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Financial institutions and services
Commercial banking
Commercial banking involves accepting deposits, providing loans, and offering financial services
such as Overdraft facilities and electronic transfer funds to individuals, businesses, and
governments
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Commercial banks are financial institutions that play a crucial role in the economic system by
facilitating the flow of money within the economy
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In India, public sector banks operate under the
guidelines of RBI which is the central bank
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Ex: ICICI Bank, HDFC etc
c) Foreign banks: It refers to commercial banks that are headquartered in a foreign country, but
operate its branches in different countries
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In this financing model, lenders provide capital based on the project's anticipated cash flow and
assets, rather than the creditworthiness of the project sponsors
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•
Non-recourse financing is a financing arrangement where lenders' claims are limited to the
project's assets and cash flows
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In Limited recourse financing, lenders have recourse to the project's assets and cash flows but
have limited recourse to the sponsors' other assets
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Hence, banks conduct
proper risk assessment before deciding on financing the projects or not
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Non infrastructure projects: They are found in manufacturing services and other sectors like
cement, steel, textiles, chemicals and pharmaceuticals
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This includes construction risks, operational risks, market risks, and regulatory risks
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This means that
lenders primarily rely on the cash flows and assets of the project for repayment, with limited or
no claim on the sponsors' assets
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3) Special Purpose Vehicle (SPV) Formation
Project finance typically involves the creation of a Special Purpose Vehicle (SPV) or a project
company formed exclusively for the project, holding its assets and assuming its liabilities
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4) Cash Flow Repayment Structure
Project finance designs a repayment structure that aligns with the project's cash flows
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Role of Commercial Banks in Project Finance
1) Providing term loans
In project finance, term loans are structured to meet the long-term funding needs of a specific
project, providing the capital required for various stages of development, construction, and
operation
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Term loans in project finance are often secured by
the assets of the project itself
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They
analyse technical, financial, legal, and market risks associated with the venture and develop risk
mitigation strategies
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3) Facilitating External Commercial Borrowings
External Commercial Borrowings (ECB) refer to the loans and debt instruments that entities in
one country raise from foreign sources typically from commercial banks
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ECB is often denominated in foreign currencies
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4) Issuing Letter of credit
A Letter of Credit is a financial instrument issued by a bank at the request of the buyer (applicant)
in favour of the seller (beneficiary)
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This is
particularly crucial in project finance, where large sums are involved
...
5) Advisory services
Commercial banks frequently offer advisory services in project financing to its client
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Advisory services contribute to informed decision-making
throughout the project finance process
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6) Syndication of loans
Syndication of loans is a common practice in project finance, especially for large-scale projects
that require significant capital investment
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This approach helps distribute the risk associated with
the loan among several lenders and allows for the mobilization of larger amounts of capital
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Working Capital Finance
Working capital finance refers to the funds a company requires for its day-to-day activities,
covering short-term operational needs like inventory, accounts payable, and daily expenses
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Commercial banks often provide working capital finance through various instruments
such as short-term loans, lines of credit, and overdraft facilities
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For instance, a company may use
working capital finance to purchase inventory, cover short-term debt, or manage fluctuations in
cash flow
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Typically, working capital finance is provided against the security of current assets with different
modes of security, including
•
•
•
•
hypothecation (security of movable property of a firm),
pledge (bailment of goods as a security),
lien (property retained with bank until loan repaid),
mortgage (immovable property)
Role of Commercial Banks in working capital finance
1) Overdraft
It is a facility given to the current account holders for a short-period generally a week
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e
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A Shopkeeper in Bicholim issues Rs
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Even though, the Shopkeeper in Bicholim has Rs
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2) Cash Credit
An eligible borrower is first sanctioned a credit limit
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The borrower cannot borrow the entire
sanctioned credit in lump sum
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The
cash credit limit can be revised
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3) Loans/Bank Finance
Under this method, the total amount of borrowing/loan is credited to the account of the borrower
or released to him in cash
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The bank provides credit on the basis of following modes of security: a
...
b
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c
...
d
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The
property may remain with the borrower, but the lender/bank enjoys the full legal title
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It is an agreement between buyer and seller of
goods and bank acts as intermediary
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They are generally used between business
entities
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When the businessman sells
invoice, the factor gives him a payment that is typically 85% to 95% of the total invoice amount
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Once the customer has paid
the invoice, the factor will pay the remaining balance to businessman, minus the agreed-upon
factoring fee
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6) Letter of Credit
It is a Letter from the bank guaranteeing that buyer’s payment to a seller will be received on time
and also correct amount
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Development Financial Institutions (DFIs)
Development Financial Institutions (DFIs) are specialized financial specialized institutions that
provide long-term financial support and expertise for projects contributing to economic
development
...
DFIs offer various financial products, including loans, equity, guarantees, and technical assistance,
to support projects in infrastructure, agriculture, healthcare, education, and other sectors
essential for economic progress
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The primary objectives of DFIs include poverty reduction, job creation, and fostering sustainable
economic development
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The various types of DFIs in India can be categorized as:
a) Term lending institutions like ICICI, IFCI, IDBI etc
b) Refinanced institutions like NABARD, NHB,
c) State level institutions
DFIs Arose during the second 5-year plan with the focus on building a strong industrial sector
post-independence
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For this purpose, the industrial finance Corporation of India
Limited was first founded
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It was set up to
provide long-term finance to industrial projects, with a focus on promoting industrial growth
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2) Industrial Credit and Investment Corporation of India (ICICI)
ICICI was established in 1955 as a joint venture between the Government of India, the World Bank,
and the public sector banks
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Over time, it transformed into a full-fledged commercial bank,
and in 2002, the merger of ICICI and ICICI Bank took place
...
Role of DFIs in India
1) Long-Term Financing
One of the primary roles of DFIs is to provide long-term financing to projects and sectors that
require substantial capital investments such as manufacturing, infrastructure, and power
generation
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2) Risk Capital Provision
DFIs play a vital role in providing risk capital for projects that may be deemed too risky by
conventional financial institutions
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This risk-sharing function is essential for
fostering innovation and entrepreneurship
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These sectors may include manufacturing, agriculture, infrastructure,
technology, and others
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4) Project Appraisal and Evaluation
Before extending financial assistance, DFIs conduct thorough assessments to evaluate the
feasibility, technical viability, and economic viability of projects
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The objective is to
ensure that the funds are directed towards projects with a high probability of success and positive
outcomes
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This may involve sharing industry-specific expertise, providing training programs, and
supporting the development of human capital within businesses
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6) Infrastructural development
DFIs play a critical role in financing infrastructure projects
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By
providing funding for these projects, DFIs contribute to infrastructural development in the
economy
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They direct
financial resources to projects in less developed or economically disadvantaged regions
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8) Innovation
DFIs foster innovation by providing crucial funding and support to research, development, and
innovative projects
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9) International Collaboration
DFIs often collaborate with international development banks, foreign DFIs, and other global
institutions
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Life insurance and Non-Life Insurance Companies in India
The insurance sector in India encompasses both public and private organisations
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The history of
insurance in India includes the nationalisation of both life and general insurance
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It absorbed 245 Indian and foreign insurers
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Both life and non-life insurance companies operate under the regulatory framework of the IRDAI
which was established in 1999
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Life Insurance Companies:
Life insurance primarily focuses on providing financial protection to individuals and their families
in the event of the policyholder's death
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Examples: Life Insurance Corporation of India (LIC), HDFC Life, ICICI Prudential Life Insurance
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Whole Life Insurance: Provides coverage for the entire life of the policyholder
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Moneyback policies: Similar to endowment, but with periodic payout during the policy term
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•
•
Many life insurance products include an investment component, where a portion of the
premium is invested in various financial instruments
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Life insurance policies typically involve a long-term commitment, often spanning several
decades
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This includes insurance for property, health, motor vehicles, travel, and more
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Examples: New
India Assurance Company, United India Insurance Company, HDFC ERGO General Insurance
Types of Non-Life Insurance Policies:
Health Insurance: Covers medical expenses and hospitalization costs
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Property Insurance: Protects against damage or loss of property due to events like fire, burglary,
etc
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•
•
Non-life insurance policies involve short term commitments
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Unlike life insurance, non-life insurance policies typically do not have an investment
components and there are no tax benefits available
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Regulated by the Securities and
Exchange Board of India (SEBI), mutual funds offer retail investors professional management and
diversification
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3) Hybrid Funds: Combine both equity and debt instruments for a balanced approach
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5) Sectoral/Thematic Funds: Concentrate on specific industries or themes- IT, agriculture,
pharma
6) Tax-Saving Funds (ELSS): Equity funds with a lock-in period, offering tax benefits under
Section 80C of the Income Tax act
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Systematic Investment Plans (SIPs) have gained popularity, allowing
investors to contribute small amounts regularly
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There is no
way to predict what will happen in the future or whether a given asset will increase or decrease
in value
...
Role of Mutual Funds
1) Diversification
Mutual funds pool money from various investors to create a diversified portfolio of stocks, bonds,
and other securities
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By investing in a variety of assets, mutual funds aim to minimize the impact of poor performance
in any single investment on the overall portfolio
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These experienced individuals or teams analyze market trends, economic indicators,
and company performance to make informed investment decisions
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3) Liquidity
Mutual funds offer high liquidity, allowing investors to easily buy or sell units at the fund's net
asset value (NAV) on any business day
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Liquidity is crucial for investors who
may need to access their funds quickly
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4) Risk Management
Mutual funds employ various risk management strategies to protect investors
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Additionally, the diversification inherent in mutual fund portfolios helps reduce the impact
of poor performance in any single asset
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5) Dividend Reinvestment
Many mutual funds offer dividend reinvestment programs, allowing investors to automatically
reinvest their earnings back into the fund
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Non-banking financial companies
Non-Banking Financial Companies (NBFCs) are financial institutions that provide a wide range of
financial services, including loans, credit facilities, and investment products, but operate without
a banking license
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It covers a wide spectrum of financial services, including providing loans and advances, acquiring
shares, stocks, bonds, debentures and securities, engaging in leasing, higher purchase, insurance,
and chit business
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NBFCs accepting public deposits and
2
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3
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However, apart from them, no NBFCs are permitted to offer interest rates on
deposits higher than those approved by RBI
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Types:
➢
➢
➢
➢
Asset finance companies
Investment companies
Loan companies
Infrastructure finance companies etc
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It provides
comprehensive financial advice to corporate entities, covering finance, marketing, management,
mergers, takeovers, project counselling and legal matters
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Merchant bankers adhere to SEBI guidelines
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While many commercial banks in India also offer merchant banking services
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Services of Merchant Banking:
1) Corporate Advisory: Merchant banks offer strategic advice to corporations on various
financial matters, including mergers and acquisitions, capital restructuring, and financial
reengineering
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They assume the risk of purchasing these securities from the issuing
company and then sell them to investors
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4) Credit Syndication: Merchant banks play a role in credit syndication, where they arrange
loans from multiple financial institutions to meet the financing needs of a client, for large scale
projects
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Underwriting
Underwriting is a financial arrangement between a company and a financial agency aimed at
ensuring the successful subscription of shares or debentures offered by the company to the public
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This concept is similar to insurance as it safeguards the issuing
company against the potential failure of a capital offering
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It is typically limited to 5% of the issue price for shares and 2
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Various types of underwriting arrangements are:
1) Syndicate underwriting: Multiple agencies collaborate to underwrite a securities issue
2) Full underwriting: A single underwriter commits to purchasing all unsubscribed shares
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4) Joint underwriting: For large issues the issuing company enters agreements with multiple
underwriters, each agreeing to buy a specific portion of unsubscribed securities
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6) Sub underwriting: In this arrangement, an underwriter delegates part of the underwriting
risk to another agency, reducing their own exposure
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It involves evaluating the ability of a borrower to meet their financial obligations and repay
borrowed money
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Examples
of well-known credit rating agencies include Standard & Poor's, Moody's, and Fitch Ratings
...
Credit ratings are typically expressed through symbols such as AAA - The highest rating
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Importance of credit rating can be summarised as follows:
1) Unbiased investment guidance: A good rating agency offers unbiased opinions to investors
supported by qualified and experienced staff
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3) Policy Formulation and Regulatory authorities like RBI and SEBI use credit ratings to formulate
investment criteria and policies
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5) Continuous monitoring: Credit ratings are continuously updated ensuring that investors are
well informed about evolving risks
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7) Assisting market intermediaries: Credit rating simplify the work of market intermediaries
like merchant bankers and brokers in conveying company’s financial position to investors
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Venture capital can take the form of loans, convertible
debentures or equity investments
...
Ex- Zomato has secured investment from Ant Financial, Sequoia
Capital, and Info Edge, among other investors
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It is a high-risk phase where the viability of the product or idea is tested
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Initial sales occur, and market research is conducted to assess this
project’s feasibility
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The focus is on gaining market share and achieve profitability
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Strategic planning and product life cycle assessment are
critical
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Venture capitalists may exit the investment with profits
proportionate with the risk taken
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It implies providing financial literacy or education regarding
various financial products and services offered by the formal financial sector
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It focuses on educating individuals and groups regarding the need for savings, concept
of risk and rewards, time value of money, various products offered by insurance
companies, customers' rights under fair practices code, phishing and identity theft
(cyber frauds) etc
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Financial counselling services are provided through face-to-face interaction as well as
through other means like e-mail, whatsapp, video conferencing, podcasts etc
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➢ Abhay credit counselling is an initiative of Bank of India
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