Merchant Banking

Dr K Ramesha
Professor
 MERCHANT BANKING HISTORY
• 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. For example, the Dutch merchant adventurers were active in
what is now Indonesia; the French and Portuguese acted similarly in their
respective colonies. The American colonies also represent the product of
merchant banking, as evidenced by the activities of the famous Hudson
Bay Company. One does not typically look at these countries' economic
development as having been fueled by merchant bank adventurers.
However, the colonies and their progress stem from the business of
merchant banks, according to today's accepted sense of the word.
• The colonies of other European countries were started in the same
manner. For example, the Dutch merchant adventurers were active in
what is now Indonesia; the French and Portuguese acted similarly in their
respective colonies. The American colonies also represent the product of
merchant banking, as evidenced by the activities of the famous Hudson
Bay Company. One does not typically look at these countries' economic
development as having been fueled by merchant bank adventurers.
However, the colonies and their progress stem from the business of
merchant banks, according to today's accepted sense of the word.
 THE HISTORICAL MERCHANT
BANK
• Merchant Banking, as the term has evolved in Europe from the 18th
century to today, 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. Merchant banking services span from the earliest
negotiations from a transaction to its actual consummation between
buyer and seller.
• In particular, 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, selling, and shipping of
goods. The role of the merchant banker, who had the expertise to
understand a particular transaction, was to arrange the necessary
capital and ensure that the transaction would ultimately produce
"collectable" profits. Often, the merchant banker also became
involved in the actual negotiations between a buyer and seller in a
transaction
THE MODERN MERCHANT BANK
• During the 20th century, however, European merchant banks
expanded their services. They became increasingly involved in the
actual running of the business for whom the transaction was
conducted. Today, merchant banks actually own and run
businesses for their own account, and that of others.
• Since the 18th century, the term merchant banker has, therefore,
been considerably broadened to include a composite of modern day
skills. These skills include those inherent in an entrepreneur, a
management advisor, a commercial and/or investment banker plus
that of a transaction broker. Today a merchant banker is who has
the ability to merchandise -- that is, create or expand a need -- and
fulfill capital requirements. The modern European merchant bank, in
many ways, reflects the early activities and breadth of services of
the colonial trading companies
THE MODERN MERCHANT BANK
• Most companies that come to a U.S. merchant bank
are looking to increase their financial stability or
satisfy a particular, immediate capital need.
• Professional merchant bankers must have: 1) an
understanding of the product, its industry and operational
management; 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); 3) and most importantly,
effective skills in concluding a transaction - the actual
sale of the product and the collection of profit. Some
people might question whether or not there are many
individuals or organizations who have the abilities to fulfill
all three areas of expertise
 Backdrop
• Financial system in particular banking system
before 1968
• Financial system, in particular financial markets
and banking system during 1968-1991
• Developments in the financial system, banking
system and financial markets in the post 1991
period
• Universal banking concept
• Creation of SEBI
 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. 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
• In addition, MBs render a variety of advisory
services to individuals and corporate bodies
including such financial institutions as
investment trust and unit trusts, of which they
are the promoters and managers. MBs
therefore from an integral part of the complex of
financial institutions like commercial banks,
discount houses, long-term financial institutions
and capital markets and have therefore
established intimate business relationships with
them through daily contacts and advisory
services.
 Merchant Banking - Britain
• The prominent MBs do acceptance of business; many of them act as
issuing houses, some are financial bankers, some do foreign exchange
business, some are engaged in bullion business, a few undertake
merchanting. All of them do banking in some form by keeping money in
current or other accounts for their customers at home or abroad. This
type of banking activity ancillary to other services, but the keeping of
current account on which their customers draw by cheque is a substantial
business for many of them. Allied with this is the keeping of securities in
safe custody including the accounts of customers and making and
realizing investments on their behalf. This has led in many cases to giving
advise to customers on their investments as well as on the management
of pension funds, college endowments and other funds of a similar
nature. Some of them have an active trustee business which either a
department or a separate subsidiary company handles. They also act as
registrars and transfer agents for industrial companies. Many MBs have
promoted and are managers of investment trusts and unit trusts. By
developing unit-linked insurance business, they have set up their own life
insurance companies, or have established business connections with the
existing life insurance offices.
 Merchant Banking - Britain
• MBs are active in the following
– Manage individual funds – individuals, 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, running
European and off-shore trusts thus concerning
themselves with foreign loan business
 Merchant Banking - USA
• In US, investment bankers are mainly engaged in
marketing corporate and other obligations. Investment
banking firm forms and manages any syndicate to
market public offerings of the issue made by a client
corporation. The investment banker is a good judge of
the timing of the issue, secondly, he is adept in
formulating the terms and conditions which are
acceptable to investors in the prevailing conditions. The
investment banking firms are, therefore, 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
• 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. They have
developed qualities of integrity, financial expertise, high
management stability, loyalty and close relationship with
clients. Many of them have substantial resources of their
own and command additional resources through access
to commercial banks, financial institutions and the stock
market with which they have established intimate
relations and enjoy a high creditworthy status
 Merchant Banking - 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, 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. Commercial banks have thus been
competing with the old established merchant
banks (IB)
 Merchant Banks - Concept
• There is no statutory or any authoritative
definition for the term Merchant Banking.
For many, it just means management of
capital issues of companies. Some
confuse this with investment banking and
an issue house. Yet another group of
persons mean it to what a merchant
banker does. In this situation, let us try to
settle for a workable definition of this term.
 Merchant Banks - Concept
• Definition
– In the Indian context, 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,
defines who a merchant banker is. “merchant 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, advisor or rendering
corporate advisory services in relation to such issue
management”
 Merchant Banks - Concept
• Merchant Banker
– Should be engaged in the business of issue
management
– Such engagement should be for
• Making arrangements regarding selling, buying or
subscribing to securities. Should be engaged as a manager,
consultant, advisor in the process of selling, buying,
subscribing to securities
• Rendering corporate advisory services in relation to such
issue management
• ‘engaging in the business of issue management
either by making arrangements regarding
selling, buying or subscribing to securities as
manager, consultant, advisor or rendering
corporate advisory services to such issue
management’
 Merchant Banks - Concept
• Merchant banking Vs Commercial banking
– Clause (c) of section 5 of BR Act of 1949, the main business of a
bank is to ‘accept, for the purpose of lending or investment, of
the deposits of money from the public, repayable on demand or
otherwise and withdrawable by cheques, drafts, orders or
otherwise’
– Sub-section of (1) of section 6 deals with the permissible
business. Clause (d) of this section enables a banking company
to internal underwriting support and to manage any issue. It
reads “the effecting, insuring, guaranteeing, underwriting,
participating in managing and carrying out of any issue, public or
private of state, municipal or other loans or shares, stock,
debentures or debenture stock of any company, corporation or
association and the lending of money for the purpose of any
such issue”
– A bank can undertake merchant banking business, but an MB
can not undertake banking business
 Merchant Banks - 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.
Generally, investment advises and dealing in
securities are not performed by MB
 Merchant Banks - Concept
• Merchant Banking Vs Management Consultancy
• Institute of Chartered Accountants of India –
management consultancy does not include the
functions of statutory periodical audits, tax
representation or advice concerning matters or
acting as liquidator, trustee, executor,
administrator, arbitrator or receiver, but shall
include…….
• The scope of management consultancy is much
wider than MB
 Merchant Banking in India
• Till early 1960s there was no merchant banking
in the Indian banking system. It was the
Grindlays Bank which started merchant banking
services as far back as 1967 in India. Others to
follow were Citibank (1970), 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.
• Private financial brokers also started private MB
organizations
 Merchant Banking in India
Merchant Banking Divisions

Foreign Indian Private

Financial
Banks Banks Merchant
Institutions
Bankers

Division in
Subsidiary Bank
Merchant Banking and Corporates

Guidance

Project Formulations

Implementation
Objectives of
Modernization
Merchant
Banking Diversification

Mobilizing Resources

Raising Working Capital

 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, mergers and takeovers
 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, banks and other
sources of finance
• Expert advise on government policies, demand-supply gaps,
raw material availability, product-mix, plan capacity
utilization, requirements of plant and machinery etc
• Consultation about alternative sources of finance, debt-equity
ratios, etc
• Liaison with government departments, financial institutions,
banks etc
• Advise and assistance for modernization, expansion and
diversification
 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, 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, 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
 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, syndication is arranged by MB
– Foreign Currency Loans
• Arranges foreign currency loans
– Portfolio Management
• Basically advisory in nature regarding purchase and sale of
securities, handling transactions, safe custody of documents,
collection of dividend etc