MERCHANT BANKING

AND
NON BANKING FINANCE
COMPANY

Akash Gupta UBS,PURC

Akash Gupta UBS,PURC
Akash Gupta UBS,PURC
A merchant banker underwrites corporate securities and provides guidelines to clients on
issues like corporate mergers. The merchant banker may be in the form of a bank, a firm,
company or even a proprietary concern. It is basically service banking which provides
non-financial services such as arranging for funds rather than providing them.

The merchant banker understands the requirements of the business concerns and
arranges finance with the help of financial institutions, banks, stock exchanges, and
money market.
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 manpower as
one of the criteria for registration as the 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, mergers,
and takeovers.
• The services of merchant bank cover project counseling, pre-
investment activities, feasibility studies, project reports, the design
of the capital structure, issue management, underwriting, loan
syndication, mobilization of funds from Non-Resident Indians, foreign
currency finance, mergers, amalgamation, takeover, venture capital,
buyback, and public deposits. A Category-1 merchant banker can
undertake issue management only. Separate registration is not
necessary to carry on the act as the underwriter.
Functions of Merchant Banking
• Portfolio Management: Merchant banks provides advisory services to
institutional investors, on account of investment decisions. They trade in
securities, on behalf of the clients, with the aim of providing them portfolio
management services.
• Raising funds for clients: Merchant banking organization assist the clients
in raising funds from the domestic and international market, by issuing
securities like shares, debentures, etc., which can be deployed for starting a
new project or business or expansion activities.
• Promotional Activities: One of the most important activities of merchant
banking is the promotion of a business enterprise, during its initial stage,
right from conceiving the idea of obtaining government approval. There is
some organization, which even provide financial and technical assistance to
the business enterprise.
•Loan Syndication: Loan Syndication means service provided by the merchant
bankers, in raising credit from banks and financial institutions, to finance the
project cost or working capital of the client’s project, also termed as project
finance service.
•Leasing Services: Merchant Banking organizations renders leasing services to their
customers. There are some banks which maintain venture capital funds to help
entrepreneurs.
REGULATION OF MERCHANT BANKING

• Securities and Exchange Board of India (SEBI) is the regulatory

authority for merchant banking in India. Activities of merchant
banks are regulated by the SEBI (Merchant Bankers) Regulations,
1992.
• Merchant banking comprises a wide set of banking activities which
involves issues management by trading in securities, underwriting
security issuances (e.g. an IPO), undertaking valuation of businesses
and setting up and packaging M&A deals. In business parlance, it is
distinguished from commercial banking, which largely revolves
around accepting deposits and giving loans (nowadays, commercial
banks also provide additional services such as bill payments,
certificates of deposits etc.).
• As per RBI’s Master Circular on Para-Banking activities, banks are
allowed to undertake merchant banking activities through a separate
subsidiary which would be required to comply with SEBI regulations.
Banking Institutions performing merchant banking activities are also
required to follow the requirements laid down in the prudential
exposure norms prescribed by RBI, as well as the statutory limits
contained in Section 19(2) & (3) of the Banking Regulation Act, 1949.
• Merchant banking can also be pursued by entities other than banks
(however, they should not be NBFCs as defined under the RBI Act),
provided they are registered with SEBI. In case a bank pursues
merchant banking activities, it would need a banking license from RBI
(to carry out banking activities) and a SEBI registration under the SEBI
Merchant Bankers Regulations to carry out merchant banking
business.
RBI exempts a merchant banking company from following
requirements:
• Provisions related to mandatory registration, maintenance of liquid
assets and creation of reserve funds under the RBI Act, 1934;
• Non-Banking Financial Companies Acceptance of Public Deposits
(Reserve Bank) Directions, 1998; and
• Non-Banking Financial Companies Prudential Norms (Reserve Bank)
Directions, 1998.
To be eligible for the above exemptions, a merchant banking company
would need to fulfil the following criteria:
• It should be registered with SEBI under section 12 of the SEBI Act
1992;
• It should conduct the business of merchant banking in accordance
with rules or regulations framed by SEBI;
• It should acquire securities only as part of its merchant banking
activities;
• It should not be engaged in any other financial activities as
mentioned in section 45I(c) of the RBI Act 1934; and
• It should not accept or hold public deposits
Provisions related to the registration of a merchant bank are laid down in
Chapter-II of SEBI Regulations, which provides for mandatory registration to
carry out the business of merchant banking in India. Following are some of
the requirements which are taken into consideration for grant of certificate:
• Applicant should be a corporate body other than a Non-Banking Financial
Company (as defined under the RBI Act);
• Applicant should not engage in any activity other than those connected to
securities market;
• Applicant should have a minimum of two employees having prior
experience in merchant banking;
• Applicant must not be related (directly or indirectly) to any other entity
which is registered as a merchant banker;
• Applicant has not been found guilty for any economic offence; and
• Applicant should have a minimum capital of 5 crore rupees (for category-I
merchant banker)
SEBI GUIDELINES FOR MERCHANT BANKING
Merchant banker will require authorization by SEBI to carry out the
business.

• SEBI has classified the merchant bankers into four categories based on the
nature and range of the activities and the responsibilities.
• Category I: It consists of merchant bankers who carry on the business of
issue management which consists of preparation of issue management
which consists of preparation of prospectus, determining the financial
structure, tie-up of the financiers and final allotment/refund of
subscription and to act in the capacity of managers, advisors or
consultants to an issue, portfolio manager and underwriter.
Minimum net worth required is Rs. 1 crore.
• Category II: It consists of those authorized to act in the capacity of co-
manger/advisor, consultant underwriter to an issue.
The Minimum net worth required is Rs. 50 Lakhs.
• Category III: It consists of those authorized to act as underwriter,
advisor or consultant to an issue.
The Minimum net worth required is Rs. 20 Lakhs.

• Category IV: It consists of Merchant Banker who act as advisor or

consultant to an issue.
There is no Minimum net worth required.
• Every merchant banker should maintain copies of balance sheet, Profit and loss account,
statement of financial position
• Half-yearly unaudited result should be submitted to SEBI
• SEBI has been vested with the power to suspend or cancel the authorization in case of
violation of the guidelines

• Every merchant banker shall appoint a ‘Compliance Officer‘ to monitor compliance of the
Act

• SEBI has the right to send inspecting authority to inspect books of accounts, records etc.
of merchant bankers

• Inspections will be conducted by SEBI to ensure that provisions of the regulations are
properly complied.

• An initial authorization fee, an annual fee and renewal fee may be collected by SEBI.

• A lead manager holding a certificate under category I shall accept a minimum

underwriting obligation of 5% of size of issue or Rs.25 lakhs whichever is less
Recognition by SEBI on merchant bankers
SEBI will grant recognition a merchant banker after taking into account
the following aspects
1. Considering how much the merchant are professionally competent.
2. Whether they have adequate capital
3. Track record, experience and general reputation of merchant
bankers.
4. Quality of staff employed by merchant bankers, their adequacy and
available infrastructure are taken into account. After considering the
above aspects, SEBI will grant permission for the merchant banker to
start functioning.
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 has to 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.
6. Lead managers are responsible for allotment of securities, refunds,
etc.
7. Merchant banker will submit to SEBI all returns and send reports
regarding the issue of shares.
8. A code of conduct for merchant bankers will be given by SEBI, which
has to be followed by them.
9. Any violation by the merchant banker will lead to the revocation of
authorization by SEBI.
NON BANKING FINANCE COMPANIES
What are Non-Banking Financial Companies – NBFCs?
• Non-banking financial companies (NBFCs) are financial institutions
that offer various banking services but do not have a banking license.
Generally, these institutions are not allowed to take
traditional demand deposits—readily available funds, such as those in
checking or savings accounts—from the public. This limitation keeps
them outside the scope of conventional oversight from federal and
state financial regulators.
• Non-banking financial companies (NBFCs) are entities or institutions
that provide certain bank-like and financial services but do not hold a
banking license.
• NBFCs are not subject to the banking regulations and oversight by
federal and state authorities adhered to by traditional banks.
• Investment banks, mortgage lenders, money market funds, insurance
companies, hedge funds, private equity funds, and P2P lenders are all
examples of NBFCs.
• Since the Great Recession, NBFCs have proliferated in number and
type, playing a key role in meeting the credit demand unmet by
traditional banks.
History of NBFCs – How NBFCs have Evolved!
• The non-banking financial companies (NBFCs) which are heterogeneous in nature in term of
activities and size are important financial intermediaries, and an integral part of the financial
system in India. They have been able to carve out a niche for themselves in meeting the credit
needs of both wholesale and retail customers.
• NBFCs in India made a humble beginning way back in the 1960’s to serve the need of the savers
and investors whose financial requirements were not sufficiently covered by the existing banking
system in India. The NBFCs began to invite fixed deposit from investors and work out leasing deal
for big industrial firms. Initially, they operated on a limited scale and could not make a significant
impact on the financial system.
• During the first stages of their development, this business of financing was regulated by the
Companies Act. At that time a need was felt that due to the unique and complex nature of
operations and also financial companies acting as financial intermediaries, there should be a
separate regulatory mechanism.
• Accordingly Chapter III B was included in the Reserve Bank of India Act, 1934, assigning limited
authorities to the Bank to regulate deposit taking companies. The RBI has since initiated
measures to bring the NBFC sector within the realm of its regulation.
• The RBI accepted and implemented the key recommendations of James S. Raj Study Group
formed in 1975 that financial companies be allowed to gearing often times. As per the salient
features of the Directions, the hire purchase and leasing companies could accept deposits to the
extent of their net owned funds. The Directions also required the Companies to maintain liquid
assets in the form of unencumbered approved government securities.
• Between 1980’s and 1990’s, NBFCs gained good ground and started to attract a huge number of
investors owing to their customer friendly reputation. Since the days of Liberalization,
Privatization and Globalization (LPG, started in 1991), there has been a mushrooming growth of
NBFCs; the number of NBFCs grew from a mere 7000 in 1981 to around 30000 in 1992. This is
when the RBI felt that it was becoming increasingly onerous for it to regulate the industry. In
1992, the RBI formed a Committee headed by A. C. Shah, former Chairman of the Bank of Baroda,
to suggest measures for the effective regulation of the industry. The Shah Committee gave its
recommendations, which ranged from compulsory registration to prudential norms.
• January 1997 witnessed drastic changes in the RBI Act, 1934, especially the Chapters III-B, III-C,
and V of the Act with the fundamental objective of putting in place a complete regulatory and
supervisory structure, aimed at protecting the interests of depositors as well as ensuring the
robust functioning of NBFCs.
• In the period following the amendment of the Act in 1997, the NBFCs have evolved substantially
in terms of operations, variety of market products and instruments, technological sophistication
etc.
• In the last 20 years, the NBFCs have gained much significance by adding depth to the overall
financial sector. In light of the growing significance of NBFCs as a key player in broadening the
financial base of India, it generates paramount academic and research interests to delve deep
into its onset, growth and performance. In August 2016, the union cabinet has given nod for
foreign direct investment (FDI) under the automatic route in regulated NBFCs.
NBFCs have been performing an important role in the process of intermediation, especially in areas
where established financial entities are not easily accessible to borrowers. They have inspired small
savers to invest money in them, and then they were courageous enough to lend to the borrowers.
What are the Types of Non-Banking Financial Companies?
NBFCs varying types playing a key role in meeting the credit demand unmet by
traditional banks. NBFCs are broadly divided into three categories namely:
• NBFCs accepting deposits from banks (NBFC-D)
• NBFCs not accepting/holding public deposits (NBFC-ND)
• Core investment Companies(CIC)
Further, they are classified into various categories namely:
• Asset Finance Company (AFC)
• Investment Company(IC)
• Loan Company(LC)
• Infrastructure Finance Company(IFC)
• Micro Finance Institution(MFI)
What are the Services Provided by the NBFCs?
NBFCs offers a range of product and services which includes loans and advances, credit
facilities, saving and investment plans, acquisition of shares, stock, bonds hire-purchase,
insurance business or chit business and money transfer service.
• It also includes private education funding, retirement planning, underwriting stocks and
shares, trading in money markets, TFCs (Term Finance Certificate) and other obligations.
• Apart from this, NBFCs also provide wealth management services such as handling
portfolios of stocks and shares and discounting services.
• Apart from this, NBFCs also provide wealth management services such as handling
portfolios of stocks and shares and discounting services.
NBFCs are typically into the funding of:
• Construction equipment
• Commercial vehicles and cars
• Gold loans
• Microfinance
• Consumer durables and two-wheelers
• Loan against shares, etc.
List of major products offered by NBFCs in India:
• Funding for commercial vehicles
• Funding of infrastructure assets
• Retail financing
• Loan against shares
• Funding of plant and machinery
• Project finance
• Unsecured personal loans
• Trade finance
• Venture finance
 Why does One Prefer NBFC over Banks?
Features Banks NBFCs
Regulated By RBI-Banking Act Companies Act and direction of RBI

The process of Loan sanction Moderately Stringent Easier and faster

Product Offering all types of loans Majorly property loans
Interest Rate Benchmark Base rate + Margin Retail Prime Lending Rate(RPLR)-Spread

Overdraft Facility Available Not Available

Passing interest rate benefit to existing No much room more existing borrowers High chance for existing and new
borrowers borrowers to get benefited from
discounts and offers
Pre-payment convenience through Available at banks for all customers Usually prefers cheque payments to
NEFT process Electronic Clearing Service(ECS)

Interest Rates Rate of interest will be comparatively Depends on the property and applicant
lower and most of the times will be higher
than banks
• The borrower prefers NBFCs over banks and the reason for this is
banks have hard rules and requires more time to approve or sanction
a loan. On the other hand, NBFCs ensures the processing is quicker
and necessary loan amount is disbursed within days.
• The rate of interest imposed by NBFC is high as compared to banks,
borrowers still prefer to take loans from NBFC considering the ease of
getting a loan and less complications.