MERCHANT BANKING

Definition
The term ‘Merchant Bank’ is widely and loosely used today. It may be applied to bankers
who are not merchants, or to merchants who are not bankers, or to that houses both. In
England, the term ‘Merchant Banker’ was used in relation to a wealthy merchant who
developed the banking side of one’s business.

According to SEBI Act 1992, A Merchant banker is “a 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.”

The company has to select a Merchant Banker keeping in view the following points:
(a) Proposed size of the issue.
(b) The condition of primary and secondary markets.
(c) The support of financial institutions by participating in the issue.
(d) The background, expertise and infrastructure facilities of the Merchant Banker.

The Merchant Banker will have to liaison with the company, institutions, bankers, stock
exchange, underwriters, brokers, registrars to the issue, the printers and establish rapport
with these persons to make the issue a success.

Need for Merchant Banking Services

In India Merchant Banking Services are needed because of the following factors:

1.) Growth of Industries: During the 1980s and 1990s, India has witnessed a
tremendous growth in industries in the field of petrochemicals, fertilizers,
chemicals, engineering, electronics and others. Such industries require specialised
services in the field of promotion of projects, investment decisions, techno-
economic surveys, etc. Thus, there is a need for merchant banking services.

2.) Expensive Consultancy Services: The Consultancy services provided by

individuals and others were quite expensive and at the same time inadequate as
per the requirements of the industry. The merchant bankers do provide adequate
and economic services as per the needs of the industry.

3.) Problems of Small and Medium Scale Industries: The small and medium scale
industries find it difficult to employ the services of experts. Again, the hiring of
managerial and technical services is quite expensive from private consultancy
firms. As such, the need for merchant banking was felt.

4.) Mega Issues: Of late Indian companies are coming up with mega issue. The
prominent among such industries that have come up with mega issues are Reliance
Power, ICICI Bank, DLF, State Bank of India, and others. Such mega issues of
hundreds of crores require efficient services from merchant bankers.

5.) Project Reports: The term lending institutions do lend long-term loans on the
basis of a proper project report of the proposed project. There is a need to plan
 and draft a systematic project, which can be easily handled by merchant bankers.
Again, reports prepared by merchant bankers do carry more weightage.

6.) Joint Ventures Abroad: There are growing opportunities in the field of joint
ventures abroad. To assess the potentialities and implications of participation in
joint ventures abroad needs a close scrutiny. Such tasks can be easily handled by
merchant bankers.

Role and Functions of Merchant Banking

Merchant bankers provide a number of services as follows:

1.) Promotional Services: The merchant bankers assist and advice the promoters in
promoting a project. To promote a project requires a number of formalities such
as obtaining clearances, preparing project reports, and so on. Such preliminary
activities in connection with the project are handled by merchant bankers.

2.) Financial Arrangement: The promoters also need long-term and short-term
finance to finance assets and pre-operative working capital needs. The merchant
bankers can handle the job of arranging finance, which involves application to the
financial institutions, monitoring the sanction o the loan and so on.

3.) Corporate Restructuring: The merchant bankers provide assistance and advice
in the case of mergers, amalgamations, take-overs, etc. They act as intermediaries
in negotiating the terms of mergers, takeovers etc.

4.) Capital Reorganization: The merchant banking may also facilitate capital
reorganization, especially when the company is facing problems of over-
capitalization and under-capitalization. Thus the merchant bankers can have the
right capital mix and in the right quantum.

5.) Capital Issue Management: For raising capital from the market, there are a
number of formalities such as drafting of prospectus, vetting of prospectus by
SEBI, appointment of underwriters, appointment of registrars, bankers and
brokers and a number of other formalities. Such formalities can be completed by
merchant bankers.

6.) Special Assistance to Small Scale Industries: Small-scale industries do lack the
technical and managerial know-how in connection with the running of the
company. The merchant bankers do provide them with adequate advice and
assistance in running their organization effectively and efficiently.

7.) Portfolio Management: Merchant bankers manage the portfolio of individuals

and institutions to suit the needs of the owners. They make investment decisions
in equity, bonds, bullion, real estate, etc. Some investments are retained and some
are disinvested to achieve target rates of return. The merchant bankers are paid a
fee and also performance-based incentives.

8.) Private Placements: The merchant bankers assist the company in private
placements to raise capital. They negotiate with mutual funds, financial
 institutions and fixed deposit holders, existing shareholders and others and raise
funds within less time and at less cost.

9.) Foreign Currency Loans: All-India financial institutions like IDBI, and IFCI
provides foreign currency loans to Indian importers to import capital goods and
machinery from abroad. The merchant bankers assist the companies in obtaining
foreign currency loans from financial institutions. The foreign currency loans are
also provided by foreign banks to Indian parties abroad to meet joint venture
needs, establishment of offices, etc. The foreign banks normally insist on
guarantees from Indian financial institutions. The merchant bankers assist the
companies to obtain foreign currency loan guarantee.

10.) Technical Assistance: Merchant bankers do advice their clients in respect of

technological upgradation and modernization of industries. The advice and
assistance of merchant bankers in respect of expansion and diversification is of
great significance.

11.) Investment Advisory Services: Merchant bankers also provide advice in respect
of investments in other companies of fields. They study balance sheets, obtain
latest information, and accordingly advise their clients to invest their funds at right
time in the right direction.

12.) Revival Packages for Sick Units: Merchant bankers also handle the revival
packages for rehabilitation of sick units. They participate in the negotiations with
‘Board of Industrial and Financial Reconstruction (BIFR) and IRBI and
consortium meetings of the banks and institutions.

Apart from public issue management the activities performed by merchant bankers
include the following:

▪ Management of investment trusts

▪ Handling insurance business
▪ Loan syndication and corporate advisory services
▪ Custodial and depository services
▪ Broking of corporate securities
▪ Attractive foreign investment
▪ Liquidity Management etc.
▪ Underwriting of Securities
▪ Bill Discounting
▪ Lease Financing
▪ Arrangement of Venture capital
▪ Acting as trustees for Debentures
▪ Mobilisation of public deposits and managing fixed deposits etc.

Classification
The merchant banks, as they developed in India, could be classified into the following
categories:

1. Division of commercial banks

2. National and State level financial corporations such as ICICI, IFCI and SFCs.
3. Leading broker firms, namely, H.L. Financial Consultancy and Management
Services, Champaklal Investment and Financial Consultancy Company, J.M.
Financial and Investment Consultancy Services and DSP Financial Consultancy.