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Merchant Banking

Introduction

Assists corporates in raising capital via public issue of shares or debentures, syndicating loan, etc. Do not provide funds but only assist Actively arrange working capital, appraise projects, scrutinize or pursue merger proposals

Definition

As the role of merchant bankers is widespread and overlapping with that of commercial banks and finance companies, the definition is usually the one which is accepted by that countrys regulatory authority. In UK, investment bank & merchant bank are synonyms. In US, merchant bank means an investment bank which is well-equipped to handle MNCs. In India, merchant banker is a body corporate who carries on any activity of the issue management (ie) assist in raising capital and advice on related issues. There is no official category as investment bank.

Origin & History


In the late 17th & 18th century Europe, the largest companies of the world were merchant adventurers. Wealthy people were financing trade and that was their profit making business. They were merchants financiers. In todays terms, they were merchant bankers. (eg) The East India Company was a merchant bank which facilitated merchants to carry out trade especially with India. In Europe, the term merchant banking has evolved from 18th century to today to include most of the services spanned from early stage negotiations to the final transaction.

Historical Perspective of Merchant Banking in India


Kautilyas Arthashastra (4th century BC) mentions about business of funding and facilitating merchants. Till 18th century, moneylenders, moneychangers, village merchants and sahukaars performed the function of banks and merchant banks. They also issued and discounted hundies (bills of exchange), bank drafts, extended loans to private parties on mutual trust, on mortgages of land, ornaments and other property, stood as guarantor for loans and for trade (ie) import and export transactions. Jagat Seth (1720-1773 AD, Bengal) and Habib & Sons (1921) which is now Habib Bank (founded in 1941, now in Pakistan) were organized merchant bankers in recent history of India.

Post Independence stage of Merchant Banking in India

In 1967, RBI issued its first merchant banking license to Grindlays Bank which started with management of capital issues, production planning, system design, market research and now it provides management consulting services as well. Citibank set up its merchant banking division in 1970 with services such as assisting new entrepreneurs, evaluating new projects and raising funds through borrowing and issuing equity. Indian banks (SBI) started merchant banking services in 1972 as a part of the multiple services they offer to their clients. Merchant banking activities are organized and undertaken in several forms. Commercial banks and foreign development finance institutions have organized them through formation of divisions, nationalized banks have formed subsidiary companies and share brokers and consultancies have constituted themselves into public limited companies or registered themselves as private limited companies. Some of them have equity stake of foreign merchant bankers.

Services of Merchant Bankers


Business Planning Stage Project feasibility study / appraisal & Advice on Capital Structuring. Equity Raising Preparation of prospectus & liaisoning with SEBI (Advisors to the issue), Pricing decisions, Marketing in the capacity of Lead Managers, Underwriters to the issue (separate license needed from SEBI for this service), Post issue management & Assistance in ADR / GDR. Debt Raising Management of Debentures issue & Preparation of Bankable proposal & Syndication of Loan.

Services of Merchant Bankers


Working Capital Raising Assistance in arranging optimal working capital finance. Strategic Advice Advice on mergers and acquisitions & Corporate structuring advice.

Qualities required of a Merchant Banker


Knowledge Capital Market Familiarity Liaisoning Ability Innovation Integrity

Guidelines for Merchant Bankers


(1) (2) (3)

(4)

Merchant Banking in India is governed by SEBI (Merchant Bankers) Regulations , 1992. Highlights of the provisions are as follows:To be a merchant banker, person should apply to SEBI in a prescribed format. Merchant banking business only includes an action as an advisor, a consultant or a manager. To act as an underwriter and portfolio manager, separate applications are to be made to SEBI under respective regulations. Applicant has to be a body corporate and should not be a NBFC carrying out activities other than those of a merchant banker as specified from time to time. It should not accept or hold deposits. At least 2 merchant banking experienced persons should be in employment.

Guidelines for Merchant Bankers


(5) Should fulfill the capital adequacy (net worth) norms as specified by SEBI from time to time. (6) A merchant banker (except a bank or public financial institution) registered under the regulations should not carry on any business other than that in the securities market. (7) Every merchant banker should furnish to the Board half-yearly unaudited financial results when required by the Board with a view to monitor the capital adequacy of the merchant banker. (8) All issues should be managed by at least one merchant banker functioning as the lead merchant banker. (9) Merchant banker or any of its directors, partners, managers or principal officers should not either on their respective accounts or through their associates or relatives enter into any transaction in securities of (client) companies. (10) Every merchant banker should appoint a compliance officer. (11) SEBI can suspend / cancel registration of defaulter merchant bankers.

Merchant Bankers Commission


(1) (2) (3)

Ceiling rates of merchant bankers commission as decided by SEBI and Ministry of Finance. Additionally, brokerage is to be paid to brokers (1.5% on public issue, 0.5% on private placement and no brokerage on promoters quota and institutional subscription if it is as a result of underwriting devolvement) Project Appraisal Fee Discretionary and negotiable (no ceiling) Public Issue Management Fees 0.5% of the total issue Lead Managers Commission 0.5% upto INR 25 crores & 0.2% in excess of INR 25 crores

Merchant Bankers Commission

Merchant Bankers & Market Making

Market making means that a trader or company puts both buy and sell orders into the market and wait for people to trade with them on either sides. This is done for ensuring liquidity in the market for a particular stock. Market making could be made compulsory at least for a period of 6 to 12 months after listing of issues. This facility is not available in India as of date. SEBI has encouraged merchant bankers to be market makers & has stipulated compulsory market making for at least 2 years from the date of listing for IPOs not satisfying certain criteria. Market making is also necessary and observed better in GSecs market. RBI appoints primary dealers (who act as merchant bankers to GOI for securities issuances) for participating in G-Secs market. A PD forms the 1st level of market makers for Gilts.

Progress of Merchant Banking in India


With stock markets progressing, merchant bankers business activitys growing. Earlier, Controller of Capital Issues was the controlling authority for the stock markets & issue pricing. Now, its SEBI. Physical shares replaced with Demat form as a part of 100% Book-Building. BSE got NSE as a strong companion. Both are highly automated and sophisticated now. With India liberalizing its policies, its presence in the international markets has increased. Also, number of merchant bankers is increasing since then. Now, almost every PSU bank has a dedicated merchant banking subsidiary. Also, giant MNC merchant bankers are now showing their presence in India.

Scope for Merchant Banking in India


Size and dynamics of the market Restrictions & Liberalization Banking Policies Corporate Culture Corporate Dynamics

Problems & Hurdles for Merchant Banking in India


Industry Compartmentalization Malafide Practices Regulations

Association of Merchant Bankers in India (AMBI)


Professional non-profit company setup to represent the industry. Expected to set code of ethics and facilitate dialogue between the industry and regulatory bodies and conduct training and awareness programmes. But, its actually dormant (practically defunct) as of date because of lack of support from the members and non-initiative from SEBI and other government bodies.

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