Finance Business

A Study on Merchant Banking Awareness

Merchant Banking

Merchant Banking is a professional financial service provided by a merchant banker to its customers depending upon their financial needs. Merchant banks are financial and capital intermediaries which provide fundraising, financial advising, and loan services and assist in the subscription of securities to large corporations. They provide advisory services to their investors right from the stage of the conception of an idea of the point when the project goes on-stream. Raising finance for its client is the primary function performed by merchant bankers. They also help the client in financing transactions through underwriting or some type of syndicated loan arrangement and in promoting and marketing the issue. 

Merchant banks are different from regular banks. They do not provide regular cheque service, nor do they take deposits. They do not provide retail or commercial banking operations to individuals. However, they are more inclined towards corporate investors having national as well as international presence. The present article discusses Merchant Banking Awareness.

Origin and Development of Merchant Bankers

The origin of Merchant Bankers can be traced bad back to the 11th Century in Italy.  Back then, its primary function was to provide finance for the production of crops, as farming was a prominent form of trade. Up till the 18th Century Merchant Banking services were not organized and were mainly provided by certain families. Over the span of time, it spread to countries. By the 17th Century, it reached large trading countries such as U.K., Germany, and Netherlands. In the 17th Century, Britain’s first merchant bank named Barings was established. By the end of the 18th Century, Barings Bank entered into a strategic alliance with another merchant bank Hope & Co. to undertake cross-border transactions.

In India, a similar concept called “hundi” existed. It was used to provide credit by indigenous bankers. In the 18th Century, when merchants from Europe travelled to India for trade, agency houses of merchant bankers in London were set up. During the British Era, foreign merchant bankers operated through the East India Company. It was in 1967 when the first Merchant Bank named National Grindlay’s Bank was established in India. Post this a number of commercial banks set up their merchant banking division.

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How is Merchant Bank different from other banks?

Merchant BankInvestment Bank
They underwrite and sell securities through private placements.They underwrite and sell securities to the general public.
Income is mainly fee-based.Income is mainly two-fold, I.e., either from fees or from advisory services.
Its clients are mainly private companies not big enough to raise an Initial Public Offer (IPO) and high-net-worth individuals.Its clients are mainly large public companies.
Merchant BankCommercial Bank
It is a financial institution.It is a banking establishment.
Its function is to provide financial services to corporate entities and high-net-worth individuals.Its function is to provide banking services to the general public.
It does not provide depository services.It provides depository services.

Functions of Merchant Bankers

The functions of merchant bankers are –

  1. Portfolio Management: Merchant bankers help investors make better investment decisions with portfolio management services. It is the role of a Merchant Banker to guide the investor right from the stage of the conception of the idea till the time the project goes on-stream. They analyse the idea of the project, look into the financial, technical and infrastructural aspects and then advise the investor. A Merchant Banker selects assets which best align with the investor’s strategic objective and meet the long-term financial goal of the investor.
    The role of a merchant banker does not end with the idea becoming a reality. They provide advisory services on the modernization and expansion of the project. Even modernization and expansion require finance, so merchant bankers come to the rescue of the investors by issuing fresh public shares or bonus shares. They also manage the public issue of the initial public offering.
  2. Comprehensive research: Merchant Bankers research the cost of the project and the finance required for the project, including the cost over-runs. They analyse the market conditions and assess the right time for issuing the shares and the quantity of shares to be issued.
  3. Raise Capital: Merchant bankers raise capital on behalf of their investors by trading in securities such as shares, debentures, stocks, etc. In case they are not able to raise sufficient capital; they arrange for loans to cater to the financial requirements of their investors. They raise funds from both the domestic and international markets.
  4. Advisory Services: Merchant Banking is advisory in nature and not decision-making. The primary role of a merchant banker is to advise the investor. Merchant Bankers advise on amalgamations, mergers and acquisitions, takeovers, foreign collaboration, diversification of business, joint ventures, up-gradation, etc. However, the final take is always of the investor.
  5. Promotional Activities: The Merchant Bankers do promotional activities for their investors by:
    • Informing the public that they are to come up with a public offer of securities for a company. This includes doing road shows, meetings, and press conferences.
    • Providing the services of a broker in stock exchanges by buying and selling shares on behalf of the investor.
    • Playing the role of a promoter for industrial enterprise.
    • Assisting in financial and technical collaboration and joint ventures.
  6. Credit Syndication: Merchant Bankers syndicate or pool the finances received in the forms of shares or debentures and loans from banks and financial institutions to meet the financial needs of the investor.
  7. Leasing Services: The Merchant Bankers lease assets of the investor on behalf of the investor to generate rental income.
  8. Obtaining clearances: Various clearance and consent are required from relevant government authorities for industrial projects. Merchant Bankers handle such clearances and consent for the clients.
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Categorization of Merchant Bankers

The study on merchant banking awareness also includes the categorization of merchant bankers –

In India, the Securities Exchange Board of India (SEBI) regulates the activities of Merchant Bankers. To be a Merchant Banker, an application has to be made for the grant of a certificate of registration to the Securities Exchange Board of India under Regulation 3 of SEBI (MB) Regulations, 1992. The application has to be made for one of the following categories of merchant banker prescribed under the regulation:

  • Category I

To carry on any activity of the issue management consisting of the preparation of prospectus and other information relating to the issue, determining financial structure, tie up of financiers and final allotment and refund of the subscriptions; and to provide services of an advisor, consultant, manager, underwriter, and portfolio manager;

  • Category II

To provide services related only to an adviser, consultant, co-manager, underwriter and portfolio manager;

  • Category III

To provide services related only to an underwriter, adviser, or consultant to an issue;

  • Category IV

To provide services related only to an adviser or consultant to an issue;

Capital Adequacy Requirement of Merchant Banks

Regulation 7 of the SEBI (MB) Regulation, 1997 provides for the requirement of capital adequacy. This regulation was amended by the Securities Exchange Board of India (Merchant Bankers) (Third Amendment) Regulations, 2006[1], to make capital adequacy requirement to “net-worth of not less than five crores” to be a merchant banker.

Prior to the amendment, the capital requirement for every category of merchant banker was as follows:

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For Category I – Rs. 5, 00, 00, 000;

For Category II – Rs. 50 00, 000;

For Category III – Rs. 20, 00 000; and

For Category IV – Nil.

Conclusion

Awareness of Merchant Banking is necessary as every business, at some point in time, requires finance. Merchant Bankers have made the work of raising funds easier for corporate entities. They are professionals dedicated to raise funds and to meet the financial needs of corporate entities. They know exactly in which asset the investment should be made, and they also know how to raise the required amount of finance by mitigating the risk of loss. Their services are beneficial for companies. Further, the industrial market is on a boom in India. This has increased the need for Merchant Bankers in India.

Read our Article: How to Get a Merchant Banking License in India

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