UNIT- 3

Merchant Banking Banking services +

Consultancy services(Collect finance) (financial, marketing, managerial

& legal matters)Haresh RAsst. Professor

Dept of CommerceChrist University

Introduction• Basically a service banking.• Provides non-fund based services (Fee Based)• Arranges funds rather than providing them• Intermediary in transferring capital from place

of surplus to deficit• An institution which understands

Requirements of FIs, Banks, Stock xchange

entrepreneurs and money market

Merchant Banking: Origin• Merchant Banking came into existence in 12th

century in Italy (Riccadi of Luca, Medici, Fugger)

• 17th and 18th century bills of exchange and money

market instruments introduced to English

businessmen by Italian Merchants.

• Merchant banking in the modern era started from

London; Merchants started to finance the foreign

trade through acceptance of bill.

• Till 1932 there was no distinction between merchant banks and commercial banks. The Glass-Steagall Act 1933 distinguished (MB/IB from CB)

• 1987 commercial banks were permitted to create subsidiaries for the purpose of undertaking MB/IB activities in USA

• Merchant banks were known as “accepting & issuing houses” in the UK and “Investment banks” in USA.(Only difference in nomenclature but not in functional aspects)

• Merchant Banking officially came to India

through ANZ Grindlays Bank in 1967 after

obtaining license from RBI (Management of

capital issue, financial services, market research,

management consultancy services)

• 1970 - Citibank merchant banking division.

• 1972 – SBI merchant banking division

• ICICI the first Pvt institution started MB service

in 1974.

• Many other banks came after this like Canara

Bank, UCO bank etc., started their operation.

• Forms of Merchant Banks

– Commercial banks & foreign development finance

institutions, nationalised banks through subsidiary

companies, sharebrokers and consultants in the

form of public or private limited companies,

collaborations with foreign merchant bankers.

Meaning of Merchant Banking

• a financial institution that provides capital to companies in the form of share ownership instead of loans.

• provides advisory on corporate matters to the firms they lend to.

• In other words…

“Merchant bank refers to an organization that underwrites securities and advises such clients on issues like corporate mergers, involving in the ownership of commercial ventures”.

DefinitionAccording to SEBI (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 advisor

or rendering corporate advisory services in

relation to such issue management”.

Merchant Bank Vs Commercial Bank

• CBs deal in debt and debt related finance. MBs deal in equity and equity related finance.

• CBs avoid risk - credit analysis of loan proposals - value of security offered – asset oriented. MBs are management oriented and are willing to accept risks.

• CBs are merely financiers. MBs undertake project counseling, corporate counseling in areas of capital restructuring, mergers, takeovers etc.,

Functions/Services of Merchant Banking

1. Corporate Counseling2. Project Counseling3. Pre investment studies4. Capital Restructuring5. Credit Syndication & Project Finance6. Issue Management & underwriting7. Portfolio Management8. Working Capital Finance

9. Acceptance of credit & bill discounting10. Merger, Amalgamation & Takeover11. Venture capital12. Lease Financing13. Foreign Currency Financing14. Fixed Deposits Broking15. Mutual Funds

Corporate Counseling• A set of activities undertaken to ensure the efficient running

of a corporate enterprise is known as corporate counseling.• A merchant banker guides the client on aspects of

– organizational goals – vocational factors– organization size– choice of product – demand forecasting – cost analysis– allocation of resources – investment decisions– capital and expenditure management– marketing strategy– pricing methods etc.

• Diagnosing sick units, assessing revival prospects for rehabilitation, suggesting suitable strategy for improving their production technology and financial structure.

• Suggestions and opinions to the client and help taking actions to solve their problems.

• It is provided to a corporate unit with a view to ensure better performance, maintain steady growth and create better image among investors.

Project Counseling

• Project counseling is the feasibility study of the project with reference to various aspects such as financial, economical, commercial technical etc.

• It includes– preparing project reports– finance for cost of project– appraising projects from the angle of technical, commercial

and financial viability.– getting approval of project from bank/Govt and other

agencies – planning for public issue.

Pre-Investment Studies

• It is a detailed feasibility study to evaluate alternative avenues of capital investment in terms of growth and profit prospects.– Analyzing environment and regulatory factors– Identification of raw material sources– Estimation of demand– Estimation of financial requirements

Capital Restructuring Services • Capital restructuring aims to reduce the cost of

capital and maximize the shareholders wealth. – Determination of optimum capital structure

conforming to legal requirements. – Getting consent of controller of Capital issues for

capitalization of reserves by way of issuing bonus shares.

– Here the Capital Structure is worked out i.e., the capital required, raising of the capital, debt-equity ratio, issue of shares and debentures, working capital, fixed capital requirements, etc.,

Credit Syndication

• Credit Syndication refers to obtaining of loans from single development finance institution or a syndicate or consortium.

• credit procurement and project financing, aimed at raising Indian and foreign currency loans from banks and financial institutions.

Steps followed by MB - Clients - FIs

• MB first makes an appraisal of the project to satisfy that it is viable

• He ensures that the project adheres to the guidelines for financing industrial projects.

• It helps in designing capital structure, determining the promoter‘s contribution and arriving at a figure of approximate amount of term loan to be raised.

• After verifications of the project, the Merchant Banker arranges for a preliminary meeting with financial institution.

• If the financial institution agrees to consider the proposal, the application is filled and submitted along with other documents.

Issue Management and Underwriting

• Issue management and underwriting is concerned with the activities of management of the public issues of corporate securities, viz. equity shares, preference shares, and debentures of bonds to procure money from the capital market.

• Underwriting is a guarantee given by the underwriter that in the event of under subscription, the amount would be provided by him to the extent of under subscription.

• All public issues are to be underwritten fully.

Portfolio Management

• Refers to investments in different kinds of securities such as shares, debentures, bonds issued by different companies and securities issued by the Govt.

• Merchant bankers advise about mix of investments a company should follow to ensure maximum return with minimum risk.– Providing advice on selection of investments. – Carrying out a critical evaluation of investment portfolio. – Collecting and remitting interest and dividend on

investment. – Undertaking investment in securities. – Safe custody of securities in India and overseas.

Working Capital Finance

• Working Capital finance is the fund required to meet the day-today expenses of an enterprise.

• The related activities are:– Assessment of working capital requirements.– Facilitating sanction of credit facilities speedy

disbursements.

Merger and Acquisition• The merchant banker arranges for negotiating

acquisitions and mergers by offering expert valuation regarding the quantum and the nature of considerations, and other related matters. – Conducting SWOT analysis in order to help formulate

guidelines and directions for future growth. – Conducting studies for locating overseas markets, foreign

collaborations and prospective joint venture associates. – Obtaining approvals from shareholders and other

stakeholders – Monitoring the implementation of merger and

amalgamation schemes.

Lease Financing

• Leasing is one of the fund based financial services of merchant banker. Leasing means ‘letting out assets on lease’ for use by the lessee for a particular period of time. Merchant banker provides the following services:– Providing advice on the viability of leasing– Providing advice on the choice of a favorable

rental structure.

Foreign Currency Financing• Foreign currency finance is the fund provided for foreign

trade transactions in the form of export-import trade finance, euro currency loans. – Assisting the study of turnkey project and construction of

contract projects.– Liaison with RBI, EXIM, ECGC and other institutions.– Providing assistance in opening and operating banks accounts

abroad.– Assisting in obtaining export credit facilities and letter or credit.– Providing guidance on forward cover for exchange risk.– Arranging foreign currency guarantees.– Arranging various types of foreign currency loans such as

Eurocurrency Loans, Syndication of Euro loans, Bank guarantees etc.

Scope for Merchant Banks in India The present capital market scenario provides a vast scope

for merchant banking in india. Below mentioned point

justify it clearly.

(i) Growth of new issue market – Due to unprecedented

growth in new issue market, MB’s has to play crucial role in

managing issue of shares & securities.

(ii) Entry of foreign investors – has further improved their

scope in India due to opening up Indian Capital market in 1992

for foreign investors. Increasing number of joint ventures

abroad by Indian companies and further increased this scope.

(iii) Changing policies of Financial Institutions –

From security orientation to project orientation has given

a further boost to MB’s as their services are required for

project preparation, appraisal and getting the projects

approved for getting finances.

(iv) Innovations in financial instrument – New

instruments are coming in capital market and MB’s are

market makers for those new instruments.

(v) Corporate restructuring – Due to increased liberalization, globalisation and privatization, competition in corporate sector is becoming intense leading to corporate restructuring in the form of merger, acquisition, take over, necessitating the services of MB‟s.(vi) Dis-investment – Policy of disinvestment in public sector is opened up good scope for MB’s in capital market.

The following are some of the reasons why specialist merchant bank have a crucial role to play in India.• Growing complexity in rules and procedures of

the government.• Growing industrialization and increase of

technologically advanced industries.• Need for encouragement of small and

medium industrialists, who require specialist services.

• Need to develop backward areas and states which require different criteria.

• Exploring the possibility of joint ventures abroad and foreign market.

• Promoting the role of new issue market in mobilizing saving from.

Problems of merchant banks1. Restrictions in scope of merchant banking activities with focus only on issue related activities and certain exceptions for portfolio management.2. SEBI guidelines stipulate a minimum net worth of Rs.1 crore for authorization of merchant bankers. Difficulty for adhering such net worth norms by small firms.3. Non cooperation of the issuing companies in timely allotment of securities and refund application money is another problem of merchant bankers.

4. Unhealthy competition among large number of merchant banks compels them to reduce their profit margin, commission etc.5. There is no exact regulatory framework for regulating and controlling the working of merchant banks in India.6. Fraudulent and fake issue of share capital by the companies are also posing problems for merchant banks who act as lead manager or issue manager of such issues.