UNIT III FINANCIAL SERVICES IN INDIA

1. What do you mean by - Lease - Hire Purchase

A lease is a contractual arrangement calling for the lessee (user) to pay the lessor (owner) for use of an asset. The lease will either provide specific provisions regarding the responsibilities and rights of the lessee and lessor, or there will be automatic provisions as a result of local law. In general, by paying the negotiated fee to the lessor, the lessee (also called a tenant) has possession and use (the rental) of the leased property to the exclusion of the lessor and all others except with the invitation of the tenant. The most common form of real property lease is a residential rental agreement between landlord and tenant.[4] The relationship between the tenant and the landlord is called a tenancy, and the right to possession by the tenant is sometimes called a leasehold interest. A lease can be for a fixed period of time (called the term of the lease) but (depending on the terms of the lease) may be terminated sooner.

Hire Purchase In cases where a buyer cannot afford to pay the asked price for an item of property as a lump sum but can afford to pay a percentage as a deposit, a hire-purchase contract allows the buyer to hire the goods for a monthly rent. When a sum equal to the original full price plus interest has been paid in equal installments, the buyer may then exercise an option to buy the goods at a predetermined price (usually a nominal sum) or return the goods to the owner. f the buyer defaults in paying the installments, the owner may repossess the goods, a vendor protection not available with unsecured-consumer-credit systems. HP is frequently advantageous to consumers because it spreads the cost of expensive items over an extended time period. Business consumers may find the different balance sheet and taxation treatment of hire-purchased goods beneficial to their taxable income. The need for HP is reduced when consumers have collateral or other forms of credit readily available. 2. What are the different types of leases ? TYPES OF LEASE AGREEMENTS Lease agreements are basically of two types. They are (a) Financial lease and (b)Operating lease. (c) Sale and lease back (d) Leveraged leasing and (e) Direct leasing. FINANCIAL LEASE

Long-term, non-cancellable lease contracts are known as financial leases. The essential point of financial lease agreement is that it contains a condition whereby the lessor agrees to transfer the title for the asset at the end of the lease period at a nominal cost. At lease it must give an option to the lessee to purchase the asset he has used at the expiry of the lease. Under this lease the lessor recovers 90% of the fair value of the asset as lease rentals and the lease period is 75% of the economic life of the asset. The lease agreement is irrevocable. Practically all the risks incidental to the asset ownership and all the benefits arising there from are transferred to the lessee who bears the cost of maintenance, insurance and repairs. Only title deeds remain with the lessor. Financial lease is also known as 'capital lease'. In India, financial leases are very popular with high-cost and high technology equipment. OPERATIONAL LEASE An operating lease stands in contrast to the financial lease in almost all aspects. This lease agreement gives to the lessee only a limited right to use the asset. The lessor is responsible for the upkeep and maintenance of the asset. The lessee is not given any uplift to purchase the asset at the end of the lease period. Normally the lease is for a short period and even otherwise is revocable at a short notice. Mines, Computers hardware, trucks and automobiles are found suitable for operating lease because the rate of obsolescence is very high in this kind of assets. SALE AND LEASE BACK It is a sub-part of finance lease. Under this, the owner of an asset sells the asset to a party (the buyer), who in turn leases back the same asset to the owner in consideration of lease rentals. However, under this arrangement, the assets are not physically exchanged but it all happens in records only. This is nothing but a paper transaction. Sale and lease back transaction is suitable for those assets, which are not subjected depreciation but appreciation, say land. The advantage of this method is that the lessee can satisfy himself completely regarding the quality of the asset and after possession of the asset convert the sale into a lease arrangement. 4)LEVERAGED LEASING Under leveraged leasing arrangement, a third party is involved beside lessor and lessee. The lessor borrows a part of the purchase cost (say 80%) of the asset fromthe third party i.e., lender and the asset so purchased is held as security against the loan. The lender is paid off from the lease rentals directly by the lessee and the surplus after meeting the claims of the lender goes to the lessor. The lessor, the owner of the asset is entitled to depreciation allowance associated with the asset. 5 DIRECT LEASING Under direct leasing, a firm acquires the right to use an asset from the manufacturer directly. The ownership of the asset leased out remains with the manufacturer itself. The major types of direct lessor include manufacturers, finance companies, independent lease companies, special purpose leasing companies etc 3. What are the advantages of lease ? No Large Outlay

The biggest advantage of leasing equipment is that the cost is spread over a number of years; there is no need for you to pay the entire amount upfront. This can significantly help maintain cash flow, which is critical to all businesses. Poor cash flow is the main cause of small business failures, and leasing can help you to keep it under better control. Leasing can also allow you to use better equipment (e.g. A more efficient / faster / more accurate product) that would be too expensive to buy outright.

(ii) Security
When you lease a product, it is still owned by the leasing company, meaning that they have better security on your finance. This means you are unlikely to need any further security to be able to start a leasing contract, and therefore you have a much better chance of acceptance (passing the credit check) than with other forms of finance.

(iii) Tax Advantages

Lease rentals are considered as an operating cost, which means that it is often possible to deduct them from taxable profits (as a trading expense). However, you should always check that the equipment you are buying is eligible before agreeing to a contract. If your business pays no or minimal taxes, then some leasing companies will claim the capital allowance on your behalf, and lower the leasing costs accordingly.

(iv) Budgeting
As a lease agreement is almost always a fixed contract, it is relatively easy to budget and forecast with. The amount can be worked into your businesses budget much more easily than an irregularly occurring lump sum; allowing you to keep a much better control over current and future cash flow. In the event that you need an item replacing quickly, you can do so with a relatively minor monthly adjustment to the budget, instead of a lump sum that could seriously damage cash flow.

4.What are the Disadvantages of Leasing? (i) No Ownership

The main disadvantage of leasing is that you never own the product. It remains the property of the leasing company during and after the lease. The only exception being if you arrange for it to be sold to another company or person, in which case the leasing company would receive the money and a percentage would be passed back to you (depending on the amount, product type, age, and which leasing company you use).

As you do not own the product, you are unable to sell it in the event it is no longer needed, and you cannot upgrade to a newer or better product without either paying off the remaining contract, or paying a large fee to cancel the contract. You also need to carry on paying a smaller lease cost, even after the cost of the equipment has been fully covered. Hire purchase will allow you to own the product at the end of the agreement, but this is normally more difficult to arrange, and is often available only on highly costly items.

(ii) Long Term Expense

Although leasing allows you to avoid paying a large lump sum, over a long period of time it often works out considerably more expensive. Over the course of a standard lease, you pay the cost of the equipment as well as the leasing companies charges. After the lease finishes you need to carry on paying rental to use the product (although after the initial lease the cost of rental goes down significantly). This means that over a number of years, you will pay considerably more than the actual cost of the equipment without ever actually owning it.

(iii) Maintenance
Although you do not own the equipment that you lease, you are still responsible for its maintenance and repair. Unless you have specifically trained employees to fix the equipment, then this could prove very costly in the event of a serious fault. Some leasing companies will allow you to cover the maintenance and repair costs for an extra sum (which is added to the monthly leasing cost). This will increase your monthly payments, but may save you money in the long run; particularly with manual or highly technical products that may go wrong frequently, and may cause severe disruption if out of action. Cover is normally through the leasing company itself, or through a separate insurance policy. Car leasing is slightly different, as many of these agreements include basic maintenance. However, it is vitally important to check, as some will not include it in the basic price, and the terms and conditions will vary with each leasing company. 5. What is the difference between hire purchase and lease ? BASIS LEASE FINANCING HIRE PURCHASE Meaning A lease transaction is acommercial arrangement,whereby an equipment owner or manufacturer conveys to the equipment user the right to use the equipment in return for a rental. Hire purchase is a type of instalment credit under which the hire purchaser agrees to take the goods on hire at a stated rental, which is inclusive of the repayment of principal as well as interest, with an option to purchase. Option to user No option is provided to the lessee (user) to purchase the goods. Option is provided to the hirer (user).

Nature of expenditure Lease rentals paid by the lessee are entirely revenue expenditure of the lessee. Only interest element included in the HP instalments is revenue expenditure by nature. Components Lease rentals comprise of 2 elements (1) finance charge and (2) capital recovery. HP instalments comprise of 3 elements (1) normal trading profit (2) finance charge and (3) recovery of cost of goods/assets. 6. What are the problems faced by the leasing companies ?

Leasing has great potential in India. However, leasing in India faces serious handicaps which may mar its growth in future. The following are some of the problems. 1. Unhealthy Competition: The market for leasing has not grown with the same pace as the number of lessors. As a result, there is over supply of lessors leading to competitor. With the leasing business becoming more competitive, the margin of profit for lessors has dropped from four to five percent to the present 2.5 to 3 percent. Bank subsidiaries and financial institutions have the competitive edge over the private sector concerns because of cheap source of finance. 2. Lack of Qualified Personnel: Leasing requires qualified and experienced people at the helm of its affairs. Leasing is a specialized business and persons constituting its top management should have expertise in accounting, finance, legal and decision areas. In India, the concept of leasing business is of recent one and hence it is difficult to get right man to deal with leasing business. On account of this, operations of leasing business are bound to suffer. 3. Tax Considerations: Most people believe that lessees prefer leasing because of the tax benefits it offers. In reality, it only transfers; the benefit i.e. the lessees tax shelter is lessors burden. The lease becomes economically viable only when the transfers effective tax rate is low. In addition, taxes like sales tax, wealth tax, additional tax, surcharge etc. add to the cost of leasing. Thus leasing becomes more expensive form of financing than conventional mode of finance such as hire purchase. 4. Stamp Duty: The states treat a leasing transaction as a sale for the purpose of making them eligible to sales tax. On the contrary, for stamp duty, the transaction is treated as a pure lease transaction. Accordingly a heavy stamp duty is levied on lease documents. This adds to the burden of leasing industry. 5. Delayed Payment and Bad Debts:

The problem of delayed payment of rents and bad debts add to the costs of lease. The lessor does not take into consideration this aspect while fixing the rentals at the time of lease agreement. These problems would disturb prospects of leasing business. Note: The current problems of Indian leasing could be listed as follows, again without any order of listing:

Asset-liability mismatch: Most non-banking finance companies in India had relied extensively on public deposits -this was not a new development, as the RBI itself was constantly encouraging and supporting the deposit-raising activities of NBFCs. If the resulting asset-liability mismatch, to everybodys agreement, is the surest culprit of all NBFC woes today, it must have been a sudden realization, because over all these years, each Governor of the RBI has passed laudatory remarks on the deposit-mobilization by NBFCs knowing fully well that most of these deposits were 1-year deposits while the deployment of funds was mostly for longer tenures. It is only the contagion created by the CRB-effect that most NBFCs have realized that they were sitting on gun-powder all these years. The sudden brakes put by the RBI have only worsened the mismatch. Generally-bad economic environment: Over past couple of years, the economy itself has done pretty badly. The demand for capital equipment has been at one of the lowest ebbs. Automobile sales have come down; corporate have found themselves in a general cash crunch resulting into sticky loans. Poor and premature credit decisions in the past: Most NBFCs have learnt a very hard way to distinguish between a good credit prospect and a bad credit prospect. When a credit decision goes wrong, it is trite that in retrospect, it invariably seems to be the silliest mistake that ever could have been made, but what Indian leasing companies have suffered are certainly problems of infancy. Credit decisions were based on a pure financial view, with asset quality taking a back-seat. Tax-based credits: In most of the cases of frauds or hopelessly-wrong credit decisions, there has been a tax motive responsible for the transaction. India has something which many other countries do not- a 100% first year depreciation on several assets. Apparently, the list of such assets is limited and the underlying fiscal rationale quite holy and sound certain energy saving devices, pollution control devices etc qualify for such allowance. But that being the law, it is left to the ingenuity of our extremely competent tax consultants to widen the range with innovative ideas of exploiting these entries in the depreciation schedule. Thus, there have been cases where domestic electric meters have been claimed as energy saving devices, and the captive water softenizer in a hotel has been claimed as water pollution control device! As leasing companies were trying to exploit these entries, a series of fraudsters was successful in exploiting, to the hilt, the propensity of leasing companies to surpass all caution and all lending prudence to do one such transaction to manage its taxes, and thus, false papers for non-existing wind mills and never-existing bio-gas plants were fabricated to lure leasing companies into losing the whole of their money, to save the part that would have gone as government taxes! Extraneous problems frauds, closures and regulation: As they say, it does not rain, it pours. Several problems joined together for leasing companies subsequent failures of

some good and several bad NBFCs, regulation by the RBI requiring massive amount of provisions to be created for assets that were non-performing, etc. It certainly was not a good year to face all these problems together. 7. What do you mean by Chit funds

A Chit fund is a kind of savings scheme practiced in India. A Chit fund company means a company managing, conducting or supervising, as foremen, agent or in any other capacity, chits as defined in Section 2 of the Chit Funds Act, 1982. According to Section 2(b) of the Chit Fund Act, 1982, "Chit means a transaction whether called chit, chit fund, chitty, kuri or by any other name by or under which a person enters into an agreement with a specified of persons that every one of them shall subscribe a certain sum of money (or a certain quantity of grain instead) by way of periodical installments over a definite period and that each such subscriber shall, in his turn, as determined by lot or by auction or by tender or in such other manner as may be specified in the chit agreement, be entitled to the prize amount".

Different chit funds operate in different ways; and there are also many fraudulent tactics practiced by many private firms. The basic necessity of conducting a 'Chitty' is a group of needy people called subscribers. The foreman - the company or person conducting the chitty - brings these people together and conducts the chitty. Foreman is also the person responsible for collecting the money from subscribers, presiding the auctions and keeping records of subscribers. He is compensated a fixed amount (generally 5% of gross chitty amount) monthly for his efforts; other than that the foreman does not have any specific privileges, he is just a subscriber of the chitty. The general pattern of the chitty can be readily noticed by a simple formula: Monthly Premium Duration in Months = Gross Amount E.g.: 1000 * 50 = 50,000/-. Where 1000 is the maximum monthly contribution needed from a subscriber, 50 is the duration of the chitty in months and 50,000 is the maximum sum assured. The duration also equals the number of subscribers, as there must be (not more or less) one subscriber to receive the price money every month. The chitty starts on an announced date, every subscriber come together for the auction/lot. As per Kerala chit act, the minimum prize money of an auction is limited to 70% of the gross sum assured that is 35,000 in the above example. When there are more than one person willing to take this minimum sum, lot are conducted and the 'Lucky subscriber' get the prize money for the month. If there is no person is willing to take the minimum sum, then a reverse auction is conducted where subscribers open-bid for lower amounts; that is from 50,000 >> 49,000 >> 48,000, and so on. The person bidding lowest sum get bid amount. In both the cases the auction discount, that is the difference between the gross sum and auction amount, is equally distributed among subscribers or is deducted from their monthly premium. For example if the auction is settled on a sum of 40,000, then the auction discount of 10,000

(50,000 - 40,000) is divided by 50 (the total number of subscribers) and every one gets a discount of 200. The same practice is repeated every month and every subscriber gets a chance of receiving some money. What do you mean by credit rating ? A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings. In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-profit organizations, or national governments issuing debt-like securities (i.e., bonds) that can be traded on a secondary market. A credit rating for an issuer takes into consideration the issuer's credit worthiness (i.e., its ability to pay back a loan), and affects the interest rate applied to the particular security being issued. The value of such security ratings has been widely questioned after the 2007-09 financial crisis. In 2003, the U.S. Securities and Exchange Commission submitted a report to Congress detailing plans to launch an investigation into the anti-competitive practices of credit rating agencies and issues including conflicts of interest.More recently, ratings downgrades during the European sovereign debt crisis of 2010-11 have drawn criticism from the EU and individual countries. A company that issues credit scores for individual credit-worthiness is generally called a credit bureau (US) or consumer credit reporting agency

What are the limitations of credit rating ? Biased rating and misrepresentation: In the absence of quality ratings , credit rating is a curse for capital market industry. To a v o i d b i a s e d r a t i n g , t h e e x p e r t i n r a t i n g a g e n c y , c a r r yi n g o u t d e t a i l e d a n a l ys i s of the company , should have no links with the company or the persons i n t e r e s t e d i n t h e company so that they can make their report impartial and judicious recommendation for rating committee. 2) Static study : Rating is done on the present and the past historical data of the company and this is only a static study . prediction of the company health through rating is m o m e n t a r y a n d anything can happen after assignment of rating symbols to the company .dependence for the future result on the rating, therefore defeat the vary purpose of the risk indicative of the rating.3) Concealment of material information : Rating company might conceal material information from the investigating team of the credit rating company, in such cases quality of rating suffers.

4) Rating is no guarantee for soundness of the company : Rating is done for a particular instrument to assess the credit risk but it should not be considered as a certificate for matching quality of the company or its management. 5) Human bias : Finding of the investigation team at times may suffer from with the h u m a n b i a s f o r unavoidable personal weakness of the staff and might effect the rating . 6) Down grade :Once the company has been rated and if it is not able to maintain its working result and performance ,credit rating agency would review the grade or downgrade the rating resulting into impairing the image of the company . 7) Validity of rating Validity of the rating ends with the maturity of a debt instrument and its n o l o n g e r subsequently benefits the issuer company because the rating is valid for the life time of the debt instrument being rated . 8) Difference in rating of two agencies: Rating done by two different credit rating agencies for the same instrument of the same issuer company in many cases would not be identical. Such difference is likely to occur because of the because of the value judgment differences on qualitative aspect of the analysis in two different rating agencies whereas quantitative analysis might be the same and identical . Corporate earnings fell very sharply due to persistent recessionary conditions prevailing in the economy. Many of the corporate are in commodity sectors where fluctuations in selling prices of products can be very sharp - leading to complete erosion of profitability.

This problem was compounded by the Asian crisis, which led to increased competition from cheap imports in many product categories. Rating agencies substantially overestimated financial flexibility of corporate especially from traditional corporate houses. Much of the financial flexibility was implicit on raising money from new issues from the capital market, which has been impossible in the last 3 years. I n t h e c a s e o f finance companies, widespread defaults like CRB and tightening of regulations made it virtually impossible for them to raise money in any f o r m . T h e s e finance companies had been in the habit of investing in longer term, illiquid assets by b o r r o w i n g s h o r t e r t e r m f i x e d d e p o s i t s . W h e n t h e f l o w o f credit stopped, they faced l i q u i d i t y p r o b l e m s . T h e s e w e r e f u r t h e r c o m p o u n d e d b y d e f a u l t s b y s o m e o f t h e companies to which they had on lent money. The experience is no different from the international scenario where reputed and highly experienced rating agencies like Standard & Poor (S&P) and Moodys were unable to predict the Asian crisis and had to face the embarrassment of seeing the credit rating of South Korea as a country go from A+ to BB+ in a short span of 3 months .By and large, the rating is a very good estimate of the actual creditworthiness of the company; however, it is not able to predict extreme situations such as the ones described above, which are unlikely to have been predicted by most investors in any case. Investors should realize that a credit rating is

not sacrosanct and that one has to do ones own due diligence and investigation before investing in any instrument. They should use the rating as a reference and a base point for their own effort .One good way of doing this is examining the behavior of the stock price in case the stock is listed. As a collective, the market is far smarter at predicting problems than any credit rating agency. Witness the sharp erosion in stock prices of companies much before their credit ratings were downgraded. Witness also the fact that foreign currency bonds from Indian issuers trade at yields lower than countries which have been rated higher by rating agencies. What are the various credit rating agencies in India ? A CRISIL rating reflects CRISIL's current opinion on the relative likelihood of timely payment of interest and principal on the rated obligation. It is an unbiased, objective, and independent opinion as to the issuer's capacity to meet its financial obligations. So far, CRISIL has rated 30,000 debt instruments, covering the entire debt market. The debt obligations rated by CRISIL include:

Non-convertible debentures/bonds/preference shares Commercial papers/certificates of deposits/short-term debt Fixed deposits Loans Structured debt

CRISIL Ratings' clientele includes all the industry majors - 23 of the BSE Sensex constituent companies and 39 of the NSE Nifty constituent companies, accounting for 80 per cent of the equity market capitalisation, are CRISIL's clients. CRISIL's credit ratings are

An opinion on probability of default on the rated obligation Forward looking Specific to the obligation being rated

But they are not

A comment on the issuer's general performance An indication of the potential price of the issuers' bonds or equity shares Indicative of the suitability of the issue to the investor A recommendation to buy/sell/hold a particular security A statutory or non-statutory audit of the issuer An opinion on the associates, affiliates, or group companies, or the promoters, directors, or officers of the issuer

CRISIL ratings are based on a robust and clearly articulated analytical framework, which ensures comprehensiveness, standardisation, comparability, and effective communication of the ratings assigned and of every timely rating action. The assessment is based on the highest standards of independence and analytical rigour.
CRISIL rates a wide range of entities, including: Industrial companies Banks Non-banking financial companies (NBFCs) Infrastructure entities Microfinance institutions Insurance companies Mutual funds State governments Urban local bodies

In India, at present, there are four credit Rating Agencies: i) Credit Rating and Information Services of India Limited (CRISIL). ii) Investment Information and Credit Rating Agency of India Limited (ICRA) . iii) Credit Analysis and Research Limited (CARE). iv) Duff and Phelps Credit Rating of India (Pvt.) Ltd.
I

CRISIL : This was set-up by ICICI and UTI in 1988, and rates debt instruments. Nearly half of its ratings on the instruments are being used. CRISIL's market share is around 75%. It has launched innovative products for credit risks assessment viz., counter party ratings and bank loan ratings. CRISIL rates debentures, fixed deposits, commercial papers, preference shares and structured obligations. Of the total value of instruments rated, debentures' accounted for 3 1.196, famed deposits for 42.3% and commercial paper 6.6%. CRISIL publishes CRISIL rating in SCAN that is a quarterly publication in Hindi and Gujarati, besides English. CRISIL evaluation is carried out by professionally qualified persons and includes data collection, analysis and meeting with key personnel in the company to discuss strategies, plans and other issues that may effect ,evaluation of the company. The rating ,process ensures confidentiality. Once . - the company decides to use rating, CRISIL is obligated to monitor the rating over the life of the debt instrument. ii) ICRA : ICRA was promoted by IFCI in 1991. During the year 1996-97, ICRA rated 261 debt instruments of manufacturing companies, finance companies and financial institutions equivalent to Rs. 12,850 crore as compared to 293 instruments covering debt volume of Rs. 75,742 crore in 1995-96. This showed a decline of 83.0% over the year in the volume of rated debt instruments. Of the total amount rated cumulatively until March-end 1997, the share in terms of number of instruments was 28.5% for debentures (including long term instruments), 49.4% for Fixed Deposit
,

programme (including medium- term instruments), and 22.1% for Commercial Paper Programme (including short term instruments). The corresponding figures of amount involved for these three broad rated categories was 23.8% for debentures, 52.2% for fixed deposits, and 24.0% for Commercial Paper. The factors that ICRA takes into consideration for rating depend on the nature of borrowing entity. The inherent protective factors, marketing strategies, competitive edge, competence and effectiveness of management, human resource development policies and practices, hedging of risks, trends in cash flows and potential liquidity, financial flexibility, asset quality and past record of servicing of debt as well as government policies affecting the industry are examined. Besides determining the credit risk associated with a debt instrument, ICRA has also formed a group under Earnings Prospects and Risk Analysis (EPRA). Its goal is to provide authentic information on the relative quality of the equity. This requires examination of almost all parameters pertaining to the fundamentals of the company including relevant sect oral perspectives. This qualitative analysis is reinforced and completed by way of the unbiased opinion and informed perspective of one analyst and wealth of judgment of committee members. ICRA opinions help the issuing company to broaden the market for their equity. As the name recognition is replaced by objective opinion, the lesser know companies are also able to access the equity market. iii) CARE : CARE is a credit rating and information services company promoted by IDBI jointly with investment institutions, banks and finance companies. The company commenced its operations in October 1993. 'In January 1994, CARE commenced publication of CAREVIEW, a quarterly journal of CARE ratings. In addition to the rationale of all accepted ratings, CAREVIEW often carries special features of interest to issuers of debt instruments, investors and other market players.

1. What is money market ? 2. What are the services provided by the banks ? 3. What do you mean by (Any 3 ) Bullion market

Treasury Bills Secondary market