MERCHANT BANKING

The word ‘merchant banking’ was originated among the Dutch and Scottish
traders. Later on, it was developed and professionalized in the UK and the USA.
Now this has become popular throughout the world.

DEFINITION

Merchant Bank may be defined as a kind of financial institution that provide a

variety of services, including investment, banking, management of customer's
securities, portfolios, insurance, acceptance of bills, etc.".

As per the Securities and Exchange Board of India (Merchant Bankers) Rules,
1992, “Merchant Bankers" means "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, adviser or rendering corporate
advisory services in relation to such issue management".

According to Random House Dictionary, “Merchant bank is an organization that

underwriters’ securities for corporations, advices such clients on mergers and is
involved in the ownership of commercial ventures. These organizations are
sometimes banks which are not merchants and sometimes merchants who are not
bankers and sometimes houses which neither merchants nor banks.”

Meaning
Merchant Banking is a combination of Banking and consultancy services. It
provides consultancy to its clients for financial, marketing, managerial and legal
matters. Consultancy means to provide advice, guidance, and service for a fee. It
helps a businessman to start a business. It helps to raise (collect) finance. It helps to
expand and modernize the business. It helps in restructuring of a business. It helps
to revive sick business units. It also helps companies to register, buy and sell
shares at the stock exchange.
To sum up, merchant bankers may be referred to an
"intermediary who provides various financial services, other than lending money,
such as managing public issues, underwriting new issues, arranging loan
syndications and giving advice on portfolio management, financial restructuring,
mergers and acquisitions".
In short, “merchant bank refers to an organization that
underwrites securities and advises such clients on issues like corporate mergers,
involving in the ownership of commercial ventures.”
 Features of Merchant Banking
They are below as;
1. The high proportion of decision-makers as a percentage of total staff.
2. Quick decision process.
3. The high density of information.
4. Intense contact with the environment.
5. Loose organizational structure.
6. A concentration of short and medium-term engagements.
7. Emphasis on fee and commission income.
8. Innovative instead of repetitive operations.
9. Sophisticated services on a national and international level.
10. The low rate of profit distribution.
11. High liquidity ratio.
Eligibility norms on Merchant Banking Reforms for the
merchant bankers

SEBI has made the following reforms for the merchant banker
1. Multiple categories of merchant banker will be abolished and there will be only
one equity merchant banker.
2. The merchant banker is allowed to perform underwriting activity. For
performing portfolio manager, the merchant banker must seek separate registration
from SEBI.
3. A merchant banker cannot undertake the function of a non-banking financial
company, such as accepting deposits, financing others ‘business, etc.
4. A merchant banker must confine himself only to capital market activities

Conditions by SEBI for merchant bankers

SEBI has laid the following conditions on the merchant bankers, for conducting
their operations. They are
1. SEBI will give authorization for a merchant banker to operate for 3 years only.
Without SEBI ‘s authorization, merchant bankers cannot operate.
2. The minimum net worth of merchant banker should be Rs. 1 crore.
3. Merchant banker must pay authorization fee, annual fee, and renewal fee.
4. All issue of shares must be managed by one authorized merchant banker. It
should be the lead manager.
5. The responsibility of the lead manager will be clearly indicated by SEBI.

In India Merchant banking services are

provided by

 (1) Commercial Banks

 (2) Financial Institutions
 (3) Private consultancy firms
DIFFERENCE BETWEEN MERCHANT BANK AND COMMERCIAL
BANK
Merchant banks are different from commercial banks. The following are the
important differences between merchant banks and commercial banks:
1. Commercial banks basically deal in debt and debt related finance. Their
activities are clustered around credit proposals, credit appraisal and loan sanctions.
On the other hand, the area of activity of merchant bankers is equity and equity
related finance. They deal with mainly funds raised through money market and
capital market.
2. Commercial banks’ lending decisions are based on detailed credit analysis of
loan proposals and the value of security offered. They generally avoid risks. They
are asset oriented. But merchant bankers are management oriented. They are
willing to accept risks of business.
3. Commercial banks are merely financiers. They do not undertake project
counselling, corporate counselling, managing public issues, underwriting public
issues, advising on portfolio management etc. The main activity of merchant
bankers is to render financial services for their clients. They undertake project
counselling, corporate counselling in areas of capital restructuring, mergers,
takeovers etc., discounting and rediscounting of short-term paper in money
markets, managing and underwriting public issues in new issue market and acting
as brokers and advisors on portfolio management.

FUNCTIONS (SERVICES) OF MERCHANT BANKERS (SCOPE

OF MERCHANT BANKING)
Merchant banks have been playing an important role in procuring the funds for
capital market for the corporate sector for financing their operations. They perform
some valuable functions. The functions of merchant banks in India are as follows:
1. Corporate counseling: One of the important functions of a merchant banker is
corporate counseling. Corporate counseling refers to a set of activities undertaken
to ensure efficient functioning of a corporate enterprise through effective financial
management. A merchant banker guides the client on aspects of organizational
goals, vocational factors, organization size, choice of product, demand forecasting,
cost analysis, allocation of resources, investment decisions, capital and expenditure
management, marketing strategy, pricing methods etc. The following activities are
included in corporate counseling:
(a) Providing guidance in areas of diversification based on the Government’s
economic and licensing policies.
(b) Undertaking appraisal of product lines, analyzing their growth and profitability
and forecasting future trends.
(c) Rejuvenating old-line companies and ailing sick units by appraising their
technology and process, assessing their requirements and restructuring their capital
base.
(d) Assessment of the revival prospects and planning for rehabilitation through
modernization and diversification and revamping of the financial and
organizational structure.
(e) Arranging for the approval of the financial institutions/banks for schemes of
rehabilitation involving financial relief, etc.
(f) Monitoring of rehabilitation schemes.
(g) Exploring possibilities for takeover of sick units and providing assistance in
making consequential arrangements and negotiations with financial
institutions/banks and other interests/authorities involved

2. Project counseling:
Project counseling relates to project finance. This involves the study of the project,
offering advisory services on the viability and procedural steps for its
implementation. Project counseling involves the following activities:
(a) Undertaking the general review of the project ideas/project profile.
(b) Providing advice on procedural aspects of project implementation.
(c) Conducting review of technical feasibility of the project on the basis of the
report prepared by own experts or by outside consultants.
(d) Assisting in the preparation of project report from a financial angle, and
advising and acting on various procedural steps including obtaining government
consents for implementation of the project.
(e) Assisting in obtaining approvals/licenses/permissions/grants, etc. from
government agencies in the form of letter of intent, industrial license, DGTD
registration, and government approval for foreign collaboration.
(f) Identification of potential investment avenues.
(g) Arranging and negotiating foreign collaborations, amalgamations, mergers, and
takeovers.
(h) Undertaking financial study of the project and preparation of viability reports to
advise on the framework of institutional guidelines and laws governing corporate
finance.
(i) Providing assistance in the preparation of project profiles and feasibility studies
based on preliminary project ideas, covering the technical, financial and economic
aspects of the project from the point of view of their acceptance by financial
institutions and banks.
(j) Advising and assisting clients in preparing applications for financial assistance
to various national financial institutions, state level institutions, banks, etc.

3. Pre-investment studies:
Another function of a merchant banker is to guide the entrepreneurs in conducting
pre-investment studies. It involves detailed feasibility study to evaluate investment
avenues to enable to decide whether to invest or not. The important activities
involved in pre investment studies are as follows:
(a) Carrying out an in-depth investigation of environment and regulatory factors,
location of raw material supplies, demand projections and financial requirements in
order to assess the financial and economic viability of a given project.
(b) Helping the client in identifying and short-listing those projects which are built
upon the client’s inherent strength with a view to promote corporate profitability
and growth in the long run.
(c) Offering a package of services, including advice on the extent of participation,
government regulatory factors and an environmental scan of certain industries in
India.

4. Loan syndication:
A merchant banker may help to get term loans from banks and financial
institutions for projects. Such loans may be obtained from a single financial
institution or a syndicate or consortium. Merchant bankers help corporate clients to
raise syndicated loans from commercial banks. The following activities are
undertaken by merchant bankers under loan syndication:
(a) Estimating the total cost of the project to be undertaken.
(b) Drawing up a financing plan for the total project cost which conforms to the
requirements of the promoters and their collaborators, financial institutions and
banks, government agencies and underwriters.
(c) Preparing loan application for financial assistance from term lenders/financial
institutions/banks, and monitoring their progress, including pre-sanction
negotiations.
d) Selecting institutions and banks for participation in financing. (e) Follow-up of
term loan application with the financial institutions and banks, and obtaining the
approval for their respective share of participation.

5. Issue management:
Issue management involves marketing or corporate securities by offering them to
the public. The corporate securities include equity shares, preference shares, bonds,
debentures etc. Merchant bankers act as financial intermediaries. They transfer
capital from those who own it to those who need it. The security issue function
may be broadly classified into two – pre-issue management and post-issue
management. The pre-issue management involves the following functions:
(a) Public issue through prospectus.
(b) Marketing and underwriting.
(c) Pricing of issues.

6. Underwriting of public issue:

In underwriting of public issue, the activities performed by merchant bankers are
as follows:
(a) Selection of institutional and broker underwriters for syndicating/ underwriting
arrangements.
(b) Obtaining the approval of institutional underwriters and stock exchanges for
publication of the prospectus.
(c) Co-ordination with the underwriters, brokers and bankers to the issue, and the
Stock Exchanges.

7. Portfolio management:
Merchant bankers provide portfolio management service to their clients. Today
every investor is interested in safety, liquidity and profitability of his investment.
But investors cannot study and choose the appropriate securities. Merchant bankers
help the investors in this regard. They study the monetary and fiscal policies of the
government. They study the financial statements of companies in which the
investments have to be made by investors. They also keep a close watch on the
price movements in the stock market. The merchant bankers render the following
services in connection with portfolio management:
(a) Undertaking investment in securities.
(b) Collection of return on investment and re-investment of the same in profitable
avenues, investment advisory services to the investors and other related services.
(c) Providing advice on selection of investments.
(d) Carrying out a critical evaluation of investment portfolio.
(e) Securing approval from RBI for the purchase/sale of securities (for NRI
clients).
(f) Collecting and remitting interest and dividend on investment.
(g) Providing tax counseling and filing tax returns through tax consultants.

8. Merger and acquisition:

A merger is a combination of two or more companies into a single company where
one survives and others lose their corporate existence. A takeover refers to the
purchase by one company acquiring controlling interest in the share capital of
another existing company. Merchant bankers are the middlemen in setting
negotiation between the offeree and offeror. Being a professional expert, they are
apt to safeguard the interest of the shareholders in both the companies. Once the
merger partner is proposed, the merchant banker appraises merger/takeover
proposal with respect to financial viability and technical feasibility. He negotiates
purchase consideration and mode of payment. He gets approval from the
government/RBI, drafts scheme of amalgamation and obtains approval from
financial institutions.

9. Foreign currency financing:

The finance provided to fund foreign trade transactions is called ‘Foreign Currency
Finance’. The provision of foreign currency finance takes the form of export
import trade finance, euro currency loans, Indian joint ventures abroad and foreign
collaborations. The main areas that are covered in this type of merchant activity are
as follows:
(a) Providing assistance for carrying out the study of turnkey and construction
contract projects.
(b) Arranging for the syndication of various types of guarantees, letters of credit,
pre-shipment credit, deferred post-shipment credit, bridge loans, and other credit
facilities.
(c) Providing assistance in opening and operating bank accounts abroad.
(d) Arranging foreign currency loans under buyer’s credit scheme for importing
goods.
(e) Arranging deferred payment guarantees under supplier’s credit scheme for
importing capital goods. (f) Providing assistance in obtaining export credit
facilities from the EXIM bank for export of capital goods, and arranging for the
necessary government approvals and clearance.
(g) Undertaking negotiations for deferred payment, export finance, buyers’ credits,
documentary credits, and other foreign exchange services like packing credit, etc.

10. Working capital finance:

The finance required for meeting the day-to-day expenses of an enterprise is
known as ‘Working Capital Finance’. Merchant bankers undertake the following
activities as part of providing this type of finance: (a) Assessment of working
capital requirements.
(b) Preparing the necessary application to negotiations for the sanction of
appropriate credit facilities.

11. Acceptance credit and bill discounting: Merchant banks accept and discount
bills of exchange on behalf of clients. Merchant bankers give loans to business
enterprises on the security of bill of exchange. For this purpose, merchant bankers
collect credit information relating to the clients and undertake rating their
creditworthiness.

12. Venture financing:

Another function of a merchant banker is to provide venture finance to projects. It
refers to provision of equity finance for funding high-risk and high-reward
projects.

13. Lease financing: Leasing is another function of merchant bankers. It refers to

providing financial facilities to companies that undertake leasing. Leasing involves
letting out assets on lease for a particular period for use by the lessee. The
following services are provided by merchant bankers in connection with lease
finance:
(a) Providing advice on the viability of leasing as an alternative source for
financing capital investment projects.
(b) Providing advice on the choice of a favourable rental structure.
(c) Providing assistance in establishing lines of lease for acquiring capital
equipment, including preparation of proposals, documentations, etc.

14. Relief to sick industries:

Merchant bankers render valuable services as a part of providing relief to sick
industries.

15. Project appraisal:

Project appraisal refers to evaluation of projects from various angles such as
technology, input, location, production, marketing etc. It involves financial
appraisal, marketing appraisal, technical appraisal, economic appraisal etc.
Merchant bankers render valuable services in the above areas. The functions of
merchant banker can be summarized as follows:
(a) Issue management.
(b) Underwriting of issues.
(c) Project appraisal.
(d) Handling stock exchange business on behalf of clients.
(e) Dealing in foreign exchange.
(f) Floatation of commercial paper.
(g) Acting as trustees.
(h) Share registration.
(i) Helping in financial engineering activities of the firm.
(j) Undertaking cost audit.
(k) Providing venture capital.
(l) Arranging bridge finance.
(m) Advising business customers (i.e., mergers and takeovers).
(n) Undertaking management of NRI investments.
(o) Large scale term lending to corporate borrowers.
(p) Providing corporate counseling and advisory services.
(q) Managing investments on behalf of clients.
(r) Acting as a stock broker

OBJECTIVES OF MERCHANT BANKING

The objectives of merchant banking are as follows:

1. To help for capital formation.
2. To create a secondary market in order to boost the industrial activities in the
country.
3. To assist and promote economic Endeavor.
4. To prepare project reports, conduct market research and pre-investment surveys.
5. To provide financial assistance to venture capital.
6. To build a data bank as human resources.
7. To provide housing finance.
8. To provide seed capital to new enterprises.
9. To involve in issue management.
10. To act as underwriters.
11. To identify new projects and render services for getting clearance from
government.
12. To provide financial clearance.
13. To help in mobilizing funds from public.
14. To divert the savings of the country towards productive channel.
15. To conduct investors conferences.
16. To obtain consent of stock exchange for listing.
17. To obtain the daily report of application money collected at various branches of
banks.
18. To appoint bankers, brokers, underwrites etc.
19. To supervise the process on behalf of NRIs for their ventures.
20. To provide service on fund-based activities.
21. To assist in arrangement of loan syndication.
22. To act as an acceptance house.
23. To assist in and arrange mergers and acquisitions.

CATEGORIES OF MERCHANT BANKS

Merchant bankers are classified into four categories according to the SEBI
(Merchant Banking) Regulations 1992. These are as follows:

(a) Category – I:
To carry on any activity relating to issue management and act as
adviser, consultant manager, underwriter and portfolio manager
for capital issues.
Merchant Bankers of this category can carry on any activity relating to
issue management. The activities are as follows:
  Preparation of Prospectus and other information relating to
issue,
 Determining the financial structure
 Tie-up of financiers,
 Final allotment of securities
 Refund of subscribes etc.,
They could also act as Advisors, Consultants, Co-Managers,
Underwriters or Portfolio Managers.

(B) Category – II:

To act as adviser, consultant, co-manager, underwriter and portfolio
manager for capital issues.

(c) Category – III:

To act as underwriter, adviser, and consultant to an issue.

(d) Category – IV:

To act only as adviser or consultant to an issue.
 WEAKNESS OF MERCHANT BANKS / PROBLEMS OF
MERCHANT BANKS
1. SEBI guidelines have authorized merchant bankers to undertake issue related
activities only with an exception of portfolio management. It restricts the scope of
merchant bank activities.
2. SEBI guidelines stipulate a minimum net worth of Rs.1 crore for authorization
of merchant bankers. Small but professional merchant bankers are facing difficulty
for adhering such net worth norms.
3. Non-cooperation of the issuing companies in timely allotment of securities and
refund application money is another problem of merchant bankers.
4. Unhealthy competition among large number of merchant banks compels them to
reduce their profit margin, commission etc.
5. There is no exact regulatory framework for regulating and controlling the
working of merchant banks in India.
6. Fraudulent and fake issue of share capital by the companies are also posing
problems for merchant banks who act as lead manager or issue manager of such
issues.

ROLE OF MERCHANT BANKERS IN MANAGING PUBLIC

ISSUE

In issue management, the main role of merchant bankers is to help the company
issuing securities in raising funds for the purpose of financing new projects,
expansion/ modernization/ diversification of existing units and augmenting long
term resources for working capital requirements. The most important aspect of
merchant banking business is to function as lead managers to the issue
management. The role of the merchant banker as an issue manager can be studied
from the following points:

1. Easy fund raising:

An issue manager acts as an indispensable pilot facilitating a public/ rights
issue. This is made possible with the help of special skills possessed by him
to execute the management of issues.
2. Financial consultant:
An issue manager essentially acts as a financial architect, by providing advice
relating to capital structuring, capital gearing and financial planning for the
company.

3.Underwriting: An issue manager allows for underwriting the issues of

securities made by corporate enterprises. This ensures due subscription of the
issue.

4. Due diligence:
The issue manager has to comply with SEBI guidelines. The merchant banker will
carry out activities with due diligence and furnish a Due Diligence Certificate to
SEBI. The detailed diligence guidelines that are prescribed by the Association of
Merchant Bankers of India (AMBI) have to be strictly observed. SEBI has also
prescribed a code of conduct for merchant bankers.

5. Co-ordination:
The issue manger is required to co-ordinate with a large number of institutions and
agencies while managing an issue in order to make it successful.

6. Liaison with SEBI:

The issue manager, as a part of merchant banking activities, should register with
SEBI. While managing issues, constant interaction with the SEBI is required by
way of filing of offer documents, etc. In addition, they should file a number of
reports relating to the issues being managed.
 MERCHANT BANKING IN INDIA

1. Prior to the enactment of Indian Companies Act, 1956, managing agents

acted as merchant bankers. They acted as issue houses for securities,
evaluated project reports, provided venture capital for new firms etc. Few
share broking firms also functioned as merchant bankers. With the rapid
 growth in the number and size of the issues made in the primary market, the
need for specialized merchant banking service was felt.
2. Grindlays Bank (foreign bank) opened its merchant banking division in
1967, followed by Citibank in 1970.
3. SBI started its merchant banking division in 1972 and it followed up by
setting up a fully owned subsidiary in 1980, namely SBI Capital Markets
Ltd.
4. The other nationalized banks and financial institutions, like IDBI, IFCI,
ICICI, Securities and Finance Company Ltd., Canara Bank (Can Bank
Financial Services Ltd.), Bank of India (BOI Finance Ltd.) and private
sector financial companies, like JM Financial and Investment Consultancy
Services Ltd., DSP Financial Consultancy Ltd. have also set up their
merchant banking divisions. With over 1,100 merchant bankers operating in
the country, the primary market activity is picking up.
5. Merchant banking services have assumed greater importance in the present
capital market scenario. With the investor becoming more cautious and
discerning, the role of merchant banker has gained more prominence.
6. In India, apart from the overall control by the RBI, merchant bankers’
operations are closely supervised by the SEBI for their proper functioning
and investor protection.