Merchant Banking

Dr K Ramesha Professor

‡ In late 17th and early 18th century Europe, the largest companies of the world were merchant adventurers. Supported by wealthy groups of people and a network of overseas trading posts, the collected large amounts of money to finance trade across parts of the world. For example, The East India Trading Company secured a Royal Warrant from England, providing the firm with official rights to lucrative trading activities in India. This company was the forerunner in developing the crown jewel of the English Empire. The English colony was started by what we would today call merchant bankers, because of the firm's involvement in financing, negotiating, and implementing trade transactions

.MERCHANT BANKING HISTORY ‡ The colonies of other European countries were started in the same manner. according to today's accepted sense of the word. as evidenced by the activities of the famous Hudson Bay Company. For example. the French and Portuguese acted similarly in their respective colonies. For example. One does not typically look at these countries' economic development as having been fueled by merchant bank adventurers. the Dutch merchant adventurers were active in what is now Indonesia. the colonies and their progress stem from the business of merchant banks. ‡ The colonies of other European countries were started in the same manner. The American colonies also represent the product of merchant banking. according to today's accepted sense of the word. However. as evidenced by the activities of the famous Hudson Bay Company. The American colonies also represent the product of merchant banking. the colonies and their progress stem from the business of merchant banks. the French and Portuguese acted similarly in their respective colonies. However. One does not typically look at these countries' economic development as having been fueled by merchant bank adventurers. the Dutch merchant adventurers were active in what is now Indonesia.

selling. Often. the merchant banker also became involved in the actual negotiations between a buyer and seller in a transaction . was to arrange the necessary capital and ensure that the transaction would ultimately produce "collectable" profits.THE HISTORICAL MERCHANT BANK ‡ Merchant Banking. The role of the merchant banker. pertained to an individual or a banking house whose primary function was to facilitate the business process between a product and the financial requirements for its development. the merchant banker acted as a capital sources whose primary activity was directed towards a commodity trader/cargo owner who was involved in the buying. ‡ In particular. as the term has evolved in Europe from the 18th century to today. Merchant banking services span from the earliest negotiations from a transaction to its actual consummation between buyer and seller. who had the expertise to understand a particular transaction. and shipping of goods.

and fulfill capital requirements.that is. ‡ Since the 18th century. These skills include those inherent in an entrepreneur. a commercial and/or investment banker plus that of a transaction broker. however. in many ways. create or expand a need -. the term merchant banker has. merchant banks actually own and run businesses for their own account. They became increasingly involved in the actual running of the business for whom the transaction was conducted. therefore. and that of others. been considerably broadened to include a composite of modern day skills. reflects the early activities and breadth of services of the colonial trading companies . Today a merchant banker is who has the ability to merchandise -. Today. a management advisor.THE MODERN MERCHANT BANK ‡ During the 20th century. European merchant banks expanded their services. The modern European merchant bank.

its industry and operational management.the actual sale of the product and the collection of profit. 2) an ability to raise capital which might or might not be one's own (originally merchant bankers supplied their own capital and thereby took an equity interest in the transaction). immediate capital need. merchant bank are looking to increase their financial stability or satisfy a particular.S.THE MODERN MERCHANT BANK ‡ Most companies that come to a U. Some people might question whether or not there are many individuals or organizations who have the abilities to fulfill all three areas of expertise . ‡ Professional merchant bankers must have: 1) an understanding of the product. effective skills in concluding a transaction . 3) and most importantly.

Backdrop ‡ Financial system in particular banking system before 1968 ‡ Financial system. banking system and financial markets in the post 1991 period ‡ Universal banking concept ‡ Creation of SEBI . in particular financial markets and banking system during 1968-1991 ‡ Developments in the financial system.

Though merchant banks themselves collect deposits and grant credit to a limited extent. they act mainly as intermediaries ± In channelling short term credit from commercial banks through discount houses to merchants engaged in the import and export trade or in the marketing of goods in the domestic market ± In channelling medium and long term capital from those who wish to lend to those who are in need of funds .Merchant Banking .Britain ‡ Merchant banking in Britain developed partly as a result of the operation of historical factors and partly in response to the requirements of trade and industry for their short and long term needs.

of which they are the promoters and managers.Britain ‡ In addition. discount houses. MBs render a variety of advisory services to individuals and corporate bodies including such financial institutions as investment trust and unit trusts. . MBs therefore from an integral part of the complex of financial institutions like commercial banks. long-term financial institutions and capital markets and have therefore established intimate business relationships with them through daily contacts and advisory services.Merchant Banking .

Allied with this is the keeping of securities in safe custody including the accounts of customers and making and realizing investments on their behalf. They also act as registrars and transfer agents for industrial companies.Merchant Banking . Some of them have an active trustee business which either a department or a separate subsidiary company handles. a few undertake merchanting. college endowments and other funds of a similar nature. but the keeping of current account on which their customers draw by cheque is a substantial business for many of them. This type of banking activity ancillary to other services. By developing unitlinked insurance business. some are financial bankers. This has led in many cases to giving advise to customers on their investments as well as on the management of pension funds. they have set up their own life insurance companies. many of them act as issuing houses.Britain ‡ The prominent MBs do acceptance of business. Many MBs have promoted and are managers of investment trusts and unit trusts. some do foreign exchange business. . All of them do banking in some form by keeping money in current or other accounts for their customers at home or abroad. or have established business connections with the existing life insurance offices. some are engaged in bullion business.

firms or charitable trusts ± on a large scale ± Finance foreign trade both in acceptance business and in the post-war practice of arranging medium term export credit ± Advise a growing number of industrial companies not only on how and when to raise capital but also on their financial affairs generally ± Engaged in foreign security business. placing American shares in Europe and vice versa.Merchant Banking . running European and off-shore trusts thus concerning themselves with foreign loan business .Britain ‡ MBs are active in the following ± Manage individual funds ± individuals.

The investment banking firms are. The investment banker is a good judge of the timing of the issue. he is adept in formulating the terms and conditions which are acceptable to investors in the prevailing conditions. secondly. Investment banking firm forms and manages any syndicate to market public offerings of the issue made by a client corporation. mainly engaged in investment advisory services bearing on domestic issues of capital as well as in arranging consortia for the issue of capital on behalf of foreign governments and foreign corporate enterprises .Merchant Banking .USA ‡ In US. investment bankers are mainly engaged in marketing corporate and other obligations. therefore.

Many of them have substantial resources of their own and command additional resources through access to commercial banks.USA ‡ It is important to bear in mind that these institutions have grown and functioned over the years in the environment of freedom wherein they have diversified their activities in tune with the changing circumstances. financial expertise. loyalty and close relationship with clients. financial institutions and the stock market with which they have established intimate relations and enjoy a high creditworthy status . high management stability.Merchant Banking . They have developed qualities of integrity.

USA ‡ In the post war period. new trends have emerged in the work frame of commercial banks in the European countries which indicate that banks are now prepared to offer multiple services including merchant banking services. Commercial banks have thus been competing with the old established merchant banks (IB) .Merchant Banking . to their individual and corporate clients. Taking advantage of this several banks (in US and UK) set up either subsidiary companies or separate divisions in their own organizations to offer these services.

Merchant Banks . let us try to settle for a workable definition of this term. Yet another group of persons mean it to what a merchant banker does. it just means management of capital issues of companies.Concept ‡ There is no statutory or any authoritative definition for the term Merchant Banking. In this situation. For many. . Some confuse this with investment banking and an issue house.

³merchant banker means 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. merchant banking is understood to be non-fund based and non-banking services ± Merchant bankers are neither merchants nor bankers ± Rule 2(e) of SEBI (merchant bankers) Rules 1992.Concept ‡ Definition ± In the Indian context.Merchant Banks . advisor or rendering corporate advisory services in relation to such issue management´ . defines who a merchant banker is.

subscribing to securities ‡ Rendering corporate advisory services in relation to such issue management ‡ µengaging in the business of issue management either by making arrangements regarding selling. consultant. buying or subscribing to securities as manager. advisor or rendering corporate advisory services to such issue management¶ . advisor in the process of selling. buying. Should be engaged as a manager. consultant. buying or subscribing to securities.Merchant Banks .Concept ‡ Merchant Banker ± Should be engaged in the business of issue management ± Such engagement should be for ‡ Making arrangements regarding selling.

orders or otherwise¶ ± Sub-section of (1) of section 6 deals with the permissible business. It reads ³the effecting. municipal or other loans or shares. participating in managing and carrying out of any issue. of the deposits of money from the public. insuring.Concept ‡ Merchant banking Vs Commercial banking ± Clause (c) of section 5 of BR Act of 1949. stock.Merchant Banks . public or private of state. but an MB can not undertake banking business . for the purpose of lending or investment. guaranteeing. Clause (d) of this section enables a banking company to internal underwriting support and to manage any issue. repayable on demand or otherwise and withdrawable by cheques. the main business of a bank is to µaccept. drafts. debentures or debenture stock of any company. underwriting. corporation or association and the lending of money for the purpose of any such issue´ ± A bank can undertake merchant banking business.

Concept ‡ Merchant Banking Vs Investment Banking ± There is a thin difference between these two ± An investment banker does the following ‡ ‡ ‡ ‡ ‡ ‡ Selling issues of securities of companies Underwriting functions Helps in mergers and acquisitions Investment advises Finding buyers for private placement Dealing in securities ‡ Hence. similarities between MB and IB.Merchant Banks . Generally. investment advises and dealing in securities are not performed by MB .

‡ The scope of management consultancy is much wider than MB . tax representation or advice concerning matters or acting as liquidator. executor.Merchant Banks . administrator. arbitrator or receiver.Concept ‡ Merchant Banking Vs Management Consultancy ‡ Institute of Chartered Accountants of India ± management consultancy does not include the functions of statutory periodical audits. trustee. but shall include««.

Merchant Banking in India ‡ Till early 1960s there was no merchant banking in the Indian banking system. ‡ Private financial brokers also started private MB organizations . It was the Grindlays Bank which started merchant banking services as far back as 1967 in India. SBI (1972) ‡ The boom in the capital market in mid 1970s with the introduction of FERA ± 1973 encouraged other banks and financial institutions to set up MB divisions. Others to follow were Citibank (1970).

Merchant Banking in India Merchant Banking Divisions Foreign Banks Indian Banks Financial Institutions Private Merchant Bankers Subsidiary Division in Bank .

Merchant Banking and Corporates Guidance Project Formulations Implementation Objectives of Merchant Banking Modernization Diversification Mobilizing Resources Raising Working Capital .

mergers and takeovers .Activities of Merchant Bankers ‡ Wide range of activities ± broadly classified under two heads .counseling and procuring finance ‡ Some of the important functions of a MB are ± Project counseling or reinvestment studies for investors ‡ ‡ ‡ ‡ ‡ ‡ ‡ Identify promising projects Prepare feasibility studies ± economic and financial Prepare in-depth project reports Assist investors in obtaining licenses Do precise capital structuring Arrange and negotiate foreign collaborations Give guidance on amalgamations.

etc ‡ Liaison with government departments. banks etc ‡ Advise and assistance for modernization. financial institutions. product-mix. banks and other sources of finance ‡ Expert advise on government policies. plan capacity utilization.Activities of Merchant Bankers ‡ Some of the important functions of a MB are ± Syndication of loans and project finance ‡ Aid in applying to financial institutions. raw material availability. requirements of plant and machinery etc ‡ Consultation about alternative sources of finance. expansion and diversification . demand-supply gaps. debt-equity ratios.

portfolio managers and financial press for pre-selling and media coverage ‡ Preparation of draft prospectus and other documents ‡ Wide coverage throughout the country for collection of applications ‡ advertisement . liaison with SEBI to the preparation of actual launch ‡ Optimum underwriting support ‡ Appointment of bankers and brokers as well as issue houses ‡ Issue management ‡ Professional liaison with share market functionaries like brokers.Activities of Merchant Bankers ‡ Some of the important functions of a MB are ± Issue management ‡ Deciding on the size and timing of a public issue in the light of market conditions ‡ Preparing the base of successful issue marketing from initial documentation.

collection of dividend etc . handling transactions.Activities of Merchant Bankers ‡ Some of the important functions of a MB are ± Provision of working capital ‡ Arrangement with banks ‡ Merchant banking is a part of the banking system ‡ Sometimes. safe custody of documents. syndication is arranged by MB ± Foreign Currency Loans ‡ Arranges foreign currency loans ± Portfolio Management ‡ Basically advisory in nature regarding purchase and sale of securities.