2011

Thoth

Vipin MK Srinath

[FINANCIAL SERVICES]
 Financial Services
For SBMJC
Vipin MK Srinath

Chapter 1

Financial Services Concept

Services that are offered by financial corporations constitute ‘financial services’. Financial
companies include both asset management and liability management companies. Asset
Management Companies include leasing companies, mutual funds, merchant bankers and
issue / portfolio managers. Liability Management Companies include bills discounting and
acceptance house.

Financial Services Objectives and Functions

Following are the objectives of financial services that are generally offered by financial
companies:

1. Fund raising: Financial services help to raise the required funds from a host of investors,
individuals. Institutions and corporate. For this purpose, various instruments of finance
are used. The funds are demanded by corporate houses, individuals, etc.

2. Funds deployment: Arrays of financial services are available in the financial markets
which help the players to ensure an effective deployment of the funds raised. Financial
services assist in the decision making regarding the financing mix. Services such as bill
discounting, factoring of debtors, parking of short-term funds in the money market,
credit rating, e-commerce, and securitization of debts are provided by financial services
firms in order to ensure efficient management of funds.

3. Specialized services: The financial services sector provides specialized services such as
credit rating, venture capital financing, lease financing, factoring, mutual funds;
merchant banking, stock lending, depository, credit cards, housing finance, book-
building, etc besides banking and insurance. Institutions and agencies such as stock'
exchanges, specialized and general financial institutions, non-banking finance
companies, subsidiaries of financial institutions, banks and insurance companies also
provide these services.
 Financial Services
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Vipin MK Srinath

4. Regulation: There are agencies that are involved in the regulation of the financial
services activities. In India, agencies such as the Securities and Exchange Board of India
(SEBI), Reserve Bank of India (RBI) and the Department of Banking and Insurance of the
Government of India, through a plethora of legislations. Regulate the functioning of the
financial service institutions.

5. Economic growth: financial services contribute, in good measure, to speeding up the

process of economic growth and development. This takes place through the
mobilization of the savings of a cross section of people, for the purpose of channelling
them into productive investments. In this connection, it is to be noted that a number of
developed and developing countries which have a highly efficient financial market, have
witnessed a greater rate of savings and investments.

Scope of Financial Services

Traditionally, the financial intermediaries have been rendering a wide range of services
encompassing both capital and money market activities. They can be grouped under two
heads, viz.

a) Fund based activities: The traditional services which come under fund based activities are the
following :
i. Underwriting or investment in shares, debentures, bonds, etc. of new issues (primary
market activities)
ii. Dealing in secondary market activities.
iii. Participating in money market instruments like commercial papers, certificate
of deposits, treasury bills, discounting of bills etc.
iv. Involving in equipment leasing, hire purchase, venture capital, seed capital.
v. Dealing in foreign exchange market activities.
 Financial Services
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Vipin MK Srinath

b) Non fund based activities: Financial intermediaries provide services on the basis of non-
fund activities also. This can be called ‘fee based’ activity. Today customers, whether
individual or corporate, are not satisfied with mere provisions of finance. They expect
more from financial services companies. Hence a wide variety of services, are being
provided under this head.
They include :
i. Managing the capital issue – i.e. management of pre-issue and post-issue
activities relating to the capital issue in accordance with the SEBI guidelines and
thus enabling the promoters to market their issue.
ii. Making arrangements for the placement of capital and debt instruments with
investment institutions.
iii. Arrangement of funds from financial institutions for the clients’ project cost or
his working capital requirements.
iv. Assisting in the process of getting all Government and other clearances.

Modern Activities

Beside the above traditional services, the financial intermediaries render innumerable
services in recent times. Most of them are in the nature of non-fund based activity. In view
of the importance, these activities have been in brief under the head ‘New financial
products and services’. However, some of the modern services provided by them are given
in brief hereunder.

a) Rendering project advisory services right from the preparation of the project report
till the raising of funds for starting the project with necessary Government approvals.
b) Planning for M&A and assisting for their smooth carry out.
c) Guiding corporate customers in capital restructuring.
d) Acting as trustees to the debenture holders.
e) Recommending suitable changes in the management structure and management
style with a view to achieving better results.
 Financial Services
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Vipin MK Srinath

f) Structuring the financial collaborations / joint ventures by identifying suitable joint

venture partners and preparing joint venture agreements.
g) Rehabilitating and restructuring sick companies through appropriate scheme of
reconstruction and facilitating the implementation of the scheme.
h) Hedging of risks due to exchange rate risk, interest rate risk, economic risk, and
political risk by using swaps and other derivative products.
i) Managing the portfolio of large Public Sector Corporations.
j) Undertaking risk management services like insurance services, buy-back options etc.
k) Advising the clients on the questions of selecting the best source of funds taking into
consideration the quantum of funds required, their cost, lending period etc.
l) Guiding the clients in the minimization of the cost of debt and in the determination
of the optimum debt-equity mix.
m) Undertaking services relating to the capital market, such as
i. Clearing services
ii. Registration and transfers,
iii. Safe custody of securities
iv. Collection of income on securities
n) Promoting credit rating agencies for the purpose of rating companies which want to
go public by the issue of debt instruments.

New Financial Products and Services

In these days of complex finances, people expect a financial service company to play a very
dynamic role not only as a provider of finance but also as a departmental store of finance.

With the opening of the economy to multinationals, the free market concept has assumed
much significance. As a result, the clients both corporate and individuals are exposed to the
phenomena of volatility and uncertainty and hence they expect the financial services
company to innovate new products and services so as to meet their varied requirements.

As a result of innovations, new instruments and new products are emerging in the capital
market. The capital market and the money market are getting widened and deepened.
 Financial Services
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Vipin MK Srinath

Moreover, there has been a structural change in the international capital market with the
emergence of new products and innovative techniques of operation in the capital market.
Many financial intermediaries including banks have already started expanding their
activities in the financial services sector by offering a variety of new products. As a result,
sophistication and innovations have appeared in the arena of financial intermediations.
Some of them are briefly explained here under:

a) Merchant Banking: A merchant banker is a financial intermediary who helps to

transfer capital from those who possess it to those who need it. Merchant banking
includes a wide range of activities such as management of customer securities,
portfolio management, project counselling and appraisal, underwriting of shares and
debentures, loan syndication, acting as banker for the refund orders, handling
interest and dividend warrants etc. Thus, a merchant banker renders a host of
services to corporate, and thus promotes industrial development in the country.
b) Loan Syndication: This is more or less similar to consortium financing. But this work
is taken up by the merchant banker as a lead manager. It refers to a loan arranged by
a bank called lead manager for a borrower who is usually a large corporate customer
or a government department. It also enables the members of the syndicate to share
the credit risk associated with a particular loan among them.
 Financial Services
For SBMJC
Vipin MK Srinath

Chapter 2

Introduction

In India, merchant bankers are a body corporate who carries on any activity of the issue
management, which consist of preparing prospectus & other information relating to the
issue. Merchant banks in India are not allowed to conduct any business other than that
related to securities market. There is no official category in investment banking.

History of Merchant Banking in India

Merchant banking originated through the entering of London merchants in foreign trade
through acceptance of bill. Later, the merchants assisted the Government of under
developed countries in raising long – terms through floatation of bonds in London money
market. Over a period they extended their activities to domestic business of syndication of
long term and short term finance, underwriting of new issues, acting as registrars and share
transfer agents, debenture trustees, portfolio managers, negotiating agents for mergers,
takeovers etc.

Merchant Banking in India – Historical Perspective: Till 18th century moneylenders,

moneychangers, village merchants, & saucers performed the function of banks & merchant
banks. They also issued & discounted bills of exchange & bank draft. They gave loans on
mutual trust, on mortgage of lands, ornaments & other property. These were the organized
merchant bankers in recent history of INDIA. Merchant Banking is an activity that includes
corporate finance activities, such as advice on complex financings, merger and acquisition
advice (international or domestic), and at times direct equity investments in corporations by
the banks.
 Financial Services
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Vipin MK Srinath

Growth of Merchant Banking in India

Formal merchant activity in India was originated in 1969 with the merchant banking division
setup by the Grindlays Bank, the largest foreign bank in the country. The main service
offered at that time to the corporate enterprises by the merchant banks included the
management of public issues and some aspects of financial consultancy. Following Grindlays
Bank, Citibank set up its merchant banking division in 1970.The division took up the task of
assisting new entrepreneurs and existing units in the evaluation of new projects and raising
funds through borrowing and equity issues. Management consultancy services were also
offered. Merchant bankers are permitted to carry on activities of primary dealers in
government securities. Consequent to the recommendations of Banking Commission in
1972, that Indian banks should offer merchant banking services as part of the multiple
services they could provide their clients, State Bank of India started the Merchant Banking
Division in 1972. In the initial years the SBI’s objective was to render corporate advice and
assistance to small and medium entrepreneurs.

The commercial banks that followed State Bank of India were Central Bank of India, Bank of
India and Syndicate Bank in 1977.Bank of Baroda, Standard Chartered Bank and Mercantile
Bank in 1978 and United Bank of India, United Commercial Bank, Punjab National Bank,
Canara Bank and Indian Overseas Bank in late ‘70s and early ‘80s. Among the development
banks, ICICI started merchant banking activities in 1973 followed by IFCI (1986) and IDBI
(1991).
 Financial Services
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Vipin MK Srinath

Functions of a Merchant Bank

a) Management of debt and equity offerings: This forms the main function of the
merchant banker. He assists the companies in raising funds from the market. The
undergoing tasks include instrument designing, pricing the issue, registration of the
offer document, underwriting support, marketing of the issue, allotment and refund
and listing on stock exchanges.
b) Placement and Distribution: The merchant banker helps in distributing various
securities like equity shares, debt instruments, mutual funds, insurance products,
and commercial paper, to name a few. The distribution network of the merchant
banker can be classified as institutional and retail in nature. The institutional
network consists of mutual funds, foreign institutional investors; private equity funds
pension funds, financial institutions, etc.
c) Corporate advisory services: Merchant bankers offer customized solutions to their
clients’ financial problems. Financial structuring includes determining the right debt-
equity ratio and the framing of appropriate capital structure theory.
d) Project advisory services: Merchant bankers help their clients in various stages of the
project undertaken by the clients. They assist them in conceptualizing the project
idea in the initial stage. Once the idea is formed, they conduct feasibility studies to
examine the viability of the proposed project.
e) Loan Syndication: Merchant bankers arrange to tie up loans for their 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, which is circulated to
various banks and financial institutions and they are invited to participate in the
syndicate. The banks then negotiate the terms of lending on the basis of which the
final allocation is done.
f) Providing venture capital financing: Merchant bankers help companies in obtaining
venture capital financing for financing their new and innovative strategies.
 Financial Services
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Vipin MK Srinath

Scope of Merchant Banking in India

Merchant banking activities help in channelizing the financial surplus of the general public
into productive investment avenues. They help to coordinate the activities of various
intermediaries to the share issue such as the registrar, bankers, advertising agency, printers,
underwriters, brokers, etc. and to ensure the compliance with rules and regulations
governing the securities market. This being the era where mergers and acquisitions are hot,
the scope of merchant banking has grown to a large extent.

Merchant Banking Practices in India

Business planning stage: 1)project feasibility study

2)advice on capital structuring

Equity raising: 3)preparation of prospectus and liaison with SEBI

4)pricing decisions

5)marketing in the capacity of lead managers

6)underwriters to the issue

7)post issue management

8)assistance in ADR/GDR

Debt raising: 9)management of debenture issue

10)preparation of bankable proposal and syndication of loan

Working capital raising: 11)assistance in arranging optimal capital finance

Strategic advice: 12)advice on mergers and acquisitions

13)corporate structuring advice

 Financial Services
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Vipin MK Srinath

The development activity through the country had exerted excess demand on the sources of
funds by the ever expanding industry and trade which could not be met by the All India
Financial Institutions. In these circumstances, the corporate sector enterprises had the only
alternative to avail themselves of the capital market services for meeting the long-term fund
requirements through capital issues of equity and debentures. The growing demand for
funds from capital market has enthused many organizations to enter into the field of
merchant banking for managing the public issues.

The need of merchant banker is also felt in the wake of huge untapped public savings as
merchant bankers can play a highly significant role in mobilizing funds from savers to invest
in channels assuring promising return on investments and thus narrow down the gap
between demand for and supply of investible funds.

Merchant bankers not only provide advisory services to corporate enterprises but also
advise the investors of the incentives available in the form of tax relief and other statutory
obligations. Thus, the merchant bankers help industry and trade to raise funds, and the
investors to invest their saved money in sound and healthy concerns with confidence, safety
and expectation of higher yields.
 Financial Services
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Vipin MK Srinath

Issue Management by Merchant Banking

Management of capital issues is a professional service rendered by the skilled and

experienced merchant bankers. Previously, the managing agents for a particular corporate
used to manage public issues. The abolition of the managing agency system, the growth in
the public limited companies in number and size, the imposition of new rules and
regulations regarding the public issue of securities made it necessary for merchant bankers
to play a definite role in the management of public issues.

Public issue management involves marketing of corporate securities by offering the

securities to the public, procuring private subscription to the securities and offering
securities to existing shareholders of the company.

As a manager to the public issue, the merchant banker, before the public issue has to obtain
the consent of the stock exchanges to the memorandum and articles of association, appoint
other managers, bankers, underwriters, brokers etc. ,advice the company to appoint
auditors, solicitors and board of directors, draft the prospectus and obtain consent from the
companies legal advisors, board of directors and other concerned parties, file the
prospectus with registrar, make an application for enlistment with stock exchanges and
finally advertise for the issue.

A merchant bankers post issue activities include final allotment and/or refund of
subscription amount, calculation of underwriters liability in case of under subscription and
complying the necessary statutory requirements for listing of securities on the stock
exchange.
 Financial Services
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Vipin MK Srinath

Under writing of public issue: A fully underwritten public issue spells confidence to the
investing public, which ensures a good response to the issue. Keeping this in view
companies, which float a public issue usually, desire a full underwriting of the issue.

Underwriting is only the guarantee given by the underwriter that in the event of under
subscription, the amount underwritten would be subscribed in proportion by the
underwriter. An underwriter of the issue gets the following benefits:

o It earns a commission of the commitment given.

o It earns the right to be appointed as bankers of that issue.
o It expands its clientele by underwriting more and more issues.

Bankers to the Issue: The merchant banker can automatically become the banker to the
issue in the following cases:

o The bank is a broker to the company

o It has given underwriting commitments.
o It acts as a manger to the issue
o The function of a banker to the issue is to accept application forms
from the public together with subscription money and transfer them
to the account of the controlling branch.
 Financial Services
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Vipin MK Srinath

Problems in the Functioning of Merchant Banking in India

1. Industry compartmentalization: company which is in merchant banking business would

have expertise in underwriting, hire purchase, leasing, and portfolio management,
money-lending. But RBI does not permit merchant banking firms to get into these
activities. So the same promoters have to setup different companies for different
purposes. Management cost increases and expertise pooling i.e. multiple use of same
talent is not possible.
2. Malicious practices: India corporate culture is bettering. But still many corporate have
excessively friendly approach. Favoured allotment of shares, tampering with project
appraisal report to bankers is common. Corporate like to use merchant bankers for
malicious intentions. This gives growth to more boutique fly-by-day firms. Giant
professional or multinational merchant bankers are cautions in their approach to
Indian market.
3. Regulations: though regulations are much better now, there is still scope for further
improvement. Merchant bankers can be made more accountable and responsible.
Professional qualification focused on merchant banking is not available. Industry is not
well organized and all the players do not play the same tune. This is specifically evident
in comparison with insurance industry and mutual funds industry.