Merchant Banking

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 organised money
market. Merchant banking consisted initially of merchants who assisted in
financing the transactions of other merchants in addition to their own trade.
In France, during seventeenth and eighteenth centuries a merchant banker (le
merchand Banquer) was not merely a trader but an entrepreneur par
excellence. He invested his accumulated profits in all kinds of promising
activities. He added banking business to his merchant activities and became a
merchant banker.

Meaning
Merchant banking implies investment management. Companies raise capital
by issuing securities in the market. Merchant bankers act as intermediaries
between the issuers of capital and the investors who purchase these
securities.

Merchant banking is the financial intermediation that matches the entities that
need capital and those that have capital for investment.

Services of merchant bankers

The services provided by merchant bankers includes management of mutual
funds, public issues, trusts, securities and international funds. It involves
dealing with the corporate clients and advising them on various issues like-
mergers, acquisitions, public issues, etc.

32.2 Objectives

After studying this lesson, you will be able to —

1. describe the terms bank and banking;
2. distinguish between banks and money lenders;
3. classify the various types of banks;
4. explain the nature and scope of banking activities;
5. enumerate the advantages of commercial banks;
6. describe how suspension of banking activities will affect trade, commerce
and industry.
Functions of merchant bankers include:

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.

Regulatory framework The merchant banking activity in India is governed by

SEBI (Merchant Bankers) Regulations, 1992. Registration with SEBI is
mandatory to carry out the business of merchant banking in India. An
applicant should comply with the following norms:
i) The applicant should be a corporate body.
ii) The applicant should not carry on any business other than those connected
with the securities market.
iii) The applicant should have necessary infrastructure like office space,
equipment, manpower, etc.
iv) The applicant must have at least two employees with prior experience in
merchant banking.
v) Any associate company, group company, subsidiary or interconnected
company of the applicant should not have been a registered merchant
banker.
vi) The applicant should not have been involved in any securities scam or
proved guilt for any offence.
vii) The applicant should have a minimum net worth Rs50 million.

Scope of merchant banking in India: Merchant banking activities help in

channelizing the financial surplus of the general public into productive
investment avenues. They help to coordinate the activities of various
intermediaries to the share issue such as the registrar, bankers, advertising
agency, printers, underwriters, brokers, etc. and to ensure the compliance with
rules and regulations governing the securities market. This being the era
where mergers and acquisitions are hot, the scope of merchant banking has
grown to a large extent.