III SEMESTER

MERCHANT BANKING AND FINANCIAL SERVICES

UNIT I: MERCHANT BANKING 9

Introduction – An Over view of Indian Financial System - Merchant Banking in India – Functions of
merchant banking –- registration of merchant bankers – general obligations- procedure for inspection –
procedure for action in case of default – code of conduct for MB - Recent Developments and Challenges
ahead – merchant banking services offered by banks – NBFC’S offering merchant banking - Banking system
– types of banks – payment banking - Legal and Regulatory Framework – Relevant Provisions of Companies
Act- SERA- SEBI guidelines- FEMA, etc. - Relation with Stock Exchanges and OTCEI.

III. PROCEDURE FOR INSPECTION

1. Boards right to Inspect: The board shall appoint one or more persons as inspecting
authority to undertake inspection of the books of accounts, records, and documents of the
merchant banker
2. Notice before inspection: Before undertaking an inspection the board shall give a
responsible notice to the merchant banker.
3. Obligation of Merchant Banker on Inspection: The merchant Banker shall allow the
inspecting authority to have reasonable access to the premises occupied. The inspection
shall be entitled to examine record statement of any employee of the Merchant Banker.
4. Submission of Report to the Board: The inspection authority shall as soon as possible
submit an inspection report to the Board.
5. Acting on Inspection or Investigating report: The board or the chairman after
considering such report shall take such actions as the board or chairman may deem fit and
appropriate.
6. Appointment of Auditor: The board may appoint a qualified auditor to investigate into
the books of accounts.
7. Communication of Finding: The board shall after considering of the inspection report
communicate the findings to the Merchant Banker.

IV. PROCEDURE FOR ACTION IN CASE OF DEFAULT

1. Liability for action in case of Default: A merchant Banker who fails to comply with
any conditions subject to which certificate has been granted, shall be dealt with in in the
manner provided under SEBI regulation.
2. Suspension of Registration: A penalty for suspension of registration may be imposed
under the following circumstances:
 Violation of the provision of the act
 Fails to furnish any detail
 Failing to resolve any complaint
 Indulging in manipulation
  Guilty of misconduct
 Fails to maintain the capital adequacy
 Fails to pay the fees
 Violates the conditions of registration
 Does not carry out his obligation
3. Cancellation of Registration: A penality of cancellation of Merchant Banker may be
imposed where:
 The merchant Banker indulges in Delibrate manipulation
 The financial position of the Merchant Banker deteriorates
 The Merchant banker is guilty of fraud.
 In case of repeated defaults.
4. Manner of making order of suspension or cancellation: Only after having an enquiry
suspension can be made.
5. Manner of holding enquiry before suspension or cancellation:
 Appoint an enquiry officer
 The enquiry officer shall issue a notice to the merchant banker
 The merchant banker within 30 days from the receipt of such report furnishes a
reply to the enquiry officer with copies of document.
 The enquiry officer shall give a reasonable opportunity of hearing to the merchant
Banker
 If it is necessary the enquiry officer may ask the board to appoint a presenting
officer to present the case.
 The enquiry officer shall then submit a report to the board and recommend the
penalty
6. Show-cause notice order: On receipt of the report from the enquiry officer, the board
shall issue a show-cause notice as to why the penalty proposed by the enquiry officer
should not be imposed. The merchant banker within 21 days send a reply to the board.
The board after considering the reply, shall as soon as possible but not later than 30 days,
if any such order as it deems fit.

7. Effect of suspension & cancellation: On and from the date of suspension or cancellation
the merchant banker shall cease to carry on any activity as a Merchant Banker. The order
of suspension or cancellation shall be published in atleast 2 daily newspaper by the board.

8. Appeal to the Securities appellate Tribunal: Any person aggrieved shall appeal to a
securities Appellate tribunal.

9. Fees:
 Every Merchant Banker shall pay a sum of 5 lacs as registration fees.
  The fee shall be paid within 15 days from the date of receipt of intimation from
board.
 He shall pay a renewal fees of 2.5 lacs every three years
 The fees shall be paid by a DD in favour of SEBI.

Every Merchant Banker shall pay:

Category I - A sum of 2.5 lakhs to be paid annually for 1st two years and 1 lakhs for 3rd year.
Category II - 1.5 lahs for the 1st two years and 1 lakhs for the third year.
- 1 lakh for the 1st two year and 25000 for the third year.
Category III
- 5000 for the 1st two years and 1000 for the 3rd year.
Category IV
Renewal Fees
Category I - A sum of 1 lakhs to be paid annually for 1st two years and 20000 for 3rd year.
Category II - A sum of 75000 to be paid annually for 1st two years and 10000 for 3rd year.
Category III - A sum of 50000 to be paid annually for 1st two years and 5000 for 3rd year.
Category IV- A sum of 5000 to be paid annually for 1st two years and 2500 for 3rd year.

In addition, the merchant banker have to pay the following towards documentation.

Size of the issue Fees per Documentation(Rs)

Upto 5 cr 10000
More than 5 Cr & upto 10 cr 15000
More than 10 Cr & upto 50 cr 25000
More than 50 Cr & upto 100 cr 50000
More than 100 Cr & upto 500 cr 250000
More than 500 Cr 500000

VI. CODE OF CONDUCT FOR MERCHANT BANKERS:

1. To prevent the interest of the investors
2. To maintain high standard of integrity
3. To fulfil his obligation in a prompt, ethical and professional manner
4. He shall always exercise Due diligence
5. Redress the grievance of the investor
6. Ensure adequate disclosure
7. Ensure that the investors are provided with true and adequate information.
8. He should not discriminate amongst the clients
 9. He shall avoid conflict of interest
10. He shall render the best possible advice
11. He shall not divulge to anybody
12. Shall not indulge in any unfair competition
13. He shall maintain long term length relationship
14. He shall have internal control procedures
15. He shall maintain an appropriate level of knowledge
16. He shall ensure that the board is promptly informed.
17. He shall provide adequate freedom and powers to its compliance officer
18. He shall develop its own internal code of conduct
19. He shall ensure good corporate policies
20. He shall be responsible for any act or omission
21. He shall ensure that it has adequate resources

RECENT DEVELOPMENTS AND CHALLENGES AHEAD OF MERCHANT

BANKING
The progress of any economy mainly depends on the efficient financial system of the
country. Indian economy is no exception of this. This importance of the financial sector reforms
affirms an effective means for solving the problems of economic, financial and social in India
and elsewhere in the developing nations of the world. The progress of the securities Industry of
any country depends mainly on the flow of funds. Infact, Capital generation is the lifeblood of
the capital market without which the health and soundness of the financial system cannot be
geared up and for which well-developed capital market as well as money market is essential.
In recent years, there has been a considerable widening and deepening of the Indian
financial system, of which banking is a significant component. With greater liberalisation, the
financial system has come to play a much larger role in the allocation of resources than in the
past and its role in future can be expected to be much larger than at present. The growing role of
the financial sector in the allocation of resources has significant potential advantages for the
efficiency with which our economy functions.

Present position and the challenges ahead

The enhanced role of the banking sector in the Indian economy, the increasing levels of
deregulation and the increasing levels of competition have placed numerous demands on banks.
Operating in this demanding environment has exposed banks to various challenges.

1. Customer service: It is no longer adequate for banks to provide only traditional banking
services. Apart from providing the conventional banking services, banks have begun
offering a bouquet of financial services to their clients, including cross selling of financial
products. The ultimate aim is to offer a one-stop-shop for meeting varied customers'
financial needs. Some banks have begun employing customer relationship management
systems to not only retain the existing customers but also to attract new customers.
2. Branch banking: Traditionally banks have been looking to expansion of their branch
network to increase their business. Against this background it is interesting to observe that
the new private sector banks as well as the foreign banks have been able to achieve business
expansion through other means. It has been realized that it might not be necessary to
establish a wider brick and mortar network to reach a wider population. Banks are, therefore,
examining the potential benefits that may accrue by tapping the agency arrangement route
and the outsourcing route. While proceeding in this direction banks ought not to lose sight of
the new risks that they might be assuming and hence put in place
appropriate strategies and systems for managing these new risks.

3.Competition: With the ever-increasing pace and extent of globalisation of the Indian economy
and the systematic opening up of the Indian banking system to global competition, banks need to
equip themselves to operate in the increasingly competitive environment. This will make it
imperative for banks to enhance their systems and procedures to international standards and also
simultaneously fortify their financial positions.

4.Technology: A few banks which have impressive branch networks have not been able to meet
their customers’ expectations due to inefficiencies arising out of inadequate investment in
technology and consequently faced an erosion of their market shares. The beneficiaries are those
banks which have invested in technology. Another distinct advantage of use of technology is the
ability to effectively use quantitative techniques and models which can enhance the quality of
their risk management systems.

5.Basel II implementation: As you are aware, Basel II is the revised framework for capital
adequacy for banks. Implementation of Basel II is seen as one of the significant challenges
facing the banking sector in many jurisdictions. With the introduction of capital charge for
market risks with effect from the year ended March 31, 2005 banks in India are compliant with
all elements of Basel I

6.Improving Risk Management Systems: With the increasing degree of deregulation and
exposure of banks to various types of risks, efficient risk management systems have become
essential. As you are aware, as a step towards further enhancing and fine-tuning risk
management systems in banks, Reserve Bank has issued guidelines on asset-liability
management and risk management systems in banks in 1999 and Guidance Notes on Credit Risk
Management and Market Risk Management in October 2002 and the Guidance Note on
Operational risk management in 2005.

7.Implementation of new accounting standards: Derivative activity in banks has been increasing
at a brisk pace. While the risk management framework for derivative trading, which is a
relatively new area for Indian banks (particularly in the more structured products), is an essential
pre-requisite, the absence of clear accounting guidelines in this area is matter of significant
concern. It is widely accepted that as the volume of transactions increases, which is happening in
the Indian banking system, the need to upgrade the accounting framework needs no emphasis.

8.Transparency and Disclosures : In pursuance of the Financial Sector Reforms introduced

since 1991 and in order to bring about meaningful disclosure of the true financial position of
banks to enable the users of financial statements to study and have a meaningful comparison
of their positions, a series of measures were initiated. The disclosure requirements broadly
covered the following aspects:
 Capital adequacy
 Asset quality
 Maturity distribution of select items of assets and liabilities
 Profitability
 Country risk exposure
 Risk exposures in derivatives
 Segment reporting
 Related Party disclosures

9.Supervision of financial conglomerates: In view of increased focus on empowering supervisors

to undertake consolidated supervision of bank groups and since the Core Principles for Effective
Banking Supervision issued by the Basel Committee on Banking Supervision have underscored
consolidated supervision as an independent principle, the Reserve Bank had introduced, as an
initial step, consolidated accounting and other quantitative methods to facilitate consolidated
supervision.

10.'Know Your Customer' (KYC) Guidelines – Anti Money Laundering Standards : Banks were
advised in 2002 to follow certain customer identification procedure for opening of accounts and
monitoring transactions of a suspicious nature for the purpose of reporting it to appropriate
authority. These ‘Know Your Customer’ guidelines were revisited in the context of the
recommendations made by the Financial Action Task Force on Anti Money Laundering
standards and on Combating Financing of Terrorism.

11.Corporate Governance: Banks are “special” as they not only accept and deploy large amount
of uncollateralized public funds in fiduciary capacity, but they also leverage such funds through
credit creation. Banks are also important for smooth functioning of the payment system. In view
of the above, legal prescriptions for ownership and governance of banks laid down in Banking
Regulation Act, 1949 have been supplemented by regulatory prescriptions issued by RBI from
time to time.
STRUCTURE OF THE INDIAN BANKING SYSTEM
Reserve Bank of India is the central bank of the country and regulates the banking system of
India. The structure of the banking system of India can be broadly divided into scheduled banks,
non-scheduled banks and development banks.

Banks that are included in the second schedule of the Reserve Bank of India Act, 1934 are
considered to be scheduled banks.

All scheduled banks enjoy the following facilities:

 Such a bank becomes eligible for debts/loans on bank rate from the RBI
 Such a bank automatically acquires the membership of a clearing house.
 All banks which are not included in the second section of the Reserve Bank of India Act,
1934 are Non-scheduled Banks. They are not eligible to borrow from the RBI for normal
banking purposes except for emergencies.

Scheduled banks are further divided into commercial and cooperative banks.

Commercial Banks
The institutions that accept deposits from the general public and advance loans with the purpose
of earning profits are known as Commercial Banks.
Commercial banks can be broadly divided into public sector, private sector, foreign banks and
RRBs.
  In Public Sector Banks the majority stake is held by the government. After the recent
amalgamation of smaller banks with larger banks, there are 12 public sector banks in
India as of now. An example of Public Sector Bank is State Bank of India.
  Private Sector Banks are banks where the major stakes in the equity are owned by
private stakeholders or business houses. A few major private sector banks in India are
HDFC Bank, Kotak Mahindra Bank, ICICI Bank etc.
 A Foreign Bank is a bank that has its headquarters outside the country but runs its
offices as a private entity at any other location outside the country. Such banks are under
an obligation to operate under the regulations provided by the central bank of the country
as well as the rule prescribed by the parent organization located outside India. An
example of Foreign Bank in India is Citi Bank.
  Regional Rural Banks were established under the Regional Rural Banks Ordinance,
1975 with the aim of ensuring sufficient institutional credit for agriculture and other rural
sectors. The area of operation of RRBs is limited to the area notified by the Government.
RRBs are owned jointly by the Government of India, the State Government and Sponsor
Banks. An example of RRB in India is Arunachal Pradesh Rural Bank.
Cooperative Banks
A Cooperative Bank is a financial entity that belongs to its members, who are also the owners
as well as the customers of their bank. They provide their members with numerous banking and
financial services. Cooperative banks are the primary supporters of agricultural activities, some
small-scale industries and self-employed workers. An example of a Cooperative Bank in India is
Mehsana Urban Co-operative Bank.
At the ground level, individuals come together to form a Credit Co-operative Society. The
individuals in the society include an association of borrowers and non-borrowers residing in a
particular locality and taking interest in the business affairs of one another. As membership is
practically open to all inhabitants of a locality, people of different status are brought together into
the common organization. All the societies in an area come together to form a Central Co-
operative Banks.
Cooperative banks are further divided into two categories - urban and rural.
 Rural cooperative Banks are either short-term or long-term.
o Short-term cooperative banks can be subdivided into State Co-operative Banks,
District Central Co-operative Banks, Primary Agricultural Credit Societies.
o Long-term banks are either State Cooperative Agriculture and Rural Development
Banks (SCARDBs) or Primary Cooperative Agriculture and Rural Development
Banks (PCARDBs).
 Urban Co-operative Banks (UCBs) refer to primary cooperative banks located in urban
and semi-urban areas.
Development Banks
Financial institutions that provide long-term credit in order to support capital-intensive
investments spread over a long period and yielding low rates of return with considerable social
benefits are known as Development Banks. The major development banks in India are;
Industrial Finance Corporation of India (IFCI Ltd), 1948, Industrial Development Bank of India'
(IDBI) 1964, Export-Import Banks of India (EXIM) 1982, Small Industries Development Bank
Of India (SIDBI) 1989, National Bank for Agriculture and Rural Development (NABARD)
1982.
The banking system of a country has the capability to heavily influence the development of a
country’s economy. It is also instrumental in the development of rural and suburban regions of a
country as it provides capital for small businesses and helps them to grow their business. The
organized financial system comprises Commercial Banks, Regional Rural Banks (RRBs), Urban
Co-operative Banks (UCBs), Primary Agricultural Credit Societies (PACS) etc. caters to the
financial service requirement of the people. The initiatives taken by the Reserve Bank and the
Government of India in order to promote financial inclusion have considerably improved the
access to the formal financial institutions. Thus, the banking system of a country is very
significant not only for economic growth but also for promoting economic equality.

FEMA (FOREIGN EXCHANGE MANAGEMENT ACT)

The Foreign Exchange Management Act (1999) or in short FEMA has been introduced as
a replacement for earlier Foreign Exchange Regulation Act (FERA). FEMA came into act on the
1st day of June, 2000.

The main objective behind the Foreign Exchange Management Act (1999) is to
consolidate and amend the law relating to foreign exchange with objective of facilitating
external trade and payments and for promoting the orderly development and maintenance of
foreign exchange market in India.

FEMA is applicable to all parts of India. The act is also applicable to all branches, offices
and agencies outside India owned or controlled by a person who is resident of India.

FEMA head-office also known as Enforcement Directorate is situated in New Delhi and
is headed by a Director. The Directorate is further divided into 5 zonal offices at Delhi, Bombay,
Calcutta, Madras and Jalandhar and each office is headed by a Deputy Directors. Each zone is
further divided into 7 sub-zonal offices headed by the Assistant Directors and 5 field units
headed by the Chief Enforcement Officers.