Unit 3

Non-Banking Financial Services

 Merchant Banking
Merchant banking may be defined as, an
institution which covers a wide range of activities
such as management of customer services,
portfolio management, credit syndication,
acceptance credit, counselling, insurance, etc.
The Notification of the Ministry of Finance
defines a merchant banker as, any person who is
engaged in the business of issue management
either by making arrangement regarding selling,
buying or subscribing to the securities as
manager, consultant, advisor or rendering
corporate advisory service in relation to such
issue management.
 Merchant Banking
Merchant Banking is a combination
of Banking and consultancy services.
Merchant Banking Services
1. Raising Finance for Clients : Merchant Banking helps its
clients to raise finance through issue of shares, debentures,
bank loans, etc. It helps its clients to raise finance from the
domestic and international market. This finance is used for
starting a new business or project or for modernization or
expansion of the business.
2. Broker in Stock Exchange : They buy and sell shares on
behalf of their clients. They conduct research on equity
shares. They also advise their clients about which shares to
buy, when to buy, how much to buy and when to sell.
3. Project Management : Merchant bankers help their clients in
the many ways. For e.g. Advising about location of a project,
preparing a project report, conducting feasibility studies,
making a plan for financing the project, finding out sources
of finance, advising about concessions and incentives from
the government.
4. Advice on Expansion and Modernization : Merchant bankers
give advice for expansion and modernization of the business
units. They give expert advice on mergers and
amalgamations, acquisition and takeovers, diversification of
business, foreign collaborations and joint-ventures,
technology up-gradation, etc.
5. Managing Public Issue of Companies : Merchant bank advice
and manage the public issue of companies. They provide
following services:
Advise on the timing of the public issue.
Advise on the size and price of the issue.
Acting as manager to the issue, and helping in accepting
applications and allotment of securities.
Help in appointing underwriters and brokers to the issue.
Listing of shares on the stock exchange, etc.
6. Handling Government Consent for Industrial Projects : A
businessman has to get government permission for starting
of the project. Similarly, a company requires permission for
expansion or modernization activities. For this, many
formalities have to be completed. Merchant banks do all this
work for their clients.
7. Special Assistance to Small Companies and Entrepreneurs :
Merchant banks advise small companies about business
opportunities, government policies, incentives and
concessions available. It also helps them to take advantage of
these opportunities, concessions, etc.
8. Services to Public Sector Units : Merchant banks offer many
services to public sector units and public utilities. They help
in raising long-term capital, marketing of securities, foreign
collaborations and arranging long-term finance from
term lending institutions.
9. Revival of Sick Industrial Units : Merchant banks help to
revive (cure) sick industrial units. It negotiates with different
agencies like banks, term lending institutions, and BIFR (Board
for Industrial and Financial Reconstruction). It also plans and executes
the full revival package.
10. Portfolio Management : A merchant bank manages the
portfolios (investments) of its clients. This makes
investments safe, liquid and profitable for the client. It offers
expert guidance to its clients for taking investment decisions.
11. Corporate Restructuring : It includes mergers or acquisitions
of existing business units, sale of existing unit or
disinvestment. This requires proper negotiations,
preparation of documents and completion of legal
formalities.
12. Money Market Operation : Merchant bankers deal with and
underwrite short-term money market instruments, such as:
Government Bonds.
Certificate of deposit issued by banks and financial
institutions.
Commercial paper issued by large corporate firms.
Treasury bills issued by the Government (Here in India by
RBI).
13. Leasing Services : Merchant bankers also help in leasing
services. Lease is a contract between the lessor and lessee,
whereby the lessor allows the use of his specific asset such
as equipment by the lessee for a certain period. The lessor
charges a fee called rentals.
14. Management of Interest and Dividend : Merchant
bankers help their clients in the management of
interest on debentures / loans, and dividend on
shares. They also advise their client about the
timing (interim / yearly) and rate of dividend.
Merchant Banking functions
What is Factoring?
 Why Factoring?
Management of cash and receivables is of
utmost important
Many business have collapsed for want of
liquidity
The key to success lies in converting credit
sales into cash within a short period of time.
 Definition of Factoring
Robert W. Johnson Factoring is a service
involving the purchase by a financial organisation,
called a factor, of receivables owed to
manufacturers and distributors by their
customers, with the factor assuming full credit
and collection responsibilities.

V.A Avadhani, factoring is a service of financial

nature involving the conversion of credit bills into
cash.
 Factoring
Factoring is a continuing arrangement
between a financial intermediary known as
the factor and a business concern (the client)
whereby the factor purchases the clients
accounts receivable/book debts either with or
without recourse to the client.
This relation enables the factor to control the
credit extended to the customer and
administer the sales ledger.
Other services provided by a factor:
Credit management and converting the credit
risk involved
Provision of prepayment of funds against the
debts it agreed to buy.
Arrangement for collection of debts.
Administration of the sales ledger.
 Types of Factoring
1. Recourse Factoring
2. Non-recourse factoring
3. Advance and Maturity factoring
4. Old line factoring
5. Cross-border factoring/international
factoring
6. Invoice discount
1. Recourse Factoring
The factor purchases trade debts and
essentially renders collection service and
maintains sales ledgers.
But, in case of default or non-payment by a
trade debtor, the client refunds the amount to
the factor.
Hence, it does not include bad-debts
protection.
It is popular in the developing countries
2. Non-Recourse Factoring
The factors obligation to the client becomes
absolute on the due date of the invoice,
irrespective of the payment made or not made by
the trade debtor.
In other words, if the trade debtor fails to make a
payment, the factor cannot recover this amount
from the client.
Factor chargers are high as they offer the client
protection against bad-debts.
Found in developed countries such as UK and
USA, where reliable credit rating services are
available.
3. Advance and Maturity factoring
Advance factoring:
The factor and the client make an arrangement
whereby the factor pays a pre-specified portion of the
factored receivables in advance to the client on
submission of necessary documents.
The balance portion is paid upon collection or on the
guaranteed payment date.
Generally, factoring is advance factoring and factor
pays 80% of the invoice amount in advance.
Maturity factoring:
No advance payment is made by the factor but
payment is made only on the guaranteed payment date
or on the date of collection.
It is also known as collection factoring
4. Old line factoring:
Also known as full factoring as it provides an
entire spectrum of services, such as collection,
credit protection, sales ledge administration,
and short-term finance.
It includes all features of non-recourse and
advance factoring.
5. Cross-border factoring/international
factoring:
In international factoring there are four
parties involved, namely, exporter(client),
importer(customer), export factor, and import
factor.
Thus, factoring services are provided by
factors of both countries, the exporter
countrys factor and the importer countrys
factor.
6. Invoice discount
It is a variant of factoring.
It provides finance against invoices backed by
letters of credit of banks.
The factor provides finance once the letter of
credit opening bank confirms the due date of
payment.
 Factoring Mechanism
1. Customer places an order with the client for goods
and/or service on credit; client delivers the goods and
sends invoice to customers.
2. Client assigns invoice to factor.
3. Factor makes prepayment upto 80% and sends
periodical statements.
4. Monthly statement of accounts to customer and
follow-up.
5. Customer makes payment to factor.
6. Factor makes balance 20% on realisation to the client.
Factoring Mechanism
 The client sends an invoice to his customer in the usual
way but adds a notification that the invoice is assigned
to and must be paid to the factor with whom he has
made an arrangement.
The client then submits copies of invoices to the factor
with a schedule of offer accompanied by the receipt,
delivery challan, or any other valid proof of dispatch.
The factor provides prepayment upto 80% of the
invoice value and follows-up with the customers for
realisation of payments due.
The balance payment is made immediately on
realisation.
The factor sends a monthly statements to the client to
keep him informed of the factored invoices.
 Advantages of Factoring
Factoring is beneficial to the client, his customers
and banks.
Benefits to the client:
Competitive credit terms to his buyers
Accelerate the production cycle
Free from tensions of monitoring his sales
ledger and can concentrate on production,
marketing, and other aspects (Reduction in overhead
expenses and increase in sales & profits).
Efficient Working Capital Management
Assessing quality of debtors (by analysing payment
history)
Expansion of business
 To the Customers (Buyers):
Adequate credit facilities
Customers save on bank charges and expenses.
Getting periodical statement from the factor
Does not impinge on the customers rights vis--vis
the suppliers in respect of quality of goods,
contractual obligations, etc.

To the banks:
Improves the quality of advances of the banks
It is not at all a threat
It is a financial service complementary to that of the
banks
 Factoring charges
Finance Charge - It represents the interest on
funds made available to the client by way of
prepayment against purchase of approved
invoices.
Service Charge - The charge levied for
rendering non-funding services such as
collection, sales ledger maintenance and other
advisory services.