LESSON - 1

INTRODUCTION

Ratios are among the best-known and most widely used tools of financial analysis. Ratio
is defined formally as "the indicated quotient of two mathematical expressions". An
operational definition of a financial ratio is the relationship between two financial
values. The word relationship implies that a financial ratio is the result of comparing
mathematically two values. A company's total asset turnover is calculated by dividing
the company's total values into its sales figure. This ratio is the quantified relationship
between sales and total assets. The resulting figure is also and indexes because it tells us
how many times the values of total assets were incorporated into the firm's products. It
is worthwhile to mention that the ratio must express a relation-ship between the sales
prices of an item on the one hand and its cost on the other. Consequently, the ratio of
cost of goods sold to sales is significant one in a sharper contrast to this, there is no
understandable relationship between freight costs incurred and the marketable
securities held by an enter-price and hence a ratio of one to the other has no
significance.
Methods of Ratio Analysis
Accounting ratios can be expressed in various ways such as:
i. a pure ratio, say ratio of current assets to current liabilities, is 2:1 or
ii. a rate say current assets are two times of current liabilities or
iii. a percentage say current assets are 200% of current liabilities
Each method of expression has a distinct advantage over the other. The analyst will
select that mode which will best suit his convenience and purpose.
Types of Analysis
(a) External Analysis by creditors, shareholders, banks and financial institutions.
(b) Internal Analysis - Analysis by the management.
(c) Horizontal Analysis - Comparative financial statements AICPA has observed.
"In any one year it is ordinarily desirable that the balance sheet, the Income statement
ant surplus statements be given for one or more presiding years as well as for the
current year.
(d) Vertical Analysis - Common size Balance Sheet Ratio is a study of a single statement
for the relationship of the components of the total by converting each amount in the
statement to a percentage of total amounts of the group.

(e) Trend Ratios - These are computed in relation to a base year which must be a normal
year. These are index numbers of changes in financial data as compared to a base year
data.
(f) Funds flow analysis and cash flow analysis.
(g) Break-even Analysis.
(h) Ratio Analysis - Balance Sheet Ratios, Profit and Loss account ratios.
Steps Involved in the Analysis
1.
2.
3.
4.
5.
6.
7.
8.

Compilation of financial data,

Study of data,
Systematic classification of data,
Scientific arrangement of classified groups of data,
Establishing relationship with related data for further comparison
Supplementing with appropriate comments,
Analysis,
Interpretation of the analysis

Tools of Analysis
1.
2.
3.
4.
5.
6.

Comparative financial statements,

Common-size statements,
Trend percentages,
Ratio analysis,
Statement of changes in the working capital,
Cash flow statements (FFS).

Objectives of Financial Analysis

1. To determine the financial soundness of the firm i.e. liquidity of the firm.
2. To judge the solvency of the firm by working out leverage rations.
3. To assess the profitably of the firm by the present shareholders and prospective
investors.
4. Management can measure the operational efficiency of the firm by means operating
ratios and turnover ratios.
5. It provides basis not only for intra-firm comparison but also for inter-firm
comparison.

6. Comparison with base year financial statements will help the management in
controlling the affairs of the firm.
Dynamic Analysis versus Static Analysis
(a) Under dynamic analysis, a base year will be selected. The percentage of each item
over base year is calculated. A dynamic analysis of financial statements is based upon
changes over a long period of time. For this statement, a number of years are to be
analysed with reference to the percentage relationship of each item to the same item in
the base year balance sheet this study will indicate the trend of liquidity, profitability
leverage and turnover rations etc. This helps in giving insight into die past' present,
future affairs of the business enterprises. Dynamic Analysis is also called Horizontal
Analysis or Trend Analysis.
(b) A static analysis means explaining the current financial position if a firm by
observing a single balance sheet of the current year. This indicates in depth study of
sources and application of funds during the current year. Similarly, a study of internal
relationship between the various items appearing in P and L A/C of the current year is
also called "Static Analysis. It is basically one of linking and ascertaining relationship
within a single set of financial statement. It is also called as "Vertical Analysis" or
"Structural Analysis" of financial statements.
(c) As stated above, ratios may be static, dynamic or inter-related. Dynamic ratios
emerge from the study of P and L A/c while static ratios from the study of items of
balance sheet. The inter-related ratios emerge from the study of items of balance sheet
in relation to the items of P and L A/c. These are also called as "combined ratios".
(d) According to AICPA Bulletin No.1, "The presentation of comparative statements in
annual and other reports enhances the usefulness of such reports and brings out more
clearly, the nature and trends, of current changes, affecting the enterprise, such
presentation emphasises the fact that statements for a series of periods are far assenting
significant than those for a single period and that accounts of one period are put an
installment of what is essentially a centimeters history. In any one year, it is normally
desired, that the balance sheet the income statement and the surplus statement be given
for one or more preceding years as well as current year".
Advantages of Ratio Analysis:
Ratio analysis stands for the process of determining and presenting the relationship of
items and groups of items in the financial statements. It is an important technique of
financial analysis. It is a way by which financial stability and health of a concern can be
judged. The following are the main points of importance of ratios analysis.
(a) Useful in financial position analysis: Accounting ratios reveal the financial position
of the concern. This helps the banks, insurance companies and other financial
institutions in lending and making investment decisions.

(b) Useful in simplifying accounting figures: Accounting ratios simplify, summarise and
systematise the accounting figures in order to make them more understandable and in
lucid form. They highlight the interrelationship, which exists between various segments
of the business as expressed by accounting statements. Often the figures standing alone
cannot help them convey any meaning and ratios help them to relate with other figures.
(c) Useful in assessing the operational efficiency: Accounting ratios help to have an idea
of the working of a concern. The efficiency of the firm becomes evident when analysis is
based on accounting ratios. They help the managements to assess financial
requirements and the capabilities of various business units.
(d) Useful in forecasting purposes: If accounting ratios are calculated for a number of
years, then a trend is established. This trend helps in setting up future plans and
forecasting. For example, expenses as a percentage of sales can be easily forecasted on
the basis of sales and expenses of the past years.
(e) Useful in locating the weak spots of the business: Accounting ratios are of great
assistance in locating the weak spots in the business even though the overall
performance may be efficient. Weakness in financial structure due to incorrect policies
in the past or present are revealed through accounting ratios. For example, if a firm
finds that increase in distribution expenses is more than proportionate to the results
expected or achieved, it can take remedial steps to overcome this adverse situation.
(f) Useful in comparison of performance: Through accounting ratios comparison can be
made between one departments of a firm with another of the same firm in order to
evaluate the performance of various departments in the firm. Manager is naturally
interested in such comparison in order to know the proper and smooth functioning of
such departments. Ratios also help him to make any change in the organisation
structure.
Limitations of Ratio Analysis
Ratio analysis is very important in revealing the financial position and soundness of the
business. But, in spite of its advantages, it has some limitations, which restrict its use.
These limitations should be kept in mind while making use of ratio analysis for
interpreting the financial statements. The following are the main limitations of
accounting ratios:
(i) False results if based on incorrect accounting data. Accounting ratios can be correct
only if the data on which they are based) are correct. Sometimes, the information given
in the financial statements is affected by window dressing, i.e., showing position better
than what actually is. For example, if inventory values are inflated or depreciation is not
charged on fixed assets, not only will one have an optimistic view of profitability of the
concern but also of its financial position. So the analyst must always be on the lookout
for signs of window dressing, if any.

(ii) No idea of probable happenings in future. Ratios are an attempt to make an analysis
of the past financial statements; so' they are historical documents. Now-a-days keeping
in view the complexities of the business, it is important to have an idea of the probable
happenings in future.
(iii) Variation in accounting methods. The two firms results are comparable with the
help of accounting ratios only if they follow the same accounting methods or bases.
Comparison will become difficult if the two concerns follow the different methods of
different standards and methods, an analysis by reference to the ratios would be
misleading. Moreover, utilisation of inbuilt facilities, availability of facilities and scale of
operation would affect financial statements of different firms. Comparison of financial
statements of such firms by means of ratios is bound to be misleading.
(iv) Price level changes. Changes in price levels make comparison for various years
difficult. For example, the ratio of sales to total assets in 1996 would be much higher
than in 1976 due to rising prices, fixed assets being shown at cost and not at market
price.
(v) Only one method of analysis. Ratio analysis is only a beginning and gives just a
fraction of information needed for decision-making. So, to have a comprehensive
analysis of financial statements, ratios should be used along with other methods of
analysis.
(vi) No common standards. It is very difficult to lay down a common standard for
comparison because circumstances differ from concern to concern and the nature of
each industry is different. For example a business with current ratio or more than 2:1
might not be in a position to pay current liabilities in time because of an unfavorable
distribution of current assets in relation to liquidity. On the other hand, another
business with a current ratio of even less than 2:1 might not be experiencing any difficult
in making the payment of current liabilities in time because of its favorable distribution
of current assets in relation to liquidity.
(vii) Different meanings assigned to the same term. Different firms, in order to calculate
ratio may assign different meanings. For example, profit for the purpose of calculating a
ratio may be taken as profit before charging interests and tax or profit before tax but
after interest or profit after tax and interest. This may affect the calculation of ratio in
different firms and such ratio when used for comparison may lead to wrong conclusions.
(viii) Ignores qualification factors. Accounting ratios are tools of quantitative analysis
only. But sometimes qualification factor may surmount the quantitative aspects. The
calculations derived from the ratio analysis under such circumstances may get distorted.
For example, though credit may be granted to a customer on the basis of information
regarding his financial position yet the grant of credit ultimately depends on debtor's
character, honesty, past record and his managerial ability.
(ix) No use if ratios are worked out for insignificant and unrelated figures. Accounting
ratios may be worked for any two insignificant and unrelated figures as ratio of sales and

investment in government securities. Such ratios may be misleading. Ratios should be

calculated on the basis of cause and effective relationship. One should be clear as to
what cause is and what effect is before calculating a ratio between two figures.

- End of Chapter LESSON 2

TYPES OF RATIOS

The chart showing the various types of ratios is given below: (more than 50 ratios)
1. Liquidity Ratios
(a) Current Ratio
(b) Liquid Ratio
(c) Absolute Liquid Ratio
(d) Over-due Liability Ratio
2. Profitability Ratios
(a) Gross Profit Ratio.
(b) Operating Profit Ratio.
(c) Net Profit Ratio.
(d) Earning Power.
(e) Return on Investment
(f) Return on the Total Assets
(g) Return on the Total Equity
(h) Return on Common Equity4

(i) Earnings per Share

(j) Dividends per share
(k) Dividend-Payout ratio
(l) Price-Earnings ratio,
(m) Dividend yield ratio,
(n) Earnings yield ratio
(o) Net profit to Net Worth
3. Leverage Ratios
(a) Debt-Equity Ratio
(b) Total Debt-Equity Ratio
(c) Debt to total capital ratio
(d) Equity Ratio
(e) Fixed Assets to Net Worth Ratio
(f) Current Assets to Net Worth Ratio
(g) Long-term Debt to Net Working Capital Ratio
(h) Current Liabilities to net Worth
(i) Total Liabilities to Net Worth
(j) Capital gearing ratio
(k) Fixed Assets to Long term funds.
(l) Interest coverage ratio
(m) Preference Dividend Coverage Ratio
4. Operating Ratios
(a) Operating Ratio

(b) Expenses Ratio

(c) Net sales to Fixed Assets
(d) Net sales to current Assets
(e) Net sales to Net Worth
(f) Net Sales to Net Profit
5. Turnover Ratios
(a) Inventory Turnover Ratio
(b) Debtors Turnover Ratio
(c) Creditors Turnover Ratio
(d) Fixed Assets Ratio
(e) Total Assets Turnover
(f) Working Capital to Inventory
(g) Working Capital to Inventory
(h) Working Capital to Total Assets
(i) Cash Turn Over Ratio
(j) Current Assets Turnover
(k) Inventory to Working Capital
(l) Debtors to Working capital
(m) Cash to Working capital
(n) Capital output Ratio
LIQUIDITY RATIOS
Christy and Roden define the liquidity of an asset as moneyness. A firm's liquidity may
vary over the business cycle. Liquidity Radio indicates the firm's ability to pay its current
liabilities.

(a) Current Ratio (CR)

Donald Miller describes the current ratio as one which is generally recognised as the
patriarch among ratios. He states at that one time, it commanded such widespread
respect that many businessmen regarded it as being endowed with the infallibility of
nature's laws - it was a law of gravity applied to the Balance Sheet. By using the current
ratio, a credit manager or lending officer can lay aside his "flipping coin" and arrive at
decisions based on some figures of logic and accuracy.
Current Assets
Current ratio = ---------------------------Current Liabilities
The ratio should be ideally 2:1. But depending on each industry's own peculiar
problems, the ratio may vary between 1.5:1 to 3:1. If cash and marketable securities
constitute 10% of total current assets, even a current ratio of 1.5:1 will be satisfactory.
(b) Liquid Ratio (LR)
Current ratio is a liberal test of liquidity whereas liquid ratio is a more stringent test of a
firm's ability to meet its current liabilities. It is also called as Acid Test Ratio (ATR) or
Quick Ratio (QR). As the conversion of inventory into cash will take time, it is excluded
from current assets in order to arrive at the amount of liquid assets. Prepared expenses
are also excluded as these are already spent.
Liquid Assets
Liquid Ratio = ---------------------------Liquid Liabilities
The ratio should be 1:1. If current ratio is more than 2:1 but liquid ratio is less than 1:1, it
indicates excessive inventory.
As the bank overdraft is a permanent arrangement with the banker, it may be excluded
to find out the liquid ratio. In such case, the formula will be as follows:
Current Assets (Inventory + Prepaid Expenses)
Liquid Ratio = ----------------------------------------------------------------------Current Liabilities Bank Overdraft

(c) Absolute Liquid Ratio (ALR)

It is still stringent test of liquidity. It may not be possible to realise amounts from all the
debtors and hence the amount of debtors also is treated non-liquid assets.
Cash + marketable securities
Absolute Liquid Ratio = --------------------------------------------Quick Liabilities
The ratio should be 0.5 : 1
(d) Overdue Liability Ratio (OLR)
The ratio should be 1.5 : 1. If OLR is lower, but current ratio is good, it indicates
excessive debtors and delay in realization of cash from debtors.

PROFITABILITY RATIOS
Christy and Roden state that profit is the figure at the bottom of the income statement what is left for shareholders after all the changes have been paid. Profit is an absolute
figures and profitability is a ratio.

Gross Profit
(a) Gross Profit Ratio (GPR) = ------------------------ x 100
Sales

EBIT
or ------------ x 100
Sales

Profit after Tax (PAT)

(b) Net Profit Ratio (NPR) = -------------------------------------- x 100
Sales
Note: PBT (1 - T) = PAT, where T = Tax rate

Earning before Interest and Tax (EBIT)

(c) Earning Power = -------------------------------------------------------------- x 100
Total Assets

PBT

Sales

(d) Return on Investment (ROI) = ---------- x --------------------------- x 100

Sales

Capital employed

PBT
= -------------------------- x 100
Capital employed

Profit after Tax (PAT)

(e) Return on total assets = ------------------------------------- x 100
Total assets

Profit after Tax (PAT)

(f) Return on total equity = ----------------------------------------- x 100
Total shareholders equity

PAT less Preference dividend

(h) Return on common equity = ------------------------------------------------- x 100
Common shareholders equity

PAT less Preference dividend

(i) Earnings per share (EPS) = -------------------------------------------------Number of equity shares

DPS
(j) Dividend Payout Ratio = --------- x 100
EPS

Market Price per share

(k) Price Earnings Ratio (PER) = --------------------------------------EPS

DPS
(l) Dividend Yield Ratio (DYR) = ---------------------------------Market Price per share

PAT less Preference dividend

(m) Net Profit to Net Worth = ------------------------------------------- x 100
Equity capital + Reserves

LEVERAGE RATIOS
Liquidity ratios are calculated to know the current financial position of the firm. In
order to know the long-term financial position, leverage ratios are calculated. These are
also called "capital structure ratios" and "Solvency Ratios". These ratios will indicate the
proportion of debt and equity in the capital structure of an organisation. These are also
calculated to know the extent to which operating profits are sufficient to cover the fixed
interest charge.
Long term debt

Loan funds

(a) Debt Equity Ratio = -------------------------------- = ----------------------Shareholder equity

Own funds

This ratio is generally 1:1 in Public Sector and 2:1 in Private Sector. Debt includes
preference shares redeemable within 13 years and fixed interest bearing securities such
as debentures, secured loans and unsecured loans etc. The Controller of Capital Issues
treats redeemable preference shares as part of the relative interest of creditors and
owners.
Barges and Alexander mention "The treatment of preference presents different risk to
shareholders. In one case failure to meet payments presents no such risk".
A high ratio is unfavorable and margin of safety for creditors will be less. "It will be
difficult for the firm to meet the fixed interest charges in case of high promotion of debt
in the capital structure. Though a low ratio provides a higher margin of safety for the
creditors, Earnings per share (ESP) will be lower on the basis of large equity base.
Hence a finance manager has to work out an optimum capital structure in order to
ensure that EPS will be lower on the basis of large equity base. Hence a finance manager
has to work out an optimum capital structure in order to ensure that EPS is higher and
shareholder's wealth is the maximum.
Debt Equity ratio, an important tool of financial analysis, depicts an arithmetical
relation between loan funds and owners funds. This is a popular measure in the hands
of investors and creditors to assess the lenders and owners against the company's assets.
The optimum mix of debt and equity ensures maximum return for equity shareholders
and also guarantees the servicing of debt in the interest of creditors. The following
factors may be considered for working out the optimum debt-equity ratio:
(a) Profitability Potential
(b) Debt-servicing potential i.e. Interest-coverage ratio
(c) Current capital market conditions, and

(d) The economic situation in the country.

Debt-equity ratio is one of the most critical parameters that an investor should look at
for the following reasons:
(i) A medium/high ratio (in the range of 1.5:1 to 4:1) would indicate that the
capital base is low and this would mean higher earnings per share in the future
once the debt is redeemed.
(ii) A debt component also ensures that a financial institution appraises the
project. The latter would also monitor the utilization of funds during the project
implementation stage as also once the company commences commercial
operations.
(iii) In a contrast situation, when a project is entirely financed by equity, the
company loses the flexibility of rescheduling funds in future.
(iv) Then again, when a project is entirely financed by equity, the risk to the
shareholder is higher as there is no financial appraisal, as the investors are neither
equipped nor have access to monitor the course of the project.
(v)The general norm for debt to equity is 1.5:1. But capital-intensive projects are
allowed a debt/equity of 4:1 while finance companies can have a ratio as high as
9:1.

Total Debt
(b) Total Debt Equity Ratio = -----------------------------Shareholders Equity

Long term debt + Current liability

= -----------------------------------------------Share holders Equity

Long term debt

(c) Debt to Total Capital Ratio = ------------------------------

Total Capital
Note: The widely held approach adopted by CCI and financial institutions is that of
relating the long term debt to shareholders equity.

Shareholders equity
(d) Equity Ratio = ----------------------------Total assets
It is also called Proprietary Ratio

Fixed assets at WDV (written down value)

(e) Fixed Assets to Net Worth Ratio = ----------------------------------------------------------------Net Worth

Current Assets
(f) Current Assets to Net Worth ratio = --------------------Net Worth

Long term debt

(g) Long term Debt to Net Working Capital = ------------------------------Net Working capital

This ratio should be 1:1; long term debt should not exceed net working capital

Current liabilities
(h) Current liabilities to Net Worth = ---------------------------Net Worth

Total liabilities
(i) Total liabilities to Net Worth = -------------------------Net Worth

(j) Capital Gearing Ratio

This ratio indicates the relationship between fixed interest bearing securities (FIBS) and
Equity Share Capital plus Reserves.
If FIBS is higher than equity share capital plus reserves, it is highly-geared capital
structure, i.e., ratio is more than 1:1
If FIBS is lower than equity share capital plus reserves, it is low-geared capital
structure, i.e., ratio is less than 1:1
If FIBS is higher than equity share capital plus reserves, it is evenly-geared capital
structure, i.e., ratio is 1:1.
Its various formulas are:

FIBS / Equity Capital

Debentures / Equity Capital
(Debentures + Preference Capital) / Equity Capital
FIBS / Total Capital employed
FIBS / Equity shareholders funds (i.e. Net Worth)

FIBS include the Debentures, Term loans and preference shares (especially when they
are cumulative). The last formula is a better one.
A highly geared company may give higher return to equity shareholders, if profits are
good and rate of return of capital is more than the rate of interest on preference
dividend. After meeting the interest charges and preference dividend out of profits, the
balance of profits will be available to the Equity Shareholders.

The following factors may affect the decision of the firm about capital gearing:

Trading on Equity
Exercise of control
Attitude towards risk
Statutory requirements
Capital market conditions
Fixed cost of financing
Rate of return on capital
Fixed Assets at WDV

(k) Fixed Assets to long-term funds = --------------------------------Long term funds

Long-term funds include shareholders' equity and long term debt. The ratio should not
exceed 1:1, it means that working capital is nil. Then current assets are financed fully by
current liabilities only.

EBIT
(l) Interest Coverage Ratio (ICR) = -----------------------------------Fixed interest charges
It is also called "Debt Service Ratio". The ratio shows how many times the interest of the
earnings cover charges before interest and tax (EBIT). It indicates the ability of a firm to
pay the interest charges. It is also an important test of satisfactory. If the ratio is 1:1,
EBIT will be just sufficient to pay the interest charges. Then net profit will be nil and tax
need not be paid.

DSCR or Debt Service Coverage Ratio:

The company has to satisfy the lender by calculating DSCR which should indicate clearly
as to what extent it will be able to discharge the loan obligations. Each company should
work out its own DSCR for proper planning and monitoring which should be part of
internal financial discipline.
If the internal generation of funds (i.e. cash inflow) is diverted for expansion,
modification or diversification of activities, it may result into default of payment of
interest and repayment of loan.

Profit after Tax (PAT)

(m) Preference Dividend Coverage Ratio (PDCR) = -----------------------------Preference Dividend

OPERATING RATIOS
These ratios are calculated to show the variations of different expenses in the operating
cost. Generally, these are expressed as percentages to net sales.
Cost of goods sold + Operating expenses
(a) Operating Ratio = ------------------------------------------------------------- x 100
Net Sales
If the operating ratio shows 90%, the balance 10% will be the operating profit ratio. This
should cover interest, income tax, dividends and retained earnings.
Each item of expenses
(b) Expenses Ratio = ------------------------------------- x 100
Net Sales
It indicates the percentage of each item of expense in relation to net sales.

Net Sales
So, Expenses Ratio = ----------------------Fixed Assets

Net Sales
(c) Net Sales to Inventory = -------------------Inventory

Net Sales
(c) Net Sales to Net Worth = --------------------Net worth

Net Sales
(d) Net Sales to Net Profit = ------------------------------ x 100
Net Profit after Tax

TURNOVER RATIOS
Turnover ratios indicate the effectiveness with which the assets are utilized in a firm.
These are also called Activity Ratios.
(a) Inventory Turnover Ratio (ITR)
It is also called Stock Turnover Ratio. It is the number of times its average inventory is
sold during a year. There are three alternative formulas for this ratio, as given below:
ITR = Cost of goods sold / Average inventory at cost
ITR = Sales / Average inventory at cost
ITR = Sales / Average inventory at selling price
A ratio of 6 or 7 times is considered satisfactory. But there is one rule of thumb": a high
inventory turnover is an indication of good inventory slow-moving and absolute items
resulting in blocking of funds, or too highly frequent stock-outs. These situations should
be avoided. Holding of inventory may be expressed in number of days also as follows:

Average holding period of inventory = days in a year / ITR

(b) Debtors Turnover Ratio (DTR)

This ratio indicates the speed at which the debtors are converted into cash. It is also
called "Receivable Turnover Ratio".

Credit Sales in a year

DTR = ----------------------------Debtors
The optimum ratio is dependent on the credit policy of the firm and credit period
allowed to the customers. If the credit period is 30 days, the ratio should be 12:1.
Suppose if the ratio is 12:2, i.e., 6:1 the realisation from debtors is taking two months
instead of credit policy of one month.
The debtors include the gross amount of debtors (i.e. without deducting the provisions
for bad and doubtful debts and provision for discount on debtors) and outstanding bills
receivable which have not been discounted with the bankers. Sometimes, we have to
calculate the average collection period of debtors. In such case, the formula is as follows:
Average Collection Period = Days in a year / DTR
Or
Average Collection Period = (Debtors x days in a year) / Credit sales in a
year

(c) Creditors Turnover Ratio (CTR)

Similar to debtors Turnover Ratio, Creditors Turnover Ratio also can be calculated as:
Credit purchase in a year
CTR = ----------------------------------------Creditor

This ratio indicates the speed at which the creditors are paid. The ratio here also is
dependent on the credit period allowed by suppliers. The creditors include the gross
amount of creditors (i.e. without deducting the provision for discount on creditors) and
bills payable.
Average payment period = Days in a year / CTR
Or
Average payment period = (Creditor x days in a year) / Credit purchases in a
year

Sales
(d) Fixed Assets Turnover = --------------------Fixed Assets
This ratio indicates the frequency with which the fixed assets are unutilized.
Sales
(e) Total Assets Turnover = --------------------Total Assets

Sales
(f) Working Capital Turnover = -----------------------Working Capital

Working Capital
(g) Working Capital to Inventory = ---------------------------Inventory

Working Capital
(h) Working Capital to Total Assets = ---------------------------Total Assets

Total cash and bank payment

(i) Total Assets Turnover = -----------------------------------------------Average cash and bank balance

Sales
(j) Current Assets Turnover = ------------------------Current Assets

Inventory
(k) Inventory to Working Capital = -------------------------Working Capital

Debtors
(l) Debtors to Working Capital = --------------------------Working Capital

Cash
(m) Cash to Working Capital = -----------------------Working Capital

Capital
(n) Capital Output ratio = -----------------------------Value of Production

- End of Chapter LESSONS - 3 & 4

SIGNIFICANCE OF IMPORTANT RATIOS

A Current Ratio
(a) indicates the firms ability to pay its current liabilities; i.e. day to day financial
obligations.
(b) shows short-term financial strength.
(c) is a test of credit strength and solvency of a firm.
(d) indicates the strength of working of capital
(e) indicates the capacity to canyon effective operations.
(f) discloses the over-trading or under-capitalisation.
(g) shows the tendency of over-investment in inventory.
(h) more than 2:1 indicates sound solvency position.
(i) less than 2:1 indicates inadequate working capital.
(j) discloses the quantity of working capital position and not its quality.
(k) helps a credit manager or lending officer to arrive at decisions based on some figures
of accuracy.

A Liquid Ratio
(a) is a more stringent test of a firm's ability to meet its intermediate liabilities.
(b) is true test of business solvency.
(c) is more of a qualitative concept whereas current ratio discloses quantitative aspect of
working capital.
(d) indicates the inventory build-up when studied along with current ratio because of
the following formula: Liquid Assets = Current Assets Inventory.
(e) is a stringent test of liquidity, because of eliminating inventory in its calculations.
(f) is a more important ratio for financial institutions.
(g) more than 1:1 indicates sound financial position.
(h) less than 1:1 indicates financial difficulty.
A Gross Profit Ratio
(a) indicates the basic profitability of a firm, i.e., trading results of a firm.
(b) indicates the degree of efficiency of the production department, purchase
department, sales department and the degree of cost control (i.e. material control,
labour efficiency and overheads control).
(c) indicates the trend of trading results by doing a comparison of GP ratios over 5 to 10
years.
(d) shows whether the percentage of mark up on the goods is maintained or not.
(e) higher ratio indicates the higher profitability.
(f) lower ratio indicates the lower profitability and unfavourable markup policy.
A Net Profit Ratio
(a) indicates the relationship between net profit and net sales.
(b) is the most significant of all revenue ratios as it indicates the ultimate profitability of
the firm.
(c) is useful to the share holders for knowing the earnings per share (EPS).

(d) is useful to investors in judging the prospects of return on their investments.

(e) indicates the degree of efficiency and profitability of the firm upon studying with
operating ratio.
(f) indicates scale of company's non-operating expenses and non-operating income,
upon studying with operating net profit ratio.
(g) indicates scale of company s non-operating expenses and non-operating income,
upon studying with GP Ratios.
(h) is described as an index of "Operational Efficiency".
(i) higher ratio indicates higher profitability,
(j) lower ratio indicates lower profitability.
Note: A high NP Ratio is not always a favourable indication of a firm's profitability.
For a detailed study of the firm's profitability, the following factors are also to be
studied:
1) Market Conditions,
2) Sales Volume
3) Pricing policy
4) Sales Mix
5) Stock turnover ratio
6) Debtors turnover ratio
7) Cost of capital
8) Return on investment (ROI) of other firms in the same industry etc.
Earning Power or Return on Total Resources
(a) is an index of earning power of a firm.
(b) is an index of optimum utilisation of funds or economic productivity capital.
(c) indicates the degree of efficiency of management.

(d) provides a standard measure of operating efficiency.

(e) helps to make capital investment decisions.
(f) higher ratio is favourable and lower ratio is unfavorable
Note: Total Resources = Total Assets Employed

Return on Total Equity

a) shows the earning capacity of proprietors funds (including preference shareholders).

b) is important to prospective investors and shareholders.
c) high ratio will improve the market price of the share in stock exchange.
d) high ratio enables the management to raise finances easily even from external
resources.
(e) high ratio gives scope for more retained earnings which can be used for expansion,
diversification and consequential development of business.
(f) When the ratio has been high for a period of 4 or 5 years, shareholders can expect the
company to issue bonus shares.
Note: While calculating the above ratio, the preference dividend need not be deducted.
Return on Common Equity

(a) shows the efficiency in the management of equity share holders funds.

(b) higher ratio indicates higher profitability and higher EPS

(c) lower ratio indicates lower profitability and ineffective utilisation of equity share
holders funds.
(d) If EPS is higher, the market value of equity shares will be higher in stock exchange
and issue of bonus shares will also be feasible.
Note: The Preference shares are considered as "Non-participating"
Earnings Per Share (EPS)

(a) indicates the earning power of equity share capital.

(b) helps in dividend declaration.
(c) helps in estimating the market price of shares.
(d) if higher, market value of equity share will be higher in the stock exchange.
(e) if it has been high for a period of 4 to 5 years, issue of bonus share will also be
feasible.
(f) can be improved by use of borrowed funds to a greater extent.
Note: Dividend Per Share (DPS) = Dividend declared / No. of equity shares

Proprietary Ratio
(a) indicates long-term financial solvency of the firm.
(b) shows the general financial strength of the firm.
(c) shows the proportion of assets financed by the proprietors.
(d) measures the extent of protection available to the creditors.

(e) is a test of long-term credit strength.

(f) determines the extent of trading on equity.
(g) higher ratio (more than 75%) shows lesser dependence on external sources, sound
financial position, greater security available to creditors, no trading on equity.
(h) lower ratio (less than 60%) shows more dependence on external sources and
unsound financial position. It is dangerous during the period of depression.
Note: It can never exceed 1:1 i.e. 100%. When there are outside liabilities, the ratio
would be 1:1 and the standard ratio would be 60% to 75%.
Capital Gearing Ratio
(a) analyses the capital structure of a company effectively.
(b) helps to ascertain whether a company is practicing trading on equity and if so, to
what extent.
(c) low gearing indicates trading on equity, over capitalization and low EPS.
(d) aids in regulating a balanced capital structure in a company.
(e) high gearing indicates under capitalization. It is favourable for a company earning
high profits. EPS will be higher but it will fall disproportionately against a slight fall in
net profits,
(f) It affects the dividend policy of the company.
Note: According to capital issues control act a ratio of 1:4 between equity and
preference capital is reasonable.
Operating Ratio
(a) brings out the relationship between cost of goods sold + operating expenses and net
sales.
(b) is useful to ascertain the administration efficiency.
(c) is a test of operational efficiency of the business.
(d) is useful for ejecting the areas of inefficiency and consequential lower profits.
(e) low ratio indicates operational efficiency and higher profits.
(f) high ratio indicates the lower profits.

(g) when trend analyses is done for a period of 5 to 10 years, reasons can be analysed for
any rise or fall in operational efficiency.
Expense Ratios
(a) bring out the relationship between various elements of operating costs and net sales.
(b) enable the management in controlling costs and improving the managerial
efficiency.
(c) when studied over a period of 5 to 10 years, trend analysis can be done to improve
profitability.
Inventory Turnover Ratio (ITR)
(a) indicates the number of times its averages inventory has been sole and replaced
during the year.
(b) is an important factor that controls profitability of firm.
(c) indicates whether investment in inventory is high or not. This ratio can be useful for
introducing effective inventory management in the areas mentioned below.
(d) helps in controlling inventory levels to avoid over-stocking and stock-outs, avoiding
slow-moving, non-moving inventories and surplus or obsolete stores etc.
(e) indicates whether capital is blocked in slow-moving inventories and thereby
indicates the possibility of reducing selling prices of those items.
(f) reflects excess stock and/or accumulation of obsolete items in stock.
(g) when studied with inventory to working capital ratio, it becomes more significant.
(h) of 6 or 7 times is considered satisfactory. A high inventory turnover is an indication
of good inventory management and favourable trading situation. A low ratio indicates
excessive inventory including slow-moving and obsolete items resulting in blocking of
funds.
Note: A too high inventory turnover ratio may be the result of low level including
frequent stock-outs. This situation should be avoided.
Debtors Turnover Ratio (DTR)
(a) If the credit period is 30 days, the ratio should be 12:1. If the ratio is 6:1, it means
that the realization from debtors is taking 2 months instead of credit policy of 1 month.
Hence, lower DTR indicates poor collection from the debtors. Then, bad debts would

increase, and profits will be lower. Hence, suitable measures are to be taken to improve
the credit collection.
(b) indicates the quality of debtors also, i.e. good, doubtful or bad etc it is useful in the
preparation of working capital budgets.
(c) is useful in the preparation of working capital budgets.
(d) is a very useful supplementary test to the current ratio.
(e) shows the effectiveness of credit control.
(f) indicates the speed at which the debtors are converted into cash.
Inventory to Working Capital Ratio
(a) shows the extent to which working capital is blocked in inventory. Working capital is
required for the firm but it should not be blocked up in inventory.
(b) if more than 1:1, indicates unsound working capital, i.e., excessive inventory.
(c) if less than 1:1, indicates sound working capital position and effective inventory
management.
(d) indicates whether working capital is adequate or not.
(e) is related to current ratio as well as liquid ratio.
PROBLEMS & SOLUTIONS
1. Calculate the following for the years 1990 and 1991 using figures made available:
a. Return on capital employed
b. Current Ratio
c. Debt/Equity Ratio
d. Fixed Assets Turnover Ratio
e. Inventory Turnover Ratio
f. Earnings Per Share
g. Dividend Cover

Solution:

2. Summarized Balance Sheet of M/s Arun and Co. for the years 1987 and 1988 is as
follows:

Using the technique of ratio analysis comment on the performance of the company
during 1988.
Solution:
The ratios for assessing the performance:

Comments:
i. Performance of the company has declined in 1988 due to:
(a) Lower turnover
(b) Higher capital employed
(c) Higher material consumption (40% of turnover)
(d) Higher working capital and higher current assets
(e) Higher wages, other costs and interest on loan
ii. Dividend-payout Ratio was 88% in 1988. The company should not have paid so many
dividends in view of lower earnings. 12% dividend should have been declared on Equity
Capital Ratio of Rs.17 lakhs i.e. Rs.3.04 lakhs dividends. Then the Dividend-payout
Ratio would have been: (2.04 / 5) x 100 = 40.8%
iii. The Profit / Capital Employed has come down from 30% to 8.62%.

3. SDG Limited has approached one of your clients with a request that he should invest
Rs.5,00,000 in the shares of the company. The shares are in addition to the existing
capital. The existing shareholders are willing to waive their rights under the companies
Act in this respect.
At present the fixed assets of the company are valued at Rs.10,00,000/- (with a
mortgage in favour of 6% Rs.4,00,000 debentures).
Some of the ratios worked out from the final accounts of the company are as follows:

Would you recommend to your client to the shares as suggested by the company?
Solution:
Improvement in sales has been achieved by reducing Gross Profit percentage. Net Profit
to Sales decreased but there is marked improvement in Yield on Capital Employed.
I recommend to my client to subscribe the shares, provided the SDG Ltd. acts on the
following lines:
a) Out of Rs. 5,00,000 only Rs.1,00,000 should be utilized for improving working
capital.
b) Balance Rs.4,00,000 should be utilized for expansion purposes.
c) Not to redeem debentures, which carry interest, at only 6%.
d) Before expansion, market potentially should be studied.

4. Following is the balance sheet of Bharat Steel Works Ltd. As on 31st March, 1992:

The Management makes the following estimates for the year ending 31st March, 1993:
Purchases upto February, 1993

Rs. 30,40,000

And during March, 1993

Rs. 2,10,000

Sales upto February 1993

Rs. 44,80,000

And during March, 1993

Rs. 5,00,000

Management decides to invest Rs.3,00,000/- in purchases of fixed assets which are

depreciated to 10%. The time lag for payment to creditors and receipts from debtors is
one month. The business earns a gross profit of 33 1/3% on turnover. Sundry expenses
against gross profit will amount to 12% of the turnover excluding depreciation of fixed
assets.
Prepare a proforma balance sheet of the company for the year ending 31st March, 1993.
Solution:

EXERCISES
1. The following are summarized Profit & Loss account for the year ending 31-12-1996
and the Balance Sheet as at the date:

Additional information:
i. Average Debtors Rs.12,500
ii. Average Credit Purchases Rs.40,000
You are required to calculate:
a) Stock Turnover Ratio
b) Debtors Turnover Ratio
c) Creditors Turnover Ratio
d) Sales to Working Capital
e) Sales of Fixed Assets
f) Sales to Capital Employed

g) Sales to Capital Employed

h) Return on Shareholders
i) Investment
j) Current Ratio
k) Acid Test Ratio
l) Gross Profit Ratio
m) Net Profit Ratio
n) Operation Ratio

2. The following is the Balance Sheet of a Limited Company as on 31 March 1996.

Calculate a) Current Ratio; b) Quick Ratio; c) Inventory to Working Capital Ratio; d)

Debt to Equity Ratio; e) Proprietary Ratio, f) Capital Gearing Ratio, g) Current Assets to
Fixed Assets Ratio.

3. Summarized balance sheets of Alpha Ltd. as of 31 March 1992, 1993, 1994 are given
below:

From the above balance sheet, compute the following as at 31st March 1992, 1993 and
1994:
a) Debt Equity Ratio, b) Current Ratio, c) Working Capital, d) Fixed Assets Ratio.

4. Mr. Desai intends to supply goods on credit to A Ltd. and B Ltd. The relevant financial
data relating to the companies for the year ended 30th June, 1994 are as under:

Advice with reasons as to which of the companies he should prefer to deal with?

5. You have been asked by the management of "The Wonderful Supplies Limited" to
project a trading and Profit & Loss account and Balance Sheet on the basis of the
following estimated figures and ratios for the next financial year ending march 31st
,1994:

Capital Employed Rs.50,00,000; Ratio of Gross Profit 25%; Stock Turnover Ratio 5
times; Average Debt Collection period 3 months; Creditors Velocity 3 months; Current
Ratio 2; Proprietary Ratio (Fixed Assets to Capital Employed) 80%; Capital Gearing
Ratio (Preference Shares and Debentures to Capital Employed) 30%; Net Profit to
issued Equity Capital 10%; General Reserve and Profit & Loss to issued Equity Capital
25%; Preference Share Capital to Debentures 2; Cost of Sales Consists of 50% for
material; Gross Profit Rs.12,50,000. Working notes should be clearly shown.

6. The Accounts of ABC Ltd. consists of fixed assets while its current liabilities comprise
bank credit and trade credit in the ratio of 2:1. From the following figures relating to the
company for the year 1996, prepare its balance sheet showing the details of working.

7. You are given the following information about two companies:

i) Calculate Liquidity Ratios for the two companies.

ii) Give your interpretation of the liquidity position of the two companies as revealed by
the ratios.

8. From the following particulars pertaining to current assets and current liabilities
given in the comparative Balance Sheet of Bharat Co. Ltd. You are required to comment
on the liquidity position of the company with the help of accounting ratios.

Hint: Calculate Current Ratio, Quick Ratio, Stock Turnover Ratio, and Debtors Turnover
Ratio.

QUESTIONS
1. Discuss the significance of financial ratios as a tool of decision making. What are the
limitations of ratio analysis?
2. How are financial ratios classified? What do these ratios convey?
3. Discuss the merits and shortcomings of ratio analysis?
4. What ratios would you calculate to measure long-term solvency position of a
company?
5. What ratios would you use to measure profitability of a company?
6. Describe with illustrations the usefulness of following ratios:
a. Gross Profit Ratio;
b. Net Profit Ratio;
c. Stock Velocity Ratio;
d. Working Capital Ratio;
e. Current Ratio;

f. Operating Leverage;
g. Financial Leverage;
h. Operating Ratio;
i. Sales to Fixed Assets;
j. Net Worth to Fixed Assets.
7. Explain and illustrate the following terms used in accounting:
a) Price Earnings Ratio
b) Capital Gearing
c) Inventory Turnover
d) Net Income - Debt Service Ratio
e) Gross Profit Ratio
f) Expense Ratio
g) Payout Ratio
h) Earnings per Share
8. Describe the various ratios that are likely to help the management of a manufacturing
unit in forming an opinion on the solvency position of business.
9. Examine the relationship between liquidity, solvency and profitability.
10. Explain five accounting rations that are likely to help the management of a
manufacturing unit in forming an opinion on the efficiency of business.
11. Ratio Analysis is a tool to examine the health of a business with a view to make the
financial results more intelligible? Explain.

- End of Chapter LESSON - 5

INTRODUCTION TO FUNDS FLOW ANALYSIS

Significant technique of financial analysis is 'Funds Flow Analysis'. It is designed to

highlight changes in the financial condition of a business concern between two points of
time, which generally conform to beginning and ending financial statement dates.
Although financial statements supply useful information to the management and
describe the nature of changes in ownership as a result of the periods productive and
commercial activates, these statements fail to mirror the fund changes have taken place
over a given time span. They do not spell out the movement of funds, it is more
important to which these funds the ultimate success of a business enterprise depends on
where got and where gone situations. The funds flow statement is, therefore, prepared
to uncover the information, which the financial statements fail to describe clearly.
Thus funds flow statement is a report, which summarizes the events taking place
between the two accounting periods. It spells out the sources from which funds were
derived and tire uses to which these funds were put. This statement is derived from an
analysis of tire changes that have occurred in assets and liabilities items between two
balance sheet dates. In this statement, only the net changes are shown so that tire
outcome of a transition or of a series of transactions up" the financial condition of a
business enterprise is reflected more sharply.
Concept of Fund
Kenneth Midgely and Ronald G. Burns define the term fund, as one used in the sense
spending power: it refers to the value embedded in assets. According to Bonneville and
Dewey, "funds" constitute the operating any business enter price. In the ordinary
parlance, fund means cash only. But it has got several different concepts mentioned
below.
Funds may mean
1. Cash only
2. Net working capital i.e. current assets less current liabilities.
3. Total resources or total funds
4. Internal resources only.
5. Net worth i.e. owner's equity capital plus reserves.
Uses of funds Flow statements
1. It is a supplementary statement to the Balance Sheet and P & L account

2. It gives the information how the funds have been obtained from different sources i.e.
External, Internal etc. and how they have been spent.
3. It helps to know where the profits went.
4. It helps the management for declaration of dividends or panning of a dividend policy
or issue of bonus shares.
5. It suggests the ways to improve the working capital position
6. It helps in planning for retirement of long-term debts.
7. Sometimes companies will be having funds in spite of net loss. Institutional finance
depreciation is higher than net loss, there will be fund form operations, and sometimes a
firm will not have funds in spite of profits. All these will be known through funds flow
statement.
8. This is useful to the bankers while sanctioning the credit to the firms.
9. It helps the finance manager in financial planning, decision-making and allocating
the resources for productive investments.
10. It helps to know the changes in working capital and determine the efficiency of
working capital management.
According to Perry Mason, funds statements reflect changes in capital structure and the
management in recommending the ways and means of straightening the working capital
position.
The National Association of Accountants states the following uses of funds statements:
1. Estimating the amount of funds needed for growth;
2. Improving the rate of income assets;
3. Planning the temporary investment of idle funds;
4. Securing additional working capital when needed;
5. Securing economies in the centralized management of cash in organizations whose
management is decentralized;
6. Planning the payment of dividend to shareholders and interest to creditors- and
7. Easing the effects of insufficient cash balance.
Funds flow statement provides ready answer to the following questions:

(a) Where did profits go?

(b) Why were dividends no larger in spite of adequate profits?
(c) How was it possible to pay dividends in excess of profits or despite a loss?
(d) How was working capital financed?
(e) How much capital was newly raised?
(f) Where was Increase in share capital utilised?
(g) Where is the value of fixed assets purchased?
(h) Whether the external financing was necessary to purchase assets?
(i) What are the sales proceeds of fixed assets sold? Why were they sold?
(j) How much debenture finance was currently raised? And why were the debenture
issued? How were these capitals?
(k) What is the change in working capital?
(l) Why should be money borrowed to finance purchase of raw materials plant and
machinery
(m) How was the increase in working capital financed? Why are the net current assets
decreased although the net profit has increased?
(n) Why are the net current assets decreased although the net profit has increased?
(o) Why are the net current assets increased although the net profit has increased?
(p) How was repayment of debit arranged?
(q) How was the expansion in a plant and equipment financed?
(r) How did the net worth increase?
(s) What happened to the assets that resulted from the increase of net worth?
Application of funds / Utilization of funds
The following are the purposes for which funds may be utilized:
(a) Purchase of fixed assets.

(b) Purchase of investments.

(c) Increase of working capital.
(d) Redemption of preference share capital.
(e) Payment of loans & long-term debt.
(f) Non-trading payments like payment of equity dividends, interim dividend, and
preference dividends.
(g) Purchase of own debentures in the markets.
Limitations of funds:
(a) Non-fund transactions are ignored and hence it cannot provide full financial analysis
unless supported by ratio analysis etc.
(b) It is criticized for just re-arranging the financial information obtained from the
financial statements.
(c) It does not give anything new or original over and financial statements.
(d) FFS is an historical statement and it does not indicate any price level changes.
(e) It does not show changes in working capital for which a separate statement has to be
prepared.
These limitations should be taken into consideration while analysing the
funds flow statement:
(i) Not Fool-proof: The financial statement is not completely fool-proof, as it depends
upon conventional financial statement, viz., balance sheet, income statement, etc.
(ii) No Introduction of New Items: It does not introduce any new or original items which
can enhance or reduce the financial data appearing elsewhere, that is, in the
conventional financial statements and supplementary schedules and focus attention on
those facts which are significant for any investigation.
(iii) Not Relevant: A study of changes in cash is more relevant than a study in changes in
funds.
(iv) Historical: The statement of changes, like other financial statements, is essentially
historical in nature. It does not estimate sources and applications of funds for the near
future.

(v) No disclosure of Structural Changes: This statement does not disclose structural
changes in financial relationship in a business enterprise nor major policy changes in
investments in current assets and short-term financing. Significant additions to
inventories financed by short-term creditors are not projected in the statement, because
they are offset by each other in the process of computation of net change in working
capital.
Preparation of Funds Flow Statement
In order to prepare a Funds Flow Statement, it is necessary to find out the "sources" and
"application" of funds.
Sources of funds:
Funds from Operation: Funds from operations is the only internal source of funds.
Some adjustments are to be made in calculating funds from operations to the net profit
given in the financial statement.
Calculation of Funds from Operation:
The following procedure is to be followed in the calculation of funds from operations
1. Start with the Net Profit given in the profit and loss account.
2. Add the following items to the net Profit, as they do not result in outflow of funds.
(i) Depreciation on fixed assets.
(ii) Preliminary expenses or goodwill etc. written off.
(iii) Contribution to debenture redemption fund, transfer to general reserve etc.,
if they have been deducted before arriving at the figure of net profit.
(iv) Provision for taxation and proposed divided. These may be taken as
appropriations of profits or current liabilities for the purposes of funds flow
Statement. Tax or dividends actually paid is shown as an application of funds. All
these items will be added back to net profit if already dedicated, to find funds
from operations.
(v) Loss on sale of fixed assets.
3. Deduct the following items from Net Profit, as they do not increase the funds.
(i) Profit on sale of fixed assets, since the full sale proceeds are taken as a
separate source of funds and inclusion here will result in duplication.
(ii) Profit on revaluation of fixed assets.

(iii) Non-operating incomes such as dividend received or accrued rent. These

items increase funds but they are non-operating incomes. They will be shown
under separate heads as "sources of funds" in the Funds Flow Statement.
In case the Profit and Loss Account shows 'Net Loss' this should be taken as an item
which decreases the funds
Statement of Sources and Application of Funds:
1. Funds from Operations: It is an internal source of funds. Funds from operations
are to be calculated as per the method stated above.
2. Funds from long-term loans: Long-term loans such as debentures, borrowings
from financial institutions will increase the working capital and therefore, there will be
inflow of funds. However, if the Debentures have been issued in consideration of some
fixed assets, there will be no inflow of funds.
3. Sale of fixed assets: Sale of land, buildings, and long-term investments will result
in Generation of funds.
4. Funds from increase in share capital: Issue of shares for cash or for any other
current asset or in discharge of a current liability is another source of funds. However
shares allotted in consideration of some fixed assets will not result in funds. However, it
is recommended that such purchase of fixed assets as well as issue of securities to pay
for them be revealed in Funds Flow Statement.
5. Decrease in Working Capital: Decrease in Working Capital is the result of
decrease in current assets or increase in current liabilities. In both the cases in flow of
funds takes place. Suppose stock, a current asset reduces from Rs.15,000 to Rs.12,000.
The decrease of Rs.3,000 is assumed to be due to the disposal of stock, which would
bring funds into the business. In the same way, increase in current liabilities means
lesser payment, so retaining funds is also a source.

- End of Chapter LESSON 6

FUNDAMENTAL FLOW STATEMENT

Total Resources Basis

The preparation of the funds flow statements on total resources basis is fairly simple.
The successive balance sheets are compared and changes in each balance sheet item is
noted and classified as a source of funds or a use of funds as follows:

Fundamental Flow Statement: Working Capital basis

The sources and uses of funds statement, on working capital basis, presents (i) the
sources of working capital (ii) the uses of working capital, and (iii) the net change in

working capital. Here, working capital is defined as the net working capital, which is
simply the difference between current assets and current liabilities.
What are the sources of working capital? What are the users of working capital?
Sources of Working Capital:
The Sources of working capital are The operation of the business generates revenues and entails expenses. Revenues
augment, working capital expenses, other than depreciation and other a motivations,
decrease working capital. Hence the working capital increase on account of operations is
equal to profit after tax + depreciation.
As issue of share capital results in an inflow of working capital because it brings cash
inflow of an increase in short-term receivable.
When a long-term loan is taken there is an increase in working capital because of cash
inflow. A short-term loan, however, does not have any effect on working capital. Why? A
short-term loan increases a current asset (cash) and current liability (short-term loan)
by the same amount, leaving the working capital position unchanged.
When a fixed asset, a long-term investment, or any other non-current asset is sold there
do cash or short-term receivables represent a working capital inflow?
Uses of Working Capital
The uses of Working capital are:
The payment of dividend results in a cash (working capital) outflow.
The repayment of long-term loans, debentures, and other long-term liabilities involves
cash outflow and hence a use of working capital. The repayment of a current liability, it
may be noted, does not affect the working capital position because it entails an equal
reduction in current liabilities and current assets.
When a firm purchases fixed assets, long-term investments, or other non-current assets,
it pays cash or incurs a short-term debt. Hence, working capital decreases.
Funds Flow Statement: Cash basis
The sources and uses of funds statement, on cash basis shows (i) the sources of cash, (ii)
the uses of cash, and (iii) the net change in cash. The sources of cash are sources of
working capital plus changes within the working capital account, which augment the
cash resources of the business. What are these working capital account changes? They
are simply the decreases in current assets other than cash, of course. The uses of cash,
again, are the uses of working capital plus changes within the working capital account,

which deplete the cash resources of the business. These latter changes are simply the
increases in current assets other than cash. The sources and uses of cash are listed
below:

Non-fund transactions are ignored and hence it cannot provide full financial analysis
unless supported by ratio analysis etc.
(a) It is criticized for just re-arranging the financial information obtained from the
financial statements.
(b) It does not give anything new or original over and above financial statements.
(c) FFS is an historical statement and it does not indicate any price level changes.
(d) It does not show changes in working capital for which a separate statement has to be
prepared.
The above limitations should be taken into consideration while analysing the funds flow
statement.
CASH FLOW STATEMENT
George Phillipatos is of the view that, in its generic sense, a cash flow is the receipt and
the payment of amount of money and that it implies more than our accrual or a financial
obligation, hence cash flow is a movement of cash, which is a real one. Leon Simons
observes that a cash flow is frequently and erroneously assumed to include only current
operations.
Funds flow statement is prepared on the basis of "working capital concept of funds". But
in cash flow statement, no classification of current and non-current is made. Hence,
even changes in the constituents of working capital are reflected in the cash flow
statement. Accordingly, realisation of debt is a source of cash and payment to creditors

is an application of cash. A separate statement of changes in working capital is not

required in this case. In addition to changes in current assets, changes in non-current
accounts are also analysed to determine the inflow and outflow of cash.

Thus a cash flow statement is a financial statement indicating the increase or decrease
in cash of a company during a period. It shows the inflow and outflow of cash during the
period and finally the balance.
While preparing the cash flow statement, "actual cash concept" is used. Where the
information regarding the actual cash inflow and outflow is not available, notional cash
concept can be used.
Cash Flow Statement for a Period

The governing body of the Bombay Stock Exchange has amended Clause 32 of the listing
agreement. The following new clause has substituted in its place:
"The company will supply a copy of the complete and full Balance Sheet, Profit and Loss
Account and the Directors' Report to each shareholder and upon application to any
member of the Exchange. The company will also give a cash flow statement along with
the Balance sheet and profit and loss account. The cash flow statement will be prepared
in accordance with the requirements prescribed by SEBI.
In view of this amendment, all listed Companies/Entities whose financial year-ends on
March 1996 and thereafter will be required to give Cash Flow Statement along with
Balance Sheet and Profit and Loss Account. The above amendment comes into effect
immediately i.e. wef 15-2-1996.
The proforma of Cash Flow Statement is given below:
ABC LTD.
Cash flow statement for .

A. Cash flow from operating activities

Net Profit before Tax and Extraordinary Items
Adjustments for;
depreciation
foreign exchange
investments
interest / dividend
Operating Profit Before Working Capital Change
Adjustments For;
Trade and Other Receivables
Inventories
Trade Payable
Cash Generated From Operations
Interest Paid
Direct Taxes Paid
Cash Flow Before Extraordinary Items
Extraordinary Items
Net Cash From Operating Activities
B. Cash Flow From Investing Activities
Purchase of Fixed Assets
Sale of Fixed Assets
Acquisitions of Companies
(as Per Annexure)

Purchase Of Investments
Sale Of Investments
Interest Received
Dividend Received
Net Cash Used In Investing Activities
C. Cash Flow From Financing Activities
Proceeds From Issue Of Share Capital
Proceeds From Long Term Borrowing
Repayment Of Finance Lease Liabilities
Dividends Paid
Net Cash Used In Financing Activities
Net Increase In Cash And Cash Equivalents
Cash And Cash Equivalents As At.
(Opening Balance)
Cash And Cash Equivalents As At .
(Closing Balance)

- End of Chapter LESSON 7

DIFFERENCES BETWEEN FUNDS FLOW AND CASH FLOW STATEMENTS

DEFINITIONS
Cash comprises cash on hand and demand deposits.
Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant risk of
changes in value.
Cash flows are inflows and outflows of cash and cash equivalents.
Operating activities are the principal revenue-producing activities of the enterprise
and other activities that are not investing or financing activities.
Investing activities are the acquisition and disposal of long -term assets and other
investments not included in cash equivalents.
Financing activities are activities that result in changes in the size and composition of
the equity capital and borrowings of the enterprise.
OBJECTIVE

Information about the cash flows of an enterprise in useful in providing users of

financial statements with a basis to assess the ability of the enterprise to generate cash
and cash equivalents and the needs of the enterprise to utilize those cash flows. The
economic decisions that are taken by users require an evaluation of the ability of an
enterprise to generate cash and cash equivalents and the timing and certainty of their
generation.
The objective of this standard is to require the provision of information about the
historical changes in cash and cash equivalents of an enterprise by means of a cash flow
statement which classifies cash flows during the period from operating, investing and
financing activities.
SCOPE
1. An enterprise should prepare a cash flow statement in accordance with the
requirements of this Standard and should present it as an integral part of its financial
statements for each period for each period for which financial statements are presented.
2. This Standard supersedes International Accounting Standard IAS 7, Statement of
Changes in Financial Position Approved in July 1977.
3. Users of an enterprise's financial statements are interested in how the enterprise
generates and uses cash and cash equivalents. This is the case regardless of the nature of
the enterprise activities and irrespective of whether cash can be viewed as the product of
the enterprise, as may be the case with a financial institution. Enterprises need cash for
essentially the same reasons however different their principal revenue-producing
activities might be. They need cash to conduct their operations, to pay their obligations,
and to provide returns to their investors. Accordingly, this Standard requires all
enterprises to present a cash flow statement.
BENEFITS OF CASH FLOW INFORMATION
A cash flow statement, when used in conjunction with the rest of the financial
statements, provides information that enables users to evaluate the changes in net
assets of an enterprise, its financial structure (including its liquidity and solvency) and
its ability to affect the amounts and timing of cash flows in order to adapt to changing
circumstances and opportunities. Cash flow information is useful in assessing the ability
of the enterprise to generate cash and cash equivalents and enables users to develop
models to assess and compare the present value of the future cash flows of different
enterprises. It also enhances the comparability of the reporting of operating
performance by different accounting treatments for the same transactions and events.
Historical cash flow information is often used as an indicator of the amount, timing and
certainty of future cash flows. It is also useful in checking the accuracy of past
assessments future cash flows and in examining the relationship between profitability
and net cash flow and the impact of changing prices.

The following are the uses of cash flow analysis:

1. It is very helpful in understanding the cash position of a firm. Since cash is the basis
for carrying on business operations, the cash flow statements is very useful in evaluating
the current cash position.
2. It helps the management to understand the past behavior of the cash cycle, and to
control the uses of cash in future.
3. The repayment of loans, replacement of assets and other such programmes can be
planned on its basis.
4. It throws light on the factors contributing to the reduction of cash balance in spite of
increase in income or vice-versa.
5. A comparison of the cash flow statement with the cash budget for the same period
helps in comparing and controlling cash expenditure.
6. The cash flow statement is helpful in making short-term financial decisions relating to
liquidity, and the ways and means position of the firm.

- End of Chapter LESSON - 8

PREPARATION OF CASH FLOW ANALYSIS

Steps in the Preparation of Cash Flow Analysis:

Cash flow statement takes into account only those transactions which result in
immediate inflow and outflow of cash. The preparation of cash flow statement involves
the following stapes.
1. Calculation of cash from operations.
(a) Operational profit.
(b) Changes in the current assets and current liabilities.

2. Changes in non-current liabilities, i.e. share capital, debentures, loans, and

mortgages.
3. Changes in non-current assets i.e. building, plant, machine and furniture etc.
CASH FROM OPERATIONS
It includes cash received against profit and inflow or outflow of cash due to change in
current assets and current liabilities. Calculation of cash from operation involves the
following:
Calculation of Operational profit:
Excess of current years profit over the previous year's profit is assumed to be in the
form of cash, if all transactions are in cash. It should be, noted that profit here means
operating net profit. While calculating this operating net profit we have to take into
account only operating income and operating expenses will be added to it and nonoperation income are to be deducted. In case of adjustment it is advisable to prepare
adjusted profit and loss account and calculate profit from operation in the same way, as
we do calculate in case of 'Funds Flow Statement'. The following adjustments are to be
made to the net profit:
Non-operating Expenses: These expenses do not result in outflow of cash but the
net profit is reduced due to the effect of these expenses. In other words, cash from
operation increases in comparison to profit.
Depreciation: Depreciation is charged on fixed assets. It appears at the debit side of
profit and loss a/c and thus reduces profit. Depreciation is non-cash item, so it does not
reduce cash. In order to ascertain operating profit depreciation will be added to net
profit. When preparing profit and loss account to find out profit earned during the year,
the depreciation account will be written at the debit side of profit and loss a/c.
Amortisation of intangible assets: Intangible assets consist of those assets, which
cannot be seen or touched. These assets are goodwill, patents right and trademarks etc.
In order to calculate cash generated from operations, we have to add back these items to
the profit made during the year. In case of preparing adjusted profit and loss account
intangible assets written off is posted at the debit side to calculate profit earned during
the year.
Amortisation of deferred expenses: These expenses are actually revenue
expenditure but they are capitalised and written off over certain year's preliminary
expenses, discount or loss on issue of shares, debentures and deferred revenue
expenditure. When these assets are written off, they are charged out of profit and loss
account and thus reduce profit. Cash will not be reduced. It is, therefore, necessary that
the amount written off for these assets should be added to profit to find out the profit
earned during the year.

Loss on sale of fixed assets: The profit of the year will reduce with this loss but cash
will not reduce. It is, therefore necessary that this item should be added to the profit to
ascertain the amount of operating profit.
Provision for doubtful debts and discount on debtors: This provision reduces
profit without reducing cash. As such the item should be added to profit ascertain the
operating net profit.
Creation of reserves: Certain reserves and funds are created to meet certain known
or unknown liabilities. These reserve and funds may be general reserve, reserve fund,
sinking fund, capital redemption reserve, dividend equalization and workmen
compensation funds etc. These funds are charged out of profit and loss a/c so they
reduce profit. These are not cash items, so the outflow of cash does not take place. In
order to calculate operating net profit these reserves and funds are added to profit to
calculate operating net profit.
Non-operating income:
Income not concerned with the day-to-day affairs of the business is known as notoperating income. Profit or gain on sale of fixed assets, refunds of taxes, receipts of
interest, dividend and compensation are the examples of the non-operating income.
These items are posted at the credit side of profit and loss account, so they increase
profit of the business without increasing cash balance. Non-operating income should be
deducted from profit to find out operating net profit.
Changes in the current liabilities and current assets (except cash): Current
assets consist of debtors, stock, bills receivable prepaid expenses, accrued income,
short-term investment, etc. Values of individual current assets may either increase or
decrease.
Changes in Non-current liabilities: Changes in non-current liabilities may also
result in inflow and outflow of cash. Inflow of cash will takes place in the following
cases.
Issue of shares or increase in capital: Increase in the value of share capital during
the current year in comparison to previous year is supposed to be the issue of shares,
which will undoubtedly bring cash into business and inflow of cash will take place.
Issue of Debentures: If additional debentures have been issued during the current
ear, inflow of cash will take place. Increase the balance of debenture current year as
compared to the previous year is assumed to be issue of debentures.
Increase in loan or mortgage: If the balance of loan or mortgage increases during
the current year, it will be assumed that additional loans have been borrowed and cash
flow inside the business has taken place.

The change in the value of non-current liabilities will result in the outflow
of cash in the following cases:
Redemption of Share capital or decrease in share capital: In certain cases
company redeems its redeemable preference shares and thus outflow of cash takes
place. Decrease in the balance of capital during the current year is assumed to be the
redemption.
Repayment of debentures: Debentures are the loans taken by the company. These
debentures are redeemed as per the terms of issue. Redemption of debentures results in
outflow of cash. Decrease in the value of debentures is assumed to be payment of
debentures.
Decrease in loan or mortgage: In case of payment of loan or mortgage, cash will
reduce and outflow of cash will takes place. .
Payment of tax and dividend: Payment of taxes and dividend is the normal feature
of the company. Whenever taxes and dividends are paid cash goes outside the business.
If the balance of provision for taxation regarding previous and current years is given, it
may be assumed that the previous year's provision of taxes has been paid during the
current year. In case of adjustment, provision fox tax account is prepared to calculate
the amount of taxes paid during the year. The same treatment is accorded to dividend.
Changes in Non-current Assets:
Change in non-current assets generally fixed assets also results in inflow or outflow of
cash.
Sale or decrease in the value of fixed assets: Sometimes the company sells a part
of its land, building, plant, machinery, furniture and vehicles etc. The sale fetches cash
and inflow of cash takes place. Decrease in the value of fixed assets is assumed to be its
sales.
Cash from operations: Cash from operations: Cash from operations for the purpose
of cash flow statement is the net flow (i.e., the difference between total receipts and total
payments). Funds from operations represent the net flow in a rough way. Further
adjustments as discussed above are required to arrive at the net flow of cash. This is
tabled below:

PREPARATION OF CASH FLOW STATEMENT

The cash flow statement is prepared starting with cash balance at the beginning of the
year. To the opening balance, cash from operations and other inflows from long-term
assets and liabilities are to be added. Items to be deducted are those involving outflowclosing balance of cash. The format of cash flow statement is given below.

PROBLEMS AND SOLUTIONS

1. From the following information prepare a Fund Flow Statement for Excellent Ltd. for
the year ended 31.3.1992.

The net profit for the year after adjustment in respect of provision for dividends taxation
was Rs.10,00,000. There was addition to fixed assets during the year amounting to
Rs.4,00,000 and depreciation for the year was Rs.3,00,000.
Solution:

The Funds Flow Statement for Excellent Limited for the year ended 31.3.1992 is given as
follows:

2. The Comparative Balance Sheets of XYZ Company are given below:

The income statement for XYZ Limited for 1991 is given below:

a) Prepare a Sources and Uses of Funds Statement on total resources basis.

b) Prepare a Sources and Uses of Funds Statement on working capital basis.
Solution
Funds flow statement (total resources basis) for XYZ company for the year ended 1991:

Funds Flow Statement (working capital basis) for XYZ Limited for the year ended 1991:

Changes in internal content of working capital:

3. The following data gives information about Black, White & Co. during the year ending
31.12.1989. You are required to prepare Funds Flow Statement for the year 1989.

Solution:

4. A company had the following transactions during the year ended 31 July, 1989:
Rs.
(i) The Profit before Tax amounted

38,0000

(ii) New equipment purchased on cash down basis 1,20,000

(iii) Bank loan raised from Bank of Baroda

1,00,000

(iv) Dividends paid to stockholders

50,000

(v) Insurance premium

10,000

There was an increase in accounts receivable by Rs.10,000. Land was sold for
Rs.1,00,000. Expenditure incurred on repairs amounted to Rs.5,000. You are required
to prepare a statement of Sources and Uses of Funds for the company for the year
ending 31st July, 1989.
Solution:

Note: the total of all sources arrives at Rs.2,38,000. However, the total use, excepting
cash, comes to Rs.1,95,000. Difference between these two amounts (Rs.2,38,000
Rs.1,95,000) is the increase in cash amounting to Rs.43,000 as indicated above.

5. The Comparative Balance Sheets of Excellent Ltd. are given below:

(i) The net profit for the year after adjustment in respect of provision for dividends
taxation was Rs.10,00,000
(ii) There was addition to fixed assets during the year amounting to Rs.4,00,000 and
depreciation for the year was Rs.3,00,000
Prepare Statement of changes in Working Capital and Funds Flow Statement.
Solution:

EXERCISES
1.From the following Profit and Loss A/C of Finolex Ltd., calculate funds from
operations of business.

2. Calculate funds from operations from the following P & L account of Apple Ltd.

3. Following are the summarized balance sheets of Modi Ltd as on 31st December 1994
and 31st December 1995:

Calculate funds from operations.

4. From the following balance sheets of PAL Ltd. as on 31st March 1995 and 1996,
prepare (i) a schedule of changes in working capital, and (ii) Statement of Sources and
Application of Funds for the year ended 31st March 1996.

Additional Information:
1. Dividend of Rs.11,500 was paid
2. Depreciation written off plant was Rs.9,000
3. Income tax paid during the year was Rs.16,500

5. The following are the summarized balance sheets of Alpha Ltd. as of 31.12.1998 and
1999. You are required to prepare a statement of changes in the work capital.

QUESTIONS
1. List any 5 main sources of funds, and any 5 main applications of funds.
2. State the objectives of analysing funds flow statement.
3. From the following P&L account of Finolex Ltd. calculate funds from operations of
business.

4. Calculate funds from operations from the following P&L account of Apple Ltd.

5. Following are the summarized balance sheets of Modi Ltd as on 31st December 1995
and 1996.

Prepare a statement of changes in working capital.

6. What are the sources of working capital? What are the uses of working capital?
7. Funds flow statement presents a decisional view of business. Comment.
8. Discuss the salient features of the format for the cash flow statement recommended
by Institute of Chartered Accountants of India.

- End of Chapter -

LESSON - 9
CAPITAL MARKET

A good capital market is an essential pre-requisite for industrial and commercial

development of a country. Credit is generally, required and supplied on short-term and
long term basis. The money market caters to the short-term needs only. The capital
market meets the long-term capital needs. Capital market is a central coordinating and
directing mechanism for free and balanced flow of financial resources into the economic
system operating in a country.
The development of a good capital market in a country is dependent upon the
availability of savings, proper organization of its constituent units and the
entrepreneurship qualities of its people. Before independence, the capital market of
India was ill-developed because of its certain defects. But in recent years since
independence, the capital market of India has substantially changed and has been
changing for the better.
What is Capital Market?
The term 'capital market' refers to the institutional arrangements for facilitating the
borrowing and lending of long-term funds. In the widest sense, it consists of a series of
channels through which the savings of the community are made available for industrial
and commercial enterprises and public authorities. It is concerned with those private
savings, individual as well as corporate, that are turned into investments through new
capital issues and also new public loans floated by government and semi-government
bodies.
A capital market may be defined as an organized mechanism for effective and efficient
transfer of money-capital or financial resources form the investing parties, i.e.,
individuals or institutional savers to the entrepreneurs (individuals or institutions)
engaged in industry or commerce in the business would either be in the private or public
sectors of an economy.
Objectives and importance of capital market
An efficient capital market is a pre-requisite of economic development. An organized
and well-developed capital market operating in a free market economy (i) ensures best
possible coordination and balance between the flow of savings on the one hand and the

flow of investment leading to capital formation on the other; (ii) directs the flow of
savings into most profitable channels and thereby ensures optimum utilization of
financial resources.
Thus, an ideal capital market is one where finance is used as a handmaid to serve the
needs of industry. Finance is available at a reasonable rate of return for any proposition,
which offers a prospective yield sufficient to make borrowing worthwhile the
development of savings proper organization of intermediary institutions and the
entrepreneurial qualities of the people. The capital market must facilitate the movement
of capital to the point of highest yield. Thus a capital market strives for the mobilization
and import of foreign capital and investment to augment the deficit in the required
financial resources so as maintain the expected rate of economic growth.
Importance: The pace of economic development is conditioned, among other things
by the rate of long-term investment and capital formation. And capital formation is
conditioned by the mobilization, augmentation and canalization of invisible funds. The
capital market serves a very useful purpose by pooling the capital resources of the
country and making them available to the enterprising investors. Well-developed capital
markets augment resources by attracting and lending funds on a global scale. The Eurocurrency and Euro-bond markets are international finance markets in terms of both the
supply and demands for funds.
The increase in the size of the industrial units and business corporations due to
technological developments, economies of scale and other factors has created a situation
where the capital at the disposal of one or few individuals is quite insufficient to meet
the investment demands. A developed capital market can solve this problem of paucity
of funds. For an organized capital market can mobilize and pool to gather even the small
and scattered savings and augment the availability of ingestible funds. While the rapid
growth of joint stock companies has been made possible to a large extent by the growth
of joint stock business, it has in its turn encouraged the development of capital markets.
A developed capital market provides a number of profitable investment opportunities
for the small savers.
Recent development in the Indian capital market
A number of developments have taken place in the Indian Capital Market with the
launching of financial reforms since July 1991. In the process, the capital market is
being built. Some of the important developments that have taken place in the Indian
capital market during the last few years are as below:
Year 1992
(1) Ordinance promulgated according statutory powers to the Securities and Exchange
Board of India (SEBI) as a regulatory authority over various constituents of the capital
market.

(2) CCI abolished and free pricing introduced.

(3) The Center Exchange of India begins operations as a second-tier course permitting
smaller companies to raise funds.
(4) Insider trading made an offence.
Year 1993
(5) A number of private sectors Mutual Funds launched schemes to mobilize fund for
investment.
(6) Increase in minimum number of share applications and proportionate basis of
allotment introduced.
(7) Capital adequacy norms for brokers announced.
(8) Ordinance to amend FERA promulgated on January 8, 1993
(9) Foreign Institutional Investors (Floss) registered by SEBI
Year 1994
(10) National Stock Exchange (NSE) begins on line scrip-less trading in India.
(11) Private placement of issues with FIIs begins.
These developments have given rise to a number of new financial intermediaries in the
Indian capital market. The important ones include (i) Merchant Banking; (ii) Mutual
Funds; (iii) Leasing and Hire Purchase Companies; and (iv) Venture Capital Companies.
The Indian capital market has undergone remarkable changes in the post-independence
era. Certain steps taken by the government to place the market on a strong footing and
develop it to meet the growing capital requirements of fast industrialization &
development of the economy have significantly contributed to developments that took
place in the Indian capital market during the last four decades or so.
The important factors that have contributed to the development of the capital market
in India are the following:
(1) Legislative measures: Laws like the Companies Act, The Securities Contracts
(Regulation) Act and the Capital Issues (Control) Act empowered the government to
regulate the activities of the capital market with a view to assuring healthy trends in the
market, protecting the interests of the investors, efficient utilization of the resources,
etc.

(2) Establishment of Development Banks and Expansion of the Public

Sector: Starting with the establishment of the lFCI, a number of development banks
have been established as the national and regional levels to provide financial and other
development assistance to the entrepreneurs and enterprises. These institutions today
account for a large chunk of the industrial finance.
The expansion of the public sector in the money and capital markets has been
accelerated by the nationalization of the insurance business and the major part of the
banking business. The life insurance was nationalized in 1956 and the General
Insurance in 1972. The Reserve Bank of India was nationalized as early as 1949. The
Imperial Bank, the largest commercial bank in India, was nationalized and established
as the State Bank of India in 1955. The fourteen major private commercial banks were
nationalized in 1969. With the nationalization of the six leading private banks in 1980,
over 90 per cent of the commercial banking business came to be concentrated in the
government sector.
Thus, an important aspect of the Indian capital market is that the government owns a
large part of the investible funds available in the organized sector. The new economic
policy will change the trend.
(3) Growth of underwriting business: There has been a phenomenal growth in the
underwriting business, thanks mainly to the public financial corporations and the
commercial banks. After the elimination of forward trading, brokers have begun to take
on underwriting risks in the new issue market. In the last one decade, the amount
underwritten as percentage of total private capital issues offered to public varied
between 72 per cent and 97 per cent.
(4) Public confidence: Impressive performance of certain large companies
encouraged public investment in industrial securities.
(5) Increasing awareness of investment opportunities: The improvement in
education and communication has created more public awareness about the investment
opportunities in the business sector. The market for industrial securities has become
broader.
Recent Developments
Particularly since the mid 1980, there has been a very remarkable up trend in the new
issues market and the stock market, culminating in a tremendous boom in the stock
market in recent years. Many issues, including some mega issues, have been very highly
oversubscribed.
The equity cult is growing very fast in India. The number of shareholders increased from
two million in 1980 to seven million in 1985 and vast projected to reach 15 million by
1990. In 1988, the Reliance Industries with over 3 million shareholders became the
second largest company in the world in terms of the number of shareholders.

The growth of the mutual funds is another remarkable recent development. The mutual
funds which serve an investor population of several millions were estimated to have an
ingestible fund of around Rs.18,000 crores at the end of March 1990, UTI alone
accounting for Rs.15,892 crores.
The Budget for 1992-93 made the following important proposals in respect of the
capital market:
(1) Government control over capital issues, including premium fixation, to be abolished.
Companies to be allowed to approach the market directly, proving the issues are in
conformity with published guidelines related to disclosure and other matters related to
investor protection.
(2) Mutual funds to be allowed in the private sector also.
(3) Companies with good track record to be permitted to issue convertible debentures or
equity to investors abroad, and to extend to these issues the same tax benefits as
available for offshore mutual funds. This is to enable domestic companies to tap the
large pool of equality funds available in the world capital markets.
(4) Governments to also consider ways of allowing reputable foreign investors to invest
in Indian capital market with suitable mechanisms to ensure that this does not threaten
loss of management control. The proposals are part of the economic reform being
ushered in India.
Capital Market Reforms and Developments
The number of Stock Exchanges has increased gradually and the capital market has
expanded substantially. However, the functioning of the stock exchanges shows many
shortcomings with long delays, lack of transparency in procedures and vulnerability to
price rigging and insider trading. To counter these deficiencies Government established
the Securities Exchange Board of India (SEBI) in 1988 and it was given statutory powers
by an ordinance promulgated on 30th January 1992. SEBI has wide ranging powers of
control over the capital market.
The Capital issues (Control) Act, 1947, was repealed in May 1992, and the office of the
Controller of Capital Issues (CCI), was subsequently abolished. With the abolition of
CCI, prior Government permission was no longer needed by companies to access the
capital markets. Companies are free to approach the documents cleared by SEBI.
Control over price and premium fixation has also been removed and most issuing
companies are free to fix the price of their securities for public as well as rights issues.
Indian companies have been permitted to access international capital markets through
Euro-equity issues aimed at mobilizing capital for modernization and import
requirements. Several companies have been given such permission.

A number of other steps have also been taken in recent years by the Government and
SEBI to introduce improved practices and greater transparency in the capital markets in
the interest of healthy capital market development:
(i) SEBI has been authorized to conduct inspections of various mutual funds. These
inspections have been conducted and SEBI has submitted a report on each inspection,
which brings out various deficiencies of individual mutual funds. Corrective steps are
being taken to set right these deficiencies.
(ii) SEBI has also drawn up a programme of inspecting stock exchanges.
(iii) The process of registration of intermediaries such as stockbrokers and sub brokers
has been provided under the provisions of the Securities and Exchanges Board of India
Act (MO) 1992. The registration is on the basis of certain eligibility norms such as
capital adequacy, infrastructure etc.
(iv) Companies issuing capital in the primary market are now required to disclose all
material facts and specific risk factors associated with their projects.
(v) Merchant banking has been statutorily brought under the regulatory framework of
SEBI. The merchant bankers are now to be authorized by SEBI. They will have to adhere
to stipulated capital adequacy norms. Merchant bankers have to abide by a code of
conduct, which specifies a high degree of responsibility towards investors in respect of
the pricing and premium fixation of issues, and disclosures in the prospectus or offer for
issues.
(vi) Financial institutions and banks have established the National Stock Exchange of
India (NSEI) with IDBI as nodal agency. The markets all over the country by providing
nation-wide stock trading facilities and electronic clearing and settlements. Over the
Counter Exchange of India (OTCEI) was also established.
(vii) In order to induce companies to exercise greater care and diligence for timely
action in matters relating to the public issue of capital, SEBI has advised the stock
exchanges to collect from companies making public issues, a deposit of one percent of
the issue amount which be forfeited in case of non-compliance with the provisions of the
listing agreement and, non-dispatch of refund orders and share certificates by registered
post within the prescribed time.
(viii) Regulations on insider trading under the provisions of the SEBI Act have been
notified. Such regulations will help in protecting and preserving the market's integrity
and in the long run help inspire investor confidence in the market.
(ix) RBI has liberalized the investment norms evolved for NRIs by allowing companies
to accept capital contributions and issue shares or debentures to NRIs or over corporate
bodies without prior permission.

(x) The Government has allowed foreign institutional investors (FIIs) such as pension
funds, mutual funds, investment trusts asset or portfolio management companies etc. to
invest in the Indian capital market provide they register with SEBI.
(xi) To make the governing body of a stock exchange more broad-based SEBI has issued
guidelines for its composition. According to these guidelines the governing body of the
stock exchanges should have five elected members, not more than four members
nominated by the Government or SEBI and three or fewer members nominated as
public representatives, besides its executive director.
(xii) The Banker to the issue' has been brought under purview of SEBI for investor
protection.
(xiii) The 'due diligence certificate' by lead managers, regarding disclosures made in
offer document has been made a part of the offer document itself for better
accountability and transparency on the part of the lead managers.
(xiv) New reforms by SEBI in the primary market included improved disclosure
standards, introduction of prudential norms and simplifications of issue procedures.
Companies are required to disclose all material facts and specific risk factors associated
with their projects while making public issues.
(xv) Stock exchanges are advised to amend the listing agreement to ensure that a listed
company furnishes annual statement to the stock exchanges showing variations between
financial projections and projected utilization of funds made in the offer documents and
actual. This will enable shareholders make comparisons between performance and
promises.
(xvi) SEBI introduced a code of advertisement for public issues for ensuring fair and
trustful disclosures.
(xvii) To reduce cost of issue, underwriting by issues made optional, subject to the
condition that if an issue was not underwritten and was not able to collect 90 per cent of
the amount offered to public, the entire amount collected would be refunded to the
investors.
(xviii) Redressal of complaints of investors is to be encouraged, sharing it with
recognized investor associations. This will facilitate filing of class action suits in
consumer courts against erring companies.
(xix) SEBI introduced regulations governing substantial acquisition of shares and
takeovers and laid down the conditions under which disclosures and mandatory public
offers are to be made to the shareholders.
(xx) Renewal of transactions in 'A' group securities is prohibited, so that transactions
could be settled within 7 days.

(xxi) Private mutual funds are permitted and a few such funds have already been set up.
All mutual funds allowed applying for firm allotment in public issues.
(xxii) UTI has been brought under the regulatory jurisdiction of SEBI
(xxiii) To improve the scope of investments by mutual funds, mutual funds have been
permitted to underwrite public issues and the guidelines for investment in money
market instruments were relaxed.
(xxiii) The practice of making preferential allotment of shares at prices unrelated to the
prevailing market prices was stopped and fresh guidelines were issued by SEBI.
(xxiv) The procedures for lodgment of securities for transfer were considerably eased for
domestic and FII's through the introduction of jumbo transfer deeds and consolidated
payment of stamp duty.
The process of reforms in the capital market has only just begun. It needs to be
deepened to bring about speedier conclusion of transactions, greater transparency in
operations, improved services to investors, and greater investor protection while at the
same time encouraging the corporate sector to raise resources directly from the market
on an increasing scale. Major modernisation of the stock exchanges to bring them in line
with world standards in terms of transparency and reliability is also necessary if foreign
capital is to be attracted on any significant scale.
Distinction between Capital Market and Money Market
The capital market should be distinguished from money market. The capital market is
the market for long-term funds; on the other hand money market is primarily the
market for short-term funds. However, the two markets are closely related as the same
institution many a times deals in both types of funds, i.e. short-term as well as long
term.
The main points of distinction between the two markets are as under:

Constituents of Indian Capital Market

After independence, the rapid growth and expansion of the corporate and public
enterprises has necessitated the development of the capital market in India. The capital
market is composed of the borrowers, who demand funds and the lenders, who supply
funds in the market. An ideal and sound capital market always tries to offer adequate
quantity of capital to any industrial and business house at a reasonable rate which is
expected to result in high prospective yield to make the borrowing worthwhile.
In India, the capital market is broadly divided into two parts, i.e. (a) The gilt-edged
market and (b) The industrial securities market.
The guilt-edged market is backed by the Reserve Bank of India for marketing the
government and semi-government securities. In this type of market, the value of
securities remains stable and therefore, it is very much demanded by the banks and
other financial institutions.

The industrial securities market is another segment of capital market, which deals
with shares and debentures of old and new companies. Such market is again divided
into new issue market and the old capital market known as stock exchange.
The new issue market indicates the system of raising new capital by selling shares and
debentures issued by companies. The old capital market refers to the marketing set up
of securities already issued by various companies. Although both the two types of
markets are equally important but sometimes the new issue market gets more
importance for the establishment of new industries so as to attain a higher rate of
growth. But the functioning of new issue market will become successful only when the
scope for transferring existing securities is abundant.
Moreover, the capital market is again divided into primary capital and secondary capital
market. The primary capital market is a kind of new issue market related to the
issue of shares, preference shares and debentures of various non-government public
limited companies and also for raising fresh capital by the Government issuing public
sector bonds. On the other hand, the secondary capital market is a market for old
and issued securities. Thus the secondary capital market is comprised of industrial
security market or the stock exchange, engaged in buying and selling of industrial
security land the gilt-edged market, engaged in buying and selling of government and
semi-government securities.

- End of Chapter LESSON - 10

FUNCTIONS OF CAPITAL MARKET

The major functions performed by a capital market are:

(i) Mobilization of financial resources on nation-wide scale.
(ii) Securing the foreign capital and know-how to fill up the deficit in the required
resources for economic growth at a faster rate.
(iii) Effective allocation of the mobilized financial resources, by directing the same to
projects yielding highest yield or to the projects needed to promote balanced economic
development.
Structure of the Indian Capital Market
The capital market in India may be classified into two categories, viz., organized and
unorganized. The structure of any capital market is composed of the sources of demand

for and supply of long-term capital. In the organized sector of capital market demand
for long-term capital comes from corporate enterprises, public sector enterprises
government and semi-government institutions. The sources of supply of funds comprise
individual investors, corporate and institutional investors, investment intermediaries,
financial institutions, commercial banks and government.
In India, even the organized sector of capital market was ill-developed till recently
because of the following reasons:
(i) Agriculture was the main occupation, which did not lend itself to the floatation of
securities.
(ii) The foreign business houses hampered the growth of securities market.
(iii) Managing agency system also accounted for ill development of capital market as
managing agents performed both activities of promotion and marketing of securities.
(iv) The investment habit of individuals.
(v) Restrictions imposed on the investments pattern of various financial institutions.
The unorganized sector of the capital market consists of indigenous bankers and private
moneylenders. The main demand in the unorganized capital market comes from the
agriculturists, private individuals for consumption rather than production, and even
small traders. The supply of money capital comes usually from own resources of
moneylenders and falls short of the requirements made on them.
Components of Capital Market:
The following are the three main components of a capital market:
1. New Issue Market
2. Stock Market
3. Financial Institutions

Steps taken by SEBI to strengthen the capital market:

The following are some of the steps taken by SEBI to strengthen and develop the Indian
capital market:
1. Primary Market Reforms:
SEBI has introduced various guidelines and regulatory measures to improve conditions
of capital issues. As per these measures companies issuing capital in the primary
markets are now required to disclose and clarify all material facts and specific risk to
calculation of premium. In order to ensure fair and truthful disclosures, SEBI has also
introduced code of advertisement for public issues. SEBI has made the underwriting of
issue operational so as introduce the cost of issue.
SEBI has also enhanced the minimum application size along with the proportions of
each issue allowed for firm allotment to institutions such as mutual funds. SEBI has
again introduced shares and take-over and also frame conditions under which
disclosures and mandatory public offers are to be made to the shareholders.
SEBI has also brought merchant banking statutorily under its regulatory framework.
Now the merchant bankers are to be authorised by SEBI and to adopt stimulatory
capital adequacy norms and also abide by the code of conduct. Under the present
framework, merchant bankers are having greater degree of accountability in the
documentation of offer and its issue process.
In order to protect the interest of investors, the Banker to the Issue is now brought
under the control of SEBI.
SEBI has also advised stock exchanges to collect a deposit of one per cent of the issue
amount from the companies in order to attain greater care and diligence for the timely
action related to public issues of capital. In case of non-compliance of the provisions

related to listing agreement, non-dispatch of refund orders, shares certificates etc. by

registered post within the stipulated time frame, the company is going to forfeit such
one per cent deposit.
In order to make a cross check between the promises and performances of the
companies, the SEBI has advised stock exchanges to amend the listing agreement and
make it obligatory on the part of listed company to furnish annual statement to the SEs
showing variations if any, between financial projections, projected utilisation of fund
and its actual utilisation.
The Government is now permitting setting up of private mutual funds and a few have
been set up. The mutual funds are now permitted to underwrite public issues in order to
improve the scope of its investment. SEBI has also relaxed the guidelines for making
investment in the money market instruments; moreover SEBI has also issued fresh
guidelines for making advertisement by mutual funds.
In order ensure that all disclosures have been clearly made by the company in its offer
documents, SEBI checks this documents carefully as a routine job. The various
guidelines and regulatory measures, of capital issues are incorporated by the SEBI to
promote healthy and efficient functioning of the many instances of break of issue
procedures in collusion with the unscrupulous promoters and corrupt officials of the
lead banks and also with the top offices of SEBI as it was found in case of mega issue of
M.S. Shoes East Ltd. in March, 1995.
2. Global Depository Receipts (GDRs):
The Government of India permitted Indian companies to have access in the
international capital markets through Euro equity shares since 1992. In the initial
period, the Government allowed the utilisation of Euro issue proceeds for approved end
uses. Later on, with the accumulation of foreign exchange reserves with RBI, the issuing
companies were allowed to retain the Euro issues proceeds abroad and repatriate them
in times of need. Till January 1995, Indian companies have been able to raise US$ 3.6
billion through launching of GDR issues and US$ 1.1 billion through launching of Euro
Convertible Bonds (ECBs). Moreover, the Government of India allowed NRIs and
Overseas corporate bodies to buy shares and debentures without prior permission from
the Reserve Bank of India.
3. Secondary Market Reforms:
SEBI has introduced secondary market reforms and as a part of its reforms; it has
started the process of registration of intermediary like stockbrokers and sub-brokers
under the provisions of the securities and Stock Exchange capital adequacy,
transparency infrastructure etc. SEBI has also introduced rules so as to make the way
for client/broker relationship more transparent and segregate client and broker
accounts.

In order to protect and preserve the integrity of stock markets, the SEBI has introduced
certain regulations under the provisions of SEBI Act, which, in turn, would help inspire
confidence of the investor in the stock exchanges. In spite of this, insider trading rigging
of the market and manipulating stock market price quotations are still continuing.
The traditional trading system of Indian SEs has been constantly reviewed by SEBI since
1992. SEBI is instrumental in simplifying procedures, attaining transparency in costs
and prices of stocks, speeding up clearing & settlement and transferring shares in the
names of buyers. SEBI has prohibited completely the "renewal" of transactions in B'
group securities so as to settle the transactions within 7 days.
SEBI has also issued guidelines for the constitution of Governing Body (GB) of stock
exchange so as to make it broader based. Moreover, SEBI has successfully reconstituted
the GBs of stock exchanges in 1994-95.
Moreover, the Government has also permitted the foreign institutional investors (FIIs)
like mutual funds, pension funds, investment trusts, asset or portfolio management
companies etc. to invest their capital in Indian capital market as and when they are
registered with SEBI. Total number of FIIs registered with SEBI, which was only 10 in
January 1993 and 136 in January 1994, has substantially increased to 286 in January
1995. Besides, the cumulative net investments of FIIs have considerably increased from
$3 billion in January 1995, which reflects the growing impact of liberalisation policy of
the country.
4. Capital Market Reforms, 1996-97:
An array of capital market reforms was introduced during 1996-97, encompassing
primary and secondary markets, equity and debt, and foreign institutional investment.
Primary market reforms aimed at imparting greater flexibility in the issue process and
strengthening the criteria for accessing the securities market. Reforms in the secondary
market aimed at improving market transparency, identity and trading infrastructure.
Among the reforms undertaken were:
* Passing of the Depositories Act, 1996 by Parliament, providing a legal framework for
recording ownership details in book-entry form and facilitating dematerialization of
securities. The Depositories Related Laws (Amendment) 1997 issued through an
ordinance, will allow banks, mutual funds and IDBI to dematerialize their scraps.
* Formulation of SEBI (Depositories & Participants) Regulations, 1996 which allow
SEBI to regulate establishment and functioning of depositories, and to protect investor
interests.
* Tightening of entry norms for equity issue by companies to improve quality.
* Giving up vetting of public issue by offer documents by SEBI to encourage selfregulation. SEBI comments (if any) are to be sent within 21 days of filing.

* Debt issues not accompanied by an equity component permitted to be sold entirely by

the book-building process.
* Issuers allowed listing debt securities on stock exchanges even if equity is not listed.
* FIIs permitted to invest up to 10 per cent in the equity of any company, to invest in
unlisted companies, to set up pure (100 percent) debt funds, and invest in government
securities.
* Eligibility criteria for registration as an FII were modified to allow endowment funds,
university funds, foundations and charitable trusts/societies to register.
* Stock lending scheme was introduced and this will not attract capital gains.
* The SEBI (Mutual Funds) Regulations, 1993 were revised to provide for portfolio
disclosure, standardization of accounting policies, valuation norms for determining net
asset value and pricing.
* SEBI regulations on venture capital funds (VCF) were issued, allowing them to invest
in unlisted companies, to finance turnaround companies, and to provide loans. These
provide flexibility to VCFs so that high-risk finance can be provided to the market.
* Modified takeover code, based on the recommendations of the Bhagwati committee,
was approved. It requires a mandatory minimum public offer of 20 per cent purchase,
when the threshold limit of 10 per cent equity holding is crossed. Those in "control" are
permitted to purchase 2 per cent of shares per annum up to 51 per cent. To discourage
frivolous attempts, acquirers will have to deposit a certain value of cash and assets in an
escrow account. The escrow deposit would be higher for conditional public offers, unless
the acquirer agrees to acquire a minimum of 20 per cent.
* SEBI approved almost all the recommendations of the Dave Committee for improving
the working of the Over the Counter Exchange of India (OTCEI)
Primary Market Reforms, 1996-97:
The following are some of the primary market reforms undertaken during 1996-97:
* Norms for companies to access the capital market further tightened to improve the
quality of paper.
* First time issuers required to have dividend payment record in three of the
immediately preceding five years.
* For issuers who do not meet this requirement, access to markets allowed, provided
their projects were appraised by a scheduled commercial bank or a public financial
institution with minimum 10 per cent participation in the equity capital of the issuer or,
provided their securities are listed on the OTCEI.

* No entry restrictions for public sector banks to access market, and they have been
allowed to price issues at premium, with only a two year profitability record.
* A norm of 5 shareholders for every Rs. 1 lakh of fresh issue of capital and 10
shareholders for every Rs.1 lakh of offer for sale prescribed as on initial and continuing
listing requirement.
* Prohibition was imposed on payment of any direct or indirect discounts or
commissions to persons receiving firm allotment.
* SEBI gave up vetting of public issue offer documents. SEBI's comments on offer
document, if any will be communicated within 21 days of dealing, as is the case with
rights issues.
* Debt issues not accompanied by an equity component permitted to be sold contracts
(Regulation) Rules.
* If minimum shareholding requirements are met, the requirement of 90 per cent
maximum subscription in case of, "offers for sale" no longer necessary.
* The 90 per cent requirement also was done away with in case of exclusive debt issue
subject to certain disclosures and exemptions under the Companies Act.
* Housing Finance companies considered to be registered for issue purposes provided
they were eligible for refinance from the National Housing Bank.
* Corporate advertisements, between the date of issue of acknowledgement card and the
date of closure of the issue have been allowed subject to specific conditions which
include the risk factors.
* Promoters with contribution exceeding Rs.100 crore have been allowed to bring their
contribution in a phased manner, irrespective of their track record.
* Issues have been allowed to list debt securities on stock exchanges without their equity
being listed.
Secondary Market reforms, 1996-97:
The following are some of the secondary market reforms undertaken in India during
1996-97:
* Custodians of securities existing for a considerable period and engaged in providing
services to a number of institutional investors can reach the required minimum net
worth of Rs. 50 crore in a phased manner over a period.
* Custodians required by SEBI to appoint a Compliance Officer who will interact with
the SEBI regarding companies and reporting issues.

* SEBI will have monthly meeting with the Association of Custodial Agencies of India
(ACAI) before incorporating any changes that have an impact on settlement of
transactions of institutional investors.
* Stock exchanges asked to modify the listing agreement to provide for payment of
interest by companies to investors from the 30th day after the closure of a public issue.
* Uniform good-bad delivery norms and procedure for time bound resolution of bad
deliveries through bad Delivery Cells prescribed. Bed Delivery Cell procedures have
helped to standardize norms.
* All exchanges to institute the buy-in or auction procedure being followed by the
National Stock Exchange.
* In view of the falling percentage of deliveries, exchanges asked to collect 100 per cent
daily margins on the national loss of a broker for every scrip, to restrict gross traded
value to 33.33 times the brokers base minimum capital and to impose quarterly
margins on the basis of concentration ratios.
* Study group constituted to make recommendations for imparting greater transparency
and fairness in bulk of negotiated deals.
* Stock exchanges asked to set up a clearing house or clearing corporation.
* Stock exchanges disallowed from renewing contracts in cash group of shares from one
settlement to another.
* A core group for inter-exchange market surveillance set up for coordination action in
case of abnormal volatility.
* The Stock Exchange, Mumbai and other exchanges with screen based trading systems
allowed to expand their trading terminals to locations where no stock exchange exists
and to others, subject to an understanding with the local stock exchange. The setting up
of trade guarantee scheme or clearing corporation, mechanisms for handling investor
grievances arising from other centers and adequate monitoring mechanisms will be a
prerequisite.
* Several restrictions, including limits on the size of issues proposed to be listed on
OTCEI removed; and listing criteria for OTCEI relaxed. Besides, OTCEI permitted to
move to a five day accounting period settlement.
* Both short and long sales will have to be disclosed to the exchange at the end of each
day. They would be regulated through the imposition of margins.
* A stock lending scheme has been introduced. Stock lending has been approved in
which short sellers could borrow securities through an intermediary before making such
sales. The approved intermediary should have a minimum net worth of Rs.50 crore.

Steps taken by the Government to strengthen SEBI:

In order to arm SEBI with sufficient additional regulatory powers to ensure smooth and
orderly development of capital market and also to raise its ability for protecting the
greater interests of the investors, the following are some of the important features of this
ordinance:
1. The ordinance enabled SEBI to respond quickly to market conditions so as to
reinforce its autonomy. Accordingly, SEBI has been empowered to notify its regulations
and to file complaints in courts without having prior approval of the Government.
2. SEBI is now entrusted with regulatory powers over companies in respect of issuance
of capital, the transfer of securities and also in other related subjects.
3. The ordinance has empowered SEBI for imposing monetary penalties on capital
market intermediaries and different other participants for making violations in a listed
range. Moreover, an adjudicating mechanism is also proposed within SEBI to get rid of
penalties and also for constituting a separate tribunal for dealing with cases of appeal
against the verdict of adjudicating authority.
4. SEBI has now been given additional power to summon the attendance of and call for
documents for all different categories of market intermediaries, along with persons
engaged in securities market as to investigate irregularities in the capital market.
Moreover, in order to protect the investors and to attain smooth development of the
securities market, SEBI has now been entrusted with additional power to issue
directives to all intermediaries and persons related to security markets.
Measures taken by SEBI:
On March 27, 1998 the SEBI approved the Chandratre Committee report recommending
uniform listing norms for all the stock exchanges in the country. The listing norms had
been tightened by permitting compulsory listing only in accordance with the norms
specified by the SEBI. The board allowed Foreign Institutional Investors (FIIs) to lend
securities to greater liquidity in the market. It also allowed FIIs investing through the
equity route to invest in government securities up to 30 per cent of the total portfolio.
The move follows the announcement by the RBI in its 1997 busy season credit policy to
permit FIIs investing through the equity route to buy government securities. At present
only FIIs investing through 100 per cent debt route are permitted to invest in gilt-edged
securities. In this regard the board has decided to amend the SEBI (FII) Regulation
1995, accordingly.
Besides on 21st April 1998, the secondary Market Advisory Committee of Securities and
Exchange Board of India (SEBI) suggested allowing provident and pension funds to
invest in the secondary market as one of the various measures to revive the market. The
Committee was also of the view that capital gains arising from sale of investments
should be exempted from tax if proceeds are re-invested in the capital market. It also

suggested an increase in the creeping acquisition limit of two per cent. Investment by
provident funds and pension funds in the secondary market could be facilitated by
allowing floating of dedicated schemes for them by institutions and mutual funds, which
in turn could invest in the securities market. The committee urged SEBI to pending
enactment of the new companies bill.
The advisory committee agreed with the suggestion of market making committee that
institution should set aside funds for trading in illiquid scripts and thereby stimulate
market activity. The Committee also suggested that the stock exchanges should have a
target of covering 1000 cities and towns in the country by the year 2000. It also felt that
stock exchanges should evolve a satisfactory contingency plan to safeguard against
possible disruption in trading. The advisory committee also stressed the need to
standardize the minimum risks to be covered by the insurance policies taken by the
member of the stock exchanges.
The Committee also agreed upon the recommendations of the L.C. Gupta Committee on
derivatives; it stressed the need for strong regulations, surveillance and investor
education.
Thus it is found that the present trend of re-orientation of SEBI is a right step towards
the rationalization of the stock or capital market in India.

- End of Chapter LESSON - 11

ROLE OF UTI AND LIC

Unit trust of India

The Unit Trust of India (UTI), a public sector investment institution, was established in
1964, under the Unit Trust of India Act, 1963.
The IDBI, LIC, SBI and its subsidiaries and other scheduled banks and financial
institutions subscribed the share capital of the UTI. Sale of units and other savings
schemes are the main source of funds for the Trust
The main objective of the UTI is to mobilize the savings of the community and
channelizes the productive corporate investment so as to provide for growth and
diversification of the economy. It is at the same time intended to provide the facility for
an equity types of investment to the large and growing number of investors in the small
and medium income groups.

The UTI mobilizes funds from the public through a number of schemes. The saving thus
mobilized is channeled into productive activities by the Trust by investing them in the
share and debentures of industrial concerns.
It is one of the main intentions of the UTI to provide opportunity to investors belonging
to small and medium income groups to indirectly participate in the ownership of shares
and debentures of joint stock companies.
For small investors the UTI offers the advantages of (l) considerably reduced risk since
funds are invested in balanced and well distribute portfolio (ii)the befit of experiment
management; (iii) a steady income; and (iv) liquidity.
The trust's investment in any one company is restricted to certain specified limits in the
interests of diversification. Its investment is expected to cover a judiciously selected
diver's portfolio of securities designed to give to the unit holder's security of capital,
besides reasonable return and capital appreciation
Under writing the public issue of shares and debentures, direct subscription send to the
shares and debentures and subscription to the privately placed debentures are the usual
forms of assistance provided by the UTI to the industries
The UTI examines the proposals for under writings from the point of view of financial
viability of projects, prospective earnings from investments to the trust and prospects of
capital appreciation. The UTI mobilizes funds from the public through a number of
schemes. The saving thus mobilized is channeled into productive activities by the Trust
by investing them in the shares and debentures.
The trust has also joined the Inter-Institutional Meeting Forum of all India financial
Institutions, viz., IBBI, IFCI, ICICI, LIC and GIC under the aegis of the IDBI and the
UTI indicates its intention to provide financial assistance to the projects in these trust
follows more or less the norms prescribed by the IDBI.
Particularly in recent years, there has been a very substantial increase in the ingestible
funds of the Trust. Several skillfully designed new savings schemes, which have enabled
the tapping of the savings potentials of various segments, have significantly contributed
to this growth.
Apart from registering appreciable growth in sales, number of unit holding accounts,
invisible resources, income and reserves, the UTI have also been one of the significant
participants in the share capital of new financial organizations such as infrastructure
Leasing and Financial Services Ltd., Discount and Finance house of India Ltd., credit
rating information services of India Ltd., Stock holding corporation of India LTD and
Can Fin Homes Ltd., which are expected to play a vital role in the improvement and
development of the money and capital markets and housing finance in India.
Life Insurance Corporation of India

Consequent to the decision to nationalize the life insurance business, the life insurance
corporation of India was established in 1956 as a wholly owned corporation of
government of India in order to carry on the business of life insurance, and deploy the
savings to the best advantage of the policyholders and the community as a whole.
A large part of the funds of LIC is deployed as loans to assist the development of social
overheads like housing, rural electrification, water supply and sewage schemes.
However, LIC provides substantial assistance to the industrial sector. Besides normal
investment operations by way of sale and purchase of securities in stock markets and
investment in government securities, the corporation has been participating with other
all-India institutions in extending direct assistance to industries in the form of loan and
direct subscription to shares and debentures of industrial concerns. LIC extends
resource support to the term lending institutions by way of subscription to their bonds
and thus contributes to industrial financing in an indirect imager. The Corporation also
helps small and medium industries by granting loans for setting up of industrial estates.
General Insurance Corporation of India
As a member of the consortium of all-India Financial Institutions, the General
Insurance Corporation of India and its four subsidiaries (The United India Insurance Co
Ltd., Oriental Fire and General Insurance co ltd., National Insurance Co Ltd., and New
India Assurance Co., Ltd.,) Provide assistance to industries in the form of loans,
underwriting and direct subscriptions to shares and debentures, placement of shortterm deposits with companies, etc.
Besides taking right entitlement and underwriting of debenture issues GIC, along with
LIC and UTI buys a back debenture tendered by individual holders back to companies
for encashment after a stipulated period and thus provides liquidity to such long-term
financial assets
It may be noted that, as per Government guidelines, investment towards socially
oriented purposes (mainly in the form of Central/State Government securities, bonds of
public sector undertaking etc.,) should constitute around 70 per cent of annual invisible
funds of GIC.
Questions:
1. What is 'Capital Market'? Discuss its function.
2. What are the functions of capital market? Outline the structure of the Indian
Capital market.
3. What do you understand by capital market? Describe the components of capital
market.
4. Distinguish clearly between capital market and money market.
5. Enumerate the important developments that have taken place in recent years in
the Indian capital market.
6. What is the role of SEBI in a stock exchange?

7. What do you understand by marketing of securities? Explain the different

methods of marketing corporate securities.

- End Of Chapter LESSON-12

CREDIT STRUCTURE OF THE INDIAN ECONOMY

In the Indian credit structure, you may include money and capital markets with their
organized and unorganized components. The following chart explains the structure of
credit delivery system in the Country.
The Reserve Bank of India (RBI)
The Reserve Bank of India occupies the prime position in the credit structure of the
country, which is the central bank of the country. As in other developing countries, the
Reserve Bank of India has assumed the role of a regulator of monetary system and
policy in the country. It functions not only as a "watchdog", of the monetary system but
also as a promotional and development banker. According to the First Five Year Plan
"central banking in a planned economy can hardly be confined to the regulation for the
overall supply of credit... It would have to create the machinery needed for financing
developmental activities all over the country... and in ensuring that the finance
available, flows in the directions needed". Accordingly, the functions of the Reserve
Bank of India have steadily expended from merely discharging the developmental and
promotional role in meeting the demands of the growing Indian economy.
Industrial Finance
With the launching of the Five-year plans, in the absence of a sufficiently broad
domestic capital market, there was need for adopting and enlarging the institutional
structure to meet the medium and long-term credit requirements of the industrial
sector. It was in this context that the RBI took the initiative in setting up statutory
corporations at the all-India and regional levels to function as specialized financial
agencies purveying term credit.
Institutional finance for small-scale industries is provided by commercial banks - the
State Bank of India group, nationalized banks, private sector banks arid development
corporations which have been specially established to provide institutional finance. In
addition, the Reserve Bank of India gives credit guarantees and the ECGC gives export
guarantees to the small-scale sector. By its finance operations, the Institutional
Development Bank of India and NABART too, play a significant role in the promotion of
the small-scale sector. For it has enabled the SFCs and commercial banks to extend a

large quantum of financial assistance to this sector. The National small Industries
Corporation offers financial assistance in the form of its hire-purchase schemes.
The development of small-scale industries is primarily the responsibility of the State
Government; but in consideration of the fact that various questions and issues involved
in the programme of development of the small industries have an all-India character
and can be efficiently considered and tackled at the national level, and also because of
the scale on which efforts were required to tackle the problems, it was considered
desirable by the Central Government to assume responsibility for planning and
coordinating the basic programme of development. With this end in View, an All-India
Board, known as the Small-Scale Industries Board, was set-up in November 1954,
charged with the responsibility of overall planning, co-ordination and development of
small-scale industries in the country. The Board is composed of Central and State
Government Officials, representatives of various institutions, financing bodies, the
Federation of Small-Scale Industries Associations and a number of non-officials
representing trade, industry and other interests. The meetings of the Board are held by
rotation in each State, usually once every six months. This, no doubt, helps the members
to acquire first-hand knowledge of developments in every state, besides drawing their
attention to the particular problems of local industries. The Board discusses questions
connected with credit facilities, supply of raw materials, and revision of the definition of
small-scale industries for the purposes of assistance programme, dispersal of industries;
it reviews the programme of implementation and formulates new directives for a further
growth of the small industry sector. Although the Board functions in an advisory
capacity, the Government gives its decisions.
Special Financial Institutions:
Special Financial Institutions are the most active constant of the Indian Capital Market.
Such Organizations provide medium and long-term loans on easy installments to big
business houses. Such institutions help in promoting new companies; expansion and
development of existing companies and meeting the financial requirement of companies
during economic depression.
The need for establishing financial institutions was felt in many countries immediately
after the Second World War, in order to re-establish their war-shattered economics. In
underdeveloped countries, the needs for such Institutions were much more due to a
large number of organizational and financial problems inherent in the process of
industrialization. After independence, a number of financial institutions have been set
up at all India and regional levels for accelerating the growth of industries by providing
financial and other assistance.
The following are the main special financial institutions that are most active
constituents of the Indian Capital Market:
1. The Industrial finance Corporation of India (I.F.C)
2. The Industrial Credit and Investment Corporation of India (I.C.I.C.I)
3. The Refinance Corporation of India (R.F.C)

4. State Financial Development corporations (S.F.D.C)

5. National Industrial Development Corporation (N.I.D.C)
6. State Industrial Development Corporation (S.I.D.C)
7. National Small Industries Corporation (N.S.I.C)
8. Industrial development Bank of India (I.D.B.I)
9. Unit trust of India (U.T.I)
10. Life Insurance Corporation of India (L.I.C)
11. Nationalized Commercial Banks (N.C.Bs)
12. Merchant Banking Institutions (M.B.Is)
13. National Industrial Reconstruction Corporation of India (N.I.R.C)
14. The Credit Guarantee Corporation of India (C.G.C)
Industrial Financing
Finance is a pre-requisite to mobilize real resources for organizing production. In a
developing economy, however, lack of finance is not the only deterrent to economic
development. Even when finance is available, other important factors like imperfections
in the information flow and dearth of important factors like imperfections in the
information flow and dearth of entrepreneurship may come in the way of industrial and
economic development. Hence, it is necessary to make finance and other development
assistance in a package to take the dormant and developing economies to the takeoff
stage. The present trend, therefore, is to set up Development Banks rather than
institutions which merely provide finance.
"A Development Bank is a multipurpose institution which shares entrepreneurial risk,
changes its approach in tune with the industrial climate and encourages new industrial
projects to bring about speedier economic growth. The concept of development banking
is based on the assumption that mere provision of finance will not help to bring about
entrepreneurial banking should include the discovery of investment projects,
undertaking the preparation of project reports, provision of technical advice and
management services and finally assisting the management of industrial units."
After Independence, starting with the establishment of the Industrial Finance
Corporation of India in 1948,A number of development banks have been set up at allIndia and State levels for assisting the development of large, medium and small
industries by providing financial and various other promotional assistances.
There are three all-India Development Financial Institutions (DFIs) viz. Industrial
Development Bank of India (IDBI), Industrial Finance Corporation of India (IFCI) and
Industrial Credit and Investment Corporation of India (ICICI). The Industrial
Reconstruction Corporation of India (IRCI).
Established in 1971 with the main objective of revival and reconstruction Bank of India
(IRBI) in 1985 with more powers.

Besides the four institutions referred to above, the all-India financial institutions (AIFI
s) providing industrial finance are some investment institutions, namely the Unit Trust
of India (UTI), Life Insurance Corporation of India (LIC) and the General Insurance
Corporation of India (GIC) and its subsidiaries.
Development banks have been established at the State level too. In 1987, there were 18
State Financial corporations, (SFCs) and 26 State Industrial Investment/Development
Corporation (SIDCs).
Financial assistance is provided, directly or indirectly, also by National Small Industries
Corporation (NSIC), State Small Industries Development Corporations (SSIDCs) and
Khadi and Village Industry Commission (KVIC) although financing is only an ancillary
function of these organizations.
The IDBI is the apex institution, which coordinates the activities of various institutions.
A very important source of industrial finance is commercial banks.
Provision of rupee and foreign currency loans subscription to shares and debentures,
underwriting of shares and debentures, guaranteeing of deferred payments and loans
are the important type of financial assistance provided by these institutions (Some of the
institutions do not provide some of these assistances).
Development activities of the DFIs include identifying industrial potentials of different
areas; development of entrepreneurship through training and motivation; assistance in
project identification, feasibility student and preparation of project reports; technical
and managerial consultancy; seed/risk capital assistance, etc.
Direct assistance from the all-India development banks is normally confined to projects
costing over Rs.3 crores; various state level institutions and certain special institutions
like the National Small Industries Corporation (NSIC), State Small Industries
Development Corporations (SSIDCs), Khadi and Village Industries Commission (KVIC)
and banks assist small-scale (including khadi and village) units and medium-scale units
involving investment of less than Rs.3crores. However, these institutions, particularly
the IDBI, assist the small-scale sector indirectly, through schemes of refinancing
rediscounting of bills, resource support to institution assisting small-scale sector, etc.
The limit of direct subscription by the all-India DFIs to equity of companies has recently
been raised from Rs.50 lakhs to Rs. l crore.
The all-India financial institutions through consortium financing assist projects
involving very large investment, (i.e., the project is jointly financed by A group of
financial institutions). In consortium financing one of the institutions plays the lead
role, The AIFIs have been trying to make the single window concept more effective and
to expedite the process of sanction and disbursement of assistance.

The DFIs have sponsored a number of Technical Constancy Organizations (TCOs) and
some institutes for entrepreneurial /management development.
The assistance sanctioned by all financial institutions (AFIs) increased very
substantially from Rs. 118.1 crores to Rs. 70.594 crores in 1995-96.
The share of the AIFIs in the total sanctions in more than 90 percent and of the state
level development banks in one-tenth. IDBI, the premier institution alone accounts for
more than 27 percent about of the total assistance by the AFIs.
About three-fourths of cumulative assistance sanctioned by the AFIs has gone to the
private sector, about 15 percent has gone to the public sector, 77 percent to the joint
sector and the co-operative sector received 33 percent.

- End Of Chapter LESSON - 13

INDUSTRIAL DEVELOPMENT BANK OF INDIA

The IDBI was established on July 1, 1964 under the Industrial Development Bank of
India Act, 1964, as a wholly owned subsidiary of the Reserve Bank of India. In terms of
the public financial institutions Laws (Amendment) Act, 1975, the ownership of IDBI
has been transferred to the central Government with effect from February 16, 1976.
The most distinguishing feature of the IDBI statute is that it has been assigned the role
of the principal financial institutions for co-ordination, in conformity with the national
priorities the activities of the institutions engaged in financing, promoting or developing
industry. IDBI has been assigned a special role to play in the matter of:
i.
ii.
iii.

Planning, promoting and developing industries to fill vital gaps in industrial

structure;
Providing technical and administrative assistance for promotion. Management or
expansion of industry;
Undertaking market and investment research and surveys as also technoeconomic studies in connection with development of industry. IDBI is also
expected to co-ordinate, guide and monitor the entire range of credit facilities
offered by the other institutions for the small cottage sector.

IDBI is empowered to finance all types of industrial concerns engaged or to be engaged

in the manufacture, processing or preservation of goods, or in mining shipping,
transport, hotel industry generation or distribution of power, fishing or providing shore
facilities for fishing or in the maintenance, repairs, fishing or servicing of machinery or

vehicles, vessels, etc. or for the setting up of industrial estates. The Bank can also assist
industrial concerns engaged in the research and development of any process or product
or in providing special or technical knowledge or other services for the promotion of
Industrial growth.
The IDBI Amendment Act, 1986, has enlarged the definition of industrial concerns
eligible for assistance from IDBI to cover diverse range of industrial activities including
the activities of services sector of industries like informatics health care, storage and
distributing of energy and other services contributing to" value addition. The Act has
also wined the scope of business of the Bank so as to cover constancy, merchant banking
and trusteeship activities. The range of financing instruments has been further enlarged
to include lines of credit and letters of credit and IDBI has been permitted to grant loan
and advances to individuals for investment in industrial concerns.
Further, the authorized capital of IDBI was raised to Rs.l,000 crores and it can be raised
further upto Rs. 2,000 crores by the Central Government by a notification in the official
gazette.
As an apex development bank, the IDBI has been playing a leading role in the field of
industrial finance and promotion. Over the last two and a half decades the bank has
evolved new areas of promotional activities to meet the emerging needs for development
of industry. It has also strengthened the institutional structure of industrial finance in
the country with effective and appropriate linkages among the development financing
institutions based on coordinated policies and practices. It provides support to State
level institutions by way of refinance facilities and certain special schemes. Although the
direct financing by the IDBI is confined, by and large, to the medium and large-scale
units, it has been assisting the small-scale sector through its contribution to several
special schemes and resource support to the State level institutions.
The IDBI provides the following types of financial and promotional assistance:
i.
ii.
iii.
iv.
v.

vi.

vii.

Term loans (both rupee and foreign currency).

Underwriting and subscription to shares and debentures.
Financial guarantees for deferred credits and loans rose from other sources.
Soft loan assistance for modernization
Under the Technical Development Fund Schemes, matching rupee resources by
way of direct loans to industrial units, which are recipients of import licenses
under T.D.F. Scheme of Government of India.
Under the Equipment Finance Scheme, loan assistance for import of capital
goods or equipment's by existing industries against IDBI credit or for imports
covered by T.D.F. licenses.
Under the Technical Assistance Fund Scheme :
a.
Assistance for entrepreneur ship Development Programmes,
b.
Assistance for Self-employment of blind and handicapped,
c.
Subsidy for turnkey arrangements entrusted to approved technical
constancy organization (TCOs).

viii.

Seed capital assistance through SFCs and SIDCs to new entrepreneurs who do
not have adequate source of their own for setting up industrial projects.

ix.

Refinance facilities to State level financial institutions and banks for providing
assistance to small and medium industrial projects.

x.

100 per cent refinance in respect of composite term loan upto Rs.25,000
sanctioned to artisans, village and cottage industries and SSI units in tiny sector
and projects promoted by SC/ST physically handicapped.

xi.

Special scheme of confessional refinance assistance to small scale units covered

under the credit guarantee scheme.

xii.

Refinance against loans upto Rs.2 lakhs granted to technician entrepreneurs by

SFCs without insisting on promoter's contribution and at concessional rate
interest.

xiii.

Concessional finance for industries in the notified backward areas

xiv.

Under the Textile Modernization Fund Scheme, assistance for modernization on

concessional terms to spinning and composite textile and woolen mills.

xv.

Under the Venture Capital Fund Scheme, financial assistance for projects
involving development and use of indigenous technology as well as for adaptation
and use of imported technology.

xvi.

Under the Technology up gradation Scheme, assistance for selected capital goods
industries.

xvii.

Scheme for providing Automatic Standby Credit for payment of enhanced

customs duty on project imports.

IDBI provides financial assistance to cottage, tiny, small and medium enterprises
through
i.
ii.
iii.
iv.

Refinance of industrial loans granted by SFCs, SIDCs commercial/cooperative

regional rural banks;
Rediscounting of bills arising out of sale of indigenous machinery;
Seed capital assistance to new entrepreneurs.
Resource support to SFCs sub NSICs by way of subscription to shares and bonds.

In order of step up the flow of assistance to the small sector and the provide a focal
point to coordinate at the apex level the availability of both financial and non financial
inputs required for the orderly and healthy growth of sector. The IDBI established in
May 1986, Small Industries Development Fund (SIDF). In fulfillment of these
objectives, the bank took variety of measures to increase the flow of assistance to this

sector. Besides liberalizing the terms of existing schemes, new schemes were
introduced in favour of such special target groups such as women entrepreneurs and
exercise men. Assistance is also made available for such purposes as financing inhouse quality testing facilities, common quality testing centers, setting up training
cum development centers in north eastern states of the country etc
Industrial Finance Corporation
The Industrial Finance Corporation of India was established in 1948 under IFCI act,
with the object of making medium and long-term credit more readily available to
industrial concerns in India. Today IFCIs role extends to the entire industrial spectrum
of the country. While it continues to be one of the most important purveyors of direct
financial assistance to eligible industrial concerns, no less important, is its promotional
role whereby it has been helping and developing the small and medium scale industrial
entrepreneurs by providing them much needed guidance through its specialized
agencies in project identification, formulation and implementation, development of
ancillary and small-scale industries, encouraging the adoption of indigenous technology,
etc.
As in the case of recent amendments, the amendment to the IDBI Act, the amendment
to the IFCI act has broadened the scope of business of corporation and enlarged the list
of industrial activities eligible for assistance by inclusion of informatics, health care etc.
Direct financing is the corporations main business, the assistance under which, can take
any one or more of the following forms:
i.
ii.
iii.
iv.

Rupee loans
Sub-loans in foreign currencies out of the foreign exchange lines of credit made
available to it.
Underwriting of and/or direct subscription to the shares and debentures of
public limited companies and
Guaranteeing of
a.
Deferred payments for machinery imported from abroad or purchased
within the country.
b.
Foreign currency loans raised by industrial concerns from foreign
institutions and;
c.
Rupee Loans raised by industrial concerns from scheduled banks or State
Co-operative Banks or the market. Like the other all-India development
banks, IFCI also provides confessional finance to industrial units in
notified backward areas.

IFCI has been designated as the nodal point to administer the Jute Modernization Fund
set up by the Government of India and which become operative from November 1986,
with a view to revitalizing the jute industry and giving thrust to its modernization
program.

Further, IFCI has been appointed as agent of the Government of India for making
disbursement of loans from the Sugar Development Fund for rehabilitation and
modernization of sugar units and monitoring the end use of loans and affecting
recoveries.
Being a development bank the IFCI has been undertaking a number of development
activities. These include the following.
i.
ii.

iii.

Guidance to new, tiny, small-scale and medium-scale entrepreneurs in project

identification, formulation, implementation, operation etc.
Help to new and small entrepreneurs by subsidizing the cost of
Feasibility/Project Reports, market studies, diagnostic studies, revival of sick
units, development of technology and in-house R&D efforts.
The Risk Capital Foundation (RCF) sponsored by the IFCI (established in 1976)
provides risk capital assistance on soft terms to the first generation entrepreneurs
to make good, the shortfall in the requirement of promoters' contribution to the
equity capital of the medium and medium-large industrial projects promoted by
them in the cost-range of Rs.2 crores to Rs.15 crores. No interest is changed. The
assistance is normally limited to 50 per cent of the promoter's contribution
excluding the contribution from SIDC and/or other similar public sector financial
institutions to the equity of a project.

During 1986-87, the Corporation introduced the Scheme of Interest Subsidy for
Encouraging Quality Control Measures in Small-Scale Sector.
Recently, IFCI has set up a Merchant Banking Division (MBD) with its head office in
Delhi and bureau in Bombay. The MBD undertakes assignments for capital
restructuring, merger and amalgamation, loan syndication with other financial
institutions and trusteeship assignments. It guides entrepreneurs in project formulation
and raising resources for meeting project costs.

- End Of Chapter LESSON 14

INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA

The industrial credit and Investment Corporation of India Limited (ICICI) was setup in
1955 to encourage and assist industrial development in India.
Its objectives inter alias, include

i.
ii.
iii.

Providing assistance in the creation, expansion and modernization of industrial

enterprises;
Encouraging and promoting the participation of private capital, both internal and
external in such enterprises; and
Encouraging and promoting industrial investment and expansion of investment
markets.

In pursuit of its objective of promoting industrial development, ICICI provides financial

assistance in various forms such as
i.
ii.
iii.
iv.
v.
vi.

Under writing of public and private issues and offers of sale of industrial
securities, ordinary shares, preference shares, bonds and debenture stock;
Direct subscription to such securities;
Securing loans in rupees, repayable over period up to 15 years;
Providing similar loans in foreign currencies for payment for imported capital
equipment and technical services;
Guaranteeing payment for credits made by others;
Providing credit facilities to Manufactures for promoting sale of industrial
equipment on deferred payment terms.

ICICI sells securities from its own portfolio to investors whenever it can get a reasonable
price for them. It does so for the dual purpose of revolving its resources for new
investments and for encouraging the investment habit in others, there by promoting
widespread distribution of private industrial securities. Thus, unlike the normal
investor, ICICI does not retain successful investments merely because they are
profitable. On the contrary, dissemination of profitable investments is in accord with its
broad objectives and the form of ICICI's own investment in particular enterprise is
influenced by the prospect of selling it eventually
The primary purpose for which assistance is extended is purchase of capital assets in the
form of land, building and machinery of the alternative types of assistance provided by
ICICI, the one best calculated to assured the success of enterprises is chosen in each
case.
A significant feature of ICICI's operations is the relatively high share of foreign currency
loans in its assistance portfolio compared to other all India development banks.
Towards the national objective of development of backward regions, ICICI has been
extending financial assistance on confessional terms to new projects located in
backward areas.
ICICI played an active role in the techno-economic surveys of various States under the
initiative of the all India financial institutions. The surveys were carried out to
determine the industrial potential of the selected States and to suggest measures for
realizing such potential. The effort was to identify specific project based on local
resources, which would be of maximum benefit to the economy.

ICICI, in consortium with IDBI and IFCI, operates the Soft Loan scheme of
modernization of industrial concerns in cement, sugar, cotton textiles, jute and certain
engineering industries.
Consistent with its corporate philosophy and its role as an experienced development
bank, ICICI provides promotional assistance to worthwhile projects. The corporation
has provided, on a formal basis since 1973, promotional assistance like identification of
new projects on the one hand and location of suitable entrepreneurs and other. In
selecting projects for this purpose, preference is given to those with a potential to cover
immediate and emergent gaps in the economy. Special consideration is also given to
new product and process. It provides comprehensive guidance to entrepreneurs on
selected projects for their formulation on sound lines and expeditious metering to a
bankable stage. In suitable cases a small fee is charged for these services. The regional
officers of the Corporation also contribute to these activities and serve as convenient
contact points for entrepreneurs.
ICICI started a Merchant Banking Division in 1973 for advising clients, on a selective
basis, on raising finances in suitable forms and on restructuring of finances in existing
companies. It also advises clients on amalgamation proposals. Assistance is provided in
preparing proposals for submission to financial institutions and banks for negotiations
with them for loans and underwriting. The Division acts as Managers to the Issue of
Capital Assistance is provided for completion of formalities for raising loans. ICICI
charges a suitable fee for these services.
The Corporation has taken some initiatives in the field of rural development since 1976.
It has assisted on an experimental basis, projects of landscaping, agricultural research
and lift irrigation
The Corporation's interest and initiative in rural development activity was enlarged
during 1977 and Rs. 25 lakhs were earmarked for projects of rural development to be
taken up in association with industrial units and voluntary social service organizations.
ICICI considers financial assistance join liberal terms to suitable rural development
schemes initiated either by voluntary organizations or corporate bodies. The scheme
should have a demonstration value and be replicable in other rural areas. They should
aim at improving living conditions of the rural population and their impact should be
measurable. For bankable rural development schemes, ICICI extends financial
assistance in the form of seed money/margin money or suitable interest rate subsidy.
For other deserving but non-bankable schemes, ICICI extends financial support
depending on their merit and requirements.
ICICI has been instrumental in setting up the Institute for Financial Management and
Research at Madras. The Institute has been conduction's specialized courses and
carrying on research in the field of financial management.

At important development initiative taken by ICICI resulted in the formation of Housing

Development Finance Corporation Limited (HDFC) in 1977. HDFC provides long-term
loans on reasonable terms, primarily for lower and middle-income group housing.
The ICICI which commenced leasing operations in 1983 provides leasing assistance for
computerization, modernization / replacement schemes, equipment for energy
conservation, export orientation, pollution control, balancing and expansion. The
industries assisted under leasing include textiles, engineering, chemicals, fertilizers,
cement, sugar etc. ICICI has made significant effort in promoting investments in
information technology service industry like hotels and agro-based sectors like hatchery
and poultry.
In 1987, ICICI launched its Venture Capital Scheme under which long-term financial
assistance is extended to projects involving development and/ or commercialization of
new technologies, for which entrepreneurs, due to inherent high risks, may not be able
to raise funds through conventional lending mechanisms. The assistance in provided in
the form of participation in share capital, conditional loans and normal loans.
The Corporation is administering and managing the Programme for the Advancement of
Commercial Technology (PACT), which commenced with a grant of US $ 10 million
from the United States Agency for International Development (USAID). The primary
emphasis of PACT in on market oriented R& D. No. Activity from which, India and USA
would derive economic benefit.
ICICI provides special assistance to technology development projects based on
indigenous R&D efforts.
In order to broad-base technology development oriented activities, the Corporation has
promoted a new company called Technology Development and Information Company of
India Ltd. (TDICE). The major functions of TDICI would be technology financing and
technology information. Technology financing will include financing of commercial
R&D schemes through grants and conditional loans, venture capital financing and
technology up gradation financing.
The Credit Rating Services of India Limited (CRISIL) promoted by ICICI became
operational in l987. CRISIL, in whose equity banks and financial institutions have
participated, is an independent organization managed professionally
Industrial Reconstruction Bank of India
In 1971, the Government of India established an institution, namely, Industrial
Reconstruction Corporation of India (IRCI), with the main objective of reconstruction
and rehabilitation of industrial units which were closed down or were facing the risk of
closure but which could be made viable with suitable assistance.
The need for a more powerful institution to deal with the problem of industrial sickness
was felt and on March 20 1985, the Industrial Reconstruction Band of India (IRBI) was

established as per the provisions of the Industrial reconstruction Bank of India Act,
1984, and the erstwhile industrial Reconstruction Corporation of India was vested and
transferred to the IRBI on that date.
It has moved into business-oriented activities from simple revival of sick unit. In 1991,
IRBI was converted into a company, transforming it into a full-fledged financial
institution.
The IRBI gives loans for modernization, diversification, expansion and renovation as
also for meeting supplementary needs such as bridging liquidity gap and for working
capital requirements. The other forms of assistance include lines of credit, equipment
leasing, hire purchase, etc. The bank extends assistance to sick small-scale units under
its line of credit scheme which is operated through various State level agencies.
To arrest sickness at its incipient stage or to prevent any unit from falling to sickness,
the IRBI has been emphasizing the need to obtain economic size of operation,
modernization, diversification, technological up gradation etc... of its assisted units,
either singly or jointly in consortium with other all India financial Institutions. The IRBI
also provides constancy services to bank and financial, institution on a selective basis
and merchant banking services for amalgamation/ merger and reconstruction.
Stock Holding Corporation of India
A new company, namely, Stock Holding Corporation of India Ltd. (SHCI), was recently
established with its registered office in Mumbai, in order to secure efficient post trade
processing services for transactions in securities canned out by the all India financial
and investment institutions (IDBI, IFCI, ICICI, IRBI, LIC, UTI and GIC).SHCI is owned
at the outset by the seven sponsoring institutions. It would hold custody of securities of
the sponsoring institutions and handle transfer of securities as also collection of
dividend/interest in respect of such securities on their behalf. After setting up the
infrastructure facilities and gaining experience in the field, SHCI would extent its
services to others such as stockbrokers and individual investors when it would make a
public issue of share capital.
Discount and Finance House of India
The Reserve Bank of India, together with public sector banks and financial institutions
has recently set up a company called the Discount and Finance house of India Ltd.
(DFHI), to deal in short-term assets, in order to provide liquidity in money market.
State Financial Corporations
The State Financial Corporations Act 1951 has enabled the state governments to setup
state financial corporation (SFCs) to function as regional development banks making a
significant contribution to the industrial advancement of their respective states.
The SFCs are meant of finance small and medium scale industries.

Apart from their share capital the SFCs depends for financial resources on payment of
loans and income from investments, issue of bonds, refinancing of loans from the IDBI
and to a limited extent and borrowing from the RBI, deposits from the public and
occasional loans from the state governments.
The SFCs do not normally lend more than RS.60 lakhs to a single concern. The
prohibition is intended to ensure that the SFCs do not deviate from the main objective of
their creation, namely, catering to the requirements of the small and medium-scale
sectors. The large concerns can approach the all-India financial institutions - IFC, IDBI
and ICICI.
Loans or advances are granted primarily for the establishment of new industries or for
expansion and development of existing industrial concerns. Loans to the new industrial
concerns will be considered where a feasible scheme has been prepared and the
prospective industrial unit has collected the initial capital. In case of existing industrial
concerns loans are granted for the purpose of acquiring tangible assets in the form of
land, building, plant and machinery and other accessories. Foreign currency loans are
granted for importing plant and machinery, other accessories and machine tools and
technical know-how in special cases. With the exception of shipping, SFCs are now
empowered to assist all industrial activities including mining, transport by ropeways
and development of industrial areas.
Types of Assistance
1. Granting of loans or advances and subscribing to the debentures of industrial
concerns, repayable within a period of not exceeding twenty years.
2. Guaranteeing loans raised by industrial concerns in the capital market or from
scheduled banks or state cooperative banks.
3. Guaranteeing deferred payments, due from any industrial concern in connection
with its purchase of capital goods within India.
4. Underwriting the issues of stocks, shares, bonds or debentures by industrial
concerns.
5. Subscribing to the stocks, bonds or debentures of an industrial concern out of the
funds representing the special class of share capital subscribed by the State
Government and the IDBI in accordance with the provisions of Section 4A of the
SFCs Act, 1951.
The main activity of the SFCs providing loans and some of them also underwrite shares
of industrial concerns. The SFCs grant loans mainly for the acquisition of fixed assets
like land, buildings and plant and machinery. Sometimes, they also provide loans for
working capital margin in combination with loans for acquisition of fixed assets.
SFCs are also providing foreign currency loans to small and medium-scale industrial
units for import of plant and machinery and/or technical know-how under the IDA World Bank credits to IDBI.
State industrial development/investment corporations

Since 1960 many States and Union Territories have set up State Industrial
Developments Corporations (SIDCs)/state Industrial Investment Corporations (SIICs),
with the main object of accelerating the industrial development of the respective States
and Union Territories.
The SIDCs/SIICs have promoted by the State and Union Territories as promotional
bodies entrusted with the major task of promoting industries and ensuring balanced
regional growth within each State.
For efficiently carrying out the functions of promotion, improvement and development
of industries, these corporations are empowered to plan, formulate and execute
industrial undertaking, project or enterprise, which is likely to accelerate industrial
development. They promote/medium /large industrial ventures as joint sector units in
collaboration with private entrepreneurs, or as wholly owned subsidiaries and provide
risk capital to new generation entrepreneurs. Various incentive schemes of central /state
governments are also administered through them.
These corporations undertake a wide range of functions. The important functions are:
Grant of financial assistance to industrial concerns in the form of :

i.
a.
b.
c.
d.
ii.

Direct investment,
Loans,
Extension of guarantee for loans and deferred payments, and
Underwriting and subscription to the issue of shares, bonds and debentures;
Promotion and management of industrial concerns;

iii.

Provision of industrial sheds/plots; and

iv.

Promotional activities such as identification of project ideas, selection and

training of entrepreneurs, provision of technical assistance during
implementations, etc.

The corporations in states like Karnataka and Bihar are empowered to undertake special
activities like establishing and managing industrial estates, development of industrial
areas, generation, transmission and sale of electricity etc.
Out of 26 corporations in operations in the country in 1986 - 87, nine were also
functioning as SFCs.
Questions:
1. Examine credit structure of the Indian economy
2. Elaborate the types of finance divided by various institution in India
3. Enumerate special financial institutions, the active consistence of the Indian
capital market.

- End Of Chapter LESSON-15

COMMERCIAL BANKS

The Indian commercial banking system consists of 279 scheduled and non-scheduled
banks. As on September 30, 1994, the total number of branches of SCBs was 62056, of
which 35,242 were in rural areas.
Lending is an important strategy of banking. Lending sets in motion a chain of economic
activities, both direct and indirect, and fasters new service, which are conductive to
accelerate social-economic growth?
Commercial banks have been in the forefront in fostering the growth of small-scale
industry. Apart from finance, they provide a package of ancillary service to small-scale
industry both in urban and rural areas.
Commercial banks provide working capital, venture capital, medium, long-term
financial assistance and export credit to new and existing small industries for
constructing of factory buildings, purchase of machinery, raw material, marketing and
advances in four-forms viz. cash credits, overdrafts, loans and packing credits. Loans are
also extended for setting up industrial estates.
The banks have been opening specialized small-scale industries branches to enable them
to provide financial assistance at the single point. The SSI specialized branches were
already functioning in 23 of the 85 identified districts with high concentration of small
units.
The outstanding gross bank credits to industrial sector at Rs.80,492 crore as on endMarch, 1994 remained almost the same as in the previous year (Rs.78,662 crore) The
share of small scale industries in outstanding gross bank credit to industrial sector
increased by 13% from Rs. 20,026 crore as on March 19, 1993 to Rs 22 620 crore as on
March 18, 1994, where as the relative share of medium and large industries declined
marginally by 1.3% from Rs.58,636 crore to Rs.57,872 crore on March 18, 1994. The
medium and large industries claimed 71.9% of the total outstanding credit as on March
18, 1994, while small-scale industries accounted for the rest. However, between March
1993-94, the number of small-scale industry (SSI) accounts with the commercial banks,
declared from 30.40 lakhs to 30.18 lakhs.
The State Bank of India is the pioneer in financing small-scale industries. Between 199394, loans to SSI units increased from Rs.5,463 crores to Rs.5,837 crores and SSI
accounts from 9.85 lakhs to 10.00 lakhs. And, the associate banks from Rs.1663 crores

spreads over 3.47 lakes accounts to Rs. 1,946 cores spread over 3 75 lakhs accounts.
Together, State Bank group accounted for 36.1% of total amount loaned to SSI units and
45.6% of total SSI accounts. As at end 1994 March, the average amount per account
stood at Rs.58,370 for State Bank of India and Rs.51,893 for associate bank, whereas, it
worked out to Rs.69,372 for commercial banks.

The RBI has listed the following shortcomings of banks. The major shortcomings related
to lack of appropriate discretionary powers with officers, delay in sanctions of limits and
completions of formalities and not computing working capital limits in accordance with
RBI guidelines. The corrective action by the banks will improve flow of credit to the
small-scale sector.
Commercial banks and assistance to small-scale industry is quite unique in the coming
years banks operations will be affixed to the priorities of small-scale industries and will
seek to average their assistance to the maximum extent possible banks participation in
the growth of small-scale industry has been meaningful and fruitful.
Functions of RBI
On 1st April, 1935 the Reserve Bank of India (RBI) was established as per the Reserve
Bank of India Act, 1934. At first this bank was established as a joint stock bank with a
share capital of Rs.5 crores. But on 1st January 1949, the Reserve Bank (Transfer to
Public Ownership) Act 1948, by purchasing all its shares. So the RBI has been working
as the Central Bank of the country since independence.
One Central Board of Directors consisting of 20 members was from for the management
of Reserve Bank of India. The Central Office of Reserve Bank is situated at Bombay.
Moreover, four Local Boards of RBI were established at Bombay, Delhi, Calcutta and
Madras. Besides, RBI has it is regional and branch offices at Bombay, Bangalore,
Calcutta, New Delhi, Kanpur, Nagpur, Madras and Guwahati.
Functions:
The Reserve Bank of India is performing various functions related to monetary
management, banking operations, foreign exchange, developmental works and research

of problems of economy. The following are some of the major functions normally
performed by the Reserve Bank of India.
Note Issue: Being the Central Bank of the Country, the RBI is entrusted with the sole
authority to issue currency notes after keeping certain minimum reserve consisting of
gold reserve worth Rs.115 crores and foreign exchange worth Rs.85 crores. This
provision was later amended and simplified.
1. Banker to the Government: The RBI is working as banker of the Government and
therefore all funds of both Central and State Governments are kept with it. It acts
as an agent of the Government and manages its public debt. RBI also offering
"ways and means advance" to the Government for short periods.
2. Banker's Bank: The RBI is also working as the banker of other banks working in
the country. It regulates the whole banking system of the country, keeps certain
percentage of their deposits as minimum reserve, works as the lender of the last
resort to its scheduled banks and operates clearing houses for all other banks.
3. Credit Control: The RBI is entrusted with the sole authority to control credit
created by the commercial banks by applying both qualitative and quantitative
credit control measures like variation in bank rate, open market operation,
selective credit control, etc.
4. Custodian of Foreign Exchange Reserves: The RBI is entrusted with sole
authority to determine the exchange rate between rupee and other foreign
currencies and also to maintain the reserve of foreign exchange rate between
rupee and other foreign currencies and also to maintain the reserve of foreign
exchange earned by the Government. The RBI also maintains its relation with
International Monetary Fund (IMF).
5. Developmental Functions: The RBI is also working as development agency by
developing various sister organizations like Agricultural Refinance Development
Corporation, Industrial Development Bank of India etc. for rendering agricultural
credit and industrial credit in the country. In July 12, 1986, NABARD Was
established and has taken over the entire responsibility of ARDC. Half of the
share capital of NABARD (Rs. 100 Crores) has been provided by the Reserve
Bank of India.
Thus, the Reserve Bank is performing a useful function for controlling and managing
the entire banking, monetary and financial system of the country.
Development in the Banking System
Social Control of Banks
The Indian banking structure had grown considerably in strength and stability due to
the vigorous control and affective monitoring by the RBI. However, in order to remove
the differences pointed above, the government introduced a scheme of social control of
banks. According to the Banking Commission (1972), the social control scheme was
introduced with the objective of "achieving a wider spread of bank spreading, preventing
its misuse, directing large volume of credit flow to priority sectors and making it a more

effective instrument of development". The schemes sought to remove the control of

banks on business without removing the private ownership of banks. Subsequently, the
National Credit Council (NCC) was established for:
(a) Assessing the demand for credit from various sectors of the economy;
(b) Determining the priorities for grant of loans for investment in the light of the
availability of resources; and
(c) Coordinating lending and investment policies among commercial banks, cooperative banks and other financial institutions
Nationalization of banks
Despite the scheme of social control there was no significant reorientation of the lending
activities of the banks towards meeting the requirement of priority sectors like
agriculture. This resulted in the nationalization of 14 major commercial banks with
individual deposits exceeding between 50 crores in July 1969. The major objectives of
nationalization, Interlaid, were:
a. Reduction in the concentration of economic power in the hands of a few;
b. Expansion of credit to the priority areas which were to be neglected like
agriculture, small-scale industries, etc,
c. Elimination of the use bank credit for speculative and unproductive purposes;
and
d. To provide professional bent to bank management and upcoming entrepreneurs.
At the time of nationalization, the 14 major banks had a paid up capital of Rs.28.5
crores, deposits of Rs.2,626 crores, advance of Rs. 1,813 crores and 4,134 branches. In
other words the nationalized banks accounted for 80 branches, 83% deposits and 84%
advances of the whole banking system.
Lead bank scheme
The objectives of nationalization were bought to be achieved by reorientation of lending
policies coupled with a mobilization of resources through the process of a massive
expansion of branches. As a follow-up to this, the lead bank scheme was introduced in
1969 conceived like the idea of "area approach" for development of banking and credit
structure, the scheme covered 336 districts in the country (except Bombay, Calcutta,
and Uts of Delhi, Chandigharh and Goa) thus the districts all over the country were
allotted to various public sector banks. Each lead bank designated for the concerned
district was made responsible for taking a lead role in surveying and meeting the credit
needs and development of branches in the respective district. "District credit plans"
were drawn-up for this purpose with subsequent modifications; the capacity of lead

banks to formulate areas specific bankable schemes and improve the credit absorption
capacity of rural sector has been strengthened.
Regional Rural Banks
Yet another component of the "multi-agency approach" of credit system for the rural
sector emerged in 1975 with the establishment of Regional Rural Banks (RRBs). Despite
the thrust given to public sector banks in geographical spread and extension of credit to
hitero-neglected sectors, certain deficiencies remained. It was felt that unless a new set
of institutions was established, the regional and functional gaps in the rural credit
structure could not be adequately filled.
Thus, the RRBs were established with a view to combine the local feel and familiarity
with the rural problems. The RRBs are primarily sponsored by the commercial banks.
The RRBs have the primary agricultural purposes, to small entrepreneurs engaged in
trade and industry and other productive activities in rural areas. They also cater to the
needs of weaker sections of the community.
Second Nationalization
In order to more effectively meet the growing development needs of the economy and to
promote the welfare of people on a large-scale sock more commercial with D&T
liabilities of more than Rs.200 crores were nationalized in April 1980. With the second
nationalization, the number of public sector banks increased to 28 (state bank of India,
7 associates of SBI and 20 banks in the nationalized sector).
Expansion in Branch network Ranks
The most striking features of the structural transformation of the Indian Banks have
been spatial expansion of their branches. The pace of this expansion is unparalleled in
the wild, between 1969 and 1975 (before the establishment of RRBs) on an average four
bank branches were opened every day. The number of public sector bank officers went
up from 6596 in dune, 1969 to 15,077 in dune 1975 and with this, fire average
population served by a bank branch declined from 65,000 to 32,000 in keeping the
policy objectives, the banks opened more branches with die rural areas.
During 1975-79 additional 6,869 new branches were opened and the RRBs set up1968
offices during this period. Further expansion took place during 1979-84when as many as
7612 new offices were opened by the public sector banks and RRBs together had 39,910
branches by the end of march 1984 thus accounting for 90% of total bank offices in the
country.
Thanks to spatial expansion of branches there has been a phenomenal increase in the
number of deposit accounts from 1.8 crores in June 1983. Along with the growth in the
banking habit the bank deposits also went up from Rs.3.885 crores in June 1969 to
Rs.64,710 crores in December 1984.

Sectoral Diversification
The changed perspective on banking accelerated the flow of credit to priority sectors.
This is striking transformation in the banking operations in the country. Till the
nationalization of the 14 major banks, the main function of banks was to extend credit to
profitable trading and industrial sectors in the basis of security. This "security-oriented"
approach precluded banks from financing other productive activities like agriculture or
small-scale industries. Though agriculture contributed a major share of the national
income, financing of agriculture was considered to be a low-security and a high-risk
proposition. Thus, in 1968, while large-scale industry only 7% of the total credit.
After the nationalization of the major banks, the position altered rapidly and the flow of
credit to rural areas increased considerably. Along with the quantitative expansion of
branch network, there was a qualitative improvement in the lending practice of the
banks. It was noticed that a general subsistence level of income in rural areas suggested
that the majority of rural population did not have any assets to offer as security for
getting loans from the banks. In order to reach this cross-section of the population,
banks broke away from the traditional low-security-purpose-oriented lending policy.
The phenomenal change in the lending practices can be termed as a transformation
from "class banking" to "mass banking".
As a result of the change, the credit deployment of banks was drastically altered. Thus in
1985, the share of medium and large-scale industry in the total bank credit came down
to 33% while the share of priority sector like agriculture and other activities went up to
25% and that of the small-scale industry become 14% of the total bank credit.
Another notable feature of this change is the reeducation in the over-dependence of
large industrial and business houses on the banking systems for funds. It has been
mainly brought about by linking the working capital limits for industries to inventory
norms laid down on the basis of the Telecom Committee and subsequently by Chore and
Martha Committees. Launching of the integrated rural Development Program (IRDP) in
1978, with the target of assisting 15 million families by 1985, added another dimension
to the social orientation given. In fact, IRDP is the largest single program ever
attempted to eradicate rural poverty. It offers a marked role to the banks in providing
the basic input of credit.

- End Of Chapter LESSON -16

SOCIAL BANKING

The structural and operational transformation in the sectional distribution of bank

credit has been brought about by fixing up the national goals for lending by the banks.
In fact, the broader national objectives of eradication of poverty, unemployment and
growth with social justice have shaped the formulation of various directives/schemes.
These directives, inertias, include the following:
1. Advances to priority sectors by banks should reach a target of 40% of outstanding
credit (by March) 1985.
2. 16% of the total advances of banks should be made as Direct Agricultural
Advances (by March 1987).
3. Advance to the weaker sections should be 25% of the total priority sector credit.
4. 1% of the total advances of banks are made under the Differential rate of Interest
Scheme (DRIS) at a concession rate of interest. Of the above, 40% should be
provided to persons belonging to SC/ST.
5. In order to reduce regional imbalances, banks have directed to attain a creditdeposit ratio of 60% in respect of rural/semi-urban areas separately on an
ongoing basis. In other words, 60% of the deposits mobilized from the rural areas
should be deployed in these areas only.
Note:
1. Prorate sectors include agriculture, small-scale industries road and water
transport operations, setting up of new industrial estates, retail trade and small
business, professional and self-employed persons, education, housing and
consumption.
2. Weaker sections include small and marginal farmers with land holdings of 5
acres or less, landless laborers, tenant-farmers and share-croppers, artisans,
village and cottage industries, IRDP beneficiaries, DRI beneficiaries and SC/ST
borrowers.
Assistance under anti poverty-programs
As mentioned earlier, banks have been given directions for deployment of their lendable
resources in socially oriented schemes of financial assistance. The emphasis of the Sixth
Five-Year Plan, and also of the Seventh Plan, has been on providing increasing
assistance to the weakest, of the weaker sections of the population. Keeping this in view,
various anti-poverty programs have been launched by the banks. Some important ones
are briefly discussed below:
Integrated Rural Development Program (IRDP): Launched in April 1978, the IRDP
mainly aims at assisting properly identified families that exist below the poverty line in
rural areas. To begin with, 2000 blocks of the country were selected for this program.
The main target groups covered under the program include small and marginal farmers,
agricultural labourers, rural craftsmen and artisans, persons belonging to SC/ST, etc.

The various schemes for financing under IRDP include the following activities:
i.
ii.
iii.

In the priority sectors like agriculture, horticulture, animal husbandry fisheries,

farm forestry, etc.
In the secondary sectors like handicrafts, handlooms, khadi and village
industries, etc... and
In the territory sectors like transport, small business and other service activities
loans up to Rs 5,000 provided under the above categories are required to be
given by bank branches without insisting on additional securities, guarantees or
margin money.

As an integral part of this program, another program called Training of Rural Youth for
Self-Employment (TRYSEM) has also been launched with the objective of equipping the
youth with necessary skills for application of technology in rural areas.
Scheme for Self-Employment to Educated Unemployed Youth (SBEUY): Launched in
August 1983, the objective of the scheme is to encourage the educated unemployed
youth to undertake self-employment ventures in industry, services or business. Under
this scheme, composite loans, not exceeding Rs.25,000 are extended to the candidates
in the age group of 18-35. The composite loans comprise the investment and the
working capital. The branches are not supposed to ask for owner's contribution in the
form of margin money or seek collateral security or third party guarantee for such loans.
Scheme of Self-Employment Program for Urban Poor (SEPUP): Recognizing that
poverty is not restricted to rural areas, the government has, recently formulated the
Scheme of Self-Employment Program for the Urban Poor (SEPUP). Under this scheme
assistance upto Rs. 5,000 is to be provided to various beneficiaries that is, by March 31,
1987 banks will choose one beneficiary for every 500 persons in all metro/urban/semiurban centres having a population of more than 10,000
For assistance under this scheme, as in other cases, no margin money or collateral
security or guarantee is to be given by the borrowers.
The Seventh Five Year Plan has cast further responsibilities on the banks. Primarily
banks, being a major source of finance, are to mobilize on an increasing scale the
necessary resources for financing the plan outlay. The plan has also emphasized the
importance of continuing the anti-poverty program under IRDP and other programme
which implies that the banks will have to involve themselves on an increasing scale to
meet the credit needs of economy which are likely to emerge during the plan period.

New Private Sector Banks:

On 22nd January 1993, the Reserve Bank of India had issued policy guidelines for the
entry of new private sector bank in the banking system of the country. The new policy
guidelines have opened the door of the banking sector for the participation of the private
sector on a large scale. The first private sector bank that has came into operation since
the introduction of policy guidelines was the UTI Bank Limited on 2nd April, 1994 with
its registered office at Ahmedabad. It this way, 10 such new private sector banks have
already been set up in the country. These new private sector banks have dedicated it to

meet the changing financial needs of the corporate sector. The following table shows
clear picture about these new private sector banks in India.
New Private Sector Banks

Source: Ministry of Finance

The entry of these new private sector banks was a part of the medium term strategy to
improve the financial and operational health of the Indian banking system. Till
September 30, 1995, eight such new banks had become operational and having set up 47
branches. They collectively enjoyed a paid up capital of Rs. 995 crore and mobilized
deposits worth Rs 4,200 crore. At the end of November 1995, total initial paid up capital
of all the 10 new private banks was Rs. 1152.13 crore.
By virtue of being new, the capital to risk weighted assets ratio of these banks was well
over, the required eight per cent. So far, the concentration has been more on wholesale
corporate banking with attempts to specialize in niche areas like custodial services and
corporate advisory services. It is expected that the entry of new banks and their
performance within the prescribed prudential norms and regulations would impart
grater structural flexibility to the financial sector.
Thus at present 10 new private sector banks have started functioning, out of the 13 in
principle approvals given for setting up of new banks in private sector, in the 1996-97

budget, an announcement was made that new private local areas, banks with
jurisdiction over three contiguous districts, would be set up. These banks will help in the
mobilization of rural saving and in channeling them into investments in the local areas.
The RBI has issued guideline for setting up such banks. It has already granted in
principle approval to two local area private banks, one each in Maharashtra and
Karnataka.
The new private sector banks entering the financial sector carry several intrinsic
advantages. They were adequately capitalized and do not carry the overhang of the
retroactive practices of the past. The backlog of non-performing assets also does not
exist and are on a higher footing in terms of technology.
Thus it is expected that new banks would manage their operations based on principles of
safety, soundness and prudence.
Questions:
1. Critically elaborate the whole of commercial banks in India
2. Give an elaborate report on the development in the banking system.

- End Of chapter LESSON - 17

INTRODUCTION

Finance is a key input of production, distribution and development. It is therefore, aptly

described as the "life-blood" of industry and is a prerequisite for accelerating the process
of industrial development.
During the pre-independence period, financial constraints had hampered the rapid
development of industries in the country. After independence, the Government has built
up a network of specialized financial institutions with a fairly big capital base to provide
financial assistance to all types to industries, including small-scale industries.
A growing economy needs the support of a financial structure which is responsive to the
needs of development. In India, in the process of financial deepening, commercial banks
had to shoulder special responsibilities for meeting the financial needs of diverse sectors
of the economy, at various stages of development. In the process, they have evolved
various modes and instruments of financing, fashioned various organizational
innovations, moved away from traditional commercial banking and evolved into
development banks, responsive to socio-economic needs.

Finance is now made available to entrepreneurs on a totality basis by commercial banks,

except in cases where the State Financial Corporations and other similar financing
agencies step in to meet their medium-term requirements an appropriate type of credit
is granted for the construction of the factory building, the purchase of plant, machinery
and equipment, and for working capital requirements. In deserving cases, loans are
advanced for the expansion, renovation and modernization of plant and machinery.
Banks and financial institutions provide the export finance needed by small industries
for letters of credit, issuance of guarantees and extension of pre-shipment and postshipment credit facilities. The interest rate structure is generally graded on a slab basis,
with a favourable bias towards the smaller loans. Institutional support and economic
factors are stimulating entrepreneurial activity and thus generating more robust
economic development.
Finance
Small units, as is well known, are not exclusively and not even mainly dependent on
Government assistance. Most of these units owe their origin to the spurt in the demand
of their products either in the local market. (Generally speaking, the demand starts
initially from the local market or neighbouring market and then is picked up from the
regional and distant markets).
The initial investment of these small units comes mainly from within; most of them
invest their own funds or borrowed funds (mainly from relatives, friends and
professional lenders). Much less comes from banks and Government channels.
The small units depend more on their own funds, borrowed funds from non-banking
and non-Government sectors because of the fact that institutional lenders like banks
and Government financial corporations are generally reluctant to advance money to
these small units, since they are yet to establish themselves.
These small units are not in a position to offer the guarantee required by the banking
sector. Even when small loans can be raised from Government agencies, the procedures
is so cumbersome that most of the entrepreneurs, who are either illiterate or
semiliterate, hesitate to make use of these facilities. And since the finance they acquire is
on a small-scale, entrepreneurs prefer to put in their own, rather than borrowed funds.
For example, skilled persons, who become potential entrepreneurs of small industries in
due course, have generally saved some money in the past while they were employed in
other firms as wageworkers. In fact it is the ambition of most skilled workers that they
should start their own business (especially in the engineering trade) after a few years of
service, when they have gained the requisite experience, studied the market trends, and
accumulated some savings.
The skilled-worker-entrepreneur generally gets some assistance from his previous
masters, depending on their relationship with these masters. Also as these mystery
entrepreneurs are already known in the market, because of their having worked in a
particular area over the years, they develop links with local market, which help to buy
inputs and sell their products.

In this way, a number of factors work together and enable the new entrepreneurs to
raise the initial capital needed for the starting of small units from sources other than
Government agencies. Of course, over a period of time institutional finance is available
for further expansion; but the extent to which they avail themselves of this finance
depends upon the ratio of growth of small units as well as the contacts they have built up
with institutional lends. Many established small units hesitate to approach institutional
financial agencies (including Government agencies) because of their traditional tie-up
with non-institutional bodies and also because of their lack of training, especially in
financial matters. This fact is supported by the Mega study conducted under the
supervision of Mr. V S.Mahajan. The finding of the study is that almost all the 300 and
odd small units engaged in the production of agricultural implements were started with
the entrepreneurs' own funds and with funds borrowed from relatives and friends and
that the nationalized banking sector and State Financial Corporation have contributed
little.
Small-Scale industrialists do not have sufficient funds of their own for fixed capital
investment, nor can they obtain the necessary resources from institutional agencies, if
the letter is doubtful of the farmer's ability to repay the loans in time. The shortage of
funds makes it difficult for them to install modern machinery and tools and to maintain
well-organized and fully-equipped factories. Moreover, they cannot buy and store goods,
quality raw materials or stock their finished products, pack their goods attractively, have
any sales organization of their own or furnish security deposits, whenever necessary.
State Finance Corporations take decisions on extending term loans. If one is in hurry to
commence a project, loan which has to be repaid out of the State Finance Corporation's
sanctioned loan. Banks also are not quick enough in the disposal of loan applications.
They too, take anywhere from one to three months to clear a project and sanction
advance facilities. Their assistance is hardly available for initial or for future expansion.
It is available only for working capital needs of small-scale units.
Financial institutions ask for a lot of information and data. They are hardly ever
satisfied with whatever information the prospective borrower supplies and go on raising
queries, often not at one time, but in installments with wide gaps. This makes matters
very difficult for the small industrialist, particularly when he is new to this way of life,
and he has to deal with both the State Finance Corporation and the bank. Quite often, a
few get up at this stage and give up the project. If only the bureaucracy were helpful, a
major problem of the small industrialist would be solved.
Types of Industrial Finance
Depending upon the nature of the activity, the entrepreneurs require three types of
finances, viz., short-term, medium-term and long-term finances. The distinctive
features of these are enumerated below:
Short-term Finance

Short-term finance usually refers to the funds required for a period of less than one
year. Short-term, finance is usually required to meet variable, seasonal or temporary
working capital requirements.
Borrowing from banks is a very important source of short-term finance. Other
important sources of short-term finance are trade credit, installment credit and
customer advances.
Medium-term Finance
The period of one year to five years may be regarded as a medium-term. Medium-term
finance is usually required for permanent working capital, small expansions,
replacements, modifications, etc.
Medium-term finance may be raised by:
i.
ii.
iii.
iv.

Issue of share
Issue of debentures
Borrowing from banks and other financial institutions; and
Sloughing back of profits (by existing concerns)

Long-term Finance
Periods exceeding 5 years are usually regarded as long-terms. Long-term finance is
required for procuring fixed assets, for the establishment of a new business, for
substantial expansion of existing bussing, modernization etc.
The important sources of long-term finance are:
i.
ii.
iii.
iv.

Issue of shares
Issue of debentures
Loans from financial institutions; and
Sloughing back of profits (for existing concerns).

Means of Financing
Equipment Finance: For procurement
Technicians Scheme. Technically qualified
of new machinery / equipment by
or experience professional-upto Rs.7.50
existing industrial units-up to Rs.90
lakhs
lakhs.
Special Capital Scheme: Soft loan
Quality Control Equipment: 100%
Assistance upto Rs.4 lakhs is available on
assistance for setting up quality control
soft terms along with them loan for
facility by existing and new SSI units
technically qualified or experienced
up to Rs.7.50 lakhs
persons.
Seed Capital Scheme: Assistance towards Assistance to Ex-Servicemen: Term
equity on soft terms up to Rs.15 lakhs along loan up to Rs. 1.80 lakhs for gaining

with term loan for technically qualified or

experienced persons

self employment.

Single window Scheme: Both term loan

and working capital together to new
Composite Loan Scheme: Both equipment
tiny and small-scale industrial units up
finance and working capital up to
to Rs.7.50 lakhs towards term loan and
Rs.50,000 for artisans and rural industries.
up to Rs.3.75 lakhs towards working
capital.
Tourisms Related Facilities: Up to
Disabled Entrepreneurs: 100% finance up
Rs.90 lakhs available for tourism
to Rs.50,000 to disabled entrepreneurs
related business ventures.
Modernization: For replacement /
MaMa Udayam Nidhi Scheme: To set
renovation of equipment for successful
up new industrial project in SSI sector
units which are in existence since 5 years
by women entrepreneurs.
assistance to Rs.90 lakhs.
National Equity Fund Scheme:
Electro-Medical Equipment: For qualified
Assistance towards equity for new
Doctors / private nursing homes - up to
projects tine and small scale sectors Rs.90 lakhs.
up to Rs.75,000
Assistance for Marketing: (a)
Maximum Assistance up to Rs.3 lakhs
Nursing Homes / Hospitals: Assistance for
per sales van, not exceeding six vehicles
full fledged nursing homes and hospitals up
per borrowers.(b) Assistance up to
to Rs.90 lakhs
Rs.7.50 Lakhs for setting up new scale
outlets

Means of Finance
A characteristic feature of small-scale units is that the personal funds of entrepreneurs
from substantial proportion of the total assets. Most of the units are not corporate
entities. The owners of small units, therefore, run a considerably higher risk than those
of corporate units. The sources that usually provide the working capital requirements
are commercial bank, special agencies like the State Industrial and Investment
Corporation (SIIC), and Corporative banks. Indigenous bankers and moneylenders also

advance loans for working capital needs. The fixed capital needs are usually met by State
Governments (under the State Aid to Industries Acts/ Rules), State Financial
Corporations (SFCs) National Small Industries Corporation (NSIC) which supplies
machinery on hire-purchase basis, State Small Industries Corporation (SSICs). State
Industrial Development Corporations (SIDCs), the State Bank of India and subsidiaries
and other commercial banks.

B. Reserve Surplus
i.
ii.
iii.

Capital reserve
Development rebate reserves
Others

C. Provisions
i.
ii.

Taxation (net on advance of income-tax)

Depreciation

II. EXTERNAL
D. Borrowings
i.
ii.
iii.
iv.

From Banks
From term-lending institutions, like IDBI, IFCI, ICICI, Industrial Development
Corporations, etc.
From Government and Semi-Government agencies.
Others

E. Trade Dues and Other Current Liabilities

i.
ii.

Sundry creditors
Others.

F. Miscellaneous
All these sources of finance are not available to all the Small units. Much would depend
on the status, character and the period of time, the units have been in operation. For
example, a new small unit has no reserves to provide for depreciation. These are built up
in gradual stages out of the funds set apart in the course of current operations.
Moreover, the funds of a small-scale industry can rsise depending upon the character of
the company, whether it is a private limited or a proprietary concern.
The funds, which a small-scale industry can raise, depending on its producing activity,
and the uses to which these funds are put:
i.

ii.

iii.

Gross Fixed Assets: Land, building, plant and machinery these are by and large,
met out of market borrowings or term loans from financial institutions, including
banks. .
Working Capital: This includes inventories - raw materials, components, finished
goods, work in progress and operating expenses - wages, salaries, lighting and
other running expenses are not out of commercial bank loans in to the form of
hypothecation credit or pledge loans.
Funds are also required for (a) Making loans and advances in the course of dayto-day purchase-and-sale operations: (b) sundry debtors - that is for sale of credit
basis; (c) investments, and (d) building up other assets.

- End Of Chapter LESSON -18

ANALYSIS OF FINANCIAL RATIOS

The financial data of small units were worked out in terms of some of the important
conventional ratios. Most of the ratios, however, do not indicate any definite
relationship with credit facilities. A detailed discussion of this aspect has undertaken in
the technical volume. It will be sufficient to mention here that comparatively high
inventory-to-sales ratios were recorded by units which received institutional credit
facilities. The average net working capital needs of small units, which are also given,
show that the units which received credit facilities need a comparatively high average
working capital. A major proportion of the net working capital, however, was accounted
for by inventories. The figures given in the statement do not, by themselves, point to any

firm conclusions regarding the place of inventories among the factors to be taken into
account by banks while examining the credit proposals of small-scale units.
Balance Sheet of Institutional and Non-Institutional Borrowings
The survey also gives information on the balance sheet of institutional and noninstitutional borrowings of small units. It shows that institutional borrowings per unit
varied from one unit to another and were the highest in the case of the following
categories of units:
i.
ii.
iii.
iv.
v.
vi.
vii.

Those units whose assets exceeded Rs. 10 lakhs

Those units which manufactured electronic and electrical goods;
Units of 6-10 years standing;
Those which employed 101 and more persons;
Public limited companies.
Units which were registered; and
Units located in industrial estates.

It may be pointed out here that those units, which had high savings per unit institutional
borrowings, recorded high inventory ratios. The average non-institutional borrowings
per unit in respect of respective classifications were the highest in the case of units
which a. Borrowed from banks/co-operatives;
b. Whose assets were above Rs.10 lakhs and which employed 101 or more persons;
c. Were private limited companies, registered units and located in industrial
estates; and
d. Belonged to the manufacturing, including chemicals, dyes, etc.
The statement also shows that both large and small units in the sample, borrowed from
institutional and non-institutional sources,which were lower in the case of large units
than in that of small units. At the same time, even the smaller units contained a major
portion of their credit needs from institutional lenders. Further, the average noninstitutional borrowings formed a major proportion of average, not approaching any
commercial bank/cooperative for credit or which did not get average institutional
borrowings were noticed in the case of units with assets over Rs.10 lakhs; which
manufactured electronic and electrical goods; which had been operating for five years,
which were public limited companies; which were located in Industrial Estates? Clearly,
the reliance on institutional sources was relatively high on the part of modern younger
and larger small-scale industrial units.
According to a recent study of small private limited companies, conducted by the
Reserve Bank of India in 1987, the small private limited companies relied on external
sources or financing assets. Of the total resources of Rs.2,708 crores, external sources
contributed as much as Rs. 1,610 crores (77.5 percent) to asset formation of this amount,
borrowings constituted more that 55.8 percent, while trade dues and other current
liabilities contributed about 38.0 percent. Bank borrowings, in particular, accounted for

more that one-third of the total external resources. Among the internal resources,
depreciation provision amounting to Rs.408 crores constituted the main source. It
presented 87.18 percent total internal resources.
While assessing the resources of a concern we have to bear in mind the following
factors: whether it is a new concern or a long-established concern; whether it is a private
company or a proprietary concern; what is the nature of activity - is it manufacturing or
trading; whether the purpose of raising resources is modernization and expansion of
business, or the establishment of a new concern, or increases in turnover.
The expansion or diversification of business involving an addition to plant and
machinery should be met of owned funds-that is, out of depreciation and provisions, or
out of increase in capital, or out of term loans. The ability of a concern to raise resources
from all or some of these sources depends upon its strength, charter and standing in the
market. If the purpose is a mere increase on the turnover of the business, which involves
a larger inventory and increased operating expenses, the additional funds should be
raised by way of bank loans.

From a banker's point of view, there are well-established guidelines for assessing the
credit requirements of a concern. A banker analyses the balance sheet and evaluates the
turnover of funds, sales and other operating results in assessing the viability of a unit.

There are certain established ratios, for example

1. The debt equity ratio;
2. Turnover to net worth;
3. Return on capital employed
4. Net profit as a percentage of net worth;
5. Dividend paid to shareholders;
6. Ratio of current assets to current liabilities.
A banker has to go behind these figures and assess the technical and managerial
competence of a management, and the integrity of the men running a concern, in order
to decide whether credit should or should not be advanced.
Credit is a very important element in the process of economic development. It
stimulates economic activity, particularly in countries which are short of capital and
entrepreneurial talent. Because of the dearth of these two basic elements in the process
of development, bankers who create credit have been assigned a vital role in stimulating
the process of development.
Schemes of Assistance
Within the broad framework, the SFCs, SIDCs and commercial banks offer the following
financial assistance:

Financing of new projects in the small and medium size category

Financing of modernization of small and medium industries.
Financing of rehabilitation of small and medium industries.
Financing of import of capital equipment.

In view of the financial constraints being faced by SFCs, SIDCs and commercial banks, it
is of interest to the borrowers to know the extent of refinancing assistance being
extended by the IDBI for the aforementioned purposes. In terms of the currently
prevaling guidelines, the following re-finance assistance is extended.

Financial Assistance to Small-Scale Units

Rupee loans to the small-scale units are granted at concessional rate of interest. The
interest charged to the small-scale units located in backward areas is at the rate of 12.50
per cent per annum. In respect of units located in on backward areas, the interest is
charged 13.50 per cent per annum on loans up to Rs.25 lakhs and at the rate of 3 of 14
percent on loans in excess of Rs.25 lakhs and at the rate of 14 percent.
Non-commitment charge is levied on loans up to Rs.5 lakhs to units in the small-scale
sector. Commitment charge at the rate of 1 percent is levied on all other rupee loans,
after an initial grace period of 12 months from the date of sanction. However, units
located in category 'A' backward areas are totally exempted from commitment charges
on rupee loans, and the units located in category 'B' and category 'C' backward areas are
eligible for 50 per cent concession on the commitment charge.
The small industrial undertakings are considered favourably and allowed a debt-equity
ratio extending up to 2.5. The promoter's contribution norm varies between12.5 per cent
and 22.50 per cent, depending on the location of the project and the status of the
entrepreneur.
Repayment schedule is fixed by the primary lending institutions after taking into
consideration the profitability and debt-servicing capacity of the assisted units. The
maximum repayment period shall, however, not exceed 10 years from the date of
sanction.
Credit Facilities to Small-Scale Industries
Small-scale Industrial Sector raises working credit and term capital required by it, from
commercial banks, cooperative banks, regional rural banks and State Financial
Corporation mainly for investment capital. Assistance is also available to the SmallScale Industrial sector from the National Small Industries Corporation (NSIC) at
national level and the State Small Industries Development Corporation (SSIDCs) at
State level in the form of supply of machinery on hire-purchase basis. The Small

Industries Development Bank of India (SIDBI), the National Bank for Agriculture &
Rural Development (NABRAD) and the Industrial Reconstruction Bank of (IRBI)
provide refinance facilities to banks and financial corporation for financing small scale
industrial sector. The credit provided by banks to small-scale industrial sector. The
credit provided by banks to small-scale industrial sector is treated as credit to "Priority
Sector". The commercial banks are required to lend 40% of their total loans to the
"Priority Sector" of which 15% to 16% are required to be in the form of the direct
agricultural advances and the rest can be to small-scale industry, small business, small
transport operators, indirect agricultural loans, etc.
Outstanding advances to small industries by public sector banks increased from Rs.
16,590.14 crores as on June 1991 to Rs. 17,688.90 crores as on June 1992 and further to
Rs.27, 612 crores by December 1885. However, the outstanding advances of Regional
Rural Banks to artisans, village and cottage industries slightly decreased from Rs.282.04
crores as on March 1990 to Rs.280.56 crores as on March 1991, more than 79%
assistance extended SFCs during 1994-95 went to the SSI sector.

During 1994-95 20,028 SSI units were sanctioned loan to the tune of Rs. 1444.50 crores.
Rs.1795.00 crores were disbursed at the end of March 1995, Rs13,706 crores were
sanctioned by all SFCs to 4,15,859 small scale industries out of which Rs.11,004 (82.5
percent) crores was disbursed to these units.
The evolution of the Banks policy framework towards the small-scale industries sector
is as follows:
a. Liberalized Scheme: Soon after its establishment, take-over of the
undertaking of the Imperial Bank of India, In July 1995, the State Bank of India
prepared a liberalized scheme for security-oriented small-scale industries,
which was a radical departure from the security-oriented approach. The bank
also showed readiness to meet all the genuine credit requirements of the unit
once the viability of the scheme was proved. The concept of margins was kept
flexible and linked, not with the sale ability of raw materials but with the ability
of the borrower to meet the margins. Collateral security was relegated to the

b.

c.

d.

e.

f.

background and no unit with a viable Scheme was denied credit for want of
collateral security.
Entrepreneur Scheme: In 1967, a novel scheme known as "Entrepreneur
Scheme" of providing financial assistance to technically qualified entrepreneurs
was evolved. The scheme covers all technically-qualified persons, as also persons
who have technical experience and skill but may not have received any formal
technical education. Later, the scheme was extended to cover persons with
management qualifications, chartered accountants, cost accountants, etc., who
had taken up industrial activity. Though normally, a ceiling of Rs.2,00,000 was
placed. Such loans, in exceptional cases, relaxations were permitted up to
5,00,000 and even higher.
Financing of Artisans and Craftsmen: Initially, the State Bank was
concentrating its assistance mainly on the small-scale industries in the organized
modern sector, but with its expanding network of branches in the rural areas, the
bank had to take increasing interest in financing rural industries and artisans.
The Scheme of Rural Industries project was introduced by the Government of
India in 1962, with the object of nurturing rural crafts as reducing imbalance
between urban and rural areas, by bringing about a wider dispersal of small
industries. In 1969, the Bank introduced a special scheme of financing artisans
and craftsmen in rural industrial projects, in co-ordination. The special features
of the scheme were: its simplicity in the terms and conditions and procedures and
the co-ordination between the bank and the Government in identifying eligible
artisans and in follow-up and recovery, etc.
Employment-oriented Lending: With the emphasis shifting of the increasing
employment potential in the country, through formulation of employmentoriented lending schemes, the bank, in 1971, started financing tiny economic
activities like manufacture of footwear, khadi, basket-making etc. In 1972,
introduction by the Government of India of the Differential Interest Rate Scheme
for financing the weaker sections of society for productive activities at a highly
concessionary rate of interest of 4 per cent per annum, gave a fillip to the
financing of cottage industries sector.
Special Cells for Village Industries: With this objective of promoting village
industries and providing financial assistance to a large number of village artisans,
the Bank set up, in 1977, a small special Village Industries Division in each of its
industries with the help of agencies engaged in the development of village
industries and assisting in the implementation of schemes and monitoring their
progress.
Technical Consultancy Cells: With a large increase in the Banks Coverage of
small-scale units, the need for providing technical and managerial guidance to
small-scale industries came into sharp focus. In 1973, the Bank, therefore decided
to set up its own technical consultancy cells in each of its local Head Offices to
provide such assistance to the borrowers. Suitable persons were selected from
among the technically and professionally qualified officials of the Bank for this
purpose. The Bank entered into an agreement with reputed business and
industrial consultancy organizations, to provide intensive training to these
officials in consultancy work for a period of one to two years. The subjects
covered include financial analysis and appraisal, financial management,

production planning and control, inventory control, budgetary control and

costing, marketing, etc.
g. Technical Counseling and Management Appreciation Programmes:
Studies conducted by the bank on the causes of sickness in small-scale industries
revealed the necessity for providing counseling and consultancy assistance to
small industries, right from the appraisal state itself. Recruiting additional
officials further strengthened the consultancy cells. The officials of the cells
provide consultancy and counseling assistance to entrepreneurs who need these.
The bank has also published counseling booklets for use of small-scale
industrialists on certain aspects of small industry management, including
maintenance of an accounting system. In order to upgrade the managerial skills
of small-scale industrialists, the Bank has also been conducting short duration
"Management Appreciation Programmes" for small-scale industries in various
parts of the country, with particularly emphasis on backward and remote areas.
h. Equity Support to Small-Scale Units: The Bank's experience with small
industry financing indicates that the deposit provision of liberal credit facilitates,
large number of small-scale unit, as one of the measures for preventing sickness
in this sector the Bank in 1975, had recommended to the Government the
creation of a National Equity Fund to provide equity-support to new small-scale
units. The State Bank of India on its part, set up its own Equity Fund in 1978,
with an initial contribution of Rs 10 million from its profits, with the objective of
providing equity assistance to new entrepreneurs who are eligible for financial
assistance under the entrepreneur scheme and also to other educational
entrepreneurs, including those who are undergoing training under the Banks
Entrepreneurial Development Programme. Preference under this Scheme is given
to units in the backward areas, tiny sector units in the rural areas and exportoriented units in the small-scale sector. Assistance under the scheme is provided
to new units by way of interest-free loans, ranging from Rs.5,000 to Rs.50,000 to
meet the shortfall in equity. The loans are repayable, after an initial moratorium
period of 5-7 years, in a further period of 5-7 years.
i. Entrepreneurial Development: In 1978, the bank also launched an
ambitious programme of entrepreneurial development in the country, with the
objective of accelerating industrial development in the backward areas with no
traditions of industrialization. The entrepreneurial development programmes
conducted by the Bank include a specialized selection process based on
psychological tests, group discussions and interviews, and intensive training
programmes of one months duration. The training aims at development of
entrepreneurial motivation, economic insight and management skills, creating
confidence through direct experience, supply of information about the region,
industry potential, etc. The programme also includes practical training in small
industrial units to impart industrial experience and develop confidence. After the
training, in the support phase of the programme, the Bank provides to the
entrepreneurs, continuous counseling and consultancy services free of charge, in
areas like project selection, preparation of project report, market surveys, project
validation etc.

- End Of Chapter LESSON-19

MODERNISATION ASSISTANCE TO SMALL AND MEDIUM-SCALE UNITS

The primary objective of this scheme is to encourage industrial units overcome the
backlog of modernisation and to adopt improved and updated technology and methods
of production and prevent mechanical and technological obsolescence. Modernisation
may include replacement or renovation of plant and machinery of acquisition of
balancing equipment for fuller and more effective utilization of installed capacity.
Units to be eligible for modernization assistance should have been in existence for a
period of at least 5 years. In the case of replacement or renovation, the machinery
should have been in use at the unit for a period of at least 5 years.
Proposals for modernisation assistance should establish the benefits that would accrue
by way of reduction in unit cost of production, technology improvement, improved
productivity, both in quality and quantity, better profitability etc. The cost of acquisition
of technical know-how could be eligible. The project proposal should clearly bring about
these aspects. Other things being equal, export-oriented and import-substitution
schemes will be accorded higher priority.
The Modernisation programmes should primarily aim at:

Up-gradation of process, technology and product;

export-orientation;
import-substitution;
energy-saving;
anti-pollution measures
Conservation/substitution of scarce raw materials and other inputs, including
recycling/recovery of wastes and byproduct.
improvement in capacity utilization within the existing capacity, through increase
in productivity and de-bottlenecking ; and
Improvement in materials handling.

Irrespective of the location of the unit interest at the rate of 11.5 per cent per annum
shall be charged on all rupee loans for modernization purposes. A commitment charge
at the rate of 0.5 per cent per annum shall be levied on the undisguised rupee loans after
an initial grace period of six months from the date of sanction.
In regard to debt-equity ratio, a more flexible approach is adopted by the primary
lending institutions. A reasonable equity base will, however be required to be
maintained to ensure servicing of the loans. Similarly, no fixed guidelines have been
stipulated for the promoter's contribution norm. Modernisation assistance being

financial assistance at existing units, internal accruals would also form a part of
promoter's contribution. The exact promoter's contribution would be decided on a caseto-case basis depending on the financial status of the unit and the ability of its
promoters to mobilize and induct additional resources.
Rehabilitation Assistance to Small and Medium-Scale Units
The scheme for rehabilitation covers all small and medium-scale industrial units,
including ancillary units in cottage and village industries which have been assisted by
SFCs and SIDCs or self-financed and which are classified as stick. It necessary, that the
past loans extended by SFCs of SIDCs should have been refinanced by IDBI.
Rehabilitation loans extended by commercial batiks to sue units will also be eligible for
refinance under the scheme. The objective is to rehabilitate sick industrial units in
portfolio of SFCs and SIDCs.
Eligibility Criteria
Under this scheme, a unit will be classified as sick if it has incurred cash loss, during the
previous accounting year and is likely to incur cash losses in the current year and there
is erosion in its net worth to the extent of 50 per cent or more. The unit should be
capable of being revived with reasonable norms of debt-equity ratio and promoter's
contribution would not be insisted upon and would depend on merits of each case.
Rehabilitation assistance would be for the following purposes;

Margin money for additional term loan and working capital requirements under
the rehabilitation programme.
Working capital term loans, if any, granted by banks to meet irregularities in the
units working capital account.
Cash loss, if any, which may be incurred during the implementation of the
nursing programme.
Overdue installments not recovered from the unit, but agreed to be under into a
separate term loan account; and minimum capital expenditure required for
restating the unit on viable level.

In order to encourage the rehabilitation of sick units, the rate of interest on

rehabilitation of the unit. Such units have also been totally exempted from any liability
on account of commitment charges on undisguised financial assistance.
Similar to modernization cases, a flexible approach is adopted in regard to debt- equity
ratio and promoters contribution. These norms shall be determined on a case-to-case
basis depending on the health of the unit and the projected profitability and debt
servicing capacity. The repayments period shall, however, not exceed a maximum of 10
years from the date of sanction.
Institutions for Small Industry

NSIC
The National Small Industries Corporation Ltd, which is wholly owned by the
Government, was established in1956. The NSCI with its head office at Delhi as
regional/sub offices in several places.
The main functions of the Corporation are the following:
1. Supply of machinery, both indigenous and imported, on hire purchase to help
setting up of the new small ancillary units and to modernize existing ones.
2. The Corporation's Prototype Development and Training Centers at Okhla,
Howrah, Rajkot and Chennai and the Sub-centres at Kashipur, Aligarh and
Dindigirl and the demonstrations-cum-training centre at Guwhati develop prototypes which may be transferred along with know-how to manufacturing units for
commercial production, and/or renders training in various engineering trades.
3. Under the Raw Materials Assistance Schemes, small-scale units are supplied raw
materialsimported and scarce indigenous ones on a continuing basis, giving
them also the benefit for bulk purchases.
4. NSIC helps the marketing of products of small-scale units under the
Governments Stores Purchase Programme as well as under its Internal
Marketing Programme through consortia approach. In the field of export
marketing, the Corporation has adopted a 'Single Window' assistance
programme.
5. Further, with a view to creating facilities for regular display of products of the
small-scale sector, NSIC has recently set up show and plans to have such centres
in other principal towns to the country.
6. NSIC undertakes small industries projects on turn-key basis and provides totals
services from feasibility studies to installation and commissioning of plant.
SSIDCs
State Small Industries Development Corporation has been set-up to serve the needs of
small-scale industries in the respective State/Union Territories. All the SSIDCs have
been incorporated under the companies Act so as to lend them the desired operational
flexibility to undertake a variety of activities for the benefit of small-scale industries.
The specific activities undertaken by the SSIDCs include:
Procurement and distribution of raw materials
Supply of machinery to small entrepreneurs on hire purchase basis;
Management assistance to production units;
Operating of seed capital scheme on behalf of the State Governments;
Construction and management of industrial estates;
Participating with other institutions on setting up of technical consultancy
organizations, and
7. Undertaking marketing activities.
1.
2.
3.
4.
5.
6.

In addition to the above, SSIDCs have been providing infrastructural facilities like
sheds, go downs and common production facilities, technical and consultancy services,
particularly to the unemployed, like preparation of feasibility reports, formulation of
project reports and planning of modernization/diversification of existing product range
and implementation of projects. Some SSIDCs have also sponsored industrial potential
surveys in some districts to identify viable small-scale projects to be based mainly on
locally available raw materials and local demand conditions.
SSIDCs also arrange for marketing of finishing products of small industrial units both in
domestic as well as international markets under their Marketing Assistance Scheme.
Many SSIDCs are actively associated with the setting up of emporia to assist small-scale
units in marketing their products. Such emporia have been set up in metropolitan cities
and also in places of tourist importance. The showrooms established are consumer
goods oriented and are aimed at ensuring reasonable price to both the producers and
the consumer. Further, SSIDCs also organize and participate in exhibitions in various
markets. The products involved are mainly handicrafts, handlooms, ready-made
garments and implements to the production of goods and their marketing.
KVIC
The Khadi and Village Industries Commission, established as a statutory organization
under the Khadi and Village Industries Commission Act 1956, provides various schemes
of assistances which cover extension of finance right from the stage of procurement of
raw materials, tools and implements to the production of goods and their marketing.
For more information about KVIC, see the chapter on Khadi, Village and Small
industries.
SIDBI
Setting up of Small Industries Development Bank of India (SIDBI) marked the
fulfillment of a long felt need to have a separate institution at the national level to
exclusive cater to the requirements of the small scale sector in the country. SIDBI
became operational on April 2, 1990 with an initial paid-up capital of Rs.250 crores and
taking over the outstanding portfolio of IDBI relating to small scale held under the
Small Industries Development Fund (SIDF) as of March 31, 1990 amounting to
Rs.4,200 crore. The authorised capital and paid-up capital of the Bank were
subsequently raised to Rs.500 crore and Rs.450 crore respectively.
SIDBI, a wholly owned subsidiary of the IDBI, is designed to function as the principal
financial institution for promotion, financing and development of industry in the small
scale sector and to co-ordinate the functions of institutions engages in similar activities.
The role envisaged is wide ranging. SIDBI's statue allows considerable flexibility and
empowers it to assist the entire spectrum of small, tiny, village and cottage industries in
the decentralized sector. The range of assistance comprises promotional, financing and
extension support, which will be made available through appropriate schemes to cover

setting up of new projects and expansion, diversification, modernization and

rehabilitation of existing units.
As principal institution for development of small-scale sector, SIDBI would make full
use of the existing credit delivery structure and support service agencies and strengthen
their capabilities so as to reach out their services to the smallest of the small-scale units
situated in the remotest parts of the country. SSI units which number, more than 18.3
lakhs have a wide geographical spread-out in the country. The network of branches and
field offices of banks and State-level institutions are ideally located for serving the small
sector units. These factors have been kept in view while envisaging the role of SIDBI
will, however, step in for directly assisting the activities, which are essential for the
healthy growth of small scale units but not covered by the existing agencies. Thus, the
approach of SIDBI will be to supplement the efforts of existing institutions,
strengthening their capabilities through financial and other forms of support and
instituting suitable coordinating through SFCs, State Industrial Development
Corporations (SIDCs), commercial banks, co-operative banks and RRBs. It provides
rediscounting facilities to commercial banks apart from the resource support so SSIDCs
and NSICs for extending raw material and marketing support and leasing the land hirepurchase facilities to SSI units.
The activities of SIDBI have been patterned to suit the requirements of small industries
consisting of both modern and traditional ones. Broadly, these activities can be
categorized as under:
1. Refinancing of term loans granted by banks and other eligible financial
institutions;
2. Direct discounting as well as rediscounting of bills arising out of sector on
deferred credit.
3. Equity type assistance under National Equity Fund (NEP) and by way of seed
capital to entrepreneurs;
4. Rediscounting of short-term trade bills arising out of sale of products of small
scale sector.
5. Resource support to NSIC and other institutions engaged in supply of raw
materials marketing of SSI products, setting up of industrial estates, development
of industrial areas and infrastructure, extension of hire-purchase and leasing
facilities;
6. Direct assistance for setting up and expansion of marketing outlets for SSI
products and development of industrial areas for SSI units;
7. Share capital and resource support to factoring organizations;
8. Assistance for promotion of exports of SSI products; and
9. Extension of technical and other related support services for promotion,
development and growth of small-scale sector.
In consonance with the objectives envisaged in the Statue. SIDBI has evolved new
schemes of assistance while at the same time continuing the schemes of assistance
hitherto operated IDBI for the small scale sector simplification of existing schemes of
assistance, simultaneously with extension and support services like modernization and

technology upgradation. Details of the extension and support services being rendered by
SIDBI* are given in Chapter 5.
Commercial Banks
Commercial Banks are a very important source of finance for the industry. The
industrial sector is getting around 50 percent of the total banks credit.
Particularly since the major bank nationalization of 1969, there has been a substantial
expansion of the bank branch network and substantial growth of the bank deposit and
credits.
Commercial banks in India have been following the orthodox British line of disfavoring
term loans to industries. However, there has been change in their attitude.
In respect of term finance, the commercial banks, besides providing term credit and
subscribing to the shares and debentures, indirectly participate in term finance by
subscribing to the shares and debentures of financial institutions. Commercial banks
also do underwriting of shares and debentures. Some of the banks have merchant
banking divisions. Scheduled banks have been permitted to hold in their own
investment portfolio shares and debentures of the private corporate sector devolving on
them through their underwriting and merchant banking commitments. However,
according to RBI directives, such investments should be normally limited to the extent
of 1.5 per cent of the incremental deposits of the previous financial year.
Further, in order to ensure proper co-ordination between commercial banks and State
level financial institutions, banks were advised to take certain measures which include
joint or simultaneous project appraisal, in principle commitment by banks at an early
stage to provide working capital finance and sanction of working capital limits by banks
at least three months before the units are due to commerce production.
The shift in favour of the 'priority sectors' led to a decline in share of the industrial
sector in total bank credit. Today the industrial sector accounts for about half of the total
bank credit compared to over-two-thirds prior to the nationalization of 1969. This
decline in the share has been and there has been a very significant increase in the
proportion of the credit flow to this sector. In the two decades March 1967 and March
1987, the share of the small-scale industries in the total bank credit more than doubled
(from 6.9 per cent to 14.6 per cent) On the other hand the share of the medium and
large industries declined from 60.6 per cent to 35.5 per cent during this period.

- End Of Chapter LESSON-20

GROWTH OF SMALL INDUSTRIES IN INDIA

The small-scale industrial sector in India has been growing at a very rapid scale. Table-1,
given below, shows that number of units in small-scale have increased from 5.86 lakhs
to 23.84 lakhs in 1993-94 accounting for nearly four times increase. Likewise, the
number of people employed in these units as well as production of these units also
increases consistently. Even investment in this sector has been increasing at a faster
rate.
TABLE-1: Growth of Small-Scale Industries (FROM 1976-77 to 1992 93)
Production
Employment
Exports as a
Exports
No. of
at current
(No.
percentage of
Year
(Rs.crores)
Units (Lakhs)
prices
millions)
production
(Rs.crores)
1976-77
5.86
5.6
12,400
766
6.17
1977-78
6.63
5.9
14,300
845
5.91
1978-79
7.34
6.4
15,790
1,069
6.77
1979-80
8.05
7.0
21,365
1,226
5.67
1980-81
8.74
7.1
28,060
1,643
5.85
1981-82
9.62
7.5
32,500
2,070
6.35
1982-83
10.55
7.9
35,000
2,095
5.99
1983-84
11.50
8.4
41,300
2,350
5.69
1984-85
12,42
9.0
50,520
2,563
5.07
1985-86
13.56
9.6
61,228
2,785
4.55
1986-87
14.64
10.1
72,250
3,631
5,03
1987-88
15.86
10.7
87,300
4,373
5.01
1988-89
17.12
11.3
1,06,400
5,490
5.16
1989-90
18.36
12.0
1,32,320
7,626
5.76
1990-91
19.48
12.5
1,55,540
9,763
6.28
1991-92
29.82
13.0
1,78,639
13,627
7.63
1992-93
22.35
13.4
2,09,300
15,154
7.24
1993-94
23.84
13.9
2,41,648
22,764
9.4
(Source: RBI Reports)
Financial requirement of small scale Industries can be classified into two heads:
(i) Equity or risk capital and (ii) Loan or borrowed capital. Loaned capital can be subdivided into (a) long term loans and (b) short-term loans.
Equity Capital: An investment by the owner of a small unit is the prerequisite for setting
up a unit. The owner has to first set up the unit by his own capital and then he can ask
for loaned funds. The owner's funds should be used to purchase fixed assets like land
and building, plant and machinery etc. If the entrepreneur is able to invest sufficient
funds to acquire fixed assets, then his chances of success are high. If they depend on
interest bearing funds for acquiring fixed assets, his earnings may not be sufficient to

support such liability. In real practice the situation is quite different. In many cases the
entrepreneurs do not have adequate funds for investing in the units, they depend upon
the dealers for the supply of raw materials and purchase of finished products. It is the
dealers who take most of the profits and entrepreneurs are left with small funds. Even
after many years in work, they are unable to create sufficient funds to meet their day-today needs.
Loan Capital: Besides equity capital small scale units require long-term and short-term
loans. Long-term loans are needed either to purchase fixed asset or for expansion and
diversification while short term loans are needed for purchasing various inputs and
other current needs. A good financial structure will be that where more investments are
from owned capital but outside funds cannot be ignored. A care should be taken to keep
loaned funds only up to the level of owners' funds and not beyond. A concern depending
more on outside funds may be in a financial problem sooner or later.
Sources of Finance
In small scale sector owners try to run the units with their own funds. As the
requirements for funds they have to look to outside sources also. The agencies which
provide funds to small scale industries are: (i) Indigenous bankers and money lenders
(ii) public deposits (iii) Commercial banks (iv) State financial corporation (v) Industrial
co-operatives (vi) Other institutions. All these sources are discussed as under:
i. Indigenous Bankers and Money Lenders. Indigenous Bankers and money lenders are
an important source of finance for small scale sector. Because of cumbersome
procedures and security requirements of banks, small entrepreneurs have to borrow
from moneylenders etc. These lenders provide funds generally for short periods i.e.
working capital needs. Their procedures of lending are simple and flexible but interest
rates are exorbitant. The loans are given as and when needed by the borrower and
amount of security demanded differs from borrower to borrower.
Money lending business is not organized activity like other lending agencies. They
devise their own methods and procedures for giving loans. The rates of interest to be
charged also vary. The reputation of the borrower is considered while fixing various
terms and conditions.
The expansion of banking sector and lending by various other agencies has reduced the
dependence of small entrepreneurs on moneylenders. The Reserve Bank of India should
try to regulate the working of indigenous bankers and money lenders so that they are
not able to exploit small businessmen.
Public Deposits: Another way of raising funds by industrial units is to get public
deposits. These deposits can be raised without offering any security. The rate of interest
to be offered, so, such deposits should be higher than that offered by commercial banks
on time deposits. Under Companies Act, Central Government prescribes the limits and
manner of accepting such deposits.

The small-scale units generally get deposits from the employees. These workers
sometimes leave some part of their earnings with the concern as deposit. These are like
recurring time deposits. The units collect only small amount in this way, Moreover,
workers may get back these deposits after short-periods only. The public in general,
deposits funds with large-scale concerns for reasons of security and regularity of getting
interest. So public deposits do help in raising some funds but it is not a significant
source in all small-scale sectors.
iii. Commercial Banks: Commercial banks are the most important source of short-term
financial needs. The major portion of working capital loans of industrial sector are
provided by commercial banks. They provide a wide variety of loans tailored to meet
specific requirements of a concern. The banks provide facilities such as loans, cash
credits, overdrafts, and purchasing and discounting of bills. But, the commercial banks
have not been helping small-scale industries to the extent it was required. This was
mainly due to two reasons: (a) weakness in small units, and (b) attitude of commercial
banks.
a. Weakness in Small Scale Units: Small Scale Units do not have enough funds of
their own. It implies that they acquire much less assets with their own funds.
Thus, the units are not in a position to offer sufficient securities required by
banks for grant of loans. As the demand of banks for securities is not met, it
results into lesser grant of loans and under financing of units. Further, the
demand for products of small-scale units remaining quantity. These factors lead
to unstable income and small units are not able to adhere to the strict schedules
of payments. Thus, the inherent weaknesses of small-scale industries do not
allow them to make use of financial resource of commercial banks.
b. Attitude of Banks: The commercial banks have a rigid and unfavourable attitude
towards small units. Their conservative lending policies do not allow them to
accept fewer securities for giving loans to small-scale units. Banks even demand
additional securities in the form of collateral securities to protect their loans.
Small units are unable to satisfy the banker's because of their limited equity base.
The resources available with banks, for small-scale sector are limited in relation
to demand for money in the market. The losses suffered by banks in lending to
small units also discourage them to extend more credit to this sector. These
banks usually prefer large sector as compared to small-scale sector.
Even since the introduction of social control of banks in 1967 and nationalization of
banks in 1959, the commercial banks have liberalized their policy to some extent for
lending to small-scale units. The change in attitude of banks would be clear from the fact
that whereas the amount of bank credit outstanding to small scale industries stood at
only Rs.258 crores in 1969, it rose to Rs.26,034 at the end of 1993. However, the fact is
that the criterion of 'credit-worthiness' and demand for sufficient securities still weighs
heavily with the commercial banks. The banks should relax lending norms for smallscale sector.
(iv) State Financial Corporations: The State Financial Corporations were set with a view
to provide financial assistance to small and medium scale industries. At present there

are 19 such corporations working in different states. These institutions provide term
loans to medium and small-scale units at the regional level.
The SFC's sanctioned loans of RS. 1,193 crores upto March 31, 1981 to small scale
industries and it was 63 percent of the total assistance sanctioned to all sectors of
industry. During 1984-85, the percentage loans sanctioned to small units rose to 72
percent of the total assistance given by these institutions.
Besides sanctioning loans and advance to industries concerns SFC's also subscribe to the
debentures of industrial concerns; guarantee loans raised by industrial concerns;
underwrite the issue of stocks, shares, bonds and debentures by these concerns and also
guarantee differed payments due from industrial concerns in connection with purchase
of capital goods in India. The SFC's also act as agents of the Central Government or
State Government in respect of any business with an industrial concern in respect of
loans sanctioned.
(v) Industrial Co-operatives: Industrial Co-operatives are playing an important role in
financing village and cottage industries in India. Through Co-operatives, small scale
units can utilize financial assistance from the government and the institutions and also
guidance from technical service institutes and training centres. In rural areas cooperatives have proved very useful to small business units. The co-operatives get funds
from financial institutions at confessional interest rates and extend both long term and
short-term loans to small scale units.
(vi) Other Institutions: There are number of exclusive institutions for helping the
development of Small scale sector. National Corporation (NSIC), State Small Industries
Development Corporations (SSIDCs) is set up to help small units. NSIC was set up in
1955 for helping small sector. It arranges supply of machinery under hire-purchase
scheme and is also empowered to underwrite and guarantee loans from banks and
similar institutions for small units. SSIDCs at the state level also help in supplying
machinery on hire purchase basis and also help in procuring scarce raw materials. There
are District Industries Centres (DIC's) throughout the
country which provide services and support to the decentralized industries sector under
a single roof at pre-investment stages. With the setting on of DIC's, the need to evolve
appropriate mechanism to ensure flow of institutional credit to small-scale sector
becomes crucial.
New Small Scale Sector Industrial Policy, 1991
The Government of India announced its new policy towards small sector on August 6,
1991. The primary objective of this new policy is to impart more vitality and growth
impetus to this sector in order to attain a higher growth rate in respect of its output,
employed and exports. The following are the main features of this new policy:
i.

Enhancement of the investment limit in case of 'tiny' enterprises to Rs.5 Lakhs

from Rs.2 Lakhs, irrespective of the location of the unit.

Widening the scope of small scale industries by including industry related

services and business enterprises.
To allow equity participation by other industrial undertakings in the small scale
units, not exceeding 24 percent of the total shareholding, so as to provide SSI
units an access to the capital markets and to encourage modernization.
Introduction of a new legal form of organization of business namely restricted or
limited partnership. In this form, the liability of at atleast one partner is
unlimited while other partners can have limited liability. This provision will
attract equity capital from friends and relatives of the small scale entrepreneurs.
Arranging adequate and regular flow of credit on a normative basis and to
improve the quality of its availability for the SSI units.
Establishing of a special monitoring agency to look after the genuine credit needs
of the small scale industrial sector.
Other measures include review of all statutes, regulations and procedures in
connection with establishing and maintaining of SSI units, entrepreneurships
equity fund, modernization, technological and quality upgradation, etc...

ii.
iii.

iv.

v.
vi.
vii.

The Government of India has a number of measures for the promotion of small scale
industries in view of the new scale industrial policy. Steps have been taken to remove
the credit bottlenecks of this sector. The eligibility limit of projects under National
Equity Fund Scheme has been doubled from Rs.5 Lakhs to Rs.10 Lakhs. Single Window
Scheme has been enlarged to cover projects upto Rs.20 Lakhs with working
requirements upto Rs.10 Lakhs. Further the single window scheme has been extended
to be operated through commercial banks also. An ordinance has been promulgated on
23rd September, 1992 making payment of interest obligatory on delayed payments to
small scale industries.
The Reserve Bank of India has announced a special package of measure on April 17,
1993 to ensure adequate and timely credit to small-scale sector. According to this
package:
I.

II.
III.

IV.

Banks should give preference to village industries, tiny industries and other
small-scale units that order, while meeting the credit requirements of the small
scale sector.
The banks should step up the credit flow to meet the legitimate requirements of
the small-scale sector in full during the Eighth Five Year Plan.
Banks should adopt the single window clearance scheme of Small Industries
Development Bank of India (SIDBI) for meeting the credit requirements of smallscale units.
An effective grievance redressed machinery to be setup within each bank for
small-scale sector.

Questions:
1. What are the financial needs of small-scale industries? Discuss the various
sources of finance available for small-scale industries unit.

2. "The inherent weakness of small-scale industries does not allow them to make
use of financial resources of commercial banks". Examine the statement.
3. Describe the financial measures undertaken by the Government of India for the
vitality and growth of small-scale industries under the New Small Scale
Industries Policy, 1991
4. Has there been any change in the attitude of commercial banks in providing
credit to small scale industries? Discuss.
5. "In spite of many weakness and financial constrains, small-scale sector Plays an
important role". Critically examine the statement and analyze the growth of
small-scale industries in India.
6. What are the credit facilities existing to small-scale industries in India?
7. Give full account of types of industrial finance available in India?
8. What are the sources and means of finances available to small-scale industries in
India?
9. Briefly explain schemes of financial assistance to small-scale Industries in India.

- End Of Chapter -