a registered trust deed the managed by a company to be appointed as Trustee or by a Board of Trustees. The appointment of a Trustee shall be subject to certain terms and conditions. Asset management company The application for approval of the AMC shall be made in Form D alongwith the Memorandum and Articles of Association. The sponsor or the trustee shall appoint an AMC approved by SEBI, to manage the affairs of the Mutual Fund. SEBI shall grant approval to an AMC after taking into account certain considerations and subject to certain conditions. The minimum net worth of an AMC shall be Rs. 10 crores. The AMC shall neither act as a Trustee of any mutual fund or as an AMC for any other mutual Fund, nor undertake any other business activity which is in conflict with the activities of the mutual fund. Custodian services The Mutual Fund shall have a custodian who is not associated with the sponsor or its associates. Schemes The schemes shall be announced by the AMC after approval of the Trustees and filing a copy of the offer document with SEBI. The draft particulars of the scheme, prospectus, letter of offer and relevant material shall be submitted to the SEBI for its approval alongwith a filing fee of Rs. 25,000. Any modifications required by the SEBI should be carried out. The letter of offer and other advertising materials should be in conformity with the advertisements code given under he regulations. Listing shall be compulsory for a close-ended scheme within 6 months. Except where the scheme provides for re-purchase facility. A close-ended scheme may be converted into open-ended if the offer documents make disclosure for the same and a majority of unit holders give he consent to that effect. The maximum offering period for all schemes except equity linked saving schemes, shall be 45 days. In case the amount collected falls short of the minimum subscription amount, the entire amount should be refunded not later than six weeks fro the date of closure of the scheme. If this is not done, the fund is required to pay an interest of 15% p.a. from the date of expiry of six weeks. Investment The Mutual Funds can invest only in transferable securities in the money and capital market or any privately placed debenture or securitized debts. The investments should be made subject to certain restrictions such as

Investments under all schemes do not exceed 10% of any companys paid-up capital carrying voting rights. Curbs on transfer of investments from one scheme to another, and inter-scheme investment or borrowing, Curbs on borrowings by a mutual fund to finance its investments. Besides, mutual funds cannot deal in option trading, short selling or carrying forward transactions in securities.

Account and reports The mutual funds are obliged to maintain books of account, expenses, appropriation of expenses among the individual schemes, the limit on expenses on the AMC that can be charged to the mutual fund, provision for depreciation and band debts. Mutual funds are under an obligation to publish schemewise annual report and half-yearly unaudited financial results, and furnish to SEBI annual report, audited annual statements of accounts, six monthly unaudited accounts, quarterly statements of movements in net asset value and quarterly portfolio statement to SEBI. The mutual fund should ensure adequate disclosures to the investors. Inspection by the board SEBI is empowered to appoint one or more persons as inspection authority to inspect the mutual fund, the trustees, AMC and custodian. SEBI is empowered to appoint an auditor to investigate into the books of account or the affairs of the mutual fund. SEBI can order suspension of registration in case of violation of the provisions of the SEBI Act or the regulations. The penalty of cancellation of registration can be imposed in case of deliberate manipulation or price rigging or in the event of financial position of the mutual fund deteriorating. The Boards Adjudicating Officer may impose penalty for any offence under the SEBI Act. Besides, the Board may order suspension of any scheme of the Mutual Fund for a period upto one year. However, no order shall be passed without giving an opportunity of being heard. Phases of Development In our country the mutual fund industry has witnessed three interrelated stages of development in terms of entry of players. Phase I - July 1964 November 1987 Phase II November 1987 October 1993 Phase III October 1993 on wards Phase I This period was market by the operations of a single institution, UTI, which prepared ground for the future-mutual fund industry. The first decade of UTIs operatins (1964-74) was the formative period. The second phase of operations (1974-84) was one of consolidation and expansion. During 1984-87, innovative and widely accepted schemes were launched. UTI was one of the few organizations to prepare it self fully to face the emerging challenges. In the following years it launched all round diversification progarmmes through backward and forward integration in order to retain its position as the undisputed market leader. Phase II This period was marked by the entry of non-UTI public sector mutual funds in the market, bringing in competition. With the opening up of the economy, many public sector financial institutions established mutual funds in India. The mutual funds industry remained the exclusive domain of public sector in this period. The entry of public sector mutual funds created waves in the market and attracted small investors. The years 1992-93 and 1993-94 saw a decline in collections by the public sector mutual funds. There were two reasons behind the fall in collection. First, SEBI had prohibited mutual funds form launching any scheme with an assured income. Second, according to SEBI Mutual Funds regulation, 1993 Indian mutual funds were to form Asset Management Companies (AMC). However, since UTI was not under the purview of SEBI, it was not prohibited from launching schemes with assured incomes. Before 1989, there were no regulatory guidelines for the mutual funds industry in India. The first such guidelines for setting up and regulating mutual funds were issued by the Reserve Bank of India in October 1989, but they were applicable only to mutual funds floated by banks. Comprehensive guidelines were issued by the Government funds floated by banks. Comprehensive guidelines were issued by the Government of India in June 1990, covering all mutual funds and making them mandatory to be registered with SEBI. These guidelines were revised and the Securities and Exchange Board of India (Mutual Funds), Regulations, 1993 came into effect from 20 January, 1993. Rules for the formation, administration and management of mutual funds in India were clearly laid down. The regulations made the formation of AMC and the listing of close ended scheme compulsory. With a view to

protecting investors rights, disclosure norms were also tightened. Another significant development during the period was the opening up of the mutual funds market to the private sector. Phase III A new era in the mutual fund industry began with the entry of private sector funds in 1993, posing a serious competition to the existing public sector funds. The new private sector funds have distinctive operational advantages. They are: 1. Starting of mutual funds has been easier for them because infrastructural inputs created by the public sector mutual funds were already available. 2. Private sector funds are able to attract the best managerial talents from the public sector. 3. Most of them are jointly floated by Indian organisation along with experienced foreign asset management companies, facilitating access to the latest technology and foreign fund management strategies. Between 1993 and 1995, further regulatory measures were introduced. Mutual funds are allowed to invest in money market instrument up to 25 percent of resources mobilized. The Government of India has allowed NRIs and Overseas corporate Bodies (OCBs) to invest in LTTI and other mutual funds (in both primary and secondary markets) on a fully repatriable basis, within the existing ceiling. The practice of reissuing of units of close ended schemes has been dispensed with. Mutual funds have been allowed to launch income schemes with assured returns for one year at a time. Mutual funds have been allowed to enter into underwriting activities to augment their resources. The practice of obtaining prior approval for advertising by mutual funds has been dispensed with. Mutual funds are allowed to buy-back their own units from the secondary market in case they are traded at a substantial discount to NAV. With effect from 1 December 1993, new issues have been allowed to reserve 20 per cent of public issue for mutual funds.

The formation and operation of mutual funds in India is solely guided by the Securities and Exchange Board of India (Mutual Funds) Regulation, 1993 which came into force on 20 January, 1993. The regulations have since been replaced by the securities and Exchange Board of India (Mutual Funds) Regulations, 1996, through a notification on 9 December, 1996. Structure of Indian Mutual Funds A mutual fund comprised four separate entities, namely sponsor, mutual fund trust, AMC and custodian. As per SEBI, Regulations, 1996, a mutual fund is to be formed by the sponsor and registered with SEBI. A mutual fund shall be constituted in the form of a trust and the instrument of trust shall be in the form a deed, duly registered under the provision of the Indian Registration Act, 1908, executed by the sponsor in favour of trustees named in such an instrument. Growth of Indian Mutual Funds Status and occupational classification of Mutual Funds, Investor in India are given in the following tables to understand the readers. Types of Schemes Mutual funds offer a variety of schemes to investors so as to provide steady income or growth or both. They differ according to the investment policies. The funds like individual investors, have different goals. If the investor, who will first ascertain has investment objectives, thinks that the units of a fund have an investment goal paralleling his objectives, then he will go for that specific type of fund. Mutual Funds are broadly classified into four categories viz., 1. On the basis of investments portfolio. 2. On the basis of function 3. On the basis of geographical areas. 4. On the basis of tax benefit

On the basis of investment portfolio On this basis mutual funds may be classified into income funds, growth funds, money market funds, leveraged funds, balanced funds, bond funds, stock funds, specialized funds, performance funds, multi-purpose funds, real estate funds and specialty funds. Income funds/schemes It seeks to maximize yearly income in the form of dividend distribution. Income schemes can be close or open-ended. In order to obtain regular flow of income, these funds invest around 70-80 percent assets in income generating securities such as debentures and bonds. Up to 31 March 1996, 62 income schemes had mobilized substantial per cent of the total funds of all schemes. Examples of this type of schemes are Unit scheme 95, Birla Income-Plus (I) Ind Jyothi B, MIP 96, Can stock. Growth Funds Under these funds there is no guarantee or assurance of returns. The funds seek to achieve maximum capital appreciation and invest around 80 per cent in equities Growth schemes are usually close ended and listed in stock exchanges. By the end of March 1995, 55 Growth schemes had mobilized 18.4 percent of the total fund. Example of this include Ind Ratna, Grandmaster Canbonus, Apple Goldshare, ICICI Premier. Balanced Funds Long term growth of both capital and income is the investment objective of these funds and it is sought to be attained through the purchase of bonds, preferred stocks and equity shares or common stock. They are termed balanced funds due to the policy followed by these funds in trying to balance portions of their investments portfolio among these different securities in some fairly constant proportions. Money market Funds Money Market Funds are open-ended mutual funds that trade only in short term debt instruments. They mobilize savings from small investors and invest in short-term debt instruments like treasury bills, commercial papers, certificates of deposits, bankers acceptance and short-term loans. Small investors who are otherwise notable to invest in these instrument due to the minimum denomination factor can buy a portion of these through money market funds. They are also known as liquidity or liquid asset funds. Leveraged funds They are also referred to as borrowed funds as they are used in order to increase the size of the value of a portfolio and thereby benefit the unit holders with gains exceeding the cost of borrowed funds. Bond Funds Under this funds are generally invested in corporate and government bonds. Safety of principal, stable earnings and lower risk are the features of these funds. Stock Funds It holds equity shares and convertible bonds as investments. Generally capital appreciation or good dividend is the sought goal. There is risk and hence probability of high return. Performance Funds Performance funds holds investments in scrips of unseasoned companies with high P.E. ratios and also price volatility. It is a speculative type. Specialized Funds Under this, funds are invested in a small group of concerns or industries. Risk is more due to negligible diversification. Multi purpose funds Multipurpose funds invest in a wide spectrum of diverse nature of scrips so that growth, income, speculative benefits, leverage benefits, etc. can be reaped. Specially Funds Specialty funds invest in goods track record companies which offer handsome growth and income opportunity.

Real-estate funds Funds are invested in real estate ventures. On the basis of function On the functional basis, mutual funds may be classified into open ended and close-ended fund. Open-ended A mutual fund is said to be open-ended, if the period of the fund and the target amount of the fund are not defined as specified. The holders of the units in the fund can resell them to the issuing mutual fund organisatoin at any time. Open ended mutual funds can sell an unlimited number or units and thus keep going larger The open-ended mutual funds can repurchase their own units. The minimum corpus for an open ended mutual fund Rs. 50 crores as per SEBI guidelines. UTI US 64 and 95, can bank Mutual Funds Canganga, Kothari Pioneer Prima etc are open-ended funds. Closed-ended A mutual fund is said to be close-ended if the period of the fund and target amount of the found are definite and specified. Its size in terms of number of units is fixed. The minimum corpus for a close-ended fund is Rs. 20 crores. Canbonus, Mastershare are examples of close-ended funds. On the basis of geographical area On this basis mutual funds may be domestic or off-share funds. Most mutual funds are domestic and funds are mobilized within the country itself. Off-share mutual funds mobilize resources from foreign countries in foreign currency. UTI India Funds is the first off-shore fund-floated in 1986. Later India Growth Fund, Common wealth Equity Fund, were floated. Performance of Mutual Funds in India As already noted UTI was the only Mutual fund in India till 1987 when State Bank of India and Canara Bank established their Mutual Funds followed by other banks and financial institutions. Till 1993 there were 7 mutual funds, all established in the public sector, which had launched 116 schemes with Rs. 8011 crore asset under their management. UTI had raised Rs. 387,976 crore asset under its management. Since then the number of mutual funds has grown to 40 as on 31st March 1999. The number of schemes introduced by them (including those of UTI) has increased to 196. The assets managed in these schemes have increased by 86% to Rs. 80,590 crores. Some foreign asset management companies have also set up joint ventures to manage some of the domestic mutual funds whose number is 9. The period 1987-94 marked the rapid expansion of mutual funds in India. All Mutual Funds in India raised funds in the market as shown in Table below. Resources Mobilised by all Mutual funds (1964-96) Period 1964-87 1987-92 1992-96 Source :Mutual Funds 2000 Report p.5 It is of clear manifestation that the mutual funds have achieved spectacular success in raising funds in the market since 1987. But UTI still commands an unique position amongst the mutual funds and has mobilized 83% of the total funds raised by all mutual funds, as is evident from the following table. The share of Public Sector Mutual funds has been 13% while private sector mutual funds could raise only 4% of the total funds Resources Mobilised 4,563.68 32,916.52 43,109.80 Cumulative Resource Mobilised 4,563.98 37,480.20 80,590.00

Cumulative Resources Mobilised by Mutual Funds 1986-96 Upto Sponsor of Mutual Fund Public Sector 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1624.00 1460.00 1683.97 5674.51 8011.21 8407.21 10550.21 10667.00 916.00 3000.00 3223.00 1624.00 1460.00 1683.97 5674.51 8011.21 9323.21 13550.21 13890.00 Private Sector Sub Total 4563.68 6738.81 11434.65 1765.92 21376.48 31805.69 38976.81 51978.00 61500.00 66700.00 4563.68 6738.81 13455.65 19110.92 23060.45 37480.20 46988.20 61301.21 75050.21 80590.00 UTI Total

Source: Mutual Funds 2000 Report p.5 With the establishment of mutual funds in the private sector or as joint ventures with foreign promoters, competitions amongst mutual funds have greatly intensified. The tax exemption granted by the Government to the Dividends received from mutual funds since. Resource Mobilised by Mutual Funds 1993-94 to 1998-99 (April-March) Mutual Fund 1. Bank Sponsored ( 1 to 6) 1.SBI MF 2.Cabbank MF 3.Indian Bank MF 4.BOI MF 5.PNB MF 6.BOB MF II Fls Sponsored (7 to 9) 7.GIC MF 8.LIC MF 9.IDBI MF III Unit Trust of India 93-94 148.11 105.00 43.11 238.61 227.23 11.38 9,297.52 (7,453.00) 94-95 765.49 218.26 205.55 94.40 53.49 155.95 37.84 576.29 319.68 68.97 187.64 8,611.00 (6,800.00) 95-96 113.30 76.00 2.71 10.32 24.27 234.81 64.68 116.51 53.42 -6,314.00 ((2,877.00) 133.03 -5,832.86 96-97 5.90 2.61 1.69 1.60 136.85 -32.40 169.25 3,043.00a (855.00)a 863.58 -2,036.67 97-98 P 242.96 190.11 52.85 205.55 -19.20 99.75 125.00 2,875.00 (2,592.00) 98-99 P 253.18 248.04 5.14 576.42 17.63 377.54 181.25 170.00 (1,300.00)

IV

Private Sector MFs

1,559.52 11,243.24

1,321.79 11,274.57

678.29 4,001.80

2,090.97 3,089.97

Total (I+II+III+IV)

Source : (Report of Development Banking in India 1997-98)

Notes 1. P- Provisional applicable a. Excludes re-investment sales 2. For UTI, the figures are gross value (with premium) of net sales under all domestic schemes and for other mutual funds, figures represent net sales under all on-going schemes. 3. Figures in brackets in case of UTI pertain to net sales for face value. 4. Data exclude amounts mobilized by off-shore funds and through roll over schemes. April 1999 has made investments in mutual funds quite attractive to the investors. The above table shows the resources raised by different categories of mutual funds during recent years. The above table clearly shows the popularity earned by the Private Sector mutual funds amongst the investing public during recent years. During 199596 and 1996-97, the mutual funds as a whole experienced negative growth in the funds mobilized, but private sector funds recorded positive growth. During 1998-99, they shared about two-thirds of the resources mobilized by all the mutual funds. During the first nine months of the fiscal 1999-2000 private sector mutual funds had a net inflow of Rs. 7819 crore, as against a net outflow of Rs. 604.4 crore in the case of public sector funds. The increased inflows to mutual funds are due to good performance of the funds and the encouragement given by the Government in the form of tax benefits. A perceptible shift of investible funds from bank deposits to mutual funds is also a significant development. Spectacular growth in 1999-2000 The financial year 1999 2000 witnessed significant changes and spectacular growth in the mutual fund industry in India. The assets under management in the mutual fund industry crossed the Rs. 1,00,000 crore mark in January and closed at Rs. 1,13,005 crore in March 2000. The dramatic spurt is evident from the inflows going up from Rs. 18,701 crores in 1997-98 to Rs. 21,377 crores in 1998-99 and to Rs. 59,739 crores in 1990-2000. Thus there has been a rise of 179 percent over 1998-99. Mutual Funds thus emerged as the preferred investment vehicle of institutions and a sizeable section of retail investors. It may be attributed mainly to the tax exemption granted to dividends from Mutual Funds in the Budget of 1999. Assets under Management of Funds Rs. Crores Material Fund Private Sector UTIs Banks Institutions Total Change over Previous Year & March 1997 3055 3886 8569 65510 March 1998 4086 57554 7344 68984 5.3 March 1999 6860 53320 8292 68472 (0.7) March 2000 25046 76547 11412 113005 65.0 CARG (%) 101.6 12.4 10.0 19.9

CARG: Compounded Annual Rate of Growth Source: Business Line, dated 7.5.2000. The share of the Unit Trust of India in the assets under management has declined steadily from over 80 percent three years ago to around 67% in March 2000. The share of the private sector funds has risen from less than 5 percent in March 1997 to 22.2 percent in March 2000 as is shown in the above table. The share of bank/institutionsponsored funds suffered a marginal decline. Amongst the private sector funds, those with foreign institutional investors linkage showed good results. The gap between them and the rest in the private sector is gradually widening. There has been a growing preference for open-end funds which accounted for 60.9% of the assets under management. Close end funds accounted for 39.1% as on 31st March 2000. Assets with open-end funds increased from Rs. 37,240 crore to Rs. 68.833 crore in March 2000 accounting for 72% of the increase in assets. Assured return funds accounted for 18 percent and other closed end funds for the remaining 10%.

Assets under Management by category of Funds March 2000 Open End Amount Rs. Income Schemes Assured Schemes Growth Schemes Balanced Schemes Gilt Funds Liquid Funds Money Market Tax Savings Funds Total Type Wise 17,478 25,534 2370 1529 698 752 68833 60.9 20,472 Share % 29.7 0.0 25.4 37.1 3.4 2.2 1.0 1.1 100.0 2284 44172 39.1 Close End Amount Rs. 4968 22564 13133 1223 Share % 11.2 51.1 29.7 2.8 0.0 0.0 0.0 5.2 100 Amount Rs. 25440 22564 30611 26757 2370 1529 698 3036 113005 100.0 Total Share % 22.5 20.0 27.1 23.7 2.1 1.4 0.6 2.7 100.0

Source : Business Line dated 7.5.2000 Amongst the closed-end fund, assured return and equity funds account for nearly 90% of the assets under management. Amongst the open-end funds, there is a more even distribution equity funds accounted for 28.5%, Income fund 29.7% and balanced funds 37.1% including US64. During the fiscal 1999-2000, the inflows during January-March 2000 at Rs. 26,102 crores were higher than the inflows for any full year in the past. Funds with linkage with foreign institutional investors accounted for above 60% of he fresh sales in 1999-2000. This may obviously be attributed to better funds management by such Mutual Funds.Equity oriented Mutual Fund captured a dominant share in the mutual fund assets from debt-oriented mutual funds because of the booming equities market. The share of Balanced funds in the total assets grew from 2% in March 1999 to 23% in February, 2000. Regulations regarding Mutual Funds 1. Mutual funds cannot deal in option reading trading, short selling or carrying forward transactions in securities. 2. They can invest only in transferable securities in the money and capital market or any privately placed debenture or debt securities. 3. Mutual funds are required to be formed as trusts and managed by separately formed asset management companies. the minimum net worth of the asset management company is stipulated at Rs. 10 crore out of which the minimum contribution of the sponsor shall be 40%. 4. Restrictions to ensure that investments under all schemes do not exceed 10% of any companys paid up capital carrying voting rights. 5. Curbs on the transfer of investment from one scheme to another and borrowing to finance investment.

6. SEBI will grant registration to only those mutual funds which can prove an efficient and orderly conduct of
business. Parameters for deciding this will include the tract record of sponsors, a minimum experience of five years in the relevant field of financial services, integrity in business transactions and financial soundness. 7. The application forms for granting registration, seeking detailed information of the sponsor, trustees of the fund and the AMC. 8. The advertisement code for marketing schemes of the mutual funds, the contents of the trust deed, investment management agreement and the schemewise balance sheet have to be in prescribed form. 9. The mutual fund should have a custodian, not associated in any way with sponsor or its associates.

10. In case the amount collected falls short of the minimum prescribed, the entire amount should be refunded not later than six weeks fro the date of closure of the scheme. If this is not done, the fund is required to pay an interest of 15% per annum from the date of expiry of six weeks. 11. Listing shall be compulsory for a close-ended scheme within 6 months, except where the scheme provides for repurchase facility. 12. A close-ended scheme may be converted into open-ended if the offer document makes disclosure for the same and a majority of unit holders give their consent to that effect. 13. The maximum offering period for all schemes except equity linked saving schemes, shall be 45 days. 14. The mutual funds are obliged to maintain books of accounts, expenses, appropriation of expenses among the individual schemes, the limit of expenses of the asset management company that can be charged to the mutual fund, provision for depreciation and bad debts. 15. Mutual funds are under an obligation to publish scheme-wise annual reports and half-yearly unaudited financial results, and furnish to SEBI annual reports, audited annual statements of accounts, six monthly unaudited accounts, quarterly statements of movements in net asset value and quarterly portfolio statement. 16. The mutual fund should ensure adequate disclosures to the investors. 17. SEBI is empowered to appoint one or more persons as inspecting authority to inspect the mutual fund.

18. SEBI is empowered to appoint an auditor to investigate into the books of accounts or the affairs of the mutual
fund. 19. SEBI can impose suspension of registration in case of violation of the previsions of the SEBI Act, 1992 or the regulations. The penalty of cancellation of registration can be imposed in case of deliberate manipulation or price rigging or in the event of financial position of the mutual fund deteriorating. 20. The SEBI may order suspension of any scheme of the mutual fund for a period upto one year. Mutual funds allowed to make rights issue The SEBI has decided to allow rights issues by mutual funds for closeended schemes provided the existing unit holders are offered repurchase facility at net asset value (NAV) related price. Merits of Mutual Funds The following are the advantages of mutual fund schemes Safety of Principal Stable and fair return Risk reduction Diversified Portfolio Investors are relieved of he botheration of managing investments Board-basing of capital market Benefit of professional skill of fund managers Capital formation takes effect Small and pawn sophisticated investors can benefit from mutual fund Variety of scheme are available to choose from Some schemes have excellent liquidity and

Limitations Most Mutual fund schemes lack liquidity. Liquidity means ability to realize the asset in cash without loss of value and time. By this yardstick, most schemes are illiquid. The stock exchange quoted schemes also suffer liquidity since their prices are far below the published net assets value. mutual funds are subject to market fluctuations. The problem is, in a growing market, mutual funds grow less than the market, as it should not be. But in a declining market they slide down keeper than the market, which should not be case. It is reported, at any point of time, sellers outnumber buyers in the case of mutual funs. This is due to upward rigidity in a booming market and downward flexibility of mutual fund values in a bearish market. Mutual funds lack transparency. Safety net is not available, i.e. schemes quote below par value. Not all mutual funds are well managed.

Lesson 4 Credit Rating Services Objective Reading this lesson the students will be in a position to understand the meaning and objectives of Credit Rating, Approaches to Credit Rating, Significance of Credit Rating, Quality of rating, Rating Process, Countrys rating, Credit Rating Agencies in India, Rating Methodology, International Credit Rating Institutions, Standard & Poors Rating (S&P) and Moodys Investor Services rating symbols. Contents Origin USA is the birthplace of credit rating where it was introduced in 1909. Credit rating uptill recently was not adopted voluntarily in the corporate circles and capital markets of India despite its various advantages to all the constituents of Indian industry and capital market, the reasons for which may be lack of information relating to rating procedures, rating process, data requirements, etc. which could have motivated corporate entities to resort to credit rating. Meaning Credit rating is a codified rating assigned to an issue by authorized credit-rating agencies like CRISIL, CARE and ICRA. These agencies have been promoted by well-established financial Institutions like IDBI, ICICI. Unit Trust of India and reputed banks/finance companies, Credit-rating is a relative ranking arrived at by a systematic analysis of the strengths and weaknesses of a company and debt instrument issued by the company, based on financial statements, project analysis, creditworthiness factors and future prospectus of the project and the company appraised at a point of time. Objectives of Credit Rating Credit rating alms to (i) provide superior information to the investors at a low cost; (ii) provide a sound basis for proper risk-return structure; (iii) subject borrowers to a healthy discipline, and (iv) assist in the framing of public policy guidelines on institutional investment. Thus, credit rating financial services represent an\exercise in faith building for the development of a healthy financial System. Approaches to Credit Rating As a technique for independent examination of the investment worth of financial securities as an input to investment decision-making, the process of credit rating usually involves use of one or more of (i) implicit judgmental approach and (ii) explicit judgmental approaches and (iii) statistical approach. While implicit judgmental follows (beauty-contest Origin Meaning Objectives of Credit Rating Approaches to Credit Rating Significance of Credit Rating Quality of rating Rating Process Countrys rating Credit Rating Agencies in India Rating Methodology Compulsory Rating of Debt Issue Drawbacks Recent Measures to reform Rating Process Methodology of Credit Rating Moodys Investor Service Rating (MIS) Standard & Poors Rating (S&P)

approach wherein a broad range of factors concerning promoter, project, environment and instrument characteristics are considered generally, explicit judgmental approach involves identification and measurement of he factors critical to an objective assessment of the credit/investment worthier of an instrument with a view to arriving at a numerical credit score or index, statistical approach involves, assignment of weights to each of the factors and obtaining the overall credit rating score with a view to doing away with personal bias inherent in both-explicit and implicit judgment. Significance of Credit Rating Credit rating is always project/Instrument specific. Credit rating for different Instruments issued by the same company at the same time can be different. In the same way credit rating for similar instruments issued by the same company at different times can also be different. Credit rating is useful for Investors, banks and other financial institutions and investments advisers as it helps them taking business decisions. Credit rating by an authorized competent authority gives a birds eye view of financial strength of an organisation and its instruments. It is of considerable help to an investor in deciding whether his investment is likely to be safe. As financial markets have grown increasingly complex and global and borrowers base has become increasingly diversified, investors and regulators have increased their reliance on the opinions of credit rating agencies. Credit ratings attempt to provide a consistent and reasonable rank ordering of relative credit risks, with specific reference to the instrument being rated. Credit rating was fist introduced to rate commercial paper in 1990 by CRISIL in India. Credit raging is gradually being adopted, used and recognized in our country. There is also a great deal of awareness among the users and investing community at large to verify and base their decisions on rating. They see rating as a barometer for financial strength of a company or enterprise and a measure of investor protection. Credit rating serves as a guiding factor for the assessing the degree of risk involved in repayment of principal and payment of return or interest. A rated company is always agencies base their rating on both quantitative and qualitative assessment of the borrower companys condition and special provision of the particular security at hand. The role of credit rating in the financial market will be more emphasized as India moves to a more deregulated system. The growth in the rating agency is directly linked to the growth in the debt market in India which has been significant in 1995-96 and 1996-97. With the liberalization of economy, growing global capital markets of India and increasing awareness, credit rating is becoming more and more popular. There is a lot of scope for rating business in future in India. Credit rating can be applied in the following areas/instruments: Equity shares Rating for banking sector Individual/credit rating Rating for insurance sector New instruments, floating rate notes, indexed based bonds, long-term deep discount bonds, etc. Rating of intermediaries in financial services Securitization Rating of Indian Corporates raising funds overseas.

It is expected that credit rating will assume multi-dimensional role covering all sectors of the economy which would include rating of products, services, suppliers, customers, management schools, merchant bankers, banks, health services, schools, political parties and politicians and so on. Quality of Rating The quality of credit rating mainly depends upon a. Quality of the rating agency b. Rating elements Quality of the rating agency will depend upon its reputation, professional competence, independence, quality of staff. Government or banks non-interference, etc. Rating Process

CRISIL evaluation is carried out by professionally qualified persons and includes data collection, analysis and meetings with key personnel in the company to discuss strategies, plans and other issues that may affect CRISILs credit evaluation of the company. Typically, companies present information to CRISIL on the topics indicated earlier at the time of requesting for a rating. The rating process begins at the request of a company. On receipt of the request, CRISIL assigns a team that will be responsible for carrying out the rating assignment. The team obtains and analysis information, meets the companys executive and interacts with a back-up team which would have also collected industry information. Their findings are presented to an Internal Committee consisting of Senior Executives of CRISIL and, thereafter, presented to the Rating Committee (which comprises some Directors not connected with any CRISIL shareholder) which then decides on the rating. The rating is, thereafter communicated to the company. Should the company want to present some additional information, it can do so at this stage. The rating process ensures objective analysis and strict confidentiality of client information. The Board of Directors of CRISIL do not get involved in the rating process CRISIL offers companies the opportunity to be evaluated on a confidential basis. Once the company decides to use the rating. CRISIL is obligate to monitor the rating over the life of the debt instrument. in assigning a rating, CRISIL takes into account the effects of a normal business cycle; however, depending upon new information, or developments concerning the company, CRISIL may change the rating. Any change so effected is made public by CRISIL. Countrys Rating Political challenges, economic transformation and policy consensus, fiscal imbalances and imposing public sector debt burdens are all factors which enhance or inhibit the credit rating of a country while political and economic forces are clearly a key determination of sovereign credit risk in emerging market countries, the financial pressures due to fiscal indiscipline pose threat to liquidity problems and default. Fiscal control is the key indicator of improving or deteriorating credit quality. Indias rating has been recently improved as under Long-term for current debt Short-term debt Outlook Stable, further, structural reforms should allow India to maintain moderate growth but significant public sector reform and deficit reduction will be necessary to stabilize debt, reduce inflation and avoid a significant deterioration in the balance of payment position. The implied ratings of the Republic of India reflects its improved economic prospectus after reforms that have led to significant deregulation and liberalisatoin of the economy. The ratings are supported by its strengthened balance of payment position but constrained by heavy external debt and public sector debt burden and weak fiscal position. GDP growth rate recovered to 4% in 1992, 1993 and has crossed 5% in 1994-94. In medium term, Indias currently comfortable balance of payments position is vulnerable to import growth and to sustained high fiscal deficit. Japan Bond Research Institute has also ungraded Indias rating from C to B in August, 1994. Moodys Investor Service, US credit rating agency has also placed India in the worlds Investment grade. Since a companys credit rating affects the rating of the commercial borrowings by its Government and corporate, this upgradation would lead to fall in interest rates in overseas borrowings by Indian Companies. Countrys upgraded rating results in Decreased dependence on loans from multilateral leading agencies. Access to cheaper foreign loans for Companies Reduced interest rates on commercial borrowings Increased inflow of foreign funds in the country Competitive advantage over countries with lower ratings. Indias competitors are Mexico, Hungary, Argentina etc. Standard & Poors and Moody Investor Service are two leading international credit rating agencies in the world. They rate equity, long-term and short-term debt obligations, fixed deposits, bonds, commercial papers, etc, and also undertake countrys ratings. Credit Rating Agencies in India The concept of credit rating ahs been widely discussed and debated in India in recent times. Since the setting up of the first credit rating agency. Credit Rating and Information Services of India Ltd. (CRISIL) in India in 1987, there has been a rapid growth of credit rating agencies in India. The major players in the Indian market, apart from CRISIL include Investment Information and Credit Rating agency of India Ltd. (ICRA), promoted by IDBI in 1991 and Credit B BB

Analysis and Research Ltd. (CARE), promoted by IFCI in 1994. Duff and Phelps has tied up with two Indian NBFCs to set up Duff and Phelps Credit Rating India (P) Limited in 1996. Credit Rating Agencies in India S. No. 1 Name of the Agency Credit Rating and Information Services of India Ltd. Ownership ICICI Principal Rating Areas Debt instrument, securitized asset Debt instruments Debt instruments

2 3 4

Investment Information & Credit Rating Agency of India Ltd. Credit Analysis and Research Ltd. Duff and Phelps credit Rating of India (P) Ltd.

IDBI IFCI

Puff & Phelps Corporation

Rating Methodology The process of arriving at the rating for any debt instruments is tuned towards achieving the basic objectives of rating in an unbiased and professional manner. The factors which are likely to affect the cash generation process of any corporate entity can be broadly classified into Business Risk Drivers and Financial risk Drivers. Business Risk Drivers include industry characteristics, competitive quality, new project and growth plans. Financial Risk Drivers include funding policies and financial flexibility. Crisil rated the first bank in the country in 1992 The ratings methodology for banks and financial institutions is essentially based on the CRAMEL approach (Capital Adequacy, Resources, Asset Quality, Management Evaluation, Earnings and Liquidity). Promotion of credit rating agencies (cras) CRAs can be promoted by public financial Institutions (FIs), Scheduled Commercial banks (SCBs), foreign banks operating in India, and foreign CRAs recognized in the country of their incorporation and having at least five years experience in rating. Besides this, any company or a corporate body having continuous net worth of minimum Rs. 100 crore as per the audited annual / accounts for the previous five years can set up a CRA. A CRA in which a bank. FI and its group holds more than 5 percent stake, would not be allowed to rate any instrument of any of he promoter and his associates. Due to this provision CRISIL and ICRA cannot rate instruments of IDBI and IFCI respectively anymore. Compulsory Rating of Debt Issue Rating are necessary for debt instruments and world over debt instruments are rated. Ratings are mandatory for deposit mobilization schemes of debt instruments and collective Investment schemes of plantation companies and animal rearing firms. In India, in case of issue of a fully, partly or non-convertible debentures with maturity or conversion period of 18 months or more, credit rating from a recognized rating agency in compulsory. A fresh credit rating is required in case of roll over debentures. No mandatory rating for public issue of shares Many experts had mooted the idea of compulsory rating for companies approaching the capital market with public or rights issue so that investors are not duped by fly-by-night operators. Earlier Securities and Exchange Board of India (SEBI) ruled out mandatory rating for public issue of shares on the following grounds: Investment is equity shares is risky and its magnitude cannot be demand. In developing countries, including the United States, ratings of equity Issues do not exist. Only a select few credit rating agencies offer rating services for equity Issues. For the long-term development of capital market, the concept of equity rating is not good.

However, the companies, at their own volition, can get themselves rated for their public issues. Rating agency ICRA Ltd. had mooted the concept of equity rating to offer details regarding risk and return associated with a public issue.

The agency, which already grades public issues, had introduced equity ratings following a continuous fall in funds mobilized from the primary market during mid-nineties and investors losing faith in companies tapping the market. Drawbacks Following are some of the drawbacks of credit rating: The ratings process attempts to provide a guidance to investors/creditors in determining the risks associated with the instrument/credit obligation. It does not attempt to provide a recommendation and does not take into account factors like market prices, personal risk/reward preferences that might Influence investment decisions. The ratings process is based on certain primitives. The agency, for instance, does not perform an audit. Instead, it has to rely solely on information provided by the user. Consequently, to the extent that the information provided is inaccurate and incomplete, the rating process is compromised. To the extent that a certain instrument of a specific company attracts a lower rating, the company has an incentive to shop around for the best possible rating, compromising the authenticity of the rating process itself.

Recent measures to reform Rating Process To take care of some of the maladies that had crept into the rating process, SEBI has announced the following measures: Disclosure of unaccepted ratings to investors has been mode compulsory. It has been made mandatory to obtain dual ratings from different recognized agencies for all public and right issues of debt Instruments greater than or equal to Rs. 100 crore. Accordingly disclosure and Investor protection guidelines have been amended. Rating agencies have been debarred from rating debt Instruments of their promoter institutions. Restrictions have been imposed on rating a debt instrument of a corporate firm if it has any common director with the rating agencys promoter institution. The guidelines cover even the borrowers of their bodies. Indian credit rating agencies feel highly uncomfortable will the last two restrictions as they severely restrict the sphere of their business because their promoters are largest financial institution in the country, such as, Industrial Credit and Investment Corporation of India (ICICI), Industrial Finance Corporation of India (IFCI) and Industrial Development Bank of India (IDBI). An obligation has been cast on the issuer company to disclose all the ratings it has got during the previous three years for any of its listed securities. CRAs have to carry out periodic reviews of the ratings given during the life-time of the rated instrument. SEBI has announced a number of measures to see that corporate provide correct and adequate information to CRAs

Methodology of Credit Rating At present, the ratings are optional in India. In the United Status it is compulsory and in some other countries it remains optional. The process of rating begins with the prospective issuer approaching the rating agency for evaluation. The experts in analyzing banks should be given a free hand and they will collect data and informant and will investigate the business strength and weaknesses in detail. The entire process of rating stands on the for of confidentiality and hence even the most confidential business strategies, marketing plans, future outlook etc., are revealed to the steam of analysis. The rating is based on the investigation analysis, study and interpretation of various factors. The world of investment is exposed to the continuous onslaught of political, economic social and other forces which does not permit any one to understand sufficiently certainty. Hence a logical approach to systematic evaluation is compulsory and within the framework of certain common features the agencies employ different methodologies. The key factors generally considered are listed below: Business analysis (or) company analysis This includes an analysis of industry risk, market position of the company, operating efficiency of the company and legal position of the company.

Industry risk: Nature and basis of competition, key success factors; demand supply position; structure of industry; government policies, etc. Market position of the company within the Industry: Market share; competitive advantages, selling and distribution arrangements; product and customer diversity etc. Operating efficiency of the company: Locational advantages; labour relation ships; cost structure and manufacturing as compared to those of competition. Legal Position: Terms of prospectus; trustees and then responsibilities; system for timely payment and for protection against forgery/fraud, etc.

Economic analysis In order to evaluate an instrument an analyst must spend a considerable time in investigating the various economic activities and also analyze the characteristics peculiar to the industry, whose issue the analyst is concerned with. It will be an error to ignore these factors as the individual companies are always exposed to changing environment and the economic activates affect corporate profits, attitudes and expectation of investors and the price of the instrument. hence the relevance of the economic variables such as growth rate, national income and expenditure cannot be ignored. The analysis, while doing the economic forecasting use surveys, various economic indicators and indices. Financial analysis This includes an analysis of accounting, quality, earnings, protection adequacy of cash flows and financial flexibility.

Accounting Quality: Overstatement/under statement of profits; auditors qualification; methods of income recognitions inventory valuation and depreciation policies, off balance sheet liabilities etc. Earnings Protection: Sources of future earnings growth; profitability ratios; earnings in relation to fixed income changes. Adequacy of cash flows: In relation to dept and fixed and working capital needs; variability of future cash flows; capital spending flexibility working capital management etc. Financial Flexibility: Alternative financing plans in ties of stress; ability to raise funds asset redeployment.

Management evaluation Track record of the management; planning and control system, depth of managerial talent, succession plans. Evaluation of capacity to overcome adverse situations Goals, philosophy and strategies. Location advantages and disadvantages Backward area benefit to the company/division/unit

Geographical Analysis

Fundamental analysis is essential for the assessment of finance companies. Fundamental analysis This includes an analysis of liquidity management, profitability and financial position and interest and tax sensitivity of the company.

Liquidity Management: Capital structure; term matching of assets and liabilities policy and liquid assets in relation to financing commitments and maturing deposits. Asset Quality: Quality of the companys credit-risk management; system for monitoring credit; sector risk; exposure to individual borrower; management of problem credits etc. Profitability and financial position: Historic profits, spread on fund deployment revenue on non-fund based services accretion to reserves etc. Interest and Tax sensitivity: Exposure to interest rate changes, hedge against interest rate and tax low changes, etc.

International Credit Rating Agencies Rating by two pioneer agencies Moodys Investor Services and Standard and Poor (S&P) of the USA Moodys Investor Service Rating (MIS) Aaa Aa A Baa B Caa Ca Best Quality High quality higher Medium Grade Possesses safety Generally lack characteristics of desirable investment Poor standing may be in default Speculative to a high degree often in default

Standard & Poors Rating (S&P) AAA AA A BBB BB B Highest grade Higher grade Upper medium grade Medium grade Lower medium Speculative elements Outright speculation Default with rating indicating relative salvage value.

CCC-CC DDD-D -

Credit rating can go a long way in establishing credit rating agencys dependability, while ensuring the growth of a healthy corporate culture and a sound market. Since the size and credit quality of issuing companies usually determine the accessibility to alternate financial markets, the development of credit ratio has gained interest and momentum. Worldwide, the credit rating system, shows that companies of high credit quality are able to satisfy their financing requirements in the markets while companies of lesser quality are forced to rely upon their banks or other financial institutions for their financial requirements. Moodys Investor Services rating symbols For long-term debts Aaa Aa A Baa Ba B Caa Ca C Best Quality High quality higher Medium Grade Medium grade Speculative Undesirable Investment Poor standing Speculative (high degree Lowest class Standard and Poors rating symbols For commercial paper P1 superior ability for Repayment P2 strong ability for repayment P3 acceptable ability for repayment

1,2 and 3 are added to the ratings to show relative standing

For long-term debts AAA AA A BBB BB B CCC CC Extremely strong Very strong Strong Adequate Speculative (various degrees) Predominantly (various degrees) Predominantly (Various degree) Very speculative (Various degrees) Default speculative speculative Bankruptcy C A1+ A1 A2 A3 D

For commercial paper Extremely strong Strong Satisfactory Adequate Speculative

Doubtful

Relative degrees are shown by (+) or (-) signs with the ratings Countrys rating denotes its ability to source debt from the international market at a reasonable cost. Low rated nations will have discounts, offer high yield and are treated as risky investment. Risk relates to default. Countrys credit rating involves evaluation of external financial accounts and macro economic factors and is directed towards future trends. Credit rating of any country involves evaluation of:

Economic growth and development gross national product and gross domestic product, population growth,. Infrastructure development, good financial management, saving growth rate, industrial production, agricultural production, growth of services sector etc. Balance of trade and balance of payments export products, export prices, diversification of products and export market, global competition, import substitution, etc. Debt service ratio this indicates the countrys external vulnerability. This is a ratio of external debt to total external earnings including export earning and earning from tourism, etc. Debt composition Soft loans, Commercial borrowings, interest rate structure. Proportion of external debt. Liquidity Level of reserves, foreign exchange reserves, import coverage ratio, currency backed by assets such as gold. Political and internal stability Socio-religious conflicts, majority government strong opposition, unequal economic distribution, relations with neighboring countries, political factors are not predictable and is prone to unexpected events. Inflation and price stability.

Major International Rating Agencies As capital flows have become increasingly global and turbulence in one economy has had contagion effects across the globe, credit ratings have spread outside the domain of the home country to overseas markets. Credit ratings are in use in the financial markets of most developed economies and several emerging market economies as well. The principal characteristics of the major internationally known rating agencies are as follows: Selected rating agencies outside India Name of the agency Moodys Service Investors Home country U.S.A Ownership Dun and Bradstreet Principle Full Service

Fitch Service

Investors

U.S.A U.S.A Canada U.S.A Japan U.S.A Japan United Kingdom

Independent Mcgraw Hill Independent Thomson Company Japan Journal Duff and Corporation Electronic Phelps

Full Service Full Service Full Service (Canada) Financial Institutions Full Service (Japan) Full Service Full Service (Japan) Financial Institutions

Standard and Poors Corporation Canadian Rating Service Thomson Rating Bond Bank

Japan Bond Rating Institute Duff and Phelps Credit Rating Japanese Credit Rating Agency IBCA Ltd.

Financial Institution Independent

Over time, the agencies have expanded the depth and frequency of their coverage. The leading U.S. credit rating agencies rate not ply the long-term bonds issued by corporate in the U.S., but also wide variety of other debt instruments including, for example, municipal bonds asset-backed securities, private placements, commercial paper programmes and bank certificates of deposit (CDs). In addition, the leading rating agencies also play a major role in evaluating sovereign ratings. Most of the rating agencies have long had their own symbols. Some of them use alphabets; others use numbers; many use a combination of both for ranking the risk of default. The default risk varies from extremely safe to highly speculative. Gradually, major agencies has emerged to provide finer rating gradations to help investors distinguish more carefully among issuers. Standard & Poor Corporation in 1974 and Moodys in 1982 started attaching plus and minus symbols to their ratings. Other modifications of the grading scheme-including the addition of a credit watch category to denote that a rating is under review-have also become standard.

Long-term Debt Rating Symbols of Major International Rating Agencies Name of the Agencies S & P and Others AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Interpretation Moodys Highest Quality High Quality High Quality High Quality Strong Payment Capacity Strong Payment Capacity Strong Payment Capacity Adequate Payment Capacity Adequate Payment Capacity Adequate Payment Capacity Likely to fulfill Obligations ongoing uncertainty

BB BBB+ B BCCC+ CCC CCC C D

Ba2 Ba3 B1 B2 B3

Likely to fulfill Obligations ongoing uncertainty Likely to fulfill Obligations ongoing uncertainty High risk obligations High risk obligations High risk obligations Current Vulnerability to default, or in default (Moodys)

Caa

Current Vulnerability to default, or in default (Moodys) Current Vulnerability to default, or in default (Moodys)

Ca d

In bankruptcy or in default, or other marked shortcoming In bankruptcy or in default, or other marked shortcoming

Regulators, like investors, value the cost savings achieved through the use of ratings in the credit evaluation process. As a result, they have come to employ a variety of specific letter ratings as thresholds for determining the capital charges and define investment prohibitions. Although the rating agencies make no such assurances, the current use of ratings in regulation assumes a stable relationship between ratings and default probabilities.

Lesson 5 Unit Trust of India Objective Reading this lesson the students will be in a position to understand the organisation and purpose of UTI, Listed Unit Schemes, Deployment of Funds by U.T.I., Crisis Period for Unit Scheme 64 and Latest position of UTI. Contents Introduction Organisation and Purpose Characteristics of Schemes and Instruments Mobilization of Savings Repurchase of income schemes Listed Unit Schemes Conversion into Open-end Scheme Deployment of Funds by U.T.I. Crisis Period for Unit Scheme 64

Introduction Unit trusts enable a small investor to hold a share in a large and diversified portfolio of assets which reduces the risks of investment. Similarly, they make it possible for small investors to have the benefit of professional management of portfolio which, in turn, help them to earn a relatively higher rate of return than they otherwise would have earned if their small savings were invested independently or separately. In other words, unit trusts help (small) investors to obtain high return-low-risk combination from their indirect holding of equities and other assets. Many unit trusts offer ancillary services such as (a) saving schemes for regular monthly investment in units, (b) some life insurance scheme whereby investment in units is linked to a regular, monthly or quarterly, payment of premiums on a life policy, (c) a share exchange scheme, (d) a personal loan scheme and (e) an automatic reinvestment of income distributions. Many unit trusts have an international dimension in the form of overseas or off shore funds. The operation of overseas funds is a truly international business in which banks and management groups in many countries participate. These overseas funds may be either open ended or closed ended. Organization and Purpose UTI was established as a Trust by the Government of India in February, 1964 in terms of the UTI Act 1963. It was an associate institute of the RBI till February 1976 when it was made an associate institute of IDBI. UTI has borrowing powers form these parent institutions. It provides attractive investment opportunities through issue of units and share under various schemes. The initial capital contributed by RBI, LIC, SBI, and other banks, borrowings from RBI/IDBI and other banks, and the unit capital are the major sources of its funds. The funds so mobilized are invested largely in corporate securities with a view to earning maximum return to the primary investor, keeping in view the element of safety. Consequent upon amendment to the UTI Act in April 1986, UTI is now allowed to grant term loans, rediscount bills, undertake equipment leasing and hire-purchase financing, provide housing and construction finance, provide merchant banking and portfolio management services, and set up overseas or off shore funds. Characteristics of Schemes and Instruments The major financial instrument introduced by UTI in the financial markets is unit. There are two kinds of units in vogue: (a) ordinary, and (b) capital. The face value of an ordinary unit is Rs. 10, whereas that of a capital unit is Rs. 100. Unit is a marketable financial instrument. although it is not a quoted security on the stock markets of the country, it is a highly liquid instrument because UTI is always ready to repurchase it at a declared price. As the repurchase price of unit does not fluctuate very much in a given year, and as the difference between the average sale price and the average repurchase price in a given year is not large, the risk of capital loss (and correspondingly the possibility of capital gain) on investment in units is much lower than on shares. Units have been declared as approved securities and also as trustee securities They are also accepted by banks as a security while granting loans.

Mobilization of Savings Commencing its operations with Unit Schemes 1964, the UTI has introduced a large number of Unit Schemes to mobilize the savings of different classes of investors. These schemes are tailored to meet the specific needs of different categories of investors. The schemes fall in both categories, i.e., Open end Unit Schemes and Closed end Unit Schemes and have different investment objectives, maturity periods, return assured etc. Broadly, these schemes may be classified as follows: Under the UTI Act, 1963 the Unit Trust is free to introduce may Unit Scheme. However, in the interest of strengthening the regulatory framework, UTI was brought within the purview of the Securities and Exchange Board of India with effect from July 1994. Since then, most of its schemes except US 64 have come under the purview of SEBI. As on June 30, 1998, 79 unit schemes were in operation consisting of 28 open-end schemes and 51 closed end ones. Unit Schemes of UTI Open-end Schemes Closed-end Schemes

Monthly Income Unit Schemes

Growing Income Unit Schemes

Growing Monthly Income Unit

Deferred Income Unit Schemes

Growth Schemes

Income cum Growth Schemes

Off Shore funds

Venture Capital Schemes

Repurchase of Income Schemes The UTI provides the facility of the purchase of units of the various income schemes after a minimum lock-in period of one year or more than one year. The repurchase price is based on historic NAV declared every month. While calculating the repurchase price UTI may deduct administrative cost and other charges not exceeding 5% of the NAV per unit. Such an assurance to the investor guarantees liquidity at a reasonable price. Listed Unit Schemes Some of the Unit Schemes of the UTI, as shown below, are listed on Stock Exchanges and can be transacted at the market prices. These are Growth Schemes, the net asset value of which are declared by UTI. The market prices need not be equal to their NAV. In fact, the market prices of these schemes have been quoted much below the NAVa fact which is called Discount to NAV as shown in the following table.: Listed Schemes of UTI Name of Schemes UTI Grand Master UTI Master Growth UTI Master Plus 91 UTI Master Share UTI Master Gain 92 UTI UGS 2000 UTI UGS 5000 the Net Asset Value as on 25.09.96 11.93 15.93 20.24 21.36 2.94 18.85 16.10 Market Price As on 25.10.96 10.60 10.00 14.00 12.55 10.25 13.65 14.50 Discount to NAV (P.C) -11.15 -37.23 -30.83 -41.25 -20.79 -27.59 -9.74

Source: Economic Times, 28 Oct. 1996 The above schemes were quoted at a discount to NAV which varies from scheme to scheme. Sometimes the growth schemes are quoted at a discount even at the original subscription price. It is due to the fact that since issue expenses are generally 6%, the very day a fund is floated, the NAV is reduced to 94% of the face value. Moreover, the fact remains that mutual funds are not exempt from the risks of the market place. It is the perception of the players in the market about share prices that leads to the depression in the prices of the Units. Even if fund managers do a decent job, the market may value funds at a discount and investors need to remember this before investing in such instruments. Some of the above schemes were open for repurchase by UTI for a week only at repurchase price fixed by it which was higher than the market price as shown above, i.e. Discount to NAV was kept within a marginal limit. Conversion into Open-end Scheme With effect from January 1, 1997 the Master Gain 92 has become an open-end scheme. The UTI will sell such units at a price which will be equal to its NAV and the unit holders can sell back units to UTI at any time at a price which will be 5% less than NAV. This will safeguard the interests of the investors as they will get a price higher than the market price, if the discount is heavy. Development of Funds by U.T.I In the employment of funds mobilized by it, UTI enjoys complete flexibility and acts on the principle of diversification. It is allowed to invest both in the corporate sector and the non-corporate sector mainly comprising Goernment Securities and Call Money Market). AS is evident from Table over 89% of the total funds under all the schemes were invested in the Corporate Sector as on 30th June 1998, leaving just 11% for the non-Corporate Sector. Funds mobilized in each scheme are separately invested in accordance with the Investment objective of the scheme. Hence, wide differences are to be noted in the pattern of investments made under different categories of Schemes. They depict the pattern of investments made under (i) Income Schemes, (ii) Growth Schemes like Master Share and (iii) Hybrid Schemes like US64 together with all the Schemes. Master Share Unit Scheme, being a growth scheme, aims at capital appreciation. Hence over 99% of its funds were deployed in the corporate equities as on 30 June 1998 (97%) in 1994). Consequently, no investment was made in Government Securities and a small proportion was held in debentures. As against the above, Monthly Income Schemes (all pooled together) and deferred Income Unit Schemes aim at providing regular income either on monthly basis or on a deferred basis. The pattern of investments under such schemes is diametrically opposite to the pattern under the growth schemes. Investments in equities are insignificant and the major portion of the funds have been invested in fixed income securities like government Securities, Corporate debentures. Term Loans, Special deposits, etc., so as to enable the UTI to pay dividend regularly. Almost the entire funds (98-99%) under the Deferred Income Schemes have been invested in the non-Corporate Sector. Pattern of Investments under its prime scheme Us64 shows about 90% of the funds being invested in the Corporate Sector. Within the Corporate Sector the largest share is that of the corporate equities which went up form approx. 40% in 1992-94 to over 50% during 1994-95, and further to approx 70% in 1997-98 followed by the share of Corporate debentures. Government Securities account for about 20% of he investible funds under the scheme. Thus, US64 has an almost balanced mix of fixed income securities and the variable income ones. This has enabled the Trust to pay regular dividends, at growing rates, reaching the level of 26% in 1994-95. In the subsequent year, the rate was brought down to 20% but with a bonus issue in the ratio of 1 : 10. Latest Trends in UTI Crisis period for unit scheme 84 Since its inception in 1964, the UTI and its flagship scheme US 64 commanded utmost public confidence. Its operations recorded consistent growth and its dividend rate was gradually raised from 6.10% in 1964-65 to 26% in 1991-92 to 1994-95. Investments in US64 was considered sound and safe investment by growing number of investors. All of a sudden towards the end of September 1998 the first report of a crisis in US 64 appeared, as it was reported that the Us 64s balance sheet carried negative reserves of Rs. 1,098 crore as on June 30, 1998. It was therefore, realized that the net asset value of the units was below par, while it was selling new unit at Rs. 14per unit. This led to heavy rush for redemption of units by unit holders and at the same time also resulted in panic selling in the equity market, as large scale off-loading of shares by the UTI was anticipated. Sensex lost over 220 points in a few trading sessions. The Unit Trust of India met the situation with financial support from the Reserve Bank of India. In October 1998 it constituted a committee under the chairmanship of Shri Deepak Parekh to under take a comprehensive

review of the functioning of the UTI and to recommend measures for sustaining investor confidence and to strengthen the US 64 Scheme. The Us64 crises coupled with huge shortfalls in assured return monthly income plans drove away investors from the trust. According to figures available with the Association of Mutual Funds in India (AMFI). During the Period April October 2002, the trust has received a gross inflow of Rs. 3,368 crore and a total redemption of Rs. 9,666 crore. Of the total redemption, Rs. 1,345 crore in September. The existing schemes have contributed Rs. 988 crore to the total inflow in October. This assets under the management of the trust have increased from Rs. 44,255 crore in September to Rs. 44,703 crore in October. The fund industry as a whole witnessed a spurt in corpus from Rs. 1,06,929 crore in September to Rs. 1,13,153 crore in October. (Rs. Crore) Type of Investme nt Unit 64 199394 Equity Shares 7957. 6 (39.46 %) 23.52 (0.12) 4637. 91 (23.00 ) 1637. 51 (8.12) 194.7 9 (0.97) Scheme MISG (Pool)** Master Share**** 199394 1069. 23 (94.6 1) 199495 1069. 48 (30.8 1) Total All Schemes **** 199394 21117 .46 (40.84 ) 23.59 (0.05) 288.0 9 (8.09) 337.5 0 (9.47) 435.2 7 (11.8 0) 275.5 0 (7.47) 27.50 (2.13) 7.42 (0.63) 11007 .28 (21.29 ) 4087. 40 (7.90) 719.6 7 (1.39) 199495 28499 .64 (47.80 ) 33.31 (0.06) 11893 .91 (19.95 ) 4122. 22 (6.91) 92.74 (0.16) 13620 .11 (69.64 ) 18.93 (0.10) 3337. 70 (17.06 ) 645.8 4 (3.30) 1.35 (0.01) 281.9 4 (19.8 7) 6.08 (0.43) 4.21 (0.35 %) * ** **** ****

199495 12668 .21 (50.57 %) 31.61 (0.13) 4380. 62 (17.49 ) 1636. 33 (6.53) 25.51 (0.10)

199394 114.2 3 (3.21)

199495 283.9 2 (7.70)

1997-98 1181. 79 (99.6 5) 31961. 97 (52.91 24.08 (0.04% ) 189,26 .42 (31.04) 2845.6 9 (14.67) 1.35 (0.00)

Preferenc e Shares Debentur es

Term Loans Advance Deposits Against Investme nt Commitm ents Special Deposits

880.9 8 (4.37) 152.0 8 (0.75) 20.34 (0.10) 2.17 (0.01) 15506 .9

406.9 6 (1.62) 84.88 (0.34) 7.00 (0.03) 0.25 (0.00) 19241 .37

968.0 0 (27.1 7)

622.0 4 (16.8 7)

3106. 29 (6.01) 465.2 9 (0.90) (0.10) 49.58 (0.03) 11.43 (0.02)

2571. 11 (4.31) 520.2 4 (0.87) 15.00 1.69 (0.00) 47449 .86

51.42 (0.26)

5.00 (0.35

589.27 (0.97)

Unsecure d Deposits Bridge Finance Applicatio n Money Total Investme

10.70 (0.05)

0.77 (0.05)

87.52 (0.09)

1707. 82

1616. 73

1096. 73

1076. 90

40587 .99

17694 .05

293.7 9

1186. 00

54406. 30

nt in Corporate Sector Deposit Against Stock Investme nt Call Deposits

(76.90 ) 33.91 (0.17)

(76.82 ) 8.65 (0.03)

(47.9 3)

(43.8 4)

(97.0 4)

(91.4 4)

(78.49 ) 33.91 (0.07)

(80.09 ) 11.17 (0.02)

(90.42 %)

(20.7 1)

(100)

(89.22)

730.0 2 (3.62) 3893. 68 (19.31 )

311.5 3 (1.24) 5486. 97 (21.91 ) 5807. 151 (23.18 ) 25048 .52 (100.0 0)

3.14 (0.09)

11.49 (0.31)

33.40 (2.96)

100.8 1 (8.56)

3036. 48 (5.87) 8050. 50 (15.57 )

2060. 93 (3.46) 9796. 68 (16.43 ) 11868 .78 (19.91 ) 18.64 (100.0 0)

352.0 1 (1.80) 1521. 27 (7.77 %) 1874. 08 (9.58) 19568 .10 (100% )

1125. 06 (79.2 9)

3808.6 0 (6.25) 2764.0 0 (4.53)

Govt. Securities etc.

1852. 64 (51.9 8) 1855. 44 (53.0 7) 3563. 26 (100. 00)

2059. 64 (55.8 5) 2071. 13 (56.1 6) 3687. 86 (100. 00) 33.40 (2.96) 100.8 1 (8.56 1) 1177. 71 (100. 00)

Total (Other Investme nt) Total Investible Funds

4667. 61 (23.10 ) 20164 .51 (100.0 0)

11120 .81 (81.51 ) 51708 .00 (100.0 0)

1125. 06 (79.2 9) 1418. 65 (100. 00)

0.00

6572.6 0 (10.78) 60978. 90 (100.0 0)

1130. 13 (100. 00)

1186. 00 (100. 00)

Unit trust of India (transfer of undertaking and repeal) ordinance, 2002 The President of India has promulgated the Unit Trust of India (Transfer of Undertaking and Repeal) ordinance, 2002 on 29.10.2002. it is aimed o provide for the transfer and vesting of the undertaking (excluding specified undertakings) of the Unit Trust of India to the specified company to be formed and registered under the Companies Act, 1956 and vesting of the specified undertaking of the Unit Trust of India in the Administration. Further, it is also aimed to repeal the Unit Trust of India Act, 1963. The ordinance provides for appointment of Administrator to manage the specified undertaking of the Trust, powers and functions of the Board of Advisors, maintenance of accounts by the Administrator etc.

Lesson 6 Life Insurance Corporation Objective Reading this lesson the students will be in a position to understand the Organization, Wide network, Regulation over Investments, Loans, Deployment of funds in Money Market Instruments, Investment in Small and Medium Scale Industries, Sector wise Break up of LICs Investment in India, LICs Investments Sector wise, I.I.C. Assistance to Corporate Sector, Resources support to financial institutions and Break-up of LICs Investments. Contents Introduction Organization Wide network Regulation over Investments Loans Deployment of funds in Money Market Instruments Investments in Small and Medium Scale Industries Sectorwise Break up of LICs Investment in India LICs Investments Sector wise L.I.C. Assistance to Corporate Sector Resources support to financial institutions Break-up of LICs Investments

Organization There has been life insurance business in India since 1818. Till 1956, the insurance business was mixed and decentralized. There were a large number of companies (245 on the eve of nationalization) of different ages, sizes, and patterns of organization, which conducted only life insurance business, and there were some companies whose main business was general insurance but they did life assurance also. In addition, there were a number of Provident Societies. In 1956, the life insurance business of all companies as mentioned was nationalized and a single monolithic organization, the Life Insurance Corporation of India (LIC), was set up. Today, life insurance is almost entirely in the hands of the LIC. A large number of insurance policies have been introduced and popularized by the LIC. Life insurance policies make a very flexible financial instrument. there are only a few basic types of such policies, viz term insurance, whole life insurance, endowment policies, annuity contracts, individual insurance, group insurance, and pension plans. These policies are mostly specific to, different income and age groups. Whole life policies charge a premium throughout ones life while endowment policies are taken for a fixed period. The latter provide life cover and also carry an adequate return. The former also cover life and are intended to be long-term investments, which cover risk rather than provide return. However, in order to serve different purposes, these basic types can be and have been combined in many ways to devise a large number of plans. Life policies of any type can be either with profits or without profits. In the letter case, the sum paid out on maturity or at death is the sum assured of the policy when it was taken out. In the former case, bonuses out of extra earnings from various investments are added to the assured sum periodically during its currency or occasionally paid out in cash. The premiums on with profits policies are higher than those on without profits as an allowance for the bonuses paid. The Life Insurance Corporation of India, the premier life insurer and one of the most stable financial institutions in the country, during the forty six years of its existence has been through several trials and tribulations, but has managed to grow and metamorphose into the gains it is today. It has done especially well in the decade and half starting from 1985 and its performance in the new millennium, which is also the beginning of the liberalized era in the Indian insurance sector, has been the best during its lifetime.

In 2001-02, LICs first premium income from new individual assurances, single premium policies and individual pension plans was Rs. 14,844 crores which was 137 per cent more than the previous years and 65 per cent more than that in 1999-2000. In the year ended March 2002, more than 2.32 crore new policies were issued for Rs. 1,92,575 crores sum assured while 14.61 lakh lives were covered under group schemes that resulted in new business income of Rs. 994.46 crores. In the year ended March 2001 more than two crore new policies were issue assuring a sum of Rs. 1,24,771 crores. The total premium in 2001-02, including renewal premium, was Rs. 49,614 cross with a growth rate of 42.25 per cent. The total income, including income from investments and estates was Rs. 70,798 crores with a growth 29.34 per cent. Wide network Since 1956, LIC has worked resolutely towards spreacing life insurance and in the process has built a wide net-work across the length and breadth of the country, consisting of 2,048 branches, 100 divisional offices, 7 zonal offices and a corporate office. The number of new policies sold each year grew from 14.62 lakh in 1961 to 1.79 crore in 2000, of which 55.10 percent are rural. The rural share in 1961 was 36.53 per cent. Similarly the annual premium income rose from Rs. 88.65 crores in 1957 to Rs. 27,850 crores in 2000. The Life Fund and Assets of the Corporation also grew from Rs. 410 crore to Rs. 1,54,044 crores and Rs. 465.04 crores to Rs. 1,60,936 crores, respectively since 1957. Investments which were Rs. 329.74 crores in 1957 rose to Rs. 1,44,954 crores in 2000, all of which is deployed in nation building activities. In an effort to leverage the organizations relationship with its existing clientele, to retain them and bring in new customers, a customers relationship management plan was drawn and implemented. Servicing standards were raised and procedures were simplified to cut down on length processes and time. Benchmarks were raised to meet heightened customer expectations. A target of zero outstanding claims was set. The IT infrastructure was revamped with extensive hardware procurements and a target was set to network the offices. As on July 2002, 65 per cent of the offices networked under an extended wide area network. Touch screen kiosks were set up to help policyholders and new customers to get information. Info centre and interactive voice response systems were put in place to boost customer service as well as marketing. Regulation over Investments To safeguard the interests of the policy-holders and also in the national interest, the investible funds of life insures are subject to Government regulations all over the worls. In India, the Insurance Act, 1938 provides the legal framework for the regulation over investment of such funds. The guidelines issues by the Government under Section 27A of the Insurance Act, 1938, as revised in 1995, stipulate that accretions to the controlled funds of L.I.C. are to be invested as follows: Controlled fund; means all funds pertaining to life insurance business of an insurer. a. In Central Government marketable securities b. Loans to National Housing Bank including (a) above c. In Central Government, State Government Securities, including the government guaranteed marketable securities (including (b) above) d. In Socially-oriented Sectors including public sector. Cooperative sector, house building by policy-holders) Own Your Housing Scheme (including (c) above) Regarding the remaining 25% of he accretion to the controlled funds, the Government had earlier stipulated the following restrictions: 8% to be granted as loans against policies within surrender values. About 2% to be invested in immovable properties. 10% to be invested in the private sector, and 5% to remain in the pipeline. Net less than 75% Not less than 20% Not less than 25% Not less than 75%

In November 1997, the Govt. has done away with the above restrictions of investing in specified proportions. Now, the corporation is permitted to invest the entire amount under the ceiling of 25% on the basis of commercial judgment but subject to prudential norms. At the same time, the investment pattern of LIC Group Insurance Scheme has also been liberalized. LIC is not permitted to invest 60% of the schemes funds in approved market investments and the balance in Government and guaranteed securities. Earlier such market related investments were restricted to 40 per cent. The scope of the socially-oriented sector has also been widened. It now includes ports, railways (BOLT projects) roads and highways and airports. LIC has been given the liberty of investing in both public as well as private sector ventures. Thus long term funds available with LIC will flow to infrastructure sector. In it thus apparent that major portion of the LICs funds are required to be invested in Govt, or Govt. approved securities & socially oriented sectors and only a smaller proportion is to be invested in the private sector. The board pattern of employment of LICs funds is depicted below: LIC Funds Sales Exchange Securities Central State Govt. Loans Corporate Other Investment

Govt. Organizations

Corporations & Societies

Policy Holders Insts

Fin

Capital of other fin. Instts. Loans

Other instruments

Laons are one of the major avenues of investment for the Corporations funds. While granting loans, the Corporation lays emphasis on financing of the following: Project/Schemes for generation and transmission of electricity of agricultural and industrial use, Housing Schemes, Piped water supply and Sewerage Project/Schemes in rural and urban areas and townships. Development of road transport, and Industrial development.

Housing loans to individuals are now granted by LIC Housing Finance Ltd. a subsidiary company of L.I.C and the existing mortgage loans are being serviced by LIC. Housing loans to the employees of the Corporation are still granted by the L.I.C. It must be noted from the above that utmost emphasis is laid by LIC on granting loans for the socially oriented sectors like housing, water supply, sewerage, road transport and electricity generation etc., which is in contrast with the emphasis laid by development banks on loans for industrial development. The reason for the same may largely be attributed to the self-interest of LIC in granting such loans, because these loans help in rising the standard of living of the people & in reducing the incidence of diseases and suffering of the people including the policy holders and thereby reducing the chances of more claims due to deaths. Loans to policy holders for housing enable them to live in healthier environments and thus raising their life expectancy and reduced claims on the corporation.

Deployment of funds in Money Market Instruments The funds which await investments are temporarily deployed in short term Money Market instruments like Call/Notice Deposits, Certificate of Deposits, Govt. of India Treasury Bills and Short term fixed deposit with banks. Investment in Small and Medium Scale Industries The Corporation indirectly helps small scale and medium scale industries by subscribing to the shares and bonds of State Financial Corporations. Sectorwise Break up of LICs Investment in India The following table shows that 84.66% of the LICs investment were in public sector followed by private sector (12.6%) as on 31st March 1998. LICs Investments Sector wise Book Value of Investments & Sector (a) Public Sector (b) Cooperative Sector (c) Joint Sector (d) Private Sector Total L.I.C. Assistance to Corporate Sector Within the constraints stipulated by Section 27A of the Insurance Act, Life Insurance Corporation grants assistance to the Corporate Sector in various ways as is evident from the following table: Component-wise Assistance Sanctioned by LIC to Corporate Sector Form of Assistance Loans Underwriting, direct Subscription, firm allotment & right issue a. Equity/Preference Shares b. Debentures/Bonds Sub Total Short term loans/unsecured Short term Deposits Term Loans to Fls Total 100.0 2,341.9 20.0 2,820.8 -3,563.1 2,644.0 21,363.4 78.8 971.9 1,916.2 325.7 156.3 1,680.4 2601.3 199.5 78.0 2,718.0 3,472.6 90.5 1,341.1 10,697.1 17,373.2 1,346.2 1995-96 865.5 1996-97 794.6 1997-98 676.6 Cumulative upto March 1998 5,335.0 Loans outstanding as at the end March 1996 54,245.6 1,857.6 380.0 7,616.3 64,099.8 1997 65,917.4 1,914.8 490.3 9,588.5 77,938.0 1998 79,235.7 2,030.3 500.0 11,834.3 93,600.3

Source: Report on Development Banking in India 1997-98 It is apparent from the table that L.I.C. employs its resources in the Corporate Sector in the form of debts or through debt instruments (i.e. Term Loans to Companies and financial institutions and debentures). Its investments in equity/preference shares accounted for less than 10% of the cumulative assistance granted to the Corporate Sector. Term Loans to the Corporate Sector are granted along with the Development Banks and Commercial banks.

Cumulative-assistance through term loans accounted of about 25% of the total assistance granted to the corporate sector. Term Loans granted to financial institutions like National Housing Bank & Housing Finance Companies augment their resources and thereby their lending capacity for housing purposes. Investments in corporate securities take place in both the primary market and the secondary market. LICs preference for corporate debentures vis--vis equity shares ins evident from the fact that out of the total assistance of Rs. 3,563 crore sanctioned to the corporate sector during 1997-98. Rs. 2,718 crore were by way of investment in debentures of the companies while only Rs. 78 crore were invested in equities. The corporate sector is sanctioned assistance for varied purposes viz. for establishment of new units, for expansion, diversification, modernization of existing units and for balancing equipment & rehabilitation and also for other purposes including mainly for relieving constraints of cash resources. Resources support to financial institutions Besides extending support to the corporate sector directly, as stated above, LIC also assists the industrial corporate sector indirectly. Break-up of LICs Investments Investments in India I.Loans 1.State Electricity Boards/Power Corporation 2.State Government for housing 3.National Housing Bank 4.State Housing Boards/Housing Finance Corporations/ Apex Cop. Housing Societies 5.Municipalities / Zilla Parishads 6.Indusrial Estates 7.State Road Transport Corporations 8.Companies & Cooperative Societies 9.On Mortgage of property [Under Mortgage Schemes of LIC] 10.On Insurers Policies within their Surrender Value 11.On Personal security 12.Loans to Power Generation 16,114.45 II. Stock Exchange Securities 1.Govt. of India Securities 2.State Government Securities 3.other govt. guaranteed securities 4.Shares and Debentures of Companies and Cooperatives 5.Other securities 37277.64 III.Special Deposits with Central Govt. IV.Other Investments (i)Contribution to the initial Capital of UTI,LIC,MF,LIC,HFL., & 50.50 50.50 23089.32 3665.48 3644.38 6878.46 45875.82 7387.96 3835.16 15171.54 266.52 72537.00 1839.41 3775.52 1184.82 948.67 3124.32 1247.88 7.71 173.59 2714.99 991.92 1945.00 0.03 5306.37 1671.77 1018.67 898.18 1564.13 6.05 251.87 3720.88 958.10 3426.70 0.03 39.20 22,862.03 31st 1995 March Rs. Crore 31st March 1998

LIC International (ii) Certificates of Deposit (iii) Kisan Vikas Patra (iv) Application money & Advance Subscription (v) House Property Total Investment Outside India Loans Stock Exchange Securities Other Investments Grand Total Source : LIC Annual Report 1994-95 and 1997-98 Also, by extending resource support to various financial institutions by way of term loans as well as by subscribing to their shares and debentures. During 1997-98 LIC subscribed to the shares/debentures of financial institutions to the extend of Rs. 1,858 crores including Rs. 589 crore IDBI, Rs. 250 crore to IFCI, Rs. 574 crore to ICICI and 444 crore to other institutions. 25.00 142.50 23.85 368.51 628.36 55859.86 14.96 276.73 30.89 322.58 56182.44 142.50 7.21 558.22 758.43 98537.87 16.25 362.41 31.24 409.90 98947.77

Lesson 7 Portfolio Management Objective Reading this lesson the students will be in a position to understand the Meaning of Portfolio and need for Portfolio Management, Inputs of Portfolio Management, Inputs for Portfolio Construction, Portfolio Goals, Types of Portfolios, Portfolio Goals, Evaluation of Portfolio Performance, Portfolio Revision. Contents Meaning of Portfolio Portfolio Management Need for Portfolio Management Inputs of Portfolios Management Inputs for Portfolio Construction Portfolio Goals Types of Portfolios Portfolio Goals Portfolio Construction Evaluation of Portfolio Performance Treynors Model Performance Measure for Portfolios Treynors Measures Jensens Model Jensens Measure Portfolio Revision Formula Plans Rules for Formula Plans Constant Rupee Value Plan Constant Ratio Plan Variable Ratio Plan

Meaning of Portfolio The set of all securities held by an investor is called his portfolio. The portfolio may contain just one security. However, since in general no one puts all ones eggs in one basket, it will contain several securities. Such a portfolio is knows as a diversified portfolio. The portfolio theory makes two fundamental assumptions about the behaviour of the investors with respect to risk and return from securities. These are (a) if two portfolios have identical expected returns, then investors would choose that portfolio which has a lower risk, and (b) if two portfolio have identical risk, then investors would choose that portfolio which has a higher expected return. On the face of it, these do not appear to be very unreasonable assumptions to make. This tendency in an investor to maximize his benefits for a given risk level, or minimize the risk for a given benefit level is also known as risk aversion. The credit for examining this relationship between risk and expected (or mean) return in detail goes to Harry Markowitz. One of the three Nobel Prize Winners in economics for 1990, whose work on mean-variance framework in the fifties set the stage for a more rigorous and objectives handling of the risk parameter in the literature on capital markets. Need for Portfolio Management Every investor wants maximum return at minimum risk. As to return there prevails non-station and as to risk there prevails aversion. Though risk and return move in the same direction, the scale of return per unit of risk can be

maximized through careful allocation of funds across different investment avenues. And such careful allocation is nothing but portfolio management. Portfolio management enables risk diversification and hence returns for unit risk can be maximized through efficient portfolio construction, selection and revision. Risk is minimized through diversification. But all diversification may not help reducing risk. So, there is an optimal level for diversification. It is achieved through efficient portfolio management. Hence there is a need for portfolio management. Portfolio management is a process encompassing many activities of investment in assets and securities. It is a dynamic and flexible concept and involved continuous and systematic analysis. Judgment and operations. The objectives of this service are to help the novices and uninitiated investors with the expertise of professionals in portfolio management. Firstly, it involves construction of a portfolio based upon the fact sheet of the investor giving out his objectives, constraints, preference for risk and return and his tax liability. Secondary, the portfolio is reviewed and adjusted from time to time in tune with the market conditions. The adjustment is done through changes in the weighting pattern of the securities and asset classes in the portfolio. The shifting of assets and securities will take advantage of changes in market conditions and in prices in the securities and assets in the portfolio. Inputs of Portfolio Management Portfolio management refers to managing efficiently the investment in securities by professionals for both corporate investors and small investors who may not have the time and expertise to arrive at a sound investment decisions. It has become a specialized arena which requires proper planning and continuous review. Proper planning and continuous review. Following are some of the key objectives of portfolio management. Safety Liquidity Reasonable Return Minimum Risk

Inputs for Portfolio Construction Portfolio is a composition of investments with the purpose, of maximizing return and minimizing risk. What individual investments would constitute the composition depends, in the first place, on the goals of the portfolio. One of the goal of the portfolio is return maximization. To achieve this, a choice of individual investment securities for inclusion in the portfolio is made. And., the return and risk of such individual investment securities are relevant inputs for portfolio construction. Thus, portfolio goal and return and risk of individual securities included in the portfolio are the inputs for portfolio constructions. Portfolio Goals As investors differ like cornflakes, their portfolio goals also differ. One investor might prefer a portfolio that gives him maximum tax savings. So, this portfolio would consist of investments that have some tax leverage tagged on them. Housing, Govt. Securities, etc constitute his portfolio. Another investor wants a low, but unfluctuating return. His portfolio would consist of scrips with stable and unbroken dividend policy and fixed yield giving bonds and the like. Another investor might want a portfolio that ensure a higher capital appreciation. So, scrips of growth sector/companies would predominantly form the portfolio. Another investor might want a sectoral portfolio-say infotech portfolio or pharma sector portfolio. So his portfolio would consist of share of info-tech companies or pharmaceutical companies. an overseas investor in India might want a portfolio replicating BSE SENSEX or CNX Fifty. So, the specific 30 scrips, 50 scrips would form the portfolio. So, portfolio goals are the first and foremost input to initiate portfolio construction process. Current return, capital gain, tax benefit, liquidity, risk reduction, opportunity for participation in future capital expansion on a preferential basis, buy-back guarantee etc., are certain portfolio goals. Return and risk of individual securities Portfolio management needs data as to return and risk of individual securities that the portfolio consists of. Because, portfolio return and portfolio risk (essential variables in portfolio management are derived from returns and risk of individual securities. Return means income of gain. Current income, capital gain, tax shield, right to subscribe to future issues, preferential allotment in future issues, etc. are all returns. The tax shield, right and preferential

allotment, etc. generally get reflected in the price of the security and that capital gain is inclusive of all these. So, current income and capital gain are the principal types of returns of a security. In the case of shares, debentures, bonds, etc. which are referred to financial assets/investments, the future returns, their size and variability, are important factors influencing investment decisions. Measurement of return is an important task. Table shows below gives some common measures of return for individual equity and debt securities. Return on Different Types of Securities Security 1. Debenture /bonds 2. Shares or stocks Current yield of estimated yield Expected interest / Current price of debenture or bond Expected dividend / Current price of share Actual yield or realized yield Interest received / Actual price of purchase Dividend received / Actual purchase price.

There is another more versatile, measure of return, known as housing period yield (HPY). This measure is useful for all classes of assets / investment securities. The formula is:

Let us compute the return for some securities now. An investor buys a 17% bond of Rs. 1000 face value, with 10 year maturity, at Rs.850. Calculate current yield and yield to maturity.

= (850 +1000) / 2 = 925

= 0.2 or 20% In the case of redeemable securities the YTM is generally calculated. The above formula can be applied to calculate the return on redeemable preference shares also for non-redeemable securities like equity shares, irredeemable debentures and preference shares YTM cannot be calculated. There the Holding Period Yield (HPY) is appropriate. An investor has bought an equity share a year ago at Rs. 85. He has just received a dividend of Rs. 20 on the share and now the ex-dividend price of the share if Rs. 105. Calculate actual yield and HPY.

Expected return based on probability distribution. Types of Portfolios Portfolio can be classified in the light of following :Objective, risk, level of diversification, basis of diversification, level of investment, geographical spread, industry spread and so on. On the basis of objectives sought, a portfolio can be income portfolio, growth portfolio, mixed portfolio, tax savings portfolio or liquidity portfolio. In income portfolio, the objective is maximum current income. Small investors, investors whose current income needs are high like pensioners and unemployed persons, persons with lower tax brackets prefer income portfolios. Here the portfolio generally consist of fixed income securities like debenture/bonds/income mutual fund/equity with continuous dividend-record. Growth portfolio stress on capital gain. Big investors, high earning professionals and persons in the higher tax brackets prefer this portfolio. Growth mutual funds, growth shares, etc. are included in the portfolio. Mixed portfolio give moderate preference for both return and growth. Salaried persons and middle income investors prefer this portfolio. Here the portfolio consists of securities like debentures/bonds, convertible debentures, growth as well as income mutual funds, growth shares and on. Liquidity portfolio emphasis on easy offloading. Frequently traded securities (with many quotations on a single day in stock exchanged), gilt-edged securities, buy-back securities. Etc. are included in the portfolio. On the basis of level of risk portfolio may be aggressive (high risk), moderate (medium risk) or conservative/ defensive (low risk). Investor interested in assuming high risk go for aggressive portfolio. They may select securities which are having positive correlations between them. The may be rewarded in proportion to the risk they take. Aggressive portfolio have beta coefficients greater than + 1 or less than -1. Beta coefficient is a measure of risk. Market folio (consisting of security of majority of companies) is said to have a beta of 1. So a beta coefficient of more than 1 or less than -1 means higher risk than the market. Moderate portfolio have risk more or less equal to that of the market portfolio. The beta of such portfolios is around. Conservative portfolio have far lesser risk than the market. Their beta coefficients are close to zero, say +2 or with beta value ranging between -0.5 and +0.5, 3. Conservative portfolio will have a high load of risk free investments like bank deposits, govt. bonds etc. Aggressive portfolios scantly include the above and contain mostly equity and convertible debenture. On the basis of level of diversification, portfolio can be classified into highly diversified, moderately diversified and lowly diversified. High diversification may be taken to mean that the portfolio has over 20 different securities in the kit. Moderate diversification includes 10-20 securities Hi the kit and low diversification means that less than 10 securities Hi the kit and low diversification means that less than 10 securities are in the kit. High diversification, if properly done, reduces the un-systematic risk to zero. In moderate diversification means substantial un-systematic risk is present in the portfolio. Consider the graph 1.1. As number of securities increases, un-sysematic risk reduces and hence total risk reduces. Beyond 20 securities, risk remains the same, as the systematic risk cannot be reduced. When you have more than say 25 securities, your portfolio is called superfluous portfolio, indicating that it is diversified more than enough. Portfolio Goals As investors differ like cornflakes, their portfolio goals also differ. One investor might prefer a portfolio that gives him maximum tax savings. So, this portfolio would consists of investments that have some tax leverage tagged on them. Housing, Government Securities, etc. constitute his portfolio. Another investor wants to low, but in fluctuating return. His portfolio would consist of scrips with stable and unbroken dividend policy and fixed yield giving bonds and the like. Another investor might want a portfolio that ensures a higher capital appreciation. So, scrips of growth sector / companies would predominantly form the portfolio. Another investor might want a sectoral portfolio say info tech portfolio or pharma sector portfolio. So his portfolio would consist of shared of info tech companies or pharmaceutical companies. an overseas investor in India might want a portfolio replicating BSE SENSEX of CNX Fifty. So, the specific 30 scrips, 50 scrips would form the portfolio. So, portfolio goals are the first and foremost input to initiate portfolio construction process. Current return, capital gain, tax benefit, liquidity, risk reduction, opportunity

for participation in future capital expansion on a preference basis, buy back guarantee etc., are certain portfolio goals. Combining securities Although holding two securities is probably less risky than holding either security alone, is it possible to reduce the risk of a portfolio by incorporating into a security whose risk is greater than that of any of the investments held initially? Fox example, given two stocks, X and Y. with Y considerably more risky than X, a portfolio composed of some of X and some of Y may be less risky than a portfolio composed exclusively of the less risky asset X. The risk involved in individual securities can be measured by standard deviation or variance. When two securities are combined, we need to consider their interactive risk, or covariance. If the rates of return of two securities move together, we say their interactive risk or covariance is positive. If the rates of return are independent, covariance is zero. Inverse movement results in covariance that is negative. mathematically, covariance is defined as

Where the probabilities are equal and Covxy RX Ry Rx Ry N = covariance between x and y = Return on security x = Return on security y = Expected return to security x = Expected return to security y = Number of observations

Portfolio Construction It refers to the allocation of funds among a variety of financial assets open for investment, the objective of theory is to elaborate the principles in which the risk can be minimized, subject to a desired level of return on the portfolio or maximize the return. To realize this objective, the portfolio manager has to keep a list of such investment avenue along with the return-risk profile tax implications, yields and other avenues, such as convertible options, bonus, rights etc. The portfolio construction is made on the basis of the investments strategy, set out for each investor. Through choice of asset classes, instruments of investments and me specific scrips says of bonds or equities of different risks and return characteristics, the choice of tax characteristics, risk level and other features of investments are decided upon. Portfolio is a composition of investment with the purpose of maximizing return and minimizing risk. What individual investments would constitute the composition depends, in the first place, on the goals of the portfolio. One the goal of he portfolio is return maximization. To achieve this, a choice of individual investment securities for inclusion in the portfolio is made. And, the return and risk of such individual investment securities are relevant inputs for portfolio construction. Thus, portfolio goals and return and risk of individual securities included in the portfolio are the inputs for portfolio construction. Efficient Portfolio To construct an efficient portfolio, we have to conceptualize various combinations of investments in a basket and designate them as portfolio 1 to n. then the expected returns form these portfolios are to be worked out. The risk on these portfolios is to be estimated by measuring the standard deviation of different portfolio returns. To reduce the risk, investors have to diversify into a number of securities whose risk return profiles vary. Evaluation of Portfolio Performance Evaluation of portfolio performance facilities the investors to appraise how well the portfolio manager has done in achieving desired return targets and how well risk has been controlled in the process. It enables me investors to assess how well the manager has achieved these targets in comparison with other managers or alternatively, with home passive investment strategy. Finally it provides for a mechanism for identifying weaknesses in the investment process and for improving these deficient areas. Nevertheless, historical performance evaluation can serve as the starting point for estimating future prospects and can serve as a feed back mechanism for improving the ongoing portfolio management process.

The portfolio manager is required to make proper diversification into different industries; asset classes and instruments so as to reduce the unsystematic risk to the minimum for a given level of return. The market related risk has to be managed by a proper selection of Beta for the securities. There was no composite index which measured both return and risk under the Traditional Theory. In Modern Portfolio Theory it became necessary to develop some composite measures of both return and risk in portfolio performance, as the objective now is maximization of return and minimization of risk. On account of the trade off between them, simple maximization of returns of single goal of minimization of risk will be defeating the objectives of Modern Portfolio Management. It was in this context that later researches have tried to evolve a competitive index to measure risk based returns taking into account the different components of risk, viz. systematic, unsystematic and residual risk. The credit for evolving these criteria goes to Sharpe, Treynor and Jensen. Example of sharpes measure

Where ST is sharpe index when, Rt is average return on portfolio, Rf is riskfree return. It measures Total risk by standard deviation. Reward is in the numerator as Risk premium. Total risk is in the denominator as standard deviation of its return. We get a measure of portfolios total risk and variability of returns in relation to the risk premium which is the product of the portfolio Managers expertise. The method adopted by Sharpe is to rank all securities on the basis of evaluation measure ST. if one portfolio has more ST man other, the first one is better performer as per the Sharpens measure. Take the following example: Portfolio A B By applying the above formula, we have For A portfolio Average Return 20% 24% S.D. 4% 8% Average Rf (Risk free Rate) 10% 10%

As the first one is ranked higher at 2.5% more than the second 1.75%, the first is a better performer. Treynors Model Performance measure for portfolios In Treynors model, the inter-section at 450 angle represents that return which is equivalent to the return on the market portfolio. The ideal fund is depicted to the left of 45 0 line. This is also above the imaginary 450 line. The return on this line is higher than that which is earned on the market portfolio. Under Treynors model if the market portfolio that reveals a negative return, under the model of characteristic line is still higher. The characteristic line draws a relationship between the market returns and a specific portfolio without taking into consideration any direct adjustment for risk. When the investors make a comparison of the characteristics lines by taking into consideration their slopes them the steeper the line higher the volatility or the movements in the fund. The Treynors performance measurement measures the systematic risk or the risk premium of the portfolio and takes into consideration difference on the return of a portfolio and the riskless rate. The equation is depicted below:

Treynors Measure In Treynors measure, the Risk Measure of standard deviation, namely, Total Risk of the portfolio is replaced by market risk, measured by Beta, which is not diversifiable. The equation can be set out as:

Tn = Treynors Measure of evaluation Rn = Return on the portfolio, Rf = Risk free rate, Bn is Beta of the portfolio as a measure of Systematic risk. Treynor based his formula on the concept of characteristic line. This line is the least squares Regression line relating the return to the risk and Beta is the slope of the line. The regression line takes the form of Rp = + Bx + c Rp is the Return of Portfolio is the intercept reflecting the Risk free return is the slope of the line and is the market Return and e is the error term This concept can be graphically represented as follows:

Based on this characteristic line Treynor formula is

Illustration Portfolio A B Return 20 24 Bn 0.5 1.0 Rf 10 10

Portfolio A performs better than portfolio B as TnA > TnB. The numerator in Treynors formula is the reward, measured by Risk premium or excess return and denominator is volatility as measured by Beta coefficient. The Treynor and Sharpe Indexes provide measure for ranking the relative performances of various portfolios, on a risk adjusted basis. Jensen attempts to construct a measure of absolute basis that is, a definite standard against which performances of various funds can be measured. This standard is based on measuring the portfolio managers predictive ability that is, his ability to earn return through successful prediction of security prices which are higher than those which those which we would except given the level of riskiness of his portfolio. Jensens Model Jensens Model is similar to the Sharpes index model and the Treynors index model, but is shows that the performance of a portfolio can be on any point including the origin. Rjt Rft = j + j (RMt Rft) Rft Rft = Average return on portfolio J for period t = Risk free rate of return for period t

j j RMt

=Intercept of the Graph, measuring the forecasting ability of the Managers =Systematic risk measure = Average return on the Market Portfolio for period t

It is possible that = 0, which is performance or the same as that of market. j > 0, it is superior performance over the market j < 0, it is inferior performance Jensens Measure Jensens measure of the performance of portfolio of different from that of Sharpe and Treynor in that the latter provide a measure of ranking the relative measure of absolute performance on a risk adjusted basis. This standard, based on CAPM, measures the portfolio Managers predictive ability to achieve higher return than expected for the given riskness. The Jensens approach can be illustrated by an example. The data on portfolio results, Beta of the portfolio and Market Index results are set out as follows: Portfolio 1 2 3 Market Index Market Beta 1.0 and Risk free Rate 10% The Return of 3 portfolios on the basis of CAPM are as follows: Rp = RF + Mj Mf) 1. Portfolio I 2. Portfolio II 3. Portfolio III = = = 10 + (16-10) x 1.2 = 17.2% 10 + (16-10) x 0.8 =14.8% 10 + (16-10) x 1.2 = 17.2% = 18 17.2 = 0.8% = 15 14.8 = 0.2% = 21 19.0 = 2.0% Return as Portfolio 18% 15% 21% 16% Portfolio Beta 1.2 0.8 1.5 16%

Actual realized Portfolio I Portfolio II Portfolio III Portfolio Revision

Portfolio are owned by individuals and organizations having dramatically different objectives and constraints. Portfolio objectives usually are related to achieving the greatest return for given risk level. The portfolio once constructed undergoes changes due to changes in market prices and a reassessment of companies. Portfolio revision will take place and composition of portfolio will change. Constant market changes necessitate readjustment of portfolio leading to purchase and sales of equities, bonds etc. which in turn will result in change in Beta and duration. Formula Plans The investor uses formula plans to facilitate him in making decisions for the future by exploiting the fluctuations in prices. The three-formula plans which are useful in making decisions are (a) the constant rupee value (b) the constant ratio (c) the variable ratio formula plans The formula plans have sketched the basic rules and regulations for purchasing and selling of investments. The formula plans make the average investors superior to others. These formula plans are based on the fact that the investors will not have the problem of forecasting fluctuation in stock prices and will continue to act according to formula. The plans have a method of building two portfolios the conservative portfolio and the aggressive portfolio. These plans are not flexible and are predetermined course of action specified for the investors.

Rules for formula plans These plans work according to a methodology which is related for the working of each plan These plans cannot be used for short periods of time The longer the period of holding the investments, the easier for formula plans to work. Generally the formula plans are strict, rigid and straight forward out they are not flexible

These plans suggest that there must be two portfolios of an investor, namely aggressive portfolio of an investor; namely aggressive portfolio and conservative portfolio. These plans do not have a selection procedure for the stocks. The methodology adopted by the formula plans is to find out the difference in movements of the aggressive portfolios and the conservative portfolios. The formula plans disclose that when the stocks must be purchased and sold. An aggressive portfolio will determine the volatile nature of the portfolio and will have large number of fluctuations; whereas the conservative portfolio will be planned to complement the aggressive portfolio and will consist of bonds. The conservative portfolio is a mechanism of defensive operations The two portfolio when combined together will achieve the results as planned by the formulae. Following are the three-formula plans that are found useful in making decisions The Constant Rupee Value The Constant Ratio The Variable Ratio Formula Plans

Constant rupee value plan This plan indicates the rupee value which remain constant in the stock portfolio of the total portfolio. This formula indicates to the investor that whenever the stock value rises his shares should be sold to maintain a constant portfolio. If the price of the stock falls, the investor must buy additional stock to keep the value of aggressive portfolio constant. By specifying that the aggressive portfolio will remain constant in money value, the plan also specifies that remainder of the total fund be invested in the conservative fund. This formula plan also indicates to the investor how to place the action points, i.e. the period of time when action should be taken. The action points can be said to be a trade-off between stock and profitability. The investor under the constant rupee value will require the knowledge of how low the fluctuations may go but it does not require the forecasting of an upward movement or limit of price rise. So the forecasting by the investor is required even under the constant rupee value formula but the knowledge will be regarding the lower limits or the depression values of the fluctuations. Constant ratio plan Under the constant ratio plan, both the aggressive and defensive portions remain in constant percentage of the portfolios total value. This plan method of identifying the ratio of the value in the aggressive portfolio to the value of he conservative portfolio. The aggressive portfolio divided by the market value of the total portfolio should be held constant. The constant ratio plan holder can adjust portfolio balance either at fixed intervals or when the portfolio moves away from the desired ratio by a fixed percentage. The formula plans based an constant ratio does not require the investor to make forecasts of the lower levels at which the prices fluctuate. Under this plan, the aggressive value is always to be kept by the investor constant of the portfolios take a long time to move in a direction which is either upwards/downwards, thus this plan does not work at its optimum value. under this plan, the investor will get high profit if there is a continuous sustained rise or fail in prices These profits would be higher rather than under the constant rupee value plan or variable ratio plan. The main advantage of the constant ratio plan is the automatism with which it forces the manager to adjust counter cyclically his portfolio.

Variable ratio plan Under this plan, the ratios are varied whenever (here is a change in the economic or market index. The significant tool of the variable ratio plan is said to be forecasting. The investor is required to make forecasts in the range of fluctuation which more both above and below the median to find out the different ratios at different levels of stock. The investor lowers the aggressive portion of the total portfolio as stock prices rise and steadily increases the aggressive portion as stock prices fall. Whenever there is a growth trend for common stock, then the variations can be accounted for by exploiting the fluctuations around the long term trends. It is clear from the above discussions, that formula plans are useful for making a decision on the timing of investments. They function according to a methodology which is related for the working of each plan. The utility of the formula plans call for the application of plans in a systematic and methodical manner. These plans enable the investors to assess the total amount that he spend on purchases. The formula plans make the average investor who adopts these techniques superior to other investors, these plans are based on the feet that the investor will not have the problem of forecasting fluctuation in stock prices and will continue to act in the light of the formula given to him. Besides using the formula plans, the investor must consider every stock that he puts in his portfolio with respect to growth potential of the securities.

Lesson 8 Services Provided by NBFCs Objective Reading this lesson, the students will be in a position to understand NBFCs and Financial Sector Reforms, NBFCs and Monetary Policy, NBFCs and Indian Money Market, Recent Trends in Non-Banking Financial Companies Sector, RBI amends NBFC directions, Auditors Responsibilities on Non-compliance, Submission of Information of PAN in respect of all the directors of NBFCs, Prudential norms for primary eligibility to accept deposits by RNBCs, Amendments to prudential norms directions, Additional measures for protection of interests of depositors, Fresh Guidelines for entry of NBFCs into insurance sector and Service Provided by NBFCs. Contents NBFCs and Financial Sector Reforms NBFCs and Monetary Policy NBFCs and Indian Money Market Recent Trends in Non-Banking Financial Companies Sector RBI amends NBFC directions Auditors Responsibilities on Non-Compliance Submission of Information on PAN in respect of all the directors of NBFCs. Exemption to Government NBFCs Modified regulation of NBFCs Amendments to prudential norms directions Additional measures for protection of interests of depositors Fresh Guidelines for entry of NBFCs into insurance sector Restrictions Services Provided by NBFCs

NBFCs and Financial Sector Reforms A number of financial reform measures were initiated during the last part of 80s such as Complete freeing of short term money market interest rates Introduction of new money market instruments like commercial paper, certificate of deposits, 182 days treasury bills. Enlargement of money market through increase in participants as well as range of instruments. Removal of all restrictions on transfer of borrowal accounts between banks. Enlargement of institutional structure. After the new industrial policy came into existence, more reforms have followed. These include Revision of maximum interest rate on deposits accepted by non-banking companies from 14 to 15 percent Increase in short-term deposit rates Removal of all restrictions on fixation of interest rates on bonds/debentures issued by private corporate sector and public sector companies except tax-free bends of public sector undertaking, which is subject to a maximum limit of 9 percent. Money market mutual funds have been allowed to be set up by banks

More reforms and liberalization of the financial sector were announced with the recommendations of Narasimham Commmittee, which submitted report on 20th November 1991.

The central objectives of reforms in the financial sector have been to improve the efficiency, competitiveness and productivity of the system. As the financial sector is a mobiliser of savings, for the reform to be successful, it should improve its allocative efficiency and facilitate accelerated real growth of the economy. The reforms also aims at making financial intermediaries, both banks and non-banks to function. The financial system in India comprises all financial institutions, financial markets, procedures and practices adopted in these markets and the financial instruments with facilitate the transfer of funds from surplus spending units to deficit spending units. The financial institutions are usually classified as banking institutions and non-banking financial institutions. The banks subject ot legal reserve requirements can advance credit by creating claims against themselves, while the non-banking financial institutions can lend only out of resources put at their disposal by the ultimate savers. The distinction between the two has been highlighted by savers while characterizing the former as creators of credit, and the letter as mere purveyors of credit. NBFCs and Monetary Policy The proliferation of NBFCs in India has coincided with a major structural transformation in the Indian financial system, which has an important bearing on the conduct of monetary policy. NBFCs started functioning in the sphere of mobilization of dormant assets and tapping of new users of credit. In the process, they channelized savings in the economy by collecting funds from savings surplus units and allocating them to savings deficit units for investment in real assets, for consumption, for portfolio adjustment of existing wealth, or for all such purposes for which access to bank credit was either denied or restricted. This mechanism is called transmutation effect which refers to the catalytic role of financial intermediaries in converting financial liability with a set of characteristics into financial assets with a different set of characteristics, so as to tailor the asset preference of the economic agents. Non-banks provide credit to those sectors which are denied credit by banking sector, thereby defecting to some extent the very purpose of quantitative credit controls. Further, it is often argued that financial innovations place an upward pressure on the money multiplier. In a regime of monetary policy operating through monetary and credit aggregates as the intermediate target, the growth of NBFCs tend to dilute the efficacy of monetary policy. On the other hand, it is also true that in a regime of monetary policy transmitting through open market operations with interest rate as an intermediate target, the existence of financially strong NBFCs can increase the potency of monetary policy. The NBFCs should be brought under the regulatory framework not only to ensure their healthy growth but also to improve the efficiency of the credit and monetary policy as well as healthy financial discipline among both providers and users of credit.

NBFCs and Indian Money Market Before 1960, the field of NBFCs was mainly occupied by non-corporate bodies like private firms, money lenders and chit fund organisatoins only after 1960, the corporate sector has emerged as a separate major group of non-banking intermediary. One of the major objectives of the financial sector reforms in India has been to integrate various segments of the financial markets. In tune with this, a package of well-sequenced financial sector reforms has been initiated in order to integrate the non-banking companies within mainstream of financial sector reform. NBFCs have emerged as an integral part of the Indian financial system. They have grown both in magnitude and depth. The money of such companies which stood at around 7000 in 1981 increased to be around 24000 by 1990; and 45,000 by 1996. The business of these NBFCs has also shown tremendous growth over the year. Another important fact is that out of 45,000 NBFCs, the number of NBFCs registered with the RBI was a mere 582 as 1.2.1999 Innovative financial services extended by NBFCs sector Initially intended to cater to the needs of the savers and investors, NBFCs later on developed into institutions that can provide services of similar to those of banks. NBFCs have been evaluating the traditional money lending business to latest money changers. Non-banking financial services include all services other than accepting demand deposits. There is new scope for such services being adopted by the NBFCs. The different credit schemes offered by the NBFCs are meant for industrial and household sector to cater to the needs of the enterprises and the individuals for production of goods as well as for consumptions of goods. Innovative Financial Services Extended by NBFCs Sector include Acceptance of Credit and Bill discounting, Assets Credit Scheme, Buyers Credit Scheme, Certificate of Deposit, Chits business, Commercial Paper (CP), consultancy Services, Consumers Credit, (i) Installment Credit, (ii) Non-Installment Credit, Equipment Procurement Scheme, Equity Participation, Factoring, Forfating, Hire Purchaser,

Housing Finance Company Installment Sale Scheme, Investment Company, Issue Management, Leasing, Loan Company, Money Changers, Mutual Funds, Portfolio Management, Underwriting. Nidhi or mutual benefit finance company The business of Nidhi or Mutual Fund Society is covered under Section 620-A of the Companies Act 1956, attracting deposits from their members and invest in for their benefits. Their objectives is to enable their members to save money, to invest their savings and to secure loans at favourable rate of return. These companies have fixed capital base and their shares are allotted to members who desire for availing of the benefits and concessions offered by these companies for depositing or borrowing moneys. Suppliers credit scheme Under this scheme, NBFCs provide facility to the manufacturing concerns to sell their equipment and the needy concerns to purchase the same for their actual use on deferred payment basis. Venture capital It refers to the risk capital supplied to growing private companies and it takes the form of share capital in the business firms. In India, venture capital comprises only seed capital finance for high technology and funds to turn research and popular in different commercial production. Venture capital is growingly becoming popular in different parts of he world because of the crucial role it plays in fostering industrial development by exploiting vast and untapped potentialities and overcoming threats. In the private sector, first venture capital company credit capital venture fund was set up in April 1989 with Rs. 10 crores to be subscribed by international financial agencies to the extent of Rs. 6.5 crores and the remaining through public subscription. This was followed by 20th Century Venture Capital Corporation and Indus Venture Capital Fund. No doubt, venture capital proves to be an innovative entrepreneurship. The economic liberalization has resulted in fast growth recorded by the financial services sector. In fact, NBFCs sub serve and not spoil the monetary policy of the country. The experience of NBFCs financial services in India is too short to prove that those who made a strategic entry are better off than those who made a casual entry. Many new NBFCs players have joined the financial services game. While some have done so with strategic insight, a lot others have casually walked into the arena. Recent Trends in Non-Banking Financial Companies Sector Initially intended to cater to the needs of the savers and investors, non-banking financial companies (NBFCs) later on develop into institutions that can provide services similar to those of banks. In India, several factors have contributed to the growth of NBFCs. They provided tailor-made services to their clients. Comprehensive regulation of the banking system and absence or relatively lower degree of regulation over NBFCs has been one of the main reasons for the growth momentum of the latter. Further, their higher level of customer orientation inasmuch as lesser pre/post sanction requirements, simplicity and speed of their services have attracted customers to these companies. the monetary and credit policy followed by the country has left a section of the borrowers outside the purview of the commercial bansk and NBFCs created to the needs of this section. Further, the marginally higher rates of interest on deposits offered by the NBFCs have also attracted towards them a large number of small savers. After the CRB fiasco, the Reserved Bank of India (RBI) had tightened its control over NBFCs. The unprecedented regulatory norms issued suddenly during January 1998 were perceived by NBFCs to be very harsh. While the RBI has maintained that such regulations were absolutely necessary to safeguard the public deposits, it has not spent adequate time for the development of NBFCs. In fact post CRB, negative sentiments, uncertainty about future of NBFCs among depositor have been resulted in the increased withdrawal of matured deposits and a serious slow down in the flow of fresh deposits. An attempt has been made in this article to review the various measures taken by RBI recently towards betterment of NBFCs. After a period of nearly 16 months since January 1998, the RBI has made certain relaxation for NBFCs. Firstly, it had removed the ceiling of bank credit in respect of all registered NBFCs. Secondly, it has classified bank credit to NBFCs for on-lending to small transport operators as priority sector lending. The move which has been perceived as a reversal of the Central Banks stringent stand is expected to have a two fold impact. Accordingly, it will come as a major relief to transport financiers which have been facing a service funds crunch following restrictions of mobilization of public deposits. The new classification is expected to prompt banks to extend more credit to this sector. RBI amends NBFC directions The Reserve Bank of India exempted potential Nidhi companies from the requirements of registration, liquid assets and reserve fund and also certain provisions of the NBFCs directions. It also exempted micro-finance companies from the provisions of entire Chapter IIIB including registration. Here after the NBFCs would be required to follow a

uniform accounting year ending March 31 every year with effect from the accounting year ending with 31 st March, 2001. NBFCs would also furnish information on suit filed and decreed debts in their reporting formats submitted to the RBI. The RBI asked those with assets more than Rs. 50 crore as per the last audited balance sheet to constitute an audit committee, consisting of not less than three members of its Board of directors. The RBI has introduced certain regulations over opening and closing of branches with an obligation of branches and an obligation of the auditors to report to it non-compliance of directions and certain provisions relating to the need for introduction of depositors and treating of deposits from first named joint shareholders outside the purview of public deposits. Auditors Responsibilities on non-compliance The auditors of NBFCs have been entrusted with the responsibility of direct reporting to the RBI along with other contraventions, if any, on the matters on non-compliance with the directions of the RBI on control over opening and closing of branches and engaging the services of agents for mobilization of public deposits by the NBFCs. The Department of Company Affairs has not framed new guidelines for Chit Fund and NBFCs. However, revised regulatory framework put in by the RBI in January 1998, sought to ensure that only financially sound well run NBFCs were allowed to accept public deposits. Directions issued by RBI in exerciser of statutory powers seek to protect the interest of depositors and to focus supervisory attention on those NBFCs accepting public deposits. The steps taken by the RBI for protecting the interest of depositor include, inter alia, the prescription of ceiling on the quantum of deposits, reintroduction of a ceiling on the interest rate on deposits, requirement of minimum investment grade credit rating for NBFCs accepting deposits, prescription of entry point net owned funds level, prescription of prudential norms and creation of a reserve fund. Submission of information on PAN in respect of all the directors of NBFCs The RBI has decided to keep on record details on Permanent Account numbers (PAN) issued by income-tax authorities of each of the directors of all NBFCs whether registered or those whose applications for certificate of registration are pending with the bank. All the NBFCs are, therefore, advised to furnish the information to the respective regional office of the RBI within 2 months from 13 th January 2000 failing which the grant or continuance of the certificate of registration would be reconsidered. Exemption to Government NBFCs The RBI has exempted Government companies conforming to section 617 of the Act from applicability of the provisions of the RBI Act relation to maintenance of liquid assets, creation of a reserve fund, directions relating to acceptance of public deposits and prudential norms. The requirement of statutory registration of these companies is, however, to continue. Minimum Period of Hybrid Debt Capital Instruments and Sub-ordinated Debts for Exclusion from the Description of Public Deposits The RBI has decided that the sub-ordinated debt instruments with a minimum maturity period of 60 months or above at the time of their initial offer which (a) are unsecured and sub-ordinated to the claims of other creditors, (o) are free from restrictive clause, (c) are not redeemable at the instance of the holder or without the consent of the supervisory authority of the NBFC, will only be exempted from the definition of public deposits. Deposits form first named joint shareholder only to be treated outside the purview of public deposits The RBI has decided that deposits accepted by a private limited NBFC from the first named shareholders will only be exempted from the purview of public deposit. The deposit accepted from the rest of the joint shareholder will be treated as public deposits. The RBI on 13th January, 2000 allowed NBFCs to maintain upto 5 percent of their liquid assets in the form of term deposits with scheduled commercial banks. At present NBFCs need to keep 15 percent statutory liquidity ratio (SLR). The RBI stipulated that any NBFC looking to change its name to take advantage of stock market sentiments particularly in the Info Tech sector will have to seek the Central Banks approval before applying to the Registrar of Companies. The RBI has reiterated that NBFCs with set-owned funds below Rs. 25 lakh may not be granted general exemption, and their applications for certificates of registration may not be considered. The RBIs deadline for NBFCs to store up

their net owned funds to Rs. 25 lakh expired on 9th January 2000. However, NBFCs not holding public deposits are no longer required to submit their liquid asset return. NBFC other than RNBCs An NBFC having a certificate of registration and otherwise entitled to accept public deposits as per NBFC directions on acceptance of public deposits is allowed to open its branch/office or allow its agents to operate for mobilization of public deposits. Within the State where its registered office is situated if its NOF is upto Rs. 50 crore: and Anywhere in India if its NOF is more than Rs. 50 crore and its fixed de-posits programming has been rated by one of the approved credit rating agencies as AA or above.

RNBCs An RNBC registered with the bank and otherwise complying with all statutory requirements is allowed to open additional branches/offices and/or allow its agents to operate or mobilization of deposits. Within the State of the location of its registered office if its NOF is upto Rs. 50 crore; and Anywhere in India if its NOF is above Rs. 50 crore. Prior intimation to RBI and Public notice

The NBFCs/RNBCs would be required to give 30 days notice to RBI prior to the opening of any branch/office for mobilization of public deposits within the specified area of operation and prior public notice of three months in leading newspaoer before closing a branch. These directions are applicable prospectively to the existing as well as new NBFCs/RNBCs. For the purpose of abundant clarification, it is advised that these directions govern only the deposit taking activities of the companies. opening of branches or engaging the services of agents for other than deposit taking business is not intended to be governed by RBI. Compulsory internal audit system and constitution of audit committees On the lines of scheduled commercial banks, it has been decided that all NBFCs having asset size of Rs. 5 crore or above should have compulsory internal audit system accountable to the chief executive officer of the company. All these companies should also mandatory constitute and audit committee from among the members of their Board of directors. This provision is applicable to all NBFCs whether holding/accepting public deposits or not. Information on suit filed accounts In order to monitor the level of loan delinquencies in the NBFCs sector, NBFCs are being advised to furnish, in their prudential norms return, information on suit field/decreed debts by and against them. Modified Regulations of NBFCs The RBI has amended the NBFCs regulations on 13th January, 2000 to address the supervisory concerns arising out of certain undesirable practices of some NBFCs so that ht e NBFCs grow on round and healthy lines. In the light of suggestions received from the NBFCs, the RBI has further amended NBFC regulations vide Notification Nos. 141 to 145 dated 30th June, 2000. Prudential norms for primary eligibility to accept deposits by rnbcs These norms are:

The provisions of prudential norms were extended to the residuary non-banking companies under the provisions of Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998 as contained in the Notification No.DFC. 119/DG(SPT)-98 dated 31st January, 1998. The RBI has decided to amend their directions providing therein that the compliance by every RNBC with prudential norms is mandatory and pre-requisite for acceptance of deposits by these companies in the interests of depositors protection. Accordingly, the RNBCs which do not comply with the prudential norms are directed to stop accepting deposits forthwith.

Amendments to prudential norms directions No doubt the equipment leasing and hire-purchase finance companies have been playing an important role in financing of new as well as second hand commercial assets. In order to bring about uniform practices among the

NBFCs, the RBI has decided to rationalize the prudential norms in respect of the equipment leasing and hirepurchase finance assets as under: The NBFCs should make provisions against NPAs with correlation to the net book value of the assets in four stages at 10, 40,70 and 100 percent (as against the present three stages of 10, 50, and 100 percent); In the case of leased asset, the amount of security deposit together with the value of any other asset to which the NBFC has a valid recourse may be deducted only against the provision stipulated under clause (it); The value of second hand assets would be the lower of the cost of acquisition of the asset by the hirer and not the invoice cost of the vehicle on the date of its original acquisition. The provisions in case of the asset becoming NPA should then be made on such cost of acquisition on the same lines as are applicable to financing of a new vehicle. The concept of net book value has been done away with and the unsecured portion has to be computed as the difference between the total dues and the depreciated value of the hire purchase asset.

Introduction for NBFC depositors Introduction for NBFCs depositors mean the identification of the prospective depositor. The NBFCs may ensure that the new depositor is not a fictitious person by verifying physically some form of identification, i.e. PAN number, Election ID card, passport ration card or introduction by one of the existing depositors, etc. A copy of such an evidence may be kept on record by the company. Additional measures for protection of interests of depositor The RBIs measures to ensure protection of interests of depositors have been spelt out below: The bank has stratified the NBFCs into two categories, viz., those taking public deposits and those not accessing public deposits. The companies specifically permitted to accept public deposits are so advised and the other companies are also advised that they should not accept public deposits without prior permission of the Bank. The companies taking public deposits are comprehensively regulated for protection of depositors interests, however, the format of certificate of registration does not make any distinction between the companies permitted to accept and not allowed to accept such deposits. RBI has advised in the interests of the NBFCs and the depositors that all the NBFCs who have so far been issued a certificate of registration by the bank should. a. Brand the certificate as deposit taking company or as non-deposit taking company in bold letters in red ink; and b. Send to the regional office of DNBS of the bank a copy thereof duly certificate by their auditors stating therein that the original certificate has been so branded. Fresh Guidelines for entry of NBFCs into insurance sector The RBI has issued guidelines for entry of NBFCs into insurance sector vide Press Release date 9th June, 2000. All NBFCs registered with RBI entering into insurance business as agents or investors or on risk participation basis will be required to obtain prior approval of the Reserve Bank. The RBI will give permission to NBFCs on a case to case basis keeping in view all relevant factors. It should be ensured that risks involved in insurance business do not get transferred to the NBC and that the NBFCs business does not get contaminated by any risks which may arise from the insurance business. Any NBFCs registered with the RBI having got owned fund of Rs. 2 crore as per the last audited balance sheet would be permitted to undertake insurance business as agent of insurance companies on fee basis, without any risk participation. Restrictions No NBFC would be allowed to conduct such departmentally. A subsidiary or company in the same group of an NBFC or of another NBFC engaged in the business of a non-banking financial institution or banking business will not normally be allowed to join the insurance company on risk participation basis. Investment limit for non-eligible NBFCs NBFCs registered with RBI that are not eligible as joint participant, as above can make investments upto 10 percent of the owned fund of the NBFC or Rs. 50 crore, whichever is lower, in the insurance company. Such participation

would be treated as an investments and should be with out any contingent liability for the NBFC. The eligibility criteria for these NBFCs will be as enumerated below. The CRAR of the NBFC (applicable only to those holding public deposits) should not be less than 12 percent if engaged on equivalent leasing / hire purchase finance activities and 15 percent if it is a loan or investment company; The level of net NPA should not be more than 5 percent of the total outstanding leased/hire purchase assets and advances; The NBFC should have net profit for the last three continuous years.

The Government is considering a new Act on NBFCs to provide greater depositor protection and to redress the difficulties experienced while administering the existing statue. In order to safeguard the interest of depositors, the Finance Minister Mr. Yaswant Sinha has pointed out the various measures undertaken by him. The details of which are summarized below: The RBI has undertaken an intensive publicity campaign to educate prospective depositors. It has put in place a comprehensive and supervisory mechanism of regulating and supervising the activities of NBFCs. The Company Law Board (CLB) has been authorized under the RBI Act to adjudicate the claims of depositors, with specific powers to direct the defaulting companies for making repayments. Regional branches of the CLB have been directing defaulting making repayments. Regional branches of the CLB have been directing defaulting companies for making payments to depositors. If an NBFC fails to honor the orders of the CLB, the RBI can launch prosecution proceedings, against it. The bank has appointed nodal officers at the regional offices for instituting prosecution proceedings in such cases. It has constituted coordination committees at four metro centres to oversee the implementation of CLB orders by the NBFCs. Full time special officers have been appointed to ensure compliance with RBI direction to protect the interest of depositors. The bank has initiated adverse action against errant NBFCs for various defaults and contravention of the provision of the RBI Act nd directions issued there under. Action against NBFCs involves issuing prohibitory orders barring them from accepting further deposits, from alienation of assets, filing winding up petitions, launching criminal proceedings against NBFCs and their management for serious violation of the RBI Act. The Bank also files complaints with the economic offences wings (EOW) of the State Police Authorities for curbing unauthorized acceptance of public deposit. In several cases, the courts have appointed provisional liquidators and have also restrained the NBFCs from disposing of their assets in any manner. In the last two years, the RBI has issued prohibitory orders to 73 companeis, filed winding up petitions in the respective High Courts against 12 NBFCs, filed criminal complaints against 17 NBFCs, filed police complaints against six NBFCs and has appointed special officers to monitor deposit repayment in four problematic NBFCs. The process of regulatory strengthening has been reinforced with the creation of an independent department, namely the Department of Non-Banking Supervision in the RBHI for focused attention to the supervision of NBFCs. To facilitate close monitoring of NBFCs, the Department has opened 16 regional offices to supervise NBFCs having registered offices under their respective jurisdiction. The centre is exploring the possibility of setting up a special body on the lines of the Debt Recovery Tribunal for speedy recovery of funds blocked in defaulting NBFCs. The Government is also actively considering to book the directors of such defaulting NBFCs under the all powerful and stringent COFEPOSA Act. A special cell has been set up at the RBI to find out the number of defaulting NBFCs and the deposits blocked with them. The RBI has already started processing the initiatives to be taken by it, while the Government is looking at legislative changes. The arduous task before the RBI is how to reconcile the objectives of encouraging the growth of a healthy NBFC sector as well as ensuring protection of depositors interests. It is hoed that the RBI will implement the recommendations of the Vasudev Committee over a period of time in a phased manner for a sound and healthy growth and development of the NBFC sector. Services Provided by NBFCs Initially intended to cater to the needs of the savers and investors, NBFC later on developed into institutions that can provide services similar to those of banks. In India, several factors have contributed to the growth of NBFCs. They

provided tailor-made services to their clients. Comprehensive regulation of the banking system and absence or relatively lower degree of regulation over NBFCs has been one of the main reasons for the growth momentum of the latter. Further, their higher level of customer orientation in as much as lesser pre/post sanction requirements, simplicity and speed of their services have attracted customers to these companies. The monetary and credit policy followed by the country has left a section of the borrowers outside the purview of the commercial banks and NBFCs catered to the needs of this section. Further, the marginally higher rates of interest on deposits offered by the NBFCs have also attracted towards them a large number of small savers. The activity of NBFCs can be fund based as well as fee based activities. For the former activities, the companies require funds. However, there is a limit on the deposits which the NBFCs can raise. Fond Based Activities 1. Equipment leasing 2. Hire purchase 3. Bill discounting 4. Loans/Investments 5. Venture Capital 6. House Finance 7. Factoring 8. Equity participation 9. Short term loans Fee Based Activities 1. Issue management 2. Portfolio management 3. Corporate counselling 4. Project counselling 5. Loan syndication 6. Arranging foreign collaboration 7. Advising Acquisition and Mergers 8. Helping in Placemen services 9. Advising on Capital Restructuring

10. Inter corporate loans

With the infrastructural facilities and proper economic environment have been created for growth in the industrial sector, this positive climate will lead to increased volume of business in the financial services sector also. Unlike in many other industries where the corporate tax reduction and the excise duty reduction may not be passed on to the ultimate consumers thereby increasing their profitability, financial companies, squared on by market forces, will have to dilute their pricing to stay on in the stiff competition passing on substantially the benefits of corporate tax reduction and the interest rate reduction. Services of NBFCs to Investors A variety of services is offered by NBFCs. Majority of the services rendered by NBFCs are similar to those services rendered by merchant bankers. The services may be classified as corporate financial advices, corporate structuring, issue management, corporate financing, foreign capital and foreign exchange advice/management, secondary market functions, portfolio management services, consumer financing, financial market research and so on. Certain services are discussed below: Forex management Foreign capital/forex management services are the up-end function in great demand. Advice on floating GDRs, FCCB and ADRs, foreign loan/financial syndications, forex risk management, foreign market opportunity evaluation, currency swap, etc are come under forex management. Secondary market operations In the secondary market almost of NBFCs, small and big, are active Membership in one of more of regular stock exchanges and in either of both of OTCEI and NSE are common with the large and medium operations. Some provide instant liquidity to sellers of scripts through them. For their operations in NSE, separate subsidiaries are established as per requirements of NSE. Portfolio management services Portfolio Management Services involve constructing, operating, improving auditing and revising portfolios on behalf of individual and institutional investors who put their funds with NBFCs for a certain period. Financing of portfolio is also done. Investment financing-financing for applying for primary issues and for secondary market dealings is also provided by NBFCs.

Consumer financing In the 1980s NBFCs well as banks plunged into this field. Car financing, white goods financing, housing finance etc come under this category. Due to credit worthiness of customer is not fully known, the NBFCs provide financing through Manufacturers of, or dealers in these goods. A tripartite credit system is thus evolved and generated. Inter corporate deposits Inter corporate deposits/loans are deposits by cash rich concerns with cash scarce concern. The deposits are generally for a period of 90 days and carry an interest of 7& to 8% per Annum depending on credit standing of the deposit seeking firms. As a single depositor may not be in a position to meet the needs of a borrower, syndication route is adopted and a plural number of deposit making firms are drafted together by NBFCs. Some times a collateral security may be instead. Capital market research Equity research, debt research, knowledge of market sentiments and forces, knowledge of fundamental of individuals. Scrips and the market knowledge of technical aspects of market price movements, knowledge of the risk types and of managing the same etc are needed. Capital market research is the route to obtain the knowledge and skill needed. Dominant NBFCs have sophisticated research and databases. Deposit mobilization The NBFCs enormously depend on fixed deposits mobilized from investors for carry out their operations. A higher interest rate, more than bank deposit rates, is generally offered. The interest rates ranges between 8 and 11 percent per annum. Credit rating for fixed deposits was made mandatory by the RBI whereby unrated NBFCs having netowned funds exceeding Rs. 2 crores are prohibited from accepting deposit. Fixed deposits for a minimum period of 12 months, and one day, for a maximum period of 84 months. RBI is interested in reducing the over-dependence of NBFCs on fixed deposits. The NBFCs are playing a unique role in mobilizing funds, directing investment, providing a push to developemnet, especially in the industrial sector, catering to the varied financial needs of medium and rural sector. All in all, thriving, helalthy and growing non-banking financial sector is necessary for promoting the growth of an efficient and competitive economy. Thus, NBFCs have emerged as a unique institution in the Indian financial system bridging the credit gaps in several sector.

UNIT V

9.

IDBI

10. IFCI & IRBI 11. RBI & Management of Gilt Securities Market

Lesson 9 IDBI Objective Reading this lesson the students will be in a position to understand the Industrial Development Bank of India, Functions, overall operations of IDBI, Operations, Direct Finance, Indirect Finance, reference, Bills Finance, Loans to and Investments in Financial Intermediaries, Merchant Banking, Debenture Trusteeship, Forex Services, Purposewise Assistance, Resources and Fellow up and Monitoring. Contents Industrial Development Bank of India Functions Overall operations of IDBI Operations Direct Finance Indirect Finance Refinance Bills Finance Loans to and Investments in Financial Intermediaries Merchant Banking Debenture Trusteeship Forex Services Purpose-wise Assistance Resources Fellow up and Monitoring

Industrial Development Bank of India Industrial Development Bank of India is one of the four All India Development Banks in India. In addition, it is the apex banking institution in the field of long term industrial finance and thus it functions as the principal finance institution for coordinating the functions and activities of all India term lending institutions and to some extent the public sector banks. IDBI was established in 1964 as a wholly owned subsidiary of the Reserve Bank of India. In February 1976 it was delinked from the Reserve Bank and its entire share capital was transferred to the Central government. In March 1994 the IDBI Act was amended to empower the Bank to issue its equity capital to persons other than the Central Government provided the government holding does not fall below 51% Consequently, the Bank made its first public issue of equity in July 1995, which was the largest equity offering in the Indian stock market till then. The majority of its shares are still held by the Central Government though the percentage holding of Government has declined to 72.15%. Functions Besides provided assistance to industries directly, IDBI also provides assistance to industries through other financial institutions and banks. Thus the assistance provided by IDBI falls in two broad categories viz (a) direct finance to large and medium enterprises and (b) Indirect finance through other financial institutions.

Functions of IDBI

Direct Finance

Indirect Finance

Finance Service

Project Finance

Underwriting & Subscription To share

Guarantees For Deferred Payments & Loan

Bills Discounting

Equipments Finance Schemes

Reference Of term Loans

Re-discounting Of Bills

Overall Operation of IDBI

Support to Shares & Bonds of Other institutions

The financial assistance sanctioned and disbursed by IDBI under different schemes during the last 3 years is shown in the following table: Financial Assistance Sanctioned and Disbursed by IDBI (Rs. Crore) Sanctions 1196-97 1.Direct Finance (i) Rupee Loans (ii)Foreign currency Loans Total Loans (a)Project Loans (b)Non Project Loans (iii)Underwriting & Direct subscription (iv)Guarantees (v)Equipment Leasing 2.Refinance 3.Bills Finance 4.Resources support to Finance Institutions Total 9577.7 3131.4 460.2 1406.0 310.3 745.5 1374.6 44.2 17049.9 11018.6 6689.7 3159.1 1484.1 291.8 373.1 906.6 59.0 23982.0 12709.5 6745.5 2744.8 2031.4 487.2 91.6 674.6 70.00 25554.6 365.7 671.2 915.6 44.2 11439.0 313.5 334.9 624.5 59.0 15170.0 247.5 102.1 475.6 70.0 14403.4 7086.6 2126.2 229.5 7632.0 5014.6 1191.5 6178.1 5552.4 1177.3 14885.6 10127.2 2581.9 199798 22643.3 13483.9 4224.4 1998-99 24718.4 18044.1 1410.9 Disbursements 199697 9808.0 7426.5 1786.3 199798 14151.6 9698.7 2947.9 1998-99 13755.7 9905.5 1825.0

Operations Despite a somewhat subdued economic and industrial investment climate the bank recorded robust growth in its operations in 1997-98 due to mainly larger flow of assistance to infrastructure sector and assistance under shortterm working capital product introduced during the year: Overall sanctions of IDBI during the year 1997-98 aggregated to Rs. 24,198.6 crore registering a growth of 41.9% over the previous year level of Rs. 17049.9 crore. Disbursement during the same year, amounted to Rs. 15,165.4 crore, which was 32.6% higher than disbursement of Rs. 11, 439 crores made in 1996-97. Direct Finance Sanctions of direct finance products recorded a decline of 11.8% to Rs. 13,288 crore and shared 78.4% of assistance for asset creation. Foreign currency loans registered a growth of 66.6%, while all other products recorded declines. The substantial increase in foreign currency loans is indicative of preference of the borrowing companies for foreign currency loans due to low interest costs compared to rupee loans. Rupee loans shared a major portion (75.4%) of direct finance Increased by foreign currency loans (19.4%). Disbursements under direct finance increased by 4.9% to Rs. 9818 crore claiming 86.6% of total asset creation. Rupee and foreign currency loans recorded increases of 11.4% and 16.5% respectively and formed 74.6% and 18.2% of disbursements under direct finance. Sanctions by way of deferred payments guarantees recorded a significant increase (60.9%) mainly due to a spurt in guarantees against foreign currency loans raised from overseas lenders. Sanctions by way of underwriting declined, reflecting he continued sluggish conditions in the capital market. Indirect Finance Refinance During 1996-97, sanctions and disbursements under refinance increased by 17.4% and 27.1% to Rs. 746 and Rs. 671 crore respectively mainly on account in increase in assistance to state level institutions. The share of SIDCs, SFCs and banks in the refinance assistance was 60.2%, 39.4% and 0.4% respectively. Bills Finance Sanctions and disbursements under bills rediscounting increased by 52.8% and 47.6% to Rs. 1147 crore and Rs. 763 crore respectively. The increase was mainly due to larger utilization by the State Electricity Boards. Assistance sanctioned and disbursed under direct discounting of Bills declined by 39.3% and 41.8% respectively. Loans to and Investments in Finance Intermediaries During 1996-97, IDBI sanctioned an amount of Rs. 44 crore by way of resource; support to financial intermediaries in the form of loans to and investments in shares and bonds of financial intermediaries. Merchant Banking IDBIs Merchant Banking Division lead managed 21 issues involving mobilization of Rs. 2923 crore during 1996-97. It won a number of mandates to financial advisory services and loan syndication for large projects in the power, petroleum, telecom and steel sectors. During 1996-97, the Bank earned an income of Rs. 5.6 crore through issue management and advisory services. Debenture trusteeship During 1996-97, IDBI accepted 35 debenture trusteeship assignments for debt funds aggregating Rs. 1070 crore. The bank also accepted four assignments as mortgage trustee/security agent to foreign and Indian lender as part of corporate trustee services. Forex Services IDBI opened Letters of Credit (LCs) for amounts aggregating Rs. 1994 crore as part of documentary credit services, relating largely to import of capital goods. Remittances against LCs for imports amounted to Rs. 2206 crore. Dealing room operations generated an income of Rs. 5.8 crore during the year. Purpose-wise Assistance Purpose wise data include sanctions under direct assistance (excluding seed capital and direct discounting), shortterm loans and underwriting/guarantees. Sanctions for expansion / diversification accounted for 47.6% followed by new projects (42.7%) and modernization (9.6%). Assistance sanctioned for modernization projects registered a growth of 74.3% while sanctions for all other purposes recorded declines.

Resources During 1996-97, IDBI raised Rs. 11,708 crore which wore mostly by way of debt instruments. This comprised domestic borrowings of Rs. 7751 crore, Rs. 134 crore by way of collections of delayed payment of allotment money in respect of IDBIs public issue of equity shares and foreign currency borrowings of Rs. 1623 crore. Of he rupee borrowings, IDBI mobilized Rs. 1682 crore through its public issue of the Flexobond series 2. Other sources of rupee borrowings include certificates of deposits, term money bond, fixed deposits, private placement of bonds and borrowings from government of India. The Bank raised US $ 100 mn by way of club loan for seven year maturity and US $ 150 mn through a seven year syndicated loan. IDBI signed a five year DEM 50 mn bilateral loan facility, a third us $ 50 mn bilateral loan. The Bank launched a US $ 150 mn Floating Rate Note issue in the Euro market. IDBI grants financial assistances to industries which are in conformity with the national priorities as set out in the national development plans. Besides each individual project is appraised in regard to its technical feasibility, commercial, profitability, financial soundness, economic return and managerial competence, and only projects that satisfy the criteria laid down are provided financial assistance. Subject to these criteria, preference is given to projects in backward areas, projects promoted by new and technically qualified entrepreneurs, project with large employment generating capacity and those which are export oriented or import substitutive. The main consideration in appraisal of the project is its commercial and economic viability. Projects with capital costs upto Rs. 3 crores are generally assisted indirectly by IDBI through the State Level agencies / commercial banks so that IDBI concentrates only on the bigger projects for grant of direct financial assistances. Projects involving projects cost of Rs. 5 crores or more are generally assisted in consortium with other development financial institutions. The amount of assistance in consortium with other development financial institutions. The amount of assistance to a single project is normally subject to the limit of 25% of the paid-up capital and reserves of IDBI. In compliance with new Industrial Policy (July 1991), IDBI has dispensed with the convertibility clause. It would not be stipulated in respect of new and expansion projects. This clause would be applicable in the case of rehabilitation assistance in overrun and burrowers default cases. In respect of loan agreement executed prior to August 1991, the convertibility stipulation would be waived provided the companies agree to pay prevailing higher rates of interest. Fellow up and Monitoring IDBI, in association with the other financial institutions, has evolved a mechanism whereby one of he participating institutions acts as the lead institutions for appraisal 01 the project as well as for post sanction matters covering documentation, disbursement, follow up and recovery. This helps the industrial units to deal with one institution only instead of all the participating institutions. Follow up of cases done by (i) periodical inspectors/visits, (ii) nomination of directors on the board of Directors of the assisted units and (iii) obtaining periodical returns about the operation of the units. Where IDBI, is not the lead institution in respect of an assisted project, it keeps a close liaison with the concern lead institution in matters of follow up. The Bank also has arrangements for close monitoring and nursing of its assisted units which may have turned sick. Besides, the bank helps to bring about, where necessary, changes in the management of such units or for amalgamation of such units with healthy ones.

Lesson 10 IFCI & IRBI Objective Reading this lesson the students will be in a position to understand the establishment of IFCI Limited, Main activities, Prime Lending Rates, Scope of financial assistance provided by IFCI, Present financial position, Project Finance, Finance Services and Promotional Services. Contents IFCI Limited IFCIs main activities Prime Lending Rates of IFCI Ltd. Scope of Financial assistance provided by IFCI Present financial position of IFCI Ltd Project Finance Finance Services Promotional Services

IFCI Limited Industrial Finance Corporation of India was the first development bank established in India in the year 1948. Its basic objective is to make medium and long term credits more readily available to industrial concerns in India. It was established as a statutory corporation under the IFCI Act, 1948 and its share capital was subscribed by the commercial banks, cooperative banks, insurance companies etc. After forty-seven years of esperience as the pioneer development bank in the country, IFCI was converted into a public limited company on July 1, 1993 and is now known as the IFCI Ltd. Every shareholder of IFCI became the shareholder of the company with effect from the same date. The necessity of IFCIs conversion into a limited company was felt to ensure greater flexibility and ability of IFCI to respond to the needs of the changing financial system. After its conversion into a public limited company IFCI now has the flexibility to reshape its business strategies with greater operational autonomy in providing quality services to customers and tapping the capital markets. Under the IFCI Act, 1948, IFCI was prohibited to enter into the capital market except when backed by a Government guarantee and was thus prevented from raising resources on competitive terms. As a joint stock company IFCI is not able to enter the capital market for resources, through debt and equity instruments. After becoming a company, IFCI made a public issue of equity shares aggregating Rs. 225 crore (including premium of Rs. 340.65 crore) during the year 1993-94. The number of is shareholders increased from 230 to 13.5 lakh at the time of allotment of shares. IFCIs Main Activities IFCIs today not only a term lending institution, but an active financial intermediary and a provider of a wide range of services to industry. Its main services fall under the following categories:

IFCI Assistance

For Assets

Creation

Short term /Corporate Loans

Direct

Indirect

Project finance is the main activity of IFCI like other development banks. Under project finance, assistance is provided in the following ways: Long term loans both in rupees and foreign currencies. Underwriting of equity, preference shares and debenture issues, Subscribing to equity, preference shares and debenture issues. Guaranteeing the deferred payments in respect of machinery imported from abroad/purchased in India, and Guaranteeing of loans raised in foreign currency from foreign financial institutions.

Financial assistance may be availed of by any limited company in public, private or joint sector or by a cooperative socity incorporated in India, which is engaged or proposes to be engaged in any of the specified industrial activities. There is no minimum or maximum ceiling on the amount of assistance to be granted of IFCI. Such assistance does not normally exceed 25% of IFCIs net worth (i.e. capital and reserves). The financial assistance rendered by IFCI is meant for setting up of new industrial projects and also for the expansion, diversification, renovation or modernization of existing ones. Under this category are also included financial assistance, not tried to any project, provided by IFCI to industrial concerns. The following schemes of assistance have been introduced by IFCI under this category. Equipment Leasing Suppliers Credit Buyers Credit

Indirect finance is provided as assistance to leasing companies Prime Lending Rates of IFCI Ltd. The IFCI Ltd. has fixed two prime lending rates only i.e., the (i) Short Term Prime Lending Rate (STPLR) for working capital loans with a maturity upto three years and (ii) Long Term Prime Lending Rate (LTPLR) for loans with maturity exceeding three years. Like ICICI and IDBI, IFCI also revised its Prime Lending Rates primarily influenced by the cost of funds and the general movement in interest rates. In April 1998 IFCI prescribed Short Term Prime Lending Rate at 13.0 and Long Term Prime Lending Rate 14.0%. The actual rate was fixed within a bond of 3.5% over the prime lending rate. In March 1999 IFCI resorted to a cut of half a percentage point in both the Prime Lending Rates; the band of 3.5 percent continued in case of LTPLR, but was reduced to 3% in case of STPLR. IFCI Ltd. has been following the policy of linking its interest rate to the prevailing prime lending rate at the time of disbursement and thus it does not carry the interest risk. This principle is applied both in case of Rupee Loans and foreign currency loans. Interest n Foreign Currency Loans is charge LIBOR + spread. IFCI Ltd. grants the loans in the same currencies in which it has borrowed the funds, and repayments from the borrowers are also sought in the same currencies. Hence no foreign exchange risk is borne by the Corporation. Scope of Financial assistance provided by IFCI The scope of financial assistance provide by IFCI cover principally project financing, financial services and promotional and development activities. Financial services includes merchant banking and allied services, equipment financing / leasing / credit / procurement and buyers/suppliers credit schemes; promotional services including support activities for technical consultancy training, risk capital, technology finance, tourism, development finance, entrepreneurship development, science and technology parks and various subsidy schemes to help mainly new entrepreneurs and enterprises mainly in such urban areas and villages and small industries sector. Project financing operation of IFCI basically cover direct financial assistance in the form of loans, direct, subscription, to equity for establishment of new industrial undertaking as also for expansion, diversification renovation or modernization of existing industrial units in the corporate and/or cooperative sector engaged or to be engaged in: The manufacture, preservation or processing of goods; Shipping; Mining; Hotel industry; Generation, storage or distribution of electricity or any other form of energy etc.

IFCI provides three types of services viz Projects Finance, Financial Service and Promotional Services. Project Finance Under this service scheme, assistance is provided to eligible industrial concerns for their expansion, diversification and modernization progarmmes in the form of rupee loans, foreign currency underwriting and direct subscription to shares/debentures, guarantees for deferred payments and foreign currency loans, suppliers and buyers credit etc. Finance Services IFCIs financial services include: Merchant Banking and Allied Services; including project conselling, issue management, loan syndication, financial restructuring, consultancy to ailing or sick industrial units, mergers and acquisition and debenture trusteeships; Equipment Financing; Equipment Leasing; Equipment Procurement; Equipment Credit; Suppliers Credit; Installment Credit; Buyers Credit, and Finance to Leasing and Hire Purchase Concerns

Promotional Services IFCIs promotional services cover funds support for: Technical consultancy; Risk Capital; Venture Capital; Technology Development Tourism and Development and finance; Housing Development and Finance; Institutional infrastructure for development of capital market; Entrepreneurships Development; Management Development Labour Development Development of rural poor and urban poor through voluntary organisatoins Development of Bio-Technology Development of science and technology entrepreneurs parks; Development of Research, etc. and Subsidy support through promotional schemes to help the Village Small Industries Sectors entrepreneurs and enterprises.

The major thrust in the area of promotional services continued to be or providing suppor and momentum to the Village and Small Industries (VSI). Financial assistance is available from IFCI to industrial concerns regardless of their size. Nevertheless, having regard to the scope of operations of the various other institutions operating at the All-India and State levels as also some of them specifically, meeting the financial requirements of cottage and small scale sectors. IFCI, has been largely catering to the needs of medium and large sized projects either singly or jointly with other all India Financial

Institutions like the Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation India Ltd. (ICICI), Unit Trust of India (UTI), Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC). IFCI extends term lending facilities to the corporate sector exactly on the pattern of other institutions, viz, IDBI or ICICI. It is to be noted that IFCI considers for sanction project with capital cost above Rs. 5 crore either on its own or in participation with other term lending institutions. It also considers project between Rs. 3 crore to Rs. 5 crore as a matter of special consideration. These are no maximum ceiling up to which project could be financed, but it is with in the exposure limit mentioned above. In respect of project financing, consideration are kept in mind, much in the same manner as other financial institutions with respect to means of financing, promoters contribution debt-equity ratio. Assistance from IFCI singly or jointly with other institutions is available for (a) setting up of new industrial project, (b) expansion of existing units or for diversification inot new lines of activity, and (c) for renovation and modernization of existing units. IFCI does not ordinarily grant assistance for purposes of working capital, as it is a normal function of the commercial banks to provide such capital. IFCI does not also allow its funds to be utilized for meeting existing liabilities of he industrial concerns save in exceptional circumstances, or for acquisition of capital goods for commercial or trading purposes. Likewise, sub-loans in foreign currencies are granted only for the import of capital goods and not for financing import of raw material or maintenance shares or payment of royalties or dividends, etc. IFCI ahs recently in line with changing business environment, introduced a schemes for sanction of working capital credit facility to meet varied needs of client. As a part of its diversification efforts, IFCI has formed IFCI Financial Services Ltd. for undertaking merchant banking, stock broking and allied services, IFCI Custodial Services Ltd. for offering custodial services to its clients, IFCI Investor Services Ltd. for providing registrar and transfer services. It has also set up the investment Information and Credit Rating Agency (ICRA) to rate various debt instruments. IFCI has also been one of the main co-promoters of the Infrastructure Development Finance Company Ltd. set up for providing finance to infrastructure projects. Present Financial Position of IFCI Ltd. For the past few years IFCIs financial position has not been satisfactory. There has been sharp drop in profits before tax during 1998-99, though total income has been larger as compared to the previous two years as is evident from the following figures: The sharp fall in profit before tax is obviously contributed by Increase in interest expenditure and other expenditures including provisions. The net Non-Performing Asset of the Corporation increased sharply form 14.41% of loan portfolio in 1997-98 to 21.44% in 1998-99. These non-performing assets comprised of the outstanding assistance to 1,110 companies aggregating 4,234 crores. The most prominent defaulters amongst borrowers are in the textiles, iron & steel, metal products, chemicals, synthetic fibers & resin & food products industries. IFCI is making efforts to reduce the level of non-performing assets by re-structuring of the borrowers concern and by granting reliefs and concessions, encouraging mergers and amalgamations with healthy companies. one time settlement of the due etc. 60% of the NPAs of the Corporation are in the form of sub-standard assets, while the reminder fall under the category of doubtful assets. A larger portion of sub-standard assets ahs been restructured during 1998-99. The task before IFCI is gigantic and the success will depend on the effective implementation of the various steps already initiated. Income & Expenditure of IFCI Ltd. 1996-97 1997-98 1998-99 P.C. variation in 1998-99 over 1997-98 8.4 422.2 11.0 21.1 160.4 94.8 93.7

Income from operations Other Income Total Income Interest Expenditure Other Expenditure Profit before tax Tax Provision Profit after tax

2568.4 13.9 2582.4 1775.6 344.2 462.6 84.0 378.6

2585.1 16.6 2601.7 1956.5 190.7* 454.5 84.0 370.5

2801.9 86.6 2888.5 2368.4 496.6** 23.5 0.0 23.5

Includes provision for depreciation. Interest tax and bad & doubtful investments less appropriations from special Reserve.

Includes provision for depreciation, interest tax and bad and doubtful Investment

IFCI has established Merchant Banking division like other financial institutions. Its headquarters is located at New Delhi. Merchant Banking division of IFCI assists corporate in their capital restructuring, merger and amalgation. It undertakes loan syndication with other financial institutions for the benefit of corporate enterprises. It undertakes trusteeship assignments also. Financial assistance sanctioned by the ICICI was Rs. 3744 crore in 1990-91 and it has increased to Rs. 32371 crore in 1998-99. Similarly financial assistance disbursed is increased from Rs. 1968 crore in 1990-91 to Rs. 19225 crore in 1998-99. Sources of funds of IFCI Ltd. and their Applications 30.6.93 Sources of Funds Share capital Reserve & surplus Borrowings Rupees Foreign currency Total Applications funds Loan to concerns of 8016 324 269 451 8412 412 278 609 22 8907 638 305 335 86 10853 1249 309 321 173 13399 1633 519 628 163 16423 2091 529 531 140 17842 2745 511 677 125 9060 9733 10271 12905 16343 19715 21900 in 202 574 5712 339 998 5843 352 1043 5614 353 1282 8655 353 1351 14442 453 1244 14362 790 936 16460 31.3.94 31.3.95 31.3.96 31.3.97 31.3.98 31.3.99

Assisted

Investments Fixed Assets Net Current Assets Mis. Expenses (other issue expenses)

1060

9733

10271

12905

16343

19715

21900

Financial assistance sanctioned and disburse by All India Financial Institutions during the period 1990-91 to 19992000. Years S 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2430 2421 2348 3746 5720 10300 7212 7693 4525 2191 1574 1604 1733 2163 2839 4563 5157 5660 4826 2966 IFCI D 3744 4095 5772 8492 14528 14595 14084 24718 32371 44479 S 1968 2351 3315 4413 6879 7120 11181 15807 19225 25836 ICICI D 6272 6510 9247 12086 18199 16476 15634 23982 23745 28308 S 4501 5782 6713 8096 10672 10695 11468 15170 14470 17059 IDBI D

IRBI Industrial reconstruction bank of India Industrial Reconstruction Bank of India (IRBI) was established by the Government of India in the year 1985. The important objectives of this financial institution is to reconstruct and rehabilitate the sick industrial units which are closed down or facing the risk of closure. IRBI assesses viability of such units after financial assistance. The Industrial Reconstruction Bank of India was established as per the provisions of the Industrial Reconstruction Bank of India Act, 1984. The erstwhile Industrial Reconstruction Corporate of India (IRCI) which was established in 1971 was transferred to the IRBI. It was established to deal with the problem of industrial sickness and provide suitable financial assistance to make them viable. IRBI was converted into a company in the year 1991 and it serves as a full fledged financial institution. IRBI provides financial assistance for modernization, diversification, expansion and renovation of industrial units. It provides financial assistance for meeting working capital requirements also. Lines of credit, equipment leasing, hire purchase etc are other forms of financial assistance of IRBI. Line of credit scheme of IRBI is operated through various state level agencies. This scheme is meant for providing financial assistance to sick small-scale units. Prevention is better than cure. IRBI takes strenuous efforts to prevent sickness in small-scale units. It suggests economic size of operation, modernization, diversification etc for its assisted small-scale units. It enters into consortium with other all India financial institutions for the purpose of designing suitable remedies to prevent sickness in small scale units. The IRBI provides consultancy services to banks and financial institutions regarding project identification and appraisal and undertakes merchant banking services for the benefit of corporate in connection with mobilizing financial resources, amalgamation, merger and reconstruction of corporate enterprises.

Lesson 11 RBI & Management of GILT Securities Market Objectives Reading this lesson, the students will be in a position to understand the Functions of he RBI, Instruments of Credit Control, Minimum Statutory Cash Reserve Ratio, Minimum Secondary Cash & Reserve Requirements, Gilt edged / Governments Securities Market, Characteristics of Gilt-edged Securities Markets, Forms of Central and State Government Securities, Participants in Gilt-edged Securities Market, Trading Procedure, Retailing in Government Securities, Types of Government Bonds and Satellite Dealers in Government Securities. Contents Functions of the RBI Instruments of Credit Control Regulation of Consumer Credit Regulation of Margin Requirements Gilt edged /Government Securities Market Meaning Characteristics of Gilt-edged Securities Market Forms of Central and State Government Securities Participants in Gilt-edged Securities Market Trading Procedure Retailing in Government Securities Types of Government Bonds Satellite Dealers in Government Securities

Reserve Bank of India is knows as Central Bank. According to Kisch and Elkin, the essential function of a central bank is the maintenance of the stabilituy of the monetary standard. De K. ock., M.H., in his book Central Banking, has specified functions of the Reserve Bank of India Central Bank). Function of the RBI Bank of Issue Banker, Agent and Financial Adviser to Government Custodian of Member banks Cash reserve Custodian of nations foreign exchange reserve Lender of the last resort Bank of central settlement and transfer acting as clearing house. Controller of credit.

Reserve bank of India serves as a banker to the Government. It does not deal with the public directly but indirectly through the commercial banks and money market. It does not mobilize deposit form public. Bank of issue The RBI is authorized by law to print and issue currency notes in India. Printing of paper currency is an important function of the RBI. De kock, M.H. has stated that the privilege of note issue was almost everywhere associated with origin and development of central banks. In fact, until the beginning of the twentieth century they were generally known as bank of issue. Vaish M.C. in his book Money Banking. Trade and Public Finance has given the following pints supporting the reasons for granting the exclusive monopoly of note issue to the Reserve bank of India.

As the use of deposit money created by commercial banks increased and with this as the growing need for credit control by a central bank was felt, it was realized that a monopoly of note issue allowed to the central bank mode its control over the excessive credit expansion of the commercial banks more effective. When the notes are issued by the central bank they carry with them the advantage of uniformity. Since the central bank handles the complicated matters relating to monetary management, it is better equipped to solve effectively the problems related to the issuing notes. Government banker, fiscal agent and advisor The Reserve Bank of India serves as Government Banker, Fiscal Agent and Adviser in all financial matters to the Government. The RBI advises the government of various important economic and financial matters such as inflation control, managing money supply, funding for national debt, deposit mobilization for commercial banks, providing loan for industry, service and business, managing deficit financing etc. Custodian of member banks cash reserve Commercial banks are directed by the Reserve Bank of India to deposit certain percentage (8%) of their total deposit as case reserve with the RBI and this apex bank serves as the custodian of the ultimate reserve of the country which support its banking system. RBI discounts bills of commercial banks arid provides credit, based on the cash reserve, DE Kock, M.H., has observed that the centralization of cash reserves in the central bank is a source of great strength to the banking system of any country. All commercial banks are expected to maintain the stipulated cash reserve with the RBI and they have to strictly follow the cash reserve ratio fixed by the RBI from time to time. Custodian of nations foreign exchange reserves The Reserve Bank of India serves as custodian of Indias foreign exchange reserves. The RBI takes timely measures to face the balance of payment crisis at any time and to maintain exchange rate stability. Current account convertibility is in practice after liberalization. Importers get required foreign exchange in the foreign exchange market. They need not approach the RBI. Similarly exporter covert the earned foreign currency into Indian rupee in forex market. The RBI takes steps to maintain the required foreign exchange reserve in the form of foreign currency, gold and SDR. Lender of the last resort The RBI serves as lender of the last resort. This function is regarded as the sine qua non of central banking. As a lender of last resort, the RBI provides funds to meet liquidity requirements of commercial banks, discount houses and other financial and credit institutions subject to its policies and procedures. If the liquidity crisis is not solved after taking all steps, financial institutions can get assistance of RBI to solve their liquidity problems. The RBI is readily available to provide necessary financial assistance to the financial institutions. Bank of central clearance, settlement and transfer The RBI serves as a bank of central clearance, settlement and transfer. As the RBI is a banker for all banks, it is easier to clear and settle claims between banks by creating transfer entries in their accounts maintained with it. Clearance, settlement and transfer are done timely when RBI serves as a central clearing agency. Willis H.P., in his book Theory and Practice of Central Banking, has highlighted that, clearing and settlement function is not only a means of economizing cash and capital, but in also a means of testing at any time the degree of liquidity. Clearing, settlement and transfer are important functions of central banking. Claims and transfers between banks are duly settled through this function. This function was pioneered by the Bank of England during the middle of nineteenth century. Controller of Credit Control of credit is the most important functions of the central bank. It is one of the features of central banking policy. The Reserve Bank of India Act 1934 states that the bank is, generally to operate the currency and credit system of the country to its advantage. Vaish M.C., has stated that, the need for controlling credit it obvious. Credit has become more important than money although later is the basis of the former. Unwarranted fluctuations in the volume of credit by causing wide fluctuations in the value of money cause great social and economic unrest in the country. Inflation control, maintaining interest rate relate to inflation rate, managing currency circulation, maintaining call money rate at manageable level and exchange rate stability are important objectives of credit control. Instruments of Credit Control The following are principal instruments used by the central banks to control credit in the economy. Bank rate

Open market operations Credit rationing Direct rationing Direct action Minimum statutory cash reserve ratio Minimum of consumer credit Regulation of margin requirements Moral suasion Publicity

Bank rate Bank rate is the rate at which the RBI provides financial assistance to other financial institutions. It is an instrument used by the RBI for the purpose of credit control in the economy. Changes in bank rate controls the volume of credit indirectly. Lending rates are changed based on the bank rate and lending rates are determining factors for loans and investment in banking system. Increase in bank rate contributes to higher deposit rate and lending rate. Reduction bank rate will reduce these two rates. Credit flow will reduce if he lending rate is high. In order to curtain the increase credit flow, bank rate is hiked by the RBI. This rate is reduced to increase the flow of credit in the banking system. Bank rate serves as a barometer the economic situation in the country. Open market Open market operations is a quantitative instruments used by the RBI to control the volume of aggregate bank credit. The RBI exercises control over the credit creating capacity of commercial banks through open mark operations. Under open market operations, the RBI buys and sells government and other approved securities in the money and capital market. During the boom period, the RBI sells the government and other approved securities from its security portfolio. This operation reduced aggregate money supply in the economy. Buyers of these securities remit money to the RBI and they withdraw from banks for payment. Bank will reduce its credit creation. During the slum period, the RBI buys the government and other approved securities from the securities market and pays money for the securities purchased. The money is deposited in commercial banks and banks can create credit. This operation increases aggregate money supply in the economy. Thus buying and selling securities in the money and capital market influences credit strength of commercial banks. Credit rationing Credit rationing is one of the instruments of credit control and credit regulation. Vaish M.C., has stated that, credit rationing by the RBI is a very important factor in the general economic policy execution. At times when the demand for credit exceeds the total available resources, it is obliged to divide the available funds in some definite way among those who need them. Direct action Direct actions is an instrument of credit control. If refers direct action taken by the RBI to reduce the availability of credit from commercial banks. Under direct action, the RBI takes steps to forbid the commercial banks to grant credit or to grant credit in a prescribed manner and for the specified purpose. The RBI uses direct action in the form of selective credit control for credit control. The RBI gives strict guidelines for providing credit against the commodities listed under selective credit control. The guidelines controls exorbitant credit. Minimum statutory cash reserve ratio Commercial banks are compelled by the direction of the RBI to keep certain percentage of their total deposits with the RBI in the form of cash reserve ratio. Increasing cash reserve ratio will reduce funds available with banks. On the other hand reducing the cahs reserve ratio will increase money supply with banks. Cash reserve ratio has been reduced periodically after financial sector reforms. Changes in cash reserve ratio is announced by the RBI through its credit policy. Minimum secondary cash reserve requirements Vaish, M.C., has highlighted that minimum secondary cash reserve is to reduce the capacity of the commercial banks to expand credit by limiting their capacity to convert government securities and surplus cash assets into business loans.

Regulation of Consumer Credit It is an instrument of credit control. If consumer credit form commercial banks is easily made available to consumers, money supply or credit will increase, on the other hand strict control over consumer credit will curtain credit creation of commercial banks. After financial and banking sector reforms, consumer credits are easily made available to consumers. Commercial banks come forward to provide consumer credit in order to utilize their funds available with them. Regulation of consumer credit is a supplementary instrument used to combat inflation. Regulation of Margin Requirements It is one of the tools of credit control used by the Reserve Bank of India. Goldenweiser A., in his book Banking studies has stated that margin requirements have served a useful purpose and some light has been thrown open their possibilities and their limitations as an instrument of credit policy. Moral suasion It is one of the steps of credit control. The RBI persuades the commercial banks to co-operate with it in pursuing credit and to follow the guidelines issued periodically for credit control. The RBI directs the commercial banks to follow the guidelines for priority sector lending and other types of lending. Credit policy and other instructions related to credit policy are systematically followed by the commercial banks for the purpose of fulfilling the objectives of credit control of the RBI. Periodical publications Annual Report and other publications of the RBI pave the way to reveal the steps taken by the RBI for credit control and their impact in banking sector and overall economy of government of India. RBI announces credit policy twice (busy season and lean season) in a year to highlight its proposals to monitor Indian Banking system. Gilt edged / Government Securities Market Meaning Government securities refer to the marketable debt issued by the government of semi-government bodies. A government security is a claim on the government. It is a totally securer financial instrument ensuring safety of both capital and income. That is why it is called gilt-edged security or stock. Central Government securities are the safest amongst all securities. Issuers of government securities Government securities are issues by: Central Government State Government Semi-Government authorities like local government authorities, e.g., city governments and municipalities Autonomous institutions, such as, metropolitan authorities, port trusts, improvement of development trusts, state electricity boards. Public Sector Corporations Other governmental agencies, such as IDBI, IFCI, SFCs, NABARD, LDBs, SIDCs, housing boards etc.

Characteristics of Gilt-edged Securities Market Gilt-edged securities market is one of the oldest market in India. The market in these securities is a significant part of Indian stock market. Main characteristics of government securities market are as follows: Supply of government securities in the market arises due to their issue by the Central, State of Local governments and other semi-government and autonomous institutions explained above. Government securities are also held by Reserve Bank of India (RBI) for purpose and sale of these securities and using as an important instrument of monetary control. The securities issued by government organisations are government guaranteed securities and are completely safe as regards payment of interest and repayment of principal. Gilt-edged securities bear a fixed rate of interest which is generally lower than interest rate on other securities. These securities have a fixed maturity period.

Interest on government securities is payable half-yearly. Subject to the limits under the Income Tax Act, interest on these securities is exempt from income tax. The gilt-edged market is an over the counter market and each sale and purpose ahs to be negotiated separately. The gilt-edged market is basically limited to institutional investors.

Forms of Central and State Government Securities These securities can be issued in three forms: Inscribed stock or stock certificate Promissory note Bearer Bond

Bearer bonds are generally not issued in India and stock certificates are not popular with investors. Most government securities are in the form of a promissory note. Of course, promissory notes of a loan can be converted into stock certificates of any other loan and vice versa. Stock certificates have some benefits over promissory notes, such as, (a) the name of the holder of stock certificate is registered in the books of Public Debt Office (PDO) and hence these are safer, (ii) these are sent to the applicant directly by registered post by the PDO, (iii) the half-yearly interest is directly remitted to the holder by an interest warrant drawn at par on any treasury or State Bank of India branch specified by the holder or is remitted by money order, if the holder so desires, and (iv) it can be sold by singing the transfer for on the reserve of the certificate. Despite these advantages stock certificates are not popular because their lack of quick transferability and negotiability. these cannot be transferred by endorsement. The procedure for their transfer is relatively more complex. Participants in Gilt-edged Securities Market Participants in government securities market belong to the following categories: 1. Central and State governments. Their holdings represent inter-government transfer of resources. 2. Banking Sector, comprising RBI, SBI, other commercial banks, and co-operative banks. 3. Insurance companies including both Life Insurance Corporation and general insurance companies. 4. Provident funds, both statutory and non-statutory 5. Other institutions including special financial institutions, joint stock companies, local authorities, trusts, individuals and non-residents. Why government securities are issued? Issue of securities takes place for the following purposes: For refunding, i.e., for conversion or refinancing of maturing securities; For advance refunding of securities which have not yet matured, known as reissue of loans; and Cash financing, i.e., raising fresh cash resources.

Trading Procedure Transactions in the gilt-edged market are carried out in the following ways: Through vouchers, i.e., direct sales Through securities general ledger (SGL) accounts, and Through bank receipts (BRs)

Direct sale of government securities is affected by PDO by pre-specifying the loan amount and the dates when subscription for government loans would be open. In case of transactions through SGL, the transactions are recorded as book entries by RBI only in the ledger on the date of the transaction and at the value at which the transaction has taken place. Under the system each dealing bank maintains an SGL account with RBI on account of the balance of the Central Government securities. The transactions are effected by selling bankers by filling out the prescribed SGL form which is then lodged with RBI. SGLs facilitate repo transactions. A repo or Ready Forward (RF) refers to a

sale transaction with a stipulation to buy-back the securities at a stipulated future date, at a price determined on the date of sale transaction. To avoid physical transfer of securities, the selling bank issues a bank receipt (BR) instead. In this case it is called transaction through BR. This avoids the hassle of writing the SGL forms and lodging them the RBI. This process is resorted to when the repo transaction is for a short time. However, conduct of short operations by banks i.e., selling government securities without owning them with a views to neutralizing the transaction by buying them at a later date) through Issue of BRs is being discouraged by RBI. Retailing in Government Securities The RBI issued guidelines to banks in June 1996 for retailing of government securities with non-bank clients. These include: No purchase of securities sold to the client before the expiry of 30 days. This conditions was removed on Oct. 21, 1997. Retailing should be on the basis of on-going market rates/yield curve emerging out of secondary market transactions. Sale should be effected by banks only if they hold the securities In their portfolio either in the form of physical scrips or in the Subsidiary General Ledger (SGL) account maintained with the RBI; and On sale, deductions of the corresponding amount by the bank from its investment accounts and also form its Statutory Liquidity Ratio (SLR) assets.

In addition, banks are required to put in place adequate internal control checks and mechanisms and these transactions are to be subjected to concurrent audit. These guidelines were issued on an expectation that non-bank client such as provident funds, trusts, non-banking financial companies and high net worth individuals will provide as big push to the development of the retail trading in government securities. In order to further promote the retail market segment and to provide greater liquidity to retail investors, it was announced on October 21, 1997, that the banks could henceforth freely buy and sell governments securities on the outright basis at prevailing market prices, without nay restriction on the period between sale and purchase. thus the condition, that the banks shall not buy the security form the person to whom it is sold within a period of days of the transaction, has been removed Types of Government bonds Zero coupon bonds These are bonds issued at discount and repaid at face value. the difference between the issue price and the redemption price represents the return to the investor. No periodic Interest payment is made. Zero Coupon bonds bear no reinvestment risk but they are prone to interest rate risk making their prices highly volatile. The buyers of zero coupon bonds make a series of periodic coupon payments to the buyer as well as paying face value at maturity. Zero Coupon Bonds on auction basis with introduced in January 1994 by Government of India. Floating rate bonds These are instruments whose periodic interest or dividend rates are indexed to some reference index such as Treasury bills etc. these instruments give a variable rate, a characteristic that allows both issuer and investor to share the risk inherent in changing interest rates. The volatility of interest rates have led to creation of these instruments designed to offer some protection to the players. Thus, Floating Rate Bonds enable investors to take advantage of movements in interest rates. Floating Rate Bonds were introduced by Government of India on September 29, 1995 linking it to 364 day Treasury bill rate. Tap stock This is a gilt edged security from an issue that has not been fully subscribed and is released into the market slowly when its market price reaches predetermined levels. Short taps are short dated stocks and long taps are long dated socks. These stocks were introduced by Government of India on July 29, 1994. Partly paid stock This is an innovative instrument (Government stock auctioned on November 15, 1994) for which the payment is made in installments. It is designed for institutions with regular flow of investible resources requiring regular investment outlet. The instrument has attracted good market response and is being traded actively.

Capital indexed bonds These bonds were floated on December 29, 1997 on tap basis. The tap was kept open upto 28 th January 198 and an amount of Rs. 704.52 crore was mobilized. These bonds are of four year maturity and carry a coupon rate of 6 per cent. The objectives of the capital indexed bonds were to provide a complete hedge against inflation for the principal amount of the Investment. Strips STRIPS stands for Separately Traded Registered Interest and Prinicpal of Securities Strips are created by separating the coupon from the principal and trading them independently. Thus, if a conventional bond of five year maturity has ten semi annual coupon payments and one payment of principal, ten coupon STRIPS and one Principal STRIP will be created on stripping the bond. Prices and yields Three types of prices are prevalent in gilt-edged securities market: RBI prices. These are prices for deals with RBI. These are not cash prices. RBI publishes a price list from time to time for securities dealt in by it. These prices are so aligned that the yield on these securities for the remaining maturity period is the same as on the bonds of similar maturity which are currently issued. Prices prevailing in the secondary market at which deals take place between different operators. Artificial or loaded prices fixed by the brokers for producing deals in securities. For helping banks to show higher book profits the dealers buy depreciated securities at an inflated price above the market price and sell the same amount of some other security to the bank again at inflated price so as to neutralize its loss on purchase. Such artificial prices distort computation of yield on securities.

Satellite dealers in Government Securities RBI announced guidelines for Satellite (SDs) in the Government Securities Market effective from December 31, 1996. The objectives behind appointing Satellite Dealers are: (i) setting up a second tier in trading and distribution of government securities with a view to further activating the government securities market (ii) providing easy liquidity to the securities, and (Hi0 establishing retail outlets in order to widen investor base. On the basis of the applications received, RBI announced the list of entities approved as SDs on April 3, 1997 and added a few more entities as SDs thereafter. By mid-November 1997, the RBI had cleared the applications of nine firms and two banks to set up business as Satellite Dealers in government securities. The nine firms are: DSP Merril Lynch, Kotak Mahindra Securities, Ltd., Hoare Govt. (i) Securities Ltd., Dil Vikas Finance Ltd., Seri International. Ceat Financial, Tower Capital & Securities Pvt. Ltd., Tata Finance Securities Ltd., and Birla Global Finance. It is envisaged that Sds would primarily supplement the PD system. A really effective and active SD, may, in due course, become a Primary Dealers. Reserve Bank has also granted in principle approval on November 18, 1997 to two banks viz. Bank of America and Bank of Madura Ltd., to be accredited as SDs, in the Government securities market. The Banks would be setting up separate units dedicated to the securities business and in particular, the Government securities market.

Lesson 12 Stock Exchanges in India Objective Reading this lesson the students will be in a position to understand the meaning, objectives, features and workings of BSE, NSE and OTCEI. Contents Regulations Governing Stock Exchanges Securities Contracts (Regulation) Rules, 1957 Recognition by Government Organisation Stock Exchanges Governing Body Role of Stock Exchanges Mumbai Stock Exchange Rights of Investors of BSE Constitution of Stock Exchange Over The Counter Exchange of India Need for OTCEI Promoters of OTC Objectives of OTCEI Features of OTCEI Trading on the OTC Exchange Settlement on OTCEI OTCEI Market Operations Participants in OTCEI Guidelines for Listing of Companies in OTCEI Advantages of OTCEI Recent Developments Dave Committee Recommendation on OTCEI National Stock Exchange Establishment of NSE NSE Objectives Market Operations Advantages Index of NSE : NSE.50 Vision

In the share market, purchases and sales of shares are effected in conditions of free competition. A Stock Exchange is an association of member brokers for the purpose of self-regulation and protecting the interests of its members. The recognized Stock Exchanges are the media through which government regulation of the securities market is made effective. Stock Exchanges in the world made a humble geginning with the establishement of the Amsterdam Stock Exchange in the year 1494. The first Stock Exchange that was established in South Easter Countries was the Bombay Stock Exchange in the year 1875. Prior to that it was known as the Native Share Brokers Association Ahmadabad and Calcutta Stock Exchanges came to be established before the First World War.

Madras Stock Exchange, a pioneer in South India was first established in April 1920. Many people took to the share broking business but in a short span of 3 years they came to the conclusion that share broking business was not a profitable one and as a result th Exchange was would up in 1923. Even then, there were certain people who continued in the broking business in the share and securities of companies listed on Bombay, Ahmadabad and Calcutta. The most active scrips were Jute, Tea, Textile and Banks. As activity broadened, the persons transacting securities business felt that there should be an association to monitor, control and regulate the function which had in August 1937 resulted in the formation of the Madras Stock Exchange Association. It was inaugurated on September 4, 1937 by Sir William Wright, the then Managing Director of E.I.D. Parry Co. Ltd. Regulations Governing Stock Exchanges Besides SC(R) Act, 1956 the Securities Contracts (Regulation) Rules were also made in 1957 to regulate certain matters of trading on the Stock Exchanges. There are also byelaws of the Exchanges, which are concerned with the following subjects: Opening / Closing of the stock exchanges, timing of trading, regulation of blank transfers, regulation of badla or carryover business, control of the settlement and other activities of the Stock Exchange, fixation of margins, fixation of market prices or making up prices (Havala rates), regulation of taravani business (jobbing), etc., regulation of brokers trading, brokerage charges, trading rules on the Exchange, arbitration and settlement of disputes, settlement and clearing of the trading etc. Securities Contracts (Regulation) Rules, 1957 Under the Act, government has promulgated the Securities Contracts (Regulation) Rules, 1957 for carrying into effect the objects of the legislation. These rules provide, among other things, for the procedure to be followed for recognition of stock exchanges, inquiry into the affairs of recognized stock exchanges and their members; and requirements for listing of securities. The rules are statutory and they constitute a code of standardized regulations uniformly applicable to all the recognized stock exchanges. Recognition by Government A Stock Exchange is recognized only after the government is satisfied that its Rules and Byelaws conform to the conditions prescribed for ensuring fair dealings and protection to investors. A government has also to be satisfied that it would be in the interest of the trade and public interest to grant such recognition. Mumbai, Calcutta, Delhi, Chennai, Ahmadabad Hyderabad, Bangalore, Indore etc. have so far been granted permanent recognition. The rules of a recognized stock exchange relating in general to the constitution of the Exchange, the powers of management of its governing body and its constitution (including the appointment thereon of not more than three government nominees), the admission of members, the registration of partnerships and the appointment of authorized representatives and clerks must be duly approved by Government. These rules can be amended, varied or rescinded only with the previous approval of government. Likewise, the byelaws of the recognized exchanges providing in detail for the regulation and control of contracts in securities and for every aspect of the trading activities of members must also be sanctioned by government and any amendments or modifications must be similarly approved. Governments authority extends much further to make or amend suo motto any rules or byelaws of a recognized stock exchange, if it so considers desirable in the interest of trade and in public interest. The stock exchanges operate under the rules, byelaws and regulations duly approved by government and constitute an organized market for securities. They offer the most perfect type of market for various reasons. There is an active bidding and in the case of shares and debentures a two-way auction trading, so that purchases and sales are made in conditions of free and perfect competition. The bargains that are struck by members of the exchanges are the fairest price determined by the basic laws of supply and demand. In consequence, though gilt-edged securities represent ownership of public debt and shares and debentures of Joint-stock companies represent interest in industrial property mills and factories, plant, machinery and equipment they become the most liquid of assets and capable of being easily negotiated. Organization The recognized stock exchanges at Mumbai, Ahmadabad, Indore are voluntary non-profit-making associations, while the Calcutta, Delhi, Bangalore, Cochin, Kanpur, Ludhiana, Guwahati and Kanara Stock Exchanges are join-stock companies limited by shares and the Mumbai, Hyderabad and Pune stock Exchanges are companies limited by guarantee. Since the Rules of Articles of Association defining the constitution of the recognized stock exchanges are approved by the Central Government, there is an uniformity in their organisation.

Stock Exchanges Governing Body The governing body of a recognized stock exchange has wide governmental and administrative powers and is the decision taking body. It has the power, subject to governmental approval, to make, amend and suspend the operation of the rules, byelaws and regulations of the exchanges. It also has complete jurisdiction over all members and in practice, its power of management and control are almost absolute. Under the constitution, the governing body has the power to admit and expel members, to warn, censure, fine and suspend members and their partners, attorneys, remisiers, authorized clerks and employees, to approve the formation and dissolution of partnerships and appointment of attorney, remisiers and authorized clerks, to enforce attendance and information, adjudicate disputes and impose penalties, to determine the mode and conditions of stock exchange business and regulate stock exchange trading all its aspects and generally to supervise, direct and control all matters and activities affecting the stock exchange. The organisation of Mumbai Stock Exchange is typical. The members on roll elect 16 members to be Directors on the Governing Board, who in turn elect a President. Vice-President and Treasurer. The Executive Director is appointed by the government on the recommendation of the Governing Board to the Chief Administrator of the Exchange. There are also three representatives from the Government, three from the public and one from the RBI on the Board to represent their interests. As per the SEBI guidelines, the Exchanges have agreed to have 50% representation to non-members on the Governing Board. Role of Stock Exchanges Stock exchanges provide liquidity to the listed companies. by giving quotations to the listed companies, they help trading and raise funds from the market. Savings of investors flow into public loans and to joint-stock enterprises because of this ready marketability and unequalled facility for transfer of ownership of stocks, shares and securities provided by the recognized stock exchanges. AS a result, over the hundred and twenty years during which the stock exchanges have existed in this country and through their medium, the Central and State Government have raised crores of rupees by floating public loans; municipal Corporations, Improvement Trusts, Local Bodies and State Finance Corporations have obtained from the public their financial requirements, and industry, trade and commerce the backbone of the countrys economy have secured capital of crores of rupees through the issue of stocks, shares and debentures for financing their day-to-day activities, organizing new venture and completing projecs of expansion, diversification and modernization. By obtaining the listing and trading facilities, public investments is increased and companies were able to raise more funds. The quoted companies with wide public interest have enjoyed some benefits and asset valuation has become easier for tax and other purposes. Types of Securities on the Stock Exchange Equity Shares Preference Shares Debentures/Bonds Securities issued by Central / State Governments, Electricity Boards, financial institutions. Units of Unit Trust of India Master Share, Securities issued by Mutual Funds, Public Sector Corporation Bonds, Equity Shares, Securities issued by Private and Public Sector Mutual Funds, Warrants, SPN etc.

What are the types of bargains The business that takes place on the Indian Stock Exchanges can be classified into trading for clearing and treading for cash/ had delivery bargains. The term trading for clearing relates to the operation on forward trading basis, which has been banned by the Government in June, 1969. The term Hand delivery bargains refers to the Cash transactions where delivery and payment are required to be completed within a period of 14 days form the date of the transaction. Forward trading transactions are permitted to be carried on form settlement to settlement, by payment of interest charges which are termed as Cantango/Backwardation (Badla Charges). Qualities for membership of a recognized stock exchange Following conditions are prescribe to become a Member of a recognized Stock Exchange: The member Should be an Indian citizen and should have attained 21 years of age, Should not have compounded with creditors Should not be convicted for fraud/dishonesty.

Should not be engaged in any other business except as agent or broker. Should not be defaulter of any other stock exchange Has worked or agrees to work for at leas 2 years, as a partner, representative member, authorized assistant, authorized clerk, or he has succeeded to the established of any of his close relative due to his death or retirement.

Accounts of members Every member of a Recognized Stock Exchange is required to maintain the following books of account and documents. Register of transactions known as Sauda Book Clients Ledger General Ledger Journal Cash Book Bank Pass Book Document Register showing full particulars of shares and securities received and delivered Members Contract books showing details of all contracts entered into by him with other members Counterfolio/duplicates of contract notes issued to clients

Audit to accounts of members Every member when so required by the Central Government must get his accounts audited by a Chartered Accountant. Accounts of stock exchange Every recognized Stock Exchange must maintain and preserve for 5 years the following books of accounts and documents.

Minute books of the meeting of (i) members (ii) governing body (iii) any standing committee(s) of the governing body or the general body of members. Register of members showing their full names and addresses. Register of authorized clerks. Register of remissors or authorized assistants. Record of security deposits Margin deposits book Ledgers Journals Cash book Bank Pass Book

Annual report and return of stock exchange Every recognized Stock Exchange must furnish to the Central Government an annual report of the activities during the preceding calendar year by the 31st January next year. The report must contain detailed information about the changes in rules and byelaws, changes in the composition of the governing body or sub-committee(s), admissions, re-admissions, death or resignation of members; disciplinary action against securities listed and delisted and securities brought on or removed from forward list A Stock Exchange is also required to furnish to the Central Government a copy of its audited balance sheet and profit and loss account for each financial year within one month of the date of holding its AGM. In India, there are 23 recognized Stock Exchanges which are as follows.

The Ahmadabad Stock Exchange The Stock Exchange, Bombay The Bangalore Stock Exchange The Calcutta Stock Exchange Association The Cochin Stock Exchange Association Ltd. The Gauhati Stock Exchange Ltd. The Hyderabad Stock Exchange Ltd. The Mangalore Stock Exchange Ltd. The Ludhiana Stock Exchange Ltd. The Madras Stock Exchange Ltd. The Madhya Pradesh Stock Exchange Ltd. The Pune Stock Exchange Ltd. The Uttar Pradesh Stock Exchange Ltd. The Magadh Stock Exchange Ltd. The Jaipur Stock Exchange Ltd. Bhubaneswar Stock Exchange Association Ltd, Saurashtra Kutch Stock Exchange Ltd. Vadodara Stock Exchange Ltd. Coimbatore Stock Exchange Ltd. Meerut Stock Exchange Ltd, OTC Exchange of India. National Stock Exchange of India Ltd.

The Indian Capital Market witnessed many event during the post independence period, notable among them are: ban on forward trading, bank Nationalization, FERA dilution. Curb on Payment of dividend, Indo-China War and indoPakistan War. With many foreign companies disinvesting their holdings by transfer of India operations, the capital market received a hitherto unknown boost during he second half of 1970s and early 1980s. the investments climate had a change for the better and both the primary and the secondary market began to attract a good percentage of investing population. The number of companies listed on the Stock Exchanges was on the increase, resulting in the spread of equity cult among the investing public. Traditional investments have way to a different type of investment namely Stock Exchange Securities. There was also a remarkable growth in the membership of the Stock Exchanges, the Government of India set up in 1984 as high powered Committee under the Chairmanship of Shri G.S. Patel to go into the working of Stock Exchanges and suggest measures to tone up the Exchanges. The various suggestions made by the Committee are being implemented in stages. The Government is taking a number of measures to provide a healthy stock market. Stock Exchanges are also governed by Securities & Exchange Board of India (Stock Brokers & Sub Brokers) Rules 1992 securities and Exchange Board of India (Stock Brokers and Sub-Brokers) Rules and Regulations, 1992. Developing capital markets With the relaxation of restrictions on foreign investment in the past six years, Indias equity market has attracted significant non-debt financial resources from foreign institutional investors such as mutual funds, pension funds and insurance companies seeking international asset diversification. At the same time, the opening of the equity market to foreign investors has highlighted the need for continued reform of capital markets, including. Developing a deep and liquid corporate bond market.

Creating the necessary policy and regulatory framework for modernization of securities depository and clearing system; Strengthen the regulatory framework for investor protection; and Reforming the insurance industry. To that end, GOI has introduced important measures over the past six ten years. Statutory power has been given to the Securities Exchange Board of India (SEBI) to regulate the functioning of Securities market and Securities industry intermediaries and oversee corporate acquisition industry intermediaries and oversee corporate acquisition and takeovers. GOI has directed the Stock Holding Corporation of India Ltd., to establish a National Clearing and Settlement System and a Central Depository Trust for Securities. In addition, in an effort to enhance investor protection. SEBI has issued detailed guidelines governing the various stages of public capital issues, in particular, the obligations of underwriters. SEBI has also made several important changes, including registering Secondary market intermediaries, establishing and customer protection fund and an Investors Grievances Cell an each Stock Exchange, broadbasing the governing bodies of the Stock Exchanges, and increasing the number of Stock Exchanges

Mumbai stock exchange The Stock Exchange, Mumbai, which was established in 1875 as the Native Share and Stockbrokers Association (a voluntary non-profit making association), has evolved over the years into its present status as the premier Stock Exchange in the country. It may be noted that the Stock Exchange is the oldest one in Asia, even older than the Tokyo Stock Exchange, which was founded in 1875. It is the most active stock market in the country accounting over 70 per cent of the listed capital in the country while in terms of market capitalisation its share is over 75 per cent. The turnover on the Exchange accounts for nearly 1/3 of the total turnover in securities all over India. The Exchange while providing an efficient market also uphold the interest of the investors and ensures redressal of their grievances, whether against the companies or the brokers. It also strives to educate and enlighten investors by making available necessary informative inputs. The strategic objective of BSE To promote, develop and maintain a well regulated market for dealing in securities. To safeguard the interest of members and the investing public having dealings on the exchange. To promote industrial development in the country through efficient resource mobilization by way of investment in corporate securities. To establish and promote honorable and just practices in securities transactions. To receive material information from the company. Prompt service from company such as transfers, sub divisions and consolidation of holdings in the company. Equity holders have a right to subscribe to further issue of capital by the company. Brokerage not to exceed 2.5 percent of the contract price. Receipt of the contract note from the broker in the specified format showing transaction price and brokerage separately. Investors can expect delivery of shares purchased / value of shares sold within 2 days after the pay-out day. Access to the Exchange arbitration facilities in case of dispute with brokers.

Rights of investors of BSE

Constitution of Stock Exchange A Governing Board comprising of 9 elected director (one third of them retire every year by rotation), an Executive Director, three Government nominees, a Reserve Bank of India nominee and five public representatives, is the apex body which regulates the Exchange and decides its policies. A President, a Vice-President and an honorary Treasurer are annually elected from among the elected directors, by the Governing Board following the election of directors. The Executive Directors as the Chief Executive Officer is responsible for the day-to-day administration of the Exchange. Earliest records of securities trading in India are available from the end of the eighteenth century. Before 1850, there was business conducted in Mumbai in shares of banks and the securities of the East India Company which were considered as securities for buying, selling and exchange. The shares of the Commercial Bank, Mercantile Bank and

Bank of Bombay were some of the prominent shares traded. The business was conducted under sprawling banyan tree in front of the Town Hall, which is now in the Horniman Circle Park. In 1850, the Companies Act was passed and that heralded the commencement of joint stock companies in India, It was the American civil war that helped Indians to establish broking business. The leading broker, Shri Premchand Roychand was responsible for developing conventions and procedures. In 1874, the Dalal Street became the prominent place of meeting of the brokers to conduct their business. The brokers organized and Association on 9th July 1875 known as the Native Share Brokers Association to protect character, status and interest of the Native Brokers and that was the foundation of the Stock Exchange, Mumbai. The Exchange was established with 318 members. The number increased to 333 in 1896 and a present, it is 641. The membership fee has increased gradually from Rs. 1 in 1887 to Rs. 1,000.- in 1896, Rs. 48,000/- in 1920, Rs. 7.51 lakhs in 1986 and Rs. 55 lakhs at present. In 1950, Stock Exchanges became an exclusively Central Government subject following adoption of the Constitution of India. In 1956, the Securities Contracts (Regulation) Act was passed. In 1992, the Securities and Exchange Board of India Act was passed though the Securities Exchange Board of India (SEBI) came into existence in 1988. In the last three years, SEBI has been empowers by the Central Government to regulate and develop capital markets in India. In 1992, the Over the Counter Exchange of India (OTCEI) came into existence where equities of small Companies are listed. In 1994, birth of the National Stock Exchange took place, in 1995, the Exchange rapidly computerized its trading operations and thus the open cut-cry system of share trading was replaced by screen based trading in the Stock Exchange, Mumbai. In January 1996, the revised carry forward system was introduced. In September 1997, BSE On-Line Trading System network went nationwide. Over the Counter Exchange of India Need for OTCE1 The traditional stock exchanges have failed to provide adequate liquidity to small scrips and access to small investors. Investors are losing confidence in the market because of lack of transparency of operations, redressal of investors grievances and prompt settlement of transactions. Keeping in view the problem, the need for a stock exchange is felt which can help in solving the problems of liquidity and inaccessibility and redress the problem of investors efficiently. Meaning Over the Counter Exchange of India (OTCEI) is a company incorporated under Sec. 25 of the Companies Act, 1956, with the objective of establishing a national, ringless, screen-based, automated stock exchange. OIC market refers to a way of trading securities through a network of brokers-dealers spread over different locations and connected to each other by modern communication systems. The OTCEI aims at creating stock exchange which will facilitate small companies to raise funds from the capital market in a cost effective manner and provide a convenient and efficient avenue of capital market investment for small investors. Promoters of OTC OTC Exchange recognized as a stock exchange under section 4 of the Securities (Contracts) Regulation Act, 1956 is promoted by the All India Financial Institutions, Insurance Companies and Merchant Banking Subsidiaries of Banks. OTCEI has been modeled on the Over the Counter Market in US called NASBAQ operated and regulated by National Association of Securities Dealer (NASD) in USA. NASD is a self-regulatory organisation. OTCEI is the first exchange in India to introduce the concept of Market Making in the Securities listed on the Exchange. Market making implies facilitation trading whereby a member makes market in the securities by offering two say quotes, continuously for a period of one and half years. The market maker stands by his quote and readily accepts to buy or sell the securities at the prices given by him. The mechanism of market making results in efficient pricing and ensures liquidity in the securities. Objective of OTCEI It aims at creating a stock exchange which will facilitate small companies to augment resources from the capital market in a cost effective manner and provide a convenient and efficient avenue of capital market investment for small investors. It aims at strengthening investors confidence in the market to provide best prices to the investors, to ensure transparency and to redress investors complaints.

Feature of OTCEI OTCEI offers small and medium sized companies access to a market nation wide as well as chance to raise finance from capital markets cost effectively. It provides a convenient avenue of capital market investment for investors. It implements a computerized, ringless, scripless, stock exchange with trading and settlement standards in tune with global standards.

Trading on the OTC Exchange Every counter has a OTC Scan and the Counter Computer through which transaction take place. The trading steps are: Investor buying Investor walks up to counter, sees prices, decides to buy. Investor gives in cheque for transaction value inclusive of brokerage, receives temporary counter receipt (TCR) Investor returns within a week when cheque has cleared, receives permanent counter receipt (PCR). Investor walks up to counter, sees prices, decides to sell. Investor hands over PCR with transfer deed, if applicable to counter, receives sale confirmation slip. Investor returns within a week, when PCR has been validated, receives cheque for payment.

Investor selling

Trading Instruments Following are the various instruments traded on the OTC Exchange: Listed equities Listed debentures Permitted equities Permitted debentures TCR PCR SCS TD AAS Temporary Counter Receipt Permanent Counter Receipt Sale Confirmed Slip Transfer Deed Application Acknowledgement slip

Trading documents

Services Application Form Deal Form Unlike a conventional exchange where the trading document is a Share Certificate, trading on OTC Exchange is undertaken with the help of Counter Receipts (CRs). These are issued in lieu of Share Certificates, which are custodized at the time of trading. The investor at any point of time has the flexibility to convert his CRs into Share Certificates, by invoking what is known as Investor Services facility at any counter. Trading documents The counter with whom the investor does a transaction or applies for an investor service in referred to as a local counter. Any other counter on whose behalf transactions are made in called a remote counter. All the buy/sell deals are classified under either of the two categories: Direct Deals When the local counter effects a transaction with the details specified by the investor, and the local counter is also the remote counter offering the quote, then the deal is known as a direct deal.

Put through deals If either the local counter is not a market maker or is not offering the best quote for the share, then the local counter will put-through the deal to the market maker offering the best quote. Transaction have to be executed at the market price or at the negotiated price. Settlement on OTCEI Settlement on OTCEI for listed securities takes place on a T + 3 rolling basis, OTCEIs depository system minimizes the possibilities of bad deliveries on the exchange by ensuring the validity of the sellers transfer deed at the time of sale rather than at the time of transfer followed in other exchanges. OTCEI continuously monitors the functioning of the registrars empanelled by it for all OTC issues to ensure timely service to the investors. OTCEI Market Operations Members and Dealers are the important players at the OTCEI, The members of OTCEI are required to sponsor the initial listing of scrips. Without a sponsor, an new coapny cannot get listing of its scrip at OTCEI. The sponsor is responsible to conduct technical, financial, managerial, commercial and economic feasibility study of the project so as to \ensure that the company is viable and investment worthy. After having satisfied about the project and the company, the sponsor is required to fix the price at which shares will be offered to the public/members and dealer of OTCEI. The sponsor is responsible for fair allotment of shares to the Public as per the guidelines prescribed by the OTCEI and the Government. In case direct offer for sale is made by the Company or the members or dealers of the OTCEI to the public, it must be accompanied with a prospectus. The sponsors are required to appoint manages to the issue of securities for public subscription. The companies and their sponsors will have to complete the process of allotment of securities, compilation of the list of allottees and refunds, mailing of allotment advice, mailing of refunds and mailing of share certificates etc. with in the time prescribed by the OTCEI. Members and Dealers of OTCEI conduct their transactions from their offices through a Computer terminal linked toe OTCEI Central Computer System by way of telecommunication network. The Computer System replaces the open outcry system as the prices of the scrips are disseminated on the screen of the computer placed at each counter operated by these members/dealers. Besides, all related data regarding the companies are also flashed on the screen. As in the case of any other stock exchange the investor places his order with a member or a dealer of OTCEI. the member may be a market maker in the scrip by himself, in which case he does a direct trade with the investor at the best market price at that point of time. In case the members is not a market maker in that scrip or it not willing to offer the best quote to the investor, then he concludes the deal for the investor from the market maker which gives the best quote at that point of time. In both the cases, the order is fed into the computer at the members office and the trade confirmed by OTCEI system. The confirmation is received forthwith by the member / dealer and a trade confirmation is printer on line. Participants in OTCEI Following are the various participants in OTCEI: Members, dealers and representative offices operate OTC Counters which are linked to a central OTCEI computer. Companies, whose securities are listed on OTCEI and are sponsored by Members. Investors, who trade and avail of investor services through any on the OTC counters. A Registrar, for transfers and related activities. A Settlement Bank, that clears the payment between counters. SEBI and Government that exercise on overall supervision on stock exchange in the country.

Guidelines for Listing of Companies in OTCEI The Ministry of Finance, Department of Economic Affairs (vide notification dated 9-5-1991) has issued guidelines for the listing of companies on OTCEI. The relaxed guidelines are also furnished in next page. The OTC Exchange can list companies with issued capital from Rs. 30 lakhs upto Rs. 25 crores. The eligibility criteria for listing of companies are as follows: Companies with issued capital from Rs. 30 lakhs to less than Rs. 3 crores should make a minimum public offer of 40% of their capital or Rs. 20 lakhs in face value, whichever is higher.

Companies with issued capital from Rs. 3 crores to Rs. 25 crores should satisfy the listing requirements and guidelines as currently applicable on other exchanges; Venture Capital Companies/funds approved by the Department of Economic Affairs. Ministry of Finance or such other authority nominated by the Central Government, should make a minimum public offer of 20% of their issued capital in relaxation of rule 19(2)(b) of the Securities Contracts (Regulation) Rules 1957; Companies engaged in hire purchase finance/leasing / amusement parks etc., shall not be eligible for listing on the OTC Exchange; Companies covered under the then MRTP/FERA Act may be listed on the OTC Exchange if they satisfy listing guidelines as on other recognized stock exchanges such as minimum issued equity capital or Rs. 30 lakhs or such other limit as prescribed. A company which is listed on any other stock exchange in India would not simultaneously be eligible for listing on the OTC Exchange;

The guidelines governing the OTC Exchange has been revised by the Finance Ministry. The Ministry has at present decided to allow listing of Closely held existing corporate house upto Rs. 100 crores New companies with paid up capital based of upto Rs. 50 crores and All currently listed companies on various stock exchanges.

As per the earlier guidelines, it was mandatory that the companies listed on OTC Exchange would have to go in for a minimum public offer of 40%. The Ministry has now decided to relax this stipulation to a 20% public offer for closely held and new companies. The Ministry has also stipulated that the premium on the public issue on the exchange will be entirely determined by market forces. Criteria for admission of Companies for listing on the OTC Exchange of India The company should be sponsored by a member of the OTCEI. The sponsor should certify to OTCEI that it has appraised the company and its project and has found the scrips proposed to be listed on the OTC Exchange to be investment worthy. The sponsor to certify that all the scrips proposed to be offered for trading on OTC Exchange have already been subscribed to by members and dealers of OTCEI. The Company agrees to abide by all statutory and OTCEIs providers for listing. The company agrees to enter into an agreement with OTCEI in a prescribed format.

Listing on OTCEI guidelines relaxed Securities and Exchange Board of India has decided to do away with the following restrictions in the existing guidelines for listing of companies on OTCEI, vide dated 6.3.1995. Prohibition form listing on the OTCEI for companies engaged in investments, leasing, finance, hire-purchase, amusement parks etc. Requirement of minimum public offer of 10% of the issued capital or Rs. 20 lakhs worth of shares in value, whichever was higher, for companies with an issued equity capital of more than Rs. 30 lakhs but less than Rs. 3 crores. Requirement that the companies covered under the MRTP Act/FFRA are to be listed on the OTCEI only if they satisfy the guidelines for listing on other stock exchanges. The requirements mentioned below, which have become redundant due to the abolition of office OTCCI. Whenever securities are issued at a price above par, the premium will be determined by the CCI. Set up support agencies, viz., (i) National clearing and settlement corporation to administer the clearing and settlement functions at national level, (ii) A Central depository trust and (iii) A securities facilities support corporation responsible for network between exchanges.

Promote a new stock exchange at New Bombay as a model stock exchange and to act as a national stock exchange. Establishment of NSE The National Stock Exchange (NSC) has been incorporated in November 1992 with an equity capital of Rs. 25 crore. It started operations in November 1994. The NSE initially began with debt instruments like UTI Units, PSU Bonds, Treasury Bills, Government Securities and Call Money. Equities and debentures also have been added on the trading list after some time. Companies with a minimum capital of Rs. 10 crores are eligible for being listed on the NSE, the same limit as at the MSE. The NSE is established to provide a nation-wide stock trading facilities to investors. The NSE, besides operating the traditional market for equities, convertible debentures, non-convertible debentures etc will also operate a wholesale debt market. The wholesale debt market termed as money market segment for convenience will be a separate segment of the NSE as distinct from the capital market segment. While the whole sale debt market segment is meant for banks, financial institutions and other institutional participants and intermediaries to enter into high value transaction in PSU Bonds, T-Bills, etc., Capital market segment covers trading in equities, convertible debentures etc. NSE Objectives Following are the various objectives of the National Stock Exchange. The establishment of a nationwide trading facility for equities, debt and hybrids. Facilities equal access to investors across the country. To ensure fairness, efficiency and transparency of securities trading. To have shorter settlement cycles and book entry settlement. To meet international securities market standards.

Market Operations National Stock Exchange provides nation-wide trading facilities and equal access to investors from all over the country. High quality service to investors will be maintained through an efficient, transparent and fair trading system. Nation wide equal access to stock trading will be provided through a network of trading members all over the country. There will be not trading floor. Instead, each trading member will have a computer at his own office, anywhere in India. This computer will be connected to the central computer at the NSE by telecommunication link. The trading system provides a lot of flexibility to trading members. Trading members can easily exercise the various options which are traditionally available to them on trading floor. When entering the order, a trading member can place various conditions on the order. The system will provide complete transparency. The identity of the trading members entering orders in the system will be protected and revealed only on confirmation of a trade to the respective counter parties. The automated trade matching system is a highly efficient means of trading. Unlike the open outcry system on trading floors where physical constraints often prevent a large number of orders from being executed, the trading member of NSE can put in a large number of transactions and carry out a high volume of business efficiently. The trading member and investors are ensured at all times that they are getting the best price in the market. Securities of medium and large companies with nation-wide investors will be treated on the NSE. This will include securities which are today being treated on other stock exchanges. By virtue of equal access nation wide, such securities can be raded at the same price from any where in the country. This will provide good trading and investment opportunities; increase the volume of trade and improve liquidity considerably. As and when securities are sold and delivery made to the clearing system, they will be transferred to a depository. Each trading member will have a pass book account in the depository wherein securities deposited by the trading member will be recorded. Every client of the trading member will have a sub-account where record or share holding of the client will be maintained. As and when delivery is made or received by each trading member, the pass book of the trading member and the client concerned will be updated by electronic book entry transfer. Advantages The NSE System provides numerous advantages to investors, trading members and issues. Advantages to issuers

As they can provide nationwide access by a single listing, their listing costs are reduced substantially. Advantages of investors: Settlement is quick and money/securities are received promptly, thereby increasing liquidity. The investor is assured of the best price in the NSE market. The system will be better monitored and regulated ensuring a fair deal to investors.

Advantages of trading members Members can benefit from high growth in trading volumes By installing a computer net work of their own to receive their client order which they can interface with the Exchange, leading to a large increase in business. Members can provide efficient service to their clients.

Index of NSE : NSE.50 Vision NSE has launched a new index of stock prices known as NSE.50 vision in April 1996. It has a heavy weightage of financial sector companies out of 50 companies, 9 are from financial segment including SBI, IDBI, IFCI, ICICI and HDFC these constitute 21.3 percent of weight. Auto industry has a weight of 12.64%, health care 9.75%, steel 5.32% and diversified companies 14.45%. the index has included big market capital stcks and is aimed to reflect day-to-day activity in the market. The base day for the index is 3 rd November, 1995 when the trading inequities completed one year on the NSE and base value has been taken as 1000. It will be published daily. NSE-50 companies are leaders in their segment and have a good share of sales or profit in their respective sector. The index will be periodically reviewed in each quarter to give representation to various industries.

Lesson 13 Securities and Exchange Board of India Objectives Reading this lesson the students will be in a position to understand establishment and Objectives of SEBI, Powers of SEBI, Additional Powers under SEBI Act, 1992, Additional powers under SC(R) Rules, 1957, Role of SEBI in the Capital Market, SEBI as a Market Regulator and Investors Protector, Trends in Indian Capital Market, Demutualization of Stock Exchange, Central Listing Authority (CLA), Delisting of Securities, innovations in investor services, Computerization of investors complaints, Investors Welfare Fund and Investors Associations. Contents Introduction Objectives of SEBI Powers of SEBI Concurrent Powers of SEBI Additional Powers under SEBI Act, 1992 delegated w.e.f. 25.1.1995 Additional powers under SC(R) Rules, 1957 have been delegated on 23.12.1996. Role of SEBI in the Capital Market SEBI Market Regulator and Investors Protector Trends in Indian Capital Market Demutualization of Stock Exchanges Central Listing Authority (CLA) Delisting of Securities Innovations in investor services Computerization of investors complaints Investors Welfare Fund Investors Associations

Introduction Shri Rajiv Gandhi, the then Prime Minister and Minister of Finance, while presenting the Finance bill for 1987-88, observed for the healthy development of capital market. As in the case of Securities Exchange Commission (SEC) in United States, Government of India had determined to constitute a separate Board for the purpose of ensuring investor protection and regulation and orderly functioning of Stock Exchanges. Dr. Manmohan Singh, the then Finance Minister in his budget speech for 1990-91 observed. The previous Government had announced the formation of SEBI in 1989. Three years have passed and the legislation for giving statutory authority to SEBI has not been introduced. We will ensure that this is done in this budget session. Accordingly, the Securities and Exchange Board of India which was constituted as an administrative body in April 1988 was given statutory status on January 30, 1992 by promulgation of SEBI ordinance which was later replaced by the Securities and Exchange Board of India Act, 1992. Objectives of SEBI According to the preamble to the SEBI Act, the objectives of SEBI are enumerated below: To protect the interests of investors in securities; To promote the development of securities market; To regulate the securities market.

SEBI can exercise its powers by way of regulations. SEBI is bound by Central Governments directions on questions of policy and is obliged to make an annual report to the Government giving therein a true and full account of the activities, policies and programmes.

Powers of SEBI Following powers have been given to SEBI under the Securities Contracts (Regulation) Act, 1956; Power to call for periodical returns from recognized stock exchanges. Power to call for any information or explanation from recognized stock exchanges or its members. Power to direct inquires to be made in relation to affairs of stock exchanges or its members. Power to grant approval to byelaws of recognized exchanges Power to make or amend byelaws of recognized exchanges Power to invoke Section 17 of the Securities Contracts (Regulation) Act in may State or Area and to grant licenses to dealers in securities. Power to compel listing of securities by public companies. Power to control and regulate stock exchanges. Power to grant registration to market intermediaries. Power to register and regulate working of collective investment schemes including mutual funds. Power to promote and regulate self-regulatory bodies. To prohibit fraudulent and unfair trade practices relating to securities. Power to prohibit insider trading Power to promoter investors education and training of intermediaries in capital market. To regulate substantial acquisition of shares and takeover of companies. Power to levy less. Power to conduct research and other functions.

Concurrent Powers of SEBI The Government has concurrently delegated to SEBI some of its powers under the Securities Contracts (Regulation) Act, 1956, with a view to ensuring more effective protection of interests of investors along with creating on efficient and well-regulated stock market. Since the powers have been delegated concurrently both the Ministry of Finance and SEBI will continue to exercise dual jurisdiction. The concurrent powers relate to following matters. Submission of application, granting and withdrawal of recognition of the Stock Exchanges. Making or amending rules of Articles of Association of a stock exchange regarding voting rights to its members at any meeting. Notifying applicability of Section 13 of SCRA to an area, so that contracts issued in that area otherwise than between members of a recognized stock exchange or through or with such member shall be illegal. Regulation and control of Business of dealing in spot delivery contracts. Hearing appeals submitted by companies against refusal of a stock exchange to list their securities. Issue of notification specifying any class of contracts as contracts to which the SCR Act or any provision contained therein shall not apply. To regulate matters relating to issue of capital, transfer of securities and connected matters. To issue direction to any relevant person in the interest of investors and securities market to carry out its mandate. To improve monetary penalties on capital market intermediaries with powers of adjudication given to the Adjudicating Officer. To summon the attendance of an call for documents from all categories of market intermediaries, including persons in the securities market, in order to enable SEBI to investigate irregularities.

Additional Powers under SEBI Act, 1992 delegated w.e.f. 25.1.1995

To make regulation with regard to depositories, custodians of securities, credit rating agencies and such other intermediaries. To grant recognition to stock exchanges and matters relating thereto. To prescribe qualifications for membership of a stock exchange To direct the government body of a stock exchange to take disciplinary action against a member To make an enquiry in relation to the affairs of the Governing Body of a Stock exchange. Stock exchanges to submit their annual reports to SEBI. To waive the requirement of minimum 25% public offer for listing of securities.

Additional powers under SC(R) Rules, 1957 have been delegated on 23.12.1996

Role of SEBI in the Capital Market Since SEBI became a statutory body in 1992, a number of steps have been taken to strengthen SEBI and reinforce its autonomy. SEBI has been playing a very active role in the capital market to achieve its objectives as enumerate earlier. With a view to develop and regulate the capital market, SEBI ahs notified several rules and regulations for brokers, sub-brokers, merchant bankers, bankers to issue, portfolio managers, registrars and share transfer agents, underwriters, debenture trustees etc. SEBI has issued guidelines for Disclosure and Investor protecting and as many as twenty one clarifications on the same so far to be followed by companies making public issue of capital. These guidelines clarifications contain a number of disclosures to be made in prospectus of companies making issues of capital, to enable the prospective investors to be stock informed before subscribing to the issue. Introduction of stock invest instrument by SEBI has been another welcome step for the investors at large. To protect further the interest of investors, SEBI has framed SEBI (insider Trading) Regulations 1992 and SEBI (Prohibition of Fraudulent and Unfair Trade practices relating to Securities Markets) Regulations, 1995, While the former set of regulations ban insider trading and treat it as a serious offence, the latter prohibit manipulation of prices in the stock market, making misleading statements to induce sale or purchase of securities and unfair trade practices relating to securities. SEBI endeavors to provide a regulatory framework which would facilitate an efficient mobilization and allocation of resources through the securities market. This will ensure that the necessary services are provide to industry and commerce and private investors in the most efficient and economical manner, stimulate competition, encourage innovation and be responsive to international developments. The SEBI has also formed a framework which is flexible and at the same time cost effective, thereby providing it with the clarity to guide and not cramp the changes. It also serves the purpose of inspiring confidence on the part of the investors and other users of the market by ensuring the market place is clean to do business in fair, transparent and efficient manner. SEBI Market Regulator and Investors Protector

SEBI is required to create a proper and conducive atmosphere required for raising money from the capital market. The atmosphere includes the rules, regulations, trade practices, customs and relations among institutions, brokers, investors and companies. it shall endeavour to restore the trust of investors and particularly to safeguard the interest of the small investors. This can be achieved by meeting the needs of the persons connected with the security market and establishing proper coordination among the three main groups directly connected with its operations, namely, (a) investors, (b) corporate sectors and (c) intermediaries. SEBI is expected to educate investors and make them aware of their rights in clear and specific terms. It shall provide investors with information and see that the market maintains liquidity, safety and profitability of the securities which are crucial for any investments. SEBI shall create a proper investments climate and enable the corporate sector to raise industrial securities easily, efficiently and at affordable minimum cost. SEBI shall develop a proper infrastructure so that the market automatically facilitate expansion and growth of business to middlemen like brokers, jobbers, commercial banks, merchant bankers, mutual funds, etc, Thus, it will ensure that they provide efficient service to their constituents, namely, investors and the corporate sector at a competitive price. SEBI shall make more effective the law in the existing status as far as they relate to the industrial securities, mutual funds, investments in Units, LIC savings plan. Chit-Fund companies and securities issued by

housing/industrial societies and corporations with the purpose of making investments in housing/industrial projects.

SEBI shall create the framework for more open, orderly, and unprejudiced conduct in relation to takeover and mergers in the corporate sector to ensure fair and equal treatment to all the security holders, and to facilitate such takeovers and mergers in the interest of efficient by prescribing a mechanism for more orderly conduct.

Trends in Indian Capital Market Demutualization of stock exchanges Historically the exchanges were formed as mutual organisatoins. They are generally not-for-profit and tax exempted entities. The trading members who provide broking services, also own, control and manager such exchanges for their common benefit, but do not distributed the profits among themselves. In contrast, in a demutual exchange, three separate sets of people own the exchange, manage it and use its services. The exchanges frame and enforce rules, which may not always, further the public interest of investors and society and the private interest (interests of trading members) simultaneously. Theoretically public interest gets precedence in a demutualised exchange while private interest gets precedence in a mutual exchange in formulation and implementation of the rules. On realizing the limitations of mutual structure and discovering the advantages of demutual structure, the stock exchanges are increasingly organizing themselves as commercial entities and undergoing a process of demutualization. Demutualization involves transfer of asset and liabilities form the erstwhile mutual (non-corporate) exchange to the emerging demutual (corporate) exchange. Since that transfer is a notional transfer on conversion of the exchange from mutual to demutual form, and it is in public interest, the transfer of capital assets has been exempted from capital gains tax. The demutual exchanges would also inherit the accumulated reserves and surplus which has grown because of so man concessions and tax benefits. Since this remains with the organization even after conversion and is not taken away by anybody, this would not be taxed. It would, however, require a restriction on distribution of this accumulated reserve and surplus inherited by the demutual exchange, as these belonged to erstwhile not-for-profit exchange. This reserve and surplus should be deployed by the exchange separately for common benefit of investors exchange/market. All future profits of the organization should be subject to normal taxation. In lieu of membership card, the existing brokers should be granted non-transferable trading rights against deposits and transferable ownership rights (equity shares). However, when they transfer ownership rights, they would be subject to capital gains tax and the cost of these rights shall be the cost of acquisition of the original membership. Thus, all the genuine tax exemptions required for demutualization have already been provided in the Income Tax Act. Central Listing Authority (CLA) Under the current dispensation, while it is mandatory to list a security on a regional exchange, it can be listed on any number of exchanges. The issuer has option to list its securities on any one or more of the exchanges. The issue fails if the regional exchange refuses listing. The issue also fails if any of the exchanges, to which application for listing has been made, refuses to list the security. This arrangement generates unhealthy competition. There is a competition among the issuers to list securities on an as any exchanges as possible to attract investors from all over the country and waste resource to comply with the listing requirements of a number of exchanges simultaneously. Similarly there is a competition among the exchanges to attract as many issuers as possible at times leading to dilution of listing standards particularly when listing constitutes a major source of income for many of them. The exchanges are now having a re-look at the way they conduct business and are gearing up to demutualise themselves by converting themselves into public limited companies. They will also be accessing securities market to finance their ever expanding trading network and would be interested to list their securities. This would create an anomalous situation where a stock exchange would admit its own securities for trading. A satisfactory solution would be to vet the listing powers with a body separate form the stock exchanges. The investors and market participants would get all the company related information, which are mandatorily required to be filed by comapneis, at one location preferably a web site maintained by the CLA. The exchanges should concentrate on trading only while pre-trading activity (listing and compliance of terms of listing) is managed by CLA and post trading activity (clearing and settlement of trades) is managed by clearing corporations. Delisting of Securities The incidence of delisting has been increasing in the recent past. This has assumed importance in view of a number of MNCs acquiring the entire equity of their Indian subsidiaries through open offers and then delisting form the exchanges.It is argued in some circles that delisting should not be permitted at all. They argue that it is the intention of legislature, as there are statutes and rules to govern listing but no statute/rule provides for delisting. Only law that governs delisting is a circular of SEBI. It is probably considered that listing is so sacrosanct that once a security is

listed, is should not be delisted. An investor subscribes to an issue on the basis of the contents in the prospectus which may state that the security would be listed on stock exchanges. Once he subscribes to the issue, he takes an irreversible decision, as the promises in the prospectus are irreversible. Another school supports delisting. It argues that listing agreement is essentially a contract between a company and an Exchange. Like any contractual relation, it must have also a way to terminate the relationship in certain circumstances. When a security at the time of issue carries an assurance that it would be listed on stock exchanges, it promises liquidity to security and hence carries a liquidity premium. This means that the security is issued at a price higher than what it would have been if it does not carry an assurance of listing. Since delisting withdraws the liquidity, the investors should be allowed get out with a premium. Non-compliance of listing agreement should not be a ground for delisting. The terms and conditions of listing have to be enforced by recourse to other means rather than delisting. A sub-committee, headed by M.R. Mayya, former Executive Director of the Bombay Stock Exchange, is reported to have favoured the merger of increasingly marginalized regional stock exchanges with the Over The counter Exchange of India (OTCEI). While doing so, the sub-panel appears to be suggesting that these splinter stock exchanges could be consolidated to form a Third Front to blunt the growing influence of BSE (Bombay Stock Exchange) and National Stock Exchange (NSE) in an era where arbitrage opportunity has dwindled considerably. With walls getting dismantled and boundaries disappearing, mergers and acquisitions (M&As) are unavoidable course corrective in the global commerce sphere. The course suggested by the Mayya panel, however, is riddled with too many imponderables. Why should OTCEI be the merged entity? The reasons are hard to comprehend. The OTCEI concept never really took off in this country, however well intentioned the objective of floating it in the first place might be. Today, one has to hold a magnifying glass to discover OTCEI counters. Likewise, regional stock exchanges have mostly gone off the brokers electronic screens and minds of corporate India. Amalgamating the merely existing and financially weak regional exchanges with an almost invisible OTCEI does not necessarily make up for a stronger entity to take on the might of NSE and BSE.In the age of connectivity and communication, the two premier bourses have seen that their terminals intrude the length and breadth of the sub-continent, rendering the regional stock exchanges inconsequential. In former times, corporate queued up to the regional exchanges primarily because the then principal bourse. BSE, did not have the connectivity. The advent of NSE has since brought a seechange in the bourse experience. Be it investors or companies and even brokers, these two exchanges have become their preferred destinations, much to the chagrin of he regional bourses. Greater business volume, better price recovery, improved liquidity and the like are the sine qua non for nay exchange worth its name to attract investors, brokers, companies and whoever else. In a dynamic environment, any cure based on non-commercial and unrealistic consideration is bound to bring fresh problem than it seeks to solve. The amalgam of too many into one, as suggested by the Mayya panel, is sure to throw up a host of issues that may not fetch readymade answers. The integration of personnel, system and the like is easier said than done in such a scenario. Before one could expend the time and money on sorting out these matters, the two principal and financially stronger exchanges will have gone miles ahead, making a mockery of the very merger exercise. An ideal prescription will be to let the able among brokers (even in regional SEs) stay by rolling out a level field. And, this lies in spreading out a uniform rules across the bourse spectrum.With listing fees evaporating (with corporate showing non-preference to regional stock exchanges) and the recently levied turnover fee not compensating them much, the regional stock exchanges have sort of survived, thanks to the income tax ex-emption, Instead of leading them up the garden path by suggesting their merger with the OTCEI, these regional stock exchanges can be left to discover their own survival strategies. Depending on their own considered wisdom, they can look at various options ranging from acting as an appendage of either of the two premier bourses to turning themselves into their local vigilance entities and what not. In the extreme case, they can even just fade away after discharging entities and what not. In the extreme case, they can even just fade away after discharging their obligations, including settlement of dues not paid by the brokers. A decision, in any case, must emanate from within and not imposed from outside. After all the job of an organisation like the Securities and Exchange Board of India is to regulated and not waste time and manpower in ensuring that these regional stock exchanges, which have out-lived their time and utility, survive somehow or the other. The race for the market will be won only by the strong and the best. Innovations in investor services Good investor service and caring for investor by companies play in important role in healthy development of capital market. Various companies have over the last few years, innovated certain ideas and implemented them in order to provide quality service to its investors. These include: Investor service centre. Buying back of non-convertible debentures (khokhas). Lodgement centre for right issues.

Service centre on the spot endorsement for call money paid Investor information and facilities, Library and reading facilities Investment counselling

The recent guidelines also require the stock exchange members to modernize investment services, introduce better and innovative practices in investors interest. Computerization of investors complaints In vies of the large number of investors complaints, the Department of Company Affiars has toned up the machinery of handling these complaints and has also decided to take strict action against the errant companies. in the recent past, apart from initiating penal action as per law against 58 selected companies, the procedure of handling these complaints has also been streamlined. A fully computerized system of processing has been introduced and the companies would no be requested to give feedback regarding the action taken on each complaint within a stipulated time frame and on computerized printer stationary to be sent by the Department of Company Affairs. Senior Officers of the Ministry are carefully monitoring the progress of action taken on investors complaints.The computer system has been designed and maintained by NIC. A Module has also been designed for sending the details of complaints to the companies on floppy disks. The companies would be requested to indicate the latest status against each complaint on the floppy itself. in this manner the computer system at the Investors Protection Cell would be able to automatically up-date the status of various complaints and also generate communications to the investors. Investors Welfare fund A noval insurance for shareholders/deposit-holders had been launched by a company as a welfare measure for the investor. The Oil and Investor Welfare Scheme launched by Gujarat Oil and Industries Ltd., Baroda is a five year twenty-four hour personal accident insurance coverage for each and every shareholder/deposit holder without any administrative procedures or costs. Investors Associations 1. Investors Guidance Society Tarang, Plot No. 224, Sion (E) Bombay 400 022 2. Vizag Investors Association, Faculty Club. Andhra University, Visakhapatnam 530 003. 3. The Gujarat Investors & Shareholders Association, 203, Samrat Building, Smrutikunj, Nr. Navrangpura Post Office Ahmedabad 380009 4. Tamilnadu Investor Association 16, Lakshman Street Mahalingapuram, Madras 600 034 5. Rajasthan Small Investors Forum 47, New Colony, Jaipur 302 001 6. Gwalior Shareholder Association M226, Madhav Nagar, Near A.G. Office Gwalior 414 001 7. Consumer Education & Research Centre, Thakorebhai Desai Smarak Bhavan New Law College, Ellisbridge, Ahmedabad 380 006 8. Pondicherry Investors Association 39, Jawaharlal Nehru Street Pondicherry 6005 001 9. All Body Corporate Shareholders Forum, Subhadra Bhavan, 120/A, Nehru Nagar, Secundrabad 500 026 (AP) 10. Investors Forum of Uttar Pradesh 1. Pinkcity Investors Association 16, Telephone Colony, Tonk Phatak, Jaipur 302 015 2. Indore Shareholders Associatoin, (Palasia) Meher Niwas, 3/3, New Palasia, Indore. 3. Vishal Share Investors Association 18, Kali Krishna Tagore Street, Calcutta 700 007 4. LSE Investors Association 20B, Sarabhal Nagar Ludhiana 141001 5. Premium Investors Association C-243, Shailendra Nagar Raipur 492 001 (MP) 6. Konark Association of Security Investors Water Supply Road, Cattack 753012 7. Kutch Investors Association Revechi Bhuvan, New Station Raod Bhuj Kutch 370001 8. Investors Association of Agra 198-101, City Station Road, Agra 282003 9. Jagrut Grahak Sardar Chharalaya, Karelibaug, Vadobara 390018 10. Lokmanya Sewa Sangh Ram Mandir

Merchant Chambers of UP Bldg. 14-76, Civil Lines, Kanpur - 208001

Raod Vila Parle (E), Bombay.

MODEL QUESTION PAPER ELECTIVE GROUP- B PAPER 4.23 FINANCIAL SERVICES AND INSTITUTIONS TIME : 3 HOURS MAX MARKS: 100 (5 X 8 = 40) PART A Answer any Five Questions 1. Explain the concept and scope of financial services. 2. What is private placement of capital issues? 3. Explain the various types of mutual fund schemes. 4. What is credit rating? State its objectives. 5. What are the special features of OTCEI? 6. What are the powers of SEBI? 7. What do you understand by Bombay Stock Exchange? Explain its role in Indian Stock Market. 8. Explain the importance of investor information and education PART B (4 x 15 = 60) Answer any Four Questions 9. Discuss the SEBI regulations regarding Lead managers and Merchant Banking functionaries. 10. Explain the SEBI regulations regarding Mutual funds. 11. What are the various credit rating institutions? Explain deposit rating and equity rating procedures. 12. Write short notes on: a. Portfolio Management b. Service of NBFCs c. Functions of RBI d. Characteristics of Gilt edged securities market. 13. Explain the function of IFCI 14. Discuss SEBI guidelines regarding role and organisation of Stock Exchange in India. 15. Discuss the objectives, features and operations of NSE *****************