MERCHANT BANKING AND FINANCIAL SERVICES

MERCHANT BANKING AND
FINANCIAL SERVICES
UNIT- 1

An overview of Indian Financial System
The word "system" implies a set of
complex and interrelated factors
organized in a particular form. These
factors are mostly interdependent but
not always mutually exclusive. The
financial system of any country
consists of several ingredients. It
includes financial institutions, markets,
financial instruments, services,
transactions, agents, claims and2

FINANCIAL
SYSTEM
According to Van Horne, financial system is defined as the purpose of financial markets
to allocate savings efficiently in an economy to ultimate users – either for investment in
real assets or for consumption. Thus the financial system mainly stands on three factors
Money‘ is the unit of exchange or medium of payment. It represents the value of financial
transactions in qualitative terms.
Credit‘, on the other hand, is a debt or loan which is to be returned normally with interest.
 Finance‘ is monetary wealth of the state, an institution or a person. Comprising
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It is a system for the efficient management and creation of finance.

The objectives of the financial system are
 Accelerating the growth of economic development
 Encouraging rapid industrialization
 Acting as an agent to various economic factors such as industry, agricultural
sector, Government etc.
 Accelerating rural development
 Providing necessary financial support to industry
 Financing housing and small scale industries
 Development of backward areas, infrastructure and livelihood
 Imposing price control in need
 Protecting environment
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functions of financialSystem
Thefunctionsof financial system can beclassified into two broad categories:
1. Controllingfunctions
Government imposes certain controls over the financial and business activities of different organizations
through theregulatory bodies. E.g. RBI playsan important part in regulatory functions. They are:
Supervision of financial institutions, Restrictionson interest and bank rates
Selectivecredit control ,Controlling foreign exchange, Regulation of stock exchange
 Framing rulefor effectiveportfolio management and distribution, diversification and reduction of risk
Imposing monetary control ,Prevention of unfair tradepractices
Formulating policieson licensing, investment or credit
Acting asthegovernment‘sand other banks‘ bankers
2. Promotional functions
Thepromotional activitiesare
 Efficient operation of thepayment mechanism.
Managing information to makeit easily availableto all interested parties
Providing training to investors, intermediariesand employeesin order to upgradetheir skills.
Conducting development and research activitiesin order to updatethesystem.
 Creation and establishment of need based financial institutions.
Promotion of fair practiceswhich aretransparent and effective.
Creating financial awarenessto captivateinvestors, entrepreneursand borrowers.
Organizing seminar, dialogues, collection of dataand publication.

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Introduction To Financial System In India
The evolution of the financial system in India is nothing but the reflections of its political and economic history.
The evolution process has been influenced by the factors of urbanization of society, advent or large scale
industrialization, introduction of railways and telegraphic communications in the 19th century, nationalization of
financial institutions in 20th century and implementation of information technology on the eve of the 21st century.
The growth of Indian Financial System is not the outcome of a normal process of development; rather, it is created
by the government and mainly expanded through its intervention. Government policies have greatly influenced the
interest rates, credit control and functionsof financial intermediaries.
PRE INDEPENDENCE SITUATIONS
During the 274 year regime of the East India Company (1600-1874) the financial system of the country was not at
all organized. It was monopolized by the mercantile houses who were involved in banking business by providing
loans, receiving deposits and issuing currency. They are commonly known as ‗agency houses‘ who actually laid
the foundation of modern banking. The formal banking business was developed by establishment of three
Presidency Banks, namely Apart from these, some exchange banks and Indian joint stock banks were set up. In
1858, as a consequence of Sepoy Mutiny, the administrative power of the East India Company was transferred to
the Governor General of India. The financial system of the country started to be organized during this period. In
1861, the Central Government took the responsibility of issuing currency notes throughout the country. Between
1865 to 1905, nine joint stock banks, each with a capital of Rs.5 lakh and over were established. In 1921, the three
Presidency Bankswereamalgamated under aspecial legislation to form theImperial Bank of India

The first central bank was established in 1935 in the country which is known as the
Reserve Bank of India. At the time of independence, banking system in India was controlled
by RBI, IBI, exchange banks, cooperative banks and Indian joint stock banks and the total
deposits in these banks during 1948 were Rs.957 Crores. During this period, the banking
sector was in the making though there was lack of supply of long term funds to all industrial
units, specially to small scale industries. The cooperative movement did not help much as it
was disorganized and not properly aided with adequate funds. In the fields of small savings
and post office savings bank played a vital role to accumulate deposits, though it is
insignificant in terms of total deposits into the country. The private sector acted a strong role
in the stock market during the first half of the 20th century. The first stock exchange was
established at Bombay in 1887 where the private sector industrial units and the Government
raised large amount of funds. The paid up capital of Joint Stock companies increased from
Rs.24 Croresin 1890 to Rs. 570 Croresin 1948 with an averagecapital issueof Rs.70 Corers
per year during 1918 to 1939. This boom is due to the increased; pace of industrialization,
protection of domestic industriesand government policiesduring thisperiod.

POST INDEPENDENCE ERA (1950-1991)
During this period, the Indian financial system passed the second phase of evolution. It has grown rapidly since 1950 in
terms of size, innovations, diversity, complicity and sophistication. The banking system has been expanded in the rural
areas through the establishment of State Bank of India in 1955. In 1951, economic planning was initiated in India. The
mixed economy model has been adopted which enhanced government control over the financial system and direct
government participation in industrialization process.. The different landmarks during this phase were • Bank
nationalization in 1969 • Establishment of various financial institutions which are need based and useful for expansion of
financial sector. • Imposing overall control on insurance sector by the Government. • Establishment of large scale
industrial units and introduction of long term finance to all industries. • Emphasizing the growth of small scale industries
by helping them through subsidized funding and direct investment. • Imposition of regulatory measures and inserting
Government intervention in business through amending the companies Act, Securities Contracts (Regulation) Act, 1956,
Monopoliesand RestrictiveTradepracticesAct 1970, Foreign ExchangeRegulation Act 1973 etc.,
ERAAFTERLIBERALISATION
The announcement of the New Economic Policy in 1991, the India Financial System has shown quite flexibility in terms
of transformation . Thereformation processhasbeen started in order to removethe stagnation of growth described before
and, till date, the response is positive. This is the phase of liberalization and globalization of Indian economy following
the world trend which is duly supported by deregulation of Government Control. Market force becomes dominant
resulting in privatization of industries, emergence of new generation financial institutions with competitive ability and
introduction of computerized business environment where information technology plays a vital role. The regulatory
framework has been duly changed giving space to this reform process and one can say that the Indian financial sector is
gradually moving towardsattainment of global standards.

Structure Of Indian Financial System
Financial system is a system of arranging different types of funds
required for the Business. It deals about
Financial Markets
Financial Institutions
Financial Instruments
Financial Services
Components of Financial
System:
Financial system Institutions
Markets
Financial Institutions Instruments
Services
Structure of Financial

Classification of Commercial Banks
Financial Institutions
 Banking
Non Banking
Companies
Non Banking
Financial companies
 Central Bank
Commercial
 Banks
Co-Operative
Banks
Non Banking
Financial
Intermediaries
Joint Stock companies

Limitations of the financial system in India
The following are the limitations of the Indian financial system.
The I ndian Financial syst em has f ailed t o meet t he f inancial needs of small scale
I ndust ries. I t has rat her pardoned t he big indust rial houses who are already well
of f .
 The mushrooming of f inancial inst it ut ions has det eriorat ed t he qualit y and
ef f ect iveness of t he sect or t o some ext ent .
I n many cases, it could not impose adequat e cont rol t owards f inancial
irregularit ies and f rauds, of t en inf luenced by polit ically and economically
organized pressure groups.
The I ndian f inancial syst em f ails t o creat e a well def ined and organized capit al
market .
I t f ails t o mot ivat e economically marginal or small ent repreneurs by providing
micro credit t o t hem.
The I ndian f inancial syst em is not f lexible at t he desired level.
It takes abnormal time to cope with the changing
situation.
Fact oring Asset Liabilit y Management

A Merchant bank is a financial institution primarily engaged in internal finance and long term loans for
multinational corporations and governments. It can also be used to describe the private equity activities of banking. Merchant
banks tend to advise corporations and wealthy individuals on how to use their money. The advice varies from counsel on
mergers and acquisitions to recommendation on the type of credit needed. The job of generating loans and initiating other
complex financial transactions has been taken over by investment banks and private equity firms. Thus, the function of
merchant banking which originated, and grew in Europe was enriched by American patronage, and these services are now
being provided throughout the world by both banking and Non-banking Institutions.
The word ―Merchant Banking originated among the Dutch and the Scottish Traders, and was later on developed and‖
professionalized in Britain. Securities and Exchange Board of India (Merchant Bankers) Rules, 1992 ― A merchant banker
has been defined as any person who is engaged in the business of issue management either by making arrangements
regarding selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering corporate
advisory services in relation to such issue management
The Notification of the Ministry of finance defines A merchant banker as , any person who is engaged in the business of‖
issue management either by making arrangements regarding selling, buying or subscribing to the securities as manager,
consultant, adviser or rendering corporate advisory service in relation to such issue management .‖
• A merchant banker is one who is a critical link between a company raising fund and the investors.
• Merchant banker is one who underwrites corporate securities and advices clients on issues like corporate mergers
• The merchant banker may be in the form of a bank, a company, firm or even a proprietary concern.
• Merchant Banker understands the requirements of the business concern and arranges finance with the help of financial
institutions, banks, stock exchanges and money market.
Merchant banking

Objectives of Merchant banking
• Channelizing the financial surplus of the general public into productive investments
avenues
• Co-coordinating the activities of various intermediaries like the registrar, bankers,
advertising agency, printers, underwriters, brokers, etc., to the share issue
• Ensuring the compliance with rules and regulations governing the securities market
Functions of merchant Banking:
Merchant banking functions in India is the same as merchant banks in UK and other European
countries. The following are the functions of merchant bankers in India.
Corporate counseling
Project Counseling
Capita l Structuring
Portfolio Management
Issue Management
Credit Syndication
Working capital
Venture Capital
Lease Finance
Fixed Deposits
.

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Merchant Banking in India The first merchant bank was set up in 1969 by Grind lays Bank. Initially they were issue mangers
looking after the issue of shares and raising capital for the company. But subsequently they expanded their activities such as
working capital management; syndication of project finance, global loans, mergers, capital restructuring, etc., initially the
merchant banker in India was in the form of management of public issue and providing financial consultancy for foreign banks.
In 1973, SBI started the merchant banking and it was followed by ICICI. SBI capital market was set up in August 1986 as a full
fledged merchant banker. Between 1974 and 1985, the merchant banker has promoted lot of companies. However they were
brought under the control of SEBI in 1992. Recent Developments in Merchant Banking and Challenges Ahead: The recent
developments in Merchant banking are due to certain contributory factors in India. They are
 The Merchant Banking was at its best during 1985-1992 being when there were
 many new issues. It is expected that 2010 that it is going to be party time for
 merchant banks, as many new issue are coming up.
 The foreign investors – both in the form of portfolio investment and through foreign
 direct investments are venturing in Indian Economy. It is increasing the scope of
 merchant bankers in many ways.
 Disinvestment in the government sector in the country gives a big scope to the
 merchant banks to function as consultants.
 New financial instruments are introduced in the market time and again. This basically
 provides more and more opportunity to the merchant banks.
 The mergers and corporate restructuring along with MOU and MOA are giving
Merchant Banking in India

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challenges faced by merchant bankers in India are
1.SEBI guideline has restricted their operations to Issue Management and Portfolio
Management to some extent. So, the scope of work is limited.
2.In efficiency of the clients are often blamed on to the merchant banks, so they are 13
into trouble without any fault of their own.
3. The net worth requirement is very high in categories I and II specially, so many
professionally experienced person/ organizations cannot come into the picture.
4. Poor New issues market in India is drying up the business of the merchant bankers. Thus
the merchant bankers are those financial intermediary involved with the activity of transferring
capital funds to those borrowers who are interested in borrowing. The activities of the
merchant banking in India is very vast in the nature of

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MERCHANT BANKING AND LEGAL REGULATORY FRAME WORK
Registration with SEBI as Merchant Banker:
Question : Is it mandatory for a merchant banker to register with the SEBI?
Answer: Yes. Without holding a certificate of registration granted by the Securities and Exchange Board of India,
no person can act as a merchant banker.
Question : Who is eligible to obtain registration as a merchant banker?
Answer: Only a body corporate other than a non-banking financial company shall be eligible to get registration as
merchant banker.
Question : What are the various categories for which registration can be obtained?
Answer: The categories for which registration may be granted are given below:
Category I – to carry on the activity of issue management and to act as adviser, consultant, manager, underwriter,
portfolio manager.
Category II - to act as adviser, consultant, co-manager, underwriter, portfolio manager.
Category III - to act as underwriter, adviser or consultant to an issue
Category IV – to act only as adviser or consultant to an issue
Question : What is the capital requirement for carrying on activity as merchant banker?
Answer: The capital requirement depends upon the category. The minimum net worth requirement for acting as
merchant banker is given below:
Category I – Rs. 5 crores
Category II – Rs, 50 lakhs
Category III – Rs. 20 lakhs
Category IV – Nil
.

Question : What is the procedure for getting registration?
Answer: An application should be submitted to SEBI in Form A of the SEBI (Merchant Bankers)
Regulations,1992. SEBI shall consider the application and on being satisfied issue a certificate of registration in
Form B of the SEBI (Merchant Bankers) Regulations, 1992.
Question : What is the registration fee payable to SEBI?
Answer: Rs. 5 lakhs which should be paid within 15 days of date of receipt of intimation regarding grant of
certificate
Question : What is the validity period of certificate of registration?
Answer: Three years from the date of issue.
Question : How to renew the certificate?
Answer: Three months before the expiry period, an application should be submitted to SEBI in Form A of the
SEBI (Merchant Bankers) Regulations, 1992. SEBI shall consider the application and on being satisfied renew
certificate of registration for a further period of 3 years.
Question : What is the renewal fee payable to SEBI?
Answer: Rs.2.5 lakhs which should be paid within 15 days of date of receipt of intimation regarding renewal of
certificate.
Question : What is the consequence of non-registration or failure to renew registration?
Answer: The person whose registration is not current shall not carry on the activity as merchant banker from the
date of expiry of validity period.

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Companies Act
(i)company means a company formed and registered under this Act or an existing company as defined in‖
clause (ii);
(ii) existing company means a company formed and registered under any of the previous companies laws‖
specified below:
any Act or Acts relating to companies in force before the Indian Companies Act, 1866 (10 of 1866) and repealed by the Act;
the Indian Companies Act, 1866
 the Indian Companies Act, 1882 d. the Indian Companies Act, 1913 e. the Registration of Transferred Companies Ordinance 1942
(iii) private company means a company which has a minimum paid-up capital of one lakh rupees or such‖
higher paid-up capital as may be prescribed, and by its articles,
 restricts the right to transfer its shares, if any;
 limits the number of its members to fifty not including
persons who are in the employment of the company, and
 persons who, having been formerly in the employment of the company, were members of the company while in that employment and have
continued to be members after the employment ceased; and
 prohibits any invitation to the public to subscribe for any shares in, or debentures of, the company;
 prohibits any invitation or acceptance of deposits from persons other than its members, directors or their relatives Provided that where two or
more persons hold one or more shares in a company jointly, they shall, for the purposes of this definition, be treated as a single member;
iv public company means a company which a. is not a private company; b. has a minimum paid-up capital‖
of five lakh rupees b. has a minimum paid-up capital of five lakh rupees or such higher paid-up capital, s may
be prescribed c. is a private company which is a subsidiary of a company which is not a private company.

Grant of Recognition of Stock Exchanges
1.If the Central Government is satisfied, after making such inquiry as may be necessary in this behalf and after obtaining such further information,
if any, as it may require,
a.that the rules and bye-laws of a stock exchange applying for registration are inconformity with such conditions as may be prescribed with a
view to ensure fair dealing and to protect investors;
b. that the stock exchange is willing to comply with any other conditions (including conditions as to the number of members) which the Central
Government, after consultation with the governing body of the stock exchange and having regard to the area served by the stock exchange and its
standing and the nature of the securities dealt with by it, may impose for the purpose of carrying out the objects of this Act; and
c. that it would be in the interest of the trade and also in the public interest to grant recognition to the stock exchange; it may grant recognition
to the stock exchange subject to the conditions imposed upon it as aforesaid and in such form as may be prescribed.
2. The conditions which the Central Government may prescribe under clause
(a)of subsection (1) for the grant of recognition to the stock exchanges may include, among other matters, conditions relating to,
i. the qualifications for membership of stock exchange s;
ii. the manner in which contracts shall be entered into and enforced as between members;
iii. the representation of the Central Government on each of the stock exchange by such number of persons not exceeding three as the Central
Government may nominate in this behalf; and
iv. the maintenance of accounts of members and their audit by chartered accountants whenever such audit is required by the Central
Government.
3. Every grant of recognition to a stock exchange under this section shall be published in the Gazette of India and also in the Official Gazette of
the State in which the principal office as of the stock exchange is situate, and such recognition shall have effect as from the date of its publication
in the Gazette of India.
4. No application for the grant of recognition shall be refused except after giving an opportunity to the stock exchange concerned to be heard in
the matter; and the reasons for such refusal shall be communicated to the stock exchange in writing.
5. No rules of a recognized stock exchange relating to any of the matters specified in sub-section (2) of section 3 shall be amended except with the
approval of the Central Government. Even though we have 23 stock exchanges in India, a major part of the transactions is controlled by Bombay
Stock Exchange. This has led to enormous speculation, rigging and cornering of shares by a few speculators. To prevent these malpractices by
companies, brokers and merchant bankers, the government constituted Securities Exchange Board of India in April 1988 for regulating and
promoting the stock market in the country and effective from 1992.

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SEBI
SEBI is a body corporate with head office at Bombay. The Chairman and the board members are appointed
by the Central government. SEBI has two major functions.
The are : 1. Regulatory and 2. Development
1. Regulatory
a.Registering the brokers and sub-brokers
b. Registration of mutual funds
c. Regulation of stock exchanges
d.Prohibition of fraudulent and unfair trade practice
e.Controlling insider-trading, take-over bids and imposing penalties
2. Development
a.Educating investors
b.Training intermediaries in stock market transactions
c.Promoting fair transactions
d.Undertaking research and publishing useful information to all Objectives:
 To deal with development and regulation of stock market in India.
To promote fair dealings by the issue of securities and ensure a market place
 where they can raise funds.
To provide protection to the investors.
Regulate and develop a code of conduct for brokers, merchant bankers, etc.
To have check on preferential allotment to promoters at a very low price.
To prevent deviations and violations of rules prescribed by stock exchange.
To prescribe required st andards f or merchant bankers.
The promot e healt hy growt h of securit y market f or t he development of capit al

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Powers of SEBI
As per the Act, SEBI has powers
 To file complaints in a court
 To regulate companies in the issue and transfer of shares including bonus and
 rights shares.
 It can levy penalties on companies and on brokers for violating transactions.
 Power to summon any broker or intermediaries and call for documents.
 It can issue directions to all brokers for protecting the interests of investors.
In addition to the above powers:
 it can call for periodical returns from stock exchange.
 seek any information from stock exchange.
 It can enquire into the functioning of stock exchange.
 It can grant permission for the change of bye-laws of any stock exchange.
 It can compel listing of securities of public company.
 It can control and regulate stock exchanges.
 Granting registration to market intermediaries, prohibit inside-trading and prohibit
Fraudulent and unfair trade practices.
 Promoting investor-education, and trading of intermediaries in capital market.
 Regulating purchase of shares and take-over of companies.

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STOCK EXCHANGES
„Stocks refers to the old securities i.e., those which have been already issued and listed on a‟
stock exchange.
These securities are purchased and sold continuously among investors without the
involvement of companies.
Objectives of Stock Exchanges
1.Assisting in buying and selling of securities
2. Regulating the business of buying and selling or dealing in securities.
Functions of Stock Exchanges
The stock market occupies a pivotal position in the financial system. It performs several
economic functions and renders invaluable services to the investors, companies, and to the
economy as a whole. They may be summarized as follows:
1.Liquidity and marketability of Securities
2.Safety of Funds
3.Supply of Long term funds
4.Flow of Capital to Profitable Ventures.
5.Motivation for improved performance
6.Promotion of Investment
7.Reflection of Business Cycle
8.Marketing of New Issues
9. Miscellaneous Services Organisation of Stock Exchanges

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Traditional Structure of stock Exchanges
The stock exchanges in India can be classified into two broad groups on the basis of their legal
structure. They are;
1. Three stock exchanges which are functioning as association of person‘s viz., BSE, ASE and
Madhya Pradesh Stock Exchange.
2. Twenty stock exchanges which have been set up as companies, either limited by guarantees or by
shares. They are
 Bangalore Stock Exchange
 Bhubaneswar Stock exchange
 Calcutta Stock Exchange
 Cochin Stock Exchange
 Coimbatore Stock Exchange
 Delhi Stock Exchange
 Gauhati Stock Exchange
 Hyderabad Stock Exchange
 Interconnected Stock Exchange
 Jaipur Stock Exchange
 Ludhiana Stock Exchange
 Madras Stock Exchange
 Magadh Stock Exchange
 Mangalore Stock Exchange
 National Stock Exchange
 Pune Stock

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OTCEI
Over the Counter Exchange of India
It is a Stock Exchange without a proper trading floor All stock exchanges have a specific place for trading their securities through counters.
But, OTCEI is connected through a computer network and the transactions are taking place through computer operations. Thus, the
development in information technology has given scope for starting this type of stock exchange. This stock exchange is recognized under the
Securities Contract ( Regulation) Act and so all the stocks listed in this exchange enjoy the same benefits as other listed securities enjoy.
OTCEI has been incorporated under Section 25 of the companies Act. As a result of which the word ‗Limited‘ need
not be used since it is promoted for a common case of promoting the interest of small and medium companies. This
privilege has been given to the company by the Central government. This company was promoted by a group of
financial institutions owned by Government of India, consisting of UTI, ICICI, IDBI, SBI Capital Market , IFCI, LIC,
GIC and CAN BANK financial Services.
FEATURES OF OTCEI
(1) Use of Modern Technology: It is an electronically operated stock exchange.
(2) Restrictions for other stocks: Stocks and shares listed in other stock exchanges will not be listed in the OTCEI and similarly, stock
listed in OTCEI will not be listed in other stock exchanges.
(3) Minimum issued capital requirements: Minimum issued equity capital should be Rs.30 lakhs, out of which minimum public offer should
be Rs.20 lakhs.
(4) Restrictions for large companies: No company with the issued equity share capital of more than Rs.25 crores is permitted for listing.
(5) Base Capital requirement for members: Members will be required to maintain a minimum base capital of Rs. 4 lakhs to trade on the
permitted or on listed segment.
(6) All India network: The network of counters links OTCEI members, located in different parts of the country.
(7) Satellite facility: The satellite required for OTCEI for its operations is jointly held with Press Trust of India
(8) Computerization of transactions: Computers at each counter enable the dealers to enter various transactions or queries or quotes through a
central OTCEI computer, using telecommunication links.

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Objectives of OTCEI:
The following are the objectives of OTCEI
1.Assisting and guiding small companies to raise funds from the capital market in a
cost-effective manner
2. Providing a convenient and an efficient avenue of capital market investments for
small investors
3.Strengthening investors‘ confidence in the financial market by offering them the two-
way best prices to them
4. Ensuring transparency, redressing investors‘ complaints and unifying the country‘s
securities market to cover even those places which do not have a stock exchange
5.Acting as a launch pad to an IPO
6.Providing liquidity advantage to the securities traded
7.Promoting organized trading in Unlisted Securities
8.Providing a source of valuation for securities traded

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Benefits To Listed Companies
1.Negotiability
2.Fixation of premium
3.Savings in costs
4.No take-over threat
5.Large access :
NSE NATIONAL STOCK EXCHANGE OF INDIA
• It is the screen based trading established to counter the influence of Bombay Stock
Exchange and to reduce the influence of certain powerful intermediaries in the stock
market.
• Both securities of companies and debt instruments are traded here. The success of
this stock exchange is quite evident that within a few years of its promotion the
volume and the value of transactions have surpassed the Bombay Stock Exchange.
Apart from this, the prices of securities prevailing in this market have its influence on
the Bombay Stock Exchange.

MERCHANT BANKING AND FINANCIAL SERVICES

MERCHANT BANKING AND FINANCIAL SERVICES

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