Financial Services And

Derivatives
Course: TYBBA
S u b je c t C o d e : 3 0 5

B y : M r . D i p a n s h u T a l u ja

Merchant Banking- Introduction

Merchant Bankers carry on consultation, leasing,

Portfolio services, assets Management.

In Other words Its is concerned with Mobilising

savings of People and Directing the funds to

Business enterprise.

Definition of merchant Banking

The Notification of Ministry Of finance Defines any

Person who is engaged in business of Issue

management either by making arrangement
regarding
Selling,
Buying
Subscribing to securities as manger, consultant or advisor

Origin of Merchant Banker

Merchant Banking originated through the entering

of London Merchants in financing foreign trade

through acceptance of bill.
Later , the merchants assisted the government of
underdeveloped countries in raising long term funds
through flotation of bonds in London Money
markets.
Over a Period they extended their activities to
domestic business of syndication of long term and
short term finance.

Origin of Merchant Banking In India

In India Prior to Enactment of Indian Companies

Act, 1956, Managing Agents acted as issue house for

securities, evaluated project Reports, planned
Capital structure and to some extent provided
venture capital for new firms.
The Need for Specilased merchant banking services

was felt in India with Rapid growth in number and

size of the issues made in Primary Market

Cont
The Merchant banking services was started by foreign

bank namely The NATIONAL GRINDLAYS BANK in

1967 and the Citibank in 1970.
The Banking commission in its report in 1972
recommend the settings of merchant Banking intuitions
by commercial bank and financial intstuitions.
The SBI was first Indian Bank to set up Merchant
Banking Division followed by Bank of India, BOB,
Canara Bank, PNB and UCO Bank.
The Mercahant Banking Gained Prominence during
1983-84 due to new issue boom.

Progress Of Merchant Banking InIndia

Upto 1970 there were only two foreign banks which

performed merchant banking operations in the

country.
SBI was the first indian commercial bank and ICICI
the first financial instution to take up the activities in
1972 and 1973 respectively.
As the capital market Grew in 1980s some
commercial bank set up their subsidies to operate
exclusively in merchant banking industry.

Cont..
In addition to Indian Merchant Bankers, a large

number of reputed international Merchant Bankers

Like:
Merrill Lynch.
Morgan Stanley.
Goldman Sachs.
Jardie Fleming.
Kleinwort Benson
Operating in India under authorisation of SEBI

The recent developments in Merchant banking are due to certain

contributory factors in India. They are the Merchant Banking was at its best
during 1985-1992 being when there were many new issues. It is expected
that 2010 that it is going to be party time for merchant banks, as many new
issue are coming up. The foreign investors both in the form of portfolio
investment and through foreign direct investments are venturing in Indian
Economy.

It is increasing the scope of merchant bankers in many ways. Disinvestment

in the government sector in the country gives a big scope to the merchant
banks to function as consultants. New financial instruments are introduced
in the market time and again. This basically provides more and more
opportunity to the merchant banks. The mergers and corporate
restructuring along with MOU and MOA are giving immense opportunity to
the merchant bankers for consultancy jobs

DEFINATION BY SEBI
The merchant banking has been defined as to what a

merchant banker does. A merchant Banker has been

defined by Securities Exchange Board Of India
(Merchant Banker) rules, 1992, as Any person
who is engaged in the business of issue
management either by making arrangements
regarding selling, buying or subscribing to
securities or acting as manager, consultant,
advisor or rendering corporate advisory
services in relation to such issue
management

ROLE IN INDIA

SCOPE IN INDIA:
Economic development requires specialist financial skills: savings banks to marshal individual
savings; finance companies for consumer lending and mortgage finance; insurance companies
for life and property cover; agricultural banks for rural development; and a range of specialized
government or government sponsored institutions. As new units have been set up and business
is expanding, they require additional financial services. A public equity or debt issue is the
logical source of fund in this situation and merchant banks can tap this opportunity of growth.
The areas of great scope could be,
1) Growth of Primary market:
If the primary market grows and number of issues increases, the scope of merchant banking will

be enhanced.
2) Entry of Foreign Investors:
Now India capital market directly taps foreign capital through euro issues.FDI is increased in

capital market. So Merchant bankers are required to advice them for their investment in India.
The increasing number of joint ventures also requires expert services of Merchant Bankers. If
more and more NRIs participate in capital market, there will be great demand for merchant
banker services.

3) Changing policy of Financial Institutions:

Now the lending policies of financial institutions are based on project

orientation, so the merchant banker services will be needed by corporate

enterprise to provide expert guidance.
4) Development of debt markets:

If the debt market is enhanced, there will be tremendous scope for Merchant
bankers. Now NSE and OTCEI are planned to raise their fund through debt
instruments.
5) Corporate restructuring:
Due to liberalization and globalization Companies are facing lot of competition.

In order to compete, they have to go for restructuring, merger, acquisitions or

disinvestments. They may offer good opportunities to merchant bankers

The scope could be extended to:1. Advising the company on designing of its Capital Structure.
2. Advising the company on the instrument to be offered to the public.
3. Pricing of the instrument.
4. Advising the company on Legal/ regulatory matters and interaction with

SEBI/ ROC/ Stock

5. Exchanges and other regulatory authorities.
6. Assisting the company in marketing the issue.
7. In channelizing the financial surplus of the general public into productive
investment avenues.
8. To coordinate the activities of various intermediaries to the share issue
such as the registrar, Bankers, advertising agency, printers, underwriters,
brokers etc.
9. To ensure the compliance with rules and regulations governing the
securities market.

FUNCTIONS/ Services of Merchant Banks

1) 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 main areas of work in this regard include: instrument
designing, pricing the issue, registration of the offer document, underwriting
support, and marketing of the issue, allotment and refund, listing on stock
exchanges.
2) Placement and distribution- The merchant banker helps in distributing

various securities like equity shares, debt instruments, mutual fund products,
fixed deposits, insurance products, 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. The size of such a network represents the wholesale reach of the
merchant banker. The retail network depends on networking with investors.

Cont...
3) Issue Management:
Management of issue involves marketing of corporate securities viz. equity shares,

preference shares and debentures or bonds by offering them to public. Merchant banks
act as an intermediary whose main job is to transfer capital from those who own it to
those who need it. After taking action as per SEBI guidelines, the merchant banker
arranges a meeting with company representatives and advertising agents to finalize
Arrangements relating to date of opening and closing of issue, registration of
prospectus, launching publicity campaign and fixing date of board meeting to approve
and sign prospectus and pass the necessary resolutions. Pricing of issues is done by the
companies in consultant with the merchant bankers.
4) Underwriting of Public Issue:
Underwriting is a guarantee given by the underwriter that in the event of under

subscription, the amount underwritten would be subscribed by him. Banks/Merchant

banking subsidiaries cannot underwrite more than 15% of any issue.

5) Financial structuring
includes determining the right debt-equity ratio and

gearing ratio for the client; the appropriate capital structure

theory is also framed. Merchant bankers also explore the
refinancing alternatives of the client, and evaluate cheaper
sources of funds. Another area of advice is rehabilitation
and turnaround management. In case of sick units,
merchant bankers may design a revival package in
coordination with banks and financial institutions. Risk
management is another area where advice from a merchant
banker is sought. He advises the client on different hedging
strategies and suggests the appropriate strategy.

CONT
6)Project Counseling: Project counseling includes preparation of

project reports, deciding upon the financing pattern to finance the cost
of the project and appraising the project report with the financial
institutions or banks. It also includes filling up of application forms
with relevant information for obtaining funds from financial
Institutions and obtaining government approval.
7) Loan syndication- Merchant bankers arrange to tie up loans for

their clients. This takes place in a series of steps. Firstly they analyses
the pattern of the clients cash flows, based on which the terms of
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.

8)Providing venture capital and mezzanine financing- Merchant bankers help

companies in obtaining venture capital financing for financing their new and innovative
strategies.
9) Portfolio Management: Portfolio refers to investment in different kinds of

securities such as shares, debentures or bonds issued by different companies and

government securities. Portfolio management refers to maintaining proper combinations
of securities in a manner that they give maximum return with minimum risk.
10) Off Shore Finance:
The merchant bankers help their clients in the following areas involving foreign

currency.
(a) Long term foreign currency loans
(b) Joint Ventures abroad
(c) Financing exports and imports
(d) Foreign collaboration arrangements

11) Non-resident Investment: The services of merchant

banker includes investment advisory services to NRI in terms of

identification of investment opportunities, selection of securities,
investment management, and operational services like purchase
and sale of securities.

12) Corporate Counseling and advisory services: Corporate

counseling covers the entire field of merchant banking activities

viz. project counseling, capital restructuring, public issue
management, loan syndication, working capital, fixed deposit,
lease financing acceptance credit, etc. Merchant bankers also offer
customized solutions to their clients financial problems.

Qualities Required for Merchant Bankers

Merchant Bankers play a significant role as a catalyst

to transform the project ideas into Industrial

Ventures.
To perform these services effectively, the merchant
bankers are expected to possess certain qualities
which are described below:

Ability to analyse various aspects such as Technical, financial and

economic aspects concerning the formation of industrial project.
Knowledge of capital markets, Trends in stock exchange,
Psychology of investing.
Ability to build up the bank client relationship and live up to
clients expectation with total involvement

Organizational set up
Organizations can be categorized into 4 group on the basis of their linkage

with parent activity. They are:

a) Institutional Base:Where merchant banks function as an independent wing or as subsidiary of
various Private/ Central Governments/State Governments Financial
institutions. Most of the financial institutions in India are in public sector and
therefore such set up plays a role on the lines of governmental priorities and
policies.
b) Banker Base:These merchant bankers function as division/ subsidiary of banking

organization. The parent banks are either nationalized commercial banks or

the foreign banks operating in India. These organizations have brought
professionalism in merchant banking sector and they help their parent
organization to make a presence in capital market.

Cont..
c) Broker Base :In the recent past there has been an inflow of Qualified and professionally skilled

brokers in various Stock Exchanges of India. These brokers undertake merchant

baking related operating also like providing investment and portfolio management
services.
d) Private Base:These merchant banking firms are originated in private sectors. These organizations

are the outcome of opportunities and scope in merchant banking business and they
are providing skill oriented specialized services to their clients. Some foreign
merchant bankers are also entering either independently or through some
collaboration with their Indian counterparts. Private Sectors merchant banking firms
have come up either as sole proprietorship, partnership, private limited or public
limited companies. Many of these firms were in existence for quite some time before
they added a new activity in the form of merchant banking services by opening new
division on the lines of commercial banks and All India Financial Institution (AIFI).

In tracing the history of the merchant banking in India, the structure of

merchant bankers appeared as follows at one point of time:

1) Merchant banking divisions of commercial banks, both Indian and
Foreign.
2) Merchant banking divisions of financial institutions (e.g. IDBI, IFCI,
etc.)
3)Merchant banking companies promoted by stock broking firms. (e.g.
JM Financial, DSP)
4) Merchant banking services of NBFCs

Cont
However, the above structure has undergone a

transformation now. The merchant banking

divisions of the commercial banks exist now as
independent subsidiary companies of the parent
firms.
For example, the SBI Capital Markets Ltd is the
subsidiary of SBI. The merchant banking activities of
the NBFCs almost cease to exist.

Importance of Merchant Bankers

Need of Funds: exerting excess demand on the sources of fund for ever expanding

industries and trade, thus leaving a widening gap unabridged between the supply
and demand of invisible funds. All financial institutions had experienced constrain of
resources to meet ever increasing demands for demands for funds frame corporate
sector enterprises.
Growth of Capital Market: In such circumstances corporate sector had the only

alternative to avail of the capital market service for meeting their long term financial
requirement through capital issue of equity shares and debentures.
Growing demand for funds put pressure on capital market that enthused commercial
banks, share brokers and financial consultancy firms to enter into the field of
merchant banking and share the growing capital market.
As a result all the commercial banks in nationalized and public sector as well as in
private sector including foreign banks in India have opened their merchant banking
windows and competing in this field.

Cont..
Government Regulations : In view of multitude of enactment, rules and regulation and

offshoot press release instructions brought out the government from time to time imposing
statutory obligations upon the corporate sector to comply with those entire requirement
prescribed there in the need of a skilled agency existed which could provide counselling in
these matters in a package form.
Specialisation and Skilled: A merchant banker with their skills updated information and
knowledge provide this service to the corporate units and advice them on such requirement
to be complied with for raising funds from the capital market under different enactment viz.
companies act, income tax act, foreign exchange regulation act, securities contracts
corporate laws and regulations.
Counselling : Merchant bank advice the investors of the incentives available in the form of
tax relief, other statutory relaxation, good return on investment and capital appreciation in
such investment to motivate them to invest their savings securities of the corporate sector.
Thus merchant banks help industries and trade to rise and the investors to invest their saved
money in sound and healthy concern with confidence, safety and expectation for higher
yields. Finance is the backbone of business activities. Merchant banker make available
finance for business enterprises acting as intermediaries between them raising demand for
funds and the supplies of funds besides rendering various other services.

Public Savings: Need for merchant banking is felt in the wake of huge

public saving lying untapped. Merchant banker can play highly significant
role in mobilizing funds of savers to invisible channels assuring promising
returns on investment and thus can assist in meeting the widening
demand for invisible funds for economic activity.
With growth of merchant banking profession corporate enterprises in

both private sectors would be able to raise required amount of funds

annually from the capital market to meet the growing requirement for
funds for establishing new enterprises, undertaking expansion,
modernization and diversification of the existing enterprises.
This reinforces the need for a vigorous role to be played by merchant

banking.

The following are some of the reasons why specialist merchant bank have a

crucial role to play in India.

Growing complexity in rules and procedures of the government.
Growing industrialization and increase of technologically advanced industries.
Need for encouragement of small and medium industrialists, who require

specialist services.
Need to develop backward areas and states which require different criteria.
Exploring the possibility of joint ventures abroad and foreign market.
Promoting the role of new issue market in mobilizing saving from.
Where merchant banks function as an independent wing or as subsidiary of
various private/central governments/ state government financial institution.
Most of the financial institution in India is in public sector and therefore such
setup plays a role on the lines of governmental priorities and policies.

Registration of merchant bankers in India

Registration with SEBI is mandatory to carry out the business of merchant
banking in India. An applicant should comply with the following norms:
The applicant should be a body corporate
The applicant should not carry on any business other than those
connected with the securities market
The applicant should have necessary infrastructure like office space,
equipment, manpower etc.
The applicant must have at least two employees with prior experience in
merchant banking
Any associate company, group company, subsidiary or interconnected
company of the applicant should not have been a registered merchant
banker
The applicant should not have been involved in any securities scam or
proved guilt for any offence

SEBI HAS DIVIDED MERCHANT BANKERS IN

FOUR CATEGORIES, WHICH ARE AS FOLLOW:CATEGORIES

ACTIVITIES

NETWORTH

Category I

To carry on the activities of issue mgt RS 1 Crore

& act as advisor, consultant, manager,
underwriter, portfolio management.

Category II

To act as advisor, consultant , co- Rs 50 lakh

manager,

Underwriter,

portfolio

management.
Category III

To act as advisor, underwriter or Rs 20 lakh

consultant to an issue

Category IV

To act only as advisor& consultant to Nil

Leading Merchant Bankers in India

In Public Sector: SBI Capital Markets Ltd., Merchant Banking
Divisions of IDBI & IFCI, PNB Capital Services Ltd., Bank of
Maharashtra, etc.
In Private Sector: ABN AMRO, ICICI Bank Ltd, Axis Bank Ltd.,

Kotak Mahindra Capital Co., Bajaj Capital, Reliance Security Ltd.,

Yes bank Ltd, Tata capital market ltd., JM Financial Co. and DCM
Financial Services Ltd etc.
Foreign Players: Goldman SACH (India) Security Pvt. Ltd.,

Morgan Stanley Indian co. Pvt. Ltd., Barclays Security Indian Pvt.
Ltd., Bank of America, Deutsche Bank, Citi Group Global Market
Indian Pvt. Ltd., Fedex Security Ltd.,

Problems of Merchant Banking

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.
Minimum net worth of Rs.1 crore:
SEBI guidelines stipulate that a minimum net worth of Rs.1 crore for

authorization of merchant bankers.

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.

Merchant Bankers 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
- Registrars 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.

The challenges faced by merchant bankers in India

1) SEBI guideline has restricted their operations to Issue

Management and Portfolio Management to some extent. So, the

scope of work is limited.
2) In efficiency of the clients are often blamed on to the merchant

banks, so they are into trouble without any fault of their own.
3) The net worth requirement is very high in categories I and II

specially, so many professionally experienced person/ organizations

cannot come into the picture.
4) Poor New issues market in India is drying up the business of the

merchant bankers.

SEBI GUIDELINES
Obligations and Responsibilities of Merchant Bankers
In the conduct of his business, a merchant banker is supposed to observe certain

codes of conduct. SEBI has issued some guidelines for regulating the merchant
banking activities and the code of conduct for the merchant banks is specified in
the Schedule III of the SEBI (Merchant Bankers) Regulations 1992.

High standards:
Due diligence:
Dealing with competing merchant bankers:
No tall claims:
Cost-effective service:
Confidentially:
Disclosure of information:
Avoid market manipulative practices:
Restrain on advisory role:

All public issues shall be managed by a merchant

banker who acts as the lead merchant banker or the
lead manager to the issue. The number of such lead
managers is linked to the size of the public issue as
given below.
The regulations of SEBI specify certain responsibilities
of the lead merchant banker. In a public issue, the
responsibilities relate to the disclosure of
information in the offer documents, allotment of
securities and refund of application money.

SEBI has pronounced the following guidelines for

Merchant Bankers:
1. Submission of Offer Document:
2. Dispatch of issue material
3. Underwriting:
4. Compliance Obligations:
5) Redressed of investor grievances:
6) The concerned lead merchant banker
7) Issue of No objection Certificate (NOC):
8) Registration of Merchant Bankers:
9) Renewal of Registration:
10) Impositions of Penalty Points: