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Chapter 8 Sources of Business Finance
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7. Institutional Finance Institutional finance refers to finance to business from lending institutions other than commercial banks. These financial institutions are specialized in providing industrial finance which is generally outside the business area of commercial banks. The term institutional finance includes the following:
The above mentioned categories are prominent sectors of business finance.
Public Financial Institutions Public financial institutions are also known as ‘term lending institutions’ ‘development banks’. Development banks have been established with the main objective of project financing. These banks differ from commercial banks in several respects. Commercial banks are focused on short term financing. Their finance is restricted to working capital requirements of the business. Development banks however are specialized in providing medium and long term finance to business. By providing finance for the expansion, diversification and modernization of industries, these banks actually promote the industrial and economic progress of the country. While commercial banks are security oriented, development banks are project oriented. A project having potential for promoting national priorities such as development of backward areas, balanced regional development, development of infrastructure etc. are treated with high priority by development banks. In India the term Public Financial Institutions includes the following: (i) Industrial Credit and Investment Corporation of India (ICICI), now in private sector (ii) Industrial Financial Corporation of India (IFCI) (iii) Industrial Development Bank of India (IDBI) (iv) Unit Trust of India (UTI) (v) Life Insurance Corporation of India (LIC) (vi) National Housing Bank(NHB) (vii) State Financial Corporations (SFC)
Thus public financial institutions include development banks, public sector insurance companies and public sector mutual funds.
Types of financial assistance provided by public financial institutions are the following: (i) They provide medium and long term finance to industrial institutions at reasonable interest (ii) They subscribe to the debenture issue of companies (iii) Some of the institutions subscribe to share issue of companies (iv) Underwriting of public issue (v) Guarantee loans raised by companies (vi) Loans granted in foreign currencies for import of machinery (vii) Guarantee for the purchase of machinery imported from foreign countries
Non-Banking Finance Companies (NBFCs) In recent times Non Banking Finance Companies have emerged as a significant sector of institutional finance. NBFCs are financial institutions specialised in activities to include specific areas not covered by other institutions.
NBFCs engaged in a variety of fund based or non fund based activities. Fund based activities are those activities in financing. Non fund based activities are fee based activities such as advisory services, agency services etc. Activities of Fund based Non Banking Financing Companies are the following: (i) Leasing (ii) Hire Purchase (iii) Housing finance (iv) Venture capital fund
The main non-fund based activities are:
(i) Issue management (ii) Corporate counselling (iii) Forex advisory service (iv) Credit rating (v) Portfolio management
NBFCs are a significant part of the financial system. They cover wide areas not generally covered by banking institutions.
Investment Trusts (Unit Trust and Mutual Funds) Investment trusts or mutual funds pool small savings from public and invest them carefully in profitable business projects. Investment trusts have large scale resources at their disposal which are invested in shares, debentures, deposits and other profitable portfolio. A portfolio refers to the set of equity shares or debentures or other securities held an investment company. Investment companies invest in several securities at the same time. They invest in a combination fixed income and variable income securities. Equity shares are selected across industries and sectors. If one sector performs poor, there are other sectors doing well, which would reduce the risk of the company. The features of investment trusts are:
(i) Risk reduction There are some investments in fixed income securities which provide a guaranteed return. Thus investment trusts reduce risk.
(ii) Professional management Investment trusts pool the funds of a large number of people. Since the volume of funds handled by these trusts are so large that it requires highly skilled professionals to make strategic decisions. Thus the investment trusts are likely to produce better results than individual investors with limited knowledge and limited skill.
(iii) Diversification An important feature of investment trusts is diversification. They enable investors interested in a certain specific line of investment only to diversify into other areas of investment as well. They reduce the risk of bad investment by diversification.
(iv) Overcome the weakness of equity investment The prominent disadvantage of equity investment is the risk. The fortunes of the investor are linked to the performance of the company he has chosen to invest. A wrong decision can prove fatal to the investor. Investments trusts make ideal form of investment for individuals with low risk.
Trust investment schemes are classified into two broad categories: a. Open ended b. Close ended
Open ended schemes do not have a specific closing date. People can invest in the scheme any time and sell the investments (units) any time they wish. This scheme offers easy liquidity and high capital mobilization.
Close ended schemes are open for a specific period only. Collection of fund to the scheme will be closed at the end of the specific period. The popular term for close ended scheme in India is mutual fund
Merits of Investment Trusts
(i)
Diversification of risks
(ii)
Professional
Management
(iii)
Liquidity (iv) Convenience It is easier to buy and sell units through agents. No commission is to be paid.
Demerits
(i) Breach of faith Investors anticipate faithful dealing and high return on their investment. In many cases investment decisions are taken due to external influences. Recent failure of Unit Trust of India is a glaring example of such a mal practice.
(ii) Stock market changes Stock exchange fluctuations cannot be easily predicted. In spite of all the estimates, market reactions may turn out to be completely different from what was anticipated. A wrong decision by a mutual fund investment will badly damage the financial hopes of a large number of people.
Institutional Finance for Small Business The small industries development bank of India is the principal financial institution for the promotion, financing and development of small business in India. It is the main financing agency for small scale industries. Following are the type of financial assistance provided by SIDBI: (i) It provides term loans to SSI units for modernization, technology upgradation and diversification. (ii) It provides assistance for working capital requirement of Small Scale Industries (iii) It supports rehabilitation assistance to potentially valuable sick units (iv) It undertakes discounting of bills of exchange for small industries (v) It provides services like factoring leasing etc. (vi) It provides venture capital to entrepreneurs (vii) It provides micro credits to self employment units.
8. Special Financial Assistance Available to Industries in Rural, Backward and Hilly Areas
Industrialization in India had been geographically uneven. Most of the industrial development concentrated in and around big cities while certain areas of the country remained completely neglected. Balanced regional development is an important objective due to the economic and social implications. For the development of backward areas the government provides a number of incentives. These include the following: i. Availability of land at low rates. ii. Location of large scale public sector projects at backward areas iii. Establishment of industrial estates in backward areas iv. Development of infrastructure facilities in backward areas v. Tax holidays and tax rebates for units in backward areas vi. Subsidies to units such as – transport subsidy, capital subsidy and infrastructure subsidy. vii. Concessions in finance rates Special programs for the development of backward areas have been initiated by the government which are collectively referred to as special areas development programmes.
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End of Chapter 8
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