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Investment Banking in India

Learning Objective
Nature and

Scope of Merchant Banking
Regulation of Merchant Banking Activity
Overview of Current Indian Merchant
Banking Scene
Structure of Merchant Banking Industry
Professional Ethics and Code of Conduct
Current Development

1. Nature and Scope of Merchant Banking
Merchant banking (MB) is a non-banking financial activity,
resembles

banking

function.

The

word

‘Merchant

Banking’ originated by the Dutch and the Scottish traders
and was later developed and professionalized in Britain.
Functions of MB were enriched by Americans and now
being provided throughout the world.
The MB functions in UK and Europe are the same as
functions of investment banking in US. In India, the term
MB is more often used due to the inheritance of the
financial system from UK and the mention in SEBI
(Merchant Bankers) Rule 1992.

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buying or subscribing to securities or acting as manager. a merchant banker is defined as any person who is engaged in the business of issue management either by making arrangements regarding selling. advisor or rendering corporate advisory services in relation to such issue management.1. Nature and Scope of Merchant Banking According to SEBI (Merchant Bankers) Rule 1992. 6 / 38 . consultant.

A merchant banker may specialize in one activity and take up other activities. corporate finance and other services. brokers or intermediaries. credit syndication. It is not necessary for a merchant banker to carry out all these activities. portfolio management. 7 / 38 . M&A advisory. Nature and Scope of Merchant Banking Merchant banks are generally engaged in providing specialized services such as issue underwriting. acceptance of bills of exchange.1. which may be complimentary or supportive to the specialized activity. MBs also arrange funds or negotiate financial deals for their clients for a fee as arrangers.

Scope of Merchant Banking MB being a service-oriented industry.  Management of Debt and Equity  Corporate Counseling  Project Counseling  Credit Syndication and Project Finance  Mergers. renders following services to its customers. Acquisitions and Corporate Restructuring  Venture Capital  Financial Engineering 8 / 38 .

Management of Debt and Equity Instrument Designing Pricing the Issue Registration of the offer document Underwriting support Marketing of the issue Allotment and refund Listing on the stock exchange .

Financial restructuring: D/E Asset turnover ratio: whether over / under trading Working capital policy: suggestions (Financing) Refinancing of high cost funds by low cost funds Turnaround management Revival of sick units Management of risk advisory. hedging strategies .Corporate Advisory Services IB offer customized solutions to financial problems of their clients.

Project Advisory Services Early stages of projects advisory Project ideas Initial feasibility studies and viability Detailed project report Project appraisal service .

circulated to various banks and invited for syndication. currency. Prepares loan memorandum. amortization.Loan Syndication IBs arrange to tie-up loans for their clients. Cash flow analysis and requirements Important loan parameters include amount. . Loan documentation process. tenure. Banks decide the amounts and interest rates.

Number and size of deals increasing.Venture Financing VC business evolved from individuals to institutionalized sector. . Returns are expected more.

then PE Company becomes profitable.Private Equity Stages of VC. establishes track record. Exit with IPO .

M&A Increased M&A activities. eliminating competition Production: Horizontal or vertical integration . Tax shields like carried forward losses or unclaimed depreciation Marketing: Growth in market share. consolidation in core competence. Advisory on acquisitions Financial. M&As growth. Pre-liberalization era. M&As in unrelated areas Post liberalization era.

develop superior processes and implement structured solutions to complex financial problems. The factors accelerated the financial innovations Interest rate volatility Exchange rate volatility Asset price volatility Regulatory and Tax changes Globalization of the markets Increased competition .Financial Engineering Design new financial products.

Merchant Banking Other Functions of Merchant Banks • Accepting Credit and Bill Discounting • Lease Financing • Foreign Currency Finance • Pre-investment Studies • Capital Restructuring • Portfolio Management .

authorized and the paid up capital. Regulation of Merchant Banking Activity Regulations MBs are governed by the SEBI (Merchant Bankers) Rules and Regulations. 1992. even if MB is bank sponsored it need to register with SEBI. MB undertaking fund based activities need to register with 10 / 38 . MB has to be incorporated under the Companies Act 1956.2. MB must register with SEBI to carry out MB activities. As a company it comes under the jurisdiction of the Registration of Companies and the formalities of the Companies Act have to be approved including Memorandum and Articles of Association.

 Activities of secondary market operations including stock broking are regulated by stock exchange and SEBI (Stock Brokers and Sub Brokers) Rules and Regulations. 1993.  Business of venture capital and private equity funds are regulated by SEBI (Venture Capital Funds) Regulations.2. 1992. Regulation of Merchant Banking Activity Underwriter business is regulated by SEBI (Underwriters) Rules and Regulations.  MBs should fulfill the eligibility criteria on an on-going  11 / 38 . 1993. 1996.  Business of portfolio management is regulated under SEBI (Portfolio Managers) Rules and Regulations.

5 Crore and initial registration fee Rs.5 Lakh every three years from fourth year of the registration.  MBs cannot accept deposits from public.  12 / 38 . MB shall pay a renewal fee of Rs. 2. SEBI classified the MBs into four categories. 5 Lakh. Later modified the rules to have only Category I merchant banker with minimum net worth Rs. Regulation of Merchant Banking Activity Initially.2.

 While registration as MB. records and documents. adequate office space. law or business management.  MB shall keep and maintain the books of account. minimum stipulated capital and previous experience as MB. SEBI ensures the professional qualification in finance. office staff having competency in MB business. manpower. other infrastructure.2. office equipment. Regulation of Merchant Banking Activity  MB not to associate with any business other than that of the securities market. 13 / 38 .

Every lead MB should enter into an agreement with corporate setting their rights. except in case of a rights issue and the issue size not exceeding Rs. 50 Crore 2 Above Rs. 50 Crore but less than Rs. 400 Crore 5 or more as agreed by SEBI 14 / 38 . 200 Crore but less than Rs. 400 Crore 5 Above Rs.2. 50 Lakh. Size of Issue Number of lead MBs Less than Rs. allotment and refund. liabilities and obligations relating to such issues on disclosures. 100 Crore 3 Above Rs. Number of lead MBs should not exceed than stated below. 100 Crore but less than Rs. Regulation of Merchant Banking Activity  Lead MBs: All issues should be managed by at least one MB functioning as a lead MB. 200 Crore 4 Above Rs.

15 / 38 .2. classified based on their activities as fund based and fee based income. Regulation of Merchant Banking Activity  Remuneration of MBs: MBs generate income.  Fund based activities generate a spread being the difference between the cost of funds and the yield from the funds.

Other banks followed to set up MB divisions such as Bank of India. 16 / 38 . SBI set up a MB division namely SBI Capital Markets Ltd (SBICAP). Central Bank of India. followed by Citibank in 1970.3. Bank of Baroda. first MB division was set up in 1967 by Grindlays Bank (merged with Standard Chartered Bank). Overview of Current Indian Merchant Banking Scene In India. Canara Bank. In 1972. Punjab National Bank and Syndicate Bank.

Private firms such as DSP financial consultants Ltd.3. Overview of Current Indian Merchant Banking Scene In 1974. 17 / 38 . and Credit Capital Finance Corporation Ltd. The number of MBs rose to about thousand in 1990s. number of MBs increased drastically. have also started MB activities.. J M Financial Services Ltd. During economic reforms period. later IFCI and IDBI also entered this field. post 1991. Later due to SEBI restrictions. many MBs have closed down and the number reduced to 124 in 2003. ICICI set up a MB division.

IDBI Capital Markets Ltd. JM Morgan Stanley Ltd. Overview of Current Indian Merchant Banking Scene Currently. major MBs in India are SBI Capital Markets Ltd.3. Enam Financial Consultants Ltd. Kotak Mahindra Capital Company ICICI Securities Ltd. 19 / 38 . DSP Merrill Lynch Ltd.

MB business has to be in a separate company as it requires a separate MB licensing from the SEBI.4. Securities business has to be separated into a different company as it requires a stock exchange membership and 21 / 38 . Equity research should be independent of the MB business to avoid the conflict of interest faced by American investment banks. For example. Structure of Merchant Banking Industry Indian MBs follow a conglomerate structure by keeping their business segments in different corporate entities. Asset management business in the form of mutual fund requires a three-tier structure under the SEBI regulations. MBs are prohibited from undertaking any business other than the securities market.

4. Other MBs have one or more entities depending activities. MB activities came under regulations which required separate registration. underwriting and advisory business. licensing and capital requirements. due to financial liberalization & primary market boom. Due to the gradual regulatory developments in the capital markets. 22 / 38 . many banks. Indian MB industry has a heterogeneous structure. FIs. financial business houses and NBFCs entered the MB. Bigger MBs have several group entities in which the core and non-core business segments are distributed. Structure of Merchant Banking Industry Post 1991. Due to the above reason.

Five forces which determine profit potential in the industry Threat of entry Competition Pressure from substitute products Bargaining power of buyers Bargaining power of suppliers ***** .Structural Analysis of Investment Banking Industry Given the industry structure. the framework is developed by Michael Porter to examine the competitive advantage to IBs. competition in the industry has its basis in the economic structure. Reviewing the competition.

Most US universal banks are shaping up to be financial conglomerates that would eventually threaten the supremacy of pure investment banks on Wall Street. investment banking. Current Development Business of MB is undergoing rapid transformation in response to the growing sophistication in the financial markets and the needs of clients. 35 / 38 . Financial conglomerates with equal presence in commercial banking. Consolidation and globalization is the key for success and growth. insurance and financial advisory are the way to go for one-stop shopping for all financial needs.7.

sales and distribution. structured financing and corporate advisory services. private equity and venture capital. primary dealing in fixed income securities. Universal banks can add all their banking products in both corporate and retail banking segments to the long list of services offered as full 37 / 38 . private banking). proprietary trading and investment. asset management (mutual funds. brokerage.7. Current Development Future therefore lies in ‘full service investment banking’ comprising of core investment banking (managing and underwriting security issues of all types. M&A advisory). portfolio management. research and analysis.

Current Development A step forward would be the financial conglomerates of the future that can even add on insurance and pension products to make them one-stop financial shops. Large financial conglomerates such as the Citigroup or ING would be the models of growth in the years to come.7. ***** 38 / 38 .