Fund and Fee Based Services

8th May 2020 1 By indiafreenotes

These terms typically relate to banking activities. The revenue that banks get out of their lending activities is fund based income, i.e. they borrow from depositors through fixed deposits/ savings accounts and lend to borrowers at a higher interest rate, the difference is their interest margins, i.e. fund based income.

In a fund based income it is more dynamic and relates to the fund’s performance.

As per your question I assume it is something to do with mutual fund. SO taking this assumption into consideration, in a fee based system it’s fixed fee for the investment you make. Whereas on the fund based, the income would be based on the fund’s performance.

On the other hand, banks make money out of services, such as selling mutual funds and insurance products to their customers, this income is called fee based income. Even banking services which do not involve lending, such as issue of demand drafts or guarantees, transfer of funds, etc. give the bank fee based income.

In a fee based income it’s a more straight forward like for this much this is the fee/charge kind of thing.

Fund Based Financial Services

Involve provision of funds against assets, bank deposits, etc.

Fund based income comes mainly from interest spread (the difference between the interest earned and interest paid), lease rentals, income from investments in capital market and real estate

Major part of the income is earned through fund-based activities. At the same time, it involves a large share of expenditure also in the form of interest and brokerage.

Examples of Fund Based Financial Services

  • Underwriting shares, debentures, bonds, etc. of new issue
  • Equipment Leasing
  • Hire Purchase
  • Bill discounting
  • Venture capital
  • Housing finance
  • Insurance services
  • Factoring

(i) Equipment leasing

A lease is an agreement under which a company or a firm acquires a right to make use of a capital asset like machinery, on payment of a prescribed fee called „rental charges‟. Long-term.

(ii) Hire Purchase

Hire purchase is a mode of financing the price of the goods to be sold on a future date. In a hire purchase transaction, the goods are let on hire, the purchase price is to be paid in installments and hirer is allowed an option to purchase the goods by paying all the installments.

(iii) Bills Discounting

Bill discounting is a short tenure financing instrument for companies willing to discount their purchase / sales bills to get funds for the short run and as for the investors in them, it is a good instrument to park their spare funds for a very short duration.

(iv) Accounts Receivable Financing / Factoring

A type of asset-financing arrangement in which a company uses its receivables – which is money owed by customers – as collateral in a financing agreement. The company receives an amount that is equal to a reduced value of the receivables pledged.

Factoring is similar to the above with the only difference that the factoring firms purchase the receivables outright taking ownership of the receivables. The entire responsibility of collecting the book debts passes on to the factor.

(v) Venture Capital

Venture capital (VC) is financial capital provided to early- stage, high-potential, high risk, growth startup companies.

The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as biotechnology, IT, software, etc.

(vi) Housing Finance

Housing finance refers to providing finance to an individual or a group of individuals for purchase, construction or related activities of house/flat etc.

Housing loan is extended by way of term loans; for a number of years (5-20) at a certain rate of interest and against some.

(vii) Insurance Services

Insurance is a form of risk management in which the insured transfers the cost of potential loss to another entity in exchange for monetary compensation known as premium

(viii) Mutual Funds.

A mutual fund refers to a fund raised by a financial service company by pooling the savings of the public. It is invested in a diversified portfolio with a view to spreading and minimizing the risk.

Free Based Financial Services

Fee based income does not involve much risk. But, it requires a lot of expertise on the part of a financial company to offer such fee-based services.

Examples of Free Based Financial Services

  • Corporate advisory services
  • Bank guarantees
  • Merchant banking
  • Issue management
  • Loan syndication
  • Credit rating
  • Stock Broking
  • M & A, Capital restructuring

(i) Merchant banking

A merchant banker is a financial intermediary who helps to transfer capital from those who possess it to those who need it.

Merchant banking includes a wide range of activities such as management of customer securities, portfolio management, project counseling and appraisal, underwriting of shares and debentures, loan syndication, acting as banker for the refund orders, handling interest and dividend warrants etc.

(ii) Loan Syndication

  • Similar to consortium financing.
  • Taken up by the merchant banker as a lead manager.
  • It refers to a loan arranged by a bank called lead manager for a borrower who is usually a large corporate customer or a government department.
  • It also enables the members of the syndicate to share the credit risk associated with a particular loan among themselves.

(iii) Credit Rating

Evaluates the credit worthiness of a debtor, especially a business (company) or a government. It is an evaluation made by a credit rating agency of the debtors ability to pay back the debt and the likelihood of default. Some credit rating agencies; ICRA, CRISIL, S & P, Moody’s.