Financial Services And Financial Intermediaries

Financial Services and Financial Intermediaries Financial system of any country normally has four important segments viz., Financial Institutions, Financial Markets, Financial Instruments and Financial Services. It is the combination and co-ordination of these segments which drives the economic system of the country. Disharmony amongst these segments can lead to the financial system going into disarray and it will not provide a strong platform for the economy to grow and be on stronger footing. A strong regulator who keeps a close eye and constant vigil on the activities of each of these segments supported by strict, effective regulatory mechanism and powers to book and penalize the violators of these regulations, completes the picture. Financial institutions such as banks, development financial institutions, non-banking financial companies, insurance companies etc. facilitate uninterrupted flow of money for industrial, manufacturing, services, trade, commerce and other sectors of the economy by channelizing the savings of people where rewards are high. Financial instruments facilitate this flow of funds through various short term, medium term, long term instruments having attractive features and characteristics to suit the individual choice, risk appetite, return expectations, need for liquidity etc. Each instrument such as equity shares, bonds, debentures, government securities, money market instruments etc. are designed in such a manner that it fulfills the requirement of each type and class of investors. Financial markets provide ‘exit options’ to the investors for liquidating their investment in secondary markets whenever need for liquidity arises. They facilitate trading in securities (financial instruments) ‘listed’ on the exchanges. Instruments such as derivatives like options, futures, forwards and swaps even help to ‘hedge’ against probable future losses arising out of fluctuations in the prices of these securities when they are traded in the secondary markets. Financial intermediaries serve as a link between the investors of funds and users of funds. They facilitate flow of information to the investors and educate them in the process of investment decision making so that investor gets complete idea as to the availability of instruments, risk attached to the instrument, likely return from these instruments, intricacies of market mechanism etc. On the other hand their utility to the users of funds is immense. Users of funds find it difficult to approach the investors individually, design products which suit individual preferences, and mobilize the funds in an un-interrupted manner. These intermediaries specialize in various types of financial activities associated with mobilization of funds ranging from designing a specific product, advising a company as to the manner of marketing the product, its pricing, timing of the issue, obtaining requisite clearance from the regulators, arranging for the publicity for reaching out to the investor fraternity and even post-issue services such as collection of applications, allotment of instruments, their listing on stock markets wherever necessary for facilitating secondary market operations. Merchant Bankers, for example, specialize in primary market issues of shares (Initial Public Offerings) for raising capital for a new

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as well existing company. They also offer other services to the corporate sector in respect of mergers, acquisitions, restructuring of business operations, raising funds from overseas markets etc. Broking companies on the other hand facilitate trading of securities on the stock markets; they being members of these stock markets. These intermediaries charge fees for the services rendered. What, however, distinguishes them from others is their professional approach, expertise, knowledge of market conditions, ability to forecast future economic scenario, psyche of investor community, and thorough knowledge of the regulatory framework of a country. The important types of financial services offered, apart from the above traditional activities, are, Mutual Funds, Hire Purchase financing, Leasing of high cost machinery and equipment, Housing finance, Venture capital financing, Factoring and forfaiting and Credit Rating of financial instruments by specialized rating agencies. We may briefly summarize functions of each of these intermediaries and the services offered by them as below. Merchant Bankers: Merchant Bankers help to transfer capital from those who have surplus funds to those who need them. Their services include profit counseling, portfolio management, credit appraisals, underwriting of share issues, debenture issues, loan syndication, acting as lead managers to the share issues (IPOs), arranging for refunds of excess subscription received, allotment of shares and arranging for their listing on the stock markets etc. Hire Purchase financing: They specialize in financing for acquiring consumer goods, automobiles etc. by bringing together manufacturers or wholesalers of these goods and direct consumers. They provide finance to the consumers for buying these goods without having to save money to acquire them in future. Manufacturers/wholesalers get a boost because of the quick turnover of their products whereas consumer gets to use the goods with the help of finance provided by the hire purchase financier which is repayable in easy installments from his future income. Once all the installments are paid by the consumer, ownership of the goods is permanently transferred to the consumer. Leasing of equipment and heavy machinery: Leasing companies help the small manufacturer to acquire costly, heavy machinery on a payment of rent payable from the income earned from use of the machinery for production, without having to block his own funds for acquiring the machinery. This helps him to divert his own funds for working capital and carry on the manufacturing activity with the limited sources of funds at his disposal. Mutual Funds: Mutual Funds pool the resources of small investors and invest them in various securities available in the market with a view to providing maximum returns to the investors with minimum risk. With their professional knowledge of the markets, their ability to interpret intricate market operations, by diversifying the portfolio to minimize the risk in investment and by using latest analytical tools and techniques, they achieve better results than the individual investor.

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Factoring and Forfaiting: Factoring services provided by professional agencies involve managing sales register of a client (company) i.e. taking over recovery function so as to free the company from hassles of recovering their dues from their clients. This enables the company to concentrate exclusively on the business operations. Apart from collection of book debts, Factors provide credit information on the clients and provide finance to the company against outstanding amount of debts. Forfaiting involves discounting export bills of exporter so as to enable him to concentrate on execution of export orders on hand and also protect him against the risk of defaults in payment obligation by foreign buyer. Venture Capital Financing: Venture capitalists offer finance for new, innovative business ventures where risk is high and hence traditional financiers like banks, financial institutions shy away from extending finance to such activities. These ventures have potential to offer very high returns if successful. Venture capitalists offer not only start up finance but also for development of business. Some of the modern business giants such as Xerox, Microsoft, and Apple are born out venture capital financing. Once the company which is given the capital starts making profits, venture capitalist withdraws/sells his share in the capital with huge profits and looks for another venture which has potential to provide high returns. Custodial Services: Custodial services involve providing services to corporate clients such as safe keeping of shares, debentures, bonds and other securities if issued in physical form. It also involves services like collection of interest, dividend, entitlement of bonus shares, right shares and advising and reporting on matters about corporate developments and corporate securities to foreign investors. Depositories and Depository Participants: The trend in current scenario is to issue investment certificates not in physical form but in dematerialized form. This reduces paper work, reduces risk in transfer of securities and also saves the hassles of safe keeping of securities. Depositories and Depository Participants offer to provide to the companies the service of maintaining on their behalf record of share holders, crediting dividend to the share holders’ account whenever declared by the company, crediting other entitlements such as rights, bonus shares etc. They also effect transfer of shares and other securities whenever bought and sold by the holders. This eases the burden of the companies to maintain these records in-house. Credit Rating: Specialized Rating Agencies help the investors in the process of rational decision making. Rating agency, when approached by a company intending to place their issue in the market for raising funds, makes a thorough assessment of repayment ability of the concerned company and allots specific “rating (AAA, AA, A etc). The rating symbols indicate degree of safety to the investment in the specific instrument on which an un-informed investor can depend to a great extent and can take a rational decision of investment. For issuing companies it helps to reduce the cost of borrowing by offering lower rate of return in case rating agency gives highest rating to the issue. These rating agencies can generally be relied upon for their judgment.

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