CU-SEM-III-MCOM-Management of Financial Services

 any sort of discrepancies, wrongful disclosures, inadequate or misleadinginformation etc., intentionally or otherwise, in the offer documents. Merchant Bankers,SEBI and the issuing company seemed to be engrossed in a game of passing the parcelwith each one shifting the blame and responsibility on the others. Pushed against the wall,the investors reacted by going on a prolonged holiday which forced the market and all itsintermediariesto take a second look. The merchant banking community realized the importance of specialization andalso the need to bring international standards of services to the profession. Foreigncollaborations were sought like ICICI tied up with JP Morgan to promote a joint ventureICICISecuritiesandFinanceCo.Ltd. The increase in the number of registered merchant bankers created unhealthycompetition in the market. Besides, there was a significant increase in the number of newpromoters coming out with new projects. Merchant bankers are solely responsible forappraising the projects of their economic and financial viability. But appraising a projectcalls for experience and professional knowledge of the highest order market and speciallyinvestors experienced the ill effects of free pricing concept after abolition of CCI and byhandling of issues by immature and unethical merchant bankers. In 1994 when SEBImadeproportionateallotmentcompulsoryandraisedminimumsubscriptionfromRs.1000toR s.5000,themarketwasputoninstitutionalizationofthemarket.Accordinglymerchantbankershadto mendtheirstrategy.Theyevolvedtheirmarketing strategieswhichwereorientedtowardslargeinvestors,orthewholesaleinvestors.Further, since they were to deal with institutional investors who are informed buyers, themerchantbankersbecamemoreconsciouswhileselectingtheissuer.Tosomeextentweak merchant bankers were out of the business. This compelled many merchant bankersto move to other related and permitted activities. Many merchant bankers used theirnetworktomobiliseonlyfixeddeposits. In an attempt to prune down the number of Category I Merchant Bankers, SEBIincreased the minimum net worth required of them from Rs.1 crore to Rs.5 crore. Thereintroduction of imposing penalty points on erring merchant bankers was welcome step.SEBIpassedontotheleadmanagersthepowerofvettingofferdocumentsforissues.SEBI’sdecis ioninearly1995tomakeunderwritingoptionalfornewissuesleadtoslumpinthebusinessofmerchant bankerswhoareengagedinunderwriting.Underwritten amount reduced from 88 per cent (of the issue amount of Rs.6060.8 crore)being Rs.5360 crore in 1992-93 to mere 28 per cent (of the issue amount of Rs.10981.7crore)beingRs.3060crorein1995- 96.Thenumberofissueunderwrittenalsocamedown from 98 per cent of (of the issues made i.e. 528) being 518 to 31 per cent (of theissuemadei.e. 1428)being440. In post CCI period free pricing was a boon for promoters since merchant bankersused to give them a green signal to go ahead with high premium. It was observed thatthose merchant bankers, who aggressively priced issues so that the company can charge ahigher premium, were preferred. But in all this the lead manager’s responsibility towardsthe investor was all 101 CU IDOL SELF LEARNING MATERIAL (SLM)

 but forgotten. It was supposed to appraise the project and price itaccording to its true worth. But this was seldom done. On the other hand the promoterswith the backing of a few brokers massively rigged the price of their share on thesecondary market prior to the public issue and then the lead managers very smuglyreferred to the prevailing market price in the offer document to justify the high price. Itwas seen that promoters were using the proceeds of the loan to buy their own stock fromthemarkettojackuptheirprice.PromoteroftheinfamousMSShoeswaschargedof using this route to prop up his stock on the BSE. The capacity of merchant banker toevaluate projects were doubted. Certainly MS Shoes episode made merchant bankerconscious of their reputation. They attempted coming odds with the promoters. To cite anexample, in April 1995 Apple Industries Ltd., which was to lead manager to an issue byContinentalEngineers,withdrewcitinglapsesonthepromotersparttodiscloseinformation. Apple Industries claimed that the promoters had not informed them that ajoint venture with Shannon Development Authority, Ireland had expired. Apple withdrewits“duediligence”certificategrantedtoContinentalandsurrenderedtheacknowledgemen tcardreceivedfromSEBI.Appleclaimedthatasresponsibleleadmanagers and to protect the interests of investors it was withdrawing from the issue. Thisepisode was a pointer to the fact that merchant bankers are slowly cleaning up their actandavoidingissueswithquestionablecredentials. Leadmanagersmademoreresponsible The primary motive for the investor, be it an individual or a corporate entity, insubscribingtopublicofferingsistogetadequatereturnsontheirinvestmentintheformof dividend/interest income and capital appreciation. The lead manager has to carry themultiple responsibility of serving his client and also ensuring the overall quality of theissuetoprotecttheinterestsoftheinvestorsandsmoothworkingandgrowthofthecapital market. The critical parameters in this connection are the promoter group, theproject(s)undertakenandtheofferpriceofthesecurities.Theviabilityandprofitabilityof the project(s) undertaken and the strength of the promoter group in terms of their trackrecord,projectmanagementcapabilitiesandsynergyoftheirpresentinterestwithproposed activities are undoubtedly key parameters in determining the strength of anissue. The recent past has witnessed inherently strong offerings from even establishedhousesreceivingapoorresponsefromtheinvestingcommunityduetoaggressivepricing. There have been a few cases where the offer price has even been higher than themarketpriceofthesharesatthetimeoftheissue.Apartfrom theoftentoutedreasonofa transition phase for the fee pricing regime, the situations has been aggravated by some oftheleadmanagerstryingto getassignmentsbypromisingahigherpremium. Thepost-issuescenariowasanareawhereinvestorshavesufferedovertheyear,as some companies have been known to be lax in dispatching certificates and refundorders and in ensuring listing on all the Stock Exchanges as mentioned in the offerdocument. Lead managers had to ensure 102 CU IDOL SELF LEARNING MATERIAL (SLM)

 proper compliance with the existing guidelinesand time schedules and also redress investor complaints within a reasonable period oftimeafterthecompletionoftheissueformalities. The importance of due diligence in ensuring proper disclosure in order to enableinvestors to take informed investment decisions can hardly be understated. While theregulatory bodies are responsible for setting the disclosure norms, the lead managers hadto ensure adequate disclosure of all important information relevant to an issue instead ofinterpretingthenuancesofexistingguidelines. BusinessPotentials For merchant banking business the year 1995-96 proved to be fatal since half ofabout 1000 merchant bankers did not have any issue to handle. As per a survey by ‘PrimeDatabase’ only 472 merchant bankers out of 1000 strong merchant banking communityhandled any issue at all either in lead manager, co-manager, or advisory capacity in thesaid period. Out of 472 only 261 were engaged as lead managers, 52 merchant bankershandledonlyoneissueand33handledtwoissueseachinthewholeyear. During 1995-96 since the assignments with merchant bankers were few, a movestarted where in merchant bankers category IV objected to advisory role in merchantbanker category I. Advisory role in open to all categories, whereas only a category Imerchant banker can lead manage an issue. According to category IV merchant bankers,there is a conflict of interests whencategory I merchant bankers are also allowed to beadvisors to an issue. Category IV merchant bankers are, in fact asked for segregationbetweenthefunctionsofinvestmentbankingandadvisorroleforthecorporatefinance team.TheprincipalcomplaintwasthatacategoryIbankercanusehisfinancialmuscleto get the advisory role whereas others in category III and IV were perfectly capable ofperforming. Interestingly, much of the business is generated by category III and IVmerchantbankers.Naturally,aftertheyhavedoneaconsiderableamountofinitialadvisory work in terms of the project, its financial structuring and in many cases evenrecommending the issue price, it hurts to see that the title of advisor goes to a category Ibanker. Association SEBI contemplated the merchant bankers as Self Regulatory Organization (SRO).In this process merchant bankers promoted Association of Merchant Bankers of India(AMBI). At different times it has acted as spokesman of merchant bankers. It prepared adue diligence report defining the role and responsibilities of merchant bankers and alsosuggested measures for evolving standard norms for exercising ‘due diligence’ in capitalissue.Itprescribeda‘duediligence’checklistwhichenliststheareastobecoveredduringsuche xercise.Thesevenareasidentifiedare:  Generalbackgroundaboutthecompany  ManagementandControl,  IndustryandCompetitors  Humanresources,  Operations 103 CU IDOL SELF LEARNING MATERIAL (SLM)

  Financialconsiderationsand  Legal A SEBI-AMBI interface committee was proposed with proposals to pass on someimportant powers to AMBI from SEBI. In this emerging SRO, difference of opinion washighlightedamongstprivatesectorandpublicsectormerchantbanks.Consequentlyanother association known as Federation of Merchant Bankers and Finance Companies(FMBFC)emerged.Besidesprovidingafeedbackchannelforregulatorybodies,it proposesinteralliatosafeguardtheprofessionalsinterestsofitsmembersandeducateinvestorsonano ngoingbasis. Inspection OntheotherhandtokeepthemerchantbankersdisciplinedSEBIstartedinspecting the merchant bankers of all the four categories. It is to scrutinize the quality ofservicesprovidedbymerchantbankersaswellastoensurethattheyfollowtheregulationsandguide linesissuedfromtimetotime.SEBIclaimsthatsuchinspectionwillbeinitiatedgenerallyasafollowup measuretoinvestorcomplaints.Throughinspection SEBI wants merchant bankers to be greater accountable and responsible. SBICapitalMarket(SBICaps)wasdebarredfromoperatingforsixmonthsinDecember1995whenm anyirregularitiesweredetectedduringinspectionbySEBI. SEBI officials have been pulling up merchant bankers for not honouring theircommitments and generally not maintaining discipline in pursuit of commercial interests.TheExecutiveDirectorofSEBI(primary market)atannualmeetingofAMBIinDecember 1996 had gone to an extent to observe that “those merchant bankers who didnot honour their commitments do not deserve to be in business”. Merchant bankers havebeen blamed for bringing poor quality issue in primary market and driving away the retailinvestors from the market. Finance Minister P. Chidambaram also made a statement that“themarketswereruinedbypoorqualityissuesbroughtbypoorqualitymerchantbankers”. He planned the black sheep in the merchant banking community for currentstateofgloominthecapitalmarket.Thesefactscanbesubstantiatedbyquotingfindingof a study of price performance of 40 equity issues, that hit the market between April1995andSeptember1996.Ofthecompaniescoveredbystudy(41inall)onlythreescrips were quoting above the offer price on the bourses in November end 1996. Two arequotedatofferpricewhiletherest36scripsarequotedbelowtheofferprice. SEBItodisciplinethemerchantbankertookafirmstandbydebarring64merchantbankersincludingl eadingmembersfrompublicaswellasprivatesectorfornot complying with the direction of SEBI to furnish information about their employees toSEBI in June 1997. Since SEBI proposed to disclose the investors about thetrack recordof lead managers to a public/right issue, in March 1997 it sought information like names,educational qualifications, income tax details, bank account, details of any other businessdone in the name of self, spouse, child or parent 104 CU IDOL SELF LEARNING MATERIAL (SLM)

 passport number, ration card number andhistory of employment of the professionals working in merchant banking firms. Further,SEBI proposed to conduct test for capital market players in 1997. At least 20 per cent ofpersonnel in such firms will be required to pass this test. The given certificate will bevalid for 3 years. Such certification system is based on experience of developed anddevelopingmarketslikeU.S., U.K.,Zambia, Sri Lanka. Challenges One general point which need attention is that ‘merchant banking is not only aboutissue management and underwriting as has been defined by SEBI in India. On this smalland medium size operators entered into pure issue management and underwriting. Easynorms made for easy entry into merchant banking. Even after raising minimum net worthcriterion new entrants entered but in absence of primary market activity they are sittingidle.In1996- 97outof1162merchantbankers720didnothaveanyassignmenttohandle. It will take time a appreciate the concept of merchant banking as “servicing everyfinancial need of the client”. Thisconcept will compel those who jumped into thebusiness without a clear plan to exit. As market matures only a few large companiesshouldsurvive. Collaboration Foreign collaboration appears to be imperative specially for merchant bankers whowant to turn to external commercial borrowings and innovative fields like mergers andacquisitions. The foreign collaboration supported by sound financial position will enablemerchant bankers to establish themselves in long run. Such collaborations enable sharingskillandknowledgeofexperiencedpartners.SEBIproposestoconducttestformerchant banks also besides other intermediaries. This is so because SEBI has made quality ofmanpower one criteria for renewal of merchant banking licence. Thus, merchant bankersare to pure skill upgradation. This is also necessary since Indian market is no longer asellersmarketandcompetitionisforcingmarketingskillstoemerge.Merchantbankingin India is still at a very primitive stage. As it matures only a few large companies willsurvive.Merchantbankerswithinnovativeideaswillflourish. 6.7 SUMMARY  Merchant banking is a type of financial service that involves issues managementandotherrelatedactivities.  Merchantbankersaretheinstitutionsengagedintheproviding merchant banking services to corporate entities.  There are several kinds ofservicerenderedbymerchantbankers.Theseincludeprojectcounselling,creditsyndication , corporate counselling, portfolio management, stock broking, venture capital,bill discounting, leasing, factoring, underwriting etc. SEBI has issued SEBI (MerchantBanking) Regulation on merchant banking. 105 CU IDOL SELF LEARNING MATERIAL (SLM)

  The regulation are applicable only to limitedactivitiesundertakenbymerchantbanker.Besidesthis,operationalguidelinesarerequ ired to be followed by merchant bankers in the discharge of their duties. They havepre- issueandpost-issueobligations,whichareapartofissuemanagement. 6.8 KEYWORDS  MerchantBank:Itisanorganisationthatunderwritescorporatesecuritiesandadvisesclientson variousissuesinvolvedintheownershipofcommercialventures.  CorporateCounselling:Servicesprovidingtowardsensuringefficientrunningofacorporatee nterprisearecalledcorporatecounselling.  CreditSyndication:ItisconcernedwithextendingfinanceinbothIndianrupeesandForeigncur rency,onaconsortiumbasis.  Underwriter: An investment and banking firm, whichenters a contract with the issuer ofnewsecuritiestodistributethemtotheinvestingpublic. 6.9 LEARNING ACTIVITY 1. Can the lessee and lessor execute 2 consecutive 30 year lease agreements? Enumerate ___________________________________________________________________________ ___________________________________________________________________________ 2. In leasing real estate, can I own the structure on the land? Justify ___________________________________________________________________________ ___________________________________________________________________________ 6.10UNIT ENDQUESTIONS A.Descriptive Questions Short Questions 1. Who is a merchant banker? 2. What do you mean by factoring? 3. Who is a lead manager? Long Questions 1. Discuss the services rendered by merchant bankers. 2. Explain the role of SEBI in regulating the merchant banking operations in India 3. Who is lead manager? Discuss his duties and liabilities. 4. Discuss the code of conduct laid down for merchant bankers by SEBI. What is its need? 5. Discuss in detail the authorized activities of merchant bankers as per SEBI. 106 CU IDOL SELF LEARNING MATERIAL (SLM)

 B. Multiple Choice Questions 1. The following is not a service provided by merchant banks: a. project counselling b. education c. raising funds d. loan syndication 2. ………………is a form of private equity and a type of financing. a. Venture Capital b. Loan c. Financial Institution d. None of these 3………… is a financing arrangement that provides a firm with an advantage of using an asset, without owing it. a. Hire Purchase b. Lease c. Venture Capital d. None of these 4………. is the owner of the asset. a. Hirer b. Lessor c. Lessee d. Hiree 5. In………… lease, the lessee uses the asset for a specific period. a. Financial b. Operating c. Sale and Lease Back d. Leverage based 6…………. may be defined as the purchasing of an exporter's receivables at a discount price by paying cash. a. Forfeiting b. Factoring c. Leasing 107 CU IDOL SELF LEARNING MATERIAL (SLM)

 d. Hire purchase 7…………. is when a company buys a debt or invoice from another company. a. Forfeiting b. Factoring c. Leasing d. hire purchase Answers '8. Invoice discounting is a source of……………… finance for the seller of goods on credit.. a. Fixed Capital b. Long-term Capital c. Working Capital d. None of these 9. in………. lease, the lessor involves one more financier who will have charge over the leased asset. a. Conveyance b. Operating c. Sale and Leaseback d. Leverage 10…………………. is a person who acquires the asset on lease and also pays lease rentals. a. Lessee b. Lessor c. Hirer d. None of these Answers 1(c) ,2(b) ,3(c) ,4(a) ,5(a) ,6(a) ,7(b) ,8(b) ,9(d) ,10(b) 6.11REFERENCES Text Books:  Bhalla, V. K.“ Management of Financial Services” Anmol Publications  Clifford Gomez “ Financial Markets, Institutions and Financial Services”, PHI Learning  Rose, Peter and Hudgins, Sylvia,“ Bank Management and Financial Services”, McGraw Hills. Reference Books: 108 CU IDOL SELF LEARNING MATERIAL (SLM)

  Padamlatha ,“ Management of Banking and Financial Services”, Pearson Education.  Saunders, Antony and Cornett, Marcia,“ Financial Institutions Management: A Risk Management Approach” McGraw Hills 109 CU IDOL SELF LEARNING MATERIAL (SLM)

 UNIT-7REGUALTION OF MERCHANT BANKING ACTIVITY STRUCTURE 7.0 Learning Objectives 7.1 Introduction 7.2 History Of Merchant Banking In India: 7.3 Merchant Banking Regulations: 7.4 Classification Of Merchant Bankers: 7.5 Capital Adequacy Norms: 7.6 Government Policy For Merchant Banking: 7.7 Summary 7.8 Keywords 7.9 Learning activity 7.10 Unit End Questions 7.11References 7.0 LEARNING OBJECTIVES After studying this unit, students will be able to:  To have a clear view on the following areas of Merchant Banking Activities  History of Merchant Banking  Regulations of Merchant Banking  Government Policy with respect to Merchant Banking 7.1 INTRODUCTION Merchant banking as it is known in present days had its origin in U.K and U.S.A in early fifties. But the roots of this servicerendering industry can be traced as back as in late eighteenth century and early 19thcentury. There were merchants, who traded overseas, built reputation and later sharedtheir goodwill with newer traders to facilitate their merchant activities especially byproviding guarantees for payments. Subsequently they entered any field which added totheirbusinessdependingonthedemandoftime.Thus,astimechangedtheirrolechanged, consequently it has never been possible to pinpoint their role. 7.2 HISTORY OF MERCHANT BANKING IN INDIA 110 CU IDOL SELF LEARNING MATERIAL (SLM)

 Merchant banking services, in India, were started only in 1967 by National Grindlays. Bank followed by Citi Bank in 1970. The State Bank of India was the first Indian commercial bank to set up a separate merchant banking division in 1972. Later, the ICICI set up its merchant banking division in 1973 followed by a number of other commercial banks like Canara Bank, Bank of Broada, Bank of India, Syndicate Bank, Punjab National Bank, Central Bank of India, UCO Bank, etc The FERA regulations in 1973, which required a large number of foreign companies to dilute their shareholdings in India, gave a boost to the merchant banking activities in India. Since then, a number of development banks and financial institutions such as IFCI and IDBI have also entered this field. Some leading banks have floated wholly owned subsidiaries for carrying out these activities. Private brokers and financial consultancy firms have also been quite active in the field of merchant banking. They, infact, have given a tough competition to the commercial banks in the operations of merchant banking. Thus, at present merchant banking services in our country are provided by the following types of organisations: (i) Commercial banks and their subsidiaries. (ii) Foreign banks including National Grindlays Bank, Citi Bank, Hongkong Bank etc (iii) All India Financial Institutions and Development Banks such as, ICICI, IFCI, IDBI. (iv) State Level Financial Institutions, such as, State Industrial Development Corporations (SIDCo’s) and State Financial Corporations. (v) Private Financial Consultancy Firms and Brokers, such as J.M. Financial and Investment Services Ltd.; DSP Financial Consultants, Fnam Financial Consultants, KotakMohindra, Ceat Financial Services, etc. (vi) Technical Consultancy Organisations (vii) Professional Merchant Banking Houses, such as VMC Project Technologies. Merchant banking in India can be categorised in four broad sections: 1. To provide long-term source of funds required by the corporate sector. The merchant banker primarily came into being as corporate counsellors 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. The buoyancy in the capital market in 1980s created a lot of scope for merchant banking activities in our country. The year 1985 was an epoch-making year in the history of merchant banking when a large number of issues were oversubscribed by several times and the importance of merchant banking activities was made evident in managing issues and their underwriting. 111 CU IDOL SELF LEARNING MATERIAL (SLM)

 Deregulation and liberalisation of the industry in India has accounted for changes in the financial sector. With the passage of time merchant banking activities have changed in line with the changing need pattern of the enterprises in the wake of economic development. Since August 1990, merchant bankers engaged in issue management, corporate advisory services, underwriting and portfolio management have to obtain authorisation from the Securities and Exchange Board of India (SEBI) after meeting the requirements of capital adequacy norms. In 1993, there were 568 merchant bankers in our country out of which 312 were authorised by the Securities and Exchange board of India. The number of registered merchant bankers with SEBI increased to 422 at the end of August 1994. The total number of merchant bankers in all categories increased to 1163 by the end of 1997-98. As the liberalisation policy continues and the financial market is expanding rapidly, the future for the country’s merchant bankers seems to be buoyant. But their roles are changing with the change in the needs of the customers. 7.3 MERCHANT BANKING REGULATIONS: SEBI (Merchant Bankers’) Regulation Act, 1992 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 or acting as manager, consultant, adviser or rendering corporate advisory service in relation to such issue management”. At present no organisation can act as a ‘merchant banker’ without obtaining a certificate of registration from the SEBI. However, It must be noted that a person/ organisation has to get himself registered under these regulations if he wants to carry on or undertake any of the authorised activities, i.e., issue management assignment as manager, consultant, advisor, underwriter or portfolio manager. To obtain the certificate of registration, one had to apply in the prescribed form and fulfill two sets of norms (i) operational capabilities and (ii) capital adequacy norms. 7.4 CLASSIFICATION OF MERCHANT BANKERS: The SEBI has classified ‘merchant bankers’ under four categories for the purpose of registration: 1. Category I Merchant Bankers: These merchant bankers can act as issue manager, advisor, consultant, underwriter and portfolio manager. 2. Category II Merchant Bankers: Such merchant bankers can act as advisor, consultant, underwriter and portfolio manager. They cannot act as issue manager of their own but can act co-manager. 3. Category III Merchant Bankers: 112 CU IDOL SELF LEARNING MATERIAL (SLM)

 They are allowed to act as underwriter, advisor and consultant only. They can neither undertake issue management of their own nor they act as co-manager. They cannot undertake the activities of portfolio management also. 4. Category IV Merchant Bankers: A category IV merchant banker can merely act as consultant or advisor to an issue of capital. 7.5 CAPITAL ADEQUACY NORMS: SEBI has prescribed capital adequacy norms for registration of the various categories of merchant bankers. The capital adequacy is expressed in terms of minimum net worth, i.e., capital contributed to the business plus free reserves. The following are the capital adequacy norms as laid down by SEBI: Fees: According to the SEBI (Merchant Bankers) Amendment Regulations, 1999, w.e.f. 30.9.1999, every merchant banker shall pay a sum of Rs. 5 lakhs as registration fees at the time of grant of certificate by the Board. The fee shall be paid by the merchant banker within 15 days of receipt of intimation from the Board. Further, a merchant banker to keep registration in force shall pay renewal fee of Rs. 2.5 lakhs every three years from the fourth year from the date of initial registration. 7.6 GOVERNMENT POLICY FOR MERCHANT BANKING: The Government issued policy guidelines for merchant bankers to ensure sufficient physical infrastructure, necessary expertise, good financial standing, professional integrity and fairness in their transactions. The merchant bankers have to be competent to serve the investors also. On 1st March, 1993 new policy guidelines have been issued by SEBI for the merchant bankers to ensure greater transparency in their operations and to make them accountable so as to protect the investor’s interest. The guidelines relate to pre-issue obligations, underwriting, ADVERTISEMENTS AND POST-ISSUE OBLIGATIONS OF THE MERCHANT BANKERS. 7.7 SUMMARY  Due to factors such as growth of primary market, increasing need of corporate restructuring and easing of FDI norms, merchant banking has never been more relevant in India. 113 CU IDOL SELF LEARNING MATERIAL (SLM)

  Therefore, it is very much required that the restrictive norms governing merchant banking, especially those related to capital adequacy and registration, should be relaxed in order to allow small players to enter and further expand the exclusive club of merchant bankers in India. 7.8 KEYWORDS  Repo Rate - When RBI provides a loan to the bank for short-term between 1 to 90 days, RBI takes some interest from the bank which is termed as Repo Rate.  Reverse Repo Rate - When bank deposit it's excess money in RBI then RBI provides some interest to that bank. This interest is known as Reverse Repo Rate.  Difference between Repo Rate and Reverse Repo Rate  SLR –(Statutory Liquidity Ratio) - Every bank has to maintain a certain % of their total deposits in the form of (Gold + Cash + bonds + Securities) with themselves at the end of every business days. Current SLR is 18.00%.  Retail banking - Retail banking is a type of banking in which direct dealing with retail customers is done. This type of banking is also popularly known as consumer banking or personal banking.  It is the visible face of banking to the general public.  Bitcoin - Bitcoin is a virtual currency/ cryptocurrency and a payment system.  It can be defined as decentralized means of tracking and assigning wealth or economy, it is a software protocol. Bitcoin uses two cryptographic keys, one public (username) and one private (password) are generated.  1Bitcoin= 108 Satoshi.  Call money - Call/Notice money is the money borrowed on demand for a very short period. When money is lent for a day it is known as Call Money.  Read: Money Market Instruments  Notice money - When the money is borrowed or lent for more than a day up to 14 days it is called Notice Money.  Scheduled bank - Banks which are included in the 2nd Schedule of RBI Act 1934 are known as a scheduled commercial bank. These banks should fulfil two conditions:  Paid up capital and collected funds should not be less than Rs.5 Lacs.  Any activity of the Bank should not adversely affect the interests of the customers.  Non-Performing Assets - NPA is an asset of a bank which is not producing any income.  Bank Usually classify as nonperforming assets any commercial loans which are more than 90 days overdue and any consumer loans which are more than 180 days overdue. 7.9 LEARNING ACTIVITY 1. What are the basic services provided by a merchant banker in India? 114 CU IDOL SELF LEARNING MATERIAL (SLM)

 ___________________________________________________________________________ ___________________________________________________________________________ 7.10 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What is meant by merchant banking? 2. List the classification of merchant bankers. Long Questions 1. Discuss the government policy towards merchant banking. 2. Discuss about the capital adequacy norms. B.Multiple Choice Questions 1.In India, merchant Banks operate in the form of divisions of India and foreign banks and financial institution, Subsidiary companies established by a. SBI Capital Markets Ltd. b. Can Bank Financial Services Ltd. c. PNB Capital Services Ltd. d. BOI Finance Ltd. e. Indian Bank Merchant Banking Services Ltd. a. 1, 2, 4, 5 b. 2, 3, 4, 5 c. 1, 2, 3, 4, d. 1, 3, 4, 5 2.Banks implement the RBI’s _______ policies. a. Monetary b. Credit c. Commercial d. Both a and b 3. State level financial institutions are: 115 1. IFCI 2. SFCs 3. SIDCs 4. IRBI 5. SIICs a. 1, 2, 4 b. 2, 3, 5 CU IDOL SELF LEARNING MATERIAL (SLM)

 c. 1, 3, 5 d. 1, 4, 5 4. _____ is basically a savings and investment corporation. a. UTI b. IDBI c. SBI d. RBI 5. Identify the money market instruments: 1. Call Money Market 2. Treasury Bills 3. Commercial bills 4. Commercial paper 5. Certificate of deposit 6. Foreign investment policy a. 1, 2, 4, 5, 6 b. 2, 3, 4, 5, 6 c. 1, 2,3, 4, 5 d. All of these 6. Secondary markets in treasury bills require involvement of ________ and _______. a. Brokers, Dealers b. Buyers, Sellers c. Consumer, Producer d. All of these 7. Merchant bank is an organization that a. Underwrites securities for corporations b. Advice clients on mergers c. Involved in ownership of commercial ventures d. All of these 8. The criteria for authorization of merchant bankers includes: 1. Professional qualification in finance, law or business management 2. Infrastructure like adequate office space, equipment and manpower 3. Employment of two persons who have the experience to conduct business of merchant Bankers 4. Capital adequacy 5. past track record, experience, general expectation and fairness in all transaction 116 CU IDOL SELF LEARNING MATERIAL (SLM)

 a. 1, 2, 4, 5 b. 1, 2, 3, 4, 5 c. 2, 3, 4, 5 d. None of these 9. The four categories of merchant bankers issued by SEBI: 1. First category i. Who act as an advisor or consultant to an issue 2. Secondary category ii. Those authorized to act as an underwriter, advisor. 3. Third category iii. Those authorized to act in the capacity of co-manager 4. Fourth category iv. Who carry on any activity of issue management? a. 1-I, 2-ii, 3-iii, 4-iv b. 1-iv, 2-iii, 3-ii, 4-I c. 1-iii, 2-I, 3-iv, 4-ii d. None of the above 10. Issue management is an important function of ______ and ______. a. Merchant banker, lead manager b. Public banker, Merchant banker c. Lead banker, Private banking. d. None of these 11.In simple terms, the management of issues for raising funds through various types of instruments by companies is known as: a. Lead management b. Merchant banking c. Issue management d. Public issue management 12.Companies raise funds for the purposes of: 1. Financing new projects 2. Expansion of existing units 3. Modernization & diversification of existing units 4.Organizing long term resources for working capital purposes a. 1, 2, 3 b. 2, 3, 4 c. 1, 2, 3, 4 d. 1, 3, 4 13. Categories of securities issue: a. Public issue b. Rights issue 117 CU IDOL SELF LEARNING MATERIAL (SLM)

 c. Private placement d. All of these 14. Private placement covers a. Shares b. Preference shares c. Debentures d. All of these Answers 1(c) ,2(d) ,3(d) ,4(b) ,5(c), 6(c) ,7(c) ,8(b) ,9(b) ,10(c) ,11(d) ,12(c) ,13(c),14(b) 7.11REFERENCES Text Books:  Bhalla, V. K.“ Management of Financial Services” Anmol Publications  Clifford Gomez “ Financial Markets, Institutions and Financial Services”, PHI Learning  Rose, Peter and Hudgins, Sylvia,“ Bank Management and Financial Services”, McGraw Hills. Reference Books:  Padamlatha ,“ Management of Banking and Financial Services”, Pearson Education.  Saunders, Antony and Cornett, Marcia,“ Financial Institutions Management: A Risk Management Approach” McGraw Hills 118 CU IDOL SELF LEARNING MATERIAL (SLM)

 UNIT-8INTRODUCTIONTOBANKING AND INSURANCE STRUCTURE 8.0 Learning Objectives 8.1Introduction 8.2Meaning and Definition of a Bank 8.3Types of Banks 8.4Functions of Commercial Banks 8.5Nature or Characteristics of Insurance 8.6Functions of Insurance 8.7Limitations of Insurance 8.8Principles of Insurance 8.9Summary 8.10Keywords 8.11 Learning activity 8.12 Unit End Questions 8.13References 8.0 LEARNING OBJECTIVES After studying this unit, students will be able to:  Definethebankandexplainvarioustypesofbanks.  Discussthefunctionsofcommercialbanks. 8.1 INTRODUCTION As for as the origin of the present banking system in the world is concerned, thefirst bank called the “Bank of Venice” is believed to be established in Italy in the year1157. The first bank in India was started in the year 1770 by the Alexander & Co., anEnglishAgencyas“BankofHindustan”whichfailedin1782duetotheclosureoftheAgencyHouse inIndia.Thefirstbankinthemodernsensewas establishedintheBengalPresidencyas“BankofBengal”intheyear1806. According to G. Crowther the modern banking has three ancestors in the history ofbankinginthisworld:-  TheMerchants  TheGoldsmiths  TheMoneyLenders TheMerchants 119 CU IDOL SELF LEARNING MATERIAL (SLM)

 It were the merchant who first evolved the system of banking as the tradingactivities required remittances of money from one place to another place which is one ofthe important functions of a bank even now. Because of the possibility of theft of moneyduring physical transportation of money, the traders began to issue the documents whichwere taken as titles of money. This system gave rise to the institution of “Hundi” whichmeans a letter of transfer whereby a merchant directs another merchant to pay the bearerof Hundi the specified amount of money in the Hundi and debit this amount against thedrawerofHundi. TheGoldsmiths Thesecondstageinthegrowthofbankingwastheroleofgoldsmiths.Thebusinessofgoldsmithswass uchthathehadtosecuresafetoprotectthegoldagainsttheft and take special precautions. In a period when paper was not in circulation and themoney consisted of gold and silver, the people started leaving their precious bullion andcoinsinthecustodyofgoldsmiths.Asthispracticespread,thegoldsmithsstartedcharging something for taking care of the gold and silver. As the evidence of receivingvaluables, he stared to issue a receipt. Since the gold and silver coins had no mark of theowners, the goldsmiths started lending them. The goldsmiths were prepared to issue anequalamountofgoldorsilvermoneytothereceiptholder,thegoldsmithreceiptsbecamelikechequ esasamediumofexchangeandameansofpaymentbyonemerchanttotheothermerchant. Themoneylenders The third stage in the growth of banking system is the changing of the character ofgoldsmiths into that of the money lenders. With the passing of time and on the basis ofexperience the goldsmiths found that the withdrawals of coins were much less than thedeposits with them and it was not necessary to hold the whole of the coins with them.After keeping the contingency reserve, the goldsmiths started advancing the coins on loanbycharginginterest.Inthiswaythegoldsmithmoneylenderbecameabankerwhostartedperfor mingtwoimportantfunctionsofthemodernbankingsystem,thatofaccepting deposits and advancing loans. The only difference is that now it is the papermoneyandthenitwasgoldorsilvercoins. 8.2 MEANING AND DEFINITION OF A BANK It is very difficult to giver a precise definition of a bank due to the fact that amodern bank performs a variety of functions. Ordinarily a ‘Bank’ is an institution whichdeals with the money and credit in such a manner that it accepts deposits from the publicand makes the surplus funds available to those who need them, and helps in remittingmoneyfromoneplacetoanothersafely.Differenteconomistshavegivendifferentdefinitio nofabank.Someoftheimportantdefinitionsareasunder: “Abankcollectsmoneyfromthosewhohaveittospareorwhoaresavingitoutoftheirincomes,anditle ndsthismoneytothosewhorequireit.” G.Crother 120 CU IDOL SELF LEARNING MATERIAL (SLM)

 “Banking means the accepting for the purpose of Indian companies lending orinvestment, of deposits of money from the public, repayable on demand or otherwise, andwithdrawablebycheque,draftorotherwise.” TheBankingCompanies(Regulation)Act,1949 Anidealdefinitionofabankcanbegivenasunder:- “A bank is a commercial establishment which deals in debts and aims at earningprofits by accepting deposits from general public at large, which is repayable on demandor otherwise through cheques or bank drafts and otherwise which are used for lending totheborrowersorinvestedinGovernmentsecurities.” 8.3 TYPES OF BANKS Banksareofvarioustypesandcanbeclassified: A. OnthebasisofReserveBankSchedule. B. Onthebasisofownership. C. Onthebasisofdomicile. D. Onthebasisoffunctions. A. OnthebasisofReserveBankSchedule: BankcanbeofthefollowingtwotypesonthebasisofSecondScheduleoftheReserveBankofIndi aAct,1934:  SchedulesBanksand  Non-scheduledBanks ScheduledBanks All thosebanks which are included in the list of Schedule Second of the ReserveBank of India are called the Scheduled Bank. Only those banks are included in the list ofscheduledbankswhichsatisfythefollowingconditions:  ThatitmusthaveapaidupcapitalandreservesofRs.5lakhs.  ThatitmustensuretheReserveBankthatitsoperationsarenotdetrimentaltotheinterestofthedep ositors.  That it must be a corporation or a cooperative society and not a single ownerfirmorapartnershipfirm. Non-scheduledBanks The banks which are not included in the second schedule of the Reserve Bank ofIndia Act, 1934 are called non-scheduled banks. They are not included in the secondschedule because they does not fulfill the three pre-conditions laid down in the act toqualifyfortheinductionin thesecondschedule. B. OnthebasisofOwnership Bankscanbeclassifiedonthebasis ofownershipinthefollowingcategories:  PublicSectorBanks  PrivateSectorBanks 121 CU IDOL SELF LEARNING MATERIAL (SLM)

  CooperativeBanks PublicSectorBanks The banks which are owned or controlled by the Government are called “PublicSectorBanks”.In1955thefirstpublicsectorcommercialbankwasestablishedbypassing a special Act of Parliament which is known as State Bank of India. SubsequentlytheGovernmenttookoverthemajorityofsharesofotherStateBankswhichwereoperat ingatthestatelevelsnamelyStateBankofPatiala,StateBankofBikaner&Jaipur, State bank of Travancore, State Bank of Mysore, State Bank of Indore, State Bankof Saurashtra and State Bank of Hyderabad presently working as subsidiaries of StateBankofIndia. Inthefieldofbanking,theexpansionofpublicsectorwasmarkedwiththenationalization of 14 major commercial banks by Mrs. Indira Gandhi on July 19, 1969throughanordinance.AgainonApril15,1980anothergroupof6commercialbankswere nationalized with the deposits Rs.200 crores each, resulting in the total of 20 suchbanks. But due to the merger of New Bank of India with the Punjab National Bank in1993- 94,thenumberofnationalizedbankhasbeenreducedto19.TheStateBankofIndiaanditssevensubsid iarieshadalreadybeennationalized.Theprogressivenationalizationofbankhasincreasedtheroleof publicsectorbankinginthecountry.In1996 these nationalized commercial banks had 31,055 branches all over India whereasStateBankofIndiaanditssubsidiariesalonehad12,903branches. Under the new liberalization policy of the Government, The Oriental Bank ofCommerce, State Bank of India, Corporation Bank, Bank of India and Bank of Barodahave offered their share to the general public and financial institutions and therefore thesebanks are no longer 100% owned by Government of India. Although majority of thesharesisstillwiththeGovernment,thereforethesearestillpublicsectorbanks. PrivateSectorBanks OnthecontraryPrivateSectorBanksarethosebankswhichareownedandcontrolled by the private sector i.e. private individuals and corporations. The privatesector played a strategic role in the growth of joint stock banks in India. In 1951 therewere in all 566 private sector banks of which 92 banks were scheduled banks and theremaining 474 were non-scheduled banks. At the time there was not even a single publicsector bank. With the nationalization of banks in 1969 and 1980 their role in commercialbanking had declined considerably. Since then the number of private sector banks isdecreasingandthenumberofpublicsectorbanksisincreasing. Co-OperativeBanks Theword‘cooperative’standsforworkingtogether.Thereforecooperativebanking means an institution which is established on the principle of cooperation dealingin ordinary banking business. Cooperative banks are special type of banks doing ordinarybanking business in which the members cooperate with each other for the promotion oftheircommoneconomicinterests. FeaturesofCooperativeBanking Followingarethedistinguishingmainfeaturesofacooperativebank:-  MembershipofCooperativeBanksisvoluntary. 122 CU IDOL SELF LEARNING MATERIAL (SLM)

  FunctionsofaCooperativeBankarecommonbankingfunctions.  OrganizationandmanagementofaCooperativeBankisbasedondemocraticprinciples.  MainobjectivesofaCooperativebankaretopromoteeconomic,socialandmoraldevelopmento fitsmembers.  BasicprincipleofCooperativeBankisequality. Therefore,wecanconcludeanddefineacooperativebankasunder: “Cooperative Bank is an institution established on cooperative basis which dealsinordinarybankingbusinessforthepromotionofeconomic,socialandmoraldevelopmentofits membersontheprincipleofequality.” The short term agriculture credit institutions cater to the short term financial needsoftheagriculturistswhichhavethefollowingthreetierfederalstructureincooperative: AttheVillagelevel : PrimaryAgriculturalCreditSocieties AttheDistrictlevel: CentralCooperativeBanks AttheStatelevel : StateCooperativeBanks B. Onthebasisofdomicile Thebankscanbeclassifiedintothefollowingtwocategories:  DomesticBanks  ForeignBanks DomesticBanks ThosebankswhichareincorporatedandregisteredintheIndiaarecalleddomesticbanks. ForeignBanks ForeignBanksarethosebankswhicharesetupinaforeigncountrywiththeircontrolandmanagementi nthehandsofheadofficeintheircountryoforiginbuthavingbusiness branches in India. Foreign Banks are also known as Foreign Exchange Banks orExchange Banks. Traditionally these banks were set up for financing the foreign trade inIndia and discounting the foreign exchange bills. But now these banks are also acceptingdepositsandmakingadvanceslikeothercommercialbanksinIndia. D. Onthebasisoffunctions Thebankscanbeclassifiedonthebasisoffunctionsinthefollowingcategories:  CommercialBanks  IndustrialBanks  AgriculturalBanks  ExchangeBanks  Central Bank CommercialBanks: Commercial Banks are those banks which perform all kinds of banking businessandfunctionslikeacceptingdeposits,advancingloans,creditcreation,andagencyfunction s for their customers. Since their major portion of the deposits are for the shortperiod, they advance only short term and medium term loans for business, trade andcommerce. Majority 123 CU IDOL SELF LEARNING MATERIAL (SLM)

 of the commercial banks are in the public sector. Of late they havestarted giving long term loans also to compete in the commercial money market. Thesecommercial banks are also called joint stock banks because they are constituted andorganizedinthe samemanneras thejointstockcompaniesareconstituted. IndustrialBanks: The Industrial banks are those banks which provide medium term and long termfinance to the industries for the purchase of land and building, plant and machinery andotherindustrialequipment.Theyalsounderwritethesharesanddebenturesoftheindustries and also subscribe to them. The main functions of an Industrial Banks are asfollows:  Theyprovidelongtermfinancetotheindustriestopurchaselandandbuildings,plantandmachin eryandconstructionoffactorybuildings.  Theyalsoacceptlongtermdeposits.  Theyunderwritethesharesanddebenturesoftheindustryandsometimessubscribetothem. In India there are number of financial institutions which perform the function of anIndustrialBank. Majorfinancialinstitutionsareasunder:-  IndustrialDevelopmentBankofIndia(IDBI)  IndustrialFinanceCorporationofIndia(IFCI)  IndustrialCreditandInvestmentCorporationofIndia(ICICI)and  StateIndustrialDevelopmentCorporationsuchasHaryanaStateIndustrialDevelopmentCorpo ration(HSIDC) AgricultureBanks: The needs of agricultural credit are different from that of industry, business, tradeandcommerce.Commercialbanksandindustrialbanksdonotdealwith agriculturecreditfinancing.An agriculturisthasbothtypeofneeds:  He requires short term credit to purchase seeds, fertilizers and other inputsand  Healsorequireslongtermcredittopurchaseland,tomakepermanentimprovementonland,topur chaseagriculturalmachineryandequipmentsuchastractorsetc. AgriculturalcreditisgenerallyprovidedinIndiabytheCooperativeinstitutions.TheCooperativ eAgriculturalCreditInstitutionsaredividedintotwocategories:- A. Shorttermagriculturalcreditinstitutionsand B. Longtermagriculturalcreditinstitutions A. Shorttermagriculturalcreditinstitutions Theshorttermagriculturalcreditinstitutionscatertotheshorttermfinancialneedsoftheagricult uristswhichhavethefollowingthreetierfederalstructure:- AttheVillagelevel : PrimaryAgriculturalCreditSocieties AttheDistrictlevel : CentralCooperativeBanks AttheStatelevel : StateCooperativeBanks B. Longtermagriculturalcreditinstitutions 124 CU IDOL SELF LEARNING MATERIAL (SLM)

 The long term agricultural credit is provided by the Land Development BankswhichwereearlierknownasLandMortgageBanks.Thelanddevelopmentbanksprovidelongt ermtoagriculturistsforaperiodrangingfrom5yearsto25years. ExchangeBanks Theexchangebanksarethosebankswhichdealinforeignexchangeandspecialisedinfinancingthefo reigntrade.Therefore,theyarealsocalledforeignexchange banks. Foreign Exchange Banks are those banks which are set up in a foreigncountry with their control and management in the hands of head office in their country oforiginbuthavingbusinessbranchesinIndia. CentralBank The Central Bank is the apex bank of a country which controls, regulates andsupervises the banking, monetary and credit system of the country. The Central Bank isownedandcontrolledbytheGovernmentofthecountry.TheRBIis theCentralBankinIndia.Theimportantfunctionsareasfollows:-  ItactsasbankertotheGovernmentofthecountry.  ItalsoactsasagentandfinancialadvisortotheGovernmentofthecountry.  Ithasthemonopolytoissuecurrencyofthecountry.  Itservesasthelenderofthelastresort.  Itactsastheclearinghouseandkeepscashreservesofcommercialbanks. 8.4 FUNCTIONSOFCOMMERCIALBANKS The Commercial Banks perform a variety of functions which can be divided in thefollowingthreecategories: 1. Basic Functions 2. AgencyFunctions 3. GeneralUtilityFunctions 1.BasicFunctions The basic functions of bank are those functions without performing which aninstitution cannot be called a banking institution at all. That is why these functions arealso called primary or acid test function of a bank. The basic/primary/acid test function ofabankare:-  AcceptingDeposits,  AdvancingofLoans and  CreditCreation AcceptingDeposits Thefirstandthemostimportantfunctionofabankistoacceptdepositsfromthose people who can save and spare for the safe custody with the bankers. It serves twopurposes for the customers. On one hand their money is safe with the bank without anyfear of theft and on the other hand they also earn interest as per the kind of saving theyhave made. For this purpose the banks have different kinds of deposit accounts to attractthepeoplewhichareasunder;- 125 CU IDOL SELF LEARNING MATERIAL (SLM)

  SavingDepositAccount  FixedDeposit Account  CurrentDepositAccount  RecurringDepositAccount  HomeLoanAccount SavingDepositAccount The Saving Bank Account is the most common bank account being utilized by thegeneral public. The basic purpose of this account is to mobilise the small savings of thegeneral public. Certain restrictions are imposed on the depositors regarding the number ofwithdrawals and amount to be withdrawn in a given period of time. Generally the rate ofinterest paid by the bank on these deposits is low as compared to recurring or fixeddepositaccount. Cheque facility is also provided to the depositors with certain extra restrictions onthe depositors. One of the conditions is that the depositor shall have to maintain aminimum balance in the account say Rs.500 which is otherwise very low in the case ofaccount without the facility of the cheque book, say Rs.20 only. Some service charges arealsoimposedifthedepositorusesthechequefacilityatlargelevels. FixedDepositAccount Thisisanaccountwheremoneycanbedepositedforafixedperiodoftimesayone year or two years or three years of five years and so on. Once the money is depositedfor a fixed period of time, the depositor is prohibited from withdrawal of money from thebankbeforetheexpiryofthestipulatedperiodoftime.Thebasicadvantagetobecustomer is that he is offered interest at the higher rate of interest and the banker is free toutilizethemoneyforthatfixedperiod. But where a customer is in need of money in any contingency or emergency, thebank also has the facility to provide loan against the fixed deposit receipt at liberal termsandconditions.Evenifacustomerinsistonthewithdrawalofhismoneythefixeddepositreceipt canalsobeencashedbeforetheexpiryofthestipulatedperiodoftimewiththeconditionthatthecustom ershallnotbe entitledtohigherrateofinterest,butthecustomer is allowed that rate of interest which is applicable on the saving deposit accountasiftheamountwasdepositedinthesavingsaccount. CurrentDepositAccount In the savings bank account there are restrictions on the number of withdrawalsthat can be made in a day or a week or a month. Therefore it does not suit to the needs oftradersandbusinessmenwhohastomakeseveralpaymentsdailyanddepositsmoneyina similar manner. Therefore, there is a facility for them in the shape of another accountcalled Current Deposit Account. These accounts are generally maintained by the tradersand businessmen who have to make a number of payments every day. Money from thisaccountcanbewithdrawnbytheaccountholderasmanytimesasdesiredbythecustomer. 126 CU IDOL SELF LEARNING MATERIAL (SLM)

 Normally bank does not pay any interest on these current accounts, rather someincidental charges are charged by the banker as service charges. These accounts are alsocalleddemanddepositsordemandliabilities. ThefacilityofOverDraftsisprovidedtothetradersthroughthesecurrentaccounts for which the banks charge interest on the outstanding balance of the customers.A limit is fixed by the bankers for withdrawal of over drafts and the customer is notallowedtowithdrawmorethanthatlimitfromhisO/Dcurrentaccount.Sayifatraderhas an O/D limit of Rs.1,00,000 with a bank, he can withdraw money upto Rs.1,00,000fromthebankwithoutdepositinganymoneywiththebank.Buthecannotwithdrawmore thanRs.1,00,000.Heshallhavetopayinterestonsuchwithdrawals. RecurringDepositAccount To encourage regular savings by the general public, another account is opened inthe banks called Recurring Deposit Account. This account is preferred by the fixedincome group, because a particular amount fixed at the time of opening the account has tobe deposited in the account every month for a stipulated period of time. Say Rs.500 permonth for a period of three years. In this case the customer is bound to deposit Rs.500 permonthregularlyforaperiodofthreeyears.Generallythebankpaysrateofinteresthigher than that of a saving account and just equal to the fixed deposit account on suchrecurringdepositaccounts. The withdrawal of money is allowed only after the stipulated period of time alongwith the interest. Rather the account stands closed at the end of the stipulated period oftime. In this case also the bank provide a facility to withdraw the money before thestipulated period of time in the case of any emergency. The bank shall allow rate ofinterest which is applicable on saving bank account in case the customer want to close theaccountbeforethenstipulatedperiodoftime. HomeLoanAccount Home loan account facility has been introduced in some scheduled commercialbankstoencouragesavingsforthepurchasingoforconstructionofahousetolive.Inthis account the customer is required to deposit a particular amount per month or halfyearly or even yearly for a period of five years. After the stipulated period bank providethree to five times of the deposited amount a loan to the subscribers to purchase orconstruct a house. Rate of interest is also very attractive on this account nearly equal tothat of the fixed deposit account. Even the rebate of Income Tax is also available on theamount contributed in this account under Section 88 of the Income Tax Act, 1961.Facilitytoclosetheaccountafterthestipulatedperiodoftimeisalsoallowed. AdvancingofLoans: Advancing of loans is the second acid test function of the commercial banks. Afterkeeping certain cash reserves, the banks lend their deposits to the needy borrowers. It isone of the primary functions without which an institution can not be called a bank. Thebanklendsacertainpercentageofthecashlyinginthedepositsonahigherrateofinterest than it 127 CU IDOL SELF LEARNING MATERIAL (SLM)

 pays on such deposits. The longer the period for which the loan is requiredthe higher is the rate of interest. Similarly higher the amount of loan, the higher shall bethe rate of interest. Before advancing the loans the bank satisfy themselves about thecreditworthinessoftheborrowers.Thisishowabankearnsprofitsandcarriesonitsbanking business. There are various types of loans which are provided by the banks to theborrowers.Someoftheimportantwaysofadvancingloansareasunder:- (i) CallMoneyAdvances (ii) CashCredits (iii)Overdrafts (iv) DiscountingBillso fExchange (v) TermLoans i)CallMoneyAdvances The Call Money Market which is also known as inter-bank call money marketdeals with very short period loans called call loans. The Call Money Market is a veryimportant constituent of the organized money market which functions as an immediatesource of very short term loans.Themajorsuppliersofthefundsinthecallmoneymarket are All Commercial Banks, State Bank of India (SBI), Life Insurance Corporationof India (LIC), General Insurance Corporation (GIC), Unit Trust of India (UTI) andIndustrial Development Bank of India (IDBI) and the major borrowers are the scheduledCommercial Banks. No collateral securities are required against these call money marketloans. Astheparticipantsaremostlybanks,itisalsocalledinter-bankcallmoneymarket. The Scheduled Commercial Banks use their surplus funds to lend for very shortperiod to the bill brokers. The bill brokers and dealers in the stock exchanges generallyborrow money at call from the commercial banks. The bill brokers in turn use them todiscount or purchase the bills. Such funds are borrowed at the call rate which varies withthe volume of funds lent by the commercial banks. When the brokers are asked to pay offthe loans immediately, then they borrow from SBI, LIC, GIC, and UTI etc. These loansare granted by the commercial banks for a very short period, not exceeding seven days inany case. The borrowers have to repay the loan immediately when ever the lender bankcallthemback. ii)CashCredits This is a type of loan which is provided to thy businessmen against their currentassetssuchasshares,stocks,bondsetc.Theseloansarenotbasedoncreditworthinessor personal security of the customers. The bank provides this loan through opening anaccount in the name of the customer and allows them to withdraw borrowed amount ofloan from time to time upto the limit fixed by the bank which is determined by the valueof security provided by the borrowers. Interest is charge only on the amount of moneyactually withdrawn from the banks and not on the amount of the sanctioned amount ofloan. Insomeothercasescertainbanksfollowadifferentprocedureforcashcredits.The whole amount of loan is credited to the current account of the borrower. In case ofnew customer a separate account is opened and amount of loan is transferred to it. Theborrower is free to withdraw the 128 CU IDOL SELF LEARNING MATERIAL (SLM)

 money through cheques as and when required by theborrower. But in this case the borrower has to pay the interest on the whole amountcreditedintheiraccounts. iii)Overdrafts The facility of Over Drafts is provided to the traders and businessmen throughcurrent accounts for which the banks charge interest on the outstanding balance of thecustomers. A limit is fixed by the bankers for withdrawal of over drafts and the customeris not allowed to withdraw more than that limit from his Over Draft Current Account.Thisfacilityisrequiredbythetradersandbusinessmenbecausetheyissueseveralcheques in a day and similarly deposits so many cheques daily in their current accounts.Theymaynotbeknowingataparticulardaythatwhetherthereisabalanceintheaccount or not and their issued cheques are not dishonored so they are provided with thefacility of overdrafts. Say it a trader has an Over Draft limit of Rs.2,00,000 with a bank,hecanwithdrawmoneyuptoRs.2,00,000fromthebankwithoutdepositinganymoneywiththeb ank.ButhecannotwithdrawmorethanRs.2,00,000.Heshallhavetopayinterestonsuchwithdrawals. iv)DiscountingBillsofExchange This is another popular type of lending by the commercial banks. A holder of a billof exchange can get it discounted with a commercial bank. Bills of Exchange are alsocalledtheCommercialBillsandthemarketdealingwiththesebillsisalsocalledcommercialbillm arket.Billsofexchangearethosebillswhichareissuedbythebusinessmen or firms in exchange of goods sold or purchased. The bill of exchange is awritten unconditional order signed by the drawer (seller) requiring the drawee (buyer) topayondemandoratafixedfuturedate,(usuallythreemonthsafterdatewrittenonthebill of exchange), a definite sum of money. After the bill has been drawn by the drawer(seller), it is accepted by the drawee (buyer) by countersigning the bill. Once the buyerputs his acceptance on the bill by signing it, it becomes a legal document. They are likepost dated cheques issued by the buyers of goods for the goods received. The bill holdercan get this bill discounted in the bill market if he wants the amount of the bill before itsactualmaturity.Thesebillsofexchangearediscountedandre-discountedbythecommercial banks for lending credit to the bill brokers or for borrowing from the centralbank. The bill of exchange market is not properly developed in India. The Reserve Bankof India introduced the bill market scheme in 1952. Its main aim was to provide financeagainst bills of exchange for 90 days. The scheduled commercial banks were allowed toconvertapartoftheiradvancesintopromissorynotesfor90daysforlodgingascollateralsecurityfor advancesfromReserveBankofIndia. v)TermLoan Earlierthecommercialbankswereadvancingonlyshorttermloans.Thecommercialbankshavealsos tartedadvancingmediumtermandlongtermloans.Nowthematurityperiodoftermloansismorethan oneyear.Theamountoftheloansanctioned is either paid to the borrower or it is credited to the account of the borrower 129 CU IDOL SELF LEARNING MATERIAL (SLM)

 inthebank.Theinterestischargedonthewholeamountofloansanctionedirrespectiveoftheamountw ithdrawnbytheborrowerfromhisaccount.Repaymentoftheloanisacceptedinlumpsumorintheinst allments. C. CreditCreation: Credit Creation is one of the basic functions of a commercial bank. A bank differfrom the other financial institutions because it can create credit. Like other financialinstitutions the commercial banks also aim at earning profits. For this purpose they acceptdepositsandadvanceloansbykeepingasmallcashinreserveforday-to-daytransactions. In the layman’s language when a bank advances a loan, the bank createscredit or deposit. Every bank loan creates an equivalent deposit in the bank. Therefore thecreditcreationmeansmultipleexpansionofbankdeposits.Thewordcreationreferstotheabilityof thebanktoexpanddepositsasamultipleofitsreserves. The credit creation refers to the unique power of the banks to multiply loans andadvances, the hence deposits. With a little cash in hand, the banks can create additionalpurchasing power to a considerable extent. It is because of this multiple credit creationpower that the commercial banks have been named the “factories of creating credit” ormanufacturersofmoney. 2.AgencyFunctions The commercial banks also perform certain agency functions for and on behalf oftheir customers. The bank acts as the agent of the customer while performing thesefunctions. Such services of the banks are called agency services. Some of the importantagencyservicesareasunder:-  Remittance of funds  Collection and Payment of Credit Instruments  Execution of Standing Orders  Purchase and Sale of Securities  Collection of dividends on shares and interest on debentures  Trustees and Executors of wills  Representation and Correspondence Remittanceoffunds: Commercial banks provide a safe remittance of funds of their customers from oneplacetoanotherthroughcheques,bankdrafts,telephonetransfersetc. CollectionandPaymentofCreditInstruments: The commercial banks used to collect and pay various negotiable instruments likecheques,billsofexchange,promissorynotes,hundis,etc. ExecutionofStandingOrders: The commercial banks also execute the standing orders and instruments of theircustomersformakingvariousperiodicpaymentslikesubscriptions,rents,insurancepremiumsa ndfeesonbehalfofthecustomersoutoftheaccountsoftheircustomers. PurchaseandSaleofSecurities: 130 CU IDOL SELF LEARNING MATERIAL (SLM)

 The commercial banks also undertake the sale and purchase of securities likeshares, stocks, bonds, debentures etc., on behalf of their customers performing thefunctionasabrokeragent. Collectionofdividendsonsharesandinterestondebentures: Commercial banks also make collection of dividends announces by the companiesof which the customer of the bank is a shareholder, and also collects the interest onthe debentures which becomes due on particular dates generally half yearly orannually. TrusteesandExecutorsofwills: The commercial banks preserves the wills of their customers as their trustees andexecutethewillsafterthedeathofthecustomerasperthewillastheexecutors. RepresentationandCorrespondence: The commercial banks also act as the representative and correspondents of theircustomers and get passports, traveler’s tickets, book vehicles and plots for theircustomersonthe directionsofthecustomers. 3.GeneralUtilityFunctions In addition to basic functions and agency functions the commercial banks alsoprovide general utility services for their customers which are needed in the various walksof life and the commercial banks provide a helping hand in solving the general problemsof the customers, like safety from loss or theft and so many other facilities some them areasunder:-  LockerFacility  Traveler’sChequeFacility  GiftChequeFacility  LetterofCredit  UnderwritingContract  ProvidesStatisticalData  ForeignExchangeFacilities  MerchantBankingServices  ActingasReferee LockerFacility: The commercial banks provide locker facility to its customers at very reasonablechargeswhichisnotpossibleatthepremisesofthecustomers.Thecustomerscanavailthef acilityoflockersindifferentsizesaccordingtotheneedsofthecustomers.Thelockerchargesalsovari eswiththesizeofthelockers.Thecustomerscankeeptheirvaluablesintheandimportantdocumentsin theselockers for safety. Lockers can be operated in the usual business hour of the bankonallworkingdays. Traveller’sChequeFacility: Where a customers want to visit long distant places and also need money, theyneed not carry the money with them which is not safe during long distant journeysandthereisalwaysafearoflossortheft during the journey. The commercialbanks provide a unique facility through traveler’s cheque. The customers can gettraveler’s cheques 131 CU IDOL SELF LEARNING MATERIAL (SLM)

 from the banks and travel without the fear of theft or loss ofmoney. Wherever they need money they can approach the branch of the bank inthatcityandencashthetraveler’schequeaccordingtotheneed. GiftChequeFacility: Some commercial banks also provide the facility of issuing gift cheques in thedenomination of different amounts according to the needs of the customers, sayRs.11,21,51,101,501andsoon.Thisfacilityisprovidedforthespecialoccasions for the customers and normally the banks do not charge any thing forissuingthesegiftcheques. LetterofCredit: The commercial banks also help their customers by providing another uniqueservice by providing the letter of credit in which the bank certifies the creditworthiness of the customers. These letters of credit are used in the long distanttrade and specially in foreign trade where the parties do not know each other and itis bank which provide the safety to them regarding their credit worthiness byissuingletterofcredit. UnderwritingContract: The commercial banks underwrite the securities issued by the public or privatecompanies and Government securities. It is the reputation of the bank whichmatters in the underwriting contracts. Where the bank is a very reputed one, theinvestorsshallnothaveanyhesitationininvestingthemoneyinwhichtheirbanker is the underwriter. In case the public do not purchase the securities, it is theunderwriting bank which has to purchase the securities upto the amount of whichthebankhasunderwritten. ProvidesStatisticalData: The commercial banks also help their customers by providing them importantinformation through statistical data. Commercial banks collect statistical data inwhich important information relating to industry, trade, commerce, money andbankingiscollectedandpublishedintheirjournalsandbulletinscontainingresearcharticlesonth eeconomicandfinancialmatters.Suchstatisticaldatamaybeusefulforthecustomersindealingwitht heirownbusiness,tradeorcommerce. ForeignExchangeFacilities: Thecommercialbanksalsodealsinthebusinessofforeigncurrencies.Thesebanks provide foreign exchange and also discount the foreign bills of exchange.Somecommercialbankshavealsoopenedspecialbranchesfortheforeignexchangeservic estothenon-residentIndianssettledabroad. MerchantBankingServices: Thecommercialbankshavealsostartedprovidingmerchantbankingfacilities.TheBankingCommi ssionReport,1972emphasisedtheneedofcreatingspecialisedinstitutionstocaterfinancialrequirem entsofdifferentsectorsexclusively and examined the need of setting up merchant banking institutions.Commissionrecommendedthesettingupofmerchantbankinginstitution. 132 CU IDOL SELF LEARNING MATERIAL (SLM)

 Consequently in 1972 itself State Bank of India started its merchant bankingdivision. Since then a number of other commercial banks and financial institutionsstarted their merchant banking divisions. Now the merchant banking firms inprivate sector have started gearing up to meet the challenge posed by commercialbanksandfinancialinstitutionsinthefieldofmerchantbankinginIndia. ActingasReferee: Thecommercialbanksarethebestsourceofseekinginformationaboutthecreditworthiness of the customers. Banks may be referred for seeking informationregardingcreditworthiness,financialposition,businessreputationandrespectabilityof theircustomers. 8.5 NATURE OR CHARACTERISTICS OF INSURANCE Thefollowingarethecharacteristicsofinsurance: 1. Sharing of risks : Insurance is a cooperative device to share the burden of riskwhich may fall on happening of some unforeseen events, such as the death of head of thefamily,oronhappeningormarineperilsorlossofbyfire. 2. Cooperative device : Insurance is a cooperative form of distributing a certain riskover a group of persons who are exposed to it. A large number of persons share the lossesarisingfromaparticularrisk. 3. Evaluation of risk : For the purpose of ascertaining the insurance premium, thevolumeofriskisevaluated,whichformsthebasisofinsurancecontract. 4. Payment on happening of specified event : On happening of specified event, theinsurance company is bound to make payment to the insured. Happening of the specifiedevent is certain in life insurance; but in the case of fire, marine or accidental insurance, itisnotnecessary.Insuchcases,theinsurerisnotliableforpaymentofindemnity. 5. Amount of Payment : The amount of payment in indemnity insurance dependson the nature of losses occurred, subject to a maximum of the sum insured. In lifeinsurance, however, a fixed amount is paid on the happening of some uncertain event oronthematurityofthepolicy. 6. Large number of insured person : The success of insurance business dependson the large number of persons insured against similar risk. This will enable the insurer tospreadthelossesofriskamonglargenumberofpersons,thuskeepingthepremiumrateatthemi nimum. 7. Insurance is not a gambling :Insurance is not a gambling. Gambling is illegalwhich gives gain to one party and loss to the other. Insurance is a valid contract toindemnity against losses. Moreover, insurable interest is present in insurance contractsandithastheelementofinvestmentalso. 8. Insurance is not charity :Charity pays without consideration but in the case ofinsurance,premiumispaidbytheinsuredtotheinsurerinconsiderationoffuturepayment. 9. Protection against risks :Insurance provides protection against risks involved 133 CU IDOL SELF LEARNING MATERIAL (SLM)

 inlife,materialsandproperty.Itisadevicetoavoidorreducerisks. 10. Spreading of risks : Insurance is a plan which spreads the risks and losses of fewpeople among a large number of people. John Magee writes, “Insurance is a plan bywhich a large number of people associate themselves and transfer to the shoulders of all,risksattachedtoindividuals”. 11. Transfer of risk : Insurance is a plan in which the insured transfers his risk on theinsurer. this may be the reason that Mayerson observes, that insuranceis a device ottransfer some economic losses to the insurer, otherwise such losses would have beenbornebytheinsuredsthemselves. 12. Ascertaining of losses :By taking a life insurance policy, one can ascertain hisfuture losses in terms of money. This is done by the insurer to determining the rate ofpremium;whichis calculatedonthebasisofmaximumrisks. 13. A contract :Insurance is a legal contract between the insurer and insured underwhich the insurer promises to compensate the insured financially within the scope ofinsurancepolicy,andtheinsuredpromisestopayafixedrateofpremiumtotheinsurer. 14. Baseduponcertainprinciple:Insuranceisacontractbaseduponcertainfundamental principles of insurance which includes, utmost good faith, insurable interest,contribution,indemnity,causaproxima,subrogation,etc.whicharethebasisforsucces sfuloperation of insuranceplan. 15. Institutionalsetup:Afternationalization,theinsurancebusinessinthecountryisoperatingund erstatutoryorganizationalsetup.InIndia,theLifeInsuranceCorporation, the General Insurance Corporation and its subsidiary companies, and privateplayersareoperatinginthevariousfieldsofinsurance. 16. Insurance for pure risks only :Pure risks give only losses to the insured, and noprofits.Examplesofpurerisksare–accident,misfortune,death,fire,injuryetc.whichare all one-sided risks and the ultimate result in loss. Insurance companies issue policiesagainst pure risks only, not against speculative risks. Speculative risks have chances ofprofitsoflosses. 17. Social device :Insurance is a plan of social welfare and protection of interests ofthepeopleandMillerobserve,“Insuranceisofsocialnature.” 18. Based on mutual good-faith :Insuranceis a contract based on good faithbetween the parties. Therefore, both the parties are bound to disclose the important factsaffecting to the contract before each other. Utmost good faith is one of the importantprinciplesofinsurance. 19. Regulation under the law :The government of every country enacts the lawgoverning insurance business so as to regulate and control its activities for the interest ofthe people. In India the Life Insurance Act 1956 and General Insurance (Nationalisation)Act 1972 and Insurance Regulatory and Development Authority Act 1999 are the majorenactmentsinthisdirection. 20. Wider scope : The scope of insurance is much wider and extensive. Various typesof 134 CU IDOL SELF LEARNING MATERIAL (SLM)

 policies have been developed in the country against risks on life, fire, marine, accident,theft,burglaryetc. To conclude, insurance is a device for the transfer of risks from the insureds toinsurers, who agree to it for a consideration (known as premium), and promises that thespecifiedextentoflosssufferedbytheinsuredsshallbecompensated.Itisalegalcontractofate chnicalnature. 8.6 FUNCTIONS OF INSURANCE Thefunctionsofinsurancemaybecategorizedasbelow: I. PrimaryFunctions II. SecondaryFunctions III. OtherFunctions I. PrimaryFunctions: Theprimaryfunctionsofinsuranceincludethefollowing: Provide protection :The primary purpose of insurance is to provide protectionagainst future risk, accidents, and uncertainty. Insurance cannot check the happending ofthe risk, but can certainly provide for the losses of risk. Professor Hopkins observes,“Insurance is a protection against economic loss by sharing the risk with others.” Hefurtheradd“Insuranceistheprotectionagainsteconomicloss.” Collective bearing of risk :Insurance is a device to share the financial loss of fewamong many others. Dinsdale opines, insurance is a mean by which few losses are sharesamong longer people. Similarly, William Beveridge observes, “The collective bearing ofrisks is insurance.” All the insureds contribute the premiums towards a fund and out ofwhichthepersonsexposedtoaparticularriskispaid.Similarly,RigelandMillerobserve,“Insuranc eisadevicewherebytheuncertainriskmaybemademorecertain.” Evaluationofrisk:Insurancedeterminestheprobablevolumeofriskbyevaluating various factors that give rise to risk. Risk is the basis for determining thepremiumratealso. Provide certainty against risk :Insurance is a device which helps to change fromuncertainty to certainty. This may the reason that John Magee writes that the function ofinsurance is to provide certainty. Similarly, Riegel and Miller observe, “The function ofinsuranceisprimarilytodecreasetheuncertaintyofevents.” Spreading risks :Professor Thomas has correctly written that “Insurance is thedeviceforspreadingordistributingrisks.” II. SecondaryFunctions Prevention of losses :Insurance cautions individuals and businessmen to adoptsuitable device to prevent unfortunate consequences of risk by observing safetyinstructions; installation of automatic sparkler or alarm systems, etc. Prevention oflosses cause lesser payment to the assured by the insurer and this will encouragefor more savings by way of premium. Reduced rate of premiums stimulate 135 CU IDOL SELF LEARNING MATERIAL (SLM)

 formorebusinessandbetterprotectiontotheinsureds.TheLossPreventionAssociationofIndiaform edbytheinsurers,alertsthepeopleaboutfuturerisksanduncertaintiesthroughpublicitymeasures. Small capital to cover larger risks :Dinsdale observes, insurance relives thebusinessmen and others from security investments, by paying small amount ofpremium against larger risk and uncertainty. There is no need for them to investseparatelyforsecuritypurposeandthismoneycanbeinvestedinotheractivities. Contributestowardsthedevelopmentoflargerenterprises:Insuranceprovides development opportunity to those larger enterprises having more risks intheir setting up. Even the financial institutions may be prepared to give credit tosickindustrialunitswhichhaveinsuredtheirassetsincludingplantandmachinery. III.OtherFunctions Thereareindirectfunctionsofinsurancewhichbenefittheeconomyindirectly. Someofsuchfunctionsare: 1. Means of savings and investment :Insurance serves as savings and investment.Insurance is a compulsory way of savings and it restricts the unnecessary expensesby the insureds. For the purpose of availing income-tax exemptions also, peopleinvestininsurance.InthewordsofMagee“Althoughinvestmentisnottheprimary function of insurance. Investment service is proved to be an importantbenefitofinsurance. 2. Source of earning foreign exchange :Insurance is an international business. Thecountrycanearnforeignexchangebywayofissueofmarineinsurancepolicies. 3. Promotes exports :Insurance makes the foreign trade risk free through differenttypes of policies issued under marine insurance cover. In case of loss of cargo andothersduetomarineperilstheinsurancecompanymakesgoodtheloss. 4. Provides social security :Through various social protection plans, the insuranceprovides social security to people. It not only provide security at the time of deathbutalsoprovidesassistancetotheinsuredsatthetimeofsickness,oldage,maternityetc. 8.7 LIMITATIONS OF INSURANCE Inspiteofnumberofadvantagesofinsurance,ithascertainlimitations.Onaccount of such limitations, the benefits of insurance could not be availed in full. Theselimitationsare: 1. All the risk cannot be insured :All the risk cannot be insured; only pure riskscanbeinsured,andspeculativerisksrenotinsurable. 2. Insurable interest (financial interest) on the subject matter :Insurance ispossible only when the insured has insurable interest in the subject matter ofinsurance either at the time of insurance or at the time of loss, or at both the times;intheabsenceofwhichthecontractofinsurancebecomesvoid. 3. Impossibility of measurement of real loss : In case the loss arisen from thehappening of the event cannot be valued in terms of money, such risks are notinsurable. 4. Not possible to insure the risk covered by a single individual or a small group:Insurance against the risk of a single individual or a small group of persons are 136 CU IDOL SELF LEARNING MATERIAL (SLM)

 notadvisablesinceitisnotpracticableduetohighercostinvolved. 5. Higher premium rates :Another important limitation is that the premium ratesare higher in our country and as such, certain category of people cannot avail theadvantage of insurance. The main reason for the higher rate of premiums is thehigheroperatingcost. 6. Moral hazards :It becomes difficult to control moral hazards in insurance. Thereare certain people who misutilize the insurance plans for their self-interest byclaimingfalseclaimsfrominsurancecompanies. 7. Certain rights cannot be insured by private insurers :The private insurers arenotpermittedtoinsurecertainspecifiedtypesofriskslikeunemploymentinsurance,bankruptc yofbanksinsurance,etc 8. Unattractive investment :Insurance is not a profitable investment. Its mainobject is to provide security against risks. Insurance business cannot be a source toacquireprofits. 9. In certain cases cooperation of government is necessary :Certain specifiedriskscanbeinsuredwithcooperationofthegovernmentonly;suchasunemploymentins urance,insolvencyofbanks,foodinsurance,etc. 10. All the pure risks are not insured :All the pure risks are not insured by theinsurer. Even if does with higher rate of premium only. For example, insurer doesnot take any interest to accept a proposal of a person whose heart surgery has gonethrough. 8.8 PRINCIPLESOFINSURANCE A contract of insurance like any other contract must possess all the essentialelementsofacontract,e.g.existenceofanagreement,freeconsentofparties,competence of parties to enter into an agreement, lawful consideration, etc. In addition tothese,thefollowingrequirements(principles)aremostessentialforacontractofinsurancetobevali d: 1.Good Faith :The legal maxim caveat emptor (let the buyer beware) prevails inordinary business contracts. However, the insurance contracts are an exception to the saidprincipleofcaveatemptor.A contract of insurance is a contract uberimaefidei (i.e. based on absolute goodfaith). It means that the insured must disclose all material facts concerning the subjectmatter of the insurance. If a material fact is not disclosed or if there is misrepresentationor fraud, it shall render the contract voidable at the option of the insurer. What is amaterial fact depends on the circumstances of each individual case. Hence it is a questionof fact and not a question of law. It is for the law court to decide whether there has or hasnot been a failure to disclose material facts. Generally speaking, a material fact is onewhich the insurer shall take into account while considering whether to accept the risk ornot to accept the risk. Further the fact is also material if it has a bearing on the amount ofpremium which the insurer will charge. It is important to remember that the onus of proofof concealment lies on the insurer. Further, the doctrine of good faith is not one-sided.Like the insured, the insurer is duty bound to disclose such material facts as are within hisknowledgeorthatofhisagents.Forexample,hemustdrawattentiontoanyrestrictionsinhispolicy. 137 CU IDOL SELF LEARNING MATERIAL (SLM)

 2.Indemnity :Life insurance is a contingent contract, i.e. the money becomespayable on the happening of an agreed event, e.g. in endowment policy the agreed sumbecomes payable after a certain specified period of time or death whichever is earlier.Hence,theagreedsumbecomespayablesoonerorlater. Otherformsofinsurance(e.g.fireormarine)arenotcontingentcontracts.Theyare contracts of indemnity. The insurer in these cases promises to indemnify the insuredperson for what he actually losses on account of some mischance or misfortune. “Thecontract of insurance contained in a marine or fire policy is a contract of indemnity and ofindemnity only, and that this contract means that the assured, in case of a loss againstwhich the policy has been made, shall be fully indemnified but shall never be more thanfullyindemnified”. The considerations of public interest also dictate that the insured must not getanything more than the actual loss since otherwise the assured may be under constanttemptationtodestroyhispropertyandcommitacertainsocialact.Evenincaseofover- insurance (i.e. where policy is taken for a sum more than the real value of the property),theassuredisentitledtoonlyactualloss. 3.Subrogation :According to the principle of subrogation, the insurer becomesentitled to all the rights of the ensured as regards the subject matter of insurance. TheprinciplehasbeenexpressedinanAmericancaseinthefollowingwords: “Subrogation is the substitution of one person in place of another,whether as a creditor or as the possessor of any other rightfulclaim, so that he who is substituted succeeds to the rights of theotherinrelationtotheclaim,itsrightsremedies,orsecurities”. The insured may have the rights against the third party on account of negligence ofthe third party or on account of some mischief of the third party or on account of anagreementbetweentheinsuredorthirdpartyetc. Thefollowingessentialcharacteristicsofthedoctrineofsubrogationdeserveconsideration:  ContractsofLifeandPersonalAccidentInsurance:Thedoctrineofsubrogation applies only to contracts of indemnity (i.e. contracts of fire and marineinsurance) since the principle is in itself a mere corollary of the ‘doctrine ofindemnity’. It does not apply to contracts of life and personal accident insurance.Hence, the legal representative can get the insured sum from the insurance as wellasthedamages,ifany,fromthethirdparty.  Payment of the whole loss :The ‘doctrine of subrogation’ applies only uponpayment of the whole loss by the insurer to the insured. In case of partial loss, theprinciple does not apply. However, the express provision may entitle the insurer toexercise his right of subrogation even before the payment has been made to theinsured.  The insured to surrender all his rights claims and remedies in favour ofinsurers:Uponpaymentofthewholelossbyinsurerstotheinsured,theinsurersshall step into the shoes of the insured and shall avail themselves of all the rights-claims and remedies which the insured hadagainst the third party/parties. If theinsured himself receives compensation for the loss from the third party after he hasbeen indemnified by his insurer, he holds that further compensation as a trustee 138 CU IDOL SELF LEARNING MATERIAL (SLM)

 forhisinsurer,totheextentthatthelatteris entitledto.  Insurer entitled to benefit only to the extent of his payment :The insurer is, byvirtue of subrogation, entitled to rights, claims and remedies only to the extent ofhis payment. It has been made quite clear in a U.S. case according to which if theinsurer, upon payment of the claim to the insured, recovers from the defaultingthirdpartymorethantheamountpaidunderthepolicy,hehastopaythisexcessto the insured, though he may charge the insured his share of reasonable expensesincurredin collectingthemoney.  The insured to provide facility to the insurer :Any action taken by the insureragainst the third party is usually in the name of the assured. However, the cost ofany action taken is borne by the insurer. The insured is duty bound to give to theinsurerallsuchreasonablefacilitiesasthelattermayrequireinenforcinghisrightsagainstthet hirdparties.  The insurer entitled to only such rights as are available to the insured :Theinsurer shall be entitled to only such rights as are available to the insured. Hecannotacquirebetterrightsagainstthepartiesatfaultthanwhattheinsurerhimselfwouldhave had. 4.Insurable Interest :The assured must possess an ‘insurable interest’ in thesubject matter of insurance. For an insurance contract to be valid, ‘Insurable Interest’ isthe legal right to insure. The legal right to insure is measured in terms of money and vestsin a person to whom the law recognizes as a person who is interested in the preservationof a thing or the continuance of a life. Mere mutual love and affection is not considered inlawassufficienttoaninsurableinterestforpurposesofobtaininganinsurancecover. Acontract of insurance without an insurable interest is a wagering agreement and is void.‘Insurableinterest’indifferenttypesofinsurancesisdiscussedbelow. Someoftheinstanceswhereapersonhasaninsurableinterestinthelifeofanotherareasfollows: 1. A son may insure his father’s life on whom he is dependent. Similarly, thefather can take an insurance policy on his son’s life when he is dependent onhim.Thesumrecoverableunderalifepolicyislimitedtotheamountorvalue of the insured’s insurable interest in the life insured at the date of thepolicy. 2. Acreditorcantakeaninsuranceonthelifeofhisdebtoronlyuptotheamount of his debt plus some additional charges on account of premiums andinterest. 3. A partner can insure the life of another partner to the extent of the latter’scapital only. It is because in the event of his death, it is only his share in thebusiness that needs to be paid out for running the business smoothly as far asmoneyisconcernedevenafterhisdeath. 4. An employer has also an insurable interest in the life of his contractor, acorporation has an insurable interest in the life of a senior officer during thecourseofhisemploymentinthecompanywhosedeathmightadverselyaffecttheprofitsoftheb usiness. 5. A trustee has an insurable interest with regard to interest of which he is atrustee. 139 CU IDOL SELF LEARNING MATERIAL (SLM)

 6. Aninsurerhasaninsurableinterestinthesubjectmatterofapolicy,therefore,hecangetre- insurablecover. 7. Suretyinthelifeofhisprincipaldebtorstotheextentofhisguaranteeonly. 5. CauseProxima:CausaproximaisaLatinphrasewhichmeansproximatecause(i.e.nearestcause).It meansthatwhenthelossarisesonaccountof morethanonecause,then the nearest cause is considered responsible for the loss. It is that cause which, in anatural and unbroken series of events, is responsible forloss or damage. It is the causeclosest to the result in order of effect, though not necessarily in time. Thus such a cause isproximate in efficiency. The principle of causaproxima states that to ascertain whetherthe insurer is liable for the loss or not, the proximate and not the remote cause must belookedto. If there is only one cause of damage or loss, there is no difficulty in fixing theliability of the insurer. However, usually the loss or damage arises on account of a seriesof causes. In such a case, the principle of causaproxima is applied. But too much stressmustnotbelaidontheword‘proximate’inthesenseastolosesightordestroyaltogether the idea of the cause itself. The true and over-ruling principle is to look at thecontractasawholeandtoascertainwhatthepartiestoitreallywant,whatwasthatwhich brought about the loss, the event the accident, and this is not in an artificial sense,but in the real sense which the parties to a contract have in mind, when they speak ofcauseatall. 6.Doctrine of Contribution :It is another corollary of the Doctrine of Indemnity.The insured can realize his loss from the insurance companies, in case he is having morethan one policy on the same subject matter which has been destroyed, in any order helikes. Of course, he is not permitted to recover more than the actual loss. The recovery ofloss by the insured according to his discretion usually creates inequities among differentinsurers. The doctrine of contribution ensures equitable distribution of loss as betweeninsurers. The doctrine of contribution states that insurer/insurers who has/have paid morethanhis/theirproportionatesharetotheinsuredshallhavetherighttorecovertheproportionate contribution from other insurer/insurers. For example, a person insures hishouse under two policies--with A for Rs.20,000 and with B for Rs.8,000. Now supposethelossifforRs.18,000,thecontributionshallbeasfollows: Ashall pay 20,000 ----------X18,000 =Rs.12857.00 28,000 Bshall pay 8,000 ---------X18,000 =Rs.5,143.00 28,000 Theabovediscussionrevealsthefollowingcharacteristicsofthedoctrineofcontribution:  Thesubject-matterofinsurancemustbesametoallthepolicies;  Theperilwhichisinsuredagainstmustbethesameinallthepolicies; 140 CU IDOL SELF LEARNING MATERIAL (SLM)

  Thesameinsuredmustbethereinallthepolicies;and  Allthepoliciesmustbeinforcewhenthelossoccurs. Itmay,however,bestatedthatthecontributionclauseisusuallythereinthepolicy.Thisclauselimitslia bilityoftheinsurancecompanytoitsretable proportion of the loss due to insured peril if there is any other insurance effected by or on behalf of the insured covering any of the property destroyed or damaged. This clause discourages multiple or over-insurance and thereby prevents unfair methods of competition. The doctrine of contribution like the principles of subrogation and indemnity is applicable to fire and marine policies only. 8.9 SUMMARY  A bank is an institution which deals with the money and credit in such a mannerthatitacceptsdepositsfromthepublicandmakesthesurplusfundsavailabletothosewho need them, and helps inremittingmoneyfrom one place to another safely.  Thebanks can be classified on the basis of Reserve Bank Schedule, ownership, domicile andfunctions.  The commercial banks perform basic functions, agency functions and generalutilityfunctions.  A contract of compensation for the loss or damage suffered on the occurrence of certain specified events by the insured is called insurance.  Premium is payable for the period of insurance.  An insurance contract is built on certain principles, such as good faith, insurable interest, compensation, subrogation, contribution etc.  A life insurance contract serves the purpose of protection as well as an investment contract. It is a protection contract since it gives protection to the assured in the event of death by making a payment of the entire amount of sum assured. It is an investment contract too, as it gives the assured the advantage of returning the money with interest and bonus at the end of the policy.  A contract of general insurance serves only as a protection contract and not as an investment contract, where the money paid as premium will come back to the insured, by way of claims, only on the occurrence of some specified events. 8.10KEYWORDS  Bank:Abankcollectsmoneyfromthosewhohaveittospareorwhoaresavingitoutoftheirincom es,and it lends this moneyto those whoacquire it.  ScheduledBank:AllthosebankswhichareincludedinthelistofScheduleSecondoftheReserve Bank of India are called Scheduled Bank.  PublicSectorBank:ThebankwhichisownedorcontrolledbytheGovernmentisknownaspubli c sector bank. 141 CU IDOL SELF LEARNING MATERIAL (SLM)

  CommercialBank:Commercialbankisthatbankwhichperformsallkindsofbankingbusiness andfunctionslikeacceptingdeposits,advancingloans,creditcreationandagencyfunctionsfort heircustomers.  CashCredit:Itisatypeofloanwhichisprovidedtothebusinessmanagainsttheircurrentassets.  Insurance: A contract whereby one party undertakes to compensate the other party for any lossor damage suffered by the latter, in consideration of payment of premium for a certain period oftimeis known as insurance.  Life Insurance: A contract in which the insurer undertakes to pay a certain sum of money to theinsured, either on the expiry of a specified period, or on the death of the insured, in considerationofpayment of premiumfor a certain periodof time is known as life insurance.  General Insurance: A contract whereby upon periodic payment of a sum of money calledpremium the insurer undertakes to compensate the insured in the event of any specified loss orloss suffered by the latter,is known as general insurance.  Fire Insurance: Under fire insurance, the insurance company undertakes to indemnify the losssustainedbythe insured party on account of fire accident.  MarineInsurance:Aninsurancecontractwhichcoverstherisksoflossarisingfromtheincident altomarineadventureis known as marine insurance. 8.11 LEARNING ACTIVITY 1. A partnership firm Sohan& Co., with Sohan, Mohan and Rohan as partners, maintains current account with a bank. The bank has received a notice that Sohan has been declared insolvent. At that time, the account is overdrawn to the extent of Rs.50,000. How would the bank proceed? __________________________________________________________________________ ________________________________________________________________ 2. You, as a Bank Manager, have been asked to add confirmation to an irrevocable letter of credit by the issuing bank. Describe the meaning and implication of adding confirmation through the letter of credit. ___________________________________________________________________________ _______________________________________________________________ 8.12UNIT END QUESTIONS 142 A. Descriptive Questions Short Questions 1. Defineabank.Explaintheoriginandgrowthofbankinginthemodernsense. CU IDOL SELF LEARNING MATERIAL (SLM)

 2. Define insurance and describe its main characteristics 3. Define insurable interest, discuss the importance of this principle. Long Questions 1. Whyisaninstitutioncalledabank?Whatarethedifferenttypesofabank? 2. Explainthefunctionswhichamodernbankperform. 3. “Insuranceisaprocessinwhichuncertaintiesaremadecertain.”Discussthestatementandexpl aintheimportanceofinsurance. 4. Describethevariouskindsofinsurance. 5. “Acontractofinsuranceisacontractofutmostgoodfaith.”Discuss. B. Multiple Choice Questions 1. We can open a savings bank account in the sole name of a minor if he completes age of a. 6 b. 10 c. 18 d. 21 2. The Banking Regulations Act, 1949 was enacted to a. Nationalise the banks b. Open regional rural banks c. Consolidate and amend the laws relating to banking companies d. Invite foreign banks. 3. How many copies of bank's lien are sent to the company? a. One b. Two c. Three d. Four 4. If the word irrevocable or revocable is not indicated in a letter of credit, then the credit shall be deemed as a. Revolving credit b. Standby credit c. Revocable credit d. Irrevocable credit 5. Which of the following are covered under pledge? a. Actual delivery of the goods b. Factory type pledge 143 CU IDOL SELF LEARNING MATERIAL (SLM)

 c. Constructive delivery of the goods d. All of these 6. When a debtor owes several debts to a bank and makes a payment, the right of appropriation lies with a. The banker b. The debtor c. The court d. None of these 7. The banker is obliged to honour the customer's cheque if there is mismatch in the a. Material alteration on the cheque b. Amount in the words and figures c. No signatures on the cheque d. Sufficiency of funds in the account 8. Borrower power of the company is restricted by its a. AOA b. MOA c. Prospectus d. Certificate of Registration 9. KYC means a. Know Your Company b. Know Your Compliance c. Know Your Credit d. Know Your Customer 10. A Bank can open an account in the name of the a. Partners individually b. Partners jointly c. Partnership firm d. Two or more partners 11. Insurance was developed as a result of the existence of a. hazards. b. indemnity. c. loss. d. risk. 144 CU IDOL SELF LEARNING MATERIAL (SLM)

 145 12. Legal liability does NOT arise from a. contracts. b. obligations to others. c. criminal acts. d. negligence. 13. The main purpose of insurance is to a. provide compensation. b. provide security. c. share the losses of a few people among many. d. create investment income. 14. Which of the following is NOT a contract of indemnity? a. A fire insurance policy b. A medical insurance policy c. A liability insurance policy d. A life insurance policy 15. Which of the following is NOT a hazard? a. An icy parking lot b. Poorly maintained heating systems c. A residence without a security system d. A high-crime neighbourhood 16. The largest single class of general insurance sold in Canada is a. automobile insurance. b. commercial property insurance. c. health insurance. d. personal property insurance. 17. Which of the following does NOT fall into the category of general insurance? a. Business interruption b. Crime insurance c. Hail insurance d. Health insurance 18. Inland marine insurance a. applies to real property only. b. deals with movable items only. c. includes an element of \"transportation\" or \"communication\" exposure. CU IDOL SELF LEARNING MATERIAL (SLM)

 d. is not offered under most property and casualty policies. 19. Which of the following is NOT used by insurers to achieve spread of risk? a. Diversity of location b. Diversity of type of risk c. Loss prevention d. Volume 20. The law of large numbers a. indicates the likelihood of an occurrence. b. indicates the probability of an event occurring. c. means that predictability increases with the number of cases. d. refers to the number of losses actually occurring divided by the number of losses that could have occurred. Answers 1(a) ,2(c) ,3(b) ,4(c) ,5(b) ,6(a) ,7(b) ,8(c) ,9(d),10(d) ,11(b) ,12(b) ,13(c), 14(d) ,15(b) ,16(b), 17(d), 18(c ) ,19(b) ,20(b) 8.13REFERENCES Text Books:  Bhalla, V. K.“ Management of Financial Services” Anmol Publications  Clifford Gomez “ Financial Markets, Institutions and Financial Services”, PHI Learning  Rose, Peter and Hudgins, Sylvia,“ Bank Management and Financial Services”, McGraw Hills. Reference Books:  Padamlatha ,“ Management of Banking and Financial Services”, Pearson Education.  Saunders, Antony and Cornett, Marcia,“ Financial Institutions Management: A Risk Management Approach” McGraw Hills 146 CU IDOL SELF LEARNING MATERIAL (SLM)

 UNIT – 9 CREDIT RATING STRUCTURE 9.0 Learning Objectives 9.1 Introduction 9.2 ConceptofCreditRating 9.3 Functions of Credit Rating 9.4 OriginofCreditRating 9.5 CreditRatinginIndia 9.6 BenefitsofCreditRating 9.7CautiontoUseCreditRating 9.8 RatingProcess 9.9 TypesofRating 9.10 Summary 9.11 Keywords 9.12 Learning activity 9.13Unit EndQuestions 9.14References 9.0 LEARNING OBJECTIVES After studying this unit, students will be able to:  Explaintheconceptofcreditratinganditsbenefits.  Describetheprocessofcreditrating.  DiscusstheservicesrenderedbythecreditratingagenciesinIndia.  ExplaintheproblemsofcreditratingandfutureofcreditratinginIndia. 9.1 INTRODUCTION The changing financial scenario in our country after liberalization movement hasled to emergence of many new institutions which were concomitant for changed financialset up. In this scene there have been innovations in the financial instruments, a result offinancial engineering. Irrespective of type of financial instrument the basic parameter toevaluate an investment proposal have been the return and safety. Debt instruments havebeen playing an important role for raising funds and in times to come still it is mostpotentialavenue.The basicfeatureofdebti.e.assuredreturnisveryattractiveforinvestors to plan their portfolio but it is associated with a risk especially if it is unsecured.Howtheinvestorsistogaugesuchrisks?CreditRatingistheanswer. Credit Rating is a symbolic indicator of the current objective assessment by arating agency of the relative capability and willingness of an issuer of a debt programmesto service the debt 147 CU IDOL SELF LEARNING MATERIAL (SLM)

 obligations as per the terms of the contract. It may be referred ascurrent opinion of a borrower’s credit quality in terms of business and financial risk. Onthe basis of such evaluation the investors get some idea about the degree of certainty oftimely repayment of the principal amount of the debt instrument besides regular paymentof returns on it i.e. interest. So credit rating is neither a general purpose evaluation of acorporateentitynoranoverallassessmentofthecreditriskassociatedwiththeinstruments issued or to be issued by the concerned business house. It only indicates arepresentativescharactersoftheparticularsecuritywhichdoesnotamounttoanyrecommendationt opurchase,sellorholdthatsecurity. 9.2 CONCEPT OF CREDIT RATING To understand the concept of credit rating it is worth to have an idea of differentcreditratingagencieswhattheyconsidercreditratingas: InvestmentInformationandCreditRatingAgencyofIndiaLtd.(ICRA) Rating is a symbolic indicator of the current opinion of the relative capability oftimely servicing of debt and obligations by the corporate entity with reference to theinstrumentrated. CreditRatingInformationServicesofIndiaLtd.(CRISIL) Rating is current opinion as to the relative safety of timely payment of interest andprincipalonadebenture,structuredobligation,preferenceshares,fixeddepositsprogrammeorsh otterminstruments. CreditAnalysisandResearchLtd.(CARE) Credit rating is an opinion on the relative ability and willingness of an issuer tomaketimelypaymentonspecificdebtorrelatedobligationsoverthelifeoftheinstrument. AustralianRatings Rating provides lender with a simple system of gradation by which the relativecapacitiesofcompaniestomaketimelyrepaymentofinterestandprincipalonaparticulartype ofdebtcanbenoted. Standard&Poors Rating is current assessment of the credit worthiness of an obligor with respect tospecificobligation. Fromtheabovedefinitionsitisunderstoodthat: 1. Credit rating is an assessment of the capacity of an issuer of debt security, by anindependentagency,topayinterestandrepaytheprincipalasperthetermsofissue of debt. A rating agency collects the qualitative as well as quantitative datafrom a company which has to be rated and assesses the relative strength andcapacityofcompanytohonouritsobligationscontainedinthedebtinstrumentthroughoutthedura tionoftheinstrument.Theratinggivenisbasedonanobjectivejudgementofateamofexpertsfromther ating agency. 2. The ratings are expressed in code number which can be easily comprehended evenby the lay investors. The ratings are the quickest way of understanding a company’financial 148 CU IDOL SELF LEARNING MATERIAL (SLM)

 standing without going into the complicated financial reports. Creditrating is only a guidance to the investors and not a recommendation to a particulardebt instrument. The important element for investment decision making in debtsecurity are (i) yield to maturity (ii) risk tolerance to investor and (iii) credit risk ofthe security. Clearly the focus of credit rating is on any one of these three elementsviz.,creditriskofthesecurityandhenceitcannotbyitselfbeabasisforinvestment decision making. It is only a current opinion on the relative capacity offirmstorepaydebtintime. 3. Credit rating, as it exists in India, is done for a specific debt security and not for acompany as a whole. No rating agency tells that it is an indicator of the financialstatus of the company. All that a rating agency claims is that the rating symbolsindicate the capacity of the company to honour the terms of contract of a debtinstrument. 4. A debt rating is not a one time evaluation of credit risk, which can be regarded asvalid for the entire life of the security. It is an on going appraisal. Changes indynamic world of business may imply a change in the risk characteristics of thesecurity. Hence debt rating agencies monitor the business and financial conditionsoftheissuertodeterminewhethermodificationinratingiswarranted. 5. A credit rating does not create a fiduciary relationship between the rating agencyandtheusersofratingsincethereisnolegalbasisforsuchrelationships. 9.3 FUNCTIONSOFCREDITRATINGS Thecreditratingfirmsaresupposedtodothefollowingfunctions: 1. Superior Information Rating by an independent and professional firm offers a superior and more reliable source of information on credit risk for three inter related risks:  It provides unbiased opinion.  Due to professional resources, a rating firm has greater ability to assess risks.  It has access to lot of information which may not be publicly available. 2. Low Cost Information A rating firm which gathers, analyses, interprets and summarizes complex information in a simple and readily understood format for wide public consumption represents a cost effective arrangement. 3. Basis for a Proper Risk-Return Trade Off If debt securities are rated professionally and if such ratings enjoy widespread investor acceptance and confidence, a more rational risk return trade off would be established in the capital market. 4. Healthy Discipline on Corporate Borrowers Public exposure has healthy influence over the management of issuer because of its desire to have a clear image. 5. Formulation of Public Policy Guidelines on Institutional Investment 149 CU IDOL SELF LEARNING MATERIAL (SLM)

 The public policy on the kinds of securities that are eligible for inclusion in different kinds of institutional portfolios can be developed with great confidence if securities are rated professionally by independent agencies. 9.4 ORIGINOFCREDITRATING The credit rating concept originated in the USA. In 1860, Henry Vannum startedpublishing financial statistics of railroad companies in 1909, Mood’s Investors Agenciesstarted rating Railroad giving more thrust to the concept. Since then the importance hasgrown extensively in the global market. System of ratings got institutionalized followingthe Great Depression. In 1933, the US Controller of Currency enacted a rule that bankscould purchase securities rated only BBB/Baa or above. In 1970, Penn Central, thenlargest Railroad company in the world went bankrupt with just under $100 million inoutstanding commercial paper. This forced the investors to ask for rating for commercialpapervolumeand99%ofthecorporatebondvolumeareratedintheU.S.A. 9.5 CREDITRATING IN INDIA TheenvironmentthatprevailedinAmericawhenfirstratingswereassigned,prevails in many developing countries today. The Indian capital market has witnessed atremendous growth in the past few years. Companies are relying on capital markets forfinancingexistingoperationsaswellasfornewprojectsratherthanoninstitutions.Inthisprocess,t heaveragesizeofdebentureissuedbycompanies,thenumberofcompaniesissuingdebenturesandth enumberofinvestorshavegrowsubstantially. As the number of companies borrowings directly from capital market increases,investors find that the company’s size or name is no longer a sufficient assurance of thetimely payment of interest and principal. Default by large and well known companiesrecently in payment of interest on fixed deposits or debentures has reinforced this beliefamong investors. They felt the need for an independent and credible agency which judgesthequalityofdebtobligationsofdifferentcompanies’andassistsindividualandinstitutionalin vestorsinmakinginvestmentdecisions. In this context, the Credit Rating Information Services of India Limited was set upin1987.Followingthis,InvestmentInformationandCreditRatingAgencyofIndiawaspromotedi n1991andCreditAnalysisandResearchLimitedwasfloatedin1993.Allthethreecreditratingagenci eshavebeenapprovedbytheReserveBankofIndia. 9.6 BENEFITSOFCREDITRATING Thefollowingarethebenefitsofcreditrating: 1. LowCostInformation Credit rating is a source of low cost information to investors. The collection,processing 150 CU IDOL SELF LEARNING MATERIAL (SLM)