A brief Post About Banking Instruments Part III
11/07/2015 04:28:00 PM
Non Banking
Financial Companies (NBFC)
NBFCs are financial institutions that provides almost similar banking
services (like providing loans and credits) but doesn't possess banking
license. So there are some limitation / restriction in its services.
NBFCs are registered under the Companies Act, 1956, whereas banks are
regulated under Banking Regulation Act, 1949.
Differences between a Bank and
an NBFC
- It cannot accept Demand
Deposits from public. If someone want to invest in an NBFC, it
could have some maturity (like happens in time deposits). Though
some special permission is given to LIC and GIC by
RBI. These two NBFC can take demand deposits.
- It is not a part of the Payments and Settlement System of India.
- It cannot issue cheques drawn
on itself.
- Deposits are not insured or covered under Deposit Insurance and Credit Guarantee Corporation (DICGC), which generally covers the bank accounts.
Most of the ATMs belong to banks, but the cash dispensing machines
that are owned and operated by NBFCs are called White
Label ATMs. Surely they charge extra money for providing
this service, and generally operates in semi-urban and rural
areas (tier III to VI areas)
NBFCs that provides WLA - Tata Communications Payment
Solutions, Prizm Payment Services Pvt. Ltd, Muthoot Finance Ltd, Vakrangee Ltd,
BTI Payments Pvt. Ltd., Srei Infrastructure Finance Ltd, RiddiSiddhi Bullions
Ltd. (total 7 as of May 2014)
NBFC businesses -
- loans and advances
- acquisition of shares, stocks,
bonds
- insurance, etc.
Investment in Corporate Sector
Suppose, you want to invest in a corporate sector. What options do you
have?
You
have two options for investment - invest in stocks/equity/share or
invest in bonds/debentures of the company.
First option points to Equity instrument, whereas the second option to Debt
instrument.
Equity Instrument
If you buy an equity instrument (i.e., shares), then you
will be a (kind of) owner of the company, known as stakeholder or
shareholder. The company is not liable to you. If the company
generates profit, then you will get a part of it (as dividends,
will explain later), and if generates loss, then you too have to bear
it.
You buy a share by paying an amount to the company, you
don't get anything in return except the claim of being a stakeholder or
shareholder. You will be only profited (i.e, benefited), when the
company provides dividends to its shareholders.
Debt Instrument
If you buy a debt instrument (i.e., bonds, debentures), then you
will be a liability of the company, and you won't be the (kind of) owner of
it. Whether the company generates profits or make loss in
its business, it is bound to provide you the investment you made
as bonds or debentures, with interest.
You buy a bond, you will get monthly/quarterly (whatever
the payment time is) return from the company, where you
invested. But you will never be a stakeholder.
·
Now,
try to summarize the differences of equity and debt instruments
-
Equity
|
Debt
|
|
Nature
|
Equity, or Stock are securities that
are a claim on the earnings and assets of a corporation.
|
Debt instruments are assets that require a fixed payments
to the holder, usually with interest.
|
Use
|
Allows a company to acquire
funds, often for investment, without incurring debts
|
Issuing a bond (debt
instrument) increases the debt burden of the bond issuer
because contractual interest payments must be paid – unlike dividends,
they cannot be reduced or suspended
|
Ownership
|
Those who purchases equity
instruments (e.g., stocks) gain ownership of the business, whose shares
they hold. In other words, they gain the right to vote on the issues
important to the firm. In addition, they have claims on the future
earnings.
|
Bond holders do not gain ownership in the business or
have any claims to the future profits of the borrower. The borrower’s
only obligation is to repay the loan with interest
|
Risks
|
Share holders gets profits or losses,
as and when business makes it, making it highly risky
|
Bonds are less risky – should the company run
into trouble, bond holders are paid first, before other
expenses are paid.
|
Earnings
|
Investors only earns when company issues dividends,
that happens when the company wants to share the profit to
their share holders
|
Returns are periodic and almost
fixed. Coupons or monthly interest is earned.
|
Raising Capital
|
Raising capital using equity
is that the company who issues shares need not pay any money to
the share holders.
|
Raising capital using debt
is a burden to the company, as they have to pay the interest
monthly
|
Instruments
|
Shares, Dividends
|
Bonds, Debentures, Certificates,
Mortgages, Leases, Notes,
or other agreements between a lender and a borrower
|
Dividends and Debentures
Now come to dividends and debentures. Don't get confused on
these two. Dividends is a equity instrument, whereas debenture
is a debt instrument.
Dividends - When a company generates
profits, it can use that amount whether as reinvestment in the
company (to extend business, or buy new equipment, etc.), or as to share among
the stakeholders / shareholders, or both.
If it shares the profit among the shareholders, then it is known
as Dividends (generally denoted as Dividends Per Share, or DPS).
Shareholders gets dividends on per share basis.
Debentures - It is a kind
of debt instrument, but without collateral. You will buy a debenture only
because you believe that the issuer (may be a company or government)
will not default on its payment to you. They will not provide
any security as collateral for your investment. The reputation
of the issuer is enough for you to buy a debenture.
The best example could be a Treasury Bill (T-Bill), issued
by government. You know that government will never default on
payment, so you buy a T-Bill, which is a debenture.
Money Market
It generally provides investment avenues
of short time tenor, by definition for a maximum one year. Money
market transactions are generally used for funding the
transactions in other markets including Government securities market,
Capital market and meeting short term liquidity mismatches.
The one year tenor can be classified into
-
- Overnight market - tenor of transactions is one working day (also
called Call Money market)
- Notice Money market - tenor from 2 days to 14 days
- Term Money market - tenor from 15 days to 1 year
Instruments used
Money market instruments include Call
Money, Repos, T-Bills, Commercial Papers (CP), Certificate of Deposits (CD),
and Collateralized Borrowing and Lending Obligations (CBLO).
Borrowing money
from RBI
Banks can borrow money from RBI with or without securities,
and for 1 day to 1 year period. Depending on these, there are 3 ways to borrow
money from RBI, and hence 3 rates -
1. Repo (Repurchase) rate -
This is a type of collateral
lending by RBI. Here, banks sells securities (gov.
securities) to RBI with a repurchase agreement (meaning banks will buy
back those securities at future date with extra interest).
The rate charged by RBI is known as Repo rate.
It comes under Liquidity
Adjustment Facility (LAF) of RBI monetary policy (i.e., a
way to adjust market liquidity, along with reverse repo).Banks borrow money by repo to meet their daily
mismatches. Repo auctions are conducted by RBI on a daily
basis, except Saturdays. Here, minimum bid size is of Rs. 5 crore and
multiple. All commercial banks (except RRBs) can borrow
through repo facility. Repo borrowings have a tenure of
1 day to 90 days.
2. Marginal Standing Facility (MSF) -
Now think what will happen if banks
are not able to maintain their daily mismatches even with repo (it
happens!). Hence RBI provided (from 2011) one more
facility to banks - Marginal Standing Facility (MSF). Albeit its a penalty
rate (because banks are not able to maintain their mismatches with repo),
and always higher than repo rate (currently 100 basis point higher).
In this scheme, banks borrow
money with minimum bid size of Rs. 1 crore and multiple. The
tenure is of 1 day only, and banks can borrow 1 % of
their respective NDTL under this scheme.
3. Bank
Rate -
For the long term, i.e., 90
days to 1 year, banks can borrow money from RBI with bank
rate. As it is a long term borrowing, the rate is higher than repo rate.
Banks doesn't need any collateral
or security, while borrowing for a long term under Bank
Rate. It is not used as a monetary policy to adjust the
market, rather used to re-discount Bills of Exchange (refer our
previous article on Discounting Bills of Exchange), or other Commercial
Paper.
To Be Continued
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