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History

Origin of Merchant Banking

The origin of merchant banking is to be traced to Italy in late


medieval times and France during the seventeenth and
eighteenth centuries. The Italian merchant bankers introduced
into England not only the bill of exchange but also all the
institutions and techniques connected with an organized money
market during seventeenth and eighteenth centuries. In France a
merchant banker (le merchant banquet) was not merely a trader
but an entrepreneur par excellence. He invested his accumulated
profits in all forms of promising activities. He added banking
business to his merchant activities and became a merchant
banker.

Money changer and exchanger

In the late medieval to early modern times distinction existed in


banking system between money changer and exchanger. Money
changers concentrated on the manual change of different
currencies operated locally and later accepted deposits for
security reasons. In course of time, money changers evolved into
public or deposit banks. International exchangers engaged in bill-
broking, raising foreign exchange and provision of long term
capital for public borrowers. The exchangers were remitters and
merchant bankers. During this period merchant banker was a
dealer in bills of exchange who operated with correspondent
abroad and speculated on the rate of exchange. Initially,
merchant banks were not banks at all and a distinction was drawn
between banks, merchant banks and other financial institutions.
Among all these institutions, it was only banks that accepted
deposits from public.

Merchant banks in the United Kingdom

In the United Kingdom, merchant's banks came into operation in


the late eighteenth century and early nineteenth century.
Industrial revolution made England into a powerful trading nation.
Rich merchant houses that made their fortunes in colonial trade
diversified into banking. Their principal activity started with the
acceptance of commercial bills pertaining to domestic as well as
international trade. The acceptance of the trade bills and
discounting gave rise to acceptances houses, discount houses
and issue houses. Merchant banker was primarily a merchant
rather than a banker but he was entrusted with funds by his
customers. The term merchant bank is used to denote banks that
are not merchants. Sometimes for merchants who are not
bankers and sometimes for business houses that are neither
merchants nor banks. These confusions emerge because of a
wide range of activities carried out by modern merchants. The
merchants provide various services, like: Finance foreign trade,
Issue capital, Manage individual funds, Undertake foreign security
business, Foreign loan business.

Since the end of the Second World War, commercial banks in


Western Europe have been offering multiple services including
merchant banking services to their individuals and corporate
clients. British banks set up divisions or subsidiaries to offer their
customers merchant banking services.

Merchant Banking in India

Merchant banking activity was formally initiated into the Indian


capital Markets when Grind lays bank received the license from
reserve bank in 1967. Grind lays started with management of
capital issues, recognized the needs of emerging class of
entrepreneurs for diverse financial services ranging from
production planning and system design to market research. Even
it provides management consulting services to meet the
requirements of small and medium sector rather than large
sector. Citibank Setup its merchant banking division in 1970. The
various tasks performed by this divisions namely assisting new
entrepreneur, evaluating new projects, raising funds through
borrowing and issuing equity. Indian banks Started banking
Services as a part of multiple services they offer to their clients
from 1972. State bank of India started the merchant banking
division in 1972. In the Initial years the SBI's objective was to
render corporate advice And Assistance to small and medium
entrepreneurs. Merchant banking activities is OF course organized
and undertaken in several forms. Commercial banks and foreign
development finance institutions have organized them through
formation divisions, nationalized banks have formed subsidiaries
companies and share brokers and consultancies constituted
themselves into public limited companies or registered
themselves as private limited companies. Some merchant
banking outfits have entered into collaboration with merchant
bankers abroad with several branches.
Definition
The Notification of the Ministry of Finance defines merchant
banker as “Any person who is engaged in the business of issue
management either by making arrangements regarding selling,
buying or subscribing to securities as manager-consultant,
advisor or rendering corporate advisory services in relation to
such issue management”

The Amendment Regulation specifies that issue management


consist of Prospectus and other information relating to issue,
determining financial structure, tie-up of financiers and final
allotment and refund of the subscriptions, underwriting and
portfolio management services.

In the words of Skully “A Merchant Bank could be best defined as


a financial institution conducting money market activities and
lending, underwriting and financial advice, and investment
services whose organization is characterized by a high proportion
of professional staff able to able to approach problems in an
innovative manner and to make and implement decisions
rapidly.”

Nature of merchant banking:


Merchant banking is skill based activities and involves serving
every financial need of every client. It requires focused skill-base
to provide for the requirements of the client. SEBI has made the
quality of man-power as one of the criteria for registration as
merchant banker. These skills should not be concentrated in issue
management and underwriting alone, which may have an adverse
impact on business. Merchant bankers can turn to any of the
activities mentioned above depending upon resources, such as
capital, foreign tie-ups for overseas activities and skills. The depth
and sophistication in merchant banking business are improving
since the avenues for participating in capital market activities
have widened from issue management and underwriting to
private placement, bought out deals (BODS), buy-back of shares,
merges and takeovers.

The services of merchant bank cover project counseling, pre


investment activities, feasibility studies, project reports, design of
capital structure, issue management, underwriting, loan
syndication, mobilization of funds from Non-Resident Indians,
foreign currency finance, mergers, amalgamation, takeover,
venture capital, buy back and public deposits. A Category-1
merchant banker can undertake issue management only.
Separate registration is not necessary to carry on the activity as
underwriter.

Structure

Category Minimum Net Worth

• I 1 Crore

 to carry on any activity of the issue management, which will


inter-alia consist of preparation of prospectus and other
information relating to the issue, determining financial
structure, tie-up of financiers and final allotment and refund
of the subscription; and
 to act as adviser, consultant, manager, underwriter, portfolio
manager.

• II 50 Lakhs
 that is, to act as adviser, consultant, co-manager,
underwriter, portfolio manager

• III 20 Lakhs

 that is to act as underwriter, adviser, consultant to an issue;

• IV Nil

 that is to act only as adviser or consultant to an issue.


The Merchant Bankers registered with SEBI
classified according to the category:-

MERCHANT

BANKER

INTERNATIONAL
PUBLIC SECTOR PRIVATE SECTOR
BANKER: - 10

COMMERCIAL
BANKS: - 10
BANKS: - 24

FINANCIAL FINANCE &

INSTITUTION: - 6 INVESTMENT: - 231

STATE
LEASING
INSTITUTION: - 4
Characteristics of Merchant Banking:
 High proportion of decision makers as a percentage of total
staff.
 Quick decision process.
 High density of information.
 Intense contact with the environment.
 Loose organizational structure.
 Concentration of short and medium term engagements.
 Emphasis on fee and commission income.
 Innovative instead of repetitive operations.
 Sophisticated services on a national and international level.
 Low rate of profit distribution.
 High liquidity ratio.

Qualities of a Merchant Banker:


 Ability to analyse
 Abundant knowledge
 Ability to built up relationship
 Innovative approach
 Integrity

Functions of merchant bankers:


i) Management of Debt and Equity Offerings:

This forms the main function of the merchant banker.


He assists the companies in raising funds from the
market. The undergoing tasks include instrument
designing, pricing the issue, registration of the offer
document, underwriting support, marketing of the
issue, allotment and refund and listing on stock
exchanges.

ii) Placement and Distribution:

The merchant banker helps in distributing various


securities like equity shares, debt instruments, mutual
funds, insurance products, and commercial paper, to
name a few. The distribution network of the merchant
banker can be classified as institutional and retail in
nature. The institutional network consists of mutual
funds, foreign institutional investors; private equity
funds pension funds, financial institutions, etc.

iii) Corporate Advisory Services:

Merchant bankers offer customized solutions to their


clients' financial problems. Financial structuring
includes determining the right debt-equity ratio and the
framing of appropriate capital structure theory.

iv) Project Advisory Services:

Merchant bankers help their clients in various stages of


the project undertaken by the clients. They assist them
in conceptualizing the project idea in the initial stage.
Once the idea is formed, they conduct feasibility
studies to examine the viability of the proposed project.
v) Loan Syndication:

Merchant bankers arrange to tie up loans for their


clients. This takes place in a series of steps. Firstly, they
analyze the pattern of the client's cash flows, based on
which the terms of the borrowings can be defined. Then
the merchant banker prepares a detailed loan
memorandum, which is circulated to various banks and
financial institutions and they are invited to participate
in the syndicate. The banks then negotiate the terms of
lending on the basis of which the final allocation is
done.

vi) Providing Venture Capital Financing:

Merchant bankers help companies in obtaining venture


capital financing for financing their new and innovative
strategies
Scope in India:

1) Growth of New Issues Market

 Indian market largest emerging market


 Domestic and foreign investors setting up their business
here.
 Many public and private issues coming up

2) Entry of Foreign Institutional Investment

 Indian capital market is globalised


 Foreign Institutional Investments are permitted to invest
in India.
 They need Merchant Banks to advise them for their
invite in India.
 Increasing number of Joint Ventures also require expert
services of Merchant Banks.

3) Changing Policy of Foreign Investments

 Liberalisation of policies
 Foreign Investments would require expert services of
Merchant Banks for project appraisal, financial
management, financial restructuring etc.

4) Development of Debt Market

 Good portion of capital can be raised through debt


instruments.
5) Innovations in Financial Instruments

 New financial instruments have come up.


 Merchant Banks are market makers for these
instruments.

6) Corporate Restructuring

 Liberalisation and globalisation


 Competition in corporate sector becoming intense.
 Companies reviewing their strategies, structure and
functioning etc. leading to corporate restructuring.

7) Disinvestment

 It means reduction of some kind of asset of a firm for


achieving either financial or ethical objectives.
 Motive of disinvestment is to obtain funds.
Problems of Merchant Banking:

1) Restriction of merchant banking activities:


 SEBI guidelines have authorized merchant bankers to
undertake issue related activities and made them
restrict their activities or think of separating these
activities from present one and float new subsidiary and
enlarge the scope of its activities.

2) Minimum net worth of Rs.1 crore:

 SEBI guidelines stipulate that a minimum net worth of


Rs.1 crore for authorization of merchant bankers.

3) Non co-operation of issuing companies:

 Non co-operation of the issuing companies in timely


allotment of securities and refund of application money
is another problem faced by merchant bankers.

4) Merchant Banker’s Commission:

 Maximum :- 0.5%
 Project appraisal fees
 Lead Manager :-

- 0.5% up to Rs.25 crores

- 0.2% more in excess of Rs.25 crores

 Underwriting fees

 Brokerage commission :- 1.5%

 Other expenses :-

- Advertising
- Printing

- Registrar’s expenses

- Stamp duty

In spite of problems popping up, merchant banking in India has


vast scope to develop because of lot of domestic as well as
foreign businesses booming here. Indian economy provides an
amicable environment for these firms to set up, flourish and
expand here.

Difference Between Commercial Banking &


Merchant Banking:
COMMERCIAL BANKING

 Deals with Debt & Debt related finance.


 Asset oriented.
 Generally avoid risks.

MERCHANT BANKING

 Deals with Equity & Equity related finance.


 Management oriented.
 Willing to accept risks.

Difference Between Investment Banking &


Merchant Banking:
INVESTMENT BANKING

 Both fee-based and fund-based.


 Commit their own funds.

MERCHANT BANKING

 Purely fee-based.
 Impossible to stay aloof from international trends.
Services of Merchant Banks

No Particulars Summary

1 Corporate Covers the entire field of merchant banking, Ltd to


Counseling giving suggestions

2 Project Preparing project report for govt. approval ,


Counseling financial assistance

3 Loan Assistance rendered to get term loan for project,


Syndication help client make appraisal, designing capital
structure etc

4 Issue Marketing corporate securities, intermediary in


Management transfer of capital from one who owns to needy

5 Underwriting Guarantee given by the underwriter, make raising


of external resource easy

6 Managers to Drafting, completion of formalities, appoint


Issue Registrar etc

7 Portfolio Investment in different kind of securities


Management

8 Mergers and Middlemen in setting negotiation


takeovers

9 Off Shore Help in areas involving foreign currency


Finance

10 Non- Resident Provide help in better and smooth trade to Non-


Investment Resident Investments
Ranking of Merchant Banking in India:

Merchant Banker OE FSS QPS QM INN

ICICI Securities 4.0 4.0 4.2 3.8 4.3

IDBI 4.2 3.2 4.5 4.0 4.8

SBI Caps 4.4. 3.9 4.6. 6.7 5.2

DPS 6.1 5.7 6.0 6.0 5.3

IFCI 6.1 5.7 6.0 6.0 6.3

Bank of Baroda 6.7 6.5 6.7 6.6 6.8

Jardine Fleming 5.8 6.2 5.9 5.0 5.5

JM Finance 6.0 6.5 5.5 5.9 5.4

ENAM 6.3 6.8 6.4 6.3 6.2

PNB Caps 6.8 6.8 6.7 6.8 6.8

OE: Overall Excellence; FSS: Financial Soundness; QPS:


Quality Product/Service; QM: Quality Management; INN:
Innovativeness.