What is Financial Services? Characteristics, Functions, Classification

  • Post last modified:27 March 2023
  • Reading time:14 mins read
  • Post category:Finance

What is Financial Services?

Financial services refer to services provided by the banks and financial institutions in a financial system.

In general, all types of activities which are of financial nature may be regarded as financial services. In a broad sense, the term financial services mean mobilisation and allocation of savings. Thus, it includes all activities involved in the transformation of savings into investment.

The finance industry covers a broad range of organizations that deal with management of inflow and outflows of funds in an economy. Among these organizations are Asset Management Companies like leasing companies, merchant bankers and Liability Management Companies like discounting houses and acceptance houses, and further general financial institutions like banks, credit card companies, insurance companies, consumer finance companies, stock exchanges, and some government sponsored enterprises.

Following are some of the examples of financial services:

  • Mutual Fund management
  • Leasing, credit card services, factoring, portfolio management and financial consultancy services
  • Underwriting, discounting and rediscounting of bills
  • Acceptances, brokerage and stock holding
  • Depository services, housing finance and book building
  • Hire purchases and installment credit
  • Insurance
  • Financial and performance guarantees
  • Loan syndicating and credit rating

Characteristics of Financial Services

  • Customer-centric: Financial services are usually customer focused. Financial Services are provided, depending on the need of customer for example, leasing finance service may be needed by an industrial customer, while merchant banker’s services may be needed by a company issuing new equity share in the market.

    Financial services firms like other service firms continuously remain in touch with their customers, so that they can design products which can cater to the specific needs of their customers.

  • Intangibility: Financial services are intangible in nature. In a highly competitive global environment, brand image is very important. Unless the financial institutions providing financial products and services have good image, enjoying the confidence of their clients, they may not be successful.

  • Concomitant: Production of financial services and delivery of these services have to be concomitant. Both these functions i.e. production of new and innovative financial services and supplying of these services are to be performed simultaneously.

  • Perishable in nature: Like other services, financial services also require a match between demand and supply. Services cannot be stored. They have to be supplied when customers need them.

  • Dominance of human element: Financial services are dominated by human element. Thus, financial services are labour intensive. It requires competent and skilled personnel to market the quality financial products.

  • Advisory: Financial services can be of three types i.e. a fund based or a fee-based or both. In case of fee-based services, the advisory function is dominant. Issue management, registrar of issue, merchant banking, pricing of securities etc. are few examples of advisory financial services.

  • Heterogeneity: Financial services are customized services. It cannot be uniform for all clients. Financial services vary from one client to other. Institutional client requirements differ from individual client. After analysing the needs of the clients, financial institutions offer customised financial services to the clients.

  • Information based: Financial service industry is an information based industry. It involves creation, dissemination and use of information. Information is an essential component in the production of financial services.

Functions of Financial Services

Financial services, through the network of financial institutions, financial markets and financial instruments serve the needs of individuals, institutions and corporate.

In essence, orderly functioning of the financial system depends to a great deal, on the range and the quality of financial services extended by the financial intermediaries. Specifically financial services perform following functions for the orderly development of an economy.

  • Mobilization of funds: A financial service helps in mobilizing fund from investors, individual, institutions and corporate entities. These funds are mobilized through different financial instruments like equity shares, bonds, mutual funds etc.

  • Effective utilization of funds: These financial services also help in effective utilization of mobilized funds. Financial services helps in this regard through services like factoring, securitization, credit rating etc. Services of Credit Rating Company enables investors to make wise and informed decisions related to investment. Similarly merchant banking services helps companies in mergers and acquisitions.

  • Transforming risk: Financial services like insurance helps in reduction of risk by transferring risk to those who are more willing to bear it.

  • Enhancement of economic development: A financial service helps in economic development of the country by mobilization and deployment of funds. Ideal savings of individuals are channelized into productive investment through financial services.

  • Provision of liquidity: The financial service industry promotes liquidity in the financial system by allocating and reallocating savings and investment into various avenues of economic activity. It facilitates easy conversion of financial assets into liquid cash.

  • Creation of employment opportunities: The financial service industry creates and provides employment opportunities to millions of people all over the world.

Classification of Financial Services

The term “financial services” refers to an assortment of institutions that provide the means for people to save for the future, hedge against risks, acquire capital for consumption and organize capital for investment.

Financial services cover wide range of activities like fund raising, funds deployment, credit rating, underwriting, merchant banking, depository, mutual fund, book building etc.

Financial services can be broadly classified as:

Traditional Financial Services

It includes services rendered for both money and capital market, which can be grouped under two heads:

Fund Based Services

In fund-based services the firm raises funds through debt, equity, deposits and the bank invests the funds in securities or lends to those who are in need of capital. Fund based Services are the activities which come under the following:

  • Primary market activities
  • Secondary market activities
  • Foreign exchange market activities
  • Specialized financial services activities
  • Financial engineering activities.

The important fund based services include:

  • Equipment Leasing / Finance
  • Hire Purchase and Consumer Credit
  • Bill Discounting
  • Venture Capital
  • Housing Finance
  • Insurance Services
  • Factoring etc.

Fee Based Services

Fee based financial services are those services wherein financial institutions operate in specialized fields to earn a substantial income in the form of fees or dividends or brokerage on operations. The major fee based financial services are as follow:

  • Managing Capital Issues according to SEBI guidelines
  • Making arrangements of funds from financial institutions to meet the project cost and working capital
  • Making arrangements for the placement of capital and debt instruments with investment institutions
  • Assisting in the process of getting all government and legislative clearances.· Managing the portfolio

The fee based/advisory services include:

  • Issue Management
  • Portfolio Management
  • Corporate Counseling
  • Loan Syndication
  • Merger and Acquisition
  • Capital Restructuring
  • Credit Rating
  • Stock broking etc.

Modern financial services

Modern financial services include innumerable activities like:

  1. Rendering project advisory services.
  2. Planning for mergers and acquisitions.
  3. Guiding corporate customers in capital restructuring.
  4. Acting as Trustees to Debenture holders.
  5. Recommending suitable changes in financial structure.
  6. Structuring the financial collaboration through joint ventures
  7. Rehabilitating and reconstructing sick companies through reconstruction.
  8. Hedging of risks through derivative trading.
  9. Managing portfolio of public sector corporations.
  10. Asset liability management.
  11. Undertaking risk management services through insurance.
  12. Advising clients for selecting the best source of funds.
  13. Guiding clients for determining the optimum debt-equity mix.
  14. Undertaking specialized services like credit rating, underwriting, registration and transfers, clearing services, custodian services etc.

Challenges to Indian Financial Service Sector

Financial service in India is industry characterized by increasingly vibrant public and private-sector institutions. A large number of banks and non-banking finance companies (NBFC) are providing a variety of financial services to both individual and institutional clients.

Therefore, the financial service industry will be facing a new, demanding competitive map, which will create challenges for financial service providers in India.

Angel Cano (2010) has identified following challenges to financial service industry in India:

  • Markets are segmented in unconventional ways: The classical financial services segments are affinities such as chartered accountants, Independent Financial Analysts or insurance agents. These are not the most effective groupings in India because the linkages between communities, localities and religious sects are often stronger than those between occupations.

  • Changes in society and relationship patterns: Deep changes in consumer preferences will determine how financial institutions reach out to their customers and relate to them. This will mean evolving towards a more efficient, more productive distribution model.

  • The talent pool is shallow and itinerant: Most financial services businesses require high quality, intelligent people. These are hard to find and already work in high paying multinationals. It is common to have 100% attrition which means that the sales force gets replaced each year. In such circumstances how can one build sustainable institutional capabilities?

  • Tougher regulatory and oversight standards will materialize as increased capital, liquidity and provisioning requirements and more stringent consumer protection. The main consequence will be greater pressure on banks’ returns, forcing them to being more selective in allocating scarce resources, in particular, capital, which will become increasingly scarce.

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