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

PUBLIC SECTOR PRIVATE SECTOR

COMMERCIAL

BANKS: - 24

INTERNATIONAL

BANKER: - 10

FINANCIAL

INSTITUTION: - 6

STATE

INSTITUTION: - 4

BANKS: - 10

FINANCE &

INVESTMENT: - 231

LEASING

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 Counseling

Covers the entire field of merchant banking, Ltd to giving suggestions

2 Project Counseling

Preparing project report for govt. approval , financial assistance

3 Loan Syndication Assistance rendered to get term loan for project, help client make appraisal, designing capital structure etc

4 Issue Management

Marketing corporate securities, intermediary in 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 Issue

Drafting, completion of formalities, appoint Registrar etc

7 Portfolio Management

Investment in different kind of securities

8 Mergers and takeovers

Middlemen in setting negotiation

9 Off Shore Finance Help in areas involving foreign currency

10 Non- Resident Investment

Provide help in better and smooth trade to Non-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.