What are Financial Services?

Financial Service Sectors

What is Financial Services Industry? 

Financial Services Sector for any country is considered a lifeline for economic growth and its development. This sector offers savings and loan products to customers for both retail and corporate and is essential for both start-ups and established businesses. This means it promotes entrepreneurship and has even created numerous jobs within the sector. Hence, lack of such a sector would restrict people to earn, save and secure their future.

So what are the different financial services offered in India?

The Financial Services Sector is broadly classified into banking and non-banking companies. Here’s how they work…

  • Banking Companies

Banking companies are allowed to collect deposits from investors. This money is then used by the banking companies to disburse as loans to retail or corporate customers. The cost of lending is more than the banking company pays for the deposits. This difference is called the spread and is the earnings for the banking company.

  • Non-Banking Companies

A non-banking company provides banking services without meeting the legal definition of banks. Unlike other countries, in India, Non-banking companies are not allowed to collect money through deposits (i.e Savings or Current accounts). Non-banking financial companies would include companies that provide Mutual Funds, Insurance, Brokerage, Investment research services, etc.

Analysis of revenue drivers

• Banks, in the traditional sense, earns the difference between the lending and deposit rate. This is called the net interest margin for the company.
• However with emergence of newer areas in finance, banks have diversified to other income streams such as charging fees to customers for
o Advisory on Insurance, Mutual Fund, Public Provident Fund etc
o Providing foreign exchange services
o Locker services
This income is called fee-based income and off late there is a greater focus on this income stream for banks.
• Revenues for non-banking companies depend on the sub industry they are operating in such as:

o Brokerage – The volume traded or number of transactions done and commissions charged on these transactions.
o Investment Banking – Number of deals successfully completed and fees charged on these deals. The deals here include Initial Public Offering (IPO), Mergers and acquisition (M&A), company restructuring etc.
o Insurance – Insurance premium charged and the number of policies issued.

Investment Case
• Increase in prime lending rates, thereby increasing the lending rates.
• High credit/deposit ratio indicates a rise in credit compared to deposits. This results in greater credit demand, thereby pushing lending rates up.
• CASA ratio (Current accounts to saving accounts). Interest rate paid on savings account is more than current account. Higher CASA points to lower cost of funds for the bank.
• Reduction in statutory ratios (CRR, SLR). Lower ratio implies more money available to banks for lending.
• Improved market conditions, leading to higher participation of investors in trading. This improves the brokerage revenue.
• Higher business activity giving Investment Banks better chance of deals.
• Increased IPO activity improves the revenues from investment banking activities.

Investment Risks
• Decline in asset quality (i.e. quality of loans made). Firms to whom money was lend are unable to repay money
• Lowering of interest rates reduces the ability of banks to charge higher rates on lending. This in turn decreases the rate offered to investors who deposit money. As a result, depositors may not place their savings with the bank, thereby reducing funds available for lending.
• Increase in statutory requirements
• Government bonds flooding the market through the banking system. More supply of bonds will reduce the price of the bonds held by the banks
• Higher inflation increases the interest rate in the markets. This reduces the bond prices and increases pressure on both lending and deposit rates

The valuation multiple generally used to value financial services companies is P/BV ratio. Banks have large tangible assets (loans) on their Balance Sheet, thereby making book value of assets a primary factor in Valuation. The higher the book value of assets the higher is the net interest income and thus higher profits.

Related Articles: