BA4003 - BANKING AND FINANCIAL SERVICES

UNIT V

INSURANCE AND OTHER FEE BASED FINANCIAL SERVICES

Insurance Act, 1938 - IRDA - Regulations - Products and services - Venture Capital Financing -
Bill discounting - Factoring - Merchant Banking - Role of SEBI

1. INSURANCE ACT, 1938

Insurance is a contract whereby the insurer undertakes to compensate the insured for any loss
suffered by the later in consideration of premium paid for certain period. There are different insurance
companies such as LIC, GIC, United India, New India assurance etc., offering wide range of insurance
options. They provide comprehensive coverage with affordable premium.

An insured can choose the policy according to his needs and ability to pay periodical premium to
cover the risk of insurance for the stipulated period. The periodical insurance premiums are calculated
according to the total insurance amount specified or estimated value of the property/things insured.

1.1 Features

The salient features of the Insurance Act 1938

 Forming a department of insurance to overlook all the insurance business.

 Mandatory registration of insurance companies.
 Compulsory submission of annual financial returns of insurance companies.
 A provision for initial deposits was made to allow only genuine companies in the insurance
sector.
 Other important provisions such as the prohibition on rebate, restriction on licensing, and
commission payment were introduced in order to instill professionalism into the business.
 Insurance companies had to go through a periodical evaluation to assess their financial stability.
 Policies with a standardized format were introduced.
 Certification of the premium tables through an actuary was made compulsory.

1.2. Types of Insurance

Various types of insurances are as mentioned hereunder:

 Life insurance: Descendant’s family receives insured amount in the case of death of the insured.
In other case the insured himself gets the insured amount
 Automobile/Motor insurance: Usually automobile insurances cover damages to the automobile
and legal financial expenditure of the automobile driver/cleaner.
 Workmen Compensation Insurance: It covers the employee for the loss of life or total/partial
permanent disablement (loss of limb) or for occupational disease arising out of his employment
during and in the course of his employment.
 Health insurance: Health insurance covers the expenditure associated with treatment and
medical expenditure including medicine.

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul

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 Credit insurance: Borrowers often fail to repay the debts, loans and mortgages, due to certain
unavoidable circumstances. Credit insurance can be of great help to the lenders during such
crisis.
 Property insurance: Property protection insurance provides protection from risks associated to
theft, fire, floods etc. This type of insurance can be further classified into specialized forms as
follows: -
 Fire insurance
 Earthquake insurance
 Flood insurance
 Home insurance
 Boiler insurance

At present insurance market is much vibrant than before and this has an impact on the rates of
insurance premium.

1.3 Types of Insurance Companies

Insurance companies can be categorized into two main divisions which are classified as follows:

 General Insurance Companies: They provide all types of insurance apart from life insurance i.e.,
fire insurance, marine insurance, vehicle insurance etc.,
 Life Insurance Companies: The companies, dealing with life insurance, pension products and
annuities are life insurance companies.

1.4 Types of Insurance Policies

Insurance provides compensation to a person for an anticipated loss to his life, business or an
asset. Insurance is broadly classified into two parts covering different types of risks:

Life Insurance

 Term plans
 ULIP (Unit Linked Insurance Plan)
 Endowment
 Money-back
 Retirement

General Insurance

 Health Insurance
 Motor/ vehicle
 Travel
 Home
 Gadgets
 Property

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul

 BA4003 - BANKING AND FINANCIAL SERVICES

2. IRDA Regulations

IRDA or Insurance Regulatory and Development Authority of India is the apex body that
supervises and regulates the insurance sector in India. The primary purpose of IRDA is to safeguard the
interest of the policyholders and ensure the growth of insurance in the country. When it comes to
regulating the insurance industry, IRDA not only looks over the life insurance, but also general insurance
companies operating within the country.

2.1 What are the functions of IRDA?

As discussed above, the primary objective of the Insurance Regulatory and Development
Authority of India is to ensure the implementation of provisions as mentioned in the Insurance Act. This
can be further understood by its mission statement which is as follows-

 To safeguard the policyholder’s interest while ensuring a fair and just treatment.
 To have a fair regulation of the insurance industry while ensuring financial soundness of the
applicable laws and regulations.
 To frame regulations periodically so that there is no ambiguity in the insurance industry.

What is the role and importance of IRDA in the insurance sector?

India began to witness the concept of insurance through a formal channel back in the 1800s and
has seen a positive improvement ever since. This was further supported by the regulatory body that
streamlined various laws and brought about the necessary amendment in the interest of the
policyholders. Below mentioned are the important roles of IRDA -

 First and foremost is safeguarding the policyholder’s interest.

 Improve the rate at which the insurance industry is growing in an organised manner to benefit
the common man.
 To ensure the dealing are carried on in a fair, integral manner along with financial soundness
keeping in mind the competence of the insurance company.
 To ensure faster and a hassle-free settlement of genuine insurance claims.
 To address the grievances of the policyholder through a proper channel.
 To avoid malpractices and prevent fraud.
 To promote fairness, transparency and oversee the conduct of insurance companies in the
financial markets.
 To form a reliable management system with high standards of financial stability.

2.2 Objective of IRDA Act

The main objective of the IRDAI is to enforce all the provisions as mentioned under the
Insurance Act. Hence, the mission statement of the IRDAI include the following:

 To protect the interest of the policyholder and exercise their fair treatment
 To frame policies regularly to ensure that the industry operates without any ambiguity
 To regulate the insurance industry in fairness and ensure its financial soundness

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul

 BA4003 - BANKING AND FINANCIAL SERVICES

 To promote fairness, orderly conduct, and transparency in financial markets dealing with
insurance and build a reliable Management Information System (MIS) to enforce financial
soundness in the insurance sector
 To ensure speedy settlement of genuine claims, prevent insurance frauds, and other prohibit
other malpractices while ensuring effective grievance redressal framework.

2.3 Significant Roles of IRDAI in the Insurance Sector in India

The IRDAI plays a vital role in highlighting the importance of the policyholders and their best
interest while framing policies and regulations. Therefore, it is quintessential to know about the
important roles of the IRDAI. Some of them are:

 To protect the policyholders’ interest

 To provide for long-term funds to enhance the nation’s economy
 To help increase the growth of the insurance sector for the benefit of the policyholders
 To set, enforce, promote, and monitor high standards of fair dealing, financial soundness, and
integrity of the insurance providers
 To prohibit fraud and malpractices by setting up a grievance redressal forum and ensuring that
the interest of the policyholder is protected
 To ensure an optimum amount of self-regulation of the insurance industry

2.4 Functions of IRDAI

Now that we know about the objectives and significant roles of the IRDAI, let us also have a look at
the functions of the authoritative body. Below are the important functions of the IRDAI towards the
insurance industry in India:

 Issuing, modifying, suspending, or cancelling registrations

 Specifying the code of conduct for the loss assessors and surveyors
 Investigating and inspecting insurers, intermediaries, and other relevant bodies
 Levying fees and other charges
 Regulating the terms and conditions, rates, and advantages that may be offered by the
insurance companies but not covered by the Tariff Advisory Committee under Section 64U of
the Insurance Act 1938
 Regulating a margin of solvency
 Promoting and regulating professional all the institutions connected with the insurance and
reinsurance industry
 Supervising the Tariff Advisory Committee
 Specifying the percentage of general and life insurance business undertaken in the social or rural
sector
 Granting, modifying, suspending, renewing, cancelling, or withdrawing registration certificates
of the insurance companies

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul

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3. VENTURE CAPITAL FINANCE

Venture Capital finance is a new type of financial intermediary which has emerged in India
during 1980s. It is a long-term financial assistance provided to projects, which are established to
introduce new products, inventions, idea and technology. Venture capital finance is more suitable to
risky oriented business which consists of huge investment and provides results after 5 to 7 year

Meaning of Venture Capital

The term Venture Capital fund is usually used to denote Mutual funds or Institutional investors.
They provide equity finance or risk capital to little known, unregistered, highly risky, young and small
private business, especially in technology oriented and knowledge intensive business

Definition of Venture Capital

According to Jame Koloski Morries, venture capital is defined as providing seed, start up and
first stage financing and also funding expansion of companies that have already demonstrated their
business potential but do not yet have access to the public securities market or to credit oriented
institutional funding sources. Venture Capital also provides management in leveraged buy out financing.

Features of Venture Capital

Venture Capital consists of the following important features:

 Venture Capital consists of high risk and high return based financing.
 Venture Capital financing is equity and quasi equity financing instruments.
 Venture Capital provides moderate interest bearing instruments.
 Venture Capital reduces the financial burden of the business concern at the initial stage.
 Venture Capital is suitable for risky oriented and high technology based industry.

Venture Capital in India

ICICI Venture Capital is the first Venture Capital Financing in India. It was started in 1988 by the
joint venture of ICICI and UTI.

The UTI launched Venture Capital Unit Scheme (VECAUS-I) to raise finance in 1990.

Technology Development and Information Company (TDICI) is another major Venture Capital
financing institution in India.

Risk Capital and Technology Finance Corporation Ltd. (RCIFC) provides Venture Capital finance
to technology based industries.

ANZ Grindlays Bank has set up India’s first private sector Venture Capital fund.

SBI and Canara Bank are also involved in Venture Capital Finance. They provide either equity
capital or conditionals loans.

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul

 BA4003 - BANKING AND FINANCIAL SERVICES

4. BILL DISCOUNTING

Bill discounting is a trade-related activity in which a company sells its outstanding invoices to a
financier (a bank or another financial institution) that agrees to pay the company for them at a future
date.

4.1 BILL DISCOUNTING PROCESS:

The step-by-step process of bill discounting is given below:

 A seller supplies goods or services to a buyer and raises an invoice.

 The buyer accepts the invoice. This approval means the buyer acknowledges the invoice and
promises to make the payment on the due date.
 The seller approaches the financial institution to get the bill discounted.
 The financial institute verifies the creditworthiness of the buyer and the legitimacy of the bill.
 Once approved, the bank disburses the funds to the seller after deducting the pre-defined fee,
discount, or appropriate margin.
 Thus, the seller gets a quicker payment for the invoice, which can be used for other business
purposes.
 At the end of the original credit period, the buyer makes the payment to the financial
institution.

4.2 FEATURES OF BILL DISCOUNTING:

 Evaluating the seller and buyer: Before approving the bill discounting, the bank or NBFC first
checks the seller’s reputation and the buyer’s creditworthiness. This is done to ensure that the
buyer does not default on making the payment to the bank.
 Making instant cash available for the buyer: It is the most salient feature of bill discounting.
The bank or NBFC purchases the invoice and immediately pays after discounting the bill. This
makes life easy for the seller. They get an immediate payment and do not need to wait for the
buyer to pay the bill.
 Discount Charge: The difference margin between the face value of the invoice and the amount
approved and disbursed by the bank is called the discount. This discount is calculated on the
maturity value at a certain percentage per annum.
 Maturity: The maturity date of a bill means the date on which payment of the invoice is due.
The average maturity period is 30, 60, 90, or 120 days.

4.3 DOCUMENTS REQUIRED FOR BILL DISCOUNTING:

Some of the most common documents required for approving a bill discounting are:

 Duly filled application form with passport-sized photographs

 Business PAN card and address proof
 Applicant’s Aadhar card.
 GST Returns

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul

 BA4003 - BANKING AND FINANCIAL SERVICES

 Income tax return & Financial statement with an audit report.

 Business Establishment Proof
 Last 12 months’ bank statement
 Bill of Exchange
 Letter of Credit
 Commercial Invoice
 Packing list with all the details
 Logistics details with a copy of the delivery note, if any
 Proof of certificates, registrations, licenses, and permits, if any

4.4 BENEFITS OF BILL DISCOUNTING

Bill discounting, as a financial transaction, is beneficial to all the parties involved – the seller, the
buyer, and the financial institution. The buyer and the seller can stabilize their fund flow, while the
financial institution can use the funds lying with them and make some profit on it.

The specific benefits of bill discounting are as follows:

1. Improves cash flow position: All businesses, big or small, depend on cash flow to survive and
grow. Bill discounting facility helps inject a quick cash flow into the business and help the
businesses survive and flourish.
2. Provides instant access to cash: For a seller, a bill discounting facility is a quick and hassle-free
way of getting payment against their invoices. It helps them manage their working capital better
and keep the working capital cycle short.
3. No collateral involved: Bill discounting, as a process, is very simple. It does not involve much
documentation. Secondly, the seller is not required to provide any collateral security to get the
funds. The invoice itself is strong enough collateral to get the funds.
4. No debt incurred: Getting funds using a bill discounting facility does not put the buyer under
any kind of debt
5. No impact on business sheet: Bill discounting facility does not create any tax liability. It is more
of an off-the-book process. So, it has no impact on the balance sheet of the business.

5. FACTORING

Factoring is a service of financial nature involving the conversion of credit bills into cash.
Accounts receivables, bills recoverables and other credit dues resulting from credit sales appear, in the
books of accounts as book credits. Here the risk of credit, risk of credit worthiness of the debtor and as
number of incidental and consequential risks are involved. These risks are taken by the factor which
purchase these credit receivables without recourse and collects them when due. These balance-sheet
items are replaced by cash received from the factoring agent.

Factoring is also called “Invoice Agent” or purchase and discount of all “receivables”. Although
these can be with recourse or without recourse, normally the risk is taken by the factoring agent. The
discount rate includes the loss of interest, risk of credit and risk of loss of both principal and interest on
the amount involved.

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul

 BA4003 - BANKING AND FINANCIAL SERVICES

Why Factoring?

Factoring is one of the most important and unavoidable part of the business concern which
meets the short-term financial requirement of the concern.

Mechanics of Factoring:

The following are the steps for factoring:

1. The customer places an order with the seller (client).

2. The factor and the seller enter into a factoring agreement about the various terms of factoring.
3. Sale contract is entered into with the buyer and the goods are delivered. The invoice with the
notice to pay the factor is sent alongwith.
4. The copy of invoice covering the above sale to the factor, who maintains the sale ledger.
5. The factor prepays 80% of the invoice value.
6. The monthly statement are sent by the factor to the buyer.
7. Follow up action is initiated if there are any unpaid invoices.
8. The buyer settles the invoices on the expiry of the credit period allowed.
9. The balance 20% less the cost of factoring is paid by the factor to the client

5.1 Types of factoring

(1) Notified factoring: Here, the customer is intimated about the assignment of debt to a factor, also
directed to make payments to the factor instead of to the firm. This is invariably done by a legend and
the invoice has been assigned to or sold to the factor.

(2) Non-notified or confidential factoring: Under this facility, the supplier/factor arrangement is not
declared to the customer unless or until there is a breach of the agreement on the part of the client, or
exceptionally, where the factor considers himself to be at risk.

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul

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(3) With recourse or without recourse factoring: Under recourse arrangements, the client will carry the
credit risk in respect of debts sold to the factor. In without recourse factoring, the bad debts are borne
by the factor.

(4) Bank Participation Factoring: The clients create a floating charge on the factoring reserves in favour
of banks and borrow against these reserves.

(5) Export Factoring: There is usually the presence of two factors: an export factor and an import factor.
The former buys the invoices of a client exporter and assumes the risk in case of default by the overseas
customers.

6. MERCHANT BANKING

“A merchant banker has been defined as any person who is engaged in the business of issue
management either by making arrangements regarding selling, buying or subscribing to securities or
acting as manager, consultant, adviser or rendering corporate advisory services in relation to such issue
management”.

6.1 Advantages

 Merchant banks perform functions that cannot be carried out by businesses on their own.
 Merchant banks have access to traders, financial institutions, and markets that companies or
individuals could not possibly reach.
 By using their skills and contacts, merchant banks can get the best possible deals for their
clients.

6.2 Disadvantages

 Merchant banks are really only for large corporate customers, or extremely wealthy smaller
businesses owned by individual clients.
 Not all deals carried out by merchant banks meet with unqualified success.
 There is always risk attached to the kinds of deal that merchant banks undertake.

6.3 Characteristics

A merchant bank should contain the following eleven characteristics:

 High proportion of decision makers as a percentage of total staff

 Quick decision process
 High density of information
 Intense contact with the environment
 Loose organizational structure
 Concentration of short and medium term engagements
 Emphasis on fee and commission income
 Innovative instead of repetitive operations
 Sophisticated services on a national and international level

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul

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 Low rate of profit distribution

 High liquidity ratio

6.4 Recent Developments in Merchant Banking and Challenges Ahead

The Recent Developments in Merchant banking are due to certain contributory factors in India. They
are

 MB Starting time 1969

 issues starting time 1985-1992
 2010 is a time for new issues coming up
 Foreign direct investment & portfolio investment
 Disinvestment in the govt sector – big scope of MB.
 To introduce new financial instruments – more opportunity to the MB
 Mergers with MOU & MOA – get consultancy jobs

Challenges faced by merchant bankers in India

 SEBI guideline
 Efficiency of the clients
 Net worth requirement is very high - so many professionally experienced person/organizations
cannot come
 Poor New issues market in India is drying up the business

6.5 Functions of Merchant banking

 Corporate Counselling
 Project Counselling
 Pre-investment Studies
 Capital Restructuring
 Credit Syndication & Project Finance
 Issue Management & Underwriting
 Portfolio Management
 Working capital Finance
 Acceptance credit & Bill discounting
 Mergers
 Venture Capital
 Lease Finance
 Foreign Currency Finance
 Fixed Deposits broking
 Mutual funds
 Relief to sick industries
 Project Appraisal

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul

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6.6 SEBI - Security Exchange Board of India

SEBI is a body corporate with head office at Bombay. The Chairman and the board members are
appointed by the Central government. SEBI has two major functions.

1. Regulatory and
2. Development
1. Regulatory

a. Registering the brokers and sub-brokers

b. Registration of mutual funds
c. Regulation of stock exchanges
d. Prohibition of fraudulent and unfair trade practice
e. Controlling insider-trading, take-over bids and imposing penalties

2. Development

a. Educating investors
b. Training intermediaries in stock market transactions
c. Promoting fair transactions
d. Undertaking research and publishing useful information to all

6.7 Powers of SEBI

 As per the Act, SEBI has powers

 To file complaints in a court
 To regulate companies in the issue and transfer of shares including bonus and rights shares.
 It can levy penalties on companies and on brokers for violating transactions.
 Power to summon any broker or intermediaries and call for documents.
 It can issue directions to all brokers for protecting the interests of investors.

6.8 SEBI Guidelines: (SEBI Guidelines for Merchant Bank)

SEBI has pronounced the following guidelines for merchant bankers:

 Submission of offer document

 Dispatch of issue material
 Underwriting
 Compliance obligations
o Association of resource personnel
o Redressal of investor grievances
o Submission of post issue monitoring reports
o Issue of No objection Certificate (NOC)
o Registration of merchant bankers
o Reporting requirements

BA4003-NOTES Dr.B.Velmurugan, HoD/MBA NPRCET, Dindigul