History Origin of Merchant Banking The origin of merchant banking is to be traced to Italy in late medieval times and Fra France nce during the seve eventee nteent nth h and eighte eighteenth enth centuri centuries. es. The Itali Italian an merchan merchantt banker bankers s introd introduced uced into in to Engl Englan and d not not only only the the bill ill of exch exchan ange ge but but als also all all the 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 entrepreneur par excellence. excellence. He invested invested his accumulated accumulated profi profits ts in all form forms s of prom promis isin ing g acti activi viti ties es.. He adde added d banki banking ng busi busine ness ss to hi his s merc mercha hant nt acti activi viti ties es and and beca became me a merc mercha hant nt banker.
Money changer and exchanger In the late medieval to early modern times distinction existed in banking system between money changer and exchanger. Money chan change gers rs conc conce entra ntratted on the manua anuall chan change ge of diffe iffere rent nt curr curren enci cies es oper operat ated ed loca locall lly y and and late laterr acce accept pted ed depo deposi sits ts for for security reasons. In course of time, money changers evolved into public or deposit banks. International exchangers engaged in billbroki broking ng,, raisi raising ng forei foreign gn excha exchang nge e and and prov provis isio ion n of long long term term capital for public borrowers. The exchangers were remitters and merch merchant ant bank bankers ers.. Duri During ng this this perio period d merc merchan hantt banke bankerr was a deal dealer er in bill bills s of excha exchang nge e who who oper operat ated ed with with corre corresp spon onde dent nt abro abroad ad and sp spec ecul ulat ated ed on the the rat rate of exc exchang hange. e. Init Initia iall lly, y, merchant banks were not banks at all and a distinction was drawn between banks, merchant banks and other financial institutions. Among Among all all thes these e inst instit itut utio ions ns,, it was only only bank banks s that that acce accept pted ed deposits from public.
Merchant banks in the United Kingdom In the United Kingdom, merchant's banks came into operation in the late ate eigh eighte teen entth cent centur ury y and and earl early y ni nine netteent eenth h cent centur ury y. 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 inte in tern rnat atiional onal trade rade.. The The acc accepta eptanc nce e of the the trade rade bills ills and discou dis counti nting ng gave gave rise rise to accept acceptance ances s houses, houses, dis discou count nt houses houses and issu issue e house houses. s. Merc Mercha hant nt banke bankerr was prima primari rily ly a merc merchan hantt rather than a banker but he was entrusted with funds by his customers. The term merchant bank is used to denote banks that are are not not merc erchant hants s. Somet ometiimes mes for for merc mercha hant nts s who who are are not not bank banker ers s and and some someti time mes s for for busi busines ness s hous houses es that that are neith neither er merch merchant ants s nor nor bank banks. s. These These confu confusi sions ons emerg emerge e beca becaus use e 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 Wester Western n Europe Europe have have been been offering offering multip multiple le service services s includ including ing merch merchant ant bank bankin ing g servi service ces s to thei theirr indi indivi vidua duals ls and and corp corpor orat ate e clients. clients. British banks set up divisions or subsidiarie subsidiaries s 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 capi capita tall issu issues es,, reco recog gni niz zed the need needs s of emer emergi ging ng clas class s of ent entrep reprene reneur urs s for for di dive vers rse e fina financ nciial serv servic ices es rang rangiing from from production planning and system design to market research. Even it provides manag nagement ent cons nsul ultting servi ervic ces to meet eet the requ requir irem emen ents ts of smal smalll and and medi medium um sect sector or rath rather er than than larg large e sector. sector. Citibank Citibank Setup its merchant banking division division in 1970. The various tasks performed by this divisions namely assisting new entrep entrepren reneur eur,, evalua evaluati ting ng new new proje project cts, s, raisi raising ng funds funds throu through gh borr borrow owin ing g and and issu issuin ing g equi equity ty.. Indi Indian an bank banks s Star Starte ted d bank bankin ing g Services as a part of multiple services they offer to their clients from from 19 1972 72.. Stat State e bank bank of Indi India a start started ed the the merc mercha hant nt banki banking ng division in 1972. In the Initial years the SBI's objective was to rende renderr corp corpora orate te advi advice ce And As Assi sist stan ance ce to smal smalll and medi medium um entrepreneurs. Merchant banking activities is OF course organized
and undertaken in several forms. Commercial banks and foreign develo developme pment nt financ finance e ins instit tituti utions ons have have organi organized zed them them throug through h formation divisions, nationalized banks have formed subsidiaries comp compani anies es and sh share are brok brokers ers and cons consult ultanc ancie ies s cons consti titu tute ted d them hemselve elves s into nto publ ublic limited companies or reg registere ered thems hemsel elve ves s as pri private vate lim limited ited com compani panies es.. Som Some merch erchan antt bankin banking g outfit outfits s have entered entered into into collab collaborat oration ion with with merchant merchant bankers abroad with several branches.
Definition The The Notif Notific icat atio ion n of the the Minis Ministr try y of Fina Financ nce e defi defines nes merc merchan hantt banker as “Any person who is engaged in the business of issue management either by making arrangements regarding selling, buyi buying ng or su subs bscr crib ibin ing g to secu securi ritties ies as mana manage gerr-co cons nsul ulta tant nt,, adviso advisorr or renderin rendering g corpor corporate ate adviso advisory ry service services s in relati relation on to such issue management” The The Amend Amendme ment nt Regu Regula lati tion on sp spec ecif ifie ies s that that issu issue e manag managem ement ent cons consis istt of Pros Prospe pect ctus us and other other infor informa mati tion on relat relating ing to issu issue, e, dete determ rmin inin ing g finan financi cial al struc structu ture, re, tietie-up up of finan financi ciers ers and final final allo allotm tmen entt and and refu refund nd of the the su subs bscr crip ipti tion ons, s, unde underw rwri riti ting ng and and portfolio management services. In the words of Skully “A Merchant Bank could be best defined as a financi financial al ins instit tituti ution on conduc conductin ting g money money market market activi activitie ties s and lend lendin ing, g, unde underw rwri riti ting ng and and fina financ ncia iall advi advice ce,, and and in inve vest stme ment nt services whose organization is characterized by a high proportion of prof profes essi sion onal al staff staff able able to able able to appr approac oach h prob proble lems ms in an inno in nova vati tive ve manne annerr and and to make ake and and imple mpleme ment nt decis ecisiions ons 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 sin ce the avenues avenues for partic particip ipati ating ng in capita capitall market market activi activitie ties s have have wide widene ned d from from issu issue e mana manage geme ment nt and and unde underw rwri riti ting ng to
private private placement, placement, bought out deals (BODS), buy-back of shares, shares, merges and takeovers. The The servi service ces s of merc merchan hantt bank bank cover cover proje project ct couns counsel elin ing, g, pre pre investment activities, feasibility studies, project reports, design of capi capita tall st stru ruct ctur ure, e, issu sue e manag anagem emen ent, t, unde underw rwri riti ting ng,, loan loan syndic syndicati ation, on, mobili mobilizat zation ion of funds funds from from Non-Re Non-Resid sident ent Indians Indians,, forei foreign gn curre currency ncy finan finance ce,, merge mergers rs,, amal amalga gama mati tion on,, take takeove over, r, ventu venture re capi capita tal, l, buy back back and publ public ic depo deposi sits ts.. A Cate Catego gory ry-1 -1 merch erchan antt banke ankerr can can und undert ertake ake iss ssue ue manag anagem emen entt onl only. Separate registration is not necessary to carry on the activity as underwriter.
Structure
Category
•
•
I
Minimum Net Worth
1 Crore
to carry on any activity of the issue management, which will inter inter-al -alia ia cons consis istt of prepa preparat ratio ion n of pros prospe pect ctus us and and other other info in form rmat atio ion n rela relati ting ng to the the issu issue, e, dete determ rmin inin ing g fina financ ncia iall 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, underwriter, portfolio manager
III
consultant,
co-manager,
20 Lakhs
that is to act as underwriter, adviser, consultant to an issue;
IV
Nil
that is to act only as adviser or consultant consu ltant to an issue.
The Mercha Merchant nt Banke Bankers rs regist registere ered d with with SEBI SEBI classified according to the category:-
MERCHANT BANKER
INTERNATIONAL PUBLIC SECTOR
PRIVATE SECTOR BANKER: - 10
COMMERCIAL BANKS: - 10 BANKS: - 24
FINANCIAL
FINANCE &
INSTITUTION: - 6
INVESTMENT: - 231
STATE LEASING INSTITUTION: - 4
Characteri harac teristic stics s of Merchant Merch ant Banki B anking: ng:
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 assi assist sts s the the comp compan anie ies s in rais raisin ing g fund funds s from from the the mark market et.. The The unde underg rgoi oing ng task tasks s in incl clud ude e in inst stru rume ment nt design designing ing,, pricin pricing g the iss issue, ue, regist registrat ration ion of the offer offer docu docume ment nt,, unde underw rwri riti ting ng su supp ppor ort, t, mark market etin ing g of the the
issue, all allotment ent and refu efund and listing on stock exchanges.
ii)
Placement and Distribution: The The merc mercha hant nt bank banker er help helps s in di dist stri ribu buti ting ng vari variou ous s securities like equity shares, debt instruments, mutual funds, funds, ins insuran urance ce produc products ts,, and commer commercia ciall paper, paper, to name a few. The distribution network of the merchant banker can be classified as institutional and retail in nature nature.. The The inst instit itut ution ional al netwo network rk consi consist sts s of mutu mutual al funds funds,, forei foreign gn inst instit itut utio ional nal inves investo tors; rs; priva private te equit equity y funds pension funds, financial institutions, etc.
iii)
Corporate Advisory Services: Merchant Merchant bankers bankers offer offer custom customize ized d soluti solutions ons to their their clie client nts' s' fina financ ncia iall prob roblems lems.. Fina Financ ncia iall st stru ruc cturi turing ng 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 various stages of the project undertaken by the clients. They assist them in conceptualizing the project idea in the initial stage. Once Once the id idea ea is form formed ed,, they hey cond onduct uct feas feasiibi billity ity studies to examine the viability of the proposed project.
v)
Loan Syndication: Merc Mercha hant nt bank banker ers s arra arrang nge e to tie tie up loan loans s for for thei theirr 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, memorandum, which is circulated circulated to various banks and financial financial institutio institutions ns and they are invited invited to participat participate e in the syndicate. The banks then negotiate the terms of lendi lending ng on the the basi basis s of which which the fina finall allo alloca cati tion on is done.
vi)
Providing Venture Capital Financing: Merchant bankers help companies in obtaining venture capital capital financing financing for financing financing their new and innovative strategies
Scop Scope e in i n Ind India ia :
1)
Growth of New Issues Market
2)
Entry of Foreign Institutional Investment
3)
Indian capital market is globalised Foreign Institutional Investments are permitted to invest in India. They They need need Merc Mercha hant nt Bank Banks s to advi advise se them them for for thei their r invite in India. Increasing number of Joint Ventures also require expert services of Merchant Banks.
Changing Policy of Foreign Investments
4)
Indian market largest emerging market Domestic and foreign investors setting up their business here. Many public and private issues coming up
Liberalisation of policies Foreign Foreign Investm Investments ents would would require require expert expert service services s of Merchant Banks for project appraisal, financial management, financial restructuring etc.
Development of Debt Market
Good Good port portio ion n of capi capita tall can can be rais raised ed thro throug ugh h debt debt instruments.
5) Innovations in Financial Instruments Instruments
New financial instruments have come up. Merchant Banks are market makers instruments.
for
these
6) Corporate Restructuring
Liberalisation and globalisation Competition in corporate sector becoming intense. Compa Compani nies es revie reviewi wing ng thei theirr strat strateg egies ies,, stru struct cture ure and and functioning etc. leading to corporate restructuring.
7) Disinvestm Disinvestment ent
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 Probl ems of Merchant Merc hant Banking: Banki ng:
1)
Restriction of merchant banking activities: SEBI SEBI guidel guidelines ines have have authori authorized zed mercha merchant nt bankers bankers to unde undert rtak ake e iss issue rela relate ted d acti activi vitties ies and and made ade them hem rest restri rict ct thei theirr acti activi viti ties es or thin think k of sepa separa rati ting ng thes these e 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 Non co-o co-ope perat ratio ion n of the the issui issuing ng comp compani anies es in time timely ly 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 - Regis egisttrar’ rar’s s expe expens nses es - Stamp duty In spite of problems popping up, merchant banking in India has vast vast sc scop ope e to deve develo lop p beca becaus use e of lot lot of dome domest stic ic as well well as foreign foreign busines businesses ses boomin booming g here. here. Indian Indian econom economy y provid provides es an amic amicab able le envir environm onmen entt for for thes these e firm firms s to set set up, up, flou flouri rish sh and and expand here.
Diff Differ eren ence ce Betw Betwee een n Comm Commer erci cial al Bank Bankin ing g & 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.
Diff Differ eren ence ce Betw Betwee een n Inve Invest stme ment nt Bank Bankin ing g & 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
Assistance rendered to get term loan for project, Loan Syndication help client make appraisal, designing capital structure etc
4
Marketing corporate securities, intermediary in Issue Management 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 Drafting, completion of formalities, appoint Registrar etc Issue
7
Investment in different kind of securities Portfolio Management
8
Mergers and Middlemen in setting negotiation takeovers
9
10
Off Shore Finance
Help in areas involving foreign currency
Non- Resident Provide help in better and smooth trade to Investment Resident Investments
Non-
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
JM Finance
6.2
6.0
5.9
6.5
5.0
5.5
5.5
5.9
ENAM
6.3
6.8
6.4
6.3
6.2
PNB Caps
6.8
6.8
6.7
6.8
6.8
5.4
OE: Overal Overalll Excelle Excellence nce;; FSS: FSS: Financ Financial ial Soundn Soundness ess;; QPS: QPS: Quality Quality Produc Product/S t/Serv ervice; ice; QM: Qualit Quality y Manage Managemen ment; t; INN: INN: Innovativeness.
