A merchant banking is a financial institution primarily engaged in offering financial services and advice to company and wealthy individuals on how to use their money. A merchant bank deal with commercial banking needs of finance, company & long term loans and stock writing. Merchant banking does not have retail offices where customer can go and access their account. A merchant bank is also called as wholesale banking.
Main objective of merchant banking is coordinating the activities like the bankers, advertising agency, printers and underwriters etc. Guide companies to get register there share under SEBI act. The merchant banking determine the number of share, price of the stocks and the timing of the release of this new stock. They also provide services to the finance housing schemes for the construction of houses and buying of land.
History and growth of Merchant Banking in India
Before 1960s there was no merchant banking in India. This system started after 1960s. The Grind lay’s bank was the first bank which started merchant banking services. Grind lay’s bank is the largest foreign bank in the country. The main service offered by merchant banking includes the management of public issues and some aspects of financial consultancy. After this more banks took initiative of merchant banking services. Bank like Citibank came in 1970. Merchant banking with Citibank play role in new entrepreneur and evaluation of new project. Raising funds through equity took place. Management consultancy services were started. State bank of India started the merchant banking in 1972. Before 1972 state bank of India used to only provide funds. But after 1972 state bank of India started multi-tasking. Commercial banks which followed state bank of India were
1. Central bank in 1977.
2. Syndicate bank in 1977.
3. Standard chartered bank, mercantile bank and bank of Baroda in 1978.
4. United bank of India, Punjab national bank, canara bank, Indian overseas bank in late 70’s and in early 80’s.
Importance of Merchant Banking
Need for Merchant Banking is felt in the wake of huge public savings lying untapped. Merchant bankers can play highly significant role in mobilizing funds of savers to investible channels assuring promising returns on investments and thus can assist in meeting the widening demand for inevitable funds for economic activity. With growth of merchant banking profession corporate enterprises are undertaking expansion, modernization, and diversification of the existing enterprises. This reinforces the need for a vigorous role to be played by merchant banking.
Reasons why specialist merchant banks have crucial role to play in India 1) Growing industrialization and increase of technologically advanced industries. 2) Need for encouragement of small and medium industrialists, who require specialist services. 3) Growing complexity in rules and procedures of the government. 4) Need to develop backward areas and states which require different criteria. 5) Exploring the possibility of joint ventures abroad and foreign markets. 6) Promoting the role of New Market in mobilizing savings from the public.
Functions performed under Merchant Banking
The important functions of merchant bankers are:
1) 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. 2) 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.
3) Corporate Advisory Services:
It denotes advice provided by a merchant banker to a corporate unit to ensure better corporate unit to ensure better corporate performance in terms of image building among investors, steady growth through good working, appreciation in market value of its equity shares. The counseling is limited to only opinions and suggestions and any detailed analysis would form part of a specific service
4) Project Advisory Services:
Project counseling is a very important and lucrative merchant banking service. It covers development of an idea into a project, preparation of the project report , estimation of the cost of the project and deciding upon the means of financial and techno-economic appraisal of projects for capital issue/financing etc. The fee charged for project report preparation / appraisal ranges between 0.25% to 2% of the total project cost. The fee charged depends upon- a)Total size of the project
b)The total complexity of the project
5) 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. 6) Providing Venture Capital Financing:
Merchant bankers help companies in obtaining venture capital financing for financing their new and innovative strategies. 7) Management of Capital Issues:
a) Pre-issue Management:
Steps required to be taken to manage Pre-issue activity are as follows:
1) Obtaining stock exchange approvals tomemorandum and articles of association.
2) Taking action as per SEBI guidelines.
3) Finalising the appointments of the following agencies –
Co managers /advisors to the issue.
Underwriters to the issue.
Brokers to the issue.
Bnakers to the issue and refund banker.
Printers and registrars to the issue.
4) Advise the company to appoint auditors, legal advisers and broad base Board of Directors.
5) Drafting the prospectus.
6) Obtaining approvals of draft prospectus from the company’s legal advisors, underwriting financial institutions/banks.
7) Obtaining consent from parties and agencies acting for the issue to be enclosed with the prospectus.
8) Approval of prospectus from Securities and exchange Board Of India(Sebi).
9) Filing of the prospectus with registrar of companies (Roc)
10) Making an application for enlistment with Stock Exchange along with copy of the prospectus.
11) Publicity of the issue with advertisement and conferences
12) Open subscription list.
B) Post Issue Management:
1) To verify and confirm that the issue is subscribed to the extent of 90% including development from underwriters in case of subscription. 2) To supervise and co-ordinate the allotment procedures of registrar to the issue as per prescribed Stock Exchange guidelines. 3) 3)To ensure issue of refund order , allotment letters/certificates within the prescribed time limit of 10 weeks after the closure of subscription list 4) To report periodically to SEBI about the progress in the matters related to allotment and refunds. 5) To ensure the listing of securities at a stock exchanges. 6) To attend the investors for managers regarding the public issue. 7) The merchant bankers managing public issue can negotiate fee subject to a ceiling .This fee is to be shared by all lead managers, advisers etc.
Registration with SEBI as Merchant Banker
Merchant banks are generally setup as subsidiary companies of banks. For e.g.: SBI caps, ICICI securities etc. Once the feasibility studies are undertaken and it comes out to be viable then the following steps are undertaken for registration with SEBI: Application for grant of certificate:
An application for grant of certificate is required to be made with SEBI as without holding the certificate no person can act as a merchant banker. The application can be made in one of the following categories: 1. Category 1: To carry out any activity of issue management which includes preparation of prospectus and other information relating to issue, determining financial structure, tie up of financers and financial allotment, and refund of the subscription. Another activity that pertains to this category is of advisor, consultant manager, underwriter, portfolio manager. 2. Category 2: To act as advisor. Consultant, co manager, underwriter and portfolio manager. 3. Category 3: To act as underwriter, advisor, and consultant to an issue. 4. Category 4: To act only as advisor and consultant to an issue. To carry on the activity of underwriter and portfolio manager, a separate certificate of registration needs to be obtained from SEBI.
Furnishing of information, clarification, and personal representation: The applicant may need to provide further information or clarification regarding matters related to activity of merchant banker. Consideration of application:
Before granting the certificate, the Board shall take into account that the applicant complies with the following requirement 1. The applicant shall be a body corporate other than a non banking financial company. 2. The merchant banker who has been granted the certificate by RBI to act as primary dealer shall carry on such activity with the condition that it should not accept or hold any public deposit. 3. The applicant should have necessary infrastructure to carry on his activities. 4. The applicant should employ atleast two persons who have the experience to conduct the business of merchant banker. 5. The applicant should fulfill the capital adequacy requirement as follows: The capital adequacy requirement should not be less than the net worth of the applicant. The net worth shall be as follows Category 1: 5 crores
Category 2: 50 lacs
Category 3: 20 lacs
Category 4: Nil
6. The applicant or any of his associate should be free of any legal charges, should not have been convicted for any offence and not found guilty of any economic offence. 7. The applicant should possess professional qualification from any recognized govt. institute in finance law or business management. Procedure for registration:
The SEBI on being satisfied with the eligibility of the applicant shall grant him a certificate . Payment of fees:
The applicant has to pay Rs. 5 lacs within 15 days of date of receipt of intimation regarding grant of certificate. If the merchant banker fails to pay the required fee, the Board may suspend the registration and applicant may cease to carry on activity as merchant banker for the period during which the subscription subsists. The merchant banker may commence on the business as merchant banker on the acquisition of Certificate of Registration from SEBI after the completion of above mentioned formalities. Procedure for Inspection: Board’s Right to inspect The Board may appoint one or more persons as inspecting authority to undertake inspection of the books of accounts, records and documents of the merchant banker for any of the purposes specified in sub-regulation (2). Notice before inspection:
Before undertaking an inspection, the Board shall give a reasonable notice to the merchant banker for that purpose. Where the Board is satisfied that in the interest of the investors no such notice should be given, it may inspect without prior notice. During the course of inspection, the merchant banker against whom an inspection is being carried out shall be bound to discharge his obligations. Obligations of Merchant Banker on Inspection:
It shall be the duty of every director, proprietor, partner, officer and employee of the merchant banker, who is being inspected, to produce to the inspecting authority such books, accounts and other documents in his custody or control and furnish him with the statements and information relating to his activities as a merchant banker within such time as the inspecting authority may require. The merchant banker shall allow the inspecting authority to have reasonable access to the premises occupied by such merchant banker or by any other person on his behalf and also extend reasonable facility for examining any books, records, documents and computer data in the possession of the merchant banker or any such other person and also provide copies of documents or other materials which, in the opinion of the inspecting authority are relevant for the purposes of the inspection.
The inspecting authority, in the course of inspection, shall be entitled to examine or record statements of any principal officer, director, partner, proprietor and employee of the merchant banker. It shall be the duty of every director, proprietor, partner, officer or employee of the merchant banker to give to the inspecting authority all assistance in connection with the inspection which the merchant banker may be reasonably expected to give. Submission of Report to the Board:
The inspecting authority shall, as soon as possible submit, an inspection report to the Board. Action on Inspection or Investigation Report:
The Board of the Chairman shall after consideration of inspection or investigation report take such action. Appointment of Auditor:
The Board may appoint a qualified auditor to investigate into the books of account or the affairs of the merchant banker. Communication of findings:
The Board shall after consideration of the inspection report communicate the findings to the merchant banker to give him an opportunity of being heard before any action is taken by the Board on the findings of the inspecting authority. On receipt of the explanation if any, from the merchant banker, the Board may call upon the merchant banker to take such measures as the Board may deem fit in the interest of the securities market and for due compliance with provisions of the Act, rules and regulations.
Guidelines of SEBI
The SEBI has issued guidelines for the issue of capital by companies. The guidelines mainly cover the requirement for the first issue by a new or existing company. The guidelines issued by SEBI are mentioned below: If any company’s other income exceeds 10% of the total income, the details should be disclosed. The company should disclose any adverse situation which affects the operations of the company. The company should also disclose the capacity utilization of plant for the last 3 years. The promoters must maintain their holding at least 20% of the expanded capital. The minimum application money payable at the time of issue should not be less than 25% of the issue price. The company should disclose the time normally taken for the disposal of investor’s grievances. The company can make firm allotments in public issues as follows: 1. Indian Mutual funds (20%)
2. FII’s (24%)
3. Regular employees of the company (10%)
4. Financial institution (20%)
The company should disclose the safety net scheme or buy back arrangements of the shares proposed in public issue. In case of public issues, atleast 30 mandatory collection centres should be established. In the guidelines regarding right issue, the company should give advertisements in not more than 2 newspapers about the dispatch of letter of offers. No preferential allotment to be made along then rights issue. The company should disclose the free agreement between the lead managers and the company in the memorandum of understanding.
Difference between Merchant Banking and Commercial Banking
Merchant banking deals with equity and equity related finance. Merchant banks are management oriented.
Merchant banks willing to accept risks of business.
The activities of merchant banks include project counseling in area of capital restructuring, mergers, amalgamations e.t.c.
Commercial banking deals with debt and debt related finance. Commercial banks are asset oriented.
Commercial banks generally avoid risks of business.
Commercial bankers are merely financiers.
Difference between Merchant Banking and Investment Banking
Merchant banking is purely fee based.
Merchant banking are impossible to stay aloof from international trends. Merchant banks expands into the field of securities, underwriting Merchant banking primarily perform international financing activities such as
1. Foreign corporate investing
2. Foreign real estate investment.
3. Trade finance and inter transaction facilitation.
Merchant banks tends to operate on small scale companies and offer creative equity financing ,and numbers of corporate credit products.
Investment banking is both fee based and fund based.
Investment banking commits their own funds.
Investment banks trade finance activities.
Investing banking facilitate mergers and acquisitions through share sales and provide research and financial consulting to companies. It focuses on IPO’s and large public and private share offering. While investment banks tends to focus on large companies. Recent developments in Merchant Banking
The recent developments in merchant banking are due to certain contributory factors in India are : The merchant banking was at its best during 1985-1992 when there were many new issues . It was expected that 2010 going to be good time for merchant banks , as many new issues 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. Disinvestments in the government sector in the country give a big scope to the merchant bankers to function as consultants. Introducing of new financial instruments in the market has increased the opportunity for the merchant banks. The merger and corporate restructuring along with MOU and MOA are giving immense opportunities to the merchant bankers for consultancy jobs.
Challenges faced by Merchant Banker in India
SEBI guideline has restricted their operations to Issue Management and Portfolio .Management to some extent due to which the scope of work is limited. The net worth requirement is very high in categories I and II specially so many professionally experienced person/organizations cannot come into the picture. Poor New issues market in India is drying up the business of the merchant bankers.
Scope for Merchant Banking
1. Growth of primary market: if the primary market grows and issues increases, the scope of merchant banking will be enhanced.
2. Entry of foreign investment: now India capital market directly taps foreign capital through euro issues.FDI is increased in capital market .so merchant bankers is required to advice them for their investment in India. The increasing number of joint ventures also requires expert services of merchant bankers. if more and more NRI’s participate in capital market ,there will be great demand for merchant banker services.
3. Changing policy of financial institutions: now the lending prices of financial institutions are based on project orientation, so the merchant banker services will be needed by corporate enterprise to provide expert guidance.
4. Development of debt markets: if the debt market is enhanced, there will be tremendous scope for merchant bankers, now NSE and OTCEI are planned to raise funds through their debt instruments.
5. Corporate restructuring: due to liberalization and globalization companies are facing lot of competitions .In order to compete, they have to restructuring, merger, acquisitions or disinvestments. They offer good opportunities to merchant bankers.