Non-Banking Services of India

This article throws light upon the top two types of non-banking services. The types are: 1. Services from Money Market 2. Services from Capital Market.

Non-Banking Service: Type # 1. Services from Money Market:

It is a financial market where people borrow and lend short-term funds. In other words, it is a process by which short-term funds are borrowed and loaned. The dealings in such a market happens through short-term credit instrument, e.g., Promissory Notes, Hundi, Trade Bills, Government Securities etc.

Traders, manufacturers, business houses, specula­tors, brokers, Govt. Commercial banks, RBI etc. deal in this market as lender and borrowers, although the main building blocks of money markets are:

(i) Commercial banks;

(ii) Central banks;

(iii) Indigenous banks.

However, India’s money market consists of two sectors:

(i) Organised sectors (i.e., RBI and commercial banks);

(ii) Unorganised sectors having an indigenous stint.

However, the organised market consists of: RBI, SBI, Commercial banks, General Insurance, LIC, UTI. The unorganised market is primarily made up of indigenous bankers and non-bank financial intermediaries (e.g., Chit fund). Moreover, DFHI (The Discount and Finance House of India Ltd.) was set up as per the Companies Act, 1956 in order to supply liquidity to money market whenever it is required as a secondary market.

The salient features of Indian money market are noted below:

(i) The Indian money market plays a dichotomy with commercials banking and an unorganised sector working on traditional lines. Both of them are not connected to each other. Each of them is working independently.

(ii) India’s money market is scattered. The two important money market of India are Calcutta and Bombay (regarded as National Money Market).

(iii) The unorganised sector of the money market is no doubt, insulated from the central banking control techniques. Monetary control and monetary flexibility of the RBI do not prove worth due to the existence of this market which is outside the control of the RBI. Because they do not follow RBI criterion.

(iv) Banking system not well organised in our country. Commercial banks maintain an excess cash reserves. In comparison with the lending policies of the unorganised market, its lending policies are often harsh.

(v) Establishment of a bill market is considered necessary in order to integrate the organised and unorganised sectors of the money market. Because, a steady supply of trade bills freely negotiable in both sectors invites integration between them which is a very healthy system. But it was absent in our country till 1971 where ‘real’ bill market scheme was introduced by the RBI.

(vi) Fluctuation in the rates of interest creates uncertainty in the money market. Because, during pick period (November to June) when demand for liquid money goes up, rate of interest consequently rises in those busy periods and during slack season, we experience an opposite situation although RBI controls such fluctuation in the market rate of interest.

It has already been stated earlier that an unorganised money market is composed of money-lenders, indigenous bankers and chit funds. However, their primary function is to lend those borrowers who do not get credit from the organised money market.

Thus, the features of unorganised money market are:

(i) The procedures are not formal rather informal;

(ii) The rates of interest to depositors are quite attractive;

(iii) Charges high rates of interest to borrowers;

(iv) The terms are quite flexible.

However, the importance of unorganised money market is in a declining trend in comparison with the organised money market although their sizes are fairly large since RBI plays a very significant role on this issue.

In short, the services rendered by a money market are noted below:

(i) It deals in Commercial Papers, Treasury Bills, Certificate of Deposits etc.;

(ii) It utilizes short-term funds, money market mutual funds;

(iii) It deals with receivable management, viz., discounting of trade bills, factoring etc.

Constituents of the Indian Money Market:

The above services are rendered by the Indian money market with the help of its following constituents:

(i) Reserve Bank of India:

It is the pivot of the entire banking system of the country and guardian of the Indian money market. It controls the volume of currency and credit and acts as a clearing house, a banker to other banks and also to Government.

(ii) State: Bank of India:

It is the biggest commercial bank in the country and supplies credit to trade and industry. It also acts as an agent of RBI where there is no RBI branch.

(iii) Commercial Banks:

Their primary function is to take short-term deposits and invest the same in short-term loans and advances. Moreover, they perform some other services, e.g., discounting of bill, collection of cheque, purchase and sale of stock and share etc.

(iv) Exchange Banks:

These banks also secure deposits and grants loans and advances like SBI. They are all foreign banks and as such, are engaged in financing foreign trade.

(v) Land Mortgage Banks:

These banks supply long-term credit to the agriculturists against the land as a security.

(vi) Co-Operative Banks:

These banks take deposits and supply loans and advances to agricul­turists and artisans at a low rate of interest for their trade.

(vii) Indigenous Bankers:

They are called by different names, viz., money lenders, shroffs, seths etc. Their primary function is to supply credit against Government securities or gold ornaments.

(viii) Public Deposits:

Many industrial concerns take this opportunity, i.e., the deposits received from the public were utilised for their short-term/ long-term financing.

Non-Banking Service: Type # 2. Services from Capital Market:

A capital market is a market where people deal in long-term credits and loans for financial assets which posses long-term or indefinite maturity. The transactions in a capital market are long-term instruments and securities, viz. Shares, Debentures, Government Bonds etc., which are issued by various business houses and Governments.

The important constituents of capital market are: Finance Companies, Investment Trusts, Insurance Companies, Investments Banks, Stock Exchange, Land Mortgage Bank etc. A good capital market is an essential pre-requisite for industrial and commercial development. But the development of a good capital market depends on many factors, viz, availability of savings, proper organisation of its constituent units etc.

Before independence the Indian capital market was ill-developed, but since independence, in recent years, the capital market of India has substantially changed and has been changing always for the better.

However, the following factors have made to bring such changes in the Indian capital market:

(i) The Companies Act, 1956, designed to safeguard the interest of shareholders, the Capital Issue (Control) Act, to discourage undesirable practice in non-essential enterprises, the Securities (Contract) Act, 1956 to provide reforms in stock exchange trading methods — all these efforts help to protect the interest of the investors.

(ii) The underwriting activity of Industrial Credit and Investment Corporation, IFC, UTI, LIC, IDB and various stock brokers and bankers have given impetus to the growth of capital market in recent years.

(iii) A good number of financial institutions (including the above) provide medium and long-term finance which also directly help for the development of capital market in our country.

(iv) The various activities of commercial banks for supplying advances against shares and debentures, in providing funds by purchasing the shares or debentures of various finance corporations etc. which have influenced the growth and develop­ment of capital market.

(v) The most significant change, however, in the capital market is the integration of the organised and unorganised sectors of the capital market on one side and the money and the capital markets on the other.

There are two types of capital market: viz:

(a) Primary market — where new issues are made;

(b) Secondary market — where outstanding issues are transacted,

(a) Primary Market:

When a company wants to raise its funds by issuing equity shares it enters into the primary market where financial securities for long-term funds are exchanged by which formation of capital is made. We know that there are three ways by which a company can raise its funds from primary market; viz.,

(i) Publics issues;

(ii) Right Issues; and

(iii) Private Placement.

(i) Publics Issues:

It is the most significant method of raising long-term funds for a firm which deals in sale of securities.

(ii) Right Issues:

Right issues, on the other hand, are those which are issued after the original issue but having an inherent right of the existing shareholders to subscribe to these issues proportions to their holding. Such issues must be offered to the existing shareholders on pro-rata basis. It is also an additional method of raising funds for long-term basis.

(iii) Private Placement:

This is also a method of raising capital by selling securities among the small group of investors privately. It is not a very significant source of raising funds.

(b) Secondary Market:

A secondary market deals in outstanding securities. Secondary markets in our country are the various stock exchanges recognised by the Government. There are 22 stock exchanges situated in the various States in our country, viz., Calcutta, Bombay, Delhi, Madras, Kanpur, Pune, Jaipur, Surat, Guwahati, Ban­galore, Cochin, Hyderabad, Baroda, Rajkot, Indore, Ludhiana, Ahmedabad, Mangalore, Bhubaneswar, Patna, Saurashtra and Coimbatore.

The stock exchanges are controlled and regulated under the Securities Contract (Regulation) Act, 1956 which allows only the stock exchanges which are recognised by the Central Government.

Over the Counter Exchange of India (OTCEI):

OTCEI is a company which was incorporated as per Sec. 25 of the Companies Act, 1956 with the objective of establishing national, ring less, screen-based automated stock exchange which is also a recognised Stock exchange as per Sec. 4 of the Securities Contract (Regulation) Act, 1956.

It is promoted by various financial institutions, insurance com­panies and merchant banking’s. As a trading in OTCEI, an investor can buy and sell any listed scrip at OTC counter.

Securities and Exchange Board of India (SEBI):

In the past, the stock market was controlled by the Companies Act, Capital Issue (Control) Act and also by the Securities Contract (Regulation) Act which were adminis­trated by various authorities.

In practice, however, they failed to control properly the security markets and also failed to protect the interest of the investors against malpractices made by the brokers, merchant bankers, investment consultants etc. SEBI, however, has been established in order to rationalize and control the existing acts and legislations.

For this purpose, it has been made up as an independent statutory board which will act as an apex body for the Indian Securities market and which will look after the interest of the investors. The SEBI was set up on 12th April, 1988 although it should have been set up much earlier as per recommendation made by Mr. G S. Patel, Chairman, and Stock Exchange Reforms Committee.

However, the primary objectives of SEBI are presented below:

(i) To see that proper dealings are made by the issues of securities and to ensure a market place where securities transactions are made at a low cost for raising funds and other purposes.

(ii) To give the proper protection to the investors and maintains their rights and interest.

(iii) To control, regulate and develop a code of conduct among the brokers, merchant bankers etc.

Portfolio Theory and the Capital Market:

While discussing the above we are to assume at first, that all investors, at least implicitly, practice portfolio theory at the time of selecting their investments.

So, an individual bases has decisions primarily on his predictions about the following three variables:

(i) Expected returns;

(ii) Variances of such returns; and

(iii) Co-relation between the returns of various securities.

In this respect we are to remember that neither transaction cost nor tax liabilities are associated with the investments.

Secondly, it has been assumed that the market is agreed about the prospects of every securities traded. In other words, it may be assumed that all investors make the same predictions relating to the above three variables for each and every kinds of security although the same is not happened in real world situation.

Yet, it has been claimed that, the theories obtained after this assumption permit us to express much of the behavior found in the real world situation.

Thirdly, it is assumed that there exists a riskless asset that is absolutely free from the possibility of default. It has also been assumed that there is a perfect capital market for this asset. So, everyone can lend or borrow as much as they are ready to receive or pay, the prevailing rate of interest for such security.

However, in equilibrium this rate will affect society’s time preference only which is, as such, called the ‘pure’ rate of interest. Thus, the security prices which will be acquired following these assumption are those which would obtain in equilibrium. So, our immediate task will be to amend our hypothesis in order to incorporate the existence of a riskless asset which has a direct bearing on the capital market proposition.

Mutual Funds:

Practically, a mutual fund is an organisation which collects money from different investors and invests the same in various securities on a scientific basis, it is a special type of portfolio management. It takes the responsibility of a large number of small investors who are not acquainted with the stock exchange formalities and procedure.

These investors depend upon the mutual funds for the investments which should be invested properly. Thus, the primary objective of such a fund is to supply the investors the benefits of low risk, high liquidity, steady return, appreciation of capital etc.

However, the mutual fund is of two categories:

(a) Close-end funds;

(b) Open-end funds.

In a close-end fund, there is a definite target amount which should be framed within a stipulated time. In other words, the desired amount is determined in advance and at the same time, both the opening and closing dates of subscriptions are properly informed to the investors.

The shares or securities or units are publicly transacted on the stock exchange and as such, they are not re-purchased by the fund itself. In the open-end fund, however, the desired amount is not determined in advance and as such, subscription is always open to the public, i.e., if it is indefinite it is called opened-end fund.

In the last few years, mutual funds are playing a very significant role in the securities market as key intermediaries.

As a result of active participation by this funds, the Indian securities market which is thinly traded and volatile, is running well, although there is limited slow supply of fresh equity. Some financial institutions are coming forward with a large amount of resources/funds.

There are various kinds of mutual funds that are available in our country according to the needs of the various investors e.g., growth oriented, income oriented, high growth fund, Income-tax planning etc.

Most of the special schemes are practically close-end funds. The UTI which was established in 1964 was the first mutual fund and the Unit Scheme 1964 was also the first open-end funds. At present, L1C, GIC, various nationalized banks have established mutual funds of their own. At the same time, it is interesting to note that some foreign institutional investors and private sector companies have also established mutual funds.

Regulated mutual funds must have to maintain the rules and regulations relating to their constitution, investment pattern and their management. They must operate their activities in the form of a trust which must also be sponsored by a reputed company.

However, if it is close-end mutual fund, the minimum size of mutual fund scheme must be Rs. 20 crores, and Rs. 50 crores in case of open-end funds. It should be remembered in this respect that within 45 days of opening of this subscription this amount must be raised.

The mutual funds are not even free from snags e.g., no mutual fund can invest their fund more than 5% in the equity share of a company and not more than 15% of its total fund may be invested in a single industry by way of investment.

We know that the investment in the mutual fund is expressed in the form of units of Rs. 10 or Rs. 50 or Rs. 100. When the units are listed in the stock exchange or at the end of the lock period, the mutual funds must have to declare the Net Assets Value (NAV) of units under each scheme maintained by them.

The Net Assets Value is determined on the basis of market value of the securities where the funds have already been invested and after making proper provisions for administration expenses or otherwise. As per terms of issue, the units are re-purchased at the Net Assets Value (NAV) or at a discount.

Arbitrage:

Arbitrage is a skilled speculative activity which is considered in order to make a profit arising out of differences in price of the security in two separate markets from stock exchange transactions.

In other words, if the price of a share is higher in one market, in comparison with the other, the speculator will purchase the shares from the cheaper market and will sell those shares at a higher price in the other market which is to be done very quickly unless the prices of both the markets will be equalised. It may also be termed as Traffic in Securities.

Such traffic may be happened either between the two markets of the country or between the two different countries. In such a case, the earlier one is known as Domestic Arbitrage and the latter is known as Foreign Arbitrage. However, in the latter case, the currencies between the two different countries should easily be convertible so that both of them may not experience any difficulty.

It should be remembered that Arbitrage is possible for a short period. Because, it tends to equalize the price of security at various places at last due to demand and supply interaction, i.e., if a security is sold at a higher price in a market, more securities will be brought in the market, as a result of an increase in supply, the price will fall and will become equal.

Underwriting:

It is a contract between the company and the persons like brokers or institutions (e.g., commercial banks, insurance companies or syndicates etc.) for the purpose of selling the shares at the cost of certain amount of stipulated commission.

In such a situation, guarantee is given about the sale of securities within the specified terms allowed by the company and agrees to take up the unsold securities, if any. No doubt, it is the most effective way of selling shares.

Thus, it relieves the promoters of the company from the anxiety/ uncertainty about the sale of securities although the cost (i.e., underwriting commission) is high in comparison with the brokerage charge. It has already been pointed out above that commercial banks, merchant bankers, financial and investment institutions, brokers etc., underwrite the issue of securities in real world situation.

It is the duty of the financial manager to assess the financial capacity of the underwriters. Since the underwriters take the risk, i.e., it is a risk-based service, they are paid a commission for such purposes.

As per Stock-Exchange rules, the scale of commission for listed securities is presented below:

Needless to mention here that the underwriters are in a better position to measure/ forecast the worth of a new firm correctly, if not, they are to suffer the loss. Having financial integrity, men of character, they can offer expert opinion on the soundness of the securities, raise the issue in public estimation.

Merchant Bankers (as Lead Manager):

For the purpose of raising finance, the companies are required to appoint SEBI approved category I merchant bankers. Practically, it encompasses all the required services but in our country, it is primarily meant for issue management and loan syndication. Their activities are regulated and controlled by SEBI i.e., on the basis of net worth, the SEBI regulates and authorizes the activities of the merchant bankers.

However, on the basis of net worth, SEBI divides them as under:

Appointment:

The appointment of merchant banker is restricted to the point that it must not belong to the group company of the company which desires to raise funds from the public, i.e., they should be independent relating the company management.

We know that the merchant banker is of repute and has the expertise and experience of transacting the various issues for the purpose of raising finance. Needless to mention here that he must have a direct contact with the broker who will practically sell the shares. So, the selection and appoint­ment of the merchant banker is very important and significant.

Fees:

The fees of the merchant banker were fixed during the period of controller of Capital Issues. Later, it was discontinued by SEBI having the complains from the merchant bankers about it. According to them, they are to perform various services against which their fees are quite inadequate.

On that basis, SEBI had relaxed the fees up to a certain limit. It had revised the fees upward and categorized how many merchant bankers may be associated with the issue which will depend on the value and volume of such issue.

Responsibilities:

The responsibilities of the merchant bankers have been presented by the SEBI by way of a format which must be maintained by the lead manager and the issuer which must also be filed with the SEBI. It is the duty of the lead manager to submit due diligence certificate with the SEBI.

The merchant banker, however, signs on it and charges his fees. If there are more than one merchant bankers both of them will sign on the due diligence certificate and thus their responsibility are also equally shared and also will share the fees. The format relating to the list of responsibility which is prescribed by the SEBI, must also be filed with the SEBI for the purpose.

Drafting the Prospectus:

Regarding the issue, the drafting of prospectus is the primary function. According to the prescribed format of the Companies Act, the prospects must be drafted. So, when the appointment of merchant banker is complete and the fees so paid are negotiated, the immediate task is to draft and prepare the prospectus which will be submitted to the Registrar of Companies before public issue.

After its preparation, it should be sent to the legal adviser who will go through it carefully before submitting the same to SEBI.

Usually, a prospectus should contain the following:

(a) Merchant bankers, Underwriters, Brokers, Advisers and Printers to the issues.

(b) Legal Advisers and Registrar to the issue.

(c) Appointment of the brokers to the issues.

(d) Consent of the various persons relating to the issues.

(e) The name of the Chartered Accountants, the name of the firm along with the accounting policies to be followed.

(f) To see that the required listing fees have been paid.

(g) A certificate that the amount has been deposited with the stock exchange.

(h) For the purpose of listing the securities, a declaration from the competent person relating to the application of the stock exchange has been filed.

Filing of the Prospectus with SEBI:

When the prospectus is prepared, the same is filed with the SEBI together with a letter which has been prescribed by the SEBI which must be followed by the inter-se agreements between the letters appointing the registrar and the merchant bankers. Moreover, the prospectus must be accompanied by the documents executed with the merchant bankers where the conditions are spelt out as per SEBI requirement.

Appointment of Brokers:

It has already been stated earlier that the brokers actually undertake to sell the issues. It is the duty of the merchant bankers to divide the underwriting commission between the brokers and the underwriters. It is known to us that brokers charge brokerage in addition to underwriting commission as per SEBI rules. Sometimes, they desire extra incentive which is not legally permitted on the basis of their procurement.

Appointment of Underwriters:

Usually, the merchant bankers do not select the underwriters as soon as the prospectus has been filed with the SEBI. The lead manager and the merchant bankers to the issue and various agencies also may take part in the underwriting in addition to the brokers/ underwriters.

The merchant bankers may distribute a particular amount to the underwriter after receiving the agreement and consent from such underwriter to act as such relating to the issue.

It should be remembered that the amount of issue which is offered to the public need be underwritten and not on the firm basis. However, the underwriters are entitled to receive their fees according to the terms of the issues. Usually the percentage is 2½ % although it can be negotiated.

Appointment of Coordinator for SEBI:

When the issuer desires to appoint more than one merchant banker, SEBI insists that there should be only one merchant banker to interact during the period of such issue and till the final report is submitted. So, the name of the coordinator of each activity appears in the inter-se agreement.

Appointment of the Registrar to the issue:

We know that many specialised firms collect data and analyse them properly. It is the duty of Registrar to collect various data daily from various branches of the bank for the purpose of preparing the summary etc. and give information to the clients whether the issue has been subscribed at the earliest date or not (relating to such issue). Closing date of subscription must be announced in the newspaper which is statutory.

After the announce­ment is made, the liability of the underwriter extinguishes, even if, it is inadvertently produced in the paper. The whole liability is to be borne by the issuer and the merchant banker is relieved. The Registrar can be appointed at any time even before submitting the draft prospectus with SEBI for the purpose.

The Registrar should present two or three alternatives which are presented to the stock exchange authorities for the purpose of listing and trading of securities. It is to be noted that Registrar to the issue must be approved by the SEBI which implies that SEBI which implies that SEBI’s authority towards the appointment is justified for proper justice.

Selection of Banker:

In consultation with merchant banker, the banker relating to the issue is selected and approved. The banker must also be approved by the SEBI. While selecting the banker relating to issue the merchant banker must be very careful so that any unpleasant activities may not arise in future.

Appointment of the Advertisement Agency:

In the present day complicated world, no one can ignore the effect of advertisement in the real world situation. Because, we know that a good advertising agency can change the image of a company in an opposite direction if it can maintain a good relation with the press, various conferences etc.

Thus, an advertising agency can perform itself to make a healthy relation with the press, brokers, investors in addition to press conference etc.

While marketing, the advertising agency can suggest the proper guidelines. This agency can arrange the meeting between the brokers and the press at a very short-time which becomes very fruitful. It also helps to print the prospectus in a better fashionable manner. That is why while selecting the advertising agency, opinion/suggestion given by the merchant bankers should be carefully considered.

Appointment of Printer:

It is the duty of the printer to print the various forms, brochures, prospectus and various publicity materials for the purpose of the issue. For this purpose, he must possess good printing machines and should have the capacity of printing the required materials within the stipulated time and supply the same to the appropriate authority.

Time factor is very significant here. Usually, after the finalization of prospectus and registered with the Registrar, the bulk printing or costly printing starts.

Listing of Securities:

Listing of securities means enrolment of a company’s shares/debentures on the official list of securities of stock exchange. Thus, an issue is said to be listed when the same is added to the list of securities in which the stock exchange is permitted to trade. It is nothing but the permission given for dealing in them on the trading ring of exchange.

It facilitates purchase and sale of such securities by providing a ready, continuous, liquid and broad market for them. The listing of securities requires permission from the Stock Exchange authorities. For this permission, a company must have to apply to the stock exchange for listing of its securities.

So, a company must have to comply all the necessary formalities. An advance copy of the prospectus, copies of Memorandum and Articles of Association together with the application must be sent. Listing of securities present the benefits to the sellers, buyers, brokers in various ways.

Importance of Advisor:

It is quite obvious that a company who is going to raise funds by issuing fresh issue of securities, it must have to take some valuable advice from an advisor. It must be positive and will produce ultimately some savings in recurring expenses. Thus, there must be a good link between merchant bank and the company as well.

For this purpose, the company takes the help from an agency who supplies the necessary advice to the company relating to issues, various formalities which are frequently needed by the company. Practically, the company enjoys confidence and credibility with the help of such agency.

The so called (consultancy) agency helps the company while selecting brokers, underwriters, advertisers, printers etc. and perform a very significant role as an adviser or consultant. About their fees, it may be said that it is negotiable although it is very high even more than merchant bankers although it is disclosed in the prospectus. Practically, an adviser is more important than the merchant banker to the company.

The adviser may be an individual, or a company. It is always better on the part of the company to take an individual as an adviser instead of a firm or a company as the individual can serve better than the latter.

The company must be careful while entering into a contract with the adviser to the issue as there is no prescribed standard draft/proforma. The company must have a faith and confidence on the adviser and should require the proper services from him which is very useful for such issue.

Bought-out deals:

It is a transaction between the merchant banker and the promoter of a company relating to the issue of shares by which the former takes up entirely the initial public offerings at a discount and sells the shares at a premium in the market over the stipulated period.

Although it is not so popular in our country in the past, it has become popular very recently due to the following advantages:

(i) Relating to Time:

Usually, time taken to complete all necessary formalities for the issue, is in between 6 months and 1 year, but bought-out deal can be negotiated and settled at a very short period.

(ii) Relating to Price:

The issue price paid to the merchant banker is fixed rationally which is comparatively high in comparison with the bought-out deal transaction.

(iii) Relating to Marketability:

It is comparatively easy than the merchant banker.

(iv) Relating to Cost:

The fixed cost of issue, particularly the small one, is very high and a bought-out deal can overcome such high cost.

But a bought-out deal is not even free from snags.

Some of them are noted below:

(i) A merchant banker may have to retain the shares till the good price is offered which sometimes, takes from 70 days to 80 days.

(ii) By selling the shares at a high price, the merchant banker gains a substantial amount and the loss actually suffered by the promoter of the company, particularly when the product of the company is good.

However, at present, SEBI is trying to regulate the bought-out deal by implementing reports and new guidelines.

The Credit Relating to Assets and Financial Advisory Services are explained while discussing the Funds Based Activities/Services and Fees Based Activities/Services.