CAPITAL MARKETS – AN OVERVIEW

Unit structure
1.1 Introduction
1.2 Learning objectives
1.3 Section title
1.3.1 Factors that affects the capital market
Political factor
Economic factors
1.3.2 Primary market

1.3.3 Causes for less number of IPOs

1.3.4 Secondary markets : Causes

1.3.5 Remedial measures

1.3.6 Reforms made by SEBI during 1996

A. Primary market
B. Secondary market
1.3.7 Activating Debt market in India

1.3.8 Government guidelines on

1.3.9 Factors to be considered while conversion of debentures

1.3.10 Role of convertible debenture in

1.3.11 Have you understood questions
1.3.12 Summary

CAPITAL MARKETS – AN OVERVIEW

1.1 INTRODUCTION
The stock market is divided into two markets—primary and secondary market.
It is considered as a game in which there are two players i.e., on one hand there are
buyers and on the other hand there are sellers. The stock markets since involving the
persons with a quite different level of skills, the number of persons on each side are
constantly changing. Thus there is the option of joining any of the side, and of the
changing sides at any time, if one makes a judgement that a side of losing — that
person may by a buyer today and a seller tomorrow. This will continue for hundreds

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of years and will continue to happen as long as there is a stock temporary advantage,
and as the night follows a day, this advantage will move to the other sides. Since, of
course, the individual player can change sides, any person can be a winner or a loser
in this game. The winner will gain in the value of the Capital, while the loser will see
his money trickle or even flood away.
1.2 LEARNING OBJECTIVES:
• Can going through this lesson, you will be conversant with
• The factors that affects the capital market
• The role of primary market in capital market
• Causes for the less number of IPOs.
• Reforms made by SEBI during 1996
• Reasons for the activation of debt market in India
• Debenture bond market in India.
There is much more risk involved in this market. The success can be achieved
if a few basic principles are followed. As we know that the advantage constantly
switches from the buyers to the sellers, which means that prices go up and come down
over a course of time. It it is assumed that stock market prices are not random, then it
is thought that longer the time, for which prices have been rising, the greater is the
chance that they will start to fall. But it is seemed to as the fact of the life that the
majority of the people think in the opposite way, i.e. when the prices have been rising
for some considerable time, then they will continue to do so, and it is sensible to
invest even more in the market.
Risk is the integral part of the investment and there are no doubts that the
stock market is a place of greater risk than a bank deposit account. Risk can be said
dependent on two major factors:
• The quality of the equity chosen for the investment, which is fled to its
volatility or historical price fluctuations. Greater the volatility, greater the risk
involved in that share.
• The second important factor in the stock market is the timing. In the absence
of the timing, investment in a very volatile share is a large gamble. Of course,
in the less volatile share is also a gamble, but with a lesser one. Thus,
1.3.1 FACTORS THAT AFFECTS THE CAPITAL MARKET:

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 Capital market is very sensitive and hence becomes the victim of all the
rumors, the current scenario to the country, the currency fluctuations, the international
happenings, the growth and the development of the economy, the political factor and
the reforms that directly or indirectly affect the economy. The factors can take the
stock index either upwards or may bring it down.
The main thing that affects the stock market as a whole is the overall
performance of the country and also the politics, the reforms and the currency. The
factors affecting the capital market are explained below:
1. Political Factor:
The political factor is one of the main causes of fall or rise in the capital
market. If we see the records of last three years of the political stableness then we can
4erive the conclusion that political factor was the main centre since all the reforms
and rule and regulations. But due to the instability no reforms were undertaken to
boost up the capital market which reflects the economic progress of the country. The
economic slowdown is still continuing since the only hope is a stable government.
In the current scenario, after the Asian crisis what every investor wish is a
uniform government Since it would lead to more emphasis on infrastructure projects
leading to sustained economic recovery from the second half of FY98. In view of the
approaching elections in February 1998 the more reliable once are the fixed returns
sectors like oil and non-industrial plays like consumer goods, telecom,
pharmaceuticals and software and are negative on automobiles and cement. In the
scenario of Asian crisis we are negative on global commodity like chemicals and
steel.
The dissolution of the parliament will have a significant negative effect on the
business confidence and government spending which usually increased in the last
quarter of the fiscal year. Investment decisions will also be postponed until the new
government presents its budget in May 1998 and spells out its policies about future
tax rates, levels of tariff protection, policies regarding foreign investments etc. In fact,
political uncertainty was cited as one of the major reasons for slow industrial growth
and infrastructure projects are being delayed mainly due to lack of clarity on
regulatory framework.

2. Economic Factors

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 (a) Economic slowdown: The industrial growth for the FY98 is expected to be
six per cent as against the previous forecast of eight per cent. Due to Asian slowdown
and in the present scenario it is expected that exports will dip to eight per cent for
FY99. With stable government it is expected that industrial growth will accelerate to
eight per cent in FY99.
The industry ministry has scaled down its industrial growth projections for the
current fiscal to 4.5-5 per cent from the earlier 6 per cent, following the release of
CSO data for the month of December 1997. Growth in December, according to CSO
figures was at 2.1 per cent as against 6 per cent in November. The sharp dip in
December has almost certainly ruled out the possibility of the internal targets for
industrial growth being met. The industrial growth during the April-December period,
is 4.7 per cent, implying that growth in the last quarter will have to be in the 7 per
cent plus range to meet the 6 per cent growth targets for the current fiscal.
The government had been earlier optimistic because of the buoyancy in
cement production. However, the sales figures of cement manufacturers do not
indicate a pickup, which means that the growth in cement industry is merely a
reflection of inventory build-up with cement manufacturers. Another positive sign
earlier was the initial estimates of growth in Electricity production in January, which
has been in the range of 7 per cent. However, indication are that much of the power
has been drawn by agriculture, while the rest has been drawn by industry.
(b) Rupee Instability: The roller coaster depreciation of the rupee against the
dollar was the subject of intense debate in the media and is a familiar story by now.
Government no longer has a role in determining the rupee’s value as the exchange
rate is now marketing determined. The Central Bank will intervene only in cases of
excessive volatility. A further fall from the level of Rs. 38 to a dollar saw speculative
pressure on the rupee and it soon catapulted to breach psychological levels of Rs. 39
to a dollar. The extent of depreciation during the calendar year is quite significant.
The rupee was ruling at 35.66 in January 1997 and by December 8th, 1997, had
already depreciated to 38.76 having breached the psychological barrier of Rs. 39 in
the intervening period. That was a depreciation of 8.7% over the period, most of it
towards the end. On 16 January 1998, in a sudden reversal, the bank rate was
increased by 200 basic points and Rs. 2,500 crore were withdrawn from the system by
increasing OW by 0.5%. Through the market was expecting RUT to intervene if the
rupee, which has lost about 8% against the dollar since October 1997, depreciated

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beyond 40, the severity of the measures left most players gasping. The hotly- debated
topic in treasury rooms of banks and corporate was: Is the medicine worse than the
disease?
The stock markets, surprisingly, moved up on 19 January 1998, the next
trading day, by 98 points. The rupee reversed its path immediately, and went on
appreciating to touch 38.77 per dollar on 21 January 1998; it continued to rule strong
even a week later. The yield on 2001 government paper jumped to 13.5% on 21
January 1998, from 11% on 15 January 1998. The forward premium on rupee shot up,
with one-month forwards trading at a premium of above 50% on 21 January 1998, as
against 34% on 15 January 1996.’
Due to the 0.5% cut in CRR and reduction in refinancing facilities of RUT,
call money rates shot up above 50%, as compared to 8-10% earlier. Low liquidity
reduces any scope of arbitrage in favour of the dollar in the local money and forex
markets. A higher interest rate creates an arbitrage opportunity in favour of the rupee.
However, due to a high premium on forward dollar, and the volatility experienced by
it in recent times, there is not expected to be much arbitrage in favour of the rupee.
The most accepted system for fundamental valuation of any scrip si considered to be
the discounted cash flow method. The hike in the bank rate by 2% signals an increase
of 2% in interest rates. An increase in interest rates by 1% should result in an
approximate 6% fall in the stock market valuations. Since the measures are termed as
short term, the markets should fall by 1.7% due to a higher incidence of interest and
higher discounting factor assuming that the measures remain in force for six months.
The halt in the decline of the rupee acted as a boost to the market; the
immediate reaction was appreciation in the stock indices. The markets went up by 98
points immediately after the announcement of the RUT package. However, as the
reality dawned on the market, and foreign institutional investors still shying away, the
journey south has begun again. RUT can also enter the forward markets in a big way,
cooling excessive forward premium, which has shot up to 50% for one-month forward
dollar and 22% for six-month forward dollar. On account of RUT’s intervention on 22
January 1998, the forward premium declined to 185% from 22%. Low forward
premium can lead to a return of confidence in the Indian rupee and can act as an
effective check to any speculative tendencies.
A currency is the medium of exchange and a store of value. A high volatility
in the currency shakes the confidence of foreign investors who adopt a wait-and-

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watch approach or pull out before it is too late. For instance, foreign institutional
investors, in the last two months, have become net sellers for the first time since their
entry for years ago, due to the volatility of the rupee. Cooperates, which have
contracted forex loans, find their debt burdens mounting. The country’s import bill
balloons, and so does the fiscal deficit.
Most agree that the rupee’s depreciation will boost exports by making them
more price-competitive. Depreciation will make imports more expensive and so
reduce overseas competition. This will lead to a rise in domestic margins and profits.
A small depreciation is usually expansionary as it allows exports to increase and
pushes up total demand in the economy. If there’s limit to how much a depreciation
by itself can do for exports, there’s no doubt that it will pose serious problems for
import-intensive industries like computers, automobiles and gems and jewellery.
In the late eighties, for instance, light commercial vehicle projects were
dependent on component imports from Japan. However, with the yen appreciating,
component costs soared and they ran up huge losses. And gems and jewellery exports
are highly dependent on imports depreciation will only push up costs and make
exports of these items uncompetitive to the extent. All along it was apparent that
exporters wanted the rupee to depreciate and was canvassing for it in various quarters.
A case was made out that the depreciation of the South East Asian currencies is
hurting Indian exports by giving them a cost advantage.
It was quite apparent that the Government as well as the RBI was seeking to
depreciate the rupee against the dollar mainly to facilitate export competitiveness.
Exporters look the biggest beneficiaries of a depreciating rupee, cost of exports has
already gone up. In a depreciating scenario, the tendency is toe delay inward
remittances of exports in order to avail of a bigger windfall later on. But exporters
may expedite their proceeds in view of higher cost and penal interest rates for any
delay in bringing in the proceeds. Many of the corporate blue-chips, including
Reliance, which has raised funds from the longest maturity fixed-income instrument,
i.e. 100-year bonds, have announced their intention to drop any plans for accessing
foreign markets. This also means lower foreign currency inflows. Another factor
favouring the depreciation of the rupee is a steep fall in the value of India’s trading
partners and competitors, which are South-East Asian countries. While direct trade
with these countries accounts for 15% of the total external trade of India, it competes
directly with 65% of India’s export basket, giving major competition to Indian exports

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in textiles (33% of the export basket), chemicals (12%) and manufactured metals
(10%). Recognizing the declining export competitiveness, a strong country like
Singapore, with sufficient foreign exchange reserves of $ 77.3 bln, bas allowed its
currency to depreciate by 24.6% over the years.
There’s only a perceived conflict between the need to hold the rupee’s
exchange rate steady to boost capital inflows and the need to improve the
competitiveness of experts through depreciation. Rather, by allowing the rupee to
remain overvalued the government could actually end up causing a pull-out of foreign
capitals this would affect profit margins of Indian industry, leading to a further
downturn in the capital market. So it is best to depreciate now and avert a crisis later.
Exporters have no business to ask for the rupee’s depreciation. Such orchestrated
currency valuations aren’t going to help in the long term, as these won’t increase
either the productivity or quality of exports.
What we need to do is work towards dependable quality rather than only call
for a depreciation. Even as the depreciation debate rages, ultimately reflects
underlying economic reality. It should be viewed as symptom rather than a cause of
an economy’s health or sickness. While the depreciation or appreciation of the
currency is partially anticipated, what offends most is the degree of the volatility.
Decision-making becomes even more risky in a highly volatile market. Exporters
move over the hedge and try to push back all remittances a hoping for better rates.
Importers move in hordes to protect whatever little they can. The resultant panic leads
to new lows everyday fuelling further hopes and fears. The decreasing liquidity and
increasing interest rates have placed FIIs in a Catch-22 position. Taking out the
proceeds will be difficult as a further fall in rupee will attract more stringent measures
from RBI, which so far have taken a cautious approach by not withdrawing suddenly
from the market. The FII funds outflow from the Indian market was limited to $ 155
mm in December 1997. FIIs, it seems, neither are taking out their funds suddenly nor
are willing to commit more funds to the Indian markets until the rupee stabilises.
Foreign direct investment which cannot be withdrawn, being illiquid, is also expected
to decline until the rupee stabilises. Global depository receipts’ income is
denominated in rupees in terms of dividend payments, and the underlying security is
the equity capital. Whether the stock market plunges or the rupee

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depreciates, GDRs are the ones to be hurt on both counts. The RBI intervention which
has been able to halt a fall in the rupee, has given a breather to GDR investors, but the
southward journey of the stock market continues to be a nightmare for investors,
1.3.2. PRIMARY MARKET:
The primary market is the IPO (Initial Public Offering) market.
If any Company wants to be listed on the stock exchange, they initially have to
come out with IPO. Upto June 1992, the primary market was under the control of CCI
(Controller of Capital Issues). But after Harshad Mehta scam in 92, all the authorities
has been transferred to SEBI (Security and Exchange Board of India).
Talking for the current or recent times, 1997 could rightly be perceived as one
of the worst year for the primary market. The number of offers that tapped the market
for subscription were at the pitiable figure of 128 through which corporate mobilised
Rs. 5032 cr. Compare these with 1445 issues in the year of 95, which mobilised Rs.
14577 cr. and 1183 issues of 96 raising as much as Rs. 12410 cr.
1.3.3 CAUSES FOR LESS NUMBER OF IPOS
(i) Absence of good issues: The fall of primary market is a direct result of the
absence of good issues and investors perceptive based on the past experiences that
allotments do not come by in good issues and even if they do get it, no reasonable
appreciation is expected.
(ii) Strict regulation by SEBI: After SEBI took over from CCI, the regulatory
focus underwent a major change. The regulatory body awoke from its slumber and
tightened the entry barriers, specially related with finance business.
As per the SEBI guidelines a manufacturing Company needs to have 3 years
dividend paying track record to tap the market. A new Company can come to market
only if it has 5% (of the project cost) participation of Fl’s/Banks in their projects. In
1997 share of manufacturing sector in total funds raised, has dropped down to 11%
from 42% in 1996 and 69% in 1995. On the other hand the financial institutions and
banks have been cornering a significant amount of funds mobilised. In 1997 almost
86% of the total mobilisation was done by IDBI and ICICI along with 6 other bank
offers. A probable reason for lack of manufacturing projects could be the possible
entry barriers.
(iii) Small investors are not taken care of Three years back markets were
flooded with issues of all sizes and from all types of Company Investors invested their
hard earned money in the hope of high returns. But contrary to their expectations,

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there were no buyers for their investments. The result, most of these companies do not
even find a quote in the market, leave aside no return to investments. To reduce the
cost. of raising capital, systematic efforts were made to drive away small investors
and attract large ones such as MFs, Ms. and FIIs. Thus, limits on minimum number of
shares to be applied were raised, the public offer proportion for small investors were
slashed and the firm allotment portion for large investors were hiked.
During the CCI regime Small investors and speculators used to get a sizeable
portion of new issues of allotment time. These used to be sold to big players. Under
the revised guidelines large investors got bigger chunk of new issues which they are
unable to sell in the market since investors with their limited individual capacity
cannot buy large offerings from large investors. Thus, small investors are forced to a
corner.
(iv) Unjustified premium: Under the revised SEBI guidelines, companies have
been allowed to fix their issue price. Most of the companies have taken undue
advantage of this freedom to fleece investors. They have charged heavy premiums.
Consequently prices of all such issues have crashed on opening of trading. Mdst of
the MFs are saddled with highly priced IPOs today. Hence all new issues are viewed
with suspicion.
(v) Dominance of DEBT offers: The interesting phenomenon noticed during
1997 was the dominance of debt offers. It is not just the primary market but on a
macro level also debt has taken a substantial lead as investment option in the year
1997. When the investors go out looking for lower risk options than equity, numerous
debt options available seem promising. Nearly 57% of the funds mobiised had been
from debt instruments, in 1997. This constitutes primarily four offers from the leading
institutions. From the market IDBI raised Rs. 1500 cr., ICICI mobilised Rs. 1100 cr.
in two trances (Rs. 800 cr. and 300 Cr.) and HUDCO Rs. 250 Cr. All the offers
succeeded in generating good response from the public.
(vi) Non-disclosure of necessary information: Many a times, companies which
are issuing shares through primary market doesn’t give necessary information to the
investors through prospectus and application form. The information carried may be
unreliable and false. In such cases, the honest investor who relies on the false data
may loose money in such companies if he invests in it. So, investors have become
very cautious against promoters who disappeared by over-night once offer issues gets
subscribed.

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1.3.4. SECONDARY MARKETS: CAUSES
(i) Badla: Although carry forward trades in “Contracts for the clearing” were banned
by the government in 1967, trading in specified shares for hand delivery contracts
were introduced in 1993.
The revised carry forward trading started on the USE on January 15th, 1996
and the JR. Varma committee proposed modified carry forward system. Forward, or
badla trading permits a transaction to be carried forward from one trading cycle to
next trading cycle (7 or 14 days).
(ii) Bad delivery: The math problem the secondary market is facing is that of
the Bad Delivery. Bad Delivery has created more problems on the BSE whereas less
on the NSE. The Bad Delivery transfers affect the investors as their funds are blocked
in the equity and they are not getting the possession of the shares. Sometimes due to
Bad Delivery, investors are not able to receive their dividends or some other benefits
on the shares. To collect this benefit they have to fight for the rights with the brokers.
(iii) Linkage of Indian stock markets with internationals: Many of the
foreign institutional investors in these markets (Hong Kong, New York) operate in the
Indian tharket also. Their investment in the Indian market are only marginal i.e., $9
billion or Rs. 30,000 crores, this is about 5% of the market capitalization. When
anything major happens in other countries where they exist, our domestic market
players act in anticipation of their reaction. So, when prices fall in the international
markets, everyone here starts selling in the anticipation that the foreign investors will
weli sell.
For example, when NYSE (DOW JONES), Hong Kong (Hang Seng) fall from
19th October 1997, Indian stock exchanges are also affected by the selling pressures
from the HIs,
(iv) Speculative market: Indian stock exchanges are mostly Speculative.
Most of the reading in the stock exchange is from speculation and in speculation most
of the investors make losses due to short term investments and due to making losses,
they keep themselves away from the stock exchanges and investments.
(v) Mutual funds values fallen more’ than the fall in market indices:
Mutual funds are not so active in the market. Many MF values have fallen more than
the fall in the market indices. It shows that the analysis and investment made by the
MFs are not fully in specified or fancy items but also in some non-fancy items which
have fallen more than the indices. The loss to the MFs ultimately leads to the loss to

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the small investors, in the falling market, MFs can better the market by reshuffling,
their investment
portfolios. But many of them don’t.
(vi) Institutional and retail investors are not active: in current situation,
most of the operations are dependent largely on the foreign investors. They are
marginal players and have only relative strength. This is mainly because of the Indian
investors, both institutional and the retail investors are not very active. FIIs have only
recently got the liquidity, but they not trading actively. MFs too are not very active.
(vii) Heavy selling pressures: Recently the market had fallen sharply because
of the heavy selling pressures after the meltdown in the South East Asian markets.
Since, India is not more isolated market, it also got the effect of the globalization
where all the investors are selling their holding. it was the pressure from the His who
have reduced their FPIs during the last month and the fresh FPI is stopped till the new
Government come. It is a wait and watch situation for them.
(viii) Volume: The volume of the stock exchanges have been reduced due to
the South East Asian crisis, Government instability, Rupee crisis, etc. most of the
investors remained away from the investments. The volume of the BSE and the NSF
had widely differed. NSF has an autonomous liquidity independent on any other
stock exchanges. It has an average daily volume of about Rs. 2000 crores during the
October. Because of its nationwide reach, the NSE does not rely excessively on any
one city. Mumbai contributes to 38% of the total volumes and the rest from all across
the country.
(ix) Trading cycle system: The trading cycle is differing from the stock
exchange to the stock exchange in India. In NSF, there is a weekly settlement cycle
and there is no ‘A’ Group, 81 Group, 82 group as compared to the 8SF. For selling a
share, people used to sell in the NSF as settlement is shorter and the pay-in and the
pay-out are also very fast whereas for purchasing the shares investors used to buy
from the BSE because of the delay in the pay-in period and longer settlement cycle.
There is no uniformly across the exchanges.
(x) Shares have undergone their face value: Around 2200 or 30% of the
total companies listed on the Bombay Stock Exchange (BSE) are being quoted below
par or Rs. 10 for more than a year, as evident from the 52 week high/low position of
BSE-listed companies.

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 The list includes mostly low and medium-cap small-sized companies from the
less fancied 82 group. The business range from steel, textile to cement, chemicals and
finance, Around 90 per cent of the companies in the sample had offered shares at par
while the remaining 10pe rcent made premium offers ranging from Rs. 10 to 53 per
share. These companies entered the market sometime during 1994 and 1995 in a
booming market, Buoyant market conditions encouraged the public to invest, a fact
reflected amply in the high listing prices these stocks achieved.
For example, Santogen Exports; the company was listed at a price of Rs. 125
on BSE, 400 per cent premium to the offer price (Rs.25). Others who offered shares
at par such as Tatia Skyline and Health Farms were also listed at an abnormally high
price of 113 and 11 times more than the offer price. Some like Ganipitak Yakshraj
cap lease and Odyssey Video Communication were listed at Rs. 97.50 and Rs. 85
respectively against an offer price Rs. 10 each. Their prices began plummeting soon
after listing. Though the performance of some of these companies was encouraging in
the past, in most cases, their financial status has deteriorated. As of now, even the
scrips are not traded regularly. Investors in premium issue have been bigger losers.
Needless to add, all these shares are quoted below par. Many of these companies, it is
felt will disappear over a period of time. Several companies have already been
delisted from the USE for non-payment of listing fees.
1.3.5. REMEDIAL MEASURES:
1. Large no of issues from strong promoters: The revival of the primary
market depends to a great extent on availability of the large number of issues from
strong parameters and an appropriate exit route. This can be possible only if the
regulators provide protection to investors against frauds.
2. Proper incentives to investors: To achieve faster revival, a trigger has to be
deployed. Incentives have to be provided to induce investors back into the capital
market. In the past MNC dilution was gobbled up by eager investors mainly, because
of the attractive valuation bright prospects and strong management. MNC’s can be
replaced by Indian navratnas and/or a few of the Indian blue chip companies. About 2
to 5% equity of these companies may be offered exclusively to the public at 20 to
30% discount to their current market prices.
3. Allotment of shares in De-Mat form: The new issues allotment of shares
may be made on the De-Mat form. For this purpose a few branches of banks in 10
important cities could provide facility for opening beneficiary accounts of investors

12
willing to subscribe to the proposed issues. This will help quick revival of the
primary market boost the de-mat process too. The proposed programme should be
spread over a period of time.
4. Offer should be at justified price: For getting more participation of small
investors pricing of the issues is of prime importance. High premium issues are
expected to get the lesser response from the retail investors. What can be counted for
returns is only the dividends if very minuscule amount and what remains is the
capital appreciation as major exceptions for booking returns.
For Example, the Bank of India which had come up with the issue in
December 1996 failed to sustain its offer price. The bank had offered its shares at Es.
45 which tumbled down to Rs. 41.
The pricing of issues have become very aggressive. Companies are pricing
their issues near the market prices which make the issues out of the small investors.
The issues pricehas to be at 20 to 30% discount than current market price.
5. MPs have to play aggresive or dominant role: Globally, in most markets small
investors are unable to subscribe to the new offerings directly. It is through MFs and
portfolio management scheme who have larger risk taking ability and also research
capabilities to facilitate better investment decisions. India also seems to be heading a
similar way. Rather than a small investor’s hard-earned money based on limited
information, the market may see more investments routed through funds with large
portfolio and diversified risks.
6. Share buy-back: The shares issued by the companies must by buy-back by
the companies for the safety of the investors. The necessary act has to be passed in the
law. Recently, when US market had collapsed, it was the announcement of the
aggressive share buy-back plans by few strong companies like Coke, Microsoft, etc.
that had changed investors sentiment and led to a continuing ball run.
7. Money and capital markets: The financial markets are mainly divided into
Money and Capital Markets. Money markets deal with assets created or traded with
relatively short maturity, less than a year. Capital markets deal with instruments
whose maturity exceeds one year or which lack definite maturity. Also in the financial
markets we have primary and secondary markets, which deals with issue of new
instruments and trading in an existing instrument and negotiable debt instrument.
8. Technological renewal of indian industry: The Government of India has to
organize technology missions to act as a catalysts in executing programes for

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technology renewal to start within existing thrust areas like textiles, leather, marine
products, gems and jewellery, electronics and software; and the items whose export
potential can be augmented such as food processing, horticulture and floriculture
industries. An orches- traded move from Government, Indian industry, foreign
technology sources and investors is necessary to improve productivity of Indian
industry and make it internationally competitive. Such technological renewal would
also improve the attractiveness of Indian equity for investment by foreign institutional
investors, policy move made to attract foreign exchange flows to the country. We
have so far dependent on demand driven stock markets in this regard.
9. Integration of capital markets policy with economic policy: The use of
portfolio investment to attract foreign savings has been adding to the excess demand
for equity shares of Indian companies. The bottom line of a large cross-section of
companies does not warrant the prices at which their shares are sold (ignoring the ups
and downs in the prices from time to time). Share prices (SENSEX) have reached a
high plateau, currently 3,500 from 1,700 at the start of reforms five years ago. Unless
the productivity of Indian industry is improved and costs are brought down to
international levels, genuine long term investment is likely to materialize. Otherwise,
the days are not far away that the punters will operate in the stock market that drive
up prices and case gains. For avoiding this, the shares have to be held for a year or
two for investment to have a desired impact in terms of motivating the managements
to achieve international standards in productivity and costs.
1.3.6. REFORMS MADE BY SEBI DURING 1996
A. Primary market:
• Norms for companies to access the capital market further tightened to improve the
quality of paper.
• First time issuers required to have a dividend payment record in three of the
immediately preceding five years.
• For issuers who do not meet this requirement, access to markets allowed, provided
their projects were appraised by a scheduled commercial bank or a public
financial institutions with minimum 10% participation in the equity capital of the
issuer or, provided their securities are listed on the OTCEI.
• No entry restrictions for public sector banks to access market, and they have been
allowed to price issues at a premium, with only a two-year profitability record.

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• A norm of 5 shareholders for every Rs.1 lath of fresh issues of capital and 10
shareholders for every Rs. I lakh of offer for sale prescribed as a initial and
continuing requirement.
• Prohibition was imposed on payment of any direct or indirect discounts or
commissions to person receiving firm allotment
• SEBI gave up vetting of public issue offer documents, if any, will be
communicated within 21 days of filing, as is the case with rights issues.
• Debt issues not accompanied by an equity component permitted to be sold entirely
by the book building process subject to section 19(2)(b) of the Securities
Contracts (Regulation) Rules.
• If minimum shareholding requirements of 90% minimum subscription in case of
“Offer of sale” no longer necessary.
• The 90% requirement also done away with in case of exclusive debt issue
subject.to certain disclosures and exemptions under the Companies Act.
• Housing Finance Companies considered to be registered for issue purpose
provided they were eligible for refinance from the national housing bank.
• Corporate advertisements, between the date of issue of acknowledgement card and
the date of closure of the issue have been allowed, subject to specific conditions
which include the disclosure of risk factors.
B. Secondary market: During 1996-97 SEBI took several initiatives to further
develop secondary markets. The Depositories Act, 1996 was enacted in July 1996.
SEBI (Depositories and Participants) Regulations, 1996 were modified. They are the
foundation of an institutional framework for minimising the problems associated with
handling of securities. They provide a legal framework to record ownership detail in a
book entry forum. Other secondary market reform were aimed at improving the
transparency and integrity of the market infrastructure and introducing uniform and
streamlined market policies. Some of these measures are listed as under
• Custodians required by SEBI to appoint a Compliance Officer who interact with
the SEBI regarding compliance and reporting issues.
• SEBI will have monthly meetings with the association of Custodial Agencies of
India (ACAI) before incorporating any changes that have an impact on settlement
of transactions of institutional investors.

15
• Stock exchanges asked to modify the listing agreement to provide for payment of
interest by companies to investors from the 30th day after the closure of a public
issue.
• Uniform good bad delivery norms and procedures for time bound resolution of
bad deliveries through Bad Delivery Cell prescribed. Bad Deliver Cell procedure
have helped to standardize norms.
• All exchanges to institute the buy-in or auction procedure being followed by the
National Stock Exchange.
• In view of the falling % of deliveries, exchanges asked to collect 100% daily
margins on the national loss of a broker for every scrip, to restrict gross traded
value to 33.33 times the brokers base minimum capital and to impose quarterly
margins on the basis of concentration ratios.
• Study group constituted to make recommendations for imparting greater
transparency and fairness in bulk negotiated deals.
• Stock Exchanges asked to set up a clearing house or clearing corporation.
• Stock Exchanges disallowed from renewing contracts in cash group of shares
from one settlement to another
• A core group for inter-exchange market surveillance set up for co-ordinating
action in case of abnormal volatility
• The Stock Exchange, Mumbai and other exchanges with screen based trading
systems allowed to expand the trading terminals to locations where no stock
exchange exists, and to other subject to an understanding with the local stock
exchange. The setting up to trade guarantee scheme or clearing corporation,
mechanisms to handling investors grievances arising from other centres and
adequate monitoring mechanics will be a prerequisite.
• Several restrictions, including limits on the size of issues proposed to be listed on
OTCEI removed, and listing criteria for OTCEI, relaxed. Besides, OTCET
permitted to move to a five-day accounting period settlement.
• Both, short and long sales will have to be disclosed to the exchange at the end to
each day. They would be regulated through the imposition of margins.
• A stock lending scheme has been introduced. Stock lending has been approved
in which short seller s can borrow securities through an intermediary before

16
 making such sales. The approved intermediary should have minimum net worth of
Rs. 50 crore.
1.3.7 ACTIVATING DEBT MARKET IN INDIA
Role and significance
Debt market, otherwise called the Fixed Income Securities Market apart
frombeing a source of funds for the corporate sector plays the role of generating the
level and term structure of interest rates or the yield curve. In a liberalized financial
system, the changes in the shape of the yield curve and also the relative shifts in the
yield curve have come to signify the market expectations about real sector activity
and inflation rates. In the absence of a vibrant and liquid debt market, emergence of a
market determined yield curve becomes well any impossible, impairing the efficiency
of financial markets, including the foreign exchange market. Therefore, development
of an active debt market is vital for financial market efficiency.
2. More often, growth in size and activity of debt market is viewed as a
reflection of poor performance of equity market and therefore the equity and debt
markets are treated a s competing with each other. On the contrary, the growth in size
of debt market is rather complementary to equity market development in as- much as
the augmentation of risk of equity capital propels the debt market debt capital cannot
grow beyond a limit without the support of equity capital, due to constraints on
leverage. Furthermore, since equity alone cannot meet the demands of investor
preferences, debt market also plays a significant role in mobilising savings and thus,
enhancing capital formation,
3. Economists classify the financial development of markets broadly into three
stages (1) Bank oriented stage, (2) early capital market oriented stage, and (3) highly
capital market oriented stage. In the first stage, the banks and development financial
institutions contribute to a significant part of capital formation and development. In
the second stage, the capital market development in the form of issues of equity and
debentures starts playing a role meeting a part of the financing needs and in the third
stage capital market becomes a major source of financing long-term funds
requirements. The nature of banking business also undergoes a change from
commercial banking to universal banking with investment banking assuming a role.
4. Recent years have seen significant transformation in the debt market in
India with far reaching policy implications. At present India’s debt market is one of
the largest in Asia next to Japan and Korea. The debt market in India is

17
conventionally classified into three segments, viz. (i) Government Securities Market,
(ii) Public Sector Units (PSU) Bonds Market and (iii) Corporate Debt Market.
5. Within the bond market, the significance of Government securities market
would depend upon the fiscal policy stance towards deficits. Among the Asian
economies, in Korea and Indonesia for example, the predominant segment is the
corporate bond market. This is because the Korean Government does not normally
run a fiscal deficit and in the case of Indonesia, Government is precluded by its
Constitution from issuing bonds in domestic markets. In Korea, bonds guaranteed by
banks have gained prominence. However, in both Korea and Indonesia, the Central
Banks issue securities for monetary stabilization purposes. In our country, the
Government securities segment has remained predominant due to large Government
deficits. The relative share of non- Government bonds is likely to tick up in the
coming years with the Government’s policy to bring down the fiscal deficit and
opening of the financial sector.
6. Even so, given the magnitudes, Central to the development of debt market
in India would be the development of the Government securities market. In fact, the
Government securities market not only provides resources to Government but also
enables pricing of other debt instruments of varying risk perceptions. Market
Dimensions The outstanding securities of the Government Sector (Central and State
Government as on March 31, 1997 amounted to about Rs. 3,50,000 crore. Similarly,
outstanding corporate debt, inclusive of private placement, could be around Rs.
1,10,000 crore. Of the outstanding corporate debt public sector accounts for about 15
per cent. Since 1996-97, the Government sector (Centre and States) mobilised Rs.
42,688 crore as compared to Rs.46,783 crore in 1995-97. The PSU bonds, through
public issue and private placement mobilised Rs. 3,394 crore in 1996-97 and Rs.
2,291 crore in 1995-96. Private sector bonds and debentures amounted to Rs. 6,731
crore in 1996-97 and Rs. 8,041 crore in 1995-96.
The Wholesale Debt Market (WDM) segment of NSE witnessed phenomenal
growth during 1996-97 with the inclusion of several new categories of securities viz.,
subordiarket; nated debt bonds issued by banks, Units 64, Promissory Notes issued
by corporates and cumulative bonds issued by public sector undertakings (PSUs).
The number of instru ments available for trading on WDM increased to 657 as at
end-March 1997 from 456 a year ago. The market capitalisation of these instruments
aggregated Rs. 3,29,172 crore by end-March 1997 indicating a rise of 42.7 per cent

18
over the level at end-March 1996. The average daily volume during 1996-97 was Rs.
145 crore as compared with Rs. 41 crore in the previous year. The Government dated
securities and Treasury Bills accounted for nearly 90 per cent of the total turnover of
WDM during 1996-97.
The monthly average turnover in outright transactions in Government
securities, as reflected through Subsidiary General Ledger (SGL) Accounts in
Mumbai, accounting for bulk of transactions, showed a substantial improvement
during 1996-97 recording a little over three fold increase to Rs. 7,827 crore. The
monthly average volume of outright
transactions showed a significant jump to Rs. 12,403 crore in the first three months of
1997-98 due to aggressive trading driven by the expectations of falling interest and
inflation rates. The institution of Primary Dealers have partly contributed to this trend,
besides easing of money market conditions and lower interest rates which encouraged
banks to trade in large volumes.
Recent developments in government securities market: With these
preliminary remarks on the role, importance and the dimensions of debt market in
India, I would now turn to trace some of the recent developments. Till about the
middle of 1991-92, the Government securities market remained almost dormant
characterised by a passive internal debt management policy with borrowing at pre-
announced interest rates, targeting a captive group of investors. This coupled with
automatic monetisation of budget deficit prevented a deep and vibrant Government
securities market. As an active Government securities market is a precursor for an
integrated financial market Reserve Bank and Government of India have undertaken
series of policy initiatives towards (a) Instrument development (b) institutional
development and (c) strengthening market transparency and efficiency with particular
reference to secondary market development.
Instrument Development: Since 1992, Central Government borrowings have
been undertaken at market related rates, primarily through auctions of Government
securities of different maturities. The new instrument of 364 day Treasury Bills
through auctions was introduced in April 1992. The auction system for the sale of
Government of India dated securities was introduced in June 1992 and for 91 day
Treasury bills in January 1993. Consequent upon the primary market acquiring depth
with market related rates, some innovative instruments were introduced viz.,
conversion of auction Treasury Bills into term security, Zero Coupon Bonds, Tap

19
Stocks and partly paid stocks. During the current fiscal year with the discontinuance
of ad hoc and 91 day tap Treasury Bills, a scheme of 14 day Intermediate Treasury
Bills was introduced to enable State Governments, foreign central banks and other
specified bodies with the Reserve Bank has an arrangement to invest their temporary
surplus funds. Coupled with this, it was decided in August 1997 to issue Treasury
Bills of varying maturities to facilitate better cash management for the Government as
also the investors. Accordingly a new instrument called 14 day auction Treasury Bill
has been introduced since June 6, 1997. Introduction of Capital Indexed Bond as a
hedge against inflation has been announced.
Institutional development: With a view to developing an efficient
institutional infrastructure for an active secondary market in Government securities
and public sector unit bonds, the Securities Trading Corporation of India (STCI) was
set up in May 1994 which commenced its operations in June 1994. Furthermore, in
order to strengthen the securities market infrastructure, improve secondary market
trading, liquidity and turnover and encourage voluntary holding of Government
securities amongst a wider investor base, a system of primary dealers (PDs) has been
operating since March 1996 with S x PDs offering two way quotes with bidding
commitments in the auction of dated securities and 81/364 day Treasury Bills. A
scheme for payment of underwriting fees of primary dealers was introduced in June 2,
1997 replacing the earlier system of payment of commission on primar’ purchases of
PDs. All auctions conducted since June 2, 1997 fall under the now scheme. In
addition, with a view to broadening he market with a second tier of bealer system and
imparting greater momentum in terms of increased liquidity and turnover, guidelines
for Satellite Dealers (SDs) were issued in December 1996. The scheme for approval
for both Primary and Satellite Dealers has been made as an on going process.
The guidelines for the scheme of liquidity support to mutual funds dedicated
exclusively to investments in Government securities, either by way of outright
purchases or reverse repos in Central Government securities outstanding as at the end
of the previous calendar month were issued on April 20, 1996.
Recently, it has been decided to allow the Foreign Institutional Investors (Fis)
in the category to 100 per cent debt funds to invest in dated Government securities.
This is expected to encourage further flow of foreign capital in to Indian capital
market and help bridge the gap between domestic savings and investment in a more

20
cost effective manner and also to provide more depth and liquidity to the Government
securities market.
Strengthening market transparency and efficiency: Several policy
measures have been undertaken to strengthen the market transparency and efficiency.
They are ( larger percentage of marked to market valuation of investment portfolio of
the banks (ii) Delivery versus Payment (DVI’) System, (110 publication of SGL data
(iv) changes in strategies of open market operations and repo auctions (t’)
liberalisation of policy on banks’ investments (vi) rationalisation of underwriting
Commission/fees for Primary Dealers (vii) abolition of Tax Deduction at Source
(TDS) on interest income from Government securities.
Investments in Government and other approved securities by banks are
classified into ‘Permanent’ and ‘Current’; while permanent category securities are
permitted to be valued at cost, the current category securities are to be ‘marked to
market’. As a step towards moving to a fully marked to market basis of valuation of
investments, the current category securities are required to be increased to 60 per cent
for the year ending March 1998.
In order to ensure settlement by synchronising the transfer of securities with
the cash payment, Delivery versus Payment (DVI’) system has been introduced in
Mumbai with effect from July 1995 in dated securities and February 19% in Treasury
Bills and the system has been extended to all Public Debt Offices by May 1996.
Greater transparency has been introduced since September 1994 with publication of
transactions in Government securities recorded by Reserve Bank under SGL
Accounts.
Monetary and credit policy: implications for debt market Open Market
Operations (OMO) including repo operations have been emerging as a principal
indirect instrument. With a view to broad basing the repo market, as part of the
Monetary and Credit Policy for the first half of 1997-98, it was aimounced that repo
facility will be extended to all dated Government of India securities and that non-bank
entities who are holders of SGL Accounts with Reserve Bank of India will be allowed
to enter into reverse repo transactions with banks and primary dealers. With the
addition of securities, the total volume of eligible securities would increase by
Rs.1,09,400 crore to Rs. 2,14,300 crore. This is expected to provide further depth to
the repo market.

21
 In a move to augment the stock of marketable securities for active Open
Market Operations (OMO), special securities at 4.6 per cent of value aggregating Rs.
20.000 crore were converted into marketable securities of 10-years, 7-year, 8-year and
5-year maturities at 13.05 per cent 12.59 per cent 11.19 per cent and 11.15 per cent on
June 3, June 18, August 12, and September 1, 1997 respectively Repo auctions were
resumed by the Reserve Bank effective November, 1996 and were effectively used for
money market interventions with répo periods of 3 and 4 days. The daily average repo
amount outstanding worked out to Rs. 2,942 crore upto August 25, 1997 at repo rates
ranging between 2.4 per cent and 5 per cent.
In the recent past, policy on banks’ investments in PSU bonds/ private
corporate debt has been considerably liberalised, taking into account the increased
market preference for these instruments vis-a-vis bank credit. Banks had been allowed
to invest in debentures/bonds/shares of private corporate bodies and PSU shares upto
5 per cent of their incremental deposits in the previous year. Within this ceiling, banks
were later allowed to purchase such debentures/bonds/shares in the secohdary market.
As pert of the Monetary and Credit Policy for the first half of 1997-98, it was further
decided to exclude from the limit, investments in preference shares/debentures/bonds
of private corporate bodies. In other words, the limit is now applicable for
investments only in respect of ordinary shares of corporates including PSUs.
During 1996-97 banks’ investments in bonds/shares/debentures of public
sector undertakings (PSUs) and private corporate sector and commercial paper
increased by Rs. 6,577 crore compared with a decline of Rs. 164 crore in the previous
year. This trend continued during the year 1997-98 with banks’ investments in these
instruments increasing substantially by Rs. 5,774 crore upto August 15,1997 as
compared with Rs. 1,598 crore during the corresponding period last year.
Abolition of tax deduction at source (TDS): It may be recalled that Tax
Deduction at Source (TDS) at the time of payment of interest on Government
Securities combined with the market practice of notionally deducting ‘voucher’ or tax
accrued for broken periods in secondary market transctions led to the unhealthy
practice of ‘voucher trading’ around interest payment dates merely to gain tax
advantage. The differential rates of tax applicable to different investors, as also tax
exemptions granted to certain institutions, have provided an opportunity for such
trading. This practice remained unhealthy because the buyer gets a benefit not
legitimately due to him. Furthermore, prices for Government Securities quoted in the

22
secondary market were not clean, since voucher element got loaded into the price;
calculation of yields on Government Securities got distorted with voucher-loaded
prices. As a part of the kudget announcement of 1997- 98 Government has exempt
interest income on Government Securities from the provision of Tax Deduction at
Source fEDS) under Section 193 of Income Tax Act, 1961 with effect from June
1997. Abolition of TDS has facilitated quotations at ‘clean pricest and genuine trading
in secondary market.
Impact of reforms: The series of policy measures had several beneficial
impacts on the system in terms of (a) greater market absorption of Government
securities with lower devolvements on RBI, (b) helping competitive pricing of
securities (c) market responsive yield curve and (d) increased attention by investors to
treasury management and interest rate risk management.
The market acceptance of Government securities at market related rates has
considerably helped to reduce the extent of devolvement on Reserve Bank of
Government securities in primary issues. The Reserve Bank’s absorption of primary
issues was 13.3 per cent and 16.6 per cent in 1996-97 and 1997-98 till August,
respectively, as against 32.6 per cent in 1995-96 and 45.9 per cent in 1992-93.
An elastic band of interest responsiveness from the investors as part of active
investment management, to a range of maturities is an important step in the process of
competitive pricing of securities in primary and secondary markets. Auctions have
contributed to the development of bidding skills among banks and institutions. Banks
are paying special attention of investment desks as centres of profit.
It is pertinent to note that a consequential impact of competitive pricing of
securities has been the shifts in yield curve reflecting changing liquidity conditions
and market expectations about interest and inflation rates and also exchange rates. In a
highly liquid market the yields in secondary market should anticipate the yields in
primary issues emerging from time to time. However, depending upon the demand-
supply balance in different maturities and the liquidity conditions in the system, there
could be small civergences between the two yields. The recent trends show that
because of high liquidity in the secondary market for Government securities of varied
maturities, there had been a convergence between the secondary market yields and
market expectations about the primary yield. This had also enabled a more efficient
price discovery process.

23
 For the Government securities yield curve, to have impact upon the pricing of
other debt instruments in the market, the various segments in the money and capital
market should remain will integrated, with level playing field for all the market
participants. The behaviour in Government securities market shows that .the yields of
short-term maturities upto around three years showed significant sensitivity to call
money market rates.
The open market operations including repo auctions have come into sharp
focus during 1993-94 and 1996-97, given the imperative of neutralising the excess
liquidity generated from the build up of the foreign exchange reserves as well as the
need for rates of interest and exchange rate to rule at reasonable levels. Reflecting
this, net sales of Government securities during 1993-94 and 1996-97 amounted
respectively to Ks. 9,047 crore and Ks. 10,435 crore as against Ks. 583 crore in 1995-
96. During 1997-98 upto August 8, 1997, the net sales amounted to Ks. 2,061 crore as
against Ks. 1.186 crore during the corresponding period of the previous year.
Easy liquidity conditions coupled with aggressive trading in secondary market,
resulted in the significant softening of interest rates on securities across the maturity
spectrum especially at the shorter end of the market, beginning in 1997. For example,
the weighted average coupon rate on Government of India dated securities has
declined to 12.19 percent in 1997-98 (upto August 29,1997) from 13.69 per centin
1996-97, Similarly, the weighted average cut-off yield rate on 364 day presury this
has come down from 12.16 per cent at end March 1997 to 9.25 per cent at present,
The decline is more perceptible in 91 day Treasury Bill weighted average cut-off
yield which came down from 9-27 per cent at end March 1997 to its present 6.75 per
cent.
The above trend was slightly reversed on September 1, 1997 when a cut-off
yield was 11.15 per cent on five-year Government paper as against a cut-off yield of
11.19 per cent for a 8-year Government paper issued on August 12. 1997.
Nevertheless, it may be notd that the rate on five-year was distinctly lower than last
year when the rate was 13.5 per cent on five-year bond.
The system of Primary Dealers (PDs) which has been operating since March
1996 with six Pl)s offering two-way quotes and with bidding commitments in the
auctions of 91 day/364 day Treasury Bill as also in the floatations of new loans has
provided the necessary fillip to activate the Government securities market. For the
year 1997-98, all PDs have given a bidding commitment of Ks. 12,600 crore in

24
Treaury Bills and Ks. 14,700 crore in dated securities. The limits for liquidity support
Primary Dealers aggregating Ks. 3,710 crore have been granted for 1997-98. During
1997-98 (upto September 4, 1997), the devolvement on Primary Dealers aggregated
Ks. 1,903 crore in Government of India dated securities and Ks. 981 crore, the
Treasury Bills.
The new scheme of paying underwriting fee should promote an element of
healthy competition and the Primary Dealers should take this as an incentive available
to them to market and also meeting inter-temporal mismatches in supply and demand
in the market for securities. They should ensure that the efficiency of price discovery
process is not distorted through the element of underwriting fee being built into their
direct deals with final investors.
Agenda for further reform: Now, it will be proper to flag some specific
issues which would be of interest for discussion and help in formulating an agenda for
further reforms.
Auction system: The auction system for the sale of dated Government
Securities is relatively new in India dating from June 3, 1992. This has enabled the
emergence of a diversified investor base, an awareness among investors of market
risks inherent in bond markets and thereby bringing about a qualitiative change in
investment management function of market agents, in particular banks, insurance
companies and provident funds.
The multiple price auction which at present is practiced in India is the most
popular method since every bidder gets allocations according to their bids quoted and
apparently the issuer collects a premium from all bidders quoting lower than the cut-
off yield. Although, the uniform price system eliminates the problem of “winners’
curse”, it is not very common for sale of Government Securities. One point that has
not, however, been
resolved is the question of cost. According to one view, the multiple price system is
more cost effective for the Government as the Government can sell bonds at a low
yields and collect premium for the bidders with quotes lower than the cut-off yield.
According to another view, however, multiple price auction actually leads to low
revenues as bidders tend to shade their bid price to avoid the ‘winners curse’.
Currently, most major countries follow multiple price system. These countries are the
U.S.A., the U.K., Germany, France, Japan, New Zealand and Australia. Switzerland

25
and Denmark, however, follow uniform price system. Italy follows multiple price
system for Treasury Bills (upto 1 year maturity)
but, uniform price auction for medium and long term bonds (i.e., of 2 years or more
maturity).For sometime, the United States, the U.K. and Germany experimented with
uniform price system but, later have given up this method. Germany switched from a
uniform price auction to a multiple price auction system because uniform price system
had resulted in small banks placing very high bids as this gave them sure access to
liquidity without the rusk of having a significant impact on the price to be paid. If the
current Seminar can throw some further light on this aspect it would be useful,
Non-competitive bids: Another important issue is the practice of entertaining
non-competitive bids and allocating amounts to non-competitive bidders on the basis
of the weighted average price. It is pertinent to note that the practice of accepting non-
competitive bids is prevalent in countries like U.S.A., the U.K. and Italy. Competitive
bidders are usually financial intermediaries who buy in large volumes and possess
expertise in financial investment. Non-competitive bidders are usually small and/or
inexperienced bidders. The country practices, thus, show that the non-competitive
bidders are made allocation within the notified amount. The procedures relating to
non- competitive bidding could be another point for discussion.
Diversification of investor base: A critical step in the direction of improving
liquidity in government securities would be the diversification of investor base to the
non-traditional investor groups like individuals, firms, trusts and corporate entities.
The level of diversification achieved in equity and private debt market has not yet
penetrated into the Government securities market. As per the present ownership
pattern, the Government securities are predominantly held by banks, financial
institutions and provident funds. For example, investments by scheduled commercial
banks in Government securities, currently showed a quantum jump with an increase
of Rs. 26,860 crore during 1996-97 as compared with an increase of Rs. 14,542 crore
during 1995-96. The diversification of investor base is also important for the reason
that only under such circumstances can there be an active market with investors’ need
to buy and sell not being in the same direction at various points in time. This
condition is nbt well met, when the investor base is narrow and where seasonal
demand for funds is more cr. less identical. Some of the possible measures to
diversify the investor base are: Primary Dealers could make special efforts in
marketing these securities. The investors should be made aware of the special

26
attributes of Government Securities in terms of safety, liquidity, return and
availability of loans from banks against them. Dedicated gilt-funds could be set up by
mutual funds. While there are several public and private sector mutual funds, their
concentration has been on income and growth oriented schemes focusing essentially
upon the equity market. There are investors who attach greater importance to safety
and liquidity factors. There is thus enormous scope to attract such investors through
pure gilt-funds. As a step in the above direction, Reserve Bank announced as part of
its credit policy for the first half of 1996-97, liquidity support to dedicated gilt-funds
and retailing of Government securities by banks. The Reserve Bank has decided to
permit banks with effect from June 8, 1996 to undertake retailing of Government
securities with non-bank clients. Government could consider extending fiscal
incentives, particularly to investment in Gilt funds by retail involators.
Major commercial banks with wide branch network have a crucial role in
marketing Government Securities to retail customers. Reserve Bank of India has
already made available the facility of a second SGL account to commercial banks to
enable them to hold Government Securities, on behalf of their customers, in safe
custody in dematerialised book entry form. This has been done so that retail and
institutional investors have access to a user-friendly system for holding
GovernmentSecurities in scripless form. The feedback that the RBI has received is
that many of the larger bank with country-wide network have yet to make this facility
available to their branch customers. Banks should take appropriate step in this
direction as it will then encourage retail investors to invest in Government Securities.
Settlement system and repo market: The secondary market can acquire
depth only with an efficient transfer, payments and settlement system and as such the
procedures should ensure that transaction costs are low. In the government securities
market, (Delivery Versus Payment) DVI’ system through the SGL Accounts has been
put in place. In the PSU bonds market as well as the private corporate bonds market
the depositories and settlement systems are yet to be made completely operational.
Furthermore, since the stamp duty on transfer of bonds/debentures falls under the
domain of State Governments it is subject to different regions in different States. It is
important to examine the scope for rationalisation of stamp duties in the interest of
activating secondary market in such instruments.
With operationalisation of the National Securities Depository Limited
(NSDL), it was expected that a sizeable stock of private debt instruments and Public

27
Sector Units/bonds would be dematerialised and covered by a secured payments and
settlements’ system. At present NSDL, is able to dematerialise only those scrips
which are exempt from stamp duty and those which are transferable by endorsement
and delivery. As most bonds and other corporate debt instruments are not exempt
from stamp duty on transfer of bonds, NSDL has expressed difficulties in
dematerialising them since in the automated environment of the depository, it is not
possible for them to keep, a track of such transfers and duty payable on them. NSDL
has, therefore viewed that unless the issue of waive of stamp duty on transfer of debt
instruments is settled with the State Governments, NSDL will not be in a position to
extend its services to bonds and other private debt instruments. However, since NSDL
is located in Mumbai and a large part of transactions take place in Mumbai, suitable
amendments to stamps duty regime by Governments of Maharashtra in the form of
one time levy or a consolidated fee payable by NSDL could resolve the issue to a
significant degree.
While DVI’ system in Government Securities transaction has eliminated
settlement risk through SGL accounts, putting in place such risk-free transfer
payments and settlements in respect of other debt instruments like PSU bonds and
corporate debentures can pave way for the resumption of repos in these instruments.
When issued market: Currently, market participants cannot undertake to
enter into firm commitments to trade in a Government paper to market participants
prior to an auction. In fact, ‘short selling’ of securities is prohibited under the
Securities Contracts (Regulation) Act, 1956. There is a view in the market in favour
of introducing ‘when issued’ market which requires a Government notification to this
effect. This is expected to enable market participants to trade in a security in the
market well before its actual date of issue, after the announcement about the issue. It
may be useful to deliberate on the usefulness of such a notification at this juncture.
Private placements: As regards the PSU and corporate bonds market another
crucial issue relates to the large volumes of private placement. In recent years private
placement has emerged as an important vehicle or raising resources by banks,
financial institutions and public and private sector companies. For example, during
1996-97 private placements increased by 12.8 per cent to Rs. 15,066 crore accounting
for as much as 49.1 per cent of total resources mobilised by the government and non-
government companies. Interestingly, the public sector has become a major user of
private placements. In private placements bonds have emerged as the most preferred

28
instrument. Further, the private placement market has been witnessing the
introduction of several innovative debt instruments such as step-down/step-up
debentures, liquid income debentures, subordinate bonds etc. The popularity of
private placement method could be attributed perhaps to lower issuance costs and
saving on issue management time lag, apart from the fact that private placement has
not been coming under the strict regulatory provisions applicable to public issues. The
issues such as inclusion of disclosure equipments in the memorandum of information,
protection of investors’ interests, transparency in the event of retailtig private
placement issues etc. may require a closer look in the interest of improving
information efficiency and avoiding problems arising out of information asymmetry
in the bonds market.
Capital Market deals with following instruments. All the instruments, as
already explained, are issued or subscribed in Primary Markets but are traded in
Secondary Market. In other words they are traded on the follow of Stock Exchange.
Table 4.1. Capital Market Instruments

However, definition of different kinds of Debentures are outlined below for under-
standing.
(1) Secured Debentures: These Debentures are secured against assets of
the Company. For the purpose a trustee for Debenture holder is appointed along with
issue of Debentures.
Trustee member look after the regular payment of interest and payment of principle
at the time of redemption. In case of non-payment, the assets can be disposed of to
satisfy the repayment of Debenture holder. Thus the investment of Debentures holder
are secured.
(2) Unsecured Debentures: In contrast to above, these Debentures are not
so secured.

29
 (3) Fully Convertible Debentures: They are issued as debentures but are
converted into Equity share capital after a certain period mentioned during the time of
issue of such debentures.
(4) Partly Convertible Debentures with/without buy back facilities: They
are converted into Equity shares partly and the balance part are not converted into
equity. This later part which are not so converted are redeemed after a specified
period to time. At the time of issue of such Debentures, there is specific mention in
the Debenture Application Form that the portion of debenture which is not being
converted into Equity can be sold by Applicant (if debenture is subsequently allotted
to them) instantly at a specified price (Normally at a discounted price). This is called
partly convertible debenture with buy back facilities. When such buy-back offer is not
made, naturally, they are called partly convertible debentures without buy-back
facilities.
(5) Non-Convertible Debentures: They are not converted into Equity
Capital and are redeemed after a specified period.
(6) Zero interest Bonds: All Debentures are issued with a mention of
Interest Rate which will be paid yearly or half-yearly. But recently in India, this form
of Debentures have been introduced. This is generally issued in case of Debentures
which are converted fully into Equity Shares after a specified period. In the
expectation of having Equity Shares in place of Debentures, the investors forgo the
interest. This helps the Company to easily service their equity in a better way since
no interest is paid against debentures for certain period.
Bearer debentures: They are debentures where name of holder of such
debentures are not available in the register of the Company. If the original holder of
such debentures whose name is registered with the Company subsequently sells them
and buyer does not register his name but sell to another buyer, name of such
subsequent buyers does not appear in the register of the Company, for the reasons
‘explained’. Such debentures are called bearer debentures which can be transferred
by mere delivery. This is in contrast to registered debenture where name is registered
in the company’s register.
1.3.8 GOVERNMENT GUDIDELINES ON DEBENTURES:
The guidelines have distinguished between convertible and non-
convertible debentures. The interest rate of non-convertible debenture is 15% p.a. and
similar rate for convertible debenture is 12.5%. In both the cases, those are the upper

30
ceilings. For a non-convertible debenture, a premium upto 5% on repayment may be
allowed. The debentures can be . put to use for diversification or expansion of any
project or for arranging long-term working capital.
Advantages of Debentures
(a) Since the debentures are for specific period, the Cash-flow projection can
be organIsed.
(b) It helps raising finance without any threat of losing control on the company
as in the case of equity issue.
(c) For an investor who is security-minded with eye for steady return, this
offers an excellent opportunity.
(d) Debenture is cheaper, as a source of finance, than equity because interest
on debenture is allowed as admissible expenditure for tax purpose.
1.3.9 FACTORS TO BE CONSIDERED WHILE CONVERSION OF
DEBENTURES
1. Effect of conversion on the earning per share on the expanded base of Equity
Capital.
2. Interest, on Debentures being an allowable taxable deduction, the effect of
such disallowance after conversion on the overall profitability of the company.
3. The effect of revised Debt/Equity ratio (on conversion) on cost of Capital.
4. The threat of lose of control on the Company because of loss of required stock
on conversion. This arises if along with existing percentage of equity holding
if some other promoter increases his stock by purchasing convertible
debentures from the market. If the convertible debentures are registered by
transfer,it automatically entitles the holder,the right to get equity. The question
of refusing transfer under Section 108 of Companies Act does not arise,
5. The effect of Conversion on the share price in the market.
6. In the case of restructuring of Capital base of the company, it may be
advisable to convert debenture into equity specially in case of company
suffering loss for last few years. This will reduce the interest burden of
debenture and may allow the company to earn cash profit. However, in such
cases the expanded base of equity Capital will also have to be considered.
1.3.10 ROLE OF CONVERTIBLE DEBENTURE IN AUGMENTING EQUITY
CAPITAL:

31
 Convertible Debentures are debentures which are issued with the
condition that after a certain period of time as mentioned in the document of such
issue, they will be converted to equity. Until such time so long it is not so converted
into equity, it is similar to any other debt instruments of long term nature.
As we know, there are two types of convertible debentures. They are,
Partly Convertible Debentures and Fully Convertible Debentures. In the case of
former, only a portion of the debenture, as mentioned in the documents of issue, is
converted into equity. The balance remains non-convertible and is redeemed after a
specified period. In contrast, as the name goes, Fully Convertible Debentures are
converted fully into Equity after a specified period. As an instrument in the Capital
Market, Convertible Debenture played so far significant role in raising finance in
recent years. Since this instrument is generally issued by Companies with good image
and consistent growth rate, they are issued at a premium. This helps the company to
increase the book value of the shares since the premium adds to the Reserve of the
Company. Besides, the investors are lured with their fancy of having equity shares
after a certain interval. Because of the fixed Interest element in the convertible
Debentures until converted, it offers a cheaper source of finance than equity in view
of the fact that interest is admissible expenditure in Income Tax whereas dividend is
not as in case of equity. Moreover, since the equity increases only on conversion of
Debentures after a specified period of time, the existing shareholders has the change
Of having a better earning per share (until conversion takes place) on earlier relatively
small equity Capital base.
The Convertible Debentures are generally issued for diversification and
exp4nsion projects. It is obvious that some gestation period of one to two years is
needed before the new project starts commercial production and yields profit. If the
timing of conversion into equity is so made that is matches with the timing of
commencement of commercial production of new project then even the enhanced
base of equity on conversion of Debenture does not affect the earning per share of
existing shareholders. In such case, the market price of shares remains firm. This
aspect also contributes to the craze of marketing the convertible Debenture as a source
of raising long term finance. Besides, during gestation period of the new project, it
provides the investors a safety value affixed interest on Convertible Debentures. 1
1.3.12 SUMMARY

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 Capital market is a market for long term funds where the long funds are
raised using shares, debentures, bonds etc., political factors and economic factors such
as economic slow drain rupee instability are the major determinant of capital market.
The primary market is regarded of Initial public offer (IPO) SEBI has made capital
market reforms during 1996. In India, the debt market has also been activated and the
performance in satisfactory.

LONG-TERM SOURCES OF FINANCE

Unit Structure
1.1 Introduction
1.2 Learning Objectives
1.3 Section title
1.3.1 Source of Capital
1.3.2 Long tern capital instruments
Ownership securities
Creditor-ship securities
1.3.2.1 Equity Shares
Advantages of equity share capital
Disadvantages of equity share capital
1.3.2.2 Preference shares
Types
Merits
Demerits
1.3.2.3 Debentures
Types
Merits
Demerits
1.3.2.4 Different modes of capital issues
Public issue
Private placement
Right issue
Bonus issues
SEBI Guidelines for public issues

LONG-TERM SOURCES OF FINANCE

33
 In this unit you will learn instruments of raising long-term capital (equity
shares, preference shares and debentures), significance of different modes of issue of
capital instruments (public, right and private placement), term lending institutions and
borrowings and public deposits as a means of long-term capital.
1.1 INTRODUCTION
Long-term capital is capital with maturity exceeding one year. Long-term
capital is used to fund the acquisition of fixed assets and part of current assets. Public
limited companies meet their long-term financial requirements by issuing shares and
debentures and through borrowing and public deposits. The required fund is to be
mobilized and utilized systematically by the companies.
1.2 LEARNING OBJECTIVES
On going through this lesson, you will be conversant with:
• The various sources of long term capital
• The different types for long term capital instruments
• Merits and demerits of equity and preference share capital
• Different types of debentures and their merits and temerity.
• Different modes of capital issues
• SEBI Guidelines on public issues.

3.1 SECTION TITLE

1.3.1 SOURCES OF CAPITAL
Broadly speaking, a company can have two main sources of funds. internal
and external, Internal sources refer to sources from within the company External
sources refer to outside sources.
Internal sources consist of depreciation provision, general reserve fund or free
reserve — retained earnings or the saving of the company. External sources consists
of share capital, debenture capital, loans and advances (short term loans from
commercial banks and other creditors, long term loans from finance corporations and
other creditors). Share capital is considered as ownership or equity capital whereas
debentures and loans constitute borowed or debt capital. Raising capital through issue
of shares, debentures or bonds is known as primary capital sourcing. Otherwise it is
called new issues market.

34
 Long-term sources of finance consist of ownership securities and shares and
preference shares) and creditor-ship securities (debentures, towing from the financing
institutions and lease finance). Short-term sources of finance consists of trade credit,
short term loans from banks and financial institutions and public deposits.
1.3.2 LONG-TERM CAPITAL INSTRUMENTS
Now, an attempt is made to discuss the long term capital instruments of a
company i.e. shares and debentures.
Corporate securities also known as company securities are said to be the
documentary media of raising capital by the joint stock companies. These are of two
classes: Ownership securities; and Creditor-ship securities.
Ownership Securities
Ownership securities consist of shares issued to the intending investors with
the right to participate in the profit and management of the company. The capital
raised in this way is called ‘owned capital’. Equity shares and securities like the
irredeemable preference shares are called ownership securities. Retained earnings also
constitute owned capital.
Creditor-ship Securities
Creditor-ship securities consist of various types of debentures which are
acknowledgements of corporate debts to the respective holders with a right to receive
interest at specified rate and refund of the principal sum at the expiry of the agreed
term. Capital raised through creditor-ship securities is known as ‘borrowed capital’.
Debentures, bonds, notes, commercial papers etc. are instruments of debt or borrowed
capital.
1.3.2.1 Equity Shares
Equity shares are instruments to raise equity capital. The equity share capital
is the backbone of any company’s financial structure. Equity capital represents
ownership capital. Equity shareholders collectively own the company. They enjoy the
reward of ownership and bear the risk of ownership. The equity share capital is also
termed as the venture capital on account of the risk involved in it. The equity
shareholders’ liability, unlike the liability of the owner in a proprietary concern and
the partners in a partnership concern, is limited to their capital subscription and
contribution.
In India, under the Companies Act 1956, shares which are not preference
shares are called equity shares. The equity shareholders get dividend after the

35
payment of dividend to the preference shareholders. Similarly, in the event of the
winding up of the company, capital is returned to them after the return of capital to
the preference shareholders. The equity shareholders enjoy a statutory right to vote in
the general body meeting and thus exercise their voice in the management and affairs
of the company. They have an unlimited interest in the company’s profit and assets. If
the profit of the company is substantial, the equity shareholders may get good
dividend; if not, there may be little or no dividend with reduced or nil profit. The
equity shareholders’ return of income, i.e. dividend is of fluctuating character and its
magnitude directly depends upon the amount of profit made by a company in a
particular year.
Now a days equity capital is raised through global equity issues. Global
depository receipts (GDRs), American depository receipts (ADRs), etc. are certain
instruments used by Indian companies to overseas capital market tc get equity capital.
Advantages of Equity Share Capital
1. Equity share capital constitutes the ‘corpus’ of the company. It is the
‘heart’ to the business.
2. It represents permanent capital. Hence, there is no problem of
refunding the capital. It is repayable only in the event of company’s winding
up and that too only after the claims of preference shareholders have been met
in full.
3. Equity share capital does not involve any fixed obligation for payment
of dividend. Payment of dividend to equity shareholders depends on the
availability of profit and the discretion of the Board of Directors.
4. Equity shares do not create any charge on the assets of the company
and the assets may be used as security for further financing.
5. Equity capital is the risk-bearing capital,
6. Equity share capital strengthens the credit worthiness and borrowing or
debt capacity of the company. In general, other things being equal, the larger
the equity base, the higher the ability of the company to secure debt capital.
7. Equity capital market is now expanding and the global capital market
can be accessed.
Disadvantages of Equity Shares capital
1. Cost of issue of equity shares is high as the limited group of
risk- seeking investors need to be attracted and targeted. Equity shares attract

36
 only those classes of investors who can take risk. Conservative and cautious
investors do not to subscribe for equity issues, S underwriting commission,
brokerage costs and other issue expense’ are high for equity capital, raising up
issue cost.
2. The cost of servicing equity capital is generally higher than the
co’ or issuing preference shares or debenture since on account of higher rise
the expectation of the equity shareholders is also high as compared preference
shares or debentures.
3. Equity dividend is payable from post-tax earnings. Unlike
interest” paid on debt capital, dividend is not deductible as an expense from t
profit for taxation purposes. Hence cost of equity is high Sometimes, dividend
tax is paid, further rising cost of equity share capital.
4. The issuing of equity capital causes dilution of control of the
equity holders.
In times of depression dividends on equity shares reach low be which leads to
drastic fall in their market values.
5. Excessive reliance on financing through equity shares reduces
the capacity of the company to trade on equity. The excessive use of equity
shares is likely to result in over capitalization of the company.
1.3.2.2 Preference Shares
Preference shares are those which catty priority rights in regard to the payment
of dividend and return of capital and at the same time are subject to certain limitations
with regard to voting rights.
The preference shareholders are entitled to receive the fixed rate of dividend
out of the net profit of the company. Only after the payment of dividend at a fixed rate
is made to the preference shareholders, the balance of it will be used for paying
dividend to ordinary shares. The late of dividend preference shares is mentioned in the
prospectus. Similarly in the event of liquidation the assets remaining after payment of
all debts of the company are first used for returning the capital contributed by the
preference shareholders.
Types of Preference Shares
There are many forms of preference shares. These are:
1. Cumulative preference shares
2. Non-Cumulative preference shares

37
 3. Participating preference shares
4. Non-participating preference shares
5. Convertible preference shares
6. Non-convertible preference shares
7. Redeemable preference shares
8. Non-redeemable preference shares
9. Cumulative convertible preference shares
Merits of Preference shares
1. The preference shares have the merits of equity shares without
their limitations.
2. Issue of preference shares does not create any charge against
the assets of the company.
3. The promoters of the company can retain control over the
company by issuing preference shares, since the preference shareholders have
only limited voting rights.
4. In the case of redeemable preference shares, there is the
advantage that the amount can be repaid as soon as the company is in
possession of funds flowing out of profits.
5. Preference shares are entitled to a fixed rate of dividend and the
company many declare higher rates f dividend for the equity shareholders by
trading on equity and enhance market value.
6. If the assets of the company are not of high value, debenture
holders will not accept them as collateral securities. Hence the company
prefers to tap market with preference shares.
7. The public deposit of companies in excess of the maximum
limit stipulated by the Reserve Bank can be liquidated by issuing preference
shares.
8. Preference shares are particularly useful for those investors
who want higher rate of return with comparatively lower risk.
9. Preference shares add to the equity base of the company and
they strengthen the financial position of it Additional equity base increases the
ability of the company to borrow in future.
10. Preference shares have variety and diversity, unlike equity
shares, Companies have thus flexibility in choice.

38
Demerits of Preference Shares
1. Usually preference shares carry higher rate of dividend than the
rate of interest on debentures.
2. Compared to debt capital, preference share capital is a very
expensive source of financing because the dividend paid to preference
shareholders is not, unlike debt interest, a tax-deductible expense.
3. In the case of cumulative preference shares, arrears of dividend
accumulate. It is a permanent burden on the profits of the company.
4. From the investor’s point of view, preference shares may be
disadvantageous because they do not carry voting rights. Their interest may be
damaged by a equity shareholders in whose hands the control is vested.
5. Preference shares have to attraction. Not even 1% of total
corporate capital is raised in this form.
6. Instead of combining the benefits of equity and debt, preference
share capital, perhaps combines the banes of equity and debt.
1.3.2.3 Debentures
A debenture is a document issued by a company as an evidence of a debt due
from the company with or without a charge on the assets of the company. It is an
acknowledgement of the company’s indebtedness to its debenture-holders.
Debentures are instruments for raising long term debt capital. Debenture holders are
the creditors of the company.
In India, according to the Companies Act, 1956, the tern debenture includes
“debenture stock, bonds and any other securities of company whether constituting a
charge on the assets of the company or not”
Debenture-holders are entitled to periodical payment of interest agreed rate.
They are also entitled to redemption of their capital as per the terms. No voting rights
are given to debenture-holders. Under section 117 of the companies Act, 1956,
debentures with voting rights cannot be issued. Usually debentures are secured by
charge on or mortgage of the assets of the company.
Types of debentures
Debentures can be various types. They are:
1. Registered debentures
2. Bearer debentures or unregistered debentures
3. Secured debentures

39
 4. Unsecured debentures
5. Redeemable debentures
6. Irredeemable debentures
7. Fully convertible debentures
8. Non-convertible debentures
9. Partly convertible debentures
10. Equitable debentures
11. Legal debentures
12. Preferred debentures
13. Fixed rate debentures
14. Floating rate debentures
15. Zero coupon debentures
16. Foreign currency convertible debentures
Registered debentures: Registered debentures are recorded in a register of
debenture-holders with full details about the number, value and types of debentures
held by the debenture-holders. The payment of interest and repayment of capital is
made to the debenture-holders whose names are entered duly in the register of
debenture-holders. Registered debentures are not negotiable. Transfer of ownership of
these type of debentures cannot be valid unless the regular instrument of transfer is
sanctioned by the Directors. Registered debentures are not transferable by mere
delivery
Bearer or Unregistered debentures: The debentures which are payable to the
bearer are called bearer debentures. The names of the debenture-holders are not
recorded in the register of debenture-holders. Bearer debentures are negotiable. They
are transferable by mere delivery and registration of transfer is not necessary.
Secured debentures: The debentures which are secured by a mortgage or
change on the whole or a part of the assets of the company are called secure
debentures.
Unsecured debentures: Unsecured debentures are those which do not cam
charge on the assets of the company. These are, also, known as debentures.
Redeemable debentures: The debentures which are repayable after a certain
period are called redeemable debentures. Redeemable debentures may be bullet
repayment debentures (i.e. one time be payment) or periodic repayment debentures.

40
 Irredeemable debentures: The debentures which are not repayable during
life time of the company are called irredeemable debentures. They are al known as
perpetual debentures. Irredeemable debentures can be redeemed or in the event of the
company’s winding up.
Fully convertible debentures: Convertible debentures can be converted in.
equity shares of the company as per the terms of their issue. Convertible debenture-
holders get an opportunity to become shareholders and to take part the company
management at a later stage. Convertibility adds a ‘sweetner’ to t debentures and
enhance their appeal to risk seeking investors.
on – convertible debentures: Non-convertible debentures are not convertible They
remain as debt capital instruments.
Partly convertible debentures: Partly convertible debentures appeal to
investors who want the benefits of convertibility and non-convertibility in one
instrument.
Equitable debentures: Equitable debentures am those which are secured by
&posit of title deeds of the property with a memorandum in writing to create a charge.
Regal Debentures: Legal debentures are those in which the legal ownership
of property of the corporation is transferred by a deed to the debenture holders,
security for the loans.
Referred debentures: Preferred debentures are those which are paid first in
the of winding up of the company. The debentures have priority over other debentures
Sixed rate debentures: Fixed rate debentures carry a fixed rate of interest
Now-a-days this class is not desired by both investors and issuing institutions.
Floating rate debentures: Floating rate debentures carry floating interest rate
coupons. The rates float over some bench mark rates like bank rate, LIBOR etc.
Zero-coupon debentures: Zero-coupon debentures merest coupons. Interest
on these is paid on maturity called as deep-discount debentures.
Foreign Currency convertible debentures: Foreign currency convertible
debentures are issued in overseas market in the currency of the country where the
floatation takes place. Later these are converted into equity, either GDR. ADR or
plain equity.
Merits of debentures
1. Debentures provide funds to the company for a long period
without diluting its control, since debenture holders are not entitled to vote.

41
 2. Interest paid to debenture-holders is a charge on income of the
company and is deductible from computable income for income tax purpose
whereas dividends paid on shares are regarded as income and are liable to
corporate income tax. The post-tax cost of debt is thus lowered.
3. Debentures provide funds to the company for a specific period.
Hence, the company can appropriately adjust its financial plan to suit its
requirements.
4. Since debentures are generally issued on redeemable basis, the
company can avoid over-capitalisation by refunding the debt when the
financial needs are no longer felt.
5. In a period of rising prices, debenture issue is advantageous.
The burden of servicing debentures, which entail a fixed monetary
commitment for interest and principal repayment, decreases in real terms as
the price level increases.
6. Debentures enable the company to take advantage of trading on
equity and thus pay to the equity shareholders dividend at a rate higher than
overall return on investment.
7. Debentures are suitable to the investors who are cautious and
who particularly prefer a stable rate of return with no risk. Even institutional
investors prefer debentures for this reason.
Demerits of Debentures
1. Debenture interest and capital repayment are obligatory
payments. Failure to meet these payment jeopardizes the solvency of the firm.
2. In the case of debentures, interest has to be paid to the
debenture holders irrespective of the fact whether the company earns profit or
not. It becomes a great burden on the finances of the company.
3. Debenture financing enhances the financial risk associated with
the firm. This may increase the cost of equity capital.
4. When assets of the company get tagged to the debenture
holders the result is that the credit rating of the company in the market comes
down and financial institutions and banks refuse loans to that company.
5. Debentures are particularly not suitable for companies whose
earnings fluctuate considerably. In case of such company raising funds

42
 through debentures may lead to considerable fluctuations in the rate of
dividend payable to the equity shareholders.
Financing through equity shares and debentures — Comparison
A company may prefer equity finance (i) if long gestation period is involved,
(ii) if equity is preferred by the market forces, (iii) if financial risk perception is high,
(iv) if debt capacity is low and (v) dilution of control isn’t a problem or does not rise.
A company may prefer debenture financing s compared to equity shares
financing for the following reasons:
i. Generally the debenture-holders cannot interfere in the
management of the company, since they do not have voting rights.
ii. Interest on debentures is allowed as a business expense and it is
tax- deductible.
iii. Debenture financing is cheaper since the rate of interest
payable on it is lower than the dividend rate of preference shares.
iv. Debentures can be redeemed in case the company does not
need the funds raised through this source. This is done by placing call option
in the debentures.
v. Generally a company cannot buy its own shares but it can buy
its own debentures.
vi. Debentures offer variety and in dull market conditions only
debentures help gaining access to capital market.
Convertible Issues
A convertible issue is a bond or a share of preferred stock that can be
converted at the option of the holder into common stock of the same company. Once
converted into common stock, the stock cannot be estranged again for bonds or
preferred stock. Issue of convertible preference shares and convertible debentures are
called convertible issues. The convertible preference shares and convertible
debentures are converted into equity shares. The ratio of exchange between the
convertible issues and the equity shares can be stated in terms of either a conversion
price or a conversion ratio.
Significance of convertible issues: The convertible security provides the
investor with a fixed return from a bond (debenture) or with a specified dividend from
preferred stock (preference shares). In addition, the investor gets an option to convert
the security (convertible debentures or preference shares) into equity shares and

43
thereby participates in the possibility of capital gains associated with, being a residual
claimant of the company. At the time of issue, the convertible security will be priced
higher than its conversion value. The difference between the issue price and the
conversion value is known as conversion premium. The convertible facility provides a
measure of flexibility to the capital structure of the company to the company which
wants a debt capital to short with, but market wants equity. So, convertible issues add
sweetners to sell debt securities to the market which want equity issues.
Convertible preference shares: The preference shares which carry the right
of conversion into equity shares within a specified period are called convertible
preference shares. The issue of convertible preference shares must be duly authorized
by the articles of association of the company.
Convertible debentures: Convertible debentures provide an option to their
holders to convert them into equity shares during a specified period at a particular
price. The convertible debentures are not likely to have a good investment appeal, as
the rate of interest for convertible debentures is lesser than the non-convertible
debentures. Convertible debentures help a company to sell future issue of equity
shares at a price higher than the price at which the company’s equity shares may be
selling when the convertible, debentures are issue. By convertible debentures, a
company gets relatively cheaper financial resource 1w business growth. Debenture
interest constitutes tax deductible expenses. So, till the debentures are converted, the
company gets a tax advantage. From the investors’ point of view convertible
debentures prove an ideal combination of high yield, low risk and potential capital
appreciation.
1.3.2.4 DIFFERENT MODES OF CAPITAL ISSUES
Capital instruments, namely, shares and debentures can be issued to the
market by adopting any of the four modes: Public issues, Private placement, Rights
issues and Bonus issues. Let us briefly explain these different modes of issues.
Public Issues
Only public limited companies can adopt this issue when it wants to raise
capital from the general public. The company has to issue a prospectus as per
requirements of the corporate laws in force inviting the public to subscribe to the
securities issued, may be equity shares, preference shares or debentures/bonds. A
private company cannot adopt this route to raise capital. The prospectus shall give an
account of the prospects of investment in the company. Convinced public apply to the

44
company for specified number of shares/debentures paying the application money,
i.e., money payable at the time of application for the shares/debentures usually 20 to
30% of the issue price of the shares/debentures. A company must receive subscription
for at least 95% of the shares/bonds offered within the specified days. Otherwise, the
issue has to be scrapped. If the public applies for more than the number of
shares/debentures offered, the situation is called over subscription. In under
subscription public subscribes for less number of shares/debentures offered by the
company. For good companies coupled with better market conditions, over —
subscription results. Prior to issue of shares/debentures and until the subscription list
is open the company go on promoting the issue. In the western countries such kind of
promoting the issue is called ‘road-show’. When there is over-subscription a part of
the excess subscription, usually upto 15% of the offer, can be retained and allotment
proceeded with. This is called as green-shoe option.
When there is over-subscription, pro-rata allotment (proportionate basis
allotment, i.e., say when there is 200% subscription, for every 200 share applied 100
shares allotted) may be adopted. Alternatively, pro-rata allotment for some applicant,
fill scale allotment for some applicants and nil allotment for rest of applicants can also
be followed. Usually the company co-opts authorities from stock-exchange where
listing is done, from securities regulatory bodies (SEI3J in Indian, SEC in USA and so
on) etc. in finalizing mode of allotment.
Public issues enable broad-based share-holding. General public’s savings
directed into corporate investment. Economy, company and individual investors
benefit. The company management does not face the challenge of dilution of control
over the affairs of the company. And good price for the share’ and competitive
interest rate on debentures are quite possible.
Private Placement
Private placement involves the company issuing security places the same at
the disposal of financial institutions like mutual finds, investment funds r banks the
entire issue for subscription at the mutually agreed upon pro-ram of interest.
This mode is preferred when the capital market is dull, shy and depressed.
During the late 1990s and early 2010s, Indian companies preferred private placement,
even the debt issues, as the general public totally deserted the capital market since
their hopes in the capital market were totally shattered. Private placement is
inexpensive as no promotion is issued. It is a wholesale deal.

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Right Shares
Whenever an existing company wants to issue new equity shares, the existing
shareholders will be potential buyers of these shares. Generally the Articles or
Memorandum of Association of the Company gives the right to existing shareholders
to participate in the new equity issues of the company.
This right is known as ‘pre-emptive tight’ and such offered shares are called
‘Right shares’ or ‘Right issue’.
A right issue involves selling securities in the primary market by issuing rights
to the existing shareholders. When a company issues additional share capital, it has to
be offered in the first instance to the existing shareholders on a pro rata basis. This is
required in India under section 81 of the Companied Act, 1956. However, the
shareholders may by a special resolution forfeit this right, partially or fully, to enable
the company to issue additional capital to public.
Under section 81 of the Companies Act 1956, where at any time after the
expiry of two years from the formation of a company or at any time after the expiry of
one year from the allotment of shares being made for the first lime after its formation,
whichever is earlier, it is proposed to increase the subscribed capital of the company
by allotment of further shares, then such further shares shall be offered to the persons
who, at the date of the offer, are holders of the equity shares of the company, in
proportion as nearly as circumstances admit, to the capital paid on those shares at that
date. Thus the existing shareholders have a pre-emptive right to subscribe to the new
issues made by a company. This right has at its root in the doctrine that each
shareholder is entitled to participate in any further issue of capital by the company
equally, so that his interest in the company is not diluted.
Significance of rights issue
1. The number of rights that a shareholder gets is equal to the
number of shares held by him.
2. The number rights required to subscribe to an additional share
is determined by the issuing company.
3. Rights axe negotiable. The holder of rights can sell them fully
or partially.
4. Rights can be exercised only during a fixed period which is
usually less than thirty days.

46
 5. The price of rights issues is generally quite lower than market
price and that a capital gain is quite certain for the share holders.
6. Rights issue gives the existing shareholders an opportunity for
the protection of their pro-ram share in the earning and surplus of the
company.
7. There is more certainty of the shares being sold to the existing
shareholders. If a rights issue is successful it is equal to favourable image and
evaluation of the company’s goodwill in the minds of the existing
shareholders.
Bonus Issues
Bonus issues are capital issues by companies to existing shareholders whereby
no fresh capital is raised but capitalization of accumulated earnings is done. The
shares capital increases, but accumulated earnings fall. A company shall, while
issuing bonus shares, ensure the following:
1. The bonus issue is made out of free reserves built out of the
genuine profits and shares premium collected in cash only.
2. Reserves created by revaluation of fixed assets are not
capitalized
3. The development rebate reserves or the investment allowance
reserve is considered as free reserve for the purpose of calculation of residual
reserves only.
4. All contingent liabilities disclosed in the audited accounts
which have bearing on the net profits, shall be taken into account in the
calculation of the residual reserve.
5. The residual reserves after the proposed capitalisation shall be
at lea 40 per cent of the increased paid up capital.
6. 30 per cent of the average profits before tax of the company for
the previous three years should yield a rate of dividend on the exp capital base
of the company at 10 per cent
7. The capital reserves appearing in the balance sheet of the
company as a result of revaluation of assets or without accrual of cash
resources are capitalized nor taken into account in the computation of the
residual reserves of 40 percent for the purpose of bonus issues.
8. The declaration of bonus issue, in lieu of dividend is not made.

47
 9. The bonus issue is not made unless the partly paid shares, if
any existing, are made fully paid-up.
10. The company — a) has not defaulted in payment of interest or
principal in respect of fixed deposits and interest on existing debentures or
principal on redemption thereof and (b) has sufficient reason to believe that it
has not defaulted in respect of the payment of statutory dues of the employees
such as contribution to provident fund, gratuity on bonus.
11. A company which announces its bonus issue after the approval
of the board of directors must implement the proposals within a period of six
months from the date of such approval and shall not have the option of
changing the decision.
12. There should be a provision in the Articles of Association of
the Company for capitalisation of reserves, etc. and if not the company shall
pass a resolution at its general body meeting making decisions in the Articles
of Association for capitalisation.
13. Consequent to the issue of bonus shares if the subscribed and
paid-up capital exceed the authorized share capital, a resolution shall be
passed by the company at its general body meeting for increasing the
authorized capital.
14. The company shall get a resolution passed at its generating for
bonus issue and in the said resolution the management’s intention regarding
the rate of dividend to be declared in the year immediately after the bonus
issue should be indicated.
15. No bonus shall be made which will dilute the value or rights of
the holders of debentures, convertible filly or partly.
SEBI General Guidelines for public issues
1. Subscription list for public issues should be kept open for at least 3
working days and disclosed in the prospectus.
2. Rights issues shall not be kept open for more than 60 days.
3. The quantum of issue, whether through a right or public issue, shall not
exceed the amount specified in the prospectus/letter of offer. No retention of
over subscription is permissible under any circumstances, except the special
case of exercise of green-shoe option.

48
 4. Within 45 days of the closures of an issue a report in a prescribed form
with certificate from the chartered accounts should be forwarded to SEBI to
the lead managers.
5. The gap between the closure dates of various issue e.g. Rights and Indian
public should not exceed 30 days.
6. SEBI will have right to prescribe further guidelines for modifying the
existing norms to bring about adequate investor protection, enhance the
quality of disclosures and to bring about transparency in the primary market.
7. SEBI shall have right to issue necessary clarification to these guidelines to
remove any difficulty in its implementation.
8. My violation of the guidelines by the issuers/intermediaries will be
punishable by prosecution by SEBI under the SEBI Act
9. The provisions in the Companies Act, 1956 and other applicable laws
shall be complied with the connection with the issue of shares a debenture.

1.4 HAVE YOU UNDERSTOOD QUESTIONS

1. Discuss the sources of long term finance of a company.
2. Critically evaluate equity shares a source of finance both the
point of (i) the company and (ii) investing public.
3. Discuss the features of preference shares and evaluate
preference share capital from the company’s point of view.
4. What are right shares? Explain the significance of the same
form the company’s and investors’ view point.
5. Define ‘debenture’ and bring out its salient features as an
instrument of corporate financing.
6. Explain the different types of debentures that may be issued by
a company.
7. What are the advantages and disadvantages of debenture
finance to a company?
8. List out the SEBI guidelines for issuing bonus shares.
1.5 SUMMARY
The long term capital resources of a company are equity capital, preference
capital, debenture capital and borrowings from term lending institutions (term loans).

49
 Equity shareholders are owners of the company. They have the right of control
and pre-emptive right to purchase additional equity issued by the company. Equity
shareholders get residual claim over assets in the event of liquidation. Equity share
capital is a permanent capital to the company and it increases the credit worthiness
also. The issue cost of equity capital is high and sale of equity shares to outsiders
results in dilution of control.
Preference shareholders have two rights over equity share holders — right to
receive dividend and also right to receive back the capital in the event of dissolution
or liquidation, if there by any surplus. Preference share capital enhances the
creditworthiness of the company. There is no legal obligation to pay preference
dividend and the issue of preference shares does not create any charge against assets
of the company. Compared to debt capital, preference capital is a very expensive
source of financing and skipping dividend on preference shares may adversely affect
of the company and create control problems.
Debenture is an acknowledgement of the company’s indebtedness to it’s
debenture-holders. Debentures are instruments for raising long term debt capital.
Debenture-holders are the creditors of the company. Raising funds by issue of
debentures does not result in dilution of control. Interest paid to debenture-holders is a
charge on income of the company and is deductible from income for income tax
purpose. In a period of rising prices, the burden servicing debentures in real terms is
less. Debenture interest and capital repayment are obligatory payments. Failure to
meet these payments jeopardize the solvency of the firm. If the capital structure is
heavily loaded debentures, the major portion of the company’s earnings is absorbed in
servicing the debt and little is left for distribution by way of dividends. This may
reduce the value of shares in the market.

INSTITUTIONAL FINANCE: FRAMEWORK, FUND TYPES AND

PROCEDURE
Unit Structure
1. Introduction
2. Learning Objectives
3. Section title
3.1 Factors responsible for the growth of term lending
institutions

50
 3.2 Institutional frame work of term lending institutions
3.2.1 IDBI
3.2.2 IFCI
3.2.3 ICICI
3.2.4 L.I.C
3.2.5 U.T.I
3.2.6 G.I.C
3.2.7 I.I.B.I
3.2.8 I.D.F.C
3.2.9 NABARD
3.2.10 SIDCs
3.2.11 EXIM BANK OF INDIA
3.2.12 SFCSs
3.2.13 TCOs
3.2.14 List Of Technical Consultancy organizations

LENDING PROCEDURES OF THE TERM LENDING FINANCIAL

INSTITUTIONS

Structure of the Unit

1. Introduction
2. Learning Objectives
3. Section title
3.1 Technical appraisal
3.2 Economic appraisal
3.3 Financial appraisal
3.4 Managerial appraisal
3.5 Social considerations

51
4.1 Conditions for assistance from financial institutions
4.2 Schemes of assistance of financial institutions
5.1 Public deposits
Merits of public deposits
Demerits of public deposits
RBI regulations for public deposit
6. Have you understand questions
LENDING PROCEDURES OF THE TERM LENDING FINANCIAL
INSTITUTIONS
1. INTRODUCTION
The essential requirements insisted upon by the financial institutions before
taking up a request for financial assistance for consideration
1. the applicant concern should have obtained industrial license or
should have made some kind of commitment, where necessary
2. the applicant should have obtained/applied for permission of
the Securities and Exchange Board of India to issue capital, wherever
necessary
3. The applicant should have obtained the approval of the
Government regarding the terms of technical and/or financial collaboration
agreement, if any.
4. the applicant should have a clearance from the Capital Goods
Committee in respect of the machinery proposed to be imported
5. The applicant should have selected a site for the location of the
factory and have prepared a detailed ‘project report’.
After the receipt of the filled up application in triplicate in the case of non-
corporate units and quadruplicate in the case of corporate bodies, the project is
appraised by a team of technical, financial and economic officers of the Corporation
from several angles — technical, financial, economic, managerial and social.
2. LEARNING OBJECTIVES
After reading this lesson you will be conversant with:
• The different types of appraisal used by term lending institution for financing
• The conditions for financial assistance
• The various schemes of assistance of financial institutions

52
 • The concept, merits and demerits of public deposits
• The regulations of RBI regarding public deposits.
3. SECTION TITLE
3.1 Technical Appraisal
The technical appraisal of the project involves a critical analysis of the
following:
1. Feasibility of the selected technical project and its suitability in Indian
conditions.
2. Location of the project in relation to the sources and availability of inputs —
raw materials, water, power, the!, transport, skilled and unskilled labour and in
relation to the market to be served by the product/service.
3. Adequacy of the plant and machinery and their specifications
4. Adequacy of the plant layout
5. Arrangements for securing technical know-how, if necessary
6. Availability of skilled and unskilled labour and arrangements for training to
the labourers.
7. Provision for the disposal of factory effluents and utilisation of byproducts if any.
8. Whether the process proposed for selection is technically sound upto date etc.
Another important feature of technical appraisal relates to the of technology to
be adopted for the project. In case new technical processes adopted from abroad,
attention is to be paid to the terms and conditions.
3.2 Economic Appraisal
The economic appraisal of a project involves:
1. Consideration of natural and industrial property of the project and contribution
to the national economy of the country in terms of contribution to GDP, down
stream and upstream projects.
2. Savings in foreign exchange or prospects of exports.
3. Employment potential, direct and indirect
4. A critical study of the existing and future demand of the products proposed to be
manufactured, the licensed and installed capacity, the level of competition etc.
5. Scrutiny of the project in relation to the import and export policies of the
Government and various other factors like regulatory controls, if any, in
regard to production, prices and raw materials.

53
3.3. Financial Appraisal
Financial appraisal of the existing concern deals with an analysis of its
working results, balance sheets and cash flow for the past years/projected future years
and an examination of the following aspects in all cases.
1. Estimated cost of the project
2. Financial plan with reference to capital structure, promoter’s
contribution, debt-equity ratio and the availability of other resources.
3. Crucial examination of the investments made outside the business and
justification therefore.
4. Projections of cash flow, both during the construction and the
operation periods.
5. Projects break-even level of operation and time required to reach that
level operation.
6. Estimation of future profitability in the light of competition and
product’ service obsolescence.
7. Internal rate of return, debt-service coverage and projected dividends
on share capital, pay-back period, abandonment value at the end of different
levels of milestones or years of operation.

3.4 Managerial Appraisal

The confidence of the lending institution in repayment prospects of a loan is
largely conditioned by its opinion of the borrowing unit’s management Therefore, it
has been remarked that appraisal of management is the touch stone of term credit
analysis. Where the technical competence, administrative ability, integrity and
resourcefulness of the management are well established, the loan application gets the
most favourable consideration. The expertise, experience and earnestness of the
management tell in the efficiency, effectiveness and excellence of the project.
3.5 Social Considerations
The social objectives of the project are considered keeping in view the interest
of the general public. The projects, which provide large employment opportunities
and canalize the income of the agricultural sector for productive use, projects located
in totally less developed areas and projects that stimulated small scale industries are
considered to serve the society well. The social benefits are more. The social cost
of\pollution consumption of scarce resources, etc. are also to be weighed.

54
4.1 Conditions for Assistance from Financial Institutions

Different financial institutions stipulate different kinds conditions depending

on the nature of the project, the borrower etc. The main conditions of a term loan are
as follows:
1. The borrower (applicant) has to obtain all relevant Government clearances
such as licensing, capital goods clearance for imported machines, import
license, clearance from pollution control board, etc.
2. For consortium loan, the borrower has to satisfy all the institutions
participating in lending
3. Concurrence of the financial institution is necessary for repayment of any
existing loan or long-term liabilities.
4. The term loan agreement may stipulate the debt-equity ratio to be followed by
the company.
5. As long as the loan is outstanding, the declaration of dividend is made subject
to the institution’s approval.
6. The term lending institution reserves the right to nominate one or more
directors in the management of the company.
7. Once the loan agreement is signed, any major commercial agreements such as
orders for equipment, consultancy, collaboration agreement, selling agency
agreement etc. and further expansion need the concurrence of the term lending
institution.
8. The borrower is not permitted to create any additional charge on the assets
without the knowledge of the financial institutions.
9. The financial institutions may appoint suitable personnel in the areas of
marketing, research and development, depending upon the nature of the
project.
10. The promoters cannot dispose their shareholders without the consent of the
lending institutions. This is stipulated for keeping the promoters involved as
long as the institutions involve in the business.

4.2 Schemes of Assistance of Financial Institutions

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 Financial institutions provide the bulk of finance required for industry. For
fulfilling the socio-economic objectives of our country, today the financial institutions
perform a variety of financing and promotional activities have designed special
programmes specifically for the development of industries in backward areas,
encouraging competent new entrepreneurs,

56
Supporting modernization schemes and development of small scale industries.
Fig.2.1 gives the schemes of assistance.

5.1 PUBLIC DEPOSITS

Deposits with companies have come into prominence in r cent years. Of these
the more important are the deposits accepted by trading and manufacturing
companies. The Indian Central Banking Enquiry Committee in 1931 recognised the
importance of public deposits in the financing of cotton textile industry in India in
general and at Ahmadabad in particular. The growth of public deposits has been

57
considerable. From the company’s point of view, public deposits are a major source
of finance to meet the working capital needs. Due to the credit squeeze imposed by
the Research Bank of India on bank loans f” the corporate sector during I 970s I 980s
and also due to the recommendations of the Tandon Committee, restricting credit,
many companies were not getting as much money in the 1980s as they used to get in
the past, from the banks. So, public deposits came handy as working capital fund for
businesses. While to the depositor the rate offered is higher than that offered by
banks, the cost of deposits to the company is less than the cost of borrowings from
bank. Moreover, the availability and volume of bank credit are restricted by
consideration of margin, security offered, periodical submission of statements etc.
The credit available to companies through public deposits is not affected by such
consideration. There is no problem of margin or security. Since the fixed deposits
from the public are unsecured, the borrowing company need not mortgage or
hypothecate any of its assets to raise loans in this form. These deposits are available
for comparatively longer terms than bank credit.
Merits of Public deposits
The merits of public deposits are as follows:
1. There is no need of creation of any charge against any of the assets of the
company for raising funds through public deposits.
2. The company can get advantage of trading on equity since the rate of interest
and the period for which the public deposits have been accepted are fixed.
3. Public deposit is a less costly method for raising short-term as well as
mediuni4erm fIrnds required by the companies, because of less restrictive
covenants governing this as against bank credits.
4. No questions are asked about the uses ot public deposits.
5. Tax leverage is available as interest on public deposits is a charge on revenue.
Demerits of public deposits
The main demerits of the public deposits are as follows:
i. This mode of financing, sometimes, puts the company into
serious financial difficulties. Even a slight rumour about the inefficiency of the
company may result in a rush of the public to the company for getting
premature payments of the deposits made by them.
ii. Easy availability of fund encourages lavish spending.

58
 iii. Public deposits are unsecured deposits and in the event of a
failure of the company, depositors have no assurance of getting their money
back.

RBI Regulations for Public Deposit

The RBI regulation of public deposits has six main aspects:
i. There is a ceiling on the quantum of deposits in terms of paid-
up capital and reserves by the company because undue accumulation of short-
term liabilities in the form of deposits can lead a company into financial
difficulties. In the beginning the definition of deposits was quite narrow and
excluded unsecured loans accepted from the public and guaranteed by the
directors. Now the term deposit covers “an money received by a non-banking
company by way of deposit or loan or in any other form but excludes money
raised by way of share capital or contributed as capital by proprietors”.
ii. The second aspect of the Reserve Bank’s regulation is the limit
on the period of such deposit. Formerly, in order to avoid direct competition
with short-term public deposits, companies were prohibited from accepting
deposits for a period of less than 12 months. But the 1973 amendment reduced
the period to less than 6 months. The Reserve Bank has made obligatory on
the part of the companies accepting deposits to regularly file returns, giving
detailed information about them, their repayment, etc. so that the Reserve
Bank can verify whether the companies adhere to the restrictions. However
such statements are not filed late and the Reserve Bank’s action to prevent a
defaulting company from accepting any deposit fails to afford any protection
to existing depositors.
iii. The Reserve Bank has stipulated that while issuing newspaper
advertisements (or even the application forms) soliciting such deposits, certain
specified information regarding the financial position and the working of the
company must accompany. This clause is often misused as much
advertisement often carried words like “as per Reserve Bank directive”,
thereby giving a wrong impression that these deposits are actually governed
by the Reserve Bank Now such advertisements would be illegal and attract
penal provision prescribed in this behalf. Similarly, the catalogues and

59
 handouts issued by brokers stating that the companies mentioned therein had
complied with Reserve Bank directives would also attract the penal provision.
iv. The Reserve Bank has entrusted the auditors of the companies
with additional responsibilities of reporting to it that the provision under the
Act has been strictly followed by the company.
v. The Reserve Bank has issued a broad “RBI Directives on
Company Deposit in order to clarify its role in protecting depositors. The bank
has reiterated that the deposits or loans are fully protected or are absolutely
safe merely because the companies claimed to have complied with the RBI
directives and that they should not presume that the Reserve Bank can come to
their rescue in the event of failure of a company to meet its obligations.
SUMMARY
The assistance of the financial institutions consists of providing long term
loan, underwriting equity, preference and debenture issues and guaranteeing of
deferred payments of machinery imported from abroad or purchased in India.
Financial institutions provide concessional finance to the projects in backward areas
and soft loans for modernization of industries. They provide technical and
administrative assistance and undertake market and investment research surveys and
also technical and economic studies related to development of industry.
Public deposits are a major source of finance to companies to meet the
working capital needs. For public deposits there is no need of creation of any charge
against any of the assets of the company. It is less costly method to the companies for
getting short term and medium term funds.
* * *

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