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Merchant Banking & Financial

Services

Presented by Anita Singhal 1


Suggested Reading

 Introduction – (Chapter 1), The


Indian Financial System – Bharati
V.Pathak
 Merchant Banking: Nature & Scope
(Chapter 1), Merchant Banking ,
Principles & Practice. – H.R. Machiraju
 Non-Banking Financial Companies
(Chapter 1), Financial Services,
M.Y.Khan
Presented by Anita Singhal 2
The Indian Financial System
 Regulators
 Ministry of Finance
 Entire financial sector
 SEBI – Securities Exchange Board of India
 Capital markets
 The RBI
 Banking and financial services sectors
 IRDA – Insurance Regulatory & Development
Authority
 The insurance sector

Presented by Anita Singhal 3


The Indian Financial System
 Financial Institutions
(Intermediaries)-
 Banking Institutions
 Scheduled Commercial Banks
 Public Sector Banks
 Private Sector Banks
 Foreign Banks in India
 Regional Rural Banks
 Scheduled Co-operative Banks

Presented by Anita Singhal 4


The Indian Financial System
 Financial Institutions
(Intermediaries)-
 Non-Banking Institutions
 Non-Banking Finance Companies
 Development Financial Institutions
 All India Financial Institutions
 IFCI, IDBI, IIBI, SIDBI, IDFC,NABARD,
EXIM Bank, NHB
 State Level Institutions
 SFCs, SIDCs
 Other Institutions
 ECGC, DICGC
Presented by Anita Singhal 5
The Indian Financial System
 Financial Institutions (Intermediaries)
 Mutual Funds
 Public sector
 Private sector
 Insurance companies
 Govt. Insurance Cos.
 Pvt. Sector
 Housing Finance Companies

Presented by Anita Singhal 6


The Indian Financial System
 Financial Markets
 Capital Market
 Equity Market
 Primary Market
 Public Issues
 Private Placement
 Secondary Market
 NSE
 BSE
 OTCEI
 Regional Stock Exchanges

Presented by Anita Singhal 7


The Indian Financial System
 Financial Markets
 Capital Market
 Debt Market
 Private Corporate Debt
 PSU Bond Market
 Government Securities Market
 Primary Segment
 Secondary Segment

Presented by Anita Singhal 8


The Indian Financial System
 Financial Markets
 Money Market
 Treasury Bills
 Call money market
 Commercial bills
 Commercial Papers
 Certificates of Deposit

Presented by Anita Singhal 9


Glossary
 Treasury Bills
 Short term securities issued by the Govt.
 Tenure – less than a year
 All other characteristics similar to G-
Secs.
 Rates are the lowest for T-Bills

Presented by Anita Singhal 10


Glossary
 Call Money Market
 Banks are the primary participants
 To fulfill CRR requirements, banks have
to show 4.25% of deposits as reserves in
specified securities
 Call money market functions to take care
of any shortages

Presented by Anita Singhal 11


Glossary
 Commercial Bills
 Bills raised by corporates
 Discounted by banks
 Commercial Paper
 Short term paper issued by Corporates
 Usually top ranked Companies
 Tenure 6 months to a year
 Subscribed to by banks and financial institutions

Presented by Anita Singhal 12


Glossary
 Certificates of Deposits
 Short term instruments
 Issued by banks
 For their fund requirements
 Generally, market is between banks and
FIs

Presented by Anita Singhal 13


The Indian Financial System
 Financial Services
 Depositories
 Custodial
 Credit Rating
 Merchant Banking
 Leasing
 Hire Purchase
 Portfolio Management
 Underwriting

Presented by Anita Singhal 14


Glossary
 Merchant Banking
 Advisory role in capital market
 New issues
 Private placement
 Mergers and acquisitions
 Other Corporate Advisory/ management
Consultancy role

Presented by Anita Singhal 15


Glossary
 Leasing
 Financing of equipment
 NBFCs /Banks major players
 Based on EMIs
 Hire Purchase
 Also financing of assets
 Difference – ownership of the asset
passes on to the hirer at the end of the
tenure

Presented by Anita Singhal 16


Glossary
 Portfolio Management
 Investment advisory services
 Personalized service for high net worth clients
 Underwriting
 Safety net for IPOs
 In cases of under-subscription, merchant
bankers subscribe to the balance.
 In cases of complete subscription from public –
merchant bankers get commission for the risk
exposure accepted.

Presented by Anita Singhal 17


Origin of Merchant Banking
 Italy
 17th and 18th centuries
 Entrepreneur
 Added banking activities to merchant
activities to become merchant banker

Presented by Anita Singhal 18


Merchant banks in UK
 18th & 19th century
 Industrial revolution
 Started from bill discounting activities
 Acceptance of trade bills and their
discounting
 Baring Brothers – oldest merchant
bank

Presented by Anita Singhal 19


Prominent contributions
 Granted long term loans to sovereign
Govts.
 Financed British Govt. to purchase
shares of the Suez Canal
 Helped America purchase the state of
Louisiana from Napoleon by raising
loans from money market in London
 Lazard Brothers lent to Govt. of India
for Durgapur steel plant
Presented by Anita Singhal 20
Merchant Banking in India
 Banking Commission Report, 1972
 In favor of merchant banks
 Grindlays was the first
 Followed by Citibank
 Indian banks like SBI
 Central Bank of India, BoI, BoB etc
 ICICI, IDBI and IFCI

Presented by Anita Singhal 21


Services rendered
 Organizing and extending finance for
projects
 Assistance in financial management
 Bill Discounting
 Raising euro-loans
 Financing infrastructure projects
 Lease and hire-purchase
 M&A
 Valuation of assets
 Investment management
Presented by Anita Singhal 22
Organizational structure
 High proportion of professionals
 A substantial delegation of decision
making
 Short chain of command
 Rapid decision making
 Flexible organization structure
 Innovation
 High level of financial sophistication
Presented by Anita Singhal 23
Investment Banking
 Sale of security issues to finance
projects
 Incl. Debt and equity
 Make secondary markets for
securities
 As brokers and dealers

Presented by Anita Singhal 24


Non Banking Financial
Companies
 Significant element of the Indian
Financial system
 Broadly involved in two activities –
fund based and/or fee based
 Supervised/regulated by RBI
 Housing Finance Cos. regulated by
NHB
 Regulated under the provisions of
Chapter III-B and Chapter III-C of
the RBI Act
Presented by Anita Singhal 25
Salient Features of Chapter III-
B of the RBI Act
 Provisions relating to Non-Banking
Institutions receiving deposits and
FIs.
 Deposit :
 Any receipt of money by way of deposit
or loan or any other form
 Exclusions – amt recd. From banks/FIs,
amt recd in ordinary course of business
etc.
Presented by Anita Singhal 26
Salient Features of Chapter III-
B of the RBI Act
 Financial Institutions
 Financing others’ activities
 Acquisition of shares & debentures
 Hire-purchase
 Any class of insurance, stock-broking
 Chit funds
 Collection of money and disbursement of
the same.

Presented by Anita Singhal 27


Salient Features of Chapter III-
B of the RBI Act
 NBFC
 A FI that is a Co.
 Principal business is receiving deposits and
lending
 Any other business that RBI may notify
 Registration & Net Owned Funds–
 Obtain certificate of regstn. from RBI
 Minimum net owned funds (NOFs) of Rs.25 lacs
 NOFs – sh.cap+free reserves-inv.in
shares/debentures/loans of/to group/other NBFC
Cos.
 Inv. Excluded only when > 10% of sh.holders
funds Presented by Anita Singhal 28
Salient Features of Chapter III-
B of the RBI Act
 Maintenance of Assets
 Reqd. to invest at least 5% or more of
their o/s deposits in specified/approved
Indian securities
 Should have it on the books on the last
working day of the second preceding
quarter.
 Any contravention, would result in penal
int. of bank rate + 3% p.a.
 If shortfall continues, rate increases to
5% p.a. above bank rate
Presented by Anita Singhal 29
Salient Features of Chapter III-
B of the RBI Act
 Powers of :
 Regulation
 Call for information
 Inspection
 Penalties
 Reserve Fund
 Must transfer atleast 20% of its profits to
this fund before declaring dividend

Presented by Anita Singhal 30


Salient Features of Chapter III-
B of the RBI Act

 Rules for acceptance of deposits


 Min. NOF of Rs. 25 Lacs
 Min. investment grade credit rating
from approved rating agencies every
year
CRISIL FA-
ICRA MA-
CARE CARE BBB (FD)
FITCH Ind BBB -
Presented by Anita Singhal 31
Salient Features of Chapter III-
B of the RBI Act
 Deposit rules :
 Min. period of 1 year upto 5 yrs
 Capital adequacy of 15%
 Max. amt. Of deposits upto 1.5 times its
NOF or Rs. 10 Cr. whichever is lower.
 In event of downgrading of credit rating,
to stop new deposits and reduce by 3
years all o/s.
 Max. interest rate on deposits @ 12.5%

Presented by Anita Singhal 32


Salient Features of Chapter III-
B of the RBI Act
 NPAs – classified as one where
interest / installment not received for
more than 6 months
 Standard asset – no default
 Sub-standard asset – NPA for < 18
months, restructured / re-negotiated
 Doubtful asset – NPA for > 18
months
 Loss asset – no hope of recovery
Presented by Anita Singhal 33
Salient Features of Chapter III-
B of the RBI Act
 Capital Adequacy Requirements
 Tier I + Tier II Cap. equivalent to 12% of
agg. Risk weighted assets & risk
adjusted value of off bal. sheet items.
 Tier II Capital not more than 100% of
Tier I Capital
 Tier I Capital = NOF
 Tier II Capital = non-convertible Pref.
Sh. + Revaluation Res.+ Debt

Presented by Anita Singhal 34


Salient Features of Chapter III-
B of the RBI Act
 Risk Weighted Assets
 Weighted aggregate of funded items
 Degree of credit risk with each item
 Weights allotted:
 Cash & approved securities – 0% incl.
 100% of all other assets
 Off Balance Sheet assets
 Financial guarantees (100%)
 Underwriting commitments (50%)
 Partly paid shares (100%)

Presented by Anita Singhal 35


Salient Features of Chapter III-
B of the RBI Act
 Restriction on Credit/Investments :
 NBFCs cannot lend to any single
borrower in excess of 15% of their NOF /
group in excess of 25% of their NOF.
 Same norms for investment in another
Company
 Ceiling on loans & investments together
not more than 25% and 40%

Presented by Anita Singhal 36


Asset-Liability Management
System
 Complexities of liberalization on financial
assets & liabilities
 Fairly deregulated environment
 Strategic mgt. of risk
 Credit risk, interest rate risk, equity risk,
liquidity risk and operational risk
 Address these risks in a structured manner
 ALM function – to enforce risk management
discipline.

Presented by Anita Singhal 37


Asset-Liability Management
System
 3 Pillars of the ALM Process
 ALM Information systems
 MIS
 Info.availability, accuracy, adequacy &
expediency
 ALM Organization
 Structure and responsibilities
 Level of top mgt. involvement
 ALM Process
 Risk parameters
 Risk identification
 Risk measurement
 Risk management
 Risk policies andbytolerance
Presented Anita Singhal levels 38
Asset-Liability Management
System
 ALM Information system
 Ensure timeliness of info.
 Accuracy
 Where geographical spread of branches
is large, the above might not be possible
 Easier for centralized functions like
investments and funds management.
 Computerization is the key

Presented by Anita Singhal 39


Asset-Liability Management
System
 ALM Organisation
 Board of Directors – overall responsibility
 Set risk mgt policy
 Set limits for liquidity, int. rate & equity/price
risks
 ALCO (Asset Liability Committee) to be set up
 ALCO made of CEO and sr. mgt
 ALM Support groups – operational staff –
analysing and monitoring risk profiles

Presented by Anita Singhal 40


Asset-Liability Management
System
 ALM Process
 Liquidity Risk Management
 Tracking maturity/cash flow mismatches
 Currency Risk
 Interest rate risk
 Gap analysis
 Gap between rate sensitive liabilities and
gap sensitive assets

Presented by Anita Singhal 41


Asset-Liability Management
System
 An asset/liability is gap sensitive if :
 There is a cash flow in the time period
under consideration
 The interest rate resets contractually
during the interval
 Dependant on the RBI changes in
interest rates / bank rate
 Contractually pre-payable or withdrawn
before maturity

Presented by Anita Singhal 42

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