Emerging Banking and Financial Services

Editorial Board
Dr. Kirti Singh

Assistant Professor, Delhi School of Economics, University of Delhi
Dr. Shivangi Jaiswal
Assistant Professor, GLA University, Mathura
Content Writers
Dr. Shruti, Dr. Priya Chaurasia, Mr. Jigmet Wangdus,
Mr. Yogesh Sharma, Mr. Ankit Suri, Mr. Gurdeep Singh,
Dr. Neerza, CS Monika Saini,Ms. Latika Bajetha
Academic Coordinator
Mr. Deekshant Awasthi
© Department of Distance and Continuing Education

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Contents
PAGE
Lesson 1 : Introduction to the Indian Banking System

1.1 Learning Objectives 1
1.2 Introduction 2
1.3 Overview of Banking System in India 2
1.4 Major Banking Reforms in the Last Decade 6
1.5 Payment Bank 10
1.6 Monetary Policy Committee 11
1.7 MCLR Based Lending 11
1.8 Innovative Remittance Services 11
1.9 Summary 13
1.10 Answers to In-Text Questions 15
1.11 Self-Assessment Questions 15
1.12 Suggested Readings 16
Lesson 2 : Issues in Financial Reforms and Restructuring

2.2 Introduction 18
2.3 Challenges and Issues in Financial Reforms 23
2.4 Assessing Non-Performing Assets (NPAs) in Indian Banking 25
2.5 Previous Methodologies for the Recovery 29
2.6 Impact of Gross NPAs on a Bank’s Bottom Line 33
2.7 Introduction to Bad Banks, Functioning of Bad Banks, National Asset
Reconstruction Company Ltd. (NARCL) 35
2.8 Summary 38
PAGE i
BBA(FIA)
PAGE
2.11 References 42
Lesson 3 : Introduction to Neobanks

3.2 Introduction 44
3.3 Traditional Banks, Neobanks & Digital Banks 45
3.4 The Rise and Growth of Neobanks 48
3.5 Operating Model of Neobanks 51
3.6 Risk, Challenges and Opportunities 53
3.7 Regulation of Neobanks 56
3.8 Global and Indian Neobanks 60
3.9 Summary 63
3.12 References 65
Lesson 4 : Merger and Acquisition in Banking

4.2 Introduction to Merger and Acquisition (M&A) 68
4.3 %HQH¿WV RI 0HUJHUV LQ WKH %DQNLQJ 6HFWRU
4.4 Synergies Accruing Out of Mergers 81
4.5 Regulatory Mechanisms Surrounding M&A in Banking 83
4.6 Case Studies of Recent Banking Mergers and Related Outcomes 87
4.7 Future Trends and Outlook for M&A in Banking 93
4.8 Summary 94
4.11 References 97
ii PAGE
CONTENTS
PAGE
Lesson 5 : Leasing and Hire Purchase

5.2 Introduction 100
5.3 Concepts of Leasing 100
5.4 Types of Leasing 101
5.5 Advantages of Leasing 103
5.6 Limitations of Leasing 105
5.7 Lease Evaluation 107
5.8 Concepts of Hire Purchase 110
5.9 Difference Between Hire Purchase and Leasing 113
5.10 Choice Criteria Between Leasing and Hire Purchase 114
5.11 Summary 116
Lesson 6 : Venture Capital

6.3 Evolution of Venture Capital 125
6.4 The Venture Investment Process 128
6.5 Steps in Venture Financing 130
6.6 Incubation Financing 132
6.7 Summary 134
6.10 References 135
Lesson 7 : Credit Ratings

PAGE iii
BBA(FIA)
PAGE

7.3 Types of Credit Rating 140
7.4 Advantages of Credit Rating 141
7.5 Disadvantages of Credit Rating 142
7.6 Credit Rating Agencies 143
7.7 Methodology of Credit Rating Agencies 144
7.8 International Credit Rating Practices 145
7.9 Credit Rating Agencies in India 147
7.10 Provisions Governing Credit Ratings 148
7.11 Summary 151
7.14 References 153
Lesson 8 : Securitization
8.3 Features of Securitization 156
8.4 %HQH¿WV RI 6HFXULWL]DWLRQ
8.5 Parties Involved in Securitization 160
8.6 Process of Securitization 162
8.7 Instruments of Securitization 165
8.8 Types of Securities 167
8.9 Securitization in India 168
8.10 Summary 174
8.13 References 176
Glossary 179
iv PAGE
L E S S O N
1
Introduction to the Indian
Banking System
Dr. Shruti
Assistant Professor
Shri Ram College of Commerce
University of Delhi
Email-Id: shruti@srcc.du.ac.in
STRUCTURE
1.1 Learning Objectives
1.2 Introduction
1.3 Overview of Banking System in India
1.4 Major Banking Reforms in the Last Decade
1.5 Payment Bank
1.6 Monetary Policy Committee
1.7 MCLR Based Lending
1.8 Innovative Remittance Services
1.9 Summary
1.10 Answers to In-text Questions
1.11 Self-Assessment Questions
1.12 Suggested Readings

To provide a brief overview on the structure of banks.
To comprehend the role of various banking reforms in shaping the overall banking
industry.
To acquaint students on emerging role of differentiated banks like payment banks.
PAGE 1
BBA(FIA)
Notes To comprehend the role of Monetary Policy Committee, MCLR Based

Lending & Innovative Remittance Services.
1.2 Introduction
Banks play an important role in shaping the economy of the country. Banks
provide a range of services like savings accounts, loans, insurance and
payments not only to the privileged group, but the vulnerable groups can also
be benefited. By providing these essential financial services to the weaker
section of society, the banking sector, on the one hand, helps them to come
out of poverty, while on the other hand, transfers the resources from the
surplus units to the deficit units. In India, the Reserve Bank of India (RBI)
plays an important role in regulating the banking Industry. RBI is a central
bank whose main objective is supervising and monitoring various public and
private banks. RBI and the government promptly bring out various policies
and regulations to provide the banks with overall financial stability and
resilience. Over the years, the structure of the banking system in India has
undergone a huge transformation. The increase in digital adoption among
large masses has prompted the use of ‘digital banking’, which provides access
to banking services 24*7 without physically visiting the bank branch. India
is slowly taking an important lead in the global financial technology sector.
Thus, considering the considerable significance of the banking system in
the country, this lesson aims to develop a better understanding of the overall
banking sector, various banking reforms taken on a time-to-time basis,
emerging bank types (like payment banks, innovative remittance types)
and some important banking related concepts such as MCLR and the role
of monetary policy committee in India.
1.3 Overview of Banking System in India

The banking system plays an important role in a national economy. The
main function of the banking system in any economy is to mobilise public
savings to allocate growth and development activities. Banking institutions
are indispensable for the money market. Commercial banks and cooperative
banks have grown significantly in the past decade among the financial
institutions in the organised segments. The existence of Regional Rural
2 PAGE
EMERGING BANKING AND FINANCIAL SERVICES
Banks (RRB) is also playing an important role in rural areas. Besides the Notes
banks above, we have special banking institutions known as ‘Development
Banks’, catering to specific industries, agriculture and foreign trade. Reserve
Bank of India (RBI) is the central bank in India which take most of policy
regulation and initiatives related to financial institutions, including banks.
The structure of the banking system is outlined in Figure 1.1 below:
Reserve Bank of India (RBI)
RBI is an apex governing body of banks established w.e.f. April 1, 1935,
with the primary objective of supervising and regulating various financial
institutions, including scheduled and non-scheduled banks. RBI function
to strengthen the policy framework of the banking system. Apart from this,
the Reserve Bank of India, through the constitution of the Monetary Policy
Committee (MPC), sets policy repo rates for the banks and strives to balance
growth and inflation.
Figure 1.1: Structure of banking system in India

Scheduled Commercial Banks (SCB)
Scheduled banks are listed as per the II schedule of the RBI Act, 1934.
Banks have to comply with certain criteria to be listed as scheduled banks.
Scheduled Commercial Banks (SCB) are subjected to a minimum fulfilment
of Section 42(6) of the RBI Act, which states the following two important
conditions i.e., firstly, there is a requirement of minimum paid-up capital and
reserves of a value which RBI prescribes from time-to-time basis; secondly,
PAGE 3
BBA(FIA)
Notes banks should always run in the interests of its depositors, and lastly, it must
be a corporation, not a partnership or a single owner firm. Since 1969, such
banks have shown fast growth due to the nationalisation of the big banks.
RBI provides them with credit and many other facilities. RBI has mandated
all the scheduled commercial banks to keep some amount from their demand
and time deposits in the form of the Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR). There are two major categories of Scheduled banks,
i.e., Scheduled Commercial Banks (SCBs) and Scheduled Cooperative banks.
Public Sector Banks (PSB)
PSBs are the nationalised banks representing a large proportion of the
banking industry. PSBs have been a key player in the Indian financial system
post-nationalisation of the State Bank of India in 1955, followed by another
major nationalisation drive in 1969 and 1980. A commercial bank has a dual
function, i.e., extending loans and advances and, at the same time, accepting
various types of deposits (such as savings bank accounts, current accounts,
fixed deposits etc.). The government upholds a major stake in these banks.
Some examples of key players are the State Bank of India (SBI) (including
all its subsidiaries), Canara Bank and Bank of Baroda.
Private Sector Banks
In Private sector banks, there is a major stake of the private individuals or
corporations. Private Sector Banks play a strategic role in the growth of
joint sector banks in India.
For instance, HDFC Bank, ICICI Bank, Axis Bank and Kotak Mahindra
Bank are examples of such banks.
Foreign Banks
These are the banks which have major stakes in foreign bodies or institutions.
Some examples of such banks are Barclays Bank, Bank of America and
Bank of Ceylon, etc.
Regional Rural Banks (RRBs)
Regional Rural Banks (RRBs) are the scheduled commercial banks recognised
per the Regional Rural Bank Act, 1976. They have ownership from the
Central Government, state government and sponsor banks. These banks are
created to serve the banking needs of people, especially in the rural area.
4 PAGE
Scheduled Cooperative Banks (SCB) Notes

These small-sized banks are regulated by the Banking Regulations Act, 1949
and the Cooperative Societies Act, 1955. Scheduled Cooperative Banks (SCB)
do not seek profits in the long run. In these banks, members are the owner
as well as the customers. Thus, Cooperative banks provide the opportunity
of last mile credit coverage with an interest rate usually lesser than local
money lenders. Based on the location of these Cooperative Banks, there can
be Urban Cooperative Banks (UCB) and Rural Cooperative Banks (RCB).
Non-Scheduled Commercial Banks
Unlike Scheduled Commercial Bank (SCB), non-scheduled banks are not
covered under the second schedule of RBI.
Development Banks
Besides these regular banks, we also have development banks in the country.
The setting up of Development Banks in India was the most outstanding
development in the sphere. Development Banks (DB) are altogether different
sets of banks which do not provide regular banking services such as deposit
and credit; instead, their main purpose is to serve the large public interest.
These banks usually extend medium to long-term credit facilities to industrial
and agricultural sectors. Besides, such banks have another important role:
providing project-related guidance, guarantees for term loans, subscriptions
to shares & debentures, underwriting new issues, upgradation of managerial
skills through training programmes, etc. The primary advantage of development
banks is that they do not take public deposits like traditional banks; instead,
they raise funds directly from the government or multilateral institutions.
The structure of development banks includes both all India and state-level
institutions.
The establishment of the Industrial Finance Corporation of India (IFCI)
marked the beginning of the era for development banks in India. IFCI came
into existence in 1948 to offer usually long-term credit to industrial enterprises
when normal retail banks could not fulfil their credit requirement. Similar to
the structure of IFCI, State Financial Corporations (SFCs) were established
under SFC Act in 1951. Though the scope of SFCs is mainly restricted
to certain states. Besides SFCs, there are State Industrial Development
Corporations (SIDCs). The main purpose of these SIDCs is to promote
PAGE 5
BBA(FIA)
Notes industrial development. Though SIDCs focus on promotional activities parts

such as identification of projects, feasibility studies, training and surveys.
Later, the establishment of India’s Industrial Credit and Investment Corporation
(ICICI) is yet another steppingstone in the diversification of the development
banks in the country. ICICI mainly provides services such as underwriting
the issue of capital, foreign currency loans from the World Bank to private
industry and so on. In 1964, Industrial Development Bank (IDBI) was formed
as a subsidiary of the RBI. These institutions serve an important role in
the economic development of the country. It not only functions to provide
finance but also coordinates all the activities of the financing institutions.
Another institution, the Small Industries Development Bank of India (SIDBI),
was established as a part of IDBI. SIDBI’s main aim is to fulfil the credit
requirement of small and medium enterprises.
Besides, SIDBI also assists in refinancing loans and advances, discounting
bills, providing seed capital, services like factoring, leasing etc. In 1982,
India’s first Export-Import bank (EXIM) was set up under the EXIM Act,
1981. The main function of such banks is to facilitate the country’s export
and import. It aids in refinancing the banking services for foreign trade.
National Bank for Agriculture and Rural Development (NABARD) is another
important development bank. These banks were established in the year 1982.
NABARD serves as an apex body for providing credit facilities to institutions
mostly engaged in developmental activities related to agriculture and allied
businesses in rural areas. Development banks could be instrumental in the
planned economic growth of various industrial sectors.
1.4 Major Banking Reforms in the Last Decade

The Indian banking sector has significantly transitioned in the last few decades.
With many IT-based financial services, banking services have become more
accessible, especially in far and remote areas. Basically, ‘banking sector
reforms’ pertain to policy initiatives and measures to improve the banking
industry’s efficiency and overall financial stability. These reforms intend
to strengthen the financial infrastructure and thereby promote economic
growth. There were many committees constituted from time to time by the
government, along with RBI, for suggesting policies and regulations for
the banking industry. Some of the key reforms taken are mentioned below:
6 PAGE
Banking Sector Reforms Since 1991 Notes

In a pre-reform era, there were some notable changes in the banking sector,
such as the nationalization of 14 SCBs in 1969, followed by six more banks
in 1980. In 1975, Regional Rural Banks (RRB) were established to facilitate
low-cost credit requirements by the people in rural counterparts. Economic
reform in 1991, followed by the constitution of two major committees viz.,
Narasimham Committee-I (1991) and Narasimham Committee-II (1998),
were the steppingstones for the growth and development of the banking
sector in India. These committees provided some important suggestions for
the banking industry. Some of these recommendations are mentioned below:
Functional Autonomy and Competition: The basic approach is the banking
system, a market-oriented one. The Committee opined that the Public Sector
Banks (PSB) should become functionally autonomous. They further suggested
that dual monitoring of banks by the Ministry of Finance and RBI should be
abolished as they viewed that this has been the cause of major operational
inflexibility and loss of Autonomy in major decision-making by the banks.
Besides the functional Autonomy, the Committee recommended the need
for healthy competition among banks for their mutual growth. Even foreign
banks should be allowed to operate in the country.
Profitability: The Committee suggested that public sector banks should be
permitted to run various profitable investments. Banks should strive to achieve
operational efficiency and thereby profit by reducing their expenditure.
Structure of the banking system
This Committee suggested some major structural changes in the existing
banking system, such as some could take the lead internationally and national
banks taking up the role of ‘universal banking’. Regional Rural Banks should
work more closely in financing agriculture and allied activities.
Capital adequacy and bad debt
They suggested increasing the Capital Adequacy Ratio (CAR) to the ‘risk-
weighted assets’. To address the issue of bad debts (or non-performing assets),
banks should have uniform accounting practices and provisions against
different categories of bad debt. These committees aimed at promoting a
healthy and competitive environment for the banks. Major reforms were
undertaken for the prudential regulation of the banks and other financial
PAGE 7
BBA(FIA)
Notes institutions, such as income recognition, provisioning norms, setting up of

an Asset Reconstruction Fund and risk-based capital adequacy norms.
Khan Committee (2005)
To strengthen financial inclusion in the country, RBI constituted Khan
Committee in the year 2004. The Committee reviewed various difficulties
people face accessing microfinance and rural credit in the country. The report
has several important recommendations, such as the ‘business correspondent
model’, to ease the outreach of banking services in unbanked places. Further,
the Committee was given strong NGO/MFI - Bank linkages. Yet another
major recommendation of the Committee is a “no-frills” banking account,
enabling low-income households to open bank accounts with negligible or
no minimum balance.
Rangarajan Committee (2008)
Rangarajan Committee had several recommendations for the inclusion of
people under the banking system. This Committee suggested the formation
of the Financial Inclusion Promotion and Development Fund and Financial
Inclusion Technology Fund under the National Bank for Agriculture and Rural
Development (NABARD). Besides, Committee also emphasized appropriate
technology adoption for Business Facilitator/Business correspondent (BF/
BC) models, upscaling the SHG - Bank Linkage Programme, Joint Liability
Groups, Micro Finance Institutions – NBFCs, Micro Insurance, and rural
credit cooperatives.
Raghuram Rajan Committee (2008)
Raghuram Rajan Committee on “Financial Sector Reforms” was constituted
in 2007 by the government. The Committee was chaired by the former Chief
Economist of the International Monetary Fund (IMF). This Committee made
noted the need for relaxation in regulation for business correspondents. This
Committee recommended integrating modern technologies with the banking
sector to limit fraud and promote cost-effective transactions.
Nachiket Mor Committee (2014)
Nachiket Mor Committee’s (2014) report titled “financial services for small
businesses and low-income households” noted some important recommendations
like a universal saving account, payments banks and wholesale banks for
better credit reach to the masses. The Committee also emphasized the need to
8 PAGE
establish payment banks, small finance banks, and the creation of a universal Notes
electronic bank account (Jan Dhan Yojana).
JAM (Jan Dhan Aadhaar Mobile) Trinity
JAM trinity, which refers to Jan Dhan-Aadhaar-Mobile was a major step by
the government of India to connect three domains, i.e., Jan Dhan accounts,
mobile numbers and Aadhaar cards of Indians. JAM Trinity can help plug
the leakage and corruption related to the government subsidiary. Pradhan
Mantri Jan-Dhan Yojana (PMJDY) is a pan-India scheme launched to afford
access to various financial services. The scheme was announced by the prime
minister of the country in the year 2014 to promote financial inclusion. While
‘Aadhaar’ are 12-digit unique identity number issued to each Indian citizen.
These ‘Aadhaar’ number is issued by a Central Government authority named
as Unique Identification Authority of India (UIDAI) which collect and store
the biometric and demographic information of the resident and
Indradhanush Framework
The Government of India launched the Indradhanush framework to revitalize
and reform public sector banks. The primary goal of this framework is to
increase the efficiency, transparency, and governance of public sector banks.
The framework recommended seven major areas Appointments, Bank Board
Bureau (BBB), Capitalization, De-stressing, Empowerment, Framework of
Accountability and Governance reforms.
4R Framework (Recognition, Recapitalization, Resolution and Reforms)
The 4R framework was launched in the country in 2017 to address the issue
of banks increasing ‘bad loans’. The framework proposed four key elements,
which are mentioned below:
Recognition: Identification and classification of stressed assets as
NPAs.
Recapitalization: Injecting capital into banks to improve their
financial health.
Resolution: Creating processes for the timely resolution of stressed
assets through interventions by the Insolvency and Bankruptcy Code
(IBC) and other resolution frameworks.
Reforms: Brining structural reforms for improving the governance,
risk management, and operational efficiency of banks.
PAGE 9
BBA(FIA)
Notes National Asset Reconstruction Company Limited (NARCL)

The constitution of National Asset Reconstruction Company Limited
(NARCL) was declared in the year 2021 by the government to address the
issue of increasing Non-Performing Assets (NPA) by the banks. In India,
the surge in Non-Performing Assets (NPA) of the banks has posed a major
policy challenge. NPA refers to the non-payment of any advance or loan
which overdue for more than 90 days. NARCL will constitute a ‘bad bank’
which would try to restructure these bad loans.
National Bank for Financing Infrastructure and Development (NaBFID)
The government established National Bank for Financing Infrastructure and
Development (NaBFID) under NABFID Act, 2021 as one of the development
banking institutions. NaBFID facilitates long-term infrastructure financing
to many sectors.
Central Bank’s Digital Currency (CBDC)
The Central Bank’s Digital Currency (CBDC), referred to by RBI as the
‘digital rupee’, is yet another major policy reform in recent times. The
government announced the first concept note on CBDC in October 2022.
CBDC is expected to be implemented in the upcoming years in the country. It
works on block chain technology with the objective to reduce physical cash
usage and increase the efficiency and speed of banking transactions. This
may, in turn, boost financial inclusion and increase overall bank lending.
1.5 Payment Bank

Payment banks are a new category that extends almost all banking services
except credit facilities. Thus, the credit risk of payment banks is negligible
as they do not deal with loans or issues of credit cards. Payment Banks are
small-scale banks which can provide services like demand deposits (up to
INR 1 lakh), remittances, transfers/purchases and third-party fund transfers.
The target customers of such banks are usually low-income individuals or
entities. The need for payment banks in India was mentioned for the first time
in 2014 in a Nachiket Mor Committee report on “Comprehensive financial
services for small businesses and low-income households”. Through payment
banks, RBI aims to widen the spread of financial services, especially in
remote and distant areas of the country. Bharti Airtel set up India’s first
payments bank, “Airtel Payments Bank”.
10 PAGE
1.6 Monetary Policy Committee Notes
RBI forms the Monetary Policy Committee (MPC) under section 45ZB of the
amended RBI Act, 1934. MPC includes six members, of which three officials
are from RBI (including the Governor of the RBI), and the Government of
India nominates three members. The main purpose of the MPC is to set the
policy repo rate in such a manner as to attend to the inflation target between
a range of 4 to 6 per cent in the country. MPC can meet at least four times
a year. Each member can have one vote; when there is equality of votes
between internal and external members, the Governor has a casting vote.
The Governor of the RBI is the chairperson “ex officio” of the committee.
1.7 MCLR Based Lending

MCLR stands for ‘Marginal Cost of Funds based Lending Rate’, which is
the bank’s lowest rate of fund lending. MCLR was introduced for the first
in India w.e.f. 1st April 2016 for pricing the rupee loan. Banks can use the
MCLR rate to estimate interest rates on various loans, such as home loans.
The interest rate under various categories is set at a fixed percentage, usually
higher than the MCLR. So, when MCLR changes, it will also change the
interest rates linked to it. The main purpose of MCLR is to bring transparency
and consistency to the interest rates levied on loans by the banks. Simply
put, when MCLR increases, it will also increase its interest rate. Financial
institutions are not allowed to lend below MCLR.
1.8 Innovative Remittance Services

Recently, a broad range of innovative remittance services has been launched
by financial institutions worldwide to provide the facility of money transfer
in an easy and timely manner. Formal financial remittance mediated through
banks often lacks more outreach in remote and rural places. Also, the individual
often needs a formal bank account to receive/send money from others. Post-
demonetization in India in 2016, there was increased opportunity for digital
payment service providers. Some private players like Paytm, Mobikwik and
Freecharge using various digital payment applications such as UPI, Aadhaar
Payment, BHIM, etc., have made digital transactions much easier and more
convenient. These digital payment methods provide an easy money transfer,
PAGE 11
BBA(FIA)
Notes especially in far and distant places in the country. Especially in COVID,
many Indian households are recently using digital payment apps for various
activities such as paying for groceries, healthcare, and even insurance. The
ease in mobile phone availability and cost-effective data plans have provided
a huge thrust for this Industry. Indeed, the Indian government is, through
initiatives and schemes, providing support for cashless transactions. There
are various innovative methods of remittance in India which are mentioned
below:
1. Unstructured Supplementary Service Data (USSD): USSD services
are provided by most mobile service providers. An internet data
facility is optional to avail of USSD on your mobile. It facilitates
the financial inclusion of unbanked people with mainstream banking
services, especially those living in rural and unreached areas.
2. AePS (Aadhaar-enabled payment system): This service enables
the customer to access banking transactions such as cash deposit/
withdrawal, intrabank/interbank transfer, balance enquiry, etc., by
using Aadhaar authentication at branch/Business Correspondents
locations.
3. BHIM Aadhaar Pay: Assists payment to merchants by customers
using Aadhaar authentication.
4. UPI (Unified payment interface): A single platform for the immediate
real-time payment system which can facilitate both Person-to-Person
(P2P) and Person-to-Merchant (P2M) transactions. A UPI ID and
PIB are required to send and receive the money.
5. BBPS (Bharat Bill Payment System): BBPS is an online payment
platform which offers interoperable and easy access to utility bill
payment services via a network of agents of registered Agent
Institutions (AI).
6. Mobile banking: Mobile banking services enable a customer to access
a bank account via a mobile device such as a smartphone or tablet
through a mobile app for that bank or other financial institution.
The service is generally available on a 24-hour basis and uses the
internet or mobile data availability.
7. Mobile wallets: It is a virtual wallet that stores mobile phone
payment card details. Mobile wallet enables users to make in-store
12 PAGE
payments conveniently. Examples of popular digital payment apps Notes

are the HDFC payZ app, ICICI Pocket and Paytm.
8. Credit card/debit card: This is a Card-enabled fund transfer.
Typically, these cards have the logo of Visa or Mastercard.
9. National Electronic Fund Transfer (NEFT): NEFT refers to a funds
transfer system which can be used electronically by any individual or
organization with a bank branch to any account. NEFT is maintained
by the Reserve Bank of India (RBI).
10. Real-Time Gross Settlement (RTGS): Unlike NEFT, Real-Time Gross
Settlement (RTGS) are the electronic fund transfer between two
banks. RTGS payment systems are done for large-value transactions.
11. Prepaid Payment Instrument (PPI): As per the RBI guidelines
under the Payment and Settlement Act, 2005. The Prepaid Payment
Instruments (PPIs) offer the facility to use the value stored on these
instruments for financial transactions.
12. Immediate Payment System (IMPS): IMPS provides an option for
an immediate fund transfer facility that can be operated through
basic mobile phones, smartphones, and internet/ ATMs. Unlike other
digital payment modes, IMPS services are available 24×7.
1.9 Summary
This lesson provides a comprehensive knowledge of the Indian banking system
in India. Post-economic reform in 1991, the banking industry underwent
major structural changes. There is a large number of public and private
sector banks which extends various financial services such as deposit, credit,
remittance and insurance. ‘Digitalization’ of banks has provided opportunities
for a large proportion of people to access financial services at their ease
and convenience. Recently, RBI has announced that Digital Banking Units
(DBUs) to be operationalized on a large scale in the country.
The Indian government, along with the Reserve Bank of India (RBI), have
taken many initiatives to further financial inclusion, especially for poor and
economically weaker sections of society. Payment Banks have paved the way
to access most of the financial services for low-income earners. Further, we
PAGE 13
BBA(FIA)
Notes have various innovative remittance methods such as mobile wallet, RTGS,
NEFT, AePS, BHIM, UPI and mobile banking, which provide wide options
for cashless payment. For the financial stability and economic growth in
the country, RBI, through Monetary Policy Committee (MPC), announced
the policy repo rate at each quarter of the year. Nonetheless, MPC intends
to limit inflation under the prescribed range of 4% to 6%.
IN-TEXT QUESTIONS
1. What is the name of the Central Bank of India?
(a) Central Bank of India
(b) Reserve Bank of India
(c) State Bank of India
(d) Indian Overseas Bank
2. In which year was the Reserve Bank of Indian established?
(a) 1935
(b) 1947
(c) 1940
(d) 1949
3. ____________is the first development financial institution in
India.
(a) IDBI
(b) IFCI
(c) ICICI
(d) RBI
4. Who is the chairperson of the Monetary Policy Committee of
India?
(a) Governor of RBI
(b) Finance Minister
(c) Prime Minister
(d) Chief Economic Advisor
14 PAGE
5. Which of the following is an innovative method of remittance? Notes
(a) Mobile Banking

(b) BHIM
(c) UPI
(d) All of the above
1.10 Answers to In-Text Questions
1. (b) Reserve Bank of India

2. (a) 1935
3. (b) IFCI
4. (a) Governor of RBI
5. (d) All of the above

1. Explain briefly the main functions of Reserve Bank of India (RBI)?
How RBI takes part in affecting the overall growth of the economy.
2. Why do you think RBI is ‘Banker’s bank’? Please elaborate.
3. Describe the basic banking structure in India? Differentiate between
scheduled bank and non-scheduled banks?
4. What are the various types of scheduled banks in India?
5. Please discuss the relevance of Development bank in India. Describe
the function and role served by following development banks:
(a) NABARD
(b) EXIM
(c) IDBI
(d) SIDBI
6. What are the various banking reforms taken in India in recent times?
7. Highlight few important suggestions made by Narasimham Committee
I & II.
PAGE 15
BBA(FIA)
Notes 8. Please elaborate the main features of following Indian government

schemes such as:
(i) Jan Dhan Yojana
(ii) Indradhanush
(iii) Bad bank
(iv) 4R Framework
9. Elaborate the role and function of payment banks in India?
10. Why do you think Central Banking Digital Currency (CBDC) will
promote the financial inclusion among large masses?
11. What do you mean by the term MCLR?
12. What do you mean by the Monetary Policy Committee (MPC)? How
is MPC constituted? What are the main objectives of MPC?
13. Describe the various types of innovative remittance methods used in
India these days?
14. Explain the following term briefly:
(a) Unified Payment Interface (UPI)
(b) Mobile Banking

Pathak, B. on Indian Financial System, (5th Ed.) Pearson Publication.
Bhole, L.M., Financial Markets and Institutions (6th Ed.) Tata McGraw
Hill Publishing Company.
Khan, M.Y on Financial Services, (9 th Ed.), Tata McGraw Hill
Education.
H.R. Machiraju, Indian Financial System, Vikas Publishing House,
Delhi.
Jeff Madura, Financial Markets and Institutions, CenGage Learning,
Delhi.
RBI website for latest updates on reforms and guidelines related to
banks.
16 PAGE
L E S S O N
2
Issues in Financial
Reforms and Restructuring
Dr. Priya Chaurasia
Assistant Professor
University of Delhi
Email-Id: priya.chaurasia@srcc.du.ac.in
STRUCTURE
2.2 Introduction
2.3 Challenges and Issues in Financial Reforms
2.4 Assessing Non-Performing Assets (NPAs) in Indian Banking
2.5 Previous Methodologies for the Recovery
2.6 Impact of Gross NPAs on a Bank’s Bottom Line
2.7 Introduction to Bad Banks, Functioning of Bad Banks, National Asset Recon-
struction Company Ltd. (NARCL)
2.8 Summary
2.11 References

Students would be familiar with banking reforms as it was to develop a more diverse,
efficient, and competitive financial system, with the ultimate goal of increasing
resource-allocative efficiency through operational flexibility, better financial viability,
and institutional strengthening.
Understanding the importance of restructuring in banking systems.
PAGE 17
BBA(FIA)
Notes 2.2 Introduction

The Indian Banking system is the backbone of the Indian Financial System
as it provides Financial Inclusion to many households. The backbone of any
economy, banks are essential to igniting and maintaining economic growth,
particularly in developing nations like India.
This industry supports one of the fastest-growing large economies across
the world. So, this industry must be technologically advanced, transparent,
responsible, and efficient. It’s a need of the Indian economy to have a
strong banking sector and in India banking is not only about the economic
function of depositing and lending but it is also attached to some social
functions such as financial literacy, financial inclusion, inclusive growth,
and economic development.
As we know, an efficient financial sector enables the smooth mobilization
of money supply, increases household savings and investment, and also
ensures their proper utilization in productive sectors. The financial sector
constitutes commercial banks, non-banking financial institutions, investment
funds, money market, insurance, pension companies, real estate, microfinance
institutions, development banks, etc.
Financial Sector Reforms
The Financial sector refers to the part of the economy which consists of firms
and institutions that have the responsibility to provide financial services to
the customers of the commercial and retail segment. The financial sector
can include commercial banks, non-banking financial companies, investment
funds, money market, insurance and pension companies, and real estate etc.
As the foundation of the economy, the financial sector is crucial for the
allocation and mobilisation of financial resources. Steps done to reform the
banking system, capital markets, government debt markets, foreign currency
markets, etc. are referred to as financial sector reforms.
To mobilise household savings and ensure their correct use in productive
sectors, a financially sound sector is required. Before 1991, the Indian
financial sector was suffering from several lacunae and deficiencies which
had reduced the quality and efficiency of their operations. Reforms in
the banking sector where a financially stable sector is necessary for the
mobilisation of household savings and the verification of their appropriate
application in productive sectors. Therefore, necessary at the time.
18 PAGE
Reasons for Financial Sector Reforms in India Notes

India acquired a number of disadvantages and issues as a result
of colonial legacies after gaining independence. Both social and
economic developments in the nation were behind. India created
a system of planned economy based on the Mahalanobis model
to achieve the objective of rapid economic development. Midway
through the 1980s and the beginning of the 1990s, this model had
already begun to reveal some of its flaws.
To promote economic growth, the government adopted a fiscal
activism approach, and significant amounts of public spending
were funded by significant borrowing at low-interest rates. India’s
financial markets were hence relatively underdeveloped and weak.
Fiscal activism has resulted in an annual increase in the fiscal deficit.
The economy was negatively impacted by inflationary tendencies
and other aspects of the automatic monetization of the fiscal deficit
policy.
Due to the nationalisation of banks, the government now has total
authority over them, which has curtailed the influence of market
forces in the financial sector. Before 1980, the growth rate was
roughly 3.5% annually, and by the middle of the 1980s, it had risen
to almost 5%. This growth rate was proving insufficient to solve
the economic and financial problems of the country.
Issues with red tape and a lack of professionalism in the banking
industry were to blame for the rise in non-performing assets.
There were difficulties with the financial sector’s lack of effective
regulation. The technologies used in the financial system and its
institutional structures were outdated.
India was dealing with several economic issues in 1991. The Foreign
Exchange Reserves of India were under stress as a result of the
Middle East conflict and the collapse of the USSR. India was
currently experiencing a balance of payment crisis, making reforms
necessary.
India received a colonial heritage that was rife with different social
and economic injustices after gaining freedom.
PAGE 19
BBA(FIA)
Notes The shortcomings of the planned economic development strategy,

which was based on the Mahalanobis model, became apparent in
the 1980s.
The government increased borrowing at favourable rates to accomplish
a number of economic goals, but this has left India’s financial
systems vulnerable and underdeveloped.
Increased red tape and bureaucratic oversight led to an increase in
non-performing assets.
Turbulent international events such as the war in the Middle East
and the fall of the USSR increased the pressure on the Foreign
Exchange Reserves of India.
Strategies Adopted for Financial Sector Reforms
India chose to implement financial reforms gradually rather than
using shock therapy. To maintain the continuity and stability of
India’s financial industry, this was required.
India incorporated International best practices at the same time
adjusted it as per the local requirements.
The first generation of reforms ensured flexibility to operate with
functional autonomy in order to develop an effective and lucrative
financial sector.
The second generation of reforms was implemented to improve the
structural stability of the financial system.
India embraced the consensus-driven liberalisation strategy because
it was essential for a democracy.
Narasimham Committee Report, 1991
The Narasimham committee was set up in August 1991 to provide detailed
suggestions on the Indian financial system, including the stock market and
banking industry.
The committee’s principal suggestions are as follows:
The committee suggested lowering the Cash Reserve Ratio (CRR) and
the Statutory Liquidity Ratio (SLR) to 10% and 25%, respectively,
over time.
20 PAGE
Recommendations on priority sector lending: The committee Notes

suggested defining priority sector to include marginal farmers, small
companies, cottage industries, etc.
Deregulation of interest rates: The committee suggested that the
interest rates that banks charge be deregulated. In order to give
banks, the freedom to choose their own interest rates for consumers,
this was necessary.
The creation of tribunals for the recovery of debts from non-
performing assets, etc., was advised by the committee. On asset
quality classes, it offered recommendations.
The committee suggested that new private banks be allowed to
operate in the financial sector.
It was created to provide reforms for India’s financial sector,
particularly the banking and capital markets. It suggested lowering
the Statutory Liquidity Ratio (SLR) to 25% over time and the Cash
Reserve Ratio (CRR) to 10%.
It suggested fixing at least 10% of the credit for priority sector
lending to marginal farmers, small businesses, cottage industries,
etc.
It suggested deregulating interest rates in order to give banks the
necessary independence to decide on interest rates for consumers.
Reforms in the Banking Sector
Banks now have more financial resources to lend to the agricultural,
industrial, and other sectors of the economy as a result of the
reduction in CRR and SLR.
The administered interest rate structure system has been eliminated,
and the RBI is no longer in charge of setting interest rates for
deposits made by banks.
Permitting local and foreign private sector banks, including HDFC
Bank, ICICI Bank, Bank of America, Citibank, American Express,
etc., to build branches in India.
Lok Adalats, civil courts, tribunals, and the Securitization and
Reconstruction of Financial Assets and the Enforcement of Security
PAGE 21
BBA(FIA)
Notes Interest (SARFAESI) Act were used to address disputes with non-
performing assets.
To allow banks to give more freedom, the selective credit control
system that had reinforced the influence of the RBI was eliminated.
From 39% to its present level of 19.5%, the SLR has decreased. The
cash reserve ratio has been reduced from 15% to 4%. Banks now
have more financial resources to lend to the agricultural, industrial,
and other sectors as a result of the SLR and CRR reduction in
different economic sectors.
Modifications to administered interest rates: Previously, banks’ interest
rates were determined by the RBI, under a system known as an
administered interest rate structure.
The primary goal was to offer financing to the government and
a few key sectors at reduced interest rates. The system has been
abandoned, and the RBI is no longer in charge of determining
interest rates for bank deposits. However, the RBI controls interest
rates for smaller loans up to Rs. 2 lakh, where they must not exceed
prime lending rates.
Capital Adequacy Ratio: The capital adequacy ratio measures how
much paid-up capital and reserves a bank has in comparison to its
deposits. The capital adequacy of 8% on the risk-weighted asset
ratio system was introduced in India.
Allowing private sector banks: As a result of financial reforms,
we now have HDFC Bank, ICICI Bank, IDBI Bank, Corporation
Bank, and other private banks were established in India. This has
brought much needed competition in the Indian money market which
was essential for the improvement of its efficiency. Foreign banks
have also been allowed to open branches in India and banks like
Bank of America, Citibank, and American Express opened many
new branches in India.
The following three avenues were available for foreign banks to
conduct business in India:
As branches of international banks.
22 PAGE
Being a subsidiary of a foreign bank that is entirely controlled by Notes

that bank.
A branch of a foreign bank that is subject to the 74% foreign
investment cap.
Non-Performing Asset (NPA) reforms: Loans that have had unpaid
instalments for 90 days or more are considered non-performing
assets. RBI introduced the Recognition Income Recognition Norm.
These standard states that if the bank’s assets’ revenue is not
received within two-quarters of the previous date, the income is not
acknowledged. Through Lok Adalats, civil courts, Tribunals, and
other means, recovery of bad debt was enforced. The Securitisation
and Reconstruction of Financial Assets and Enforcement of Security
Interest (SARFAESI) Act was brought to handle the problem of bad
debts.
The elimination of direct or selective credit controls: Previously, the
RBI controlled the supply of credit by adjusting the margin used to
provide loans to traders against the stocks of sensitive commodities
and stockbrokers against shares. Since the direct credit control
system was removed, banks are now freer to extend credit to their
clients.
Promoting microloans for financial inclusion: The government created
a microloan programme, and the Reserve Bank of India provided
instructions for it. The most important model for microfinance has
been the Self-Help Group Bank linkage programme. This program
is executed by the scheduled Commercial Bank and RRBs.
2.3 Challenges and Issues in Financial Reforms

Challenges include Non-Performing Assets (NPAs), recapitalization, an
increase in bank fraud, asset quality challenges, and human resource
problems that are hindering industry performance and endangering future
economic growth. This will have effects on both banks and the economy.
Financial inclusion in India has the following obstacles:
Low income and inability to offer collateral security.
The barrier to financial inclusion is still the scarcity of bank branches
in rural areas.
PAGE 23
BBA(FIA)
Notes A greater reliance on unregulated lending.

Complicated financial terms, conditions, and several product offerings.
One of the foundations of the Transforming India project is financial
inclusion, and banks play a significant part in this through programmes
like the Jan Dhan Yojana, Direct Benefit Transfer, and Mudra Yojana.
Aadhaar, Digi locker, India Stack, and other recent government initiatives
are establishing an unprecedented “publicly accessible, unified digital
infrastructure” through which users can authorise financial firms to access
their data. However, the industry is battling several novel challenges that
are putting its resiliency and tenacity to the test.
Although India’s financial system has achieved remarkable heights and
adopts a solid method that is applicable considering the current worldwide
Despite positive economic outlook, there have been problems with the
Indian financial system. The following are some of the most recent issues
that continue to have a significant impact on India’s financial system:
NPAs: The rise of Non-Performing Assets (NPAs), including bad loans
or problems in the agricultural and corporate sectors. Currently, the
nation’s NPAs total more than 10 lakh crores, with the business
sector accounting for more than 70% of the total.
Bad Loan problem: After the 2008-09 global financial crisis, there
was push in lending to infrastructure and capital goods sectors.
But as the economy slowed down, demand decreased and capacity
remained idle, making it harder for businesses to pay off their debt.
Under the weight of Rs. 10 trillion in stressed assets, which included
Rs. 7.8 trillion in defaulted loans and Rs. 2.2 trillion in restructured
loans over nearly half a decade, the Indian banking sector collapsed.
Recapitalization: In order to bring state-owned banks up to capital
adequacy norms, recapitalisation of banks entails putting extra capital
into them. It means an infusion of capital into banks to enable them
to meet the mandatory capital adequacy norms set by the Reserve
Bank of India from time to time.
Increase in Bank Fraud: The increasing number of frauds, including
accounting fraud, demand draft fraud, uninsured deposits, fraudulent
loans, and others.
24 PAGE
Lack of banking for the underserved and rural population: It is Notes

approximately 69% of India’s total population. According to a World
Bank estimate, 1.4 billion Indians lack access to formal banking.
Asset Quality: One of the most important factors in assessing a
bank’s general health is asset quality. For banks, loans made to
individuals and businesses are assets. The interest earned on these
assets is a substantial source of income and profit for banks, and
the likelihood that the loans won’t be returned is their biggest risk.
As the credit risk rises, the loan’s “asset quality” decreases.
Human Resource Challenges: The banking sector has been struggling
with significant attrition, a sizable staff emigration rate, and scale
and speed recruitment issues.
Illiteracy and Lack of Awareness of Government Schemes: Lack
of reach in rural areas, where technical enablement and use of
financial services remain a big challenge.
These challenges are dragging down the industry’s performance and
threatening future economic growth. This will have implications for both
banks as well as for the economy. Therefore, the Central Government and
RBI introduced various reform attempts to solve these issues and seize
new chances. Therefore, the Central Government and RBI introduced
various reform attempts to solve these issues and seize new chances.
2.4 Assessing Non-Performing Assets (NPAs) in Indian

Banking
NPA expands to Non-Performing Assets (NPA). Any advance or loan that
is more than 90 days past due is considered a non-performing asset in
India, according to the Reserve Bank of India.
When an asset stops bringing in money for the bank, it is said to be
no longer performing. NPAs must be further divided into sub-standard,
doubtful, and loss assets by banks. NPA refers to loans made by Indian
banks and other active financial institutions that have interest payments
and principal balances that have been past due for an extended period
of time.
PAGE 25
BBA(FIA)
Notes Banks mostly rely on interest from advances and loans as well as principal
payments for their income. The Reserve Bank of India defines an NPA
as a credit facility whose interest and/or principal instalments have been
“past due” for a predetermined amount of time.
The asset is typically categorised as a non-performing asset if loan
payments have not been made for 90 days. Banks are obligated to group
non-performing assets into one of the following categories according to
how long they have been non-performing:
1. Sub-standard Assets
Sub- standard assets are non-performing assets that have been due
for anywhere from 90 days to 12 months. They are regarded as
having typical risk levels when it comes to non-performing assets.
2. Doubtful Assets
The non-performing assets that are due past more than twelve
months are known as sub-standard assets. In comparison to standard
assets, they pose significantly higher risk levels. Banks and financial
institutions are more sceptical of borrowers with sub-standards
of non-performing assets and thus assign them with a haircut (market
value reduction).
3. Loss Assets
Loss assets are non-performing assets with such extended periods that
lenders have given up hope that they would be able to recover their
money. They are forced to write it off as a loss on their balance
sheets.
NPA Provisioning
Keeping aside the technical definition, provisioning means an amount that
the banks set aside from their profits or income in a particular quarter
for non-performing assets, such as assets that may turn into losses in the
future. It is a method by which banks provide for bad assets and maintain
a healthy books of account.
According to the category to which the asset belongs, provisioning is
carried out. In the section above, the categories were mentioned. The
type of bank affects both asset type and provisioning in addition to asset
type. For instance, the provisioning standards for Tier-I banks and Tier-II
banks differ.
26 PAGE
GNPA and NNPA Notes

Banks are obligated to periodically report their NPA figures to the RBI
and to the public. Two metrics in particular aid in our understanding of
each bank’s NPA situation.
GNPA: GNPA stands for gross non-performing assets. GNPA is an
absolute amount. It provides information on the overall amount of gross
non-performing assets held by the bank during a specific quarter or
financial year, as applicable.
NNPA: NNPA stands for net non-performing assets. NNPA subtracts the
provisions made by the bank from the gross NPA. Therefore, net NPA
gives you the exact value of non-performing assets after the bank has
made specific provisions.
NPA Ratios
Alternatively, NPAs can be calculated as a proportion of total advances.
It enables us to estimate the portion of the total advances that are not
recoupable. The math is rather easy to understand this way:
The ratio of total GNPA to total advances is known as the GNPA
ratio.
Net NPA ratio is used to calculate the ratio to total advances.
Reasons for arising Non-performing Assets
Given below are some instances that may lead to non-performing assets
in the long run:
1. When banks lend to individuals/businesses with poor credit ratings
or without proper investigation.
2. When lenders don’t promptly follow up on pending payments with
borrowers.
3. Corruption in financial institutions (lenders) in nexus with borrowers
(generally businesses).
4. Political pressure on banks (especially PSUs) to lend to struggling
sectors/industries.
5. Inefficient collection competencies and recovery efforts by banks.
6. The factors that contribute to Non-Performing Assets (NPA) are
as follows:
PAGE 27
BBA(FIA)
Notes (i) The bank’s lending to the corporations/persons etc. whose

creditworthiness is not guaranteed and taking a lot of high
risks. (NPA in Banking)
(ii) The banks are not able to diminish their losses by a complete
understanding of the sufficiency of the bank in terms of the
loan or capital loss at a specific time frame.
(iii) The funds are being redirected elsewhere by the promoters
of the companies.
(iv) The banks try to fund projects that are not viable.
(v) Not enough means to collect as well as distribute credit
information between the commercial banks and
(vi) Non-efficient recovery of the debts from the overdue borrowers.
Preventive Measures Against Non-Performing Assets
1. Lenders should rigorously scan the credit ratings (from Credit
Information Bureau India Limited) of individuals/businesses at the
time of evaluating the loan application.
2. Lenders should proactively send reminders to borrowers urging them
to make the due payments.
3. Lenders should offer payment plans and settlements to borrowers to
facilitate regularizing their loan accounts.
4. Lenders may use alternative dispute resolution procedures, such as
Lok Adalats and Debt Recovery Tribunals, in addition to traditional
courts, to reach speedy settlements of debts.
5. Lenders should be strict against large non-performing assets.
6. Lenders may employ the services of professional asset reconstruction
companies to manage their non-performing assets better.
7. Lenders should circulate the details of defaulters so that others
hesitate to lend to these defaulters again.
8. Lenders should implement insolvency and bankruptcy policies to aid
distressed borrowers.
9. Borrowers can use corporate debt restructuring.
10. Lenders should be vigilant that borrowers (especially corporates)
should not divert their funds (loans) to other subsidiaries or start
ups.
28 PAGE
2.5 Previous Methodologies for the Recovery Notes
In Indian banks, the process by which banks and financial institutions

recover outstanding debts that have been labelled as non-performing is
known as the NPA (Non-Performing Asset) recovery process. Loans are
classified as NPAs when borrowers don’t make timely principal or interest
payments. Being a bank employee, I am aware of how challenging it is
for a bank to deal with a scenario like this. There is an NPA account
recovery technique that banks use for circumstances like these.
To reduce Non-Performing Assets (NPA) in Indian banks, several measures
can be implemented. The measures to reduce NPA are:
Banks should enhance their due diligence and credit appraisal
processes to assess the borrower’s creditworthiness effectively.
Regular monitoring of loan accounts can help identify early signs
of potential defaults.
Banks should establish comprehensive risk management frameworks
to identify, measure, and mitigate credit risks.
Banks should proactively initiate recovery measures and adopt efficient
debt recovery mechanisms.
Promoting financial literacy initiatives can help borrowers make
informed decisions and manage their finances effectively.
Banks should maintain high standards of corporate governance and
transparency in their operations.
Regulators such as the Reserve Bank of India (RBI) can play a
crucial role in monitoring and supervising banks’ asset quality.
Debt Recovery Tribunal (2013)
By putting these strategies into practice, banks can reduce the risks
brought on by Non-Performing Loans (NPAs) and seek to maintain a
healthier loan portfolio, thereby guaranteeing the stability and soundness
of the banking industry.
The development of sub-prime loans on a bank’s books is not a good thing
because it affects the size and stability of the balance sheet. Additionally,
there is a negative effect on the rate of return on assets. Profitability is
decreased since a large number of profits must be set aside for shaky
PAGE 29
BBA(FIA)
Notes and problematic loans. Banks are even plagued by the rising cost of
NPA accounts’ carrying, which could have been put to more profitable
use. Additionally, it is desired that the financial institutions maintain a
specific capital adequacy level to strengthen their net worth. A group
of banks or other financial organisations is worth at least Rs. 20 lakhs.
Credit Information Bureau (2000)
It was set up to reduce the time required for settling cases Credit
Information Bureau (2000). This step is taken to prevent NPA’s by sharing
of information on wilful defaulters. Credit Information Companies, also
called credit bureaus, are organizations that collect, analyse, and maintain
credit data on borrowers, businesses, and organizations.
ARC (Asset Reconstruction Companies)
It is licensed by the Reserve Bank of India an Asset Reconstruction
Company is a specialized financial institution that buys the NPAs or bad
assets from banks and other financial entities so that they can balance
their books.
ARCs buy subprime loans from banks, in other words, which is their
line of work. It is established for recovering value from stressed loans
by passing courts which was a 2013 measure implemented by the Debt
Recovery Tribunal (DRT) to control Non-Performing Assets (NPA). For
the swift adjudication and recovery of debts owed to banks and financial
institutions, insolvency resolution, bankruptcy of individuals and partnership
firms, and related matters, the RDB Act, 1993, establishes Debts Recovery
Appellate Tribunals (DRATs), which have appellate jurisdiction, and Debts
Recovery Tribunals (DRTs), which have original jurisdiction.
While not discouraging borrowers, the Act seeks to protect the interests of
banks and other financial institutions as lenders. Because the corresponding
provisions have not yet come into effect, the Tribunals have not yet started
taking on bankruptcy and insolvency resolution cases. Instances where
the amount of debt owed to any bank or financial institution described
by the Act or me-consuming process.
30 PAGE
Corporate Debt Restructuring (2005) Notes

It is made to reduce the burden of debts on the company by giving more
time to the company to pay back as well as decreasing the rates along
with it. It has to pay the obligation back. Corporate debt restructuring
is the process of reorganising a company’s outstanding obligations in
order to restore its liquidity and maintain its operations. It is frequently
achieved through negotiation between financially distressed businesses
and their creditors, including banks and other financial institutions, by
lowering the total amount of debt the business has and by reducing the
interest rate the business pays while lengthening the time it has to repay
the obligation.
5:25 Rule (2014)
The scheme allowed the Bankers to fix a longer repayment period for loans
to infrastructure and core industries say 25 years, based on the economic
life or concession Period of the project, with periodic reviews, say every 5
years. Flexible Restructuring of Long-Term Project Loans to Infrastructure
and Core Industries is another name for this. This involves refinancing
of long-term Restructuring of Corporate Debt (2005). By extending the
company’s repayment period and lowering the rates concurrently, it is
designed to lessen the burden of debts on the business.
The plan permitted the bankers to set a lengthier loan repayment period
for projects. A special group of lender banks called the Joint Lender’s
Forum was established to hasten decision-making when an asset worth
more than Rs. 100 crore or more turns out to be a stressed asset. 2014
saw the release by the RBI of guidelines for the creation of the JLF for
the efficient management of stressed assets.
Mission Indradhanush (2015)
The Indradhanush for PSBs mission aims at revamping the functioning
of the Public Sector Banks to enable them to compete with the Private
Sector Banks. It aims to boost credit and reduce political meddling in
PSB operations in order to revive economic growth.
Mission Indradhanush (2015) Indradhanush for PSBs intends to upgrade
the operations of public sector banks so they can compete with private
sector banks.
PAGE 31
BBA(FIA)
Notes By lowering political meddling in PSB operations and enhancing lending,

it aims to revive economic growth. The Mission Indradhanush is a seven-
pronged strategy to address the problems facing public sector banks.
The PJ Nayak Committee’s report served as the basis for the goals that
Mission Indradhanush achieved.
It enables the Joint Lenders Forum (JLF), or just the lender group, to
turn a portion of their financing in a struggling business into equity. If a
company that has borrowed money from a bank is unable to pay it back,
the bank may convert all or part of the debt into stock in the company.
Asset Quality Review
Asset Quality Review is a unique activity carried out by Reserve Bank
of India (RBI) inspectors to examine bank records. A sizable sample of
loans is examined to determine whether asset classification matched loan
repayment and whether banks had made sufficient reserves. This is a
type of preventive intervention that involves the early identification of
assets that may end up being stressed in the future.
Insolvency and Bankruptcy Code (2016)
An act to harmonise and update the laws governing the timely reorganisation
and insolvency resolution of businesses, partnerships, and individuals in
order to maximise the value of their assets, encourage entrepreneurship,
increase credit availability, and balance the interests of all parties involved.
It is a One-stop process for solving insolvencies that aims to protect
small investors.
Process of Recovery of NPA
An outline of the NPA recovery procedure in Indian banks is provided
below:
Identification and Classification: Based on predetermined criteria,
such as the length of non-payment, banks identify loans that have
turned into NPAs.
Bank Recovery Efforts: Banks contact borrowers to remind them
of past-due payments as the first step in the recovery process. This
is carried out to make it easier for the borrower to pay back the
loan.
32 PAGE
Legal Action: Banks may turn to legal action if discussions and Notes
restructuring efforts fail. This could entail bringing a lawsuit or
starting a recovery process.
Asset Seizure and Auction: As a last resort, if the borrower continues
to default on payments, banks may seize collateral, or assets provided
as security against the loan.
Debt Recovery Companies: To aid in the recovery process, banks may
also use specialised debt recovery companies or Asset Reconstruction
Companies (ARCs).
2.6 Impact of Gross NPAs on a Bank’s Bottom Line

The surge in bad loans for the banking sector resulted in greater provisions,
which eliminated earnings and required additional capital infusion. But
fresh capital has not been forthcoming with the government on a path
of fiscal consolidation and trying to control deficits and because of this
lending has slowed down to a trickle.
According to the RBI’s Financial Stability Report, banks’ percentage of
the money flowing into the commercial sector fell to 38% in 2016–2017.
Reduced investments, decreased production, unemployment, a slowdown
in the economy, and finally a decrease in the rate of economic growth
are the results of this. First, RBI in had directed the banks to take the
12 largest loan defaulters, accounting for one-fourth of the industry’s
bad loans, to NCLT.
Second, it created a second list of 26 defaulters and determined that banks
should identify faulty assets and address them by any available method
before filing for bankruptcy. Only those instances that cannot be handled
through one of 2023-06-30 Words 873 Characters 7501 Page 1 of 4 the
RBI’s current bad loan resolution schemes, like S4A or SDR, should be
brought before the NCLT under the bankruptcy code.
The NCLT, for instance, chose to remove the board of directors of
Unitech Ltd., a prestigious real estate business, and ordering the Ministry
of Corporate Affairs to propose 10 directors is a wise move to address
the issue of bad loans.
PAGE 33
BBA(FIA)
Notes Impacts of Non-Performing Assets (NPA)

Banks won’t have enough money for additional development initiatives,
which will affect the economy.
Banks will be compelled to raise interest rates in order to preserve
a profit margin.
The reduction in new investments could cause unemployment to
increase.
Government of India and RBI’s Non-Performing Assets (NPA) Control
Measures.
Since non-performing assets are not a recent phenomenon, the Indian
government and RBI have made numerous attempts to address the
issue.
Negative Impact on Balance Sheet
The main issue for the banking system in any economy that causes the
entire banking system of the nation to tremble is a high level of non-
performing assets.
The investor’s, depositors’, and stockholders’ level of confidence is also
important. Money rotates as a result of this.
Due to NPA, profitability has declined
Non-performing assets cause the bank to lose more money in addition to
reducing its profit. Additionally, banks provide an additional 25 to 30 per
cent in provisions for non-performing assets, which have a direct influence
on the profitability of the bank. The bank also simulates the amount’s
recovery; nevertheless, until the impact of NPAs on bank profitability
causes a dent in the bank’s balance sheet, the amount is non-performing.
Difficult Liability Management
High non-performing assets led the bank to cut deposit interest rates,
and advances are anticipated to have higher interest rates going forward.
This situation is exceedingly challenging and hurts the banking industry.
Decrease Share Holders confidence
Not in the banking industry, but shareholders still need to know that
their money is secure. They are also interested in increased investment
and market capitalization. High non-performing assets decrease investor
34 PAGE
confidence, which has a substantial impact on the share price of the Notes
company. The Bank in this case stopped paying dividends to shareholders,
which was against the investor’s best interests.
Banks must conduct a proper review of the proposal at the outset, since
this will expose the status of unviable projects as well. The rise in non-
performing assets also affects stakeholder and investor expectations.
Before accepting the loan, the bank must gather all relevant information
regarding the industry, management, and future prospects.
Decrease Public Confidence
The bank’s bad performance as a result of rising non-performing assets
not only hurts investor sentiments but also causes the public to lose faith
in the institution, which has a negative impact on deposits. High non-
performing assets have an impact on the entire economy. Thus, we can
say that the increase in NPAs reduces the profitability of the banks due
to their lack of credibility.
The capital basis of the public sector banks was also severely impacted
by this NPA. Any bank’s NPAs will continue to climb, which will make
the problem chronic and make it difficult for the banks to stabilise once
more. Account holders want to withdraw their money because they no
longer have faith in the banks.
The banking system is greatly impacted, and the bank is in danger of
failing. Because of the high NPA, banks are compelled to lower their
interest rates on savings accounts in order to boost their margin. Thus,
it is clear that the high NPA on banks has a detrimental effect on both
their reputation and ability to conduct business.
Some of the key actions that must be taken to improve the banking
situation include the government of India adopting numerous adjustments
and increasing transparency in order to control and attempt to lower the
number of NPA.
2.7 Introduction to Bad Banks, Functioning of Bad Banks,

National Asset Reconstruction Company Limited (NARCL)
It is a financial institution. It deals with the problems of Non-Performing
Assets (NPAs), or bad loan held by commercial banks and, release the
PAGE 35
BBA(FIA)
Notes Banks from this burden by purchasing them below their book value. Thus,
Banks only focus on lending to customers without any restriction. It is
government-owned, managed, and operated. It is an Asset Management
Company (AMC). It helps commercial banks in setting up the bad loans.
The Securitization and Reconstruction of Financial Assets and Enforcement
of Security Interest (SARFAESI) Act, which was passed in 2002, gave
rise to the concept of bad banks. The purpose of the Act was to resolve
the problems of increasing rate of NPA’s in India. However, this was
limited to secured loans.
There are 4 types of bad bank structures:
Bad Bank Spinoff
Regarding a balance sheet guarantee
Internal Restructuring
Special Purpose Entity
Bad banks can either be sector-specific or general purpose. The former
does not differentiate between the sectoral composition of assets. However,
the later buy only target assets.
Functioning of Bad Banks:
The main objective of Bad Banks is to take NPAs of commercial banks at
a mutually agreed price. It is the responsibility of bad banks to manage
these loans. The process encompasses numerous strategies, including
reshuffling loans, conferring new terms and conditions with borrowers,
putting on sale the assets reorganization of loans, and legal options. The
difference between the acquisition price and the selling price of assets
is the profit of a bad bank. The nature and quality of assets acquired,
and the market for stressed assets determine the transfer price of NPA.
Assets disposal techniques for various assets are different. While Viable
loans may be restructured, non-variable loans are sold.
The following are the factors that help in deciding the acquisition process
of NPA:
It can be voluntary or mandatory.
The degree of government involvement.
Rules and regulations of NARCL.
36 PAGE
In a few cases, bad banks can take over some of the NPA not all, Notes
and the presence of geographical restrictions.
Numerous factors help in deciding the volume of NPAs that will be
taken over.
India’s first ever bad bank is National Asset Reconstruction Company
Limited (NARCL). A business structure known as a “bad bank” isolates
problematic assets held by banks in a different entity. A bad bank is
formed up to purchase non-performing assets from banks for a price
fixed by the institutions.
The NARCL has requested for a licence to operate as an Asset Reconstruction
Company (ARC) with the Reserve Bank of India after being incorporated
under the Companies Act. The government essentially turned NARCL into
a bad bank by modelling it after an asset rehabilitation firm. When bad
loans from banks reach a certain threshold, the NARCL will buy them
to sell them to potential distressed debt buyers.
National Asset Reconstruction Company Limited (NARCL) and India Debt
Resolution Company Ltd. (IDRCL) are the two structures of bad banks
in India. The former dispose off NPA and later sell off NPA. The Union
Budget 2021 highlighted the NARCL-IRDCL structure and approved it
in FY 2022-23 budget session. NARCL takes over the assets at a 15:85
structure i.e., 15% price in cash and 85% as Security Receipts. The
work of IDRCL is management, valuation pricing of assets and attracting
investors. There is a Principal-Agent arrangement between NARCL and
IDRCL.
NARCL is a Centralised Asset Management Company (CAMC). It is a
Centralised bad bank in India. Political consensus, efficient legal processes,
competent statutory powers, realistic pricing, well-developed financial
markets, and using private sector expertise are pillars for the success of
bad banks. There are two ways of funding NARCL. It can be partial
or full funding by the government. It can raise funds by issuing bonds,
equity contributions, loans from RBI, or a public offering of shares. It
started with a capital base of ` 6,000 crores. More than 51% of shares
are held by PSUs and the rest is held by private institutions.
The NARCL will also be responsible for valuing the defaulted loans in
order to establish the price at which they will be auctioned. The bad
PAGE 37
BBA(FIA)
Notes bank would provide government receipts to banks when it purchased

non-performing assets off of their books.
2.8 Summary
The government of India is running various schemes for financial inclusion
of the people especially in vulnerable and marginalised areas with the
help of different stakeholders including Micro Finance Institutions. The
development of new prospects in the sector is being fuelled by favourable
macroeconomic and technical trends. The Indian banking industry has
seen significant upheaval since liberalisation in 1991.
As a result of the New Economic Policy 1991, Financial Sector Reforms
are adopted by GOI to change the drawbacks of the Indian banking System.
The goal of financial sector reforms is to create an effective financial
system that will increase resource allocation effectiveness, promote financial
inclusion, and safeguard public confidence in the financial system.
IN-TEXT QUESTIONS
1. What was the maximum limit of the Statutory Liquidity Ratio
had Narasimham Committee recommended?
(a) 25%
(b) 20%
(c) 15%
(d) 30%
2. What was the maximum limit of Cash Reserve Ratio had
Narasimham Committee recommended?
(a) 25%
(b) 20%
(c) 15%
(d) 10%
3. Which of the following acts is specially launched to facilitate
banks in recovery of bad loans?
(a) Banking Regulation Act
(b) Companies Act
38 PAGE
(c) Income-tax Act Notes
(d) SARFAESI Act

4. The assets of the banks which do not perform are called:
(a) Non-Performing Assets (NPA)
(b) Bad loans
(c) Fixed loan
(d) (a) and (b)
5. The SARFAESI Act provides alternative methods for the recovery
of non-performing assets:
(a) Securitisation
(b) Asset Reconstruction
(c) Enforcement of Security without the intervention of the
Court
6. According to SARFAESI Act, 2002, the registration and regulation
of securitization companies or reconstruction companies are
done by:
(a) RBI
(b) SEBI
(c) SBI
(d) All of these
7. Know Your Customer (KYC) norms are required to be strictly
followed by banks. It means:
(a) Providing improved customer services
(b) Determining the identity and residence proof of account
holders through approved documents
(c) Ensuring that staff members know the customers
(d) Organising regular customer service meetings
8. Which of the following is not a recommendation of the
Narasimham Committee, 1991?
PAGE 39
BBA(FIA)
Notes (a) Reduction of CRR and SLR

(b) Phasing out the directed credit programme
(c) Reduction of Capital Adequacy Ratio
(d) Autonomy to Public Sector Bank
9. The Narasimham Committee-I was setup to suggest some
recommendations for improvement in the:
(a) Efficiency and productivity of the financial institution
(b) Banking reform process
(c) Export of IT sector
(d) Fiscal reform process
10. NPA implemented under the recommendation of which committee
__.
(a) Shivraman committee
(b) Narasimham committee
(c) K P committee
(d) None of these
11. Under asset classification of NPA accounts above one year but
upto three years assets due known as:
(a) Sub-standard asset
(b) Standard assets
(c) Doubtful asset
(d) Bad debts
12. If anyone fails to meet its payment obligations to the lender even
when it has the capacity to honour the obligations is known as
____.
(a) Drawer
(b) Drawee
(c) Wilful Defaulter
(d) Spot Defaulter
13. Which is the first Bad Bank in India:
(a) National Asset Reconstruction Company (NARCL)
40 PAGE
(b) Muthoot Finance Ltd. Notes
(c) HDB Finance Services

(d) Power Finance Corporation Limited
14. NPA implemented under the recommendation of which committee
__.
(a) Shivraman committee
(b) Narasimham committee
(c) K P committee
(d) None of these
15. When banks ensure that bank maintain a buffer of capital that
can be used to absorb losses during economic stress is known
as ____.
(a) Conservation Buffer
(b) Surplus
(c) Profit
(d) Surcharge
1. (a) 25%
2. (d) 10%
3. (d) SARFAESI Act
4. (d) (a) and (b)
6. (a) RBI
7. (b) Determining the identity and residence proof of account holders
through approved documents
8. (a) Reduction of CRR and SLR
9. (a) Efficiency and productivity of the financial institution
10. (b) Narasimham committee
11. (c) Doubtful asset
PAGE 41
BBA(FIA)
Notes 12. (c) Wilful Defaulter

13. (a) National Asset Reconstruction Company (NARCL)
14. (b) Narasimham committee
15. (a) Conservation Buffer

1. What do you understand by Financial Sector Reform in India? Explain
its objective.
2. Explain some Financial Sector Reforms in context with Banking
Industry in India.
3. What do you mean by Non-Performing Assets? Explain their Types
in details.
4. What do you mean by Bad Bank? Explain its role and Function.
5. Explain the Impact of Non-Performing Assets in the Banking Sector
of India.
2.11 References
Financial Institutions, Markets Structure Growth and Innovations of
I.M. Bhole and Jitendra Mahakud by McGraw Hill Publication.
Banking And Finance Year Book 2023 By Indian Institute of Banking
and Finance of Taxmann Publications.

Financial Markets and Institutions & Services of Dr. Vinood Kumar
by Taxmann Publications.
Financial Markets and Institutions and Financial Services of Prof.
Bimal Jaiswal by Sahitya Bhawan Publication.
Banking Operations Management of Bimal Jaiswal by Vikas Publishing
House Private Limited.
42 PAGE
L E S S O N
3
Introduction to Neobanks
Jigmet Wangdus
Assistant Professor
University of Delhi
Email-Id: Jigmet.wangdus@srcc.du.ac.in
STRUCTURE
3.2 Introduction
3.3 Traditional Banks, Neobanks & Digital Banks
3.4 The Rise and Growth of Neobanks
3.5 Operating Model of Neobanks
3.6 Risk, Challenges and Opportunities
3.7 Regulation of Neobanks
3.8 Global and Indian Neobanks
3.9 Summary
3.12 References

Define the concept of neobanks and explain their role in the banking industry.
Identify the key features and benefits of neobanks.
Understand the impact of neobanks on traditional banking institutions.
Analyze the potential challenges and risks associated with neobanks.
Evaluate the opportunities and considerations for customers in choosing neobanks.
PAGE 43
BBA(FIA)

In this era of rapid technological advancements, traditional banking models
are being challenged by the emergence of neobanks. These digital-first
financial institutions are revolutionizing how customers interact with their
money and disrupting the traditional banking landscape. In this lesson, we will
delve into the world of neobanks, exploring their key features, advantages,
challenges, and potential impact on the banking industry.
Definition and concept of neobanks
Neobanks refer to financial institutions that operate entirely online without
any physical branches. They leverage digital technology and innovative
approaches to provide banking services to customers through mobile
applications or web platforms. Neobanks typically offer a range of banking
services, including account opening, deposits, payments, transfers, loans,
and budgeting tools, all accessible through user-friendly interfaces.
The concept of neobanks emerged as a response to the limitations and
inefficiencies of traditional brick-and-mortar banks. Neobanks aim to disrupt
the traditional banking industry by offering customers greater convenience,
transparency and flexibility. By utilizing advanced technology, such as
artificial intelligence, machine learning, and data analytics, neobanks strive
to deliver personalized and seamless banking experiences.
Key characteristics of neobanks include:
Digital-first approach: Neobanks prioritize digital channels, providing
customers with 24/7 access to their accounts and banking services
through mobile devices or web browsers.
User-friendly interfaces: Neobanks emphasize intuitive and user-
friendly interfaces, making it easy for customers to manage their
finances, track expenses, and perform banking transactions.
Agile and responsive: Neobanks can quickly adapt to changing
customer needs and market trends, often introducing new features
and services swiftly and agilely.
Enhanced customer experience: Neobanks prioritize customer-
centricity, offering personalized services, instant notifications, real-
time insights and responsive customer support.
44 PAGE
Lower fees and competitive rates: Due to their streamlined operations Notes
and cost-efficient models, neobanks often provide competitive interest
rates, lower fees and transparent pricing structures.
Integration with third-party services: Neobanks frequently collaborate
with financial technology (fintech) companies and other service
providers to offer additional features, such as investment options,
automated savings, or integration with payment apps.
3.3 Traditional Banks, Neobanks & Digital Banks

Understanding the differences between traditional, Neobanks and Digital
banking models helps individuals choose the banking experience that aligns
with their preferences and needs.
Difference between Neobanks and traditional banks
Neobanks have emerged as a new breed of financial institutions that differ
from traditional banks in several ways. Here are some differentiating factors
between neobanks and traditional banks:
Basis Neobanks Traditional Banks
Approach Neobanks are built with a digital-first In contrast, traditional
approach, meaning they prioritize online banks have a physical
and mobile banking experiences. They branch network and offer
operate solely through digital channels, both in-person and digital
offering their services through mobile banking services.
apps and web platforms.
Physical Presence Neobanks typically do not have physical Traditional banks have to
branches or physical customer service maintain physical branches
locations. They rely on technology to and infrastructure.
interact with customers and provide
banking services. This allows them to
operate with lower overhead costs.
Account Opening Neobanks often offer quick and seamless Traditional banks, on the
account opening processes. Customers other hand, may require
can sign up for an account directly from customers to visit a branch
their smartphones, usually within minutes, and go through a lengthier
by providing necessary identification account opening procedure.
documents and completing a digital
onboarding process.
PAGE 45
BBA(FIA)
Notes Basis Neobanks Traditional Banks

Interfaces Neobanks prioritize user-friendly interfaces Traditional banks may
and intuitive designs for their digital offer digital banking ser-
platforms. They aim to provide a smooth vices, but their interfaces
and streamlined banking experience with may be more complex and
simplified navigation, real-time transaction less tailored to individual
updates, and personalized features. customer needs.
Innovative Neobanks often incorporate innovative Traditional banks may

Features and features and leverage technology to offer have fewer integrations
Integrations value-added services. They may integrate and may take longer to
with various third-party applications adopt new technologies.
and services, such as budgeting tools,
expense trackers, or investment platforms,
to provide a more holistic financial
experience.
Fees and Interest Neobanks frequently offer lower fees Traditional banks may
Rate and competitive interest rates on savings have higher fees and may
accounts and loans. By operating with offer less competitive
lower overhead costs and leveraging interest rates due to
digital platforms, they can pass on cost their higher operational
savings to customers. expenses.
Customer-Centric Neobanks often prioritize customer Traditional banks may
Approach experience and aim to provide personalized, have customer service
responsive and efficient customer support. available through various
They may offer 24/7 customer service channels, including in-
through digital channels, chatbots or live person interactions, but
chat features. Tradition their response times and
availability may be more
limited.
46 PAGE
Notes
Neo Banks Traditional

Banks
Figure 3.1: Difference between Neobanks,

Digital Banks and Traditional Banks
Difference between Neobanks and Digital banks
A digital bank and Neobank are different, despite being constructed with
a mobile-first strategy and a focus on digital operating models. Digital
banks are typically the online-only subsidiary of a reputable and regulated
operator in the banking business, even though the terms are occasionally
used synonymously. A neobank, on the other hand, exclusively does business
online, has no physical branches, and works either independently or with
traditional banks.
Basis Neobanks Digital Banks
Nature of Neobanks are exclusively digital D i g i t a l b a n k s m a y h a v e a
operation banks that operate entirely online combination of physical branches
without any physical branches. and digital platforms to deliver
banking services.
Ownership and Neobanks are often independent Digital banks can be either
Regulation financial technology (fintech) independent fintech companies
startups not associated with or the digital arms of established
traditional banking institutions. traditional banks. They operate
PAGE 47
BBA(FIA)
Notes Basis Neobanks Digital Banks

They typically obtain licenses and within the regulatory framework
partnerships to operate as financial of banking regulations and are
service providers. subject to the same regulatory
oversight as traditional banks.
Customer Neobanks strongly emphasise Digital banks, whether traditional
Experience delivering a seamless, user- banks with digital channels or
friendly and personalised customer online subsidiaries, aim to enhance
experience through their digital customer convenience by providing
platforms. online and mobile banking services.
Range of Neobanks typically focus on Digital banks, an extension of
Services providing core banking services, traditional banks, generally offer a
such as savings accounts, payments, broader range of banking services
and money transfers. They may beyond basic transactions. These
also offer additional features like may include loans, mortgages,
budgeting tools, financial insights, investment products, credit cards,
and integration with third-party and other services commonly
applications. associated with traditional banking.
Partnership Neobanks often collaborate with Digital banks, especially those
other fintech companies or financial affiliated with traditional banks,
service providers to expand their m a y l e v e r a g e t h e e x i s t i n g
offerings and provide customers infrastructure and partnerships
with a wider range of services. of the parent organization. They
They may integrate third-party can leverage the bank’s resources,
services, such as payment gateways customer base, and expertise to
or investment platforms, into their enhance their digital banking
digital banking platforms. services.
3.4 The Rise and Growth of Neobanks

The rise and growth of neobanks globally have significantly transformed
the banking industry and challenged traditional banking models. Here is an
overview of how neobanks have gained prominence and expanded their reach:
The emergence of Neobanks: Neobanks emerged around the early
2010s, driven by technological advancements, changing consumer
behaviours, and dissatisfaction with traditional banking services.
These startups recognised the potential to leverage digital platforms
to offer innovative and customer-centric banking experiences.
Early Pioneers: Some of the early pioneers in the neobank space
include companies like Simple (founded in 2009), Moven (founded
48 PAGE
in 2011), and Fidor Bank (founded in 2009). PayQ, Kotak 811 by Notes
Kotak Mahindra Bank and Digibank launched by DBS Bank, are
the pioneer neobanks in India. They paved the way for the neobank
concept by introducing user-friendly interfaces, mobile banking
capabilities, and personalised financial management tools.
Regulatory Environment: The regulatory environment plays a
crucial role in the growth of neobanks. Many countries introduced
regulatory frameworks and licenses specifically for digital banks,
enabling them to operate within established regulatory boundaries.
This provided a level playing field for neobanks and fostered their
growth. The regulatory framework for neobanks in India is currently
in the early stages of development. While specific regulations
dedicated solely to neobanks have not been issued by the Reserve
Bank of India (RBI), the existing guidelines applicable to all banks
also encompass neobanks. These guidelines address important
aspects such as customer protection, data security, and anti-money
laundering measures.
Expansion of Neobanks: Neobanks initially gained traction in
developed markets such as the United States, the United Kingdom,
and parts of Europe. However, their popularity quickly spread to
other regions, including Asia-Pacific, Latin America, and Africa.
Neobanks capitalised on the increasing smartphone penetration and
the growing demand for digital financial services in these markets.
Investment and Funding: Neobanks attracted significant investment
and funding from venture capital firms and established financial
institutions. This influx of capital allowed them to expand their
operations, enhance their technology infrastructure, and offer a
broader range of financial products and services.
Disruption and Innovation: Neobanks disrupted traditional banking
by introducing innovative features and services. They focused on
delivering seamless account opening experiences, real-time transaction
updates, personalised financial insights, budgeting tools, and easy
integration with third-party apps. This approach appealed to tech-
savvy customers who sought convenience, transparency and tailored
banking experiences.
PAGE 49
BBA(FIA)
Notes Partnerships with Incumbents: In some cases, neobanks formed

partnerships with traditional banks to leverage their regulatory
licenses, infrastructure, or customer base. These collaborations
allowed neobanks to accelerate their growth and access a broader
range of financial services.
Expansion into New Product Offerings: Neobanks initially started
with basic banking services such as current accounts, payments
and money transfers. However, many have expanded their product
offerings to include savings accounts, loans, investments, insurance,
and even business banking solutions. This diversification has further
strengthened their position in the market and broadened their customer
base.
Focus on Customer Experience: Neobanks prioritise delivering
excellent customer experiences. They leverage data analytics,
machine learning and AI technologies to understand customer
preferences, provide personalised recommendations and improve
overall satisfaction. This customer-centric approach has been a key
driver of their growth and customer acquisition.
Regulatory Challenges: Despite their growth, neobanks face regulatory
challenges in some regions. Compliance with regulations, obtaining
necessary licenses and meeting stringent security and data protection
requirements can pose hurdles to their expansion. However, governments
and regulators increasingly recognise the importance of fostering
innovation in the financial sector and are adapting regulations to
accommodate neobanks.
IN-TEXT QUESTIONS
1. Neobanks are financial institutions that primarily operate:
(a) Through physical branches
(b) Via mobile apps and online platforms
(c) With traditional banking systems
(d) By offering investment services only
2. What is a key advantage of neobanks over traditional banks?
(a) Higher interest rates on savings accounts
(b) More physical branch locations
50 PAGE
(c) Advanced digital user experience Notes
(d) Access to a wide range of financial products

3. Neobanks typically target which customer segment?
(a) Small and medium-sized enterprises (SMEs)
(b) High-net-worth individuals
(c) Retired individuals
(d) Government organizations
4. Neobanks differentiate themselves through:
(a) Brick-and-mortar branch network
(b) Offering complex investment options
(c) Innovative digital features and personalized services
(d) Higher fees and charges
5. The primary revenue source for neobanks is:
(a) Interest income from loans
(b) Account maintenance fees
(c) Transaction fees
(d) Government subsidies
6. What is a potential challenge for neobanks?
(a) Limited access to technology and internet connectivity
(b) Lack of security features in their mobile apps
(c) Strict regulations imposed by the government
(d) Higher interest rates on savings accounts
3.5 Operating Model of Neobanks

The operating model of neobanks is characterized by a digital-first approach and
a customer-centric focus. Neobanks differentiate themselves from traditional
banks by leveraging modern technology to deliver more streamlined and
efficient banking services. Here are the key components of the operating
model of neobanks:
PAGE 51
BBA(FIA)
Notes Digital Platform: Neobanks operate primarily through digital platforms

such as mobile apps and websites. These platforms are the primary
touchpoints for customers to access their accounts, make transactions,
and manage their finances. The digital interface is designed to be
intuitive, user-friendly and accessible from anywhere at any time.
Automated Processes: Neobanks rely on automation to streamline
operations and reduce manual intervention. By utilizing advanced
technology such as Artificial Intelligence (AI) and Machine Learning
(ML), they automate various processes, including account opening,
identity verification, transaction categorization, and risk assessment.
This automation enables neobanks to provide faster and more efficient
customer services.
Cloud-based Infrastructure: Neobanks often leverage cloud computing
infrastructure, which offers scalability, flexibility and cost-efficiency.
Cloud technology allows neobanks to quickly scale their operations,
handle increased customer demand and adapt to changing market
conditions. It also enables them to store and process large volumes
of customer data securely.
Open APIs: Neobanks utilize open Application Programming Interfaces
(APIs) to integrate with third-party services and platforms. These
APIs facilitate seamless connectivity with various financial and non-
financial service providers, allowing neobanks to offer a broader
range of products and services. For example, neobanks can integrate
with payment gateways, lending platforms, investment services, and
personal finance management tools.
Data-driven Decision Making: Neobanks harness the power of data
analytics to gain insights into customer behaviour, preferences, and
needs. They collect and analyze vast customer data to personalize
their offerings, improve customer experiences and make data-driven
decisions. This data-driven approach helps neobanks understand
their customers better and provide tailored financial solutions.
Personalized Customer Support: While neobanks operate digitally,
they prioritize delivering personalized customer support. They employ
various methods, such as in-app messaging, chatbots and online
chat, to provide real-time assistance to customers. These support
52 PAGE
channels enable neobanks to address customer inquiries, resolve Notes

issues promptly, and provide high customer service.
Regulatory Compliance: Neobanks must comply with their jurisdictions’
applicable banking and financial regulations. Some neobanks obtain their
banking licenses, while others partner with established financial institutions
with the necessary licenses. Compliance with regulations ensures the security
and protection of customer funds, data privacy, and adherence to Anti-Money
Laundering (AML) and Know-Your-Customer (KYC) requirements.
3.6 Risk, Challenges and Opportunities

Risk and Challenges
While neobanks have gained significant traction and disrupted the traditional
banking sector, they also face various challenges and risks they must navigate.
Understanding and effectively addressing these challenges is crucial for the
long-term success and sustainability of neobanks. Here are some of the key
challenges and risks faced by neobanks:
Regulatory Compliance: Neobanks operate in a highly regulated
environment and compliance with financial regulations is a significant
challenge. They must adhere to Anti-Money Laundering (AML),
Know-Your-Customer (KYC) regulations, data protection laws and
licensing requirements. Meeting these regulatory obligations can be
complex, time-consuming and costly, particularly when expanding
into new markets with different regulatory frameworks.
Building Customer Trust: Neobanks often lack the long-established
reputations and brand recognition that traditional banks possess.
Gaining customer trust is crucial for neobanks to attract and retain
customers. Building trust involves demonstrating robust security
measures, protecting customer data and privacy, and providing
reliable and efficient customer support. Any breaches in security
or loss of customer trust can severely impact the reputation and
viability of a new bank.
Scalability and Profitability: Achieving scalability and profitability
can challenge neobanks. While they may experience rapid customer
growth, generating sustainable revenue streams is essential. Neobanks
often rely on transaction-based revenue, such as interchange fees,
PAGE 53
BBA(FIA)
Notes foreign exchange charges, and premium service subscriptions. They

must carefully manage costs, optimize operations, and explore
additional revenue streams to ensure long-term profitability.
Competition from Traditional Banks and Fintechs: Traditional
banks have recognized the threat posed by neobanks and have
started to enhance their digital offerings. This increased competition
from established banks can make it challenging for neobanks to
attract and retain customers. Additionally, the rise of other fintech
companies offering niche financial services and solutions further
intensifies the competition in the market.
Technological Infrastructure and Cybersecurity: Neobanks heavily
rely on robust technological infrastructure to deliver seamless digital
experiences to customers. Maintaining uptime, scalability, and
ensuring system reliability can be demanding. Neobanks also face
cybersecurity risks, including hacking attempts, data breaches, and
fraud. Investing in advanced cybersecurity measures, data encryption,
and regularly updating systems to protect against emerging threats
is crucial.
Customer Acquisition and Retention: Acquiring and retaining new
customers is a constant challenge for neobanks. While their digital-
first approach attracts tech-savvy users, convincing customers to
switch from traditional banks and building long-term loyalty can
be difficult. Neobanks must continuously innovate, offer unique
value propositions, and provide exceptional customer experiences
to attract and retain a loyal customer base.
Economic and Market Volatility: Neobanks are not immune to
economic downturns and market volatility. Changes in interest rates,
shifts in consumer behaviour and macroeconomic factors can impact
the profitability and stability of neobanks. They must be prepared to
adapt their business models, manage risk effectively and diversify
their revenue streams to withstand challenging economic conditions.
Opportunities and Considerations for Customers
Neobanks, with their digital-first approach and innovative financial
solutions, offer various opportunities and considerations for customers.
These opportunities can enhance the banking experience, provide greater
54 PAGE
convenience, and offer unique benefits. However, customers should also Notes
consider certain factors before fully embracing neobanks. Here are some
opportunities and considerations for customers:
Opportunities:
Seamless Digital Experience: Neobanks provide a user-friendly and
seamless digital banking experience. Customers can easily access
their accounts, perform transactions, make payments and manage
their finances through intuitive mobile apps and online platforms.
The convenience of 24/7 banking from anywhere with an internet
connection is a significant advantage.
Lower Fees and Competitive Rates: Neobanks often have lower
overhead costs than traditional banks, allowing them to offer
competitive rates and lower fees. This can include reduced or no
monthly maintenance fees, lower transaction fees and attractive
interest rates on savings accounts. Customers can save money on
banking services and benefit from higher returns on their deposits.
Personalized Financial Management: Neobanks leverage advanced
technologies like artificial intelligence and machine learning to
provide personalized financial management tools. Customers can gain
insights into their spending habits, set savings goals, track expenses
and receive tailored financial advice. These tools can empower
customers to make informed financial decisions and improve their
well-being.
Innovative Products and Services: Neobanks often introduce
innovative financial products and services that cater to specific
customer needs. They may offer budgeting tools, round-up savings
features, instant peer-to-peer payments, international money transfers
at competitive rates and integration with third-party financial apps.
Customers can access various fintech solutions through a single
platform, enhancing their financial capabilities.
Enhanced Customer Support: Neobanks prioritize customer support
and aim to deliver responsive and efficient assistance. With dedicated
customer support teams and chatbots, customers can receive real-
time assistance and quick resolutions to their queries or issues.
Additionally, many neobanks have vibrant online communities and
PAGE 55
BBA(FIA)
Notes knowledge hubs where customers can interact, share experiences,

and seek guidance.
Considerations:
Deposit Insurance and Security: Customers should verify if the
neobank is covered by deposit insurance schemes to protect their
funds in case of bank failure. While neobanks employ robust security
measures, customers should be cautious about sharing sensitive
information and follow recommended security practices to safeguard
their accounts from cyber threats.
Integration and Interoperability: As neobanks are relatively new
entrants in the financial landscape, customers should consider the
integration and interoperability of neobank services with other
financial institutions. Compatibility with existing financial systems
and the ability to link multiple accounts and services can be important
considerations for customers with complex financial needs.
Limited Physical Presence: Neobanks primarily operate digitally,
which means they may have limited or no physical branch presence.
While this can be advantageous for tech-savvy customers who prefer
digital banking, those who require in-person banking services or
face-to-face interactions should evaluate their comfort level without
physical branches.
Regulatory Oversight and Stability: Customers should assess the
regulatory environment in which neobanks operate and ensure
that the neobank adheres to applicable regulations and licensing
requirements. Understanding the stability and credibility of the
neobank is crucial to mitigate potential risks.
Evolving Features and Offerings: Neobanks continually evolve, introduce
new features and refine their offerings. Customers should stay updated on
the latest developments and assess whether the neobank’s services align
with their changing financial needs over the long term.
3.7 Regulation of Neobanks

Regulation of Neobanks in India:
The regulation of neobanks in India is still in its early stages, with the
Reserve Bank of India (RBI) still waiting to issue specific regulations for
56 PAGE
these banks. However, the RBI has provided guidelines that are applicable to Notes
all banks, including neobanks. These guidelines include customer protection,
data security, and anti-money laundering.
The RBI is currently evaluating the feedback received on the discussion paper
and is expected to issue final regulations for digital banks in the near future.
Some of the key regulatory requirements that neobanks in India must adhere
to include the following:
Customer protection: Neobanks must comply with the RBI’s
guidelines on customer protection. These guidelines cover fair
practices, transparency, and dispute resolution.
Data security: Neobanks must ensure that they have adequate security
measures in place to protect customer data. This includes measures
such as encryption, access control, and vulnerability management.
Anti-money laundering: Neobanks must comply with the RBI’s
Anti-Money Laundering (AML) regulations. These regulations
are designed to prevent the use of the banking system for money
laundering or terrorist financing.
Additionally, the RBI is contemplating additional regulatory requirements
for neobanks, such as:
Capital requirements: Neobanks may be required to hold a certain
amount of capital to protect depositors.
Liquidity requirements: Neobanks may be required to maintain a
certain level of liquidity to meet customer withdrawals.
Risk management: Neobanks will need robust risk management
systems to manage the risks associated with their operations.
As the regulatory framework for neobanks in India continues to evolve, the
RBI aims to strike a balance between consumer protection and fostering
innovation in the banking sector.
Regulation of Neobanks Outside India
The regulation of neobanks outside of India varies across different countries,
with some countries subjecting neobanks to the same regulations as traditional
banks while others adopt a lighter regulatory approach.
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BBA(FIA)
Notes Here are examples of neobank regulations in different countries:

United States: Neobanks in the United States are subject to the
same regulations as traditional banks, including the Bank Secrecy
Act (BSA) and the Truth in Lending Act (TILA), Anti-Money
Laundering (AML) regulations, and Consumer Financial Protection
Bureau (CFPB) guidelines.
United Kingdom: Neobanks in the United Kingdom are subject to
the same regulations as traditional banks, including those set by the
Financial Conduct Authority (FCA). Neobanks must follow capital
adequacy requirements, implement robust risk management systems,
and comply with AML and KYC regulations.
Singapore: Neobanks in Singapore operate under a lighter regulatory
regime compared to traditional banks. While they are not required
to hold a banking license, they are still subject to the Monetary
Authority of Singapore’s (MAS) regulations on payment services.
Australia: Neobanks in Australia also face a lighter regulatory regime
compared to traditional banks. They are not mandated to hold a
banking license but are subject to the regulations imposed by the
Australian Prudential Regulation Authority (APRA) on payment
services.
European Union: Neobanks operating within the European Union
(EU) are subject to regulations such as the Second Payment Services
Directive (PSD2) and the General Data Protection Regulation (GDPR).
Neobanks must obtain relevant licenses from national regulatory
authorities within the EU and comply with capital, consumer
protection, data privacy, and transaction security requirements.
Regulating neobanks is a complex issue, as it necessitates balancing consumer
protection with promoting innovation within the banking sector. Regulators
in different countries actively work to find the appropriate balance for
neobank regulation.
CASE STUDIES
Neobanks Redefining Financial Services:
A Case Study on Revolut
Introduction:
This case study explores the success story of Revolut, a prominent
neobank that has revolutionized the banking landscape with its
58 PAGE
innovative approach and disruptive business model. We will examine Notes

the key strategies and factors contributing to Revolut’s growth, its
impact on the financial industry, and the lessons learned from its
journey.
Background:
Revolut was founded in 2015 by Nikolay Storonsky and Vlad Yatsenko
in the United Kingdom. The neobank aimed to provide a digital
alternative to traditional banking services, offering customers greater
control, convenience and transparency over their finances. Initially
launched as a prepaid card, Revolut quickly expanded its offerings to
include features such as money transfers, foreign exchange services,
cryptocurrency trading and budgeting tools.
Key Strategies and Success Factors:
Seamless Digital Experience: Revolut focuses on delivering
a frictionless and user-friendly digital experience. Through
its mobile app, customers can easily open accounts, manage
finances and perform transactions. The app provided real-time
notifications, categorized spending insights and instant money
transfers, empowering users to control their financial activities
fully. This emphasis on simplicity and convenience attracted a
large customer base, particularly among tech-savvy individuals
and frequent travellers.
Disruptive Pricing and Transparent Fees: Revolut challenged
traditional banking models by offering competitive pricing and
transparent fee structures. It eliminated many common fees
associated with traditional banks, such as foreign exchange
fees and ATM withdrawal charges. Revolut positioned itself
as a cost-effective alternative for international travellers and
individuals conducting cross-border transactions by providing
real-time exchange rates at interbank rates and offering fee-free
spending abroad.
Innovation in Financial Services: Revolut continually introduced
innovative features and expanded its product range to meet
evolving customer needs. It leveraged emerging technologies like
artificial intelligence and machine learning to provide personalized
insights, budgeting tools, and tailored recommendations to its
users. Additionally, Revolut embraced cryptocurrencies, allowing
PAGE 59
BBA(FIA)
Notes customers to buy, sell, and hold various digital assets directly
within the app. This commitment to innovation helped the
neobank differentiate itself and attract a diverse customer base.
Global Expansion and Regulatory Compliance: Revolut adopted
an aggressive expansion strategy, targeting international markets
to scale its operations rapidly. It obtained banking licenses in
multiple jurisdictions, allowing it to offer full-fledged banking
services and establish customer trust. Simultaneously, Revolut
prioritized regulatory compliance and implemented robust security
measures to protect customer data and funds. By adhering to
strict regulatory standards, the neobank gained credibility and
demonstrated its commitment to ensuring a secure financial
environment.
Results and Impact: Revolut’s innovative approach and customer-
centric services propelled its growth and disrupted the financial
industry. Within a short period, the neobank acquired millions of
customers globally and reached a valuation of billions of dollars. Its
success forced traditional banks to reevaluate their digital offerings
and strive for improved customer experiences. Revolut’s impact
extended beyond its customer base, influencing the broader financial
industry to embrace digital transformation and focus on customer-
centric services.
Conclusion: The case study of Revolut showcases the transformative
potential of neobanks in reshaping the financial services landscape.
By prioritizing user experience, offering competitive pricing, and
leveraging technology to innovate, Revolut has established itself as
a leading neobank globally. The success of Revolut demonstrates
that consumers are increasingly seeking convenient, transparent and
personalized financial solutions. Neobanks like Revolut continues
to challenge traditional banks, prompting the industry to adapt and
evolve to meet customers’ changing needs and expectations in the
digital age.
3.8 Global and Indian Neobanks

The emergence of neobanks dates back to the early 2010s when a cluster of
startups started providing banking services solely through digital platforms.
These initial neobanks, including Simple and Moven, were established by
60 PAGE
tech-savvy entrepreneurs who recognized the potential to revolutionize the Notes

conventional banking sector.
In the late 2010s and early 2020s, neobanks experienced rapid growth and
gained significant traction. This was primarily due to the rising preference
for online banking, the widespread adoption of mobile devices and the
increasing demand for cutting-edge and customer-centric banking solutions.
List of some Global Neobanks:
Revolut: A UK-based neobank that offers various financial services,
including multi-currency accounts, international money transfers
and cryptocurrency trading. It has a large user base and operates
in multiple countries.
N26: A German neobank that provides mobile banking services,
including a fully digital banking experience, expense tracking and
savings features. It has gained popularity across Europe and has
expanded its services to the United States.
Chime: An American neobank that offers fee-free banking, early
paycheck access and automatic savings features through its mobile
app. It has attracted a significant user base and has been valued as
one of the highest-valued neobanks in the United States.
Monzo: A UK-based neobank known for its user-friendly app, real-
time spending notifications and budgeting tools. It has a strong
presence in the UK market and has expanded its services to the
United States.
Starling Bank: Another UK-based neobank that provides mobile
banking services savings goals and real-time transaction updates.
It has gained recognition for its innovative features and customer-
centric approach.
Varo Money: A US neobank that offers mobile banking services,
high-yield savings accounts and personalized financial insights. It
has received regulatory approval to operate as a national bank in
the United States.
Chime: A US-based neobank offering fee-free checking and savings
accounts and automated savings features. It has experienced rapid
growth and attracted a large United States customer base.
PAGE 61
BBA(FIA)
Notes Neobanks in India

Neobanks have gained significant traction in India in recent years. These
fintech companies leverage technology and innovative business models to
offer modern, user-centric banking experiences. Here are some notable neo
banks in India:
RazorpayX: RazorpayX provides various business banking services,
including digital banking, expense management, vendor payments
and payroll solutions. It offers features like virtual corporate cards,
automated bank transfers, and real-time financial insights.
Niyo: Niyo offers personalized banking solutions for individuals and
businesses. Its offerings include salary accounts, travel cards and
expense management tools. Niyo also offers international banking
services, enabling customers to transact and manage their finances
globally.
Open: Open provides a business banking platform for startups and
SMEs. It offers digital business accounts, expense management
tools, automated bookkeeping and integration with various business
apps. Open’s platform enables businesses to manage their finances
efficiently and access banking services seamlessly.
Jupiter: Jupiter is a neobank that focuses on providing personalized
banking experiences. Its offerings include savings accounts, debit
cards, and goal-based financial planning. Jupiter emphasizes user-
friendly interfaces, real-time notifications, and intelligent expense
tracking to help customers manage their money effectively.
PayZello: PayZello is a digital banking platform that offers personalized
banking experiences for millennials and Gen Z customers. It provides
features like instant savings accounts, virtual debit cards and expense
management tools. PayZello aims to simplify banking and enhance
financial wellness for its users.
These neo banks in India are known for their digital-first approach, user-
friendly interfaces and innovative features. They aim to disrupt traditional
banking models by offering customers convenience, transparency and
personalized financial solutions. As the fintech landscape continues to evolve,
neo banks are expected to play a significant role in shaping the future of
banking in India.
62 PAGE
Indian and Global Neobanking business model: Notes

Basis Global model (licensed Indian Model (partnerships with
digital banks) licensed banks)
Regulated Some countries, particularly Indian neobanks are FinTech companies not
developed ones, grant licenses directly regulated by the Reserve Bank of
to neobanks and regulate India (RBI). Instead, they collaborate with
their operations. licensed banks, NBFCs and other financial
institutions to offer financial services through
digital platforms.
Branches Neobanks globally typically Due to the nature of their business model
do not function as traditional and the absence of regulatory requirements,
banks and, therefore, have neobanks in India need a physical presence.
minimal or no physical They primarily interact with customers
branches to comply with through digital platforms, although customers
prevailing laws. can still access physical branches of partner
banks/financial institutions.
Scope of The primary role of Neobanks partners with regulated entities to
Services neobanks worldwide is to offer various financial services, including
provide banking services opening bank accounts, providing loan/credit
through the internet or facilities, prepaid card services, investment
other electronic channels advisory services and insurance services.
instead of physical branches. Some neobanks targeting MSMEs and
Established neobanks offer non-retail segments also offer white-label
a comprehensive range of solutions such as expense management,
financial services. invoice preparation, and vendor payment
management.
Permissibility The regulatory framework Partnership business models similar to those
allows for the digital banking found in neobanks are prevalent in India
business model in the UK, without specific operational restrictions.
US, Canada, Singapore, and
Hong Kong.
Compliances Digital banks must adhere Neobanks in India is not directly obligated
to regulatory authorities’ to comply with RBI regulations due to the
relevant frameworks and absence of a specific licensing regime.
regulations. Typically, partnerships with regulated
entities follow guidelines such as the
RBI’s Outsourcing Regulations, Business
Correspondent Guidelines and Master
Directions on Digital Payment Security
Controls, which apply to the partnering
regulated entities based on the nature of
services offered by neobanks.
3.9 Summary
Neobanks, also known as digital banks or challenger banks, are
financial institutions that operate primarily online and provide
PAGE 63
BBA(FIA)
Notes banking services through digital platforms. Unlike traditional banks,

neobanks often have no physical branches and offer a seamless
and user-friendly banking experience through mobile apps or web
interfaces.
Neobanks have gained popularity recently due to their focus on
convenience, accessibility and innovation. They leverage technology
to offer features such as instant account setup, easy-to-use mobile
banking apps, personalized financial insights, budgeting tools, and
competitive foreign exchange rates. Neobanks also tend to have
lower fees and offer transparent pricing models than traditional
banks.
These digital-first banks often target tech-savvy and digitally
oriented customers, offering them a range of banking services,
including savings accounts, current accounts, payment solutions,
money transfers, lending and investment options. Some neobanks
also partner with traditional banks or fintech companies to provide
a broader suite of financial products and services.
While neobanks challenge the traditional banking landscape with
their innovative approach and customer-centric offerings, they still
face regulatory requirements. They must comply with banking
regulations in the countries they operate in. The global neobank
industry continues to evolve, with established players and new
entrants striving to capture market share and provide customers
with a seamless and frictionless banking experience.
1. (b) Via mobile apps and online platforms

2. (c) Advanced digital user experience
3. (a) Small and medium-sized enterprises (SMEs)
4. (c) Innovative digital features and personalized services
5. (c) Transaction fees
6. (a) Limited access to technology and internet connectivity
64 PAGE
3.11 Self-Assessment Questions Notes
1. Explain the concept of neobanks and how they differ from traditional
banks in terms of their operating model and customer experience.
2. Discuss the advantages and disadvantages of neobanks for consumers,
considering factors such as convenience, accessibility and financial
services offered.
3. Analyze the regulatory challenges and considerations faced by
neobanks in various jurisdictions. How do these challenges impact
their operations and growth?
4. Describe the key technological innovations and digital features that
neobanks typically offer to their customers and discuss how these
features enhance the banking experience.
5. Evaluate the impact of neobanks on the traditional banking industry.
How are traditional banks responding to the emergence of neobanks,
and what strategies are they adopting to stay competitive?
6. Assess the risks associated with neobanks, such as cybersecurity
threats, data privacy concerns and financial stability. How do
neobanks address these risks and what measures do they take to
ensure the security of customer information and transactions?
7. Explore the funding and investment landscape for neobanks. How
do neobanks secure funding for their operations and what types of
investors are typically involved in supporting neobank ventures?
8. Discuss the future prospects and potential challenges for neobanks.
What trends and developments do you foresee in the neobanking
industry, and how will neobanks continue to disrupt and innovate
the traditional banking sector?
3.12 References
Agarwal, S., Vakil, T. & Narang, A. (2022). The evolution of
neobanks in India: Impact on the financial ecosystem. PwC India.
Retrieved from https://www.pwc.in/assets/pdfs/consulting/financial-
services/fintech/publications/the-evolution-of-neobanks-in-india.pdf
PAGE 65
BBA(FIA)
Notes Monis, E., & Pai, R. (2023). Neo Banks: A Paradigm Shift in
Banking. International Journal of Case Studies in Business, IT and
Education (IJCSBE), 7(2), 318-332.

Bradford, T. (2020). Neobanks: Banks by any other name. Federal
Reserve Bank of Kansas City, Payments System Research Briefing,
August 12, 1-6.
Ravindran, S (2020) Neo Banking 2.0.
Temelkov, Z. (2020). Differences between traditional bank model
and fintech based digital bank and neobanks models. SocioBrains,
International scientific refereed online journal with impact factor,
(74), 8-15.
Temelkov, Z. (2020). Overview of neobanks model and its implications
for traditional banking. Challenges of Tourism and Business Logistics
in the 21st Century, 3(1), 156-165.
66 PAGE
L E S S O N
4
Merger and Acquisition in
Banking
Yogesh Sharma
Senior Research Fellow
Atal Bihari Vajpayee School of Management and Entrepreneurship
Jawaharlal Nehru University
Email-Id: yogesh.ysharma93@gmail.com
Ankit Suri
Senior Research Fellow
Atal Bihari Vajpayee School of Management and Entrepreneurship
Jawaharlal Nehru University
Email-Id: ankitsuridse@gmail.com
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To understand the idea and relevance of M&A in the banking sector and how it
affects the sector.
PAGE 67
BBA(FIA)
Notes To recognise and assess the advantages that mergers may give
the banking sector, such as greater market presence, diversity of
offerings, cost synergies, enhanced risk management, and access to
new markets.
To understand the different synergies, including operational, financial,
technical, human resource, and customer base synergies, that may
be realised through banking mergers.
To examine and evaluate the legal and compliance issues, significant
regulatory approvals, antitrust issues, and the effects of the regulatory
environment on M&A activity that surround M&A in the banking
industry.
To review and assess case studies of recent banking mergers, taking
into account their justification, integration procedures, difficulties
encountered, financial performance, and results.
To examine the forecast for M&A in the banking industry, including
possible obstacles and possibilities, emerging trends, factors influencing
future M&A activity, and the influence of technology improvements.
To draw lessons from recent banking mergers that will help us
better grasp the main elements of M&A deals that succeed.
Apply the learned information to provide well-informed suggestions
and conclusions for banks thinking about M&A while taking into
consideration the advantages, difficulties, and potential developments
in the banking sector.
4.2 Introduction to Merger and Acquisition (M&A)
4.2.1 Definition and Concept of M&A

The term “Mergers and Acquisitions” (M&A) refers to the joining of
businesses or their key financial assets through business-to-business
financial transactions. M&A can take many different forms, including
the outright purchase and absorption of one firm by another, the merging
of two businesses to establish a new one, the acquisition of some or all
of a business’s significant assets, tender stock offers, or even hostile
takeovers (Hayes, 2023).
A merger occurs when two organisations come together to establish a
new legal entity, whereas an acquisition happens when one business
68 PAGE
buys out another (Gartner, 2020; CFI, 2020). Organisations can expand, Notes
contract, and modify their competitive position through M&A transactions
(Gartner, 2020).
Increased market presence, product diversity, cost synergies, greater risk
management, and access to new markets are just a few advantages that
mergers and acquisitions may give businesses and the banking industry
(Hayes, 2023). Through M&A, synergies in areas like operations, finance,
technology, human resources, and client base may be realised (CFI, 2020).
Legal and compliance issues, important regulatory approvals, antitrust
issues, and the influence of the regulatory environment on M&A activity
are all part of the regulatory systems governing M&A in banking. In order
to guarantee the legitimacy and successful completion of M&A transactions
in the banking industry, compliance with rules is crucial (Hayes, 2023).
Recent banking merger case studies offer practical illustrations of the
justification, integration procedures, difficulties encountered, financial
performance, and results of these transactions. Understanding the practical
ramifications of M&A in the banking business through analysis of such
case studies is helpful (Hayes, 2023).
Examining new trends, factors impacting future M&A activity, the
influence of technology improvements, as well as possible problems and
opportunities, is necessary when examining future trends and forecasts
for M&A in banking. Banks can make informed judgments and maintain
their competitiveness by having a solid understanding of the banking
M&A environment in the future (Hayes, 2023).
4.2.2 Importance of M&A in the Banking Sector

It is critical to acknowledge the major influence these transactions have on
the business to comprehend the significance of mergers and acquisitions
(M&A) in the banking sector. Here are some crucial details emphasising
the significance of M&A in the banking industry:
1. Growth and Expansion: Through the ability to enter new markets,
broaden their clientele, and enhance their market share, M&A
gives banks the chance to develop and expand. Banks may quickly
diversify their product and service offerings through M&A, access
new consumer categories, and increase their geographic reach.
PAGE 69
BBA(FIA)
Notes 2. Enhanced Competitive Position: Banks may improve their competitive

position in the market by using M&A. Banks can obtain economies
of scale, boost operational effectiveness, and gain a competitive edge
over smaller or less diverse institutions by pooling their resources,
knowledge, and clientele. Banks may more effectively compete with
bigger companies and adjust to shifting market conditions through
M&A.
3. Synergies and Cost Efficiencies: Synergies and cost savings are
frequently the consequence of M&A deals in the banking industry.
Banks may reduce costs and increase profitability by simplifying
procedures, consolidating activities, and getting rid of redundant ones.
Synergies may be achieved in many areas, including distribution
networks, risk management, and back-office operations.
4. Access to New Technologies and Expertise: Banks may gain
access to cutting-edge technology, creative solutions, and specialised
knowledge through M&A. Traditional banks may strengthen their
digital capabilities, increase client experiences, and maintain their
competitiveness in the quickly changing financial market by acquiring
or combining with fintech firms or tech-savvy institutions.
5. Risk Diversification: By diversifying their business lines or joining
related industries, M&A enables banks to reduce their risk exposure.
Banks can reduce the risks associated with a concentration in certain
markets or products by diversifying their portfolios and sources of
income. Their resilience is increased and their sensitivity to market
volatility is decreased by this diversity.
6. Regulatory Compliance and Capital Requirements: M&A deals in
the banking industry can assist organisations in adhering to capital
adequacy and regulatory compliance norms. To meet regulatory
requirements, improve risk management skills, and assure compliance
with strict capital requirements set by regulatory authorities, smaller
banks may occasionally combine with larger ones.
7. Financial Stability and Systemic Importance: The banking indus-
try’s M&A activity is essential for resolving systemic concerns and
preserving financial stability. Mergers and acquisitions can speed up
the resolution process in cases of financial difficulty or insolvency
for banks and minimise disruptions to the wider financial system.
70 PAGE
4.2.3 Factors Driving M&A Activity in the Banking Industry Notes
The following is a list of some of the variables that affect M&A activity.
It’s critical to remember that the relative importance of these criteria
might change based on the particular market circumstances, regulatory
landscape, and personal bank strategy:
1. Market Consolidation: As smaller banks find it difficult to compete
with bigger institutions, the banking sector is becoming more
consolidated. Banks have the chance to streamline their operations,
increase their market share, and obtain economies of scale through
mergers and acquisitions.
2. Enhanced Competitiveness: Increasing competition is a common driver
of M&A activity in the banking industry. To achieve a competitive
edge in terms of product offerings, client base, geographic reach,
technology infrastructure, and other strategic competencies, banks
look to buy or merge with other institutions.
3. Regulatory and Compliance Pressures: The profitability and
operational effectiveness of banks can be dramatically impacted
by regulatory changes and heightened compliance requirements. By
pooling resources and expertise, mergers and acquisitions can assist
banks in navigating these regulatory obstacles and more successfully
achieving compliance requirements.
4. Cost Reduction and Efficiency: Through the removal of redundant
tasks, the consolidation of back-office activities, and the rationalisation
of branch networks, mergers and acquisitions can save costs. Banks
may increase their profitability and solidify their financial position
by working towards better efficiency.
5. Technological Advancements: The banking sector is changing as
a result of the quick development of technology. To keep up with
shifting client expectations and boost operational effectiveness, banks
are investing more money in automation, cutting-edge technology,
and digital banking products. M&A activity can make it easier
to gain access to the new technology, knowledge, and resources
required to maintain competitiveness in the digital environment.
6. Geographic Expansion: M&A deals provide banks the chance to
establish themselves in new worldwide and local markets. Banks
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BBA(FIA)
Notes may access a broader client base, diversify their revenue sources,
and take advantage of cross-selling possibilities by entering new
markets.
7. Synergies and Value Creation: Synergies that increase the value
of the merged firm can be produced as a result of mergers and
acquisitions. Operational efficiency, cross-selling possibilities,
common infrastructure, greater risk management skills, and improved
financial performance can all lead to synergies.
8. Changing Customer Preferences: Banking preferences are changing
as a result of a rise in demand for individualised services, frictionless
digital interactions, and integrated financial solutions. Through M&A
activity, banks may gain the skills and knowledge required to adapt
to these shifting client demands and offer a wide range of goods
and services.
9. Economic Conditions and Financial Stability: The banking industry’s
M&A activity may be impacted by macroeconomic variables
including financial stability, interest rates, and economic cycles.
Banks may be more likely to participate in mergers and acquisitions
to take advantage of possibilities and increase their position in the
market during times of economic expansion and favourable market
circumstances.
10. Investor Pressures: Investors and shareholders frequently put pressure
on banks to increase profits and enhance financial performance. Due
to their potential to raise profitability, market value, and shareholder
value, mergers and acquisitions can be a strategic reaction to these
investor demands.
IN-TEXT QUESTIONS
1. Which of the following is NOT a form of M&A transaction?
(a) Outright purchase and absorption of one company by another
(b) Merger of two companies to create a new entity
(c) Acquisition of some or all major assets of a company
(d) Joint venture between two companies
72 PAGE
2. What are some factors driving M&A activity in the banking Notes
industry?
(a) Market consolidation
(b) Technological advancements
(c) Regulatory and compliance pressures
3. Mergers and acquisitions in the banking sector can provide
_______ to companies and the banking sector, including enhanced
market presence, diversification of offerings, cost synergies,
and improved risk management.
(a) Challenges
(b) Benefits
(c) Disadvantages
(d) Consequences
4. M&A transactions in the banking sector often result in _______
and cost efficiencies, achieved through combining operations,
eliminating redundancies, and streamlining processes.
(a) Market fluctuations
(b) Regulatory compliance
(c) Synergies
(d) Shareholder pressures
4.3 Benefits of Mergers in the Banking Sector
4.3.1 Enhanced Market Presence and Competitiveness

The improved market presence and better competitiveness that may be
gained via merging the resources and skills of two or more banks are
two of the major advantages of mergers in the banking business. When
banks combine, they may broaden their client bases and geographic
reach, which enables them to service a broader market and establish
a stronger presence in new areas. By working together, merging banks
may increase their market presence and become more recognisable by
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BBA(FIA)
Notes combining their customer trust, reputation, and brand recognition. With
more exposure, businesses may draw in more clients and strengthen their
bonds with current ones, expanding their market share and giving them
an edge against independent, smaller institutions. Additionally, mergers
provide banks the chance to combine their assets and skills, including
branch networks, technological foundations, and product offerings. Through
the elimination of duplications and the optimisation of processes, this
consolidation enables the combined business to function more effectively
and efficiently. As a result, the merged bank can satisfy a wider spectrum
of clients’ wants and preferences by providing a wider range of goods
and services.
Mergers strengthen a bank’s market power, which can help it negotiate
more favourable terms with its suppliers and vendors, leading to lower
operating expenses and higher profits. Merged banks may benefit from
increased negotiating power and economies of scale that can reduce costs for
infrastructure, technology, marketing, and compliance. These cost synergies
can boost profitability and provide businesses with a competitive edge in a
sector where margins are under pressure. Additionally, a bigger and more
aggressive bank may draw in top talent and seasoned experts, building a
workforce that is stronger and more knowledgeable. This skill base may
encourage innovation, propel the creation of new financial products, and
enhance customer service, all of which will increase the bank’s ability
to compete in the market. Overall, the strengthened market position and
heightened competition brought about by banking sector mergers can
position the merged entity as a dominant player in the market, able to
draw in and keep customers, expand its product offerings, and achieve
sustainable growth in a cutthroat sector.
4.3.2 Diversification of Product and Service offerings

The chance to broaden product and service offerings is one of the main
advantages of mergers in the banking industry. When two banks unite
through a merger, their separate product and service portfolios are
combined, which can result in a wider and more comprehensive variety
of options for clients.
74 PAGE
Diversification of product and service offerings is advantageous for Notes

several reasons:
1. Increased customer satisfaction: Banks can meet the varied demands
and tastes of their clients by providing a larger range of goods and
services. This increases convenience and happiness for clients by
enabling them to access a wider range of financial products from
a single organisation.
2. Competitive advantage: A combined bank that offers a diverse
selection of goods and services obtains a competitive advantage
in the industry. It can overtake rivals who provide a smaller range
of financial goods in terms of market share by luring new clients,
keeping those it already has, and retaining those it already has.
3. Revenue growth: By using new revenue sources, diversification
may promote revenue growth. For instance, if one bank focuses on
corporate banking and the other on retail banking, a merger might
open up chances for cross-selling, allowing the new company to
provide integrated banking solutions to both corporate and retail
customers.
4. Risk mitigation: For banks, a wide range of goods and services can
help reduce risk. Banks can lessen their exposure to certain sectors
or businesses that may be vulnerable to economic downturns or
regulatory changes by diversifying their activity across a variety
of financial activities.
5. Enhanced innovation and research capabilities: Banks that have
merged can combine their resources, knowledge, and research skills
to create new goods and services. The introduction of new financial
technology, enhanced client experiences, and better solutions suited
to the changing market demands can all result from this partnership.
6. Improved operational efficiency: While diversification makes a
bank’s operations more difficult, it may also result in scale savings
and operational benefits. The amalgamated business can cut costs,
optimise resource allocation, and boost overall operational performance
by reducing procedures and combining overlapping functions.
It is crucial to remember that thorough planning and execution of the
integration process are necessary for effective diversification. To create a
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BBA(FIA)
Notes unified and uniform client experience across the enlarged range of goods
and services, the combined bank must guarantee seamless integration of
systems, processes, and cultures. Additionally, informing clients about
the new goods and the value they provide requires strong marketing and
communication techniques.
Overall, the diversity of service and product offerings brought about by
bank mergers may provide a more competitive and client-focused banking
environment, promoting growth, profitability, and client pleasure.
4.3.3 Economies of Scale and Cost Synergies

Realising economies of scale and cost synergies is one of the key
advantages of mergers in the banking industry. When two or more banks
unite, they can pool their resources and operations, increasing productivity
and lowering expenses. This may be done in several ways:
1. Increased operational efficiency: Bank mergers can simplify processes
by getting rid of redundant tasks. As a consequence, duplicated
systems, procedures, and infrastructure are removed, saving money.
The combined organisation can realise economies of scale and lower
total operating expenses by integrating back-office activities, IT
systems, and administrative tasks.
2. Shared infrastructure and resources: Banks might rationalise their
branch networks through mergers to increase the physical presence
of the organisation. This enables the efficient use of assets like
branches, ATMs, and other facilities. The combined firm can save
money while maintaining an appropriate network to serve clients
effectively by decreasing overlapping branches in close proximity.
3. Bargaining power with suppliers: Merged banks frequently has
stronger negotiating positions with suppliers and partners. The
combined business may negotiate better agreements and price
arrangements with suppliers thanks to its increased client base and
combined purchasing power, which lowers the cost of numerous inputs
including technological solutions, office supplies, and professional
services.
4. Enhanced risk management capabilities: Banks that merge can pool
their resources and expertise in risk management. As a result, the
76 PAGE
combined organisation may put in place stronger frameworks and Notes

processes for risk management, which leads to better methods for
risk assessment and mitigation. The combined business can eliminate
redundancy and cut costs in risk management activities by pooling
resources for compliance, auditing, and regulatory reporting.
5. Economies in technology and innovation: Banks that merge can
make use of their combined technology resources and infrastructure
to improve their technical capabilities. The combined company can
speed up innovation, digitalization, and automation activities by
combining its resources for research and development, data analytics,
and digital solutions. This can lead to savings by improving the
customer experience, reducing IT expenses, and streamlining business
processes.
In general, cost synergies and economies of scale brought about by mergers
in the banking industry can increase profitability and competitiveness.
The amalgamated entity is better able to maximise resource allocation,
reduce costs, and deploy capital. These advantages can enhance financial
performance, provide value for shareholders, and open up options for
investment in fresh growth strategies and client-focused services.
4.3.4 Improved Risk Management Capabilities

The improvement of risk management skills is one of the key advantages of
mergers in the banking industry. The stability and sustainability of financial
institutions depend on effective risk management, and mergers can be key
to accomplishing this goal. The following are some significant ways that
mergers enhance the banking industry’s capacity for risk management:
1. Consolidation of Resources: Through mergers, banks may pool
their resources, such as staff, technology, and knowledge, to create
a stronger and more complete risk management framework. In
order to more effectively discover, evaluate, and mitigate possible
risks, banks might commit more significant expenditures in risk
management systems and technology by combining their resources.
2. Diversification of Risk: Increased risk diversification for the newly
created firm is a common outcome of mergers. Banks can lessen
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BBA(FIA)
Notes their exposure to certain risks and improve overall risk diversification
by merging various portfolios, client bases, and geographic reach.
This diversity assists in offsetting possible losses in one area with
profits in other areas, lowering the combined institution’s overall
risk profile.
3. Enhanced Risk Assessment: Combined knowledge and experience
from merged institutions may be used to enhance risk assessment
skills. The merging businesses’ exchange of best practises and
expertise enables a more thorough comprehension of various risk
variables and their possible effects. This makes it possible for the
amalgamated institution to carry out more precise risk assessments,
recognise emerging threats, and proactively establish risk mitigation
plans.
4. Strengthened Compliance and Regulatory Frameworks: A thorough
investigation of regulatory and compliance requirements is frequently
necessary for mergers. In order to ensure compliance with compliance
standards, banks must connect their risk management frameworks
with regulatory requirements during the merger process. This focus
on compliance and regulatory alignment aids in improving risk
management procedures and lowering the possibility of fines and
reputational concerns due to non-compliance.
5. Economies of Scale in Risk Management: In the area of risk
management, combined banks can benefit from economies of scale.
Banks may minimise redundancies and expedite risk management
procedures by merging their operations. Cost reductions in risk
management software, staff, training, and systems are a result of this
consolidation. The combined company can devote greater resources to
cutting-edge risk management technologies like artificial intelligence
and machine learning, which may enhance risk detection, analysis,
and monitoring capabilities, thanks to the ensuing economies of
scale.
6. Robust Stress Testing and Scenario Analysis: Because merged
banks have access to a wider range of data and risk indicators,
they may conduct more thorough stress tests and scenario analysis.
With more customers and a broader data pool, it is possible to see
a more complete picture of potential dangers under various stress
78 PAGE
conditions. This makes it possible for the combined institution to Notes

assess its resilience and create suitable risk mitigation plans to
endure challenging market circumstances.
In conclusion, the ability to better control risk is a key benefit of mergers
in the banking industry. Merged banks can improve their overall framework
for risk management and better navigate the complex and changing risk
landscape in the financial sector by consolidating resources, diversifying
risks, improving risk assessment, bolstering compliance frameworks, taking
advantage of economies of scale, and utilising advanced risk management
technologies.
4.3.5 Access to New Markets and Customer Base

Access to new markets and a larger clientele are two important advantages
that mergers provide to the banking industry. Banks are always looking
for new methods to expand their client base and boost their market share
in today’s fiercely competitive business climate. An effective means
of attaining these goals is through mergers. Financial institutions can
expand into new geographic regions where they previously had little or
no presence by merging with another bank. With this development, banks
may reach underserved client groups and take advantage of the potential
and economic growth in such areas. The ability to diversify their revenue
sources and lessen their dependency on a particular market or location
also helps companies become more robust to market swings. Additionally,
mergers provide businesses the chance to reach a bigger and more varied
client base. By utilising the already-existing client relationships of both
banks, the merged company may take advantage of cross-selling and up-
selling opportunities. Offering a wider selection of goods and services
not only boosts profits but also increases client happiness and loyalty.
Having access to more customers and new markets also helps businesses
achieve economies of scale. Banks can achieve cost savings by spreading
their fixed expenses over a bigger base of income when they have a
larger client base. This may result in increased profitability and a market
edge. Additionally, mergers can provide banks the opportunity to use their
combined resources and experience to create new goods and services
that are suited to the demands of emerging markets and clientele. Their
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BBA(FIA)
Notes market position is strengthened and their prospects for long-term success
are improved by their flexibility and responsiveness to client needs. To
guarantee a seamless merger and effective development into new markets,
it is crucial for banks to thoroughly analyse the compatibility of their
cultures, systems, and procedures before merging with another institution.
Additionally, to prevent any legal or compliance concerns, it is important
to comprehend and adhere to regulatory regulations in the new markets.
In conclusion, mergers in the banking industry provide the benefit of
opening up new markets and expanding the clientele. Banks may broaden
their geographic reach, diversify their sources of income, and take
advantage of economies of scale by making this strategic move. Banks
may provide a wider choice of goods and services and boost revenue and
customer satisfaction by integrating their client ties. To ensure a successful
entry into new markets and to reap the rewards of the merger, however,
meticulous preparation and integration are required.
IN-TEXT QUESTIONS
5. Which of the following is NOT a benefit of mergers in the
banking sector?
(a) Enhanced market presence and competitiveness
(b) Diversification of product and service offerings
(c) Economies of scale and cost synergies
(d) Improved risk management capabilities
6. Mergers in the banking sector can lead to improved risk management
capabilities through:
(a) Consolidation of resources
(b) Diversification of risk
(c) Enhanced risk assessment
7. One of the key benefits of mergers in the banking sector is the
_______ of product and service offerings.
(a) Consolidation
80 PAGE
(b) Diversification Notes
(c) Optimization
(d) Standardization
8. Access to new markets and an expanded _______ base are
significant benefits of mergers in the banking sector.
(a) Customer
(b) Product
(c) Investment
(d) Employee
4.4 Synergies Accruing Out of Mergers

Synergies, or the joint advantages that occur from the integration of two
or more businesses, are a frequent outcome of mergers in the banking
sector. These synergies might appear in numerous areas of the combined
organisation and help it succeed as a whole. The following are the main
categories of synergies that might result from mergers:
4.4.1 Operational Synergies

When merging institutions can simplify their operations and get rid of
redundant tasks, operational synergies develop. The combined entity
can save money and operate more efficiently by combining processes,
systems, and infrastructure. This may entail streamlining branch networks,
consolidating back-office tasks, and improving IT infrastructure. Cost
savings, increased productivity, and better customer service are all possible
as a result of operational synergy.
4.4.2 Financial Synergies

The financial advantages that come from a merger are referred to as
financial synergy. These synergies might lead to cost reductions, increased
revenue, and better financial results. The amalgamated business can cut
expenses in areas like procurement, marketing, and administrative tasks
thanks to economies of scale. New income streams may also be created
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BBA(FIA)
Notes through the larger product offers and united client base. Financial synergies
can result in more profits, better liquidity, and higher stock value for
shareholders.
4.4.3 Technological Synergies

Integration of technology platforms and systems leads to technological
synergy. In order to improve their total technology skills, merging
banks can take advantage of each other’s infrastructure, knowledge,
and technological capabilities. This may lead to better cybersecurity
safeguards, better digital financial services, and more innovative product
creation. In the world of digital banking, technological synergies may
result in increased operational effectiveness, greater client experiences,
and competitive advantage.
4.4.4 Human Resources Synergies

Synergies in human resources involve the workforce’s combined abilities,
skills, and knowledge from the two merging banks. The combined company
may maximise employee productivity, harmonise organisational culture,
and build on employee strengths by combining human resource services.
This may lead to more staff engagement, information exchange, and
talent retention. Synergies in human resources can result in a staff that
is more productive and motivated, establishing a good work environment
and promoting organisational success.
4.4.5 Customer Base Synergies

Synergies between customer networks and market reach result in a
customer base. Banks that merge can access a bigger client base, opening
up prospects for cross-selling and market development. This may lead
to a rise in market share, better client retention, and a wider selection
of goods and services for clients. Customer base synergy can result in
more sales, better client relationships, and a competitive advantage in
luring and keeping clients.
82 PAGE
4.5 Regulatory Mechanisms Surrounding M&A in Banking Notes
4.5.1 Overview of Regulatory Frameworks and Authorities

in India
In India, a number of significant bodies and frameworks control the
regulatory environment around mergers and acquisitions (M&A) in the
banking sector. The Reserve Bank of India (RBI), the country’s national
banking organisation in charge of regulating and supervising banks, is
the main regulatory body in charge of regulating M&A activities in the
banking sector. The RBI is essential in guaranteeing the consistency,
reliability, and effectiveness of the financial system, and it also supervises
M&A deals.
Additionally, mergers and acquisitions involving listed banking organisations
are subject to regulation by the Securities and Exchange Board of India
(SEBI), the nation’s capital markets regulator. In M&A deals in the banking
industry, SEBI oversees the securities market and provides transparency,
disclosure standards, and investor protection.
4.5.2 Legal and Compliance Considerations in M&A

Transactions
There are several legal and regulatory issues that must be taken into
account when doing M&A deals in the banking industry. These factors
consist of:
(a) Companies Act: The Companies Act, 2013 largely governs mergers
and acquisitions in India. Banks engaging in M&A transactions must
conform to a number of Act rules, including getting shareholder
permission, submitting merger paperwork, and following corporate
governance standards.
(b) Banking Regulation Act: The RBI is given authority to oversee and
regulate Indian banks under the Banking Regulation Act of 1949.
The regulatory standards outlined in this Act must be followed by
M&A transactions involving banks, including getting prior RBI
clearance.
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BBA(FIA)
Notes (c) Competition Act: The provisions of the Competition Act, 2002 pertain
to M&A transactions in the banking industry. The jurisdiction to
examine mergers for potential anti-competitive consequences and
guarantee fair competition in the market belongs to the Competition
Commission of India (CCI).
(d) Foreign Exchange Management Act: Foreign Exchange Management
Act, 1999 regulations apply to mergers and acquisitions involving
foreign banks or foreign stakes in Indian banks. Cross-border
transactions, including foreign investments and acquisitions, may
need RBI approval.
4.5.3 Key Regulatory Approvals and Requirements

In India, the M&A process in the banking industry is subject to certain
regulatory permissions and regulations that must be met. These consist of:
(a) Prior Approval from the RBI: In order to complete an M&A deal,
banks must first obtain RBI clearance. Before approving, the RBI
carefully considers the combining firms’ financial stability, legal
compliance, and other relevant issues.
(b) Shareholder Approval: The shareholders of the merging firms must
consent to M&A transactions. The process for getting shareholder
consent through special resolutions or postal votes is outlined in
the Companies Act.
(c) Due Diligence: Banks participating in M&A deals must perform
thorough due diligence to evaluate the merging firms’ financial,
legal, operational, and regulatory elements. This aids in locating
any potential dangers, liabilities, and synergies linked to the deal.
(d) Disclosure and Reporting Requirements: The disclosure and
reporting requirements set out by regulatory bodies like the RBI,
SEBI, and CCI must be complied with by banks. These criteria
guarantee openness and aid stakeholders in making well-informed
decisions.
84 PAGE
4.5.4 Anti-trust Considerations and Competition Regulations Notes
Antitrust issues and competition laws are quite important in India when it
comes to M&A deals in the banking industry. Anti-competitive agreements
and the misuse of dominant positions are prohibited by the Competition
Act, which is enforced by the CCI. Important factors include:
(a) Combination Regulations: M&A transactions must be reported to
the CCI for approval if they fulfil specific criteria, such as asset
and turnover restrictions. The CCI considers whether the acquisition
would have a negative impact on market competition by looking at
the probable impact on competition.
(b) Applicability of Dominant Position: The CCI assesses whether the
combined firm will gain market dominance, which might result in
anti-competitive behaviour. The CCI may take appropriate measures
to maintain fair competition if a dominating position is formed.
4.5.5 Impact of Regulatory Environment on M&A Activity

The regulatory climate has an immense influence on merger and acquisition
activities in the Indian banking industry. A strong framework is created
by the regulatory specifications and approvals, such as those from the
RBI, SEBI, CCI, and other pertinent agencies, which assures the stability,
openness, and fairness of M&A transactions. Several facets of M&A
activity are influenced by the regulatory environment, including:
(a) Transaction timelines: The regulatory authorities’ assessment and
evaluation of the proposed merger may influence the approval
procedure and compliance requirements, which might affect the
overall timing of M&A transactions.
(b) Investor confidence: By assuring compliance with legal and regulatory
duties, defending stakeholder rights, and upholding market integrity,
a well-regulated environment fosters investor confidence.
(c) Competition and market dynamics: The CCI in particular, which
provides regulatory monitoring, aids in preserving fair competition
in the banking industry. By preventing market distortions and anti-
competitive behaviour, this protects consumers and the economy as
a whole.
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BBA(FIA)
Notes (d) Risk management and stability: Regulations impose sensible risk
management techniques in M&A deals, fostering stability and
protecting the interests of stakeholders like depositors.
India aims to find a balance between enabling M&A activity in the banking
industry and safeguarding the health and stability of the financial system
by maintaining a robust regulatory environment.
IN-TEXT QUESTIONS
9. What are the key types of synergies that can be accrued through
mergers in the banking sector?
(a) Operational, Financial, Technological, Human Resources
(b) Operational, Financial, Technological, Customer Base
(c) Operational, Financial, Technological, Regulatory
(d) Operational, Financial, Technological, Compliance
10. Which regulatory authority in India oversees M&A activity in
the banking industry?
(a) Reserve Bank of India (RBI)
(b) Securities and Exchange Board of India (SEBI)
(c) Competition Commission of India (CCI)
(d) Foreign Exchange Management Act (FEMA)
11. M&A transactions in the banking sector are subject to the
provisions of the ___________ Act, 2002.
(a) Companies
(b) Banking Regulation
(c) Competition
(d) Foreign Exchange Management
12. Banks intending to undertake an M&A transaction must seek
prior approval from the ___________.
(a) RBI
(b) SEBI
(c) CCI
(d) FEMA
86 PAGE
4.6 Case Studies of Recent Banking Mergers and Related Notes

Outcomes
A. Citigroup and Travelers Group merger
Overview and Rationale:
A significant development in the banking sector occurred in 1998 with
the merger of Citigroup and Travellers Group. In order to form a diverse
financial conglomerate, Travellers Group, and Citigroup, two major
providers of insurance and financial services, joined together. The merger
was driven by a desire to centralise banking, insurance, and investment
services in order to better take advantage of synergies and opportunities
afforded by the combined entities.
Integration Process and Challenges:
The diverse business structures, cultures, and regulatory frameworks of
Citigroup and Travellers Group made the integration process a challenging
one. Aligning organisational hierarchies, integrating IT systems, and
combining various product offerings were some of the major obstacles
encountered throughout the integration. Additionally, regulatory licenses
from several agencies in charge of regulating the banking and insurance
industries were necessary.
Financial Performance and Outcomes:
There were substantial financial results from the combination of Citigroup
and Travellers Group. The merged company profited from greater market
reach, cost efficiencies, and improved revenue sources. To provide its
consumers with a greater selection of financial goods and services, Citigroup
made use of Travellers’ expertise in the insurance industry. Additionally,
Citigroup was able to increase its capacity for risk management and realise
economies of scale thanks to the acquisition. With a diverse portfolio
and a strong competitive position as a consequence, Citigroup grew to
become one of the biggest financial organisations in the world.
Lessons Learned:
The Citigroup and Travellers Group merger provides several valuable
lessons for the banking industry:
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BBA(FIA)
Notes (a) Clear strategic rationale: The merger was successful due to a clear
strategic justification that centred on building a diversified financial
services giant.
(b) Effective integration planning: Particularly when working with
various business models and regulatory contexts, the integration
process necessitates careful preparation and execution.
(c) Cultural integration: For a merger to be successful, cultural barriers
must be overcome and a strong organisational culture must be
fostered.
(d) Regulatory considerations: To get the required permissions and
guarantee compliance throughout the merger process, it is essential
to comprehend and navigate the regulatory landscape.
(e) Synergy realization: To maximise the advantages of a merger, it
is crucial to find and take advantage of synergies across product
lines, distribution networks, and operational activities.
Impact on the Banking Industry:
The Travellers Group and Citigroup merger had a significant effect on the
banking sector. It established a standard for other financial institutions to
follow when seeking to diversify and grow their operations through mergers
and acquisitions. The merger brought to light the potential advantages of
integrating banking, insurance, and investing services under one roof. The
effects of such conglomerates on market competitiveness and systemic
risk have sparked regulatory discussions and considerations.
Conclusion:
A significant case study in the banking sector illustrating the advantages of
building diverse financial conglomerates and the transformational potential
of mergers is the Citigroup - Travellers Group merger. The upshot of
the combination was improved consumer offers, market presence, and
financial success. It also highlighted the difficulties with integration,
cultural adequacy, and regulatory complications. Overall, the merger of
Citigroup and Travellers Group continues to be a significant turning point
in the development of the banking industry.
88 PAGE
B. Bank of America and Merrill Lynch merger Notes

In September 2008, Merrill Lynch, a renowned international investment
banking and wealth management organisation, was acquired by Bank
of America, one of the biggest commercial banks in the United States.
The financial crisis, which had a significant impact on the banking and
financial sector, prompted the merger. Bank of America has been working
to strengthen its market presence and diversify its product offerings in
recent years. Bank of America would be able to access a huge network
of financial advisers, robust investment banking capabilities, and a sizable
clientele by purchasing Merrill Lynch. The goal of the merger was to
build a worldwide financial powerhouse that could compete globally and
provide consumers with a wide variety of financial services.
The process of integrating Bank of America with Merrill Lynch was
complicated. Due to the disparate corporate cultures, business models, and
operating systems between the two organisations, a seamless integration
needed meticulous planning and execution. The integration of Merrill
Lynch’s large number of financial advisers into Bank of America’s
existing wealth management division was one of the biggest obstacles.
To guarantee a smooth transition for both staff and clients, it was
necessary to harmonise remuneration structures, harmonise client servicing
procedures, and provide training and assistance. The two entities’ respective
technological platforms and systems had to be integrated, which was a
difficult process. To guarantee operational efficiency and risk reduction,
the convergence of back-office operations, risk management systems,
and trading platforms needed large expenditures in infrastructure and
technological improvements.
The merged company’s financial performance was significantly impacted
by the merger of Bank of America and Merrill Lynch. Due to the global
financial crisis and market turbulence, the integration process initially
ran into difficulties, resulting in financial losses for both organisations.
However, the integration eventually began to have fruitful outcomes.
Bank of America now has a solid presence in the investment banking
PAGE 89
BBA(FIA)
Notes and wealth management industries thanks to the acquisition of Merrill

Lynch. A broad range of financial services, such as retail and business
banking, investment banking, wealth management, and capital market
operations, might be provided by the merged company. Through the
convergence of operations and back-office duties, the merger allowed Bank
of America to increase its client base, cross-sell goods and services, and
generate cost savings. Additionally, the merged company benefited from
scale economies, increased risk management skills, and easier access to
international markets. The acquisition also helped Bank of America survive
the financial crisis by strengthening its capital base and diversifying its
income streams. It put the bank in a position to compete with other sizable
financial institutions on a worldwide basis as a prominent participant in
the financial services sector.
Lessons Learned:
The Bank of America and Merrill Lynch merger provides several key
lessons for banking mergers:
1. Cultural integration: To guarantee a seamless transition and alignment
of values, objectives, and practises when merging organisations with
various cultural backgrounds, thorough preparation and excellent
communication are essential.
2. Technology integration: Harmonising technology platforms and
systems is essential for smooth operations and effective service
delivery. Upgrades to the IT system and infrastructure should be
planned and carried out with care.
3. Employee and client retention: Maintaining business continuity
and preserving connections depends on keeping important staff and
clients. Potential dangers can be reduced by offering assistance,
instruction, and clear communication.
4. Regulatory considerations: In banking mergers, adherence to
regulatory regulations and securing required permits are crucial.
Successful integration requires navigating the regulatory landscape
and comprehending it.
5. Strategic alignment: Mergers should have a distinct strategic
justification and be in line with corporate goals. To produce long-
90 PAGE
term value, it is essential to identify synergies and prospective Notes

growth opportunities.
The merger of Bank of America and Merrill Lynch is a crucial case study
for the banking sector because it illustrates the difficulties, results, and
lessons that can be drawn from such a high-profile union. It illustrates the
possible advantages and difficulties of integrating two significant financial
organisations as well as the strategic factors that motivate such mergers.
C. JP Morgan Chase and Bank One merger
An important development in the banking sector was the 2003 announcement
and 2004 completion of the JP Morgan Chase and Bank One merger.
Both banks made this strategic choice to boost their market positions
and establish a worldwide financial behemoth. One of the biggest banks
in the country, JP Morgan Chase sought to increase its retail banking
footprint and diversify its income sources. Jamie Dimon, the CEO of
Bank One, aimed to expand the company’s skills in investment banking
and take use of JP Morgan Chase’s broad global network.
Due to the size and complexity of the transaction, integrating JP Morgan
Chase and Bank One presented a number of issues. The blending of many
systems and cultures was one of the main obstacles. Due to the disparate
organisational and operating frameworks of the two banks, careful planning
and cooperation were necessary. The management group had to make sure
the transition went smoothly while causing the fewest possible hiccups
in operations and customer service. The integration process required
careful planning, extensive communication methods, and committed teams
responsible for various areas of the merger to overcome these problems.
The banks used a staged strategy, giving priority to crucial operations and
progressively integrating systems and procedures. Cross-functional teams
were created to oversee integration-related tasks such as technological
integration, managing human resources, and keeping customers.
JP Morgan Chase and Bank One’s merger produced profitable results for
both businesses. The united organisation, which had a wider geographic
reach and an improved product offering, became one of the biggest banks
PAGE 91
BBA(FIA)
Notes in the world. Because duplicate branches and back-office tasks were
reduced as a result of the merger, there were considerable cost savings
and increased operational effectiveness. Additionally, the merger enabled
JP Morgan Chase to strengthen its investment banking capabilities and
expand its market share in retail banking. Bank One benefited from
JP Morgan Chase’s global presence and expertise in areas such as risk
management and international markets. The combined entity experienced
revenue growth and increased profitability, leveraging the synergies
generated by the merger.
Lessons Learned:
The combination of JP Morgan Chase and Bank One offers important
insights into effective banking mergers. Several significant takeaways
from this case study include:
1. Strategic alignment: A distinct strategic vision and objective alignment
are essential for merging banks. The merger was successful because
JP Morgan Chase and Bank One have complementary skills and a
similar strategy for expansion.
2. Integration planning: To manage the integration process efficiently,
careful planning and cooperation are required. To reduce interruptions
and guarantee a seamless transition, banks should set up specialised
teams and use a phased approach.
3. Cultural integration: A successful merger requires addressing cultural
differences. Overcoming obstacles and facilitating integration can
be facilitated by open communication, cultural awareness, and
encouraging a collaborative atmosphere.
4. Synergy realization: Finding and using synergies is essential to
getting the most out of a merger. JP Morgan Chase and Bank One
were able to save costs and increase income by combining their
respective capabilities.
In conclusion, the merger of JP Morgan Chase and Bank One is an
example of a successful banking merger that benefited both organisations
strategically and increased their market positions and financial performance.
The acquisition also helped Bank of America survive the financial crisis
by strengthening its capital base and diversifying its income streams.
92 PAGE
4.7 Future Trends and Outlook for M&A in Banking Notes
A. Emerging technologies and digital transformation

Future M&A activity in the banking industry will be significantly influenced
by developing technology. Increased M&A activity is anticipated as a
result of the technology’s quick development in fields including Artificial
Intelligence (AI), blockchain, cloud computing, and data analytics. Banks
now have additional potential to improve the effectiveness of their
operations, the customer experience, and their product offers thanks to
these technologies.
Banking M&A will continue to be significantly influenced by digital
change. To obtain access to cutting-edge technology and increase their
digital capabilities, banks will want to purchase or combine with fintech
businesses and creative entrepreneurs. Through the M&A deals that integrate
these technologies, banks will be able to provide individualised services,
streamline operations, and strengthen cybersecurity defenses, eventually
increasing their competitiveness in the digital era.
B. Impact of globalization and cross-border M&A
Cross-border M&A activity has increased as a result of increased cross-
border financial system connectivity brought about by globalisation. Banks
are expanding internationally to gain a competitive edge, reduce risk, and
get access to new markets. The prognosis for M&A in banking includes
a sustained focus on international business deals.
Cross-border M&A has several advantages, including scale economies,
access to untapped client groups, and geographic diversity. However, it
also presents difficulties because of disparities in regulatory standards,
cultural blending, and geopolitical dangers. These complications must be
carefully navigated by banks thinking about cross-border M&A in ensuring
a trouble-free amalgamation and the necessary synergies.
C. Regulatory and policy changes shaping the industry.
The future trends and prospects for M&A in banking are heavily influenced
by regulatory and policy developments. To preserve stability, avoid
systemic risks, and safeguard the interests of consumers, governments
and regulatory bodies regularly improve their frameworks. The following
factors are expected to influence how M&A plays out in the banking sector:
PAGE 93
BBA(FIA)
Notes 1. Compliance and Risk Management: The need for rigorous due
diligence and risk assessments during M&A transactions will result
from the continued strictness of regulatory compliance requirements.
To reduce legal and reputational concerns, banks must make sure
they follow Anti-Money Laundering (AML), “know your customer,”
and data protection requirements.
2. Capital and Prudential Standards: The financial viability of M&A
deals will be impacted by the further evolution of regulatory capital
requirements and prudential norms. To assess the feasibility of
M&A agreements, banks will need to evaluate the effects of these
restrictions on their capital levels and financial stability.
3. Fintech Regulation: Regulators are concentrating on developing
frameworks for fintech businesses as the nexus between banking
and technology grows stronger. In order to handle possible risks and
promote innovation, M&A operations involving fintech businesses
may be subject to increased scrutiny and certain regulatory concerns.
4. Competition and Antitrust Regulations: To preserve healthy market
competition and avoid monopolistic practices, antitrust regulators will
rigorously monitor M&A transactions in the banking industry. Banks
that are involved in M&A transactions must adhere to competition
laws and handle any issues with market dominance.
5. Political and Economic Factors: The banking sector’s M&A
activity will continue to be influenced by global macroeconomic
circumstances, political stability, and trade policy. Cross-border
transactions and the strategic interests of banks may be impacted
by changes in the economic landscape, such as trade agreements
or geopolitical events.
4.8 Summary
Beginning with the definition and idea of mergers and acquisitions (M&A),
the chapter gives a thorough review of M&A in the banking industry. It
says that M&A entails the financial consolidation of businesses or their
key commercial assets through different financial transactions, including
mergers, acquisitions, and tender offers. The chapter outlines the advantages
of mergers and acquisitions (M&A) for the banking industry, including
94 PAGE
greater market presence, product diversity, cost synergies, enhanced risk Notes
management, and access to new markets. Additionally, it highlights the
significance of M&A in the banking industry by going over the main
factors that motivate M&A activity, including improved market presence
and competitiveness, product and service diversification, economies of
scale and cost synergies, enhanced risk management capabilities, and
access to new markets and clientele. These elements support the expansion,
prosperity, and competitive advantage of banks that participate in M&A
deals.
The chapter also looks at the authorities and regulatory structures that control
mergers and acquisitions in the Indian banking industry. It emphasises
the significance of the Securities and Exchange Board of India (SEBI)
and Reserve Bank of India (RBI) in regulating M&A activity, as well
as the legal and regulatory issues that arise in such deals. It also covers
important regulatory approvals, antitrust issues, and how the regulatory
climate affects M&A activity. The chapter places particular emphasis
on the impact of cutting-edge technology and the digital revolution
when looking at the trends and forecast for M&A in banking. In order
to improve their digital capabilities, banks are looking to buy fintech
businesses and cutting-edge startups, which is covered in this article
on how technologies like AI, blockchain, and data analytics will affect
M&A activity. The chapter also emphasises the effects of globalisation
and cross-border M&A, highlighting the advantages and difficulties of
growing companies abroad. It also emphasises how important regulatory
and policy changes are in influencing the sector. To take advantage of
M&A possibilities, banks must manage the ongoing changes in regulatory
and governmental frameworks that are designed to preserve stability and
safeguard customers. Institutions that proactively adapt to shifting trends
and regulatory constraints are recognised as being in the best position to
create sustainable development through mergers and acquisitions in the
banking sector’s changing environment.
The chapter offers a thorough overview of M&A in the banking industry
overall, covering its definition, advantages, motivating reasons, regulatory
issues, and future developments. The chapter provides readers with the
expertise to make educated decisions and maintain competitiveness in
the changing M&A in the banking landscape by studying real-world case
studies and emphasising the practical ramifications.
PAGE 95
BBA(FIA)
Notes 4.9 Answers to In-Text Questions
1. (d) Joint venture between two companies

3. (b) Benefits
4. (c) Synergies
5. (d) Improved risk management capabilities
7. (b) Diversification
8. (a) Customer
9. (a) Operational, Financial, Technological, Human Resources
10. (a) Reserve Bank of India (RBI)
11. (c) Competition
12. (a) RBI

1. What does the term “mergers and acquisitions” (M&A) mean in
the context of the banking industry?
2. What other guises might M&A adopt in the banking sector?
3. Describe a few advantages that M&A can have for businesses and
the financial industry.
4. What rules apply to mergers and acquisitions in the banking industry?
5. In what ways might case studies of recent banking mergers aid in
comprehending the real-world effects of M&A?
6. What variables influence M&A activity in the banking sector? Give
instances.
7. Describe the significance of increased market presence and competition
brought about by mergers in the banking industry.
8. How does M&A help the banking industry diversify its product and
service offerings?
96 PAGE
9. In the context of M&A in the banking industry, what are economies Notes
of scale and cost synergies? How are they accomplished?
10. Talk about how important it is for the banking industry to have
better risk management skills as a result of mergers.
11. Describe how access to new markets and a larger client base are
made possible by banking industry mergers.
12. What are the main categories of synergies that mergers in the
banking industry can generate?
13. Describe the legal structures and agencies involved in M&A deals
in India’s banking industry.
14. What legal and regulatory factors must be taken into account when
doing M&A deals in the banking industry?
15. List the important regulatory clearances and procedures for the M&A
process in India’s banking industry.
16. Go through the competition laws and antitrust concerns that apply
to M&A deals in the Indian banking industry.
17. How is M&A activity in the banking industry affected by the regulatory
environment? Use examples to clarify.
18. In terms of new technologies and digital transformation, what are
the trends and prospects for M&A in the banking industry?
19. Talk on the effects of globalisation on banking sector M&A and their
potential future effects.
20. How will future M&A patterns and outlook in the banking sector be
influenced by regulatory and policy changes? Give illustrations.
4.11 References
CFI. (2020, April 26). Mergers & Acquisitions (M&A). Corporate Finance
Institute; Corporate Finance Institute. https://corporatefinanceinstitute.
com/resources/valuation/mergers-acquisitions-ma/
Gartner. (2020). 'HILQLWLRQ RI 0HUJHUV DQG $FTXLVLWLRQV 0 $
*DUWQHU )LQDQFH *ORVVDU\. Gartner. https://www.gartner.com/en/
finance/glossary/mergers-and-acquisitions-m-a-
PAGE 97
BBA(FIA)
Notes Hayes, A. (2023). 0HUJHUVDQG$FTXLVLWLRQV 0 $ 7\SHV6WUXFWXUHV

Valuations. Investopedia. https://www.investopedia.com/terms/m/
mergersandacquisitions.asp

Bartlett, C. A., & Beamish, P. W. (2018). Transnational management:
Text, cases, and readings in cross-border management (8th ed.).
Routledge.
Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of
corporate finance (12th ed.). McGraw-Hill Education.
Gaughan, P. (2010). Mergers, acquisitions, and corporate restructuring.
John Wiley & Sons.
Hitt, M. A., Ireland, R. D., & Hoskisson, R. E. (2018). Strategic
management: Concepts and cases: Competitiveness and globalization
(12th ed.). Cengage Learning.
Krishnamurti, C., & Vishwanath, S. R. (2018). Mergers, Acquisitions,
and Corporate Restructuring | Online Resources. Sage Publishing.
https://study.sagepub.in/krishnamurti_macr
Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2018). Fundamentals
of corporate finance (12th ed.). McGraw-Hill Education.
98 PAGE
L E S S O N
5
Leasing and Hire Purchase
Gurdeep Singh
Assistant Professor
Department of Finance and Business Economics
University of Delhi
Email-Id: g.swork@yahoo.com
STRUCTURE
5.2 Introduction
5.3 Concepts of Leasing
5.4 Types of Leasing
5.5 Advantages of Leasing
5.6 Limitations of Leasing
5.7 Lease Evaluation
5.8 Concepts of Hire Purchase
5.9 Difference Between Hire Purchase and Leasing
5.10 Choice Criteria Between Leasing and Hire Purchase
5.11 Summary

Understand the concepts, classification, advantages, and limitations of Leasing.
Explain the importance of studying choice criteria between Leasing and Hire Purchase.
Describe the different types of leasing for decision making.
Understand the difference between Hire Purchase and Leasing.
PAGE 99
BBA(FIA)

From a financial perspective, assets are purchased to produce cash flow.
Finance leaders and managers are aware that using assets rather than
just owning them produces cash flows. Mostly every asset that can be
purchased or sold can also be leased. For instance, a company with a
factory 35 kilometres from Amritsar City needs a few buses to transfer
employees from the city to the production location. The company has three
options for financing the acquisition of the buses: using its own money
through equity financing, borrowing money from a bank through debt
financing, or a combination of the two i.e., equity and loan financing. As
an alternative, the company can also take the buses on lease. Therefore,
leasing is just another type of finance arrangement. Leasing is specifically
a financial choice. Deciding to invest in an asset that will produce cash
flow is the first step for a business. The finance manager must then decide
if the asset will be purchased using their own funds, borrowed money,
or a combination of the two, or can also take the asset on lease. Before
comparing a lease with other forms of finance i.e., equity or debt, it is
important to comprehend how lease agreements operate and how different
types of leases differ from one another.
5.3 Concepts of Leasing

Leasing is a contractual agreement between two parties: the lessor, who
owns the asset, and the lessee, who uses it. The lessor grants the lessee
the right to use the asset in exchange for monthly, quarterly, semi-
annually, or annual payments. The payments are tailored to the lessee’s
requirements. When the lease time expires, the leased asset reverts to the
lessor, who is the asset’s owner. However, the lessor may grant the lessee
an option to purchase the asset for a specified sum at the end of the lease
period.
In other words, a right to use property or capital goods in exchange
for periodic payment is referred to as a lease. With some minor variations,
this can be broadly compared to the owner of capital assets giving an
instalment credit to the individual who is using the asset.
100 PAGE
In any leasing deal, there are two main participants, as follows: Notes
Lessor: The person who is the legal owner of the property but
who agrees to let the other party use it in exchange for periodic
payments.
Lessee: An individual who obtains the right to use property in
exchange for a periodic payment.
The lease is created by the contract between the lessor and the lessee.
Understanding the type of leasing and how it will affect the lessor and
lessee financially depends on the parameters of the contract of the leasing.
Example: For a fee of Rs. 38,000 per month for a year, HM Car Rental
Ltd. gives a car on lease to JV Builders Ltd. and allows JV Builders Ltd.
to use a car to show clients several Mumbai locations where JV Builders
Ltd has developed apartments. In accordance with the contract, HM Car
Rental is the lessor and JV Builders Ltd is the lessee.
5.4 Types of Leasing

We commonly refer to two kinds of lease agreements: Operating Lease
which is a short-term cancellable lease agreement. Also known as a
service lease, the lease time under such an arrangement does not fully
amortize the cost of the asset, implying that the lessor cannot recover his
investment in the asset through a single operating lease agreement. As a
result, when one lease expires, the lessor enters into a lease agreement
with a different party. Lease agreements of this type are widespread with
laptops, air conditioners, automobile rentals, and so on. The lessor bears
the cost of the leased asset’s maintenance, obsolescence, depreciation,
and so on, which he or she normally recovers from the lessee in the
form of an add-on to lease rentals. The second kind of lease, known as
a Finance Lease, is the more significant one. The lease, which is also
known as a capital lease, covers the majority of the asset’s useful life,
usually non-cancellable, and the rentals mostly amortize the asset’s whole
cost throughout its lifetime. In such a lease, the lessee is responsible for
all maintenance, insurance, and obsolescence costs. Since this is a long-
term lease, an escalation provision has also been added, which stipulates
that rent may be revised in the event of specific occurrences, such as
changes in the government’s tax benefits after the contract has been
PAGE 101
BBA(FIA)
Notes signed, a significant change in the market interest rate, etc. A leased asset
may be financed by the lessor, financial institutions, or perhaps even the
lessee. If it is a Direct Lease, then the lessee chooses the asset and seeks
out the lessor who is willing to finance it and offer it to the lessee for
usage. The term Sale and Lease Back refer to an arrangement where the
lessee, who is usually the asset’s owner, sells the asset to the lessor, who
subsequently leases it back to the lessee. The lessor typically compares
the cost of the leased item against the present value of lease rentals that
the Lessor must collect from the lessee in sale and leaseback cases and
occasionally in other types of leasing as well.
As an illustration, the asset cost is Rs. 152 lakhs, and the present value
of the lease rental is Rs. 146.15 lakhs. No businessman would want to
pursue this project unless he also saw some other advantages and the
Depreciation tax shield is one of the main perks. The equation completely
changes if we add the depreciation tax shield of 49.06 lakhs to the
aforementioned example; the project that was previously unfeasible now
becomes so. In some cases, the gain from depreciation is so large that
the lessor passed some of the gain on to the lessee in the form of lower
rentals. When leasing costly assets, the lessor may only provide a portion
of the financing; the remainder may come from a financial institution.
A loan is made by the financial institution or lender and is secured by
the asset. The lender’s obligation is initially satisfied with the lease
rentals received, and any surplus is given to the lessor. Leveraged Lease
arrangements are these kinds of lease contracts.
IN-TEXT QUESTIONS
1. A Short-term lease which is usually cancellable is known as:
(a) Sale and Leaseback
(b) Operating Lease
(c) Finance Lease
(d) None of the above
2. With regard to a lessor, a lease is a:
(a) Investment Decision
(b) Financing Decision
102 PAGE
(c) Dividend Decision Notes

3. From the perspective of the lessee, a lease is:
(a) Working Capital Decision
(b) Financing Decision
(c) Investment Decision
4. A lease which is normally non-cancellable and covers the asset’s
entire economic life is referred to as:
(a) Sale and Leaseback
(b) Operating Lease
(c) Finance Lease
5. Which of the following is not a type of leasing?
(a) Sale and leaseback
(b) Goods on Approval
(c) Leverage Lease
(d) Direct Lease
6. The tenant and landlord in the case of a leasehold property
are referred to as the _____________ and the _____________,
respectively.
(a) Lessor, Lessee
(b) Lessee, lessor
(c) Leasehold, Freehold
5.5 Advantages of Leasing

(i) Tax Benefit: In some circumstances, the tax benefit of depreciation
that can be obtained by purchasing an asset may be less favourable
than that obtained for lease payment. In other words, choosing
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BBA(FIA)
Notes to lease an asset over purchasing it could be influenced by the

different tax treatment of each of the alternatives. For instance, an
organization that owns an asset receives tax savings for depreciation
on book value; however, in the case of lease rent, the entire lease
rental is tax deductible. This alternative tax treatment can result in
more tax savings for lease in some circumstances, which indicates
leasing is more beneficial subject to other factors.
(ii) Working capital conservation: A bank or other financial institution is
unlikely to grant 100% financing for a company to purchase an asset.
Banks may finance 75% or 60% of the asset’s cost depending on
the creditworthiness of this business. The remaining 25% or 40%
depending on the situation must be contributed by the business, and
this money is known as margin money. The necessity for margin
money naturally affects the working capital of the organization. If
the asset has a high value, the amount involved could be significant
and have a negative effect on doing business.
(iii) Maintaining Debt Capacity: A operational lease cannot be capitalized
in the lessee’s books according to accounting standards. Payment
for an operating lease is accounted for as an expense in the profit
and loss account. The balance sheet does not show either the leased
asset as an asset or the liability for the cost of the leased asset. In
other words, an operating lease does not affect the balance sheet.
Therefore, the operating lease is irrelevant for calculating the debt-
to-equity ratio. This makes it simpler for the lessee to obtain loan
financing. The aforementioned maintenance of debt capacity, it
should be noted, does not generally apply to finance leases because
the present value of future lease payments that is, the cost of the
leased asset appears as a liability on the lessee’s balance sheet and
must be properly taken into account when calculating debt equity
ratio.
(iv) Restrictive Requirements for Debt Financing: In the loan agreement,
the lender may set numerous restrictions on the borrower organization
to safeguard the lender’s interests when a business borrows money,
let’s say to buy an asset. Lenders may request collateral securities
on additional assets in addition to placing a charge on the purchased
104 PAGE
asset. In order to ensure optimal money utilization, the lender’s Notes

representative may be appointed to the board, or dividend payments
may be restricted. In the event of a lease, such stringent requirements
are not necessary because the lessor still maintains legal ownership
of the asset and is still able to seize it if the lessee violates the
lease’s terms.
(v) Obsolescence and Disposal: After a leased item is purchased, it may
become obsolete technologically. This implies that after purchase,
an asset with superior capacity and updated technology may become
available. The lessee as the user might have to choose the improved
asset to maintain its edge over competitors. When sold, the outdated
asset might only bring in a small percentage of its total book value,
which leads to a capital loss. If there is a cancellable operational
lease, the lessee may end the contract under these conditions. The
lessor is going to cover the risk by charging more for the lease
rental if there’s a likelihood of technical obsolescence.
(vi) Leasing may be a more affordable option than buying: Leasing
is an alternative to buying. A lease contract is comparable to a
debt contract in that the lessee is required to make a number of
payments in exchange for using an asset. Based on a comparison
of leasing and purchasing an asset, leasing has advantages. Due
to the low cost, many lessees find leasing to be more desirable.
An individual, for instance, might be relocated for six months to
a different city, and for that reason, an individual needs a vehicle
for daily travel. According to the Motor Vehicles Act, if someone
purchases a vehicle in their own name, they must also pay additional
costs over and beyond the car’s purchase price, such as a one-time
road tax.
5.6 Limitations of Leasing

(i) The lease rentals are due as soon as the assets are acquired,
and unlike term loans from financial organisations, there is no
moratorium period allowed. Because the lease agreement would
require cash outflows even before the project becomes operational,
it could not be appropriate for starting up new projects.
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BBA(FIA)
Notes (ii) When compared to interest levied on term loans by banks and other
financial institutions, lease financing carries an extremely high cost
of interest.
(iii) Lessors often seek loans from banks and other financial institutions
in order to buy a leased asset, and these loans are subject to a
hypothecation charge in favour of the bank or financial institution that
issued the loan. Sometimes banks may seize assets due to a default
on payments by the lessor, resulting in a loss for the lessee.
(iv) The lessor, who is the asset’s owner, owns the leased assets. Lessees
may not be permitted to take advantage of the seller’s warranties
on the proper functioning of assets that are leased.
IN-TEXT QUESTIONS
7. Consider the following scenario that Raju rents a flat from owner
John. So, what relationship do Raju and John have?
(a) Raju is a lessor and John is a landlord
(b) John is the lessor and Raju is the lessee
(c) John is the lessee and Raju is the lessor
(d) John is the lessee and Raju is a tenant
8. The primary difference between operating and finance leases is
that:
(a) There is usually an option to purchase in an operating
lease
(b) A call option is usually included in a finance lease
(c) An operating lease is generally cancellable
(d) A finance lease is usually cancellable
9. An operational lease is:
(a) Non-cancellable
(b) Cancellable at the choice of either the lessor or the lessee
(c) Cancellable at the sole discretion of the lessor
(d) Cancellable at the sole discretion of the lessee
106 PAGE
10. From the perspective of the lessee, the risk of: Notes
(a) The operating lease is the same as the financing lease

(b) The operating lease is greater than the financing lease
(c) The operating lease is less than the financing lease
(d) An operating lease is not similar to a finance lease
11. From a financial perspective:
(a) A lease has an advantage over a loan from the bank or
financial institution because it requires no margin money
and hence enables 100% financing
(b) Regardless of the amount of margin money required, a loan
from the bank or financial institution is always preferable
(c) Margin money is not a crucial factor in deciding whether
to borrow and buy or lease
(d) The single criterion for which a lease is always preferred
over a loan from the bank or financial institution is the
necessity for margin money
5.7 Lease Evaluation

A lease can be analysed as a financial option or as an investment choice.
A company (lessee) must decide whether it should buy the asset or acquire
it on a lease. The lease rentals may be considered as the interest on
the debt. Leasing is essentially a type of financing that is used in place
of borrowing. Therefore, the lease evaluation compares debt financing
to lease financing. The calculation for the decision-making criterion is
the Net Present Value of Leasing (NPV) or Net Advantage of Leasing
(NAL). When calculating the Net Present Value of Leasing (NPV) or Net
Advantage of Leasing (NAL), the value of the interest tax shield will be
taken into account as forgone cash flow.
Calculations of the Net Present Value of Leasing (NPV) or Net Advantage
of Leasing (NAL) are as under:
Net Present Value of Leasing (NPV) or Net Advantage of Leasing
(NAL) = Cost of the Asset – Present Value (P.V.) of Lease rentals (LR) +
Present Value (P.V.) of tax shield on LR - Present Value (P.V.) of interest
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BBA(FIA)
Notes on debt tax shield. - Present Value (P.V.) of tax shield on depreciation -
Present Value (P.V.) of salvage value.
Note: The discount rate employed in the above calculation is the marginal
cost of capital (Ke) for all cash flows excluding the payments for leases
and the Pre-tax cost of the company’s long-term debt (Kd) for payment
of lease.
If the Net Present Value of Leasing (NPV) or Net Advantage of Leasing
(NAL) is positive, the leasing option should be taken; otherwise, the
borrowing option should be chosen.
Evaluation Methods of Lease
A lease proposal can be evaluated in the following three manners:
(i) Analysis of Present Value: This approach compares the Present
Value (P.V.) of the annual lease payments (tax adjusted) to the
Present Value (P.V.) of the yearly loan repayments (tax shield on
depreciation as well as interest adjusted) and the one that results
in a lower cash outflow is chosen.
(ii) Internal rate of return analysis: With this approach, no discount
rate is required. This differs from the prior method in that the rate
of discount was determined using the after-tax cost of borrowed
capital. The outcome will be the after-tax cost of capital that is
specifically stated in the lease, which can be compared to the
costs of other financing options including a fresh issue of equity
capital, or debt.
(iii) Bower-Herringer-Williamson: The financial and tax-shield compo-
nents of lease finance are separated using this strategy. The model
compares the tax advantages or operating benefits of leasing with
the financial benefits of leasing.
Whether to buy or lease an asset relies on whether leasing generates
additional value. Leasing is often preferable to buying when an asset
is used for only a short duration that is one year. A decision between
buying and borrowing is involved in an operating lease. In this scenario,
the lessor still bears the risk and reward of ownership, making it a lesser
risk for the lessor. When compared to buying, where the lessee bears the
ownership risk, leasing may be a significantly more expensive option.
108 PAGE
The choice of a finance lease is between borrowing and leasing it. For Notes
the purposes of valuation, a finance lease is essentially another option
for obtaining funding for the leased asset because the lessee now bears
the majority of the risk involved and is responsible for managing the
business risk of ownership and operation.
Illustration: A potential client looking to purchase an equipment with
Rs. 3 crore cash down payment has contacted the leasing company ABC
Finance. The customer has sought a price for a three-year lease with rentals
payable at the end of each year, but in a diminishing manner whereby these
are in the ratio of 3: 2: 1, to leverage his tax position. ABC Finance’s
marginal tax rate is 35%, and depreciation can be considered going to
take place on a straight-line basis. 10% is ABC Finance’s desired rate
of return on the deal. Required: Calculate the three-year lease rents that
will be quoted.
Solution: Capital value to be included in the Lease
Rs. in lakhs
Cash Down price of the Equipment 300.00
Present Value (P.V.) of Depreciation Tax Shield
100 × 0.35 × 1/ (1.10) (31.82)
100 × 0.35 × 1/ (1.10)2 (28.93)
100 × 0.35 × 1/ (1.10)3 (26.30)
212.95
Cash flow will be as follows if the normal annual lease rent is x:
Year 3RVWWD[ FDVK ÀRZ 3UHVHQW 9DOXH 39 RI SRVWWD[ FDVK ÀRZ
1 3x × (1 - 0.35) = 1.95x 1.95 × (1/1.10) = 1.7727x
2 2x × (1 - 0.35) = 1.3x 1.30 × [(1/ (1.10)2] = 1.0743x
3 x × (1 - 0.35) = 0.65x 0.65 × [1/ (1.10)3] = 0.4884x
3.3354x
Therefore, 3.3354 X = 212.95 or X = Rs. 63.8454 lakhs
Year-wise lease rentals:
Year Rs. in lakhs
1 3 × 63.8454 lakhs = 191.54
2 2 × 63.8454 lakhs = 127.69
3 1 × 63.8454 lakhs = 63.85
PAGE 109
BBA(FIA)
Notes 5.8 Concepts of Hire Purchase

In the case of Hire Purchase, the counterpart of the lessee, the hirer,
agrees to take the goods on hire for a specified rental termed a hire
instalment, which includes principal and interest. After the hirer has
paid all of the instalments, the hirer is permitted to acquire the asset;
but, until the final payment is paid, each instalment is considered to
be a hire charge. This means that if a payment is missed, the hire who
is the counterpart of the lessor has the right to take possession of the
asset. Although Hire Purchase appears to be the same as the instalment
system, there are at least two fundamental differences between the two.
Firstly, with an instalment system, the asset is given to the buyer upon
payment of the first instalment, but with a hire purchase agreement,
ownership is transferred upon payment of the final instalment. Second,
with a hire-purchase agreement, the hirer may end the arrangement at
any time, and once he does so, he cannot be required to pay additional
instalments. In contrast, with an instalment agreement, since ownership
is transferred upon payment of the first instalment, neither party may end
the agreement except under certain special circumstances. What the hirer
pays: Usually, the hire charges a flat rate of interest and computes the
interest throughout the hire purchase instalment using that flat rate. Each
instalment’s amount is calculated after adding the principal and interest
that must be paid. The hire instalment that the hirer must pay can be
calculated using at least two different approaches. The first is known
as the Sum of the Year’s Digits (SOYD) Method, while the second is
known as the Capital Recovery Method. The Sum of the Year’s Digits
(SOYD) Method is constructed in such a way that during the early years
of instalment payment for hire purchase, the interest component is given
more weight than the principal, and the opposite occurs during the latter
years of instalment payment. This is accomplished by using a ratio in
which the denominator is the sum of the digits of all the ‘n’ years and
the numerator is the nth specified year in reverse order. The example
provided below can be used to clarify this:
Example: Mr. X offers a hire purchase proposal to Mr. Y on the following
terms:
The cost of the equipment shall be Rs. 10,00,000. The flat rate of interest
to be charged shall be 15% p.a. The instalments are to be paid annually
110 PAGE
for three years. You are required to calculate the annual hire purchase Notes
instalment and split it between principal and interest.
Solution: The total Payable interest shall be = 0.15 × Rs. 10,00,000 × 3
= Rs. 4,50,000.
Interest Allocation for the three years shall be:
Year Applicable Ratio Share of Total Interest
1 3/6 3/6 × Rs. 4,50,000 = Rs. 2,22,500
2 2/6 2/6 × Rs. 4,50,000 = Rs. 1,00,000
3 1/6 1/6 × Rs. 4,50,000 = Rs. 75,000
The Annual Hire Purchase instalment shall be calculated as under:
= (Rs. 10,00,000 + Rs. 4,50,000)/3
= Rs. 4,83,333.
The split of the Hire Purchase Instalment between the principal and
Interest shall be as follows:
Year Annual Hire Purchase Interest Principal
Instalment (Balancing Figure)
1 Rs. 4,83,333 Rs. 2,22,500 Rs. 2,58,333
2 Rs. 4,83,333 Rs. 1,00,000 Rs. 3,33,333
3 Rs. 4,83,333 Rs. 75,000 Rs. 4,08,333
Note: If the instalment is to be paid a basis (in common parlance this
is called EMI) then in the Sum of the Year’s Digits (SOYD) formula
the denominator shall be the sum of the digits of all the months and the
numerator being the instalment in the reverse order. This is shown in
the example below.
Example: Consider the example given above split the instalment into
principal and interest when the time period is only one year while the
instalment is to be paid on a monthly basis.
Solution: The total payable interest shall be = 0.15 × Rs. 10,00,000 × 1
= Rs. 1,50,000.
Month Applicable Ratio Share of Total Interest
1 12/78 12/78 × Rs. 1,50,000 = Rs. 23,076.9
2 11/78 11/78 × Rs. 1,50,000 = Rs. 21,153.8
3 10/78 10/78 × Rs. 1,50,000 = Rs. 19,230.8
4 9/78 9/78 × Rs. 1,50,000 = Rs. 17,307.7
PAGE 111
BBA(FIA)
Notes Month Applicable Ratio Share of Total Interest

5 8/78 8/78 × Rs. 1,50,000 = Rs. 15,384.6
6 7/78 7/78 × Rs. 1,50,000 = Rs. 13,461.5
7 6/78 6/78 × Rs. 1,50,000 = Rs. 11,538.5
8 5/78 5/78 × Rs. 1,50,000 = Rs. 9,615.4
9 4/78 4/78 × Rs. 1,50,000 = Rs. 7,692
10 3/78 3/78 × Rs. 1,50,000 = Rs. 5,769
11 2/78 2/78 × Rs. 1,50,000 = Rs. 3,846
12 1/78 1/78 × Rs. 1,50,000 = Rs. 1,923
The monthly hire purchase instalment shall be calculated as under:
= (Rs. 10,00,000 + Rs. 1,50,000)/12 = Rs. 95,833.33
The split of monthly Hire Purchase Instalment between the Principal and
Interest shall be as follows:
Month Applicable Ratio Share of Total Interest Principal
(Balancing Figure)
1 Rs. 95,833.33 Rs. 23,076.9 Rs. 72756.43
2 Rs. 95,833.33 Rs. 21,153.8 Rs. 74679.53
3 Rs. 95,833.33 Rs. 19,230.8 Rs. 76602.53
4 Rs. 95,833.33 Rs. 17,307.7 Rs. 78525.63
5 Rs. 95,833.33 Rs. 15,384.6 Rs. 80448.73
6 Rs. 95,833.33 Rs. 13,461.5 Rs. 82371.83
7 Rs. 95,833.33 Rs. 11,538.5 Rs. 84294.83
8 Rs. 95,833.33 Rs. 9,615.4 Rs. 86217.93
9 Rs. 95,833.33 Rs. 7,692 Rs. 88141.33
10 Rs. 95,833.33 Rs. 5,769 Rs. 90064
11 Rs. 95,833.33 Rs. 3,846 Rs. 91987.33
12 Rs. 95,833.33 Rs. 1,923 Rs. 93910.33
The second method to split the hire purchase instalment into principal
and interest is called the Capital Recovery Method and makes use of
the present value tables. First, we calculate the Capital Recovery Factor
by the following formula:
Capital Recovery Factor = (Cost of the Asset to be taken on Hire Purchase)/
Annual Hire Purchase Instalment
Having calculated the Capital Recovery Factor (CRF) by applying the
above formula, its value is searched by using the PVIFA table against
the number of years for which the instalment is to be paid i.e., ‘n’ and
112 PAGE
we try to locate the corresponding ‘r’ from the table. The ‘r’ value Notes
obtained shall be the annual percentage rate of interest where the cost of
the asset was Rs. 10,00,000 and the annual Hire Purchase Instalment as
Rs. 4,83,333. The Capital Recovery Factor (CRF) for this comes out as
2.069. Locating this figure in the PVIFA table against n=3 should give
the exact rate of interest but since this figure is not available, we look for
its nearest two values i.e., 2.074 (21%) and 2.042 (22%). So, our rate of
interest lies in between these two values. If we take the geometric mean
of these two values, we get 2.058 (21.5%). Again, taking the geometric
mean of 2.074(21%) and 2.058(21.5%) we get 2.066(21.25%) which is
very close to our requires Capital Recovery Factor (CRF) and hence our
annual percentage rate of interest is being charged by the hire while this
information is not revealed under the Sum of the Year’s Digits (SOYD)
method.
5.9 Difference Between Hire Purchase and Leasing

The primary distinction between a hire-purchase transaction and a lease
transaction is that the person utilizing the asset on a hire-purchase basis
is the asset’s owner, and the complete title is given to that person once
the person has paid the specified instalments. The asset will then be
recorded in the balance sheet, and the individual may deduct depreciation
and other expenses on it for tax purposes both during the duration of
the hire-purchase arrangement as well as thereafter. However, in a lease
arrangement, the lessor always retains ownership of the assets, and
the lessee merely receives the right to use them. The lessor will claim
depreciation as well as other allowances for the asset, and the asset is
also going to be recorded in the lessor’s balance sheet. The lessee’s
profit and loss account get employed for charging the lease money that
the lessee has paid. The asset will not, however, appear in this regard
in the lessee’s balance sheet. Because of this, the asset is referred to as
an off-balance-sheet asset for the lessee.
Characteristics Hire Purchase Leasing
1. Ownership Normally, ownership is No transfer of ownership shall be
transferred after the final automatically performed after all
instalment is paid, however, lease payments have been made.
the Hirer has the option. However, the lessor may, in some
PAGE 113
BBA(FIA)
Notes Characteristics Hire Purchase Leasing

cases, agree to transfer the asset to the
lessee in exchange for payment of a
certain amount.
7D[ EHQH¿WV Only the interest portion Entire lease rentals are tax deductible.
to the user of the of the instalment is tax
asset deductible.
3. Maintenance It is covered by the hirer. In the case of a Finance lease, the lessee
Cost, Risk of bears while in the case of an operating
Obsolescence lease, the lessor bears it.
4. Down Payment A down payment is usually Usually, a Down Payment at the time
at the time of the asked for by the hire. of the Deal is not required.
Deal
5. Scrap Value The Hirer receives it. The lessor receives it.
5.10 Choice Criteria Between Leasing and Hire Purchase

When we look at the formula for calculating the Net Present Value
(NPV) of leasing, what we actually performed was to compare the
purchasing criteria with the leasing criteria, or the cost of buying was
compared to the cost of leasing, and we agreed to the leasing alternative
if the Net Present Value (NPV) was positive indicating the cost of leasing
to be less than the cost of buying the asset. Other costs, such as interest
tax shield, which lowers the cost of the asset in purchasing criteria but
is disadvantageous when we choose the leasing option, have an impact
on both criteria. By applying the principles, we can create a formula for
the cost of leasing (as opposed to Hire Purchase) and the cost of Hire
Purchase (as opposed to leasing).
Cost of leasing (as opposed to Hire Purchase) = Present Value (P.V.) of
lease rentals - Present Value (P.V.) of the tax shield on Lease Rentals
Cost of Hire Purchase (as opposed to leasing) = Down Payment (if any)
+ Present Value (P.V.) of Hire Purchase Payments-Present Value (P.V.)
of tax shield on hire charges-Present Value (P.V.) of Scrap.
Example: Find out which of the two options—leasing or hire purchase—
is better for the user of the asset. The following details are available:
Cost of the Asset= Rs. 100 lakhs
114 PAGE
Annual Lease Rentals/Annual Hire Purchase Instalments: 35 lakhs. Notes

Duration of lease rentals/Hire Purchase Instalments: 5 years.
Depreciation on the asset @ 25% on Written Down Value, Pre-tax Interest
Rate is 16.5%.
Tax Rate is 40%, Scrap Value of the asset is Nil.
Solution: We must compute the Cost of Leasing (as opposed to Hire
Purchase) to decide which option is preferable, and we do this as follows:
Calculation of Post tax discount rate: Since the pre-tax rate is 16.5% and
the tax rate is 40%, the post-tax rate shall be 16.5 (1-0.40) = 9.9% p.a.
but for ease of calculation we take it as 10%.
1. Present Value (P.V.) of Lease Rentals: PVIFA (5,10) = 3.791x Rs.
35 lakhs = 132.68 lakhs.
2. Present Value (P.V.) of Tax Shield on Lease Rentals: Using the
formula, we first determine the tax shield.
Tax Shield = Tax Rate x Lease rental and then determine the present
value of it using the post-tax rate.
i.e., Tax Shield on Lease Rentals shall be 0.4 × 35 lakhs = Rs. 14 lakhs
and its Present Value shall be: PVIFA (5,10) = 3.791 × Rs. 14 lakhs =
Rs. 53.07 lakhs.
Cost of leasing (as opposed to Hire Purchase) = Present Value of Lease
Rentals + Present Value of Tax Shield on Lease Rentals i.e., Rs. 132.68
lakhs – Rs. 53.07 lakhs = Rs. 80.61 lakhs.
Next, we calculate the Cost of Hire Purchase (as opposed to leasing).
1. Present Value (P.V.) of Hire Purchase Instalments: This shall be the
same as that of the Present Value of Lease Rentals i.e., Rs. 132.68
lakhs.
2. Present Value (P.V.) of Tax Shield on Hire Charges: Hire Charges
i.e., the interest component is not given so needs to be calculated.
Applying Capital Recovery Method, we get CRF as (Rs. 100 lakhs)/ (Rs.
35 lakhs) = 2.857.
The PVIFA table value for 2.86 is given for n = 5 years against r = 22%.
Now the interest shall be calculated as under:
PAGE 115
BBA(FIA)
Notes Year Annual Hire Amount Interest @ Principal (Hire Purchase

Purchase Outstanding 21% Instalment - Interest)
Instalment (Balancing Figure)
1 Rs. 35 lakhs 100 22 13.00
2 Rs. 35 lakhs 87 19.14 15.86
3 Rs. 35 lakhs 71.14 15.65 19.35
4 Rs. 35 lakhs 51.79 11.39 23.61
5 Rs. 35 lakhs 28.18 6.2 28.8
It’s important to note that the variation in the total principal and the
amount outstanding at the beginning is due to the rounding off of figures at
various places.
Year Interest Tax shield Present Value (P.V.) of Tax Shield
(Discounting Factor 10%)
1 22.00 8.8 7.999
2 19.14 7.66 6.33
3 15.65 6.26 4.701
4 11.39 4.56 3.115
6.20 2.48 1.54
Total Rs. 23.68 lakhs
Finally, we calculate the Present Value (P.V.) of Tax Shield on Interest
Charges.
Therefore, the Present Value (P.V.) of Tax Shield on Hire Charges shall
be Rs. 23.68 lakhs.
Cost of Hire Purchase (as opposed to leasing) = Present Value (P.V.) of
Hire Purchase Payments - Present Value (P.V.) of tax shield on hire charges
= Rs. 132.68 lakhs - Rs. 23.68 lakhs
= Rs. 109 lakhs.
Leasing is preferred to hire purchase since the cost of leasing is lower
than the cost of hire purchase.
5.11 Summary
A lease is an arrangement between two parties under which the asset’s
owner also known as the lessor gives the person obtaining the asset
116 PAGE
on the lease right to use the asset in exchange for periodic payments. Notes
The lease is created by the contract between the lessor and the lessee.
Understanding the type of leasing and how it will affect the lessor and
lessee financially depends on the parameters of the contract of the leasing.
In some circumstances, the tax benefit of depreciation that can be obtained
by purchasing an asset may be less favourable than that obtained for lease
payment. In other words, choosing to lease an asset over purchasing it could
be influenced by the different tax treatment of each of the alternatives.
Based on a comparison of leasing and purchasing an asset, leasing has
advantages. Due to the low cost, many lessees find leasing to be more
desirable. In the loan agreement, the lender may set numerous restrictions
on the borrower organization to safeguard the lender’s interests when
a business borrows money while in the case of a lease, such stringent
requirements are not necessary because the lessor still maintains legal
ownership of the asset and is still able to seize it if the lessee violates
the lease’s terms. There are some disadvantages of leasing such as the
lease rentals are due as soon as the assets are acquired, and unlike term
loans from financial organisations, there is no moratorium period allowed
and also When compared to interest levied on term loans by banks and
other financial institutions, lease financing carries an extremely high cost
of interest. Whether to buy or lease an asset relies on whether leasing
generates additional value. The primary distinction between a hire-purchase
transaction and a lease transaction is that the person utilizing the asset
on a hire-purchase basis is the asset’s owner, and the complete title is
given to that person once the person has paid the specified instalments.
However, in a lease arrangement, the lessor always retains ownership
of the assets, and the lessee merely receives the right to use them. The
lessor will claim depreciation as well as other allowances for the asset,
and the asset is also going to be recorded in the lessor’s balance sheet.
IN-TEXT QUESTIONS
12. Financial leasing for a long time is:
(a) A non-balancing sheet item that has no bearing on the
debt-to-equity ratio
(b) An item of the balance sheet that raises the debt-to-equity
ratio
PAGE 117
BBA(FIA)
Notes (c) An item of the balance sheet that lowers the debt-to-equity
ratio
(d) An item of the balance sheet with no effect on the debt-
to-equity ratio
13. A person has enough money and requires a vehicle for 4 months.
A person will:
(a) Buy the vehicle with the funds, use it for 4 months, and
then sell it
(b) Borrow to buy the vehicle, use it for 4 months, then sell
it and repay the debt
(c) A person will take the vehicle on lease for 4 months and
return it at the end of the leasing period
14. Under a hire purchase agreement, ownership of an item is
transferred at the time of:
(a) Making a down payment
(b) Full and final payment of last instalment
(c) Payment of the First Instalment
(d) None of the Above
15. The hire purchase and instalment purchase systems are similar.
(a) True
(b) False
1. (b) Operating Lease

2. (a) Investment Decision
3. (b) Financing Decision
4. (c) Finance Lease
5. (b) Goods on Approval
6. (b) Lessee, lessor
118 PAGE
7. (b) John is the lessor and Raju is the lessee Notes

8. (c) An operating lease is generally cancellable
9. (b) Cancellable at the choice of either the lessor or the lessee
10. (c) The operating lease is less than the financing lease
11. (a) A lease has an advantage over a loan from the bank or financial
institution because it requires no margin money and hence enables
100% financing
12. (b) An item of the balance sheet that raises the debt-to-equity ratio
13. (c) A person will take the vehicle on lease for 4 months and return
it at the end of the leasing period
14. (b) Full and final payment of the last instalment
15. (b) False

1. What are the lease financing evaluation methods?
2. Why take an Asset on Lease when one can purchase it.
3. What Prevents the Business from taking the Asset on Lease?
4. ABC Company wants to spend $750,000 on sophisticated technological
equipment. In three years, it will be entirely obsolete. Options
available to ABC company include borrowing the money for three
years at 10% interest from the bank or leasing it. If leased, the
lease rental will be Rs. 2,80,000, payable at the end of each year
for the next three years. If ABC Company purchases equipment,
straight-line depreciation is going to be provided in three years.
The rate of tax is 34%. Respond to the following questions:
(a) Should ABC Company lease or purchase?
(b) What is the Net Present Value (NPV) to the lessor?
(c) What lease rental is going to enable the lessor and lessee to
break even?
PAGE 119
BBA(FIA)
Notes 5.14 Suggested Readings

Pathak, B.(2018). Indian Financial System. Pearson Publication (5thed)
Khan, M.Y.(2017). Financial services. McGraw Hill Education (6thed)
Rakesh Shahani, Financial Markets in India
Machiraju, H.R. (2002). Indian Financial System. Vikas Publication
House (5thed)
Wright M., Watkins T. & Ennew C. (2016). Marketing of Financial
Services. Routledge
120 PAGE
L E S S O N
6
Venture Capital
Dr. Neerza
Assistant Professor
Department of Commerce
PGDAV College, University of Delhi
Email-Id: neerza@pgdav.du.ac.in
STRUCTURE
6.2 Introduction
6.3 Evolution of Venture Capital
6.4 The Venture Investment Process
6.5 Steps in Venture Financing
6.6 Incubation Financing
6.7 Summary
6.10 References

To develop basic understanding of the concept of venture capital.
To know about the evolution of venture capital landscape.
To learn about the venture capital investment process.
To understand various steps involved in venture financing.
To learn about the concept of incubation financing.
PAGE 121
BBA(FIA)

To convert ideas into reality, to get from concept to execution, everything
requires money. Without critical financial support, even the best ideas
will not go far. For entrepreneurs, Venture Capital (VC) is a critical
funding source in the initial stages. It provides financial support to
young, high-risk and technology focussed firms. Venture capital fills the
gap between traditional sources and sources of funds from corporations,
government bodies, and friends and family (Zider, 1998). Venture capital
is an investment capital, often accompanied by huge risk and uncertainty.
Venture capital fosters the spirit of entrepreneurship within the economy
and is associated with highly innovative and high-growth companies.
Venture capital, a form of private equity, provides funding to start-ups
and early-stage emerging companies needing more operating history with
significant growth potential (Baldrige & Curry, 2023). In exchange for
financial support, technical guidance and managerial expertise from venture
capitalists, the portfolio companies offer them equity ownership and a
seat on board. VC investors also provide portfolio companies access to
their network of partners and experts, which help them raise additional
rounds of money in the future.
A venture capital firm is an investment company that manages venture
capital funds and makes capital from the funds available to start-ups
(Baldrige & Curry, 2023). Accel Partners India, Sequoia Capital India,
Nexus Venture Partners, SAIF Partners, Lightspeed Venture Partners India,
Matrix Partners India, Kalaari Capital, Helion Venture Partners, etc., are
a few examples of venture capital firms operating in the Indian market.
Large institutions like pension funds, financial firms, insurance companies,
endowment funds, and high-net-worth individuals invest in venture capital
funds. The pooled money is then invested in high-growth start-ups and
early-stage companies. Venture capital funds are often structured as limited
partnerships, where general partners (VC firm and its principals) manage
the fund while serving as advisors to the portfolio companies. Limited
partners are investors in the fund. These funds generate revenue by charging
management and performance fees/carried interest in two (2%) and twenty
(20%) ratios. The Indian venture capital landscape is dynamic, with new
funds continuously emerging, leading to further expansion. Access India
122 PAGE
Fund, Aditya Birla Private Equity Trust, Blume Ventures Fund I, Canbank Notes
Venture Capital Fund, Gaja Capital India Fund I, ICICI Prudential Venture
Capital Fund, ICICI Venture Fund Management Company Limited, IDFC
Infrastructure Fund 2, IL&FS ORIX Trust, India Advantage Fund V, JM
Financial India Fund, Kotak India Growth Fund II, Reliance India Power
Fund, are few VC funds presently investing in India. While investing,
venture capital funds usually target a specific industry or sector, geography
or stage of development in which the company.
Venture capital can generate spectacular returns. Venture capitalists have
repeatedly proven this by funding some of the largest businesses in the
world. They provide capital in the form of equity, helping businesses to
start operations, meet working capital requirements and for expansion. Many
capital expenditure expenses, like the purchase of equipment, vehicles, or
inventory required for operations, are also funded through venture capital.
Venture capitalists also finance the research and development activities
of the companies, which lead to new product development, services and
technologies. They provide funding to those start-ups which have limited
access to traditional financing.
Venture capitalists often bring their expertise, networks, professional
business insights, and financial capital. As mentors, venture capitalists
provide valuable guidance and strategic advice to entrepreneurs to make
important decisions and sail through challenging business scenarios. Venture
capitalists have a wide range of networks from the industry, which help
start-ups get access to potential customers and investors. They also enable
entrepreneurs to raise additional rounds of funding in the future.
An association of venture capitalists with a start-up not only validates the
growth potential of the start-up but also adds credibility signalling the
investors, partners and customers that the business is worthy of support.
Venture capitalists actively participate in their portfolio companies, build
long-term partnerships while helping them succeed, and bear the risk
of investing in high-risk early-stage companies. Venture capitalists take
start-ups public through an IPO or selling them to a larger company.
Both exit alternatives generate substantial returns for venture capitalists
and start-ups. Fostering the spirit of innovation, job creation, stimulating
economic growth and developing new products/services/technologies are
other benefits of venture capital investment.
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BBA(FIA)
Notes In India, venture capital has emerged as a significant and vibrant source of
finance for start-ups. The VC segment in the Indian market has witnessed
remarkable growth over the past years. While attracting substantial venture
funding, India emerged as an attractive destination for domestic and
international VC investors due to the rise of many successful ventures
like Flipkart, Ola, Paytm, OYO, etc. Our country has witnessed a record
influx of venture capital over the last few years. As India continued to
show resilience towards the global slowdown, the investor community
adopted an optimistic view of the economy.
During 2021-22, India celebrated the addition of its 100th unicorn while
outpacing China (11) in terms of the number of unicorns added in the
country (23) (Seth et al., 2023). Unicorn, a term often used in the venture
capital industry, refers to a start-up that reaches a valuation exceeding
US$ 1 billion over a short period. According to Forbes (2023), BYJU’s,
Swiggy, OYO Rooms, Purplle, LivSpace, XpressBees Logistics, Dream11,
Razorpay, and Ola Cabs are well-known unicorns in India. The growing
number of unicorns in India are innovative powerhouses, have achieved
incredible valuations and attracted global investors (Forbes, 2023).
IN-TEXT QUESTIONS
1. Venture capital firm is organised as___.
(a) Non-profit organisations
(b) Limited partnerships
(c) Joint venture
(d) Close-ended mutual funds
2. Which of the following is backed by venture capital ___.
(a) Swiggy
(b) OYO
(c) Razorpay
(d) All of these
Indian venture capital ecosystem is characterised by steady investment
momentum in fintech and SaaS (Software-as-a-Service); emergence of
space tech, generative AI and climate/clean tech; rise of domestic VC
firms and increased international participation; increased presence of
124 PAGE
large-sized micro VC funds; decline in exits with VC participation in Notes

2022; investors shifting towards sustainable businesses; and tightening of
regulatory norms like ban on prepaid instruments, tax on virtual digital
assets, launch of Open Network for Digital for Commerce (ONDC) (Seth
et al., 2023). Indian venture capital business is thriving and attracting
global capital. Indian market is the hub for early-stage investments, and
with strong economic fundamentals, it continues to expand, providing
ample opportunities to raise and invest funds.
Figure 6.1: Shark Tank (US and India)

Shark Tank (US) is a platform where emerging entrepreneurs present their
unique business ideas to a panel of renowned venture capital investors
called “sharks”, who then decide to invest in their companies or not.
On similar lines, Shark Tank India also provide a platform to aspiring
Indian entrepreneurs to pitch their business models to group of venture
capitalists and convince them to invest money into their business ideas.
6.3 Evolution of Venture Capital

Globally, the evolution of venture capital goes back several decades, in the
US’s late 1940s and early 1950s. Since then, the industry has transformed
significantly. American Development Corporation (ARDC) was first among
the venture capital firms that financed early-stage companies. During the
1960s-1970s, the venture capital market witnessed tremendous growth and
development with investments in technology, electronics and biotechnology.
Around this time, National Venture Capital Association in the US laid
down best practices to promote the venture capital industry. With the
entry of institutional investors like pension funds, large corporations and
endowments, and the establishment of professional firms managing VC
PAGE 125
BBA(FIA)
Notes investments, the industry witnessed the emergence of technology giants

like Apple, Microsoft and Intel. The venture capital industry recorded
high/attractive investment returns during this time.
Later from the 1990s to 2010s, venture capital saw a surge in investments;
growth of internet-related start-ups; a temporary decline in investment
activity due to the downturn, expansion beyond Silicon Valley to other
regions, including emerging markets like India and China, increased
diversification in terms of cleantech, fintech, etc.; the rise of unicorns in
2010s; and the emergence of hedge funds, sovereign wealth funds entering
the venture capital space. In recent years, the industry has focused on
impact/responsible investing and the importance of Environmental, Social
and Governance (ESG) concerns in investment decision-making.
Evolution of Venture Capital in India
Before the emergence of venture capital, Development Financial Institutions
(DFIs) played the role of venture capitalists until the 1980s when the
Indian government gave legal status to venture capital transactions in
the country. The concept of venture capital began to take shape with the
establishment of ICICI, IFCI and IDBI in the 1980s, which significantly
promoted venture capital investments in India. Such institutions provided
early-stage financing for Small and Medium Enterprises (SMEs) and
technology-driven start-ups. Technology Development and Information
Company of India Ltd. (TDICI), a joint venture of ICICI and UTI, was
among the first organisation to offer venture capital services in our country.
Later during the 1990s, venture capital was formalised through a set of
guidelines issued under SEBI (Venture et al.) Regulations, 1996, followed
by SEBI (Foreign et al. Investor) Regulations, 2000. Liberalisation, policy
reforms, and regulatory frameworks introduced in the 1990s brought
significant changes to the venture capital landscape in India. As India
showed scope for economic development and growth, the venture capital
market in the country became attractive to more and more private investors
from within and abroad. With liberalisation and changing market dynamics,
venture capital investment preferences shifted from manufacturing to
consumer services and retail. Over the years, the venture capital market
witnessed diversified investments across various sectors, including IT and
IT-related services, software development, telecommunications, electronics,
126 PAGE
biotechnology and pharmaceuticals, banking and finance, insurance, media Notes

and entertainment and education.
The venture capital industry in India reached its peak in 2007, witnessing
the highest investment value since inception, and has been experiencing
multiple years of highest value since then. Many well-known venture
capital firms like Sequoia Capital India, Accel Partners India, Nexus
Venture Partners, and Helion Venture Partners started actively investing in
Indian start-up businesses. Technological advancements during the 2010s
contributed to the rapid growth of Indian start-ups and led to successful
ventures like Flipkart, Ola, Paytm, and Zomato. Indian venture capital
industry attracted the attention of domestic and international venture capital
investors, which helped Indian start-ups to expand their operations with
larger and more rounds of funding.
DO YOU KNOW?
Indian start-up ecosystem is a home to 6 of the world’s top 100
unicorns in terms of valuation: BYJU’s ($ 22 billion), Swiggy ($ 10.7
billion), OYO Rooms ($9 billion), Dream11 ($ 8 billion), Razorpay
($ 7.5 billion) and Ola Cabs ($ 7.5 billion).
Our country has become a hotbed for VC investments from domestic
and international investors. The average deal size rose from US$ 6.7
million in 2012 to US$ 14.7 million in 2019. Government initiatives like
Start-up India launched in 2016 aimed at promoting entrepreneurship,
simplifying regulatory compliance and providing access to funds. Tax
incentives like tax exemptions for start-ups and the setting up funds like
the Fund of Funds for Start-ups (FFS) further promoted venture capital
investment activity in India. In 2021, India recorded the highest average
investment value of US$ 24.9 million across 1545 deals before recalibration
in 2022, recording US$ 16 million as the average deal size (Seth et al.,
2023). International venture capital firms like SoftBank, Tiger Global and
Sequoia Capital have invested significantly in Indian start-ups. There has
been a growing emphasis on early-stage investments (including seed and
angel funding) and social and environmental aspects of venture capital
investments in India. The evolution of the venture capital landscape in
India is remarkable as the industry continues to adapt and evolve to
support innovation and entrepreneurship worldwide.
PAGE 127
BBA(FIA)
Notes 6.4 The Venture Investment Process

The venture investment process involves the following steps:
Deal Sourcing: Venture capital firms actively seek investment
opportunities via networking, participating in industry events,
engaging with incubators, and online platforms, using their contacts/
relationships in the start-up ecosystem and various other channels.
Deal Screening: After identifying the potential investment opportunity,
venture capital firms evaluate whether the start-up matches their
investment criteria. The suitability is judged by reviewing the
venture’s business plan, financial projections, operating model,
market potential, etc.
Due Diligence: Once the start-up passes the initial screening,
the venture capital firm undertakes due diligence. In addition to
examining the business model, financials, intellectual property,
technology, legal and regulatory compliance, and other challenges/
risks, personal interviews may be conducted with the founders,
employees and industry experts.
Investment Proposal and Negotiation: On achieving satisfactory
due diligence, the venture capital firm may prepare an investment
proposal with details like ownership stake, investment amount,
valuation, rights of the investors, etc. To proceed further, negotiation
takes place between the parties to decide on the key terms and
conditions of the investment proposal. A term sheet mentioning key
aspects like funding amount, valuation, investor rights, governance,
liquidation preferences, etc., is issued.
Legal and Documentation: After the parties agree upon the terms
and conditions, legal documentation, including investment agreement,
shareholders’ agreement and other important legal contracts, are
prepared and finalised. Such documents highlight the rights, obligations
and protections for the investors and the start-up.
128 PAGE
Notes
Figure 6.2: The Venture Investment Process

Closing: After passing the legal documentation stage, investors
make investments in exchange for the specified ownership stake.
The deal is closed once the parties sign the investment agreements,
complete all the legal formalities and fulfil all the important terms
and conditions.
Post-investment: Venture capitalists actively participate in the start-
up by providing expert guidance, professional support, and strategic
advice to sail through all the challenges and capitalise on all the
opportunities. Such alignment between the investor and the start-up
helps everyone grow and succeed. They may also help in arranging
for additional rounds of funding in future.
Exit: While working closely with the start-up, venture capital firms
monitor the performance of their investments. Once the company
has matured and created value, the venture capital firm would look
for exit avenues to realise returns on its investment. IPOs, mergers
and acquisitions and secondary sales are common exit routes for
venture capital investors.
Venture capital is significant for any start-up as it paves the way for growth
and success. The venture investment process varies according to the nature
of the investment, start-up company and various other circumstances of
each deal. The process involves continuous participation from venture
capital firms and start-ups. There may be plenty of attractive potential
investment opportunities. However, not all lead to investments.
IN-TEXT QUESTIONS
3. ___provide financing to young, technology-oriented start-up
businesses.
PAGE 129
BBA(FIA)
Notes (a) Private Equity

(b) Angel Investor
(c) Venture Capital
4. Venture capital provide___.
(a) Seed financing
(b) Early-stage financing
(c) Late-stage financing
(d) All of these
6.5 Steps in Venture Financing

Portfolio companies pass through different stages in the venture capital
investment process. At every stage, a portfolio company has different
financing requirements. Some venture capital funds invest at any time,
while some invest in a particular stage a company is in. Therefore, start-
ups would go through the following rounds of financing:
Seed Round: In this round, venture capitalists provide a small
amount of capital to entrepreneurs to support their research and
development activities; and formulate business plans. In this phase,
a start-up builds a prototype or Minimum Viable Product (MVP) to
validate the feasibility and growth potential of the plan/idea. Own
funds, funding from family and friends and angel investors, who
have faith in the start-up’s potential, are the source of financing.
Early Stage: Once the idea is viable and founders ramp up their
businesses, they raise the first round of funding, Series A. In this
stage, start-ups reach out to venture capital firms for early-stage
funding. Venture capital firms undertake comprehensive due diligence
to assess business potential, propose investment terms and finalise
the agreement. Once all parties agree to the terms, the venture
capital firm invests in the start-up. As they reach the first growth
stage and need additional capital to scale up their operations, start-
ups raise Series B and C funding rounds.
130 PAGE
Notes
Figure 6.3: Steps in Venture Financing

(Source: https://carocked.wordpress.com/2016/06/26/fundraising-stages-for-startup/)
Late Stage: When the start-up grows, becomes mature and demonstrates
a profitable outlook, it may prepare for an Initial Public Offering
(IPO) or a strategic merger and acquisition. The start-up may require
large funds known as Series C, D or E to fuel further expansion.
At this stage, private equity firms and hedge funds become more
involved than venture capital firms. The process of raising funds is
more complex in late-stage venture capital funding. The objective
of venture capital firms is to support and grow their portfolio
companies and sell them off at a profit.
Mezzanine Financing: Venture capital financing may also involve
mezzanine financing that occurs at the time of exit from the portfolio
company via IPO or acquisition. Such financing involves the use
of convertible debt or preferred equity instruments.
Exit: Lastly, the venture capital firm exits its investment from the
portfolio company by going public (selling its shares on the stock
exchange), acquiring by another company or selling its stake to
another investor or private equity firm.
Therefore, venture financing varies according to the stages of a company’s
lifecycle and funding requirements. Venture capitalists had been actively
investing in blockchain, Artificial Intelligence (AI), robotics, etc., in India
PAGE 131
BBA(FIA)
Notes in 2022. Moreover, such early-stage investments rose to more than $1.50
billion from $1.17 billion in 2021.
6.6 Incubation Financing

Incubation is the trial period in which an investment company test new
funds. In this period, the incubation fund is offered privately to select
investors (like employees and family members). The purpose is to test
some investment strategies, and if successful, the fund may offer/launch.
The strategies (new or only the best-performing). Incubation financing
refers to business incubators’ financial support offered to start-up and early-
stage businesses. Business incubators are various organisations offering
resources, mentorship, infrastructure and networking opportunities to support
start-ups. ZX Ventures, P&G Ventures, SAP.iO Venture, Rise by Barclays,
Wayra, AstraZeneca Incubator, Digital Garage, Ericsson ONE, InGenius,
Volvo Innovation Lab and so on are examples of business incubators.
Incubation financing is most important during the initial stages of the
company. Hence, it becomes imperative to understand its various aspects:
Government agencies, universities, private investors, non-profit
organisations and corporate entities may provide incubation financing
to start-ups through loans, equity investments, grants, or a combination.
As part of incubation financing, seed capital is provided to start-ups
to develop the business idea, conduct market research and validate
their business model. This way, incubation financing enhances the
chances of success for start-ups.
Support services like mentorship/guidance in business planning, access
to co-working spaces and market research and industry expertise,
legal support services, networking opportunities, and access to
potential customers and investors are provided by business incubators
to start-ups.
Business incubators provide support and guidance to start-ups from
a few months to a few years. They also organise events, workshops
and networking sessions for collaboration among early-stage ventures.
In exchange for providing funds and other support services, an
incubator may take up an equity stake in the start-ups.
132 PAGE
Even after graduating from the incubation program, a start-up may Notes
continue to receive support from the incubator(s) through networking,
access to potential investors, and so on.
Incubation Scheme
Incubation Scheme, launched by Ministry of Micro, Small &
Medium Enterprises (MSMEs), Government of India, provides
opportunity to the entrepreneurs to develop and nurture their
innovative ideas to produce for the new innovative products/
services.
A financial assistance of 75% to 85% of the project cost up to
maximum of 8 lakh, is offered by Government of India.
The scheme is open to IITs, NITs, Engineering Colleges approved
by AICTE, Central/State Universities recognized by UGC, and
recognized R&D/Technical Institutes/Centres, other Development
Institutes, etc.
Incubators like Amity Innovation Incubator, Centre for Innovation Incubation

and Entrepreneurship established by Indian Institute of Management
Ahmedabad; Start-up Village sponsored by the Department of Science
and Technology, the Government of India, Technopark Trivandrum, and
MobME Wireless; IAN Incubator established by the National Science and
Technology Entrepreneurship Development Board (NSTEDB), Department
of Science & Technology (DST), Government of India; Srijan Capital;
Indavest; iCreate-a project of the Gujarat Foundation of Entrepreneurial
Excellence (GFEE); Khosla Labs and many more have boosted the start-up
ecosystem in India. Incubation financing is crucial, especially in the initial
stages of the growth and development of a start-up. With guidance, support,
expertise and networking, incubation financing increases the chances of
success and reduces the possibility of failure for early-stage ventures.
IN-TEXT QUESTION
5. Incubation financing ______.
(a) Provide business support services
(b) Is part of seed financing
(c) Provided in the form of equity, grants or loans
(d) All of these
PAGE 133
BBA(FIA)
Notes
6.7 Summary
For entrepreneurs, Venture Capital (VC) is a critical funding source
in the initial stages. It provides financial support to young, high-
risk and technology focussed firms.
In India, venture capital has emerged as a significant and vibrant
source of finance for start-ups. The VC segment in the Indian market
has witnessed remarkable growth over the past years.
During 2021-22, India celebrated the addition of its 100th unicorn
while outpacing China (11) in terms of the number of unicorns
added in the country (23) (Seth et al., 2023).
With the entry of institutional investors like pension funds, large
corporations and endowments, and the establishment of professional
firms managing VC investments, the industry witnessed the emergence
of technology giants like Apple, Microsoft and Intel.
Development Financial Institutions (DFIs) were venture capitalists
until the 1980s when the Indian government gave legal status to
venture capital transactions in the country.
Technology Development and Information Company of India Ltd.
(TDICI), a joint venture of ICICI and UTI, was among the first
organisation to offer venture capital services in our country.
Liberalisation, policy reforms, and regulatory frameworks introduced
in the 1990s brought significant changes to the venture capital
landscape in India.
The average deal size rose from US$ 6.7 million in 2012 to US$
14.7 million in 2019. Government initiatives like Start-up India
launched in 2016 aimed at promoting entrepreneurship, simplifying
regulatory compliance and providing access to funds.
The venture investment process varies according to the nature of
the investment, start-up company and various other circumstances
of each deal.
Portfolio companies pass through different stages in the venture
capital investment process. At every stage, a portfolio company has
different financing requirements. Some venture capital funds invest
134 PAGE
at any time, while some invest in a particular stage a company is Notes

in, like seed, early and late stage.
Incubation is the trial period in which an investment company test
new funds.
Business incubators are various organisations offering resources,
mentorship, infrastructure and networking opportunities to support
start-ups.
1. (b) Limited partnerships

2. (d) All of these
3. (c) Venture Capital
4. (d) All of these
5. (a) Provide business support services

1. “Venture capital, a form of private equity, provides funding to start-
ups and early-stage emerging companies having very little or no
operating history with significant growth potential.” Elaborate.
2. Discuss how the venture capital landscape has evolved over time in
India and across the globe.
3. Explain the venture capital investment process in detail.
4. Discuss the various steps in venture capital financing.
5. What do you understand by incubation financing? Describe its
features.
6.10 References
Baldrige, Rebecca, Curry, Benjamin. 2023. Understanding Venture
Capital. (2023, June). Forbes. https://www.forbes.com/advisor/
investing/venture-capital/.
PAGE 135
BBA(FIA)
Notes Kuhlor, Vanessa. What is Venture Capital. (September 2021). Silicon

Valley Bank. https://www.svb.com/startup-insights/vc-relations/what-
is-venture-capital.
Mehra, Mayank. How Venture Capital Financing Work in India. (2022,
October). Times of India. https://timesofindia.indiatimes.com/blogs/
voices/how-venture-capital-financing-work-in-india/.
Sheth, Krishnan, Deo and Talwar. India Venture Capital Report
2023. (March 2023). Bain Capital. https://www.bain.com/insights/
india-venture-capital-report-2023/Venture Capital. IGNOU. https://
egyankosh.ac.in/bitstream/123456789/6454/1/Unit-18.pdf.
Paplikar, S.R. Why businesses need Financing, and How investors
benefit. (February 2023). Times of India. https://timesofindia.
indiatimes.com/blogs/voices/why-businesses-need-financing-and-
how-investors-benefit/.
Zider, Bob. How Venture Capital Works. (1998, November-December).
Harvard Business Review. https://hbr.org/1998/11/how-venture-capital-
works.
h t t p s : / / w w w. s e b i . g o v. i n / s e b i w e b / o t h e r / O t h e r A c t i o n . d o ? d o
RecognisedFpi=yes&intmId=21.
https://msme.gov.in/incubation.
https://payu.in/blog/a-detailed-overview-of-top-10-incubators-in-india/.

Bussgang, J. (2010). Mastering the VC Game: A venture Capital
insider reveals how to get from Start-up to IPO on your terms.
Penguine Group.
Ramsinghani, M. (2014). The Business of Venture Capital: Insights
from Leading Practitioners on the Art of Raising a Fund, Deal
Structuring, Value Creation, and Exit Strategies. Wiley.
Calacanis, J. (2017). Angel: How to Invest in Technology Start-ups-
Timeless Advice from an Angel Investor who Turned $100,000 into
$100,000,000. Harper Business.
136 PAGE
Feld, B. and Mendelson, J. (2019). Venture Deals: Be Smarter than Notes

Your Lawyer and Venture Capitalist. Wiley.
Mallaby, S. (2023). The Power Law: Venture Capital and the Making
of the New Future. Penguin Books Ltd.
Klonowski, D. (2010). The venture capital investment process.
Palgrave Macmillan.
Kortum, S. and Lerner, J. (2000). Assessing the contribution of
venture capital to innovation. RAND Journal of Economics, 31(4),
674-679.
Iyer, S. V. (2020). Venture capital: A catalyst for Indian entrepreneurship.
Venture Capital, 22(3), 215-238.
https://www.oecd.org/industry/ind/28881195.pdf.
https://www.icsi.edu/media/portals/86/manorama/Venture%20Capital%20
SSIM%20BOOK.pdf.
PAGE 137
L E S S O N
7
Credit Ratings
Monika Saini
Assistant Professor
PGDAV College (M)
Email-Id: monika.saini@pgdav.du.ac.in
STRUCTURE
7.2 Introduction
7.3 Types of Credit Rating
7.4 Advantages of Credit Rating
7.5 Disadvantages of Credit Rating
7.6 Credit Rating Agencies
7.7 Methodology of Credit Rating Agencies
7.8 International Credit Rating Practices
7.9 Credit Rating Agencies in India
7.10 Provisions Governing Credit Ratings
7.11 Summary
7.14 References

To understand Credit Ratings.
To learn about merits and demerits of credit rating.
To comprehend various types of credit rating.
138 PAGE
To know about credit rating agencies. Notes

To develop understanding of methodology of credit rating agencies.
To understand international practices of credit rating agencies.
7.2 Introduction
Credit rating’s history can be traced back to the year 1840. After the
economic crisis of 1837, Mr. Lewis Tappan started a mercantile credit
rating agency, presently known as a credit rating agency, in 1841 in New
York. These agencies are used to
assess the ability of a person to According to Reserve Bank of
meet his/her financial obligations. India (RBI), Non-Banking Finance
Companies (NBFCs) with net
Credit rating refers to a quantitative
owned funds of more than Rs. 2
assessment of an individual or
crore must get their fixed deposit
entity’s creditworthiness, which
programmers rated. The minimum
indicates their ability to fulfil
rating required by the NBFCs to be
financial obligations and repay
eligible to raise fixed deposits are
borrowed money. Credit ratings are
FA (-) from CRISIL/ MA (-) from
assigned by credit rating agencies
ICRA/BBB from CARE. Similar
(like Standard & Poor’s, Moody’s,
regulations have been issued by
or Fitch). The assessment is based
National Housing Bank (NHB)
on an evaluation of various factors,
for housing finance companies.
including financial history, income,
debt levels, payment history, and
other relevant information. Credit ratings are typically represented by a
letter grade or a combination of letters and symbols. The exact rating
s c a l e m a y v ary am ong
different rating agencies.
However, generally, higher As per the regulations of the
ratings indicate lower credit Ministry of Petroleum, the parallel
risk and a greater likelihood marketers of Liquefied Petroleum
of timely repayment, while Gas (LPG) and Superior Kerosene
lower ratings suggest higher Oil (SKO) in India are also
credit risk and a higher subjected to mandatory rating.
possibility of default. For
example, on Standard &
PAGE 139
BBA(FIA)
Notes Poor’s rating scale, AAA is the highest, indicating a shallow credit risk.
At the same time, ratings such as BB or lower indicate higher credit risk
or speculative-grade (also known as junk) ratings.
Credit ratings are used by lenders, investors, and other financial
institutions to assess the creditworthiness of individuals, corporations,
and even countries. A higher credit rating can lead to easier access to
credit, lower interest rates on loans, and better terms for borrowing. In
comparison, a lower credit rating may result in limited access to credit
or higher borrowing costs. It’s important to note that credit ratings are
not static and can change over time based on an individual or entity’s
financial behaviour and economic conditions. Monitoring and managing
one’s credit are crucial to maintaining a favourable credit rating.
7.3 Types of Credit Rating

Different types of credit ratings are used to assess the creditworthiness
of various entities. Here are some common types of credit ratings:
1. Individual Credit Rating: This type of credit rating is assigned to
individuals and is commonly known as a personal credit score. It
assesses an individual’s creditworthiness and is used by lenders to
determine their ability to repay loans and manage credit responsibly.
Examples of individual credit ratings include FICO scores and
VantageScore.
2. Corporate Credit Rating: Corporate credit ratings are assigned
to businesses and organizations to evaluate their creditworthiness.
These ratings help investors and lenders assess the risk of providing
credit or investing in a particular company. Credit rating agencies
analyze the financial health, debt levels, profitability, and other
relevant factors to assign a corporate credit rating.
3. Sovereign Credit Rating: Sovereign credit ratings assess national
governments’ creditworthiness and ability to meet financial obligations.
These ratings are crucial for governments seeking to issue bonds
or borrow from international markets. Sovereign credit ratings are
based on economic stability, political climate, debt levels, and fiscal
policies.
140 PAGE
4. Municipal Credit Rating: Municipal credit ratings apply to cities, Notes

towns, and other local government entities. These ratings assess
municipalities’ creditworthiness and ability to meet financial obligations
when issuing bonds or seeking funding from the capital markets.
In municipal credit ratings, economic strength, tax base, budget
management, and debt levels are considered.
5. Structured Finance Credit Rating: Structured finance credit ratings
apply to complex financial instruments or securities typically backed
by a pool of assets, such as Mortgage-Backed Securities (MBS) or
Collateralized Debt Obligations (CDOs). These ratings assess the
credit risk of these structured products and help investors evaluate
their investment choices.
7.4 Advantages of Credit Rating
The Finance Ministry representatives convened with Moody’s Investors

Service in New Delhi, with the aim of applying pressure to improve the
sovereign rating. Leading the delegation was V. Anantha Nageswaran,
the Chief Economic Adviser.
According to senior government officials, a decision on India’s rating
upgrade by Moody’s will be made during an internal meeting in August.
The discussions during the meetings revolved around India’s ongoing
economic reforms, particularly its focus on infrastructure development, the
significant foreign exchange reserves nearing $600 billion, well-managed
inflation, and other favourable macroeconomic trends. Moreover, officials
engaged with Moody’s on topics such as borrowing, state budgets, and
disinvestment objectives.
- June 19, 2023
Advantages and disadvantage of credit rating:
1. Easy Access to Credit: A good credit rating makes it easier for
individuals or entities to access credit facilities such as loans,
mortgages, and credit cards. Lenders are more likely to offer
borrowers with higher credit ratings favourable terms and lower
interest rates.
PAGE 141
BBA(FIA)
Notes 2. Lower Borrowing Costs: A higher credit rating often translates into
lower loan interest rates. This can result in significant savings over
the life of a loan, reducing the overall cost of borrowing.
3. Enhanced Borrowing Capacity: Individuals or entities can qualify
for higher credit limits with a higher credit rating. This provides
more financial flexibility and the ability to take advantage of
opportunities requiring larger financing.
4. Increased Trust and Credibility: A good credit rating helps build
trust and credibility with lenders, suppliers, and other business
partners. It demonstrates a history of responsible financial behaviour
and increases the likelihood of being approved for credit or entering
favourable business relationships.
5. Safeguard against Bankruptcy: An instrument with a high credit
rating gives the investors assurance of safety and security, and
thereby they have minimum risk of bankruptcy.
6. Investment Choice: Investors can choose from a variety of instruments
which are rated. A person can choose an instrument based on his
risk appetite.
7.5 Disadvantages of Credit Rating

1. Limited Access to Credit: Individuals or entities with poor or low
credit ratings may need help to obtain credit. Lenders may hesitate
to extend credit or require higher interest rates and stricter terms
to compensate for the perceived higher risk.
2. Higher Borrowing Costs: A lower credit rating typically results in
higher interest rates and loan fees. Borrowers with lower credit
ratings may have to pay more interest, making borrowing more
expensive.
3. Negative Impact on Financial Opportunities: A poor credit rating
can limit financial opportunities, such as obtaining a mortgage,
starting a business, or making significant purchases. It may also
affect the ability to secure rental housing, utilities, or insurance
policies.
142 PAGE
4. Potential for Negative Credit Cycle: A negative credit rating can Notes
create a cycle where it becomes more difficult to improve one’s
credit. Limited access to credit and higher borrowing costs can
make it challenging to meet financial obligations and rebuild
creditworthiness.
5. Rating is not a Guarantee: Rating cannot be taken as a certificate
for the company’s or its management’s soundness. Users should
research other aspects as well before investing in any company.
6. Human Bias: Ratings might be affected by the personal human bias
of the rating staff.
IN-TEXT QUESTIONS
1. Which of the following best defines a credit rating?
(a) The interest rate charged by a lender on a loan
(b) A measure of an individual’s credit card debt
(c) An assessment of the creditworthiness of a borrower
(d) The duration of time it takes to repay a debt
2. Which type of credit rating indicates a higher risk of default?
(a) AAA
(b) BBB
(c) A
(d) D
7.6 Credit Rating Agencies

1. Standard & Poor’s (S&P): S&P Global Ratings is among the largest
and most well-known credit rating agencies. It provides credit
ratings for individuals, corporations, municipalities, and sovereign
entities worldwide. S&P uses letter grades, such as AAA, AA, A,
BBB, etc., to indicate creditworthiness.
2. Moody’s Investors Service: Moody’s is another major credit rating
agency that assesses the credit risk of various entities. It assigns
PAGE 143
BBA(FIA)
Notes credit ratings using a combination of letters and numbers, such as

AAA, AA, A, BAA, etc. Investors and financial institutions widely
use Moody’s ratings.
3. Fitch Ratings: Fitch Ratings is a global credit rating agency that
provides credit ratings for various entities, including corporations,
governments, and structured finance products. Fitch uses letter grades,
such as AAA, AA, A, BBB, etc., to represent creditworthiness.
4. A.M. Best Company: A.M. Best specializes in providing credit
ratings for the insurance industry. It assesses insurance companies’
financial strength and creditworthiness, allowing policyholders and
investors to make informed decisions.
5. DBRS Morningstar: DBRS Morningstar is a credit rating agency
that provides ratings for various entities, including corporate issuers,
financial institutions, and structured finance products. It uses letter
grades, such as AAA, AA, A, BBB, etc., to denote creditworthiness.
6. Japan Credit Rating Agency (JCR): JCR is a leading credit
rating agency based in Japan. It provides credit ratings for various
entities, including corporations, banks, municipalities, and sovereign
governments.
7.7 Methodology of Credit Rating Agencies

Credit rating agencies use specific methodologies to assess the creditworthiness
of entities and assign credit ratings. While the exact methodologies may
differ among agencies, here are some common factors and considerations
they typically take into account:
1. Financial Analysis: Credit rating agencies analyze an entity’s
financial statements, including income statements, balance sheets,
and cash flow statements, to assess its financial health. They evaluate
profitability, debt levels, liquidity, and asset quality.
2. Industry and Competitive Analysis: Agencies consider the industry
in which the entity operates and evaluate its competitive position.
Factors like market dynamics, competition, regulatory environment,
144 PAGE
and technological advancements are considered to understand the Notes

entity’s ability to generate cash flows and meet financial obligations.
3. Management and Governance: The quality of management and
corporate governance practices is crucial in credit ratings. Agencies
assess the entity’s leadership, management expertise, strategic
decision-making, risk management processes, and adherence to
corporate governance standards.
4. Economic Analysis: Credit rating agencies consider the economic
environment in which the entity operates domestically and globally.
Economic growth, inflation, interest rates, and political stability
are evaluated to gauge the entity’s ability to withstand economic
fluctuations and repay debts.
5. Debt Structure and Coverage: Agencies assess the entity’s debt
structure, including the types of debt instruments and their terms.
They evaluate the entity’s ability to generate sufficient cash flows
to cover interest payments and principal repayments.
6. Cash Flow and Financial Projections: Credit rating agencies analyze
historical and projected cash flows to assess the entity’s ability to
generate consistent revenue and meet financial obligations. Cash
flow stability and predictability are important factors in determining
creditworthiness.
7. Credit History and Payment Patterns: Agencies consider the
entity’s credit history, including past repayment patterns, defaults,
and any history of delinquency. A track record of timely payments
and responsible credit management positively impacts credit ratings.
8. External Factors: Credit rating agencies also consider external factors
such as legal and regulatory risks, environmental considerations,
geopolitical factors, and market conditions that could impact the
entity’s creditworthiness.
7.8 International Credit Rating Practices

International credit rating practices generally involve assessing the
creditworthiness of entities across different countries. While the fundamental
PAGE 145
BBA(FIA)
Notes principles of credit rating remain consistent, some key considerations and
practices are specific to international credit rating. Here are a few aspects:
1. Country Risk Assessment: International credit rating evaluates the
credit risk associated with sovereign entities or governments. Credit
rating agencies analyze factors such as political stability, economic
policies, fiscal discipline, external debt levels, and institutional
frameworks to assess a country’s creditworthiness.
2. Local Market Analysis: Credit rating agencies consider local markets’
specific dynamics and risks. They consider factors like currency
stability, exchange rate risks, legal and regulatory frameworks, and
local market conditions that can impact an entity’s ability to meet
its financial obligations.
3. Cross-Border Risk Assessment: International credit rating includes
evaluating entities that operate across borders. Credit rating agencies
assess factors such as currency risk, geopolitical risks, regulatory
environments, and the ability to manage cross-border operations
and transactions.
4. Comparative Analysis: Credit rating agencies often conduct com-
parative analyses across countries or regions. They assess credit-
worthiness relative to other countries or peers in the same region
to provide a broader perspective on credit risk.
5. Country-Specific Factors: International credit rating incorporates
country-specific factors into the assessment. These factors may
include social and environmental risks, governance frameworks,
legal systems, and unique economic characteristics relevant to the
creditworthiness of entities within that country.
6. Global Economic Conditions: International credit rating considers
global economic conditions and their potential impact on credit risk.
Factors such as economic interdependencies, global market volatility,
and international financial flows are considered when assessing the
creditworthiness of entities operating in a global context.
7. Multilateral Agencies and International Institutions: Credit rating
agencies may also consider the support or backing provided by
146 PAGE
multilateral agencies and international financial institutions, such Notes

as the International Monetary Fund (IMF) or the World Bank when
assessing the creditworthiness of sovereign entities.
7.9 Credit Rating Agencies in India

1. Credit Rating Information Services of India Limited (CRISIL): CRISIL
is one of India’s leading credit rating agencies and is a subsidiary
of S&P Global. It provides credit ratings for various entities and
instruments, including corporate issuers, banks, financial institutions,
commercial papers, bonds, and structured finance products.
2. ICRA Limited: ICRA is a credit rating agency established by Moody’s
Investors Service and several Indian financial institutions. It offers
credit ratings for various entities, including corporations, banks,
Non-Banking Financial Companies (NBFCs), and Public Sector
Undertakings (PSUs).
3. India Ratings and Research (Ind-Ra): Ind-Ra is a subsidiary of
Fitch Ratings and provides credit ratings and research services in
India. It offers credit ratings for various sectors, including corporate
issuers, banks, NBFCs, public finance, and structured finance.
4. CARE Ratings: CARE Ratings is one of India’s leading credit rating
agencies. It provides credit ratings for various entities, including
corporate issuers, banks, NBFCs, infrastructure projects, state
governments, and municipal corporations.
5. Brickwork Ratings India Private Limited: Brickwork Ratings is a
credit rating agency based in India. It offers credit ratings for entities
such as corporate issuers, SMEs (Small and Medium Enterprises),
banks, NBFCs, and state governments.
6. India Credit Rating Agency (ICRA): ICRA is an independent credit
rating agency in India. It provides credit ratings for various entities,
including corporate issuers, banks, NBFCs, public sector units, and
infrastructure projects.
PAGE 147
BBA(FIA)
Notes
Figure 7.1: Credit Rating Process
7.10 Provisions Governing Credit Ratings

The provisions and rules governing credit rating and credit rating agencies
vary across different jurisdictions. Here are some examples of applicable
provisions and rules related to credit rating and credit rating agencies:
Table 7.1: Provisions applicable to CRA in various countries
Country Regulatory Regulation
Body
USA Securities Securities Exchange Act of 1934: This act establishes the
and regulatory framework for credit rating agencies operating
Exchange in the United States.
Commission Rule 17g-5: Requires credit rating agencies to provide
(SEC): disclosure of certain credit rating information to the
SEC and to make the ratings publicly available.
EU European Regulation (EC) No. 1060/2009: Establishes a framework
Securities for the supervision of credit rating agencies in the
and Markets European Union.
Authority Regulation (EU) 2016/679: Contains provisions related to
(ESMA): the protection of personal data in the context of credit
rating activities.
148 PAGE
Country Regulatory Regulation Notes

Body
INDIA Securities SEBI (Credit Rating Agencies) Regulations, 1999: Provides
and guidelines and regulations for credit rating agencies
Exchange operating in India.
Board SEBI (Listing Obligations and Disclosure Requirements)
of India Regulations, 2015: Contains provisions related to credit
(SEBI): rating requirements for listed companies in India.
UK Financial FCA Handbook: Contains rules and guidance for credit
Conduct rating agencies operating in the United Kingdom, including
Authority the Conduct of Business Sourcebook (COBS) and
(FCA): the Prudential Sourcebook for Credit Rating Agencies
(CREDS).
Regulations of Credit Rating Agencies in India
The Securities and Exchange Board of India (SEBI) has established
regulations and guidelines for credit rating agencies operating in India. The
SEBI (Credit Rating Agencies) Regulations, 1999, along with subsequent
amendments and circulars, govern the country’s functioning and conduct
of credit rating agencies. Here are some key provisions and rules under
the SEBI regulations:
1. Registration and Eligibility:
Credit rating agencies must obtain registration from SEBI to operate
in India.
They must meet the eligibility criteria prescribed by SEBI, including
minimum net worth requirements, infrastructure, and personnel
qualifications.
2. Code of Conduct:
Credit rating agencies are required to adhere to a code of conduct
prescribed by SEBI.
They must maintain independence, objectivity, and integrity in their
rating activities.
They should avoid conflicts of interest and ensure their ratings are
free from undue influence.
3. Rating Process and Methodology:
Credit rating agencies must have a well-defined and transparent rating
process and methodology.
PAGE 149
BBA(FIA)
Notes They should disclose their methodologies, models, and key rating
assumptions.
They must periodically review and update their rating methodologies
to align with market practices and changing circumstances.
4. Disclosure and Transparency:
Credit rating agencies must disclose key information about their
ratings, including the meaning and limitations of the rating symbols
used.
They must disclose any material conflicts of interest that may
influence their rating decisions.
They should provide timely and accurate information and maintain
a public ratings database.
5. Compliance and Reporting:
Credit rating agencies must comply with various reporting requirements
specified by SEBI.
They are required to submit periodic reports and information to
SEBI, including details of rating actions, rating migration, and
compliance with the regulations.
6. Investor Grievance Redressal:
Credit rating agencies must establish a robust mechanism for addressing
investor complaints and grievances.
They should maintain proper records of complaints and take necessary
steps to resolve them promptly.
Prakash, Ayachit and Garg (2017) pointed out that the underlying
causes of conflict of interest are the “issuer pays” model and long-term
relationships. They said that SEBI should introduce rotation in employees
of CRA, and analysis of CRAs should be done in a phased manner.
CRA regulations should be amended to make changes in CRA’s payment
methods, and the exchange pays model can be adopted.
SEBI should develop a mechanism where CRAs can be held liable for
loss to investors due to negligence of rating agencies by compensations
to the investors.
150 PAGE
IN-TEXT QUESTIONS Notes
3. What is the role of credit rating agencies?

(a) Setting interest rates for loans
(b) Evaluating the creditworthiness of borrowers
(c) Determining the maturity of a debt instrument
(d) Issuing government regulations on lending practices
4. What is an investment-grade credit rating?
(a) A rating that indicates a high credit risk
(b) A rating that indicates a low credit risk
(c) A rating assigned to government debt only
(d) A rating based on the borrower’s income level
5. What does a rating outlook indicate?
(a) The potential for an upgrade or downgrade in a credit
rating
(b) The time it takes for a borrower to repay a debt
(c) The overall financial health of a company
(d) The market value of a bond
7.11 Summary
Credit rating is an essential tool used to assess the creditworthiness
of individuals, companies, or financial instruments. It indicates the
likelihood of timely repayment of debts and helps investors and
lenders make informed decisions. Credit rating agencies are crucial
in assigning ratings based on various factors.
The factors influencing credit ratings include financial health
indicators such as financial statements, liquidity, and profitability.
Qualitative factors like business risk, industry conditions, and
management quality are also considered-additionally, external factors
like economic conditions and regulatory environment impact credit
ratings.
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BBA(FIA)
Notes Credit rating agencies employ specific methodologies to assign

ratings, which involve data collection, analysis, and rating committee
decisions. However, these methodologies have their limitations and
challenges. Investors rely on credit ratings to evaluate risk and
make investment decisions, while borrowers’ credit ratings affect
their borrowing costs and access to capital.
The regulatory framework for credit rating agencies ensures their
accountability and accuracy. However, credit rating agencies have
faced criticism and controversies due to conflicts of interest
and potential biases. These agencies have also been associated
with financial crises, raising concerns about their role in market
stability.
Looking ahead, technological advancements and data-driven credit
assessments are emerging as alternatives to traditional credit rating
agencies. Understanding credit ratings is crucial for investors,
borrowers, and financial markets, and further research in this field is
encouraged to navigate the complexities of credit ratings effectively.
1. (c) An assessment of the creditworthiness of a borrower

2. (d) D
3. (b) Evaluating the creditworthiness of borrowers
4. (b) A rating that indicates a low credit risk
5. (a) The potential for an upgrade or downgrade in a credit rating

1. What are the benefits and Limitations of Credit rating?
2. What is credit rating agency?
3. What are the methodologies for giving ratings?
4. What are the various types of credit rating agencies?
5. Explain the regulation of credit rating agencies in India?
6. What are the various international credit rating agencies?
152 PAGE
Notes
7.14 References
A Credit Rating is an Informed Opinion. (n.d.). Retrieved 2023, from
S & P Global: https://www.spglobal.com/ratings/en/about/intro-to-
credit-ratings.
Finance, M. O. (2009). Report of the Committee on Comprehensive
Regulation for Credit Rating Agencies. Delhi: Capital Markets
Division.
Sharma, T.J. (2008). CREDIT RATING AGENCIES IN INDIA: A
CASE OF AUTHORITY WITHOUT RESPONSIBILITY. Company
Law Journal, 89-109.
Shreya Prakash, A.A. (July 2017). REGULATION OF CREDIT RATING
AGENCIES IN INDIA. Vidhi, Centre for Legal Policy.
Varma, V.R. (1993). When AAA Means B : The State of Credit Rating
in India. Indian Institute of Management Ahmedabad, Research and
Publication Department.
White, L.J. (2010). Markets: The Credit Rating Agencies. Journal
of Economic Perspectives, 24(2), 211-226.

Ganguin, & Bilardello, J. (2005). Fundamentals of corporate credit
analysis. McGraw-Hill.
Kaur, K., & Kaur, R. (2013). Credit Rating Agencies in India: An
Appraisal (1st ed.). LAP LAMBERT Academic Publishing. Retrieved
from https://www.perlego.com/book/3377272/credit-rating-agencies-
in-india-an-appraisal-pdf (Original work published 2013).
Credit Analysis: A Complete Guide (Frontiers in Finance Series) by
Roger H. Hale.
Credit Professional’s Handbook by Research Credit Foundation.
Standard & Poor’s Fundamentals of Corporate Credit Analysis by
Blaise Ganguin and John Bilardello.
Credit Rating in India: Institutions, methods & Evaluation by Mamta
Arora.
SEBI (Credit Rating Agencies) Regulations and Circulars.
PAGE 153
L E S S O N
8
Securitization
Ms. Latika Bajetha
Assistant Professor
Department of Commerce
Email-Id: latika.bajetha@srcc.du.ac.in
STRUCTURE
8.2 Introduction
8.3 Features of Securitization
8.4 %HQH¿WV RI 6HFXULWL]DWLRQ
8.5 Parties Involved in Securitization
8.6 Process of Securitization
8.7 Instruments of Securitization
8.8 Types of Securities
8.9 Securitization in India
8.10 Summary
8.13 References

Understand the concept and process of securitization, including its purpose and benefits.
Explain the role and importance of credit enhancement in securitization, and identify
various techniques used for credit enhancement.
Identify and describe the key parties involved in a securitization transaction, such as
the originator, Special Purpose Vehicle (SPV), servicer, and investors.
154 PAGE
Differentiate between different instruments used in securitization, Notes

such as Asset-Backed Securities (ABS), Mortgage-Backed Securities
(MBS), and Collateralized Debt Obligations (CDOs).
Classify and describe the types of securities created through securitization,
including pass-through securities, pay-through securities, and structured
securities.
Gain insight into the securitization market in India, including its
development, regulatory framework and potential challenges.
Evaluate the advantages and risks associated with securitization as
a financial tool.
Analyze real-world examples of securitization transactions and their
implications for various stakeholders.
Apply the knowledge gained to assess the feasibility and suitability
of securitization for specific financial scenarios.
8.2 Introduction
Some companies or firms involved in sending money or making credit
sales must have a huge balance of receivables on their Balance Sheet.
Though they have a huge receivable, they may face a liquidity crunch to
run their business. One way may be to adopt a borrowing route, but this
results in changing the company’s debt-equity ratio, which may not only
be acceptable to some stakeholders but also put companies at financial
risk, which affects the future borrowings by the company. To overcome
this problem, the term ‘securitization’ was coined.
Concept and Definition
Securitization is a procedure that usually entails aggregating illiquid
financial assets, like receivables or loans, and transforming them into
marketable securities. In simpler terms, it involves repackaging or bundling
illiquid assets into securities easily traded in the market. Examples of these
assets may include automobile loans, credit card receivables, residential
mortgages, or any other type of future receivables.
PAGE 155
BBA(FIA)
Notes 8.3 Features of Securitization

1. Creation of Financial Instruments: Securitisation involves creating
additional financial instruments or securities in the market. These
instruments are typically backed by collateral, such as a pool of
assets like receivables or loans. These illiquid assets are transformed
through securitisation into marketable securities that can be bought
and sold in the financial markets.
2. Bundling and Unbundling: When assets are combined into a single
pool, it is known as bundling. This aggregation of assets allows for
diversification and creates a larger pool of collateral to support the
securities created. On the other hand, unbundling refers to breaking
down the bundled assets into instruments of fixed denominations.
This process lets investors choose specific tranches or portions of
the securitised assets that align with their risk and return preferences.
3. Tool of Risk Management: Securitisation can act as a risk management
tool, particularly when assets are securitised on a non-recourse
basis. Non-recourse securitisation means that the risk of default is
shifted away from the originator of the assets (such as a bank or
lender) to the investors who purchase the securitised instruments. By
transferring the default risk to investors, the originator can reduce
its exposure to potential losses and manage its overall risk profile.
4. Structured Finance: The securitisation process falls under the realm of
structured finance. Structured finance involves designing and tailoring
financial instruments to meet specific risk-return preferences and
requirements. In securitisation, the securities created are structured
to align with the risk and return profile desired by investors. This
customisation allows investors to choose investments that suit their
investment objectives.
5. Trenching: Securitisation involves splitting the portfolio of different
receivables, loans, or assets into several parts, known as tranches.
Each tranche represents a distinct level of risk and return. Tranches
are created based on the underlying characteristics and performance
of the assets. Investors can then select the tranche that matches their
156 PAGE
risk appetite and return expectations. Higher tranches typically have Notes
lower risk but lower returns, while lower tranches carry higher risk
but potentially higher returns.
6. Homogeneity: Within each tranche, the securities issued are
homogenous. This means the securities within a tranche share similar
characteristics, such as credit quality, maturity or interest rate.
Additionally, securitised instruments are designed to be accessible
to small investors who may not have large sums of capital to invest.
This allows smaller investors to participate in the securitisation
market by investing smaller amounts in specific tranches that suit
their investment capacity.
Securitisation in India mainly takes the form of a trust structure, wherein
the underlying assets are sold to a trustee company, which holds the
security in trust for investors. In this case, the trustee company is a
Special Purpose Vehicle (SPV), which issues securities in the form of
pass-through or Pay-Through Certificates (PTCs). The trustee is the legal
owner of the underlying assets. Investors holding the PTCs are entitled
to the beneficial interest in the trustee’s underlying assets.
IN-TEXT QUESTIONS
1. Which of the following best describes the concept of securitization?
(a) Converting illiquid financial assets into marketable securities
(b) Transforming equity into debt instruments
(c) Creating additional collateral for borrowing purposes
(d) Bundling different types of securities for diversification
2. In the context of securitization, what role does the Special
Purpose Vehicle (SPV) play in India?
(a) Acting as a trustee for the underlying assets
(b) Purchasing securities from investors
(c) Providing credit enhancement for securitized assets
(d) Bundling and unbundling illiquid assets for marketability
PAGE 157
BBA(FIA)
Notes 8.4 Benefits of Securitization

1. From the angle of the originator
Securitisation offers several advantages to the originator (the entity that
sells assets collectively to a Special Purpose Vehicle):
(a) Off–Balance Sheet Financing: The securitisation process frees up
capital that would otherwise be tied up in the loans or receivables.
This leads to improved liquidity for the originator, as it can utilise
the released capital for expanding its business. By moving the
assets off the balance sheet, the originator can enhance its financial
flexibility and strengthen its overall liquidity position.
(b) Enhanced focus on core business: Through securitisation, the entity
can redirect its attention and resources towards its core business
activities. Transferring the assets to a Special Purpose Vehicle (SPV)
relieves the entity of servicing the loans or receivables. This allows
the originator to concentrate on its primary operations while the
SPV handles the ongoing management and collection of securitised
assets. In the case of a non-recourse arrangement, the default burden
is also shifted away from the originator, further freeing up their
resources and reducing potential risks.
(c) Improved financial ratios: For financial institutions and banks,
securitisation can effectively manage capital-to-weighted asset
ratios. The originator can reduce the overall amount of assets on
its balance sheet by securitising assets, such as loans. This asset
reduction, combined with the corresponding decrease in liabilities,
can help improve key financial ratios and metrics, enabling the
entity to meet regulatory requirements and demonstrate a stronger
financial position.
(d) Reduced borrowing costs: Securitised papers, due to credit enhancement
and the assigned credit ratings, often carry a lower risk profile
than other debt forms. As a result, these securities can be issued
at reduced interest rates, allowing the originator to benefit from
lower borrowing costs. The difference between the interest earned
from the securitised assets and the reduced interest paid on the
securitised papers creates a spread, contributing to the reduced
158 PAGE
cost of borrowings for the originator. This can lead to increased Notes
profitability and financial efficiency for the entity.
2. From the angle of the investor
Investors in securitised securities can enjoy several benefits, which are
as follows:
(a) Risk Diversification: Investing in securities backed by various
types of assets allows for portfolio diversification, thereby reducing
overall risk. By purchasing securities tied to different asset classes,
investors can spread their risk across various industries or sectors,
mitigating the impact of any potential defaults or fluctuations in
specific markets.
(b) Regulatory Compliance: Investing in asset-backed securities that
belong to a specific industry, such as micro-industries, can help banks
and financial institutions meet regulatory requirements regarding
industry-specific fund allocation. By investing in these targeted
assets, investors can fulfil regulatory obligations while benefiting
from the specific characteristics of the chosen industry.
(c) Protection Against Default: In the case of recourse arrangements,
if a third-party defaults on their payment obligations, the originator
of the securitised assets is responsible for covering the least loss.
Additionally, there can be insurance arrangements in place to provide
compensation for any defaults that may occur. This offers investors
protection against potential losses arising from default events.
IN-TEXT QUESTIONS
3. From the angle of originator, which of the following is an
advantage of securitization?
(a) Reduced focus on core business activities
(b) Increased borrowing costs
(c) Off-Balance Sheet Financing
(d) Worsened financial ratios
4. From the angle of investors, what benefit does securitization
provide in terms of risk management?
(a) Regulatory compliance
PAGE 159
BBA(FIA)
Notes (b) Increased exposure to specific industries

(c) Limited protection against default
(d) Risk Diversification
8.5 Parties Involved in Securitization

1. Primary Participants
The primary participants in the securitization process include the following:
(a) Originator/Securitizer: The originator, also known as the securitizer,
is the entity that initiates the securitization deal. It sells the assets
held on its books and receives funds generated from selling them.
The originator transfers the assets’ legal and beneficial interest to
the Special Purpose Vehicle (SPV), which is discussed below.
(b) Special Purpose Vehicle (SPV): The SPV, also called the issuer, is
created specifically to execute the securitization deal. It holds the
legal title to the assets transferred by the originator. The SPV is
typically structured as a separate entity, such as a company, firm,
society or trust. Its primary objective is to remove the securitized
assets from the originator’s balance sheet. Additionally, the SPV
plays a crucial role in the securitization process by making an
upfront payment to the originator and issuing the securities (referred
to as Asset-Based Securities or Mortgage-Based Securities) to the
investors.
(c) Investors: Investors are the purchasers of securitized papers, including
individuals and institutional investors such as mutual funds, provident
funds, insurance companies and financial institutions. By acquiring a
stake in the total pool of assets or receivables, investors receive their
investment returns in the form of interest and principal payments
according to the agreed terms.
2. Secondary Participants
Apart from the primary participants, several other parties play important
roles in the securitization process:
(a) Obligors: Obligors are the main source of the securitization process.
They are the parties who owe money to the firm and are listed as
160 PAGE
assets on the originator’s balance sheet. The amount owed by the Notes
obligors is transferred to the Special Purpose Vehicle (SPV) and forms
the foundation of the securitization process. The creditworthiness of
the obligors is crucial in determining the success of the securitization.
(b) Rating Agency: Since securitization is based on pools of assets
rather than the originators themselves, it is necessary to assess the
underlying assets’ credit quality and credit support. Rating agencies
evaluate factors such as cash flow strength, mechanisms for timely
interest and principal payments, credit quality of the securities,
liquidity support, and the strength of the legal framework. While
rating agencies are secondary participants, they play a vital role in
assessing the securities’ creditworthiness.
(c) Receiving and Paying Agent (RPA)/Servicer/Administrator: The
RPA collects payments from the obligors and passes them on to the
SPV. It also follows up with defaulting borrowers and, if necessary,
initiates appropriate legal actions against them. Typically, the
originator or its affiliates act as the servicer.
(d) Agent/Trustee: Trustees are appointed to ensure that all parties
involved in the securitization deal comply with the terms of the
agreement. They primarily safeguard the interests of the investors
who acquire the securities.
(e) Credit Enhancer: Investors in securitized instruments often seek
additional security due to their direct exposure to the performance
of the underlying assets and limited or no recourse to the originator.
Credit enhancement provides this additional comfort. Originators or
third parties, such as banks, may offer credit enhancement through
over-collateralization, cash collateral, letters of credit, or surety
bonds. Credit enhancement also contributes to the marketability of
the securities.
(f) Structurer/Arranger: The structure, often an investment banker,
brings together the originator, investors, credit enhancers, and
other parties involved in the securitization deal. They ensure the
securitization deal meets all legal, regulatory, accounting, and tax
requirements, facilitating a smooth and compliant process. The
structure acts as an arranger and co-ordinates the various aspects
of the securitization transaction.
PAGE 161
BBA(FIA)
Notes IN-TEXT QUESTIONS

5. Who holds the legal title to the assets transferred by the
originator in a securitization deal?
(a) Originator/Securitizer
(b) Special Purpose Vehicle (SPV)
(c) Investors
6. Which party assesses the creditworthiness of the securities in
securitization based on factors such as cash flow strength and
credit quality of the underlying assets?
(a) Obligors
(b) Rating Agency
(c) Receiving and Paying Agent (RPA)/Servicer/Administrator
8.6 Process of Securitization

The securitisation process involves several steps, which are explained in
detail below:
1. Creation of Pool of Assets: The first step in securitisation is to
create a pool of assets. Similar types of mortgages or other assets
are grouped based on factors such as interest rate, risk, maturity and
concentration units. This pooling allows for better risk diversification
and helps in structuring the securities.
Example: A financial institution gathers a portfolio of residential
mortgages with similar interest rates, risk profiles and maturities.
2. Transfer to Special Purpose Vehicle (SPV): Once the assets are
pooled, they are transferred to a Special Purpose Vehicle (SPV). The
SPV is a separate legal entity created specifically for securitisation.
The originator sells the assets to the SPV, which now holds legal
ownership of the assets.
Example: The financial institution transfers the pool of residential
mortgages to the SPV.
3. Sale of Securitised Papers: The SPV designs and issues securities
based on the pool of assets. These securities can take various forms,
162 PAGE
such as Pass Through Securities or Pay Through Certificates. Pass- Notes

Through Securities distribute the cash flows from the underlying
assets directly to the investors. At the same time, Pay Through
Certificates divide the cash flows into different tranches with varying
levels of risk and return.
Example: The SPV creates Mortgage-Backed Securities (MBS) based
on the pool of residential mortgages. These MBS represent fractional
ownership of the mortgage payments made by homeowners.
4. Administration of Assets: The administration of the assets in the
pool is subcontracted back to the originator or a designated servicer.
The servicer collects principal and interest payments from the
underlying assets and transfers them to the SPV. The servicer acts
as a conduit between the borrowers and the investors.
Example: The financial institution that originated the residential
mortgages continues to collect the monthly mortgage payments
from homeowners and forwards them to the SPV.
5. Recourse to Originator: Securitised securities’ performance depends
on the underlying assets’ performance. In case of default or other
specified events, the cash flows or losses may be passed back to
the originator from the SPV. The level of recourse depends on the
terms of the securitisation transaction.
Example: If a homeowner defaults on their mortgage payment, the
SPV may pass the responsibility for any resulting losses back to
the financial institution that originated the mortgage.
6. Repayment of Funds: The SPV uses the cash flows generated by
the pooled assets to repay the funds raised from the issuance of
securitised securities. This includes making interest and principal
payments to the investors.
Example: The SPV uses the monthly mortgage payments collected
from homeowners to make regular interest and principal payments
to the holders of the mortgage-backed securities.
7. Credit Rating to Instruments: Before the sale of securitised
securities, credit rating agencies may assess the risk of the issuer
and assign a credit rating to the securities. This rating indicates
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BBA(FIA)
Notes the creditworthiness and risk associated with the securities, which
helps investors make informed investment decisions.
Example: A credit rating agency evaluates the mortgage-backed
securities issued by the SPV and assigns them a credit rating based
on factors such as the credit quality of the underlying mortgages,
the structure of the securities, and the level of credit enhancement
provided.
Overall, the securitisation process involves creating a pool of assets,
transferring them to an SPV, issuing securities based on the pool,
administering the assets, potentially providing recourse to the originator,
repaying funds with cash flows from the assets, and obtaining a credit
rating for the securities. This process allows for transforming illiquid
assets into marketable securities, providing benefits to both the origin.
Credit Originator/
Enhancer Servicer
Provides Credit Loan sale

Receives
Enhancement
Fund
Transfer of
Assets
Trustee S.P.V.
Principal and
Interest Minus
Servicing Fees Revenues from
Debt
Securities
Disburses
Revenues to
Investors
Investors
Figure 8.1: Process of Securitisation

IN-TEXT QUESTIONS
7. What is the purpose of creating a pool of assets in the securitization
process?
(a) Risk diversification
164 PAGE
(b) Legal ownership Notes
(c) Credit rating assignment

8. Who collects principal and interest payments from the underlying
assets and transfers them to the SPV in the securitization
process?
(a) Credit rating agency
(b) Originator
(c) Servicer
8.7 Instruments of Securitization

The securitized instruments can be categorized into three types based on
their maturity characteristics:
1. Pass-Through Certificates (PTCs): In the case of Pass-Through
Certificates, the originator (seller of the assets) transfers the entire
cash flow received as interest or principal repayment from the
securitized assets. This means that investors have a direct claim
on all the assets securitized through the Special Purpose Vehicle
(SPV). Since all cash flows are passed through to the investors,
they hold a proportional beneficial interest in the underlying assets
held in trust by the SPV. It is important to note that any principal
prepayment is also distributed proportionately among PTC holders
of the PTCs. Additionally, once all the securitized assets are fully
paid off, all the PTCs are terminated simultaneously. There may be
a skewness in the cash flows during the early stages if borrowers
repay their principal earlier than the scheduled time.
2. Pay Through Securities (PTS): To overcome the limitations of a
single maturity structure in PTCs, Pay Through Securities (PTS)
are used. In contrast to PTCs, PTS are debt securities issued by the
SPV backed by securitized assets. This allows for the creation of
different tranches with varying maturities of receivables. In other
words, the PTS structure allows for the desynchronization of the
servicing of securities issued from the cash flow generated by the
assets. It also allows the SPV to reinvest surplus funds for short-
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BBA(FIA)
Notes term purposes as needed. Unlike PTCs, where all cash flows are
immediately passed through, in PTS, cash can be used for short-term
yield in the case of early retirement of receivables. This structure
also provides the flexibility to issue multiple debt tranches with
varying maturities.
3. Stripped Securities: Stripped Securities are created by dividing
the cash flows of underlying securities into two or more new
securities. These securities are: (i) Interest Only (IO) Securities:
The holder of IO securities receives only the interest component
of the cash flows. (ii) Principal Only (PO) Securities: The holder
of PO securities receives only the principal component of the cash
flows. Since each investor receives a combination of principal and
interest, these securities can be “stripped” into separate interest and
principal portions.
It is worth noting that these securities are highly volatile and are less
preferred by investors. Investors’ perceptions influence the prices of IO
and PO securities. For example, when interest rates rise, the value of IO
securities increases as more interest is earned on borrowings. On the other
hand, if interest rates fall, borrowers tend to repay their loans, decreasing
the value of IO securities. In contrast, the price of PO securities tends
to fall when interest rates rise because borrowers prefer to postpone
payment on cheaper loans. Conversely, when interest rates fall, the value
of PO securities tends to rise as borrowers prefer to borrow fresh funds
at lower interest rates. Therefore, the prices of IO and PO securities are
mainly determined by investor perception.
IN-TEXT QUESTIONS
9. Which type of securitized instrument allows investors to have a
direct claim on all the assets securitized through the SPV?
(a) Pass Through Certificates (PTCs)
(b) Pay Through Securities (PTS)
(c) Stripped Securities
10. Which type of securitized instrument allows for the creation of
different tranches with varying maturities of receivables?
166 PAGE
(a) Pass Through Certificates (PTCs) Notes
(b) Pay Through Securities (PTS)

(c) Stripped Securities
8.8 Types of Securities

Securitization can be classified into two main types: “traditional”
securitization and “synthetic” securitization. Let us examine each type
in more detail.
In “traditional” securitization, there are two main product subsets:
1. Asset-Backed Securities (ABS): These securities have collateral
that consists of either mortgage loans (known as mortgage-backed
securities or MBS) or collections of other types of financial assets
(known as non-mortgage securities). Residential mortgages are the
most common underlying assets for MBS, but there is also a market
for Commercial Mortgage-Backed Securities (CMBS). Non-mortgage
securities can include assets like automotive loans or future returns
on assets like planes or copyrights.
2. Collateralized Debt Obligations (CDO): These securities have a
collateral pool that includes bonds, loans, other types of debt and
asset-backed securities. CDO is an umbrella term that encompasses
different types of securities, including Collateralized Bond Obligations
(CBO), Collateralized Loan Obligations (CLO), and Collateralized
Fund Obligations (CFO).
On the other hand, “synthetic” securitization refers to transactions where
banks use credit derivatives to transfer only the credit risk of the asset
pool to third parties, such as insurance companies or other banks. In
synthetic securitization, the assets are not transferred but rather the
associated credit risk. This allows investors to receive cash flows from
the security as if the Special Purpose Entity (SSPE) owned the underlying
assets. Synthetic securitization offers access to a potentially unlimited
pool of collateral while reducing costs for originators. However, during
the financial crisis, synthetic securitization revealed certain drawbacks.
Valuing these securities became more complex as they relied on the ability
of counterparties (e.g., insurers like AIG) to fulfil payment obligations.
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BBA(FIA)
Notes Additionally, multiple CDOs could reference the same underlying asset,
leading to a significant impact if that asset defaulted.
Furthermore, when an originator purchases a pool of securities previously
issued by an SSPE in earlier securitizations and securitizes them again,
it is referred to as “re-securitization.” Re-securitization can be either
traditional or synthetic, depending on the assets being securitized in the
initial securitization.
Slaughter and May, a law firm, identifies three main types of
re-securitization products:
1. CDO of ABS (where the receivables come from a pool of securities
from an ABS securitization).
2. CDO of CDO or CDO (where the receivables come from a pool of
securities from a CDO securitization).
3. CDO of ABS and CDO (where the receivables come from a mixture
of ABS and CDO securitizations).
IN-TEXT QUESTIONS
11. Which type of securitization involves the transfer of credit risk
associated with assets through the use of credit derivatives?
(a) Traditional securitization
(b) Synthetic securitization
(c) Re-securitization
12. What are the two main product subsets of “traditional”
securitization?
(a) Asset-Backed Securities (ABS) and Collateralized Debt
Obligations (CDO)
(b) Collateralized Bond Obligations (CBO) and Collateralized
Loan Obligations (CLO)
(c) Mortgage-Backed Securities (MBS) and Commercial Mortgage-
Backed Securities (CMBS)
8.9 Securitization in India

In India, securitization primarily occurs through a trust system, where
the assets are transferred to a trustee company. This trustee company,
168 PAGE
functioning as a Special-Purpose Vehicle (SPV), is responsible for holding Notes

the assets as security on behalf of the investors. The SPV issues securities
called pass-through or Pay-Through Certificates (PTCs) to raise funds.
Figure 8.2: Securitisation Structure in India

PTC=Pass-through (or pay-through) Certificate, SPV=Special-Purpose Vehicle.
Legally, the trustee company owns the underlying assets, while investors
who possess PTCs gain a beneficial stake in the assets held by the trustee.
(Figure 8.2)
Currently, the Indian market witnessed three common types of securitized
instruments. Firstly, Asset-Backed Securities (ABSs) are financial instruments
supported by receivables derived from different financial assets, such
as personal loans, vehicle loans, credit cards, and other consumer loans
(excluding housing loans). Secondly, Mortgage-Backed Securities (MBSs)
are instruments that rely on receivables stemming from housing loans.
Lastly, collateral debt securities encompass instruments backed by diverse
forms of debt, including corporate bonds or loans.
The process of arranging cash flows allows originators to customize
instruments according to investor preferences, considering risk tolerance
and duration needs. In India, the two frequently employed cash-flow
structures are:
(i) Par structure: Under this structure, investors pay an amount equal
to the principal component (par value) of future cash flows. As a
result, investors receive scheduled principal repayments from the
asset pool, along with the contracted yield (PTC), every month.
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BBA(FIA)
Notes Typically, the asset yield exceeds the PTC yield, resulting in surplus
cash flows referred to as Excess Interest Spread (EIS). For instance,
a pool of assets with a principal amount of Rs. 1 billion and a
collective yield of 10% may be sold to investors at an 8% yield.
In this scenario, investors are entitled to the principal amount of
Rs. 1 billion and an 8% yield (figure 8.2). The additional 2% yield
generated from the asset pool serves as EIS, safeguarding against
any shortfall in cash flow from the asset pool.
Assets sold at
face value:
Asset Pool: Rs1,000 million

Rs1,000 million
Investors
(Pool Yield: 10%)
Interest Contracted yield: 8%

Payments
Excess interest: 2% Originator
Source: CRISIL.
Figure 8.3: Par Structure—An Illustration

(ii) Premium structure: In this arrangement, investors receive the cash
flow from the asset pool every month. Investors pay an amount
higher than the principal component of future cash flows. The
purchase consideration is the net present value of the entire cash
flow, discounted at a predetermined rate (PTC yield). Unlike the par
structure, the premium structure does not involve an Excess Interest
Spread (EIS). For instance, let’s consider a pool of assets with a
principal amount of Rs. 1 billion and a yield of 10%. The total cash
flows from the pool would amount to Rs. 1.13 billion (figure 8.3).
In a premium structure, investors are entitled to the entire cash flow
of Rs. 1.13 billion, for which the purchase consideration might be
slightly higher than Rs. 1 billion, let’s say, Rs. 1.05 billion.
170 PAGE
Notes
Assets sold at
premium:
Rs1,053 million
Asset Pool
(Rs1,000 million
Investors
Pool Yield: 10%)
Pool Cash-flows: Premium:

Pool Cash-flows: Rs1,319 million Rs53 million
Principal + Interest
Originator
Source: CRISIL.
Figure 8.4: Premium Structure—An Illustration

(iii) Risk Tranching, a type of cash-flow tranching commonly observed
in India, entails the development of instruments with varying risk
characteristics. Senior PTCs (Pass-Through Certificates) hold the
highest priority on cash flows and are ranked based on credit
quality, ranging from highest to lowest, as well as the associated
risk level, ranging from lowest to highest. Subordinate PTCs, on
the other hand, provide support for payments of the senior tranches
but possess lower credit ratings. Please refer to Figure 8.5 for a
visual representation.
Cash flows from Senor PTCs,

securized assets rated AAA (SO)
Orginator SPV Investors

Subordinate PTCs
rated BBB (SO)
PTC = pass-through (or pay-through) certificate, SPV = special-purchase vehicle,

SO = Structured obligation. Source : CRISIL.
Figure 8.5: Risk Tranching in Securitization
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BBA(FIA)
Notes Credit enhancement plays a crucial role in securing funds and safeguarding
investors in the event of asset securitization losses. It aims to enhance
the credit quality of securitized instruments to attain the desired credit
ratings. Credit enhancement methods typically involve a combination of
internal sources, such as subordinated cash flows and Excess Interest
Spread (EIS), as well as external sources, like cash collateral and corporate
undertakings.
In addition to securitization through issuing PTCs via the SPV (special-
purpose vehicle) route, financial institutions also engage in direct assignment
transactions, directly selling pools of assets to other financial institutions
without issuing PTCs. These transactions are commonly known as direct
assignments. In direct assignments, the purchased assets are recorded
as loans on the balance sheets of acquiring institutions. However, only
lending institutions are eligible to participate in direct assignments, barring
investors like mutual funds from participating. This preference for direct
assignments is because PTCs, being investments, require mark-to-market
valuation, whereas loans and advances do not have this requirement.
Furthermore, direct assignment transactions are beneficial for banks in
meeting their Priority Sector Lending (PSL) targets. Hence, the assignees,
usually banks, offer premium pricing to originators, primarily Non-Banking
Financial Companies (NBFCs), which is not feasible for mutual funds or
other potential investor segments.
According to the regulations set by the Reserve Bank of India (RBI), direct
assignment transactions are not allowed to have credit enhancements. In
such cases, the institution purchasing the pool of assets typically adjusts
the purchase price to compensate for the absence of credit enhancement.
Securitization Trend in India
The securitization market in India has been in operation since the 1990s
and has experienced significant growth. This growth can be attributed to
repackaging retail assets and residential mortgages, focusing on the priority
sector segment. Non-Banking Financial Companies (NBFCs) and housing
finance companies play a pivotal role as originators of securitization deals
in India. On the other hand, banks emerge as the primary investors due
to their Priority Sector Lending (PSL) targets. These factors contribute
to the continued dominance of retail assets and residential mortgages in
the Indian securitization market.
172 PAGE
ABSs take the lead in the securitization market of India, with banks and Notes
NBFCs being the key players in selling their retail assets through this
process. Please refer to Figure 8.5 for further details.
ABS asset-backed security, MF = mutual fund, MHP = minimum holding period,

MRR = minimum retention requirement, RBI = Reserve Bank of India, RIDF = Rural
infrastructure Development Fund, SARFAESl = Securitization and Reconstruction
of Financial Assets and Enforcement of Security Interest, SLSD = single-loan
selldown, SPV = special-purpose vehicle.
Figure 8.6: Key Events in the Indian Securitization Market
The market has matured in the past decade since the implementation of the
Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI) Act, 2002, which provided the framework
for the creation of asset reconstruction companies specialising in the
securitisation of assets purchased from banks. The securitisation of auto
loans has dominated the market throughout its development and, in the
2000s, was supported by the emergence of residential MBSs.
However, the market has seen limited diversification among investors and
originators. The originators have typically been PSBs, foreign banks, and
NBFCs, with underlying assets mostly retail and corporate loans. The
investors have been PSBs looking to meet their PSL needs.
PAGE 173
BBA(FIA)
Notes The securitisation market is expected to grow, especially since foreign

portfolio investors can now invest in securitised debt instruments. The
option for foreign investors to invest in securitisation allows overseas
financial entities to take a share of India’s lucrative, fast-growing retail
borrowing without formally getting into the business.
In March 2018, the SEBI re-constituted its committee that suggests a
roadmap for developing the corporate bond market in the country. The
27-member committee would now be chaired by Harun R Khan, former
Deputy Governor at the Reserve Bank of India (RBI). Earlier, the panel
was headed by Shyamala Gopinath, a former Deputy Governor at RBI.
The committee -- corporate bonds and securitisation advisory -- has
representations from the government, banks, markets regulators, mutual
funds, rating agencies, stock exchanges and depositories.
The panel was set up in 2011 under the chairmanship of R.H. Patil and
is mandated to advise the regulator on developing the corporate bond
market and securitised instruments in the country. It also advises SEBI
on “implementing the recommendations of the high-level committee
on corporate bonds and securitisation”. It also suggests that SEBI on
removing regulatory hurdles under its purview and advises on issues
which need to be taken up with other regulators. One of this committee’s
major terms of reference is to advise SEBI on issues for addressing the
operational and systemic risks, if any, in the market for corporate bonds
and securitised instruments.
8.10 Summary
The chapter provides an overview of securitisation, credit enhancement,
parties involved, types of securities, and the state of securitisation in India.
Securitisation is a financial process where assets with predictable cash
flows, such as loans, are packaged into securities and sold to investors.
The concept and process of securitisation are explained, highlighting three
common instruments: Asset-Backed Securities (ABSs), Mortgage-Backed
Securities (MBSs) and collateral debt securities.
Credit enhancement is crucial in securitisation to enhance the credit
quality of securitised instruments and achieve desired credit ratings.
Various methods of credit enhancement, such as subordinated cash flows,
174 PAGE
Excess Interest Spread (EIS), cash collateral, and corporate undertakings, Notes
are discussed.
The chapter also delves into the parties involved in a securitisation
transaction, including originators, investors, Special-Purpose Vehicles
(SPVs), and asset reconstruction companies. It explains the roles and
responsibilities of each party in the securitisation process.
Different securitisation instruments are explored, focusing on Pass-Through
certificates (PTCs). The cash-flow structures of securitised instruments,
namely the par and premium structures, are explained in detail, outlining
how investors receive cash flows and the presence or absence of excess
interest spread.
The chapter then shifts its focus to securitisation in India. It highlights the
growth and maturity of the Indian securitisation market since the 1990s,
attributing it to the repackaging of retail assets and residential mortgages.
The chapter also highlights the regulatory framework and committees
involved in developing the corporate bond market and securitisation in
India, including the Securities and Exchange Board of India (SEBI) and
the Securitization and Reconstruction of Financial Assets and Enforcement
of Security Interest (SARFAESI) Act, 2002.
Overall, the chapter provides a comprehensive understanding of securitisation,
credit enhancement, parties involved, types of securities, and the securitisation
market in India.
1. (a) Converting illiquid financial assets into marketable securities

2. (a) Acting as a trustee for the underlying assets
3. (c) Off-Balance Sheet Financing
4. (d) Risk Diversification
5. (b) Special Purpose Vehicle (SPV)
6. (b) Rating Agency
7. (a) Risk diversification
8. (c) Servicer
PAGE 175
BBA(FIA)
Notes 9. (a) Pass Through Certificates (PTCs)

10. (b) Pay Through Securities (PTS)
11. (b) Synthetic securitization
12. (a) Asset-Backed Securities (ABS) and Collateralized Debt Obligations
(CDO)

1. What is the concept of securitization and how does it differ from
traditional financing methods?
2. How does credit enhancement play a role in securitization transactions?
What are some common credit enhancement techniques?
3. Who are the key parties involved in a securitization transaction and
what are their respective roles and responsibilities?
4. What are the different instruments used in securitization and how
do they function within the process?
5. Can you describe the various types of securities that can be created
through securitization?
6. How has securitization been implemented in the Indian market? What
are some key features and developments specific to securitization
in India?
7. What are the potential benefits and risks associated with securitization
as a financial tool?
8. What are some current trends and challenges in the securitization
industry, both globally and within the Indian context?
8.13 References
Baig, S., & Choudhry, M. (2013). The mechanics of securitization:
A practical guide to structuring and closing asset-backed security
transactions (Vol. 840). John Wiley & Sons.
Chincarini, L. B. (2006). Quantitative equity portfolio management:
176 PAGE
An active approach to portfolio construction and management. Notes

McGraw-Hill.
Culp, C. L. (2002). The risk management process: Business strategy
and tactics. John Wiley & Sons.
Duffie, D., & Singleton, K. J. (2004). Credit risk: Pricing, measurement
and management.
Fabozzi, F. J. (Ed.). (2016). The handbook of mortgage-backed
securities. Oxford University Press.
Fabozzi, F. J., & Mann, S. V. (2012). The handbook of fixed income
securities. McGraw-Hill Education.
Vernimmen, P., Quiry, P., & Le Fur, Y. (2022). Corporate finance:
Theory and practice. John Wiley & Sons.

“The Handbook of Asset-Backed Securities” by Jess Lederman and
Laurie S. Goodman.
“Securitization: Structuring and Investment Analysis” by Andrew
Davidson, Anthony Sanders and Lan-Ling Wolff.
“The Securitization Markets Handbook: Structures and Dynamics of
Mortgage- and Asset-Backed Securities” by Charles Austin Stone,
Anne Zissu and Jesse Beatson.
“Credit Enhancement and Leveraged Finance” by Mariarosa Verde
and Arvind Rajan.
“Structured Finance and Collateralized Debt Obligations: New
Developments in Cash and Synthetic Securitization” by Janet M.
Tavakoli.
“The Handbook of Mortgage-Backed Securities” edited by Frank J.
Fabozzi.
“Securitization in the Investment Marketplace” by Vasant Raval and
LeRoy Rooker.
“Securitization: Understanding and Managing Financial Risks” by
Gunter Meissner and Eva Weber.
PAGE 177
BBA(FIA)
Notes “Securitisation in India: Concept and Applications” by P. Lakshmi

Narayanan.
“Securitization and Reconstruction of Financial Assets and Enforcement
of Security Interest (SARFAESI) Act, 2002” by Taxmann Publications.
“Securitisation in India: Perspectives and Challenges” edited by
Rajesh Kumar and B.S. Sahay.
178 PAGE
Glossary
Acquisition: An acquisition is when one company takes over ownership and control of
another company.
AePS: ‘Aadhaar enabled payment system’ enable customer to access various banking
services.
Angel Investor: Wealthy private investors provide capital to start-ups in exchange for
convertible debt or equity ownership.
Artificial Intelligence (AI): Intelligence achieved by combining computer science and
robust datasets to provide solution to the problems.
Asset-Backed Securities (ABS): Financial instruments supported by receivables derived
from various types of financial assets, such as personal loans, vehicle loans, credit cards
and other consumer loans (excluding housing loans).
Bad Bank: It is a financial institution. It deals with the problems of Non-Performing
Assets (NPAs), or bad loan held by commercial and, release the Banks from this burden
by purchasing them below their book value.
Blockchain: A shared database which shares and stores information in blocks linked
together through cryptography.
Bundling: The process of combining assets into a single pool to create a larger pool of
collateral to support the securities created.
Business Correspondent: These are the individual or entities which can help in extending
the basic banking services especially in unbanked places.
Capital Markets Regulator: The organisation in charge of monitoring and policing the
capital markets, as well as mergers and acquisitions.
Carried Interest: A share of profit earned by the general partner in a fund. It is usually
20% of the amount earned by the investor.
CDO of ABS: Re-securitization where the receivables come from a pool of securities
from an ABS securitization.
CDO of ABS and CDO: Re-securitization where the receivables come from a mixture of
ABS and CDO securitizations.
CDO of CDO or CDO: Re-securitization where the receivables come from a pool of
securities from a CDO securitization.
PAGE 179
BBA(FIA)
Notes Central Bank Digital Currency: CBDC is the digital currency whose
main purpose is to promote financial inclusion.
Cleantech: A clean technology reduces negative impact on the environment
through sustainability, efficiency and protection initiatives.
Collateral: Assets or property that is pledged as security for a loan or
other financial obligation.
Competitiveness: The capacity of a business to outperform rivals in
terms of market share, profitability and client happiness.
Compliance: The observance of laws, rules, and business standards to
guarantee moral and lawful behaviour.
Corporate Rating: A credit rating assigned to a company or corporation,
reflecting its ability to repay debt obligations and its overall financial
strength.
Cost Synergies: When two businesses merge, there are cost savings and
operational efficiency that occur, which lower costs and boost profitability.
Credit Enhancement: Measures taken to reduce credit risk or increase the
creditworthiness of a particular debt instrument, such as collateralization,
guarantees or insurance.
Credit Rating: An assessment of the creditworthiness of an individual,
company, or financial instrument, indicating the likelihood of timely
repayment of debts.
Credit Rating Agency: A company that evaluates and assigns credit
ratings to issuers of debt securities, such as corporations, governments
and municipalities.
Credit Rating Migration: The movement of a credit rating from one
category to another, such as an upgrade or a downgrade.
Credit Risk: The risk of default or failure to meet financial obligations
associated with a borrower or a debt instrument.
Credit Spread: The difference in yields between a debt instrument with
a lower credit rating and one with a higher credit rating, reflecting the
additional risk premium required by investors.
Cross-border M&A: Acquisitions and mergers involving businesses from
several nations.
180 PAGE
GLOSSARY
Cross-selling: The process of offering current customers new goods or Notes

services.
Customer Base: The group of clients or consumers that business service.
Customer Experience: The total experience clients have with a business
and their pleasure with it along that trip.
Default: Failure to meet the contractual obligations of a debt instrument,
such as failing to make interest or principal payments when due.
Default Probability: The likelihood of an issuer defaulting on its debt
obligations within a specified period, typically expressed as a percentage.
Development Bank: DB are the specialized bank which unlike scheduled
commercial banks provide special services such medium to long term credit,
advisory services, commission, guarantee, etc. to some specific sectors.
Development Financial Institution: An organisation providing funds
for growth and development like SIDBI, EXIM Bank, IFCI, IDBI, etc.
Digital Assets: Anything that exist only in digital form.
Digital Transformation: The full integration of digital technology into
corporate processes, which profoundly alters how an organisation functions
and provides value to consumers.
Disclosure Requirements: The details that businesses must make public
or reveal to regulatory agencies.
Doubtful Assets: The non-performing assets that are due past more
than twelve months are known as sub-standard assets. In comparison to
standard assets, they pose significantly higher risk levels.
Due Diligence: Collect and analyse information before making a decision
with the purpose of reducing risk exposure.
Economies of Scale: Cost benefits are attained through expanding output,
which lowers average costs.
Endowment: Fund created by pooling money from donations is invested
in securities.
ESG: Investing while considering environmental, social and governance
concerns.
PAGE 181
BBA(FIA)
Notes Excess Interest Spread (EIS): The surplus cash flows generated from
the asset pool in the par structure. It provides a safeguard against any
shortfall in cash flow from the asset pool.
Financial Inclusion: It is providing accessible and affordable banking
services especially to poor and economically weaker section of the society
(such as slum dweller, poor & marginal labours, workers, farmers, elderly
and women).
Financial Sector: Financial sector refers to the part of the economy which
consists of firms and institutions that have the responsibility to provide
financial services to the customers of the commercial and retail segment.
Fintech: Organisations that employ cutting-edge technology to deliver
financial services.
GNPA: GNPA stands for gross non-performing assets. GNPA is an
absolute amount. It provides information on the overall amount of gross
non-performing assets held by the bank during a specific quarter or
financial year, as applicable.
Hedge Funds: Investing the pooled money of investors to earn attractive
returns.
Illiquid Assets: Financial assets that are not easily converted into cash
without significant loss of value or time.
Initial Public Offering: Offering shares of private company for the first
time on a recognised stock exchange to the public.
Investment Grade: A credit rating assigned to a bond or other debt
instrument that indicates a low default risk. These ratings typically range
from AAA (highest) to BBB- (lowest).
Investor Protection: Measures and rules intended to protect investors’
interests.
Liquidity Crunch: A situation where a company or firm faces a shortage
of liquid assets, making it difficult to meet short-term financial obligations.
Loss Assets: Loss assets are non-performing assets with such extended
periods that lenders have given up hope that they would be able to
recover their money. They are forced to write it off as a loss on their
balance sheets.
182 PAGE
GLOSSARY
Management Fee: Money charged by the fund manager for professionally Notes
managing an investment fund.
MCLR: Marginal Cost of Funds based Lending Rate indicates the lowest
rate of fund lending by the banks.
Merger: A merger happens when two organisations come together to
create a new legal entity.
Mezzanine Financing: A business loan which is a hybrid of debt and
equity financing. Repayment terms are more flexible than the conventional
debt. Senior to equity but subordinate to the pure debt.
Mobile Wallets: There are virtual wallet which stores payment card details.
Mortgage-Backed Securities (MBS): Instruments that rely on receivables
stemming from housing loans.
MPC: Monetary Policy Committee is a six-member committee constituted
to set the policy repo rate.
Narasimham Committee Report, 1991: The Narasimham committee
was set up in August 1991 to provide detailed suggestions on the Indian
financial system, including the stock market and banking industry.
National Asset Reconstruction Company Limited: NARCL was constituted
for the purpose to address bad debt in the banks by setting ‘bad bank’.
National Bank for Agriculture and Rural Development: NABARD
addresses the special financing need of agriculture and allied industries.
National Bank for Financing Infrastructure and Development: NaBFID
offers infrastructure financing.
National Electronic Fund Transfer: NEFT enables one to perform
electronic fund transfer.
NNPA: NNPA stands for net non-performing assets. NNPA subtracts the
provisions made by the bank from the gross NPA. Therefore, net NPA
gives you the exact value of non-performing assets after the bank has
made specific provisions.
‘No Frill’ Account: It offers negligible or zero balance facility to the
users.
PAGE 183
BBA(FIA)
Notes Non-Banking Financial Companies (NBFCs): Financial institutions that

provide banking services but do not hold a full banking license. They
play a significant role as originators of securitization deals in India.
Non-Investment Grade (Speculative or High-Yield): A credit rating
assigned to a bond or other debt instrument that indicates a higher risk
of default. These ratings are typically below BBB- and are commonly
referred to as junk bonds.
Non-Performing Assets: Any advance or loan that is more than 90 days
past due is considered a non-performing asset in India, according to the
Reserve Bank of India.
Operational Efficiency: The capacity of a business to optimise its
procedures and resources to produce the most with the least input.
Pass-through Certificates (PTCs): Securities issued by the Special
Purpose Vehicle (SPV) that represent a fractional interest in the cash
flows generated by the underlying assets.
Pay-Through Securities (PTS): Debt securities issued by the SPV
and backed by securitized assets. PTS allow for different tranches with
varying maturities, desynchronizing the servicing of securities from the
cash flows generated by the assets. Surplus funds can be reinvested, and
cash flows can be used for short-term yield in case of early retirement
of receivables.
Payment Banks: It is a new category of differentiated banks which
extends almost all banking services except the credit facility.
Pension Funds: Are pooled monetary contributions from the pension
plans set up by employers, unions or other organizations.
Portfolio: A collection of assets, such as residential mortgages, with
similar characteristics like interest rates, risk profiles and maturities,
gathered by a financial institution.
Priority Sector Lending (PSL): A target set by regulators for banks to
lend a certain portion of their loans to specific sectors identified as priority
sectors, such as agriculture, micro and small enterprises, education, and
housing for economically weaker sections.
Private Equity: Capital investment in companies that are not traded
publicly.
184 PAGE
GLOSSARY
4R Framework: Recognition, Recapitalization, Resolution and Reforms Notes

was introduced to address the issue of Non-Performing Assets by the banks.
Rating Committee: A group of analysts and experts within a credit rating
agency responsible for reviewing and making decisions on credit ratings.
Rating Outlook: An opinion by a credit rating agency on the potential
direction of a credit rating over a specified time horizon, typically indicating
whether it is likely to be upgraded, downgraded, or remain stable.
Rating Scale: A system used by credit rating agencies to categorize
creditworthiness, usually depicted through a set of letters, numbers or
symbols.
Rating Watch: A status assigned by a credit rating agency to indicate
that a particular credit rating is under review for a potential change, such
as an upgrade or a downgrade.
Rating Withdrawal: The removal of a credit rating by a rating agency
due to factors such as the issuer’s request, non-compliance with the
agency’s rating criteria, or lack of sufficient information.
Real-time Gross Settlement: RTGS is a mode of instantaneous electronic
fund transfer.
Recapitalization: It means an infusion of capital into banks to enable
them to meet the mandatory capital adequacy norms set by the Reserve
Bank of India from time to time.
Recovery Rating: A rating that assesses the potential recovery of principal
and interest in the event of a default or a distressed financial situation.
Regulatory Capital: The minimum amount of capital that financial
institutions are required to maintain based on the credit ratings of their
assets to ensure solvency and stability.
Reserve Bank of India: RBI is the central bank of India which was
established in the year 1935 to mainly regulate and supervise various
financial institutions in the country.
Risk Management: Identification, evaluation, and mitigation of risks in
order to reduce possible losses and guarantee the stability of a financial
institution.
PAGE 185
BBA(FIA)
Notes SaaS: Software as a service like email, calendar, MS Office, etc.

Scheduled Commercial Banks: SCBs are the major banking institutions
regulated by RBI.
SEBI: Securities and Exchange Board of India, the regulatory body
responsible for overseeing the securities market in India.
Securitization: The process of aggregating illiquid financial assets, such
as receivables or loans, and transforming them into marketable securities.
Sovereign Rating: A credit rating assigned to a country or its government,
indicating its creditworthiness and ability to meet its financial obligations.
Space Tech: Space vehicles like spacecrafts, satellites, space stations, etc.
Special Purpose Vehicle (SPV): A legal entity created specifically for
a particular purpose, such as holding the securitized assets and issuing
securities.
Sub-Standard Assets: These are non-performing assets that have been
due for anywhere from 90 days to 12 months.
Tranche: A distinct level of risk and return created by splitting the
portfolio of receivables, loans, or assets into several parts.
Trustee: The legal owner of the underlying assets in a securitization
transaction. The trustee holds the assets on behalf of the investors.
Unbundling: The process of breaking down bundled assets into instruments
of fixed denominations, allowing investors to choose specific tranches or
portions of the securitized assets.
Unicorn: Any company that reaches the valuation of US$ 1 billion without
being listed on the stock exchange in a short span of time.
Unsolicited Rating: A credit rating issued by a rating agency without
a formal request or engagement from the issuer, usually done based on
publicly available information.
UPI: Unified payment interface is a single platform for the immediate
real time payment.
Up-selling: The act of persuading clients to buy a more expensive item
or service.
186 PAGE

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Editorial Board

Dr. Kirti Singh

© Department of Distance and Continuing Education

Corrections/Modifications/Suggestions proposed by Statutory Body, DU/

© Department of Distance & Continuing Education, Campus of Open Learning,

Lesson 1 : Introduction to the Indian Banking System

Lesson 2 : Issues in Financial Reforms and Restructuring

Lesson 3 : Introduction to Neobanks

Lesson 4 : Merger and Acquisition in Banking

Lesson 5 : Leasing and Hire Purchase

Lesson 6 : Venture Capital

Lesson 7 : Credit Ratings

7.2 Introduction 139

1.1 Learning Objectives

Notes  To comprehend the role of Monetary Policy Committee, MCLR Based

1.3 Overview of Banking System in India

Figure 1.1: Structure of banking system in India

Scheduled Cooperative Banks (SCB) Notes

Notes industrial development. Though SIDCs focus on promotional activities parts

1.4 Major Banking Reforms in the Last Decade

Banking Sector Reforms Since 1991 Notes

Notes institutions, such as income recognition, provisioning norms, setting up of

Notes National Asset Reconstruction Company Limited (NARCL)

1.5 Payment Bank

1.6 Monetary Policy Committee Notes

1.7 MCLR Based Lending

1.8 Innovative Remittance Services

payments conveniently. Examples of popular digital payment apps Notes

5. Which of the following is an innovative method of remittance? Notes

(a) Mobile Banking

1.10 Answers to In-Text Questions

1. (b) Reserve Bank of India

1.11 Self-Assessment Questions

Notes 8. Please elaborate the main features of following Indian government

1.12 Suggested Readings

2.1 Learning Objectives

Notes 2.2 Introduction

Reasons for Financial Sector Reforms in India Notes

Notes  The shortcomings of the planned economic development strategy,

 Recommendations on priority sector lending: The committee Notes

 Being a subsidiary of a foreign bank that is entirely controlled by Notes

2.3 Challenges and Issues in Financial Reforms

Notes  A greater reliance on unregulated lending.

 Lack of banking for the underserved and rural population: It is Notes

2.4 Assessing Non-Performing Assets (NPAs) in Indian

GNPA and NNPA Notes

Notes (i) The bank’s lending to the corporations/persons etc. whose

2.5 Previous Methodologies for the Recovery Notes

In Indian banks, the process by which banks and financial institutions

Corporate Debt Restructuring (2005) Notes

Notes By lowering political meddling in PSB operations and enhancing lending,

2.6 Impact of Gross NPAs on a Bank’s Bottom Line

Notes Impacts of Non-Performing Assets (NPA)

2.7 Introduction to Bad Banks, Functioning of Bad Banks,

Notes bank would provide government receipts to banks when it purchased

(c) Income-tax Act Notes

(d) SARFAESI Act

Notes (a) Reduction of CRR and SLR

(b) Muthoot Finance Ltd. Notes

(c) HDB Finance Services

2.9 Answers to In-Text Questions

Notes 12. (c) Wilful Defaulter

2.10 Self-Assessment Questions

Notes To comprehend the role of Monetary Policy Committee, MCLR Based

Notes The shortcomings of the planned economic development strategy,

Recommendations on priority sector lending: The committee Notes

Being a subsidiary of a foreign bank that is entirely controlled by Notes

Notes A greater reliance on unregulated lending.

Lack of banking for the underserved and rural population: It is Notes

Notes Partnerships with Incumbents: In some cases, neobanks formed

Notes Digital Platform: Neobanks operate primarily through digital platforms

Notes Hayes, A. (2023). 0HUJHUVDQG$FTXLVLWLRQV 0 $ 7\SHV6WUXFWXUHV