Fund-Based Financial Services
Since 1990, the Indian financial services industry has undergone a significant transformation. Before its emergence, the field was predominantly dominated by commercial banks and other financial institutions, which catered to the financial requirements of the Indian industry. However, with the advent of economic liberalization, the financial service sector gained prominence and has now evolved into a full-fledged industry.
Presently, the financial services industry stands as one of the largest globally. It plays a crucial role as a fundamental component of the financial system and serves as the bedrock for a modern economy. The prosperity of a nation heavily relies on the indispensable presence of the financial service sector.
Meaning of Financial Services
Financial services are one type of service offered by the finance industry, which comprises various organizations involved in money management. These organizations encompass banks, credit card companies, insurance companies, consumer finance companies, stock brokers, investment funds, and certain government-sponsored enterprises.
Financial services include a wide range of financial activities, which can be considered as activities related to money matters. In a broader context, the term financial service refers to the process of gathering and distributing savings. Therefore, it encompasses all the actions involved in converting savings into investments.
Financial services can be defined as the range of products and services provided by financial institutions to facilitate different financial transactions and related activities.
Functions of financial services
1. Exchange of goods and services (Facilitating transactions) in the economy.
2. Mobilizing savings (expand the outlets available for allocating funds, which would otherwise be significantly limited.).
3. Assigning capital funds (particularly for finance productive investment).
4. Monitoring managers (the allocated funds can be utilized as intended, ensuring that they are spent according to the envisioned purposes).
5. Transforming risk (It helps in reducing the risk associated with transactions by consolidating and enabling it to be undertaken by those who are more willing and capable of handling it.)
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Scope of Financial Service
The scope of financial services is extensive, as it encompasses a wide array of services. Financial services can be broadly categorized into two main types: (a) fund-based services and (b) non-fund services (also known as fee-based services).
In this blog, we are going to discuss Fund Based Financial Services.
Fund based Services
The fund-based or asset based services are as follows:
1. Equipment leasing/Lease financing:
A lease refers to an agreement where a company obtains the right to use a capital asset, such as machinery, by paying a predetermined fee known as lease rentals. The individual or company that obtains the right is called the lessee, but they do not gain ownership of the asset. They only acquire the right to use it. The person or company that grants the right is referred to as the lessor.
2. Hire purchase and consumer credit:
Hire purchase serves as an alternative to leasing. It involves a transaction where goods are bought and sold under the condition that payment is made in instalments. The buyer gains possession of the goods but not ownership. Ownership is transferred to the buyer only after the final instalment is paid. In the event of the buyer defaulting on any instalment, the seller has the right to reclaim the goods. Each instalment also includes interest charges.
3. Bill discounting:
The discounting of bills is an interesting fund-based financial service offered by finance companies. When it comes to a time bill, which is payable after a specified period, the holder does not have to wait until maturity or the due date.
If the holder requires immediate funds, they can choose to discount the bill with their banker. The banker deducts a certain amount as a discount and credits the net amount into the customer’s account.
Essentially, the bank purchases the bill and credits the customer’s account with the bill amount minus the discount. On the due date, the drawee makes the payment to the banker. If the drawee fails to make the payment, the banker will recover the amount from the customer who had discounted the bill. In summary, discounting bills involves providing loans based on the security of a bill of exchange.
4. Venture capital:
Venture capital pertains to the capital made accessible for financing new business ventures. It entails providing financial support to expanding companies. Venture capital involves investing in high-risk projects to achieve a substantial return on investment. In essence, venture capital signifies long-term risk capital provided in the form of equity finance.
5. Housing finance:
Housing finance is the provision of financial assistance for constructing houses. It originated as a fund-based financial service in India when the Reserve Bank of India (RBI) established the National Housing Bank (NHB) in 1988. The NHB serves as the apex housing finance institution in the country. Since then, several specialized financial institutions and companies have ventured into the housing finance sector. Examples of such institutions include HDFC, LIC Housing Finance, Citi Home, Indian Bank Housing, and more.
6. Insurance services:
Insurance service there is a contract between two parties: the insured and the insurer. The insured is the person who obtains coverage for their life or property through an insurance policy.
In other words, they are the ones whose risk is being insured. On the other hand, the insurer is the insurance company that assumes the risk transferred by the insured. They are the ones providing the insurance coverage.
The sum for which the insurance policy is taken is referred to as the “sum assured.” It represents the specific amount of coverage provided by the insurance policy. The consideration given by the insured in exchange for the insurer’s commitment to cover any losses is called the “insurance premium.” The insured is required to make regular payments of this premium, which can be done on a monthly, quarterly, half-yearly, or yearly basis.
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7. Factoring:
Factoring is an arrangement where a factor purchases the account receivables resulting from the credit sales of goods or services and provides an immediate cash payment to the supplier or creditor. In this arrangement, a financial institution or banker buys the account receivables from a firm (client).
The factor, in turn, offers financing to the supplier based on these account receivables. The factor assumes the responsibility of collecting the account receivables and bears the associated risk. In exchange for this service and the interest provided, the factor charges a fee for the intervening period, known as factor age.
8. Forfaiting:
Forfaiting is a financing method commonly used for receivables associated with international trade. It involves a non-recourse purchase by a banker or other financial institution of receivables arising from the export of goods and services.
In this arrangement, the exporter relinquishes their right to future payment from the buyer, to whom the goods have been supplied, transferring it to the forfeiter.
Forfaiting allows exporters to sell their goods on credit while receiving cash well in advance of the due date. In essence, forfeiting enables a forfeiter (a financing agency) to discount an export bill and provide immediate cash to the exporter. The exporter no longer needs to be concerned with the collection of the export bill, allowing them to focus solely on their export trade activities.
9. Mutual fund:
Mutual funds serve as financial intermediaries that gather savings from individuals and allocate them into a diversified portfolio of corporate and government securities. Skilled mutual fund operators actively manage this portfolio, generating income through dividends, interest, and capital gains. Ultimately, these earnings are distributed to the mutual fund shareholders, allowing them to benefit from the returns generated by the invested funds.
In conclusion,
Fund-based services include a diverse range of financial offerings, including equipment leasing, hire purchase, bill discounting, venture capital, housing finance, insurance, factoring, forfeiting, and mutual funds. These services fulfil various needs such as capital acquisition, risk management, cash flow optimization, and investment opportunities. By providing these services, financial institutions support economic growth and enable individuals and businesses to achieve their financial goals.
