Merchant Banking
Meaning:
The term 'merchant banking' has been used
differently in different parts of the world. While in U.K. merchant banking
refers to the 'accepting and issuing houses', in U.S.A. it is known as
'investment banking'. The word merchant banking has been so widely used that
sometimes it is applied to banks who are not merchants, sometimes to merchants
who are not banks and sometimes to those intermediaries who are neither
merchants not banks.
In India merchant banking services were
started only in 1967 by National Grindlays Bank followed by Citi Bank in 1970.
The State Bank of India was the first Indian Commercial Bank having set up
separate Merchant Banking Division in 1972. In India merchant banks have been
primarily operating as issue houses than full- fledged merchant banks as in
other countries.
A merchant bank may be defined as an
institution or an organisation which provides a number of services including
management of securities issues, portfolio services, underwriting of capital
issues, insurance, credit syndication, financial advices, project counselling
etc. There is a distinction between a commercial bank and a merchant bank. The
merchant banks mainly offer financial services for a fee. while commercial
banks accept deposits and grant loans. The merchant banks do not act as
repositories for savings of the individuals.
Merchant Banking The
term ‘Merchant banker’ was used in relation to a wealthy merchant, who
developed the banking side of one’s business, in England. In India, merchant
banking definition is framed in SEBI rules 1992. It defines merchant banker as
“ any person who is engaged in the business of issue management either by
making arrangement regarding selling, buying or subscribing to securities as
manager, consultant, advisor or rendering corporate advisory services in
relation to such issue management.
Functions of Merchant
Banks:
The basic function of a merchant banker is
marketing corporate and other securities. Now they are required to take up some
allied functions also.
Functions of Merchant
Bankers
1. Corporate Counseling 2.
Project Counseling 3. Pre investment
studies
4. Capital Restructuring 5. Credit Syndication and Project
Finance
6. Issue Management and
underwriting 7. Portfolio Management
8. Working Capital
Finance 9. Acceptance of credit and
bill discounting
10. Merger,
Amalgamation and Takeover 11. Venture
capital
12. Lease Financing 13.Foreign Currency Financing 14. Fixed Deposits Broking 15. Mutual Funds
1. Corporate Counseling
A set of activities undertaken to ensure the efficient running of a corporate
enterprise is known as corporate counseling. The merchant banker is guiding in
the following activities:
➢➢ Diversification based
on the Government’s economic and licensing policies.
➢➢ Appraisal of product
lines, analyzing their growth and profitability and forecasting future trends.
➢➢ Diagnosing sick units,
assessing revival prospects for rehabilitation by way of modernization and
diversification, suggesting suitable strategy for improving their production
technology and financial structure.
➢➢ Arranging funds for
rehabilitation through banks/financial institutions.
➢➢ Monitoring of
rehabilitation schemes.
➢➢ Assisting takeover of
sick units
2. 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 the following activities:
➢ Review of project
idea, conducting feasibility study and providing advice for implementation.
➢➢ Providing assistance
in the preparation of project reports, conducting market surveys and obtaining
government consents (approvals/licenses/permissions/grants) for implementation
of the project. Providing guidance in making investment in Indian projects in
India and abroad.
➢➢ Arranging and
negotiating foreign collaborations, amalgamations, mergers, and takeovers.
3.Pre-Investment
Studies It is a detailed feasibility study to evaluate alternative avenues of
capital investment in terms of growth and profit prospects. Activities related
to pre-investment studies are:
➢➢ Analyzing environment
and regulatory factors
➢➢ Identification of raw
material sources
➢➢ Estimation of demand
➢➢ Estimation of
financial requirements
4. Capital Restructuring
Services Capital restructuring aims to reduce the cost of capital and maximize
the shareholders wealth. Merchant bankers provide the following services
related to capital restructuring:
➢➢ 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.
5. Credit Syndication
Credit syndication refers to activities connected with credit procurement and
project financing, aimed at raising Indian and foreign currency loans from
banks and financial institutions, are collectively known as ‘credit
syndication’. The activities are:
➢➢ Estimating the total
cost of the project and drawing up a financing plan for the total project cost.
➢➢ Preparing loan application for financial assistance
from term lenders/financial institutions/banks, and monitoring their progress,
including pre-sanction negotiations.
➢➢ Selecting institutions
and banks for participation for financing.
6. 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. The activities and SEBI guidelines in
this regard are discussed later elaborately in this unit.
7. Portfolio Management
Portfolio management is making investment decisions in marketable securities
for maximizing returns with minimum risk. The services are
➢➢ 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.
➢➢ Undertaking review of
Provident fund investment, Trust investment, etc.
8. 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.
9. Acceptance Credit
and Bills Discounting ‘Acceptance credit and bill
discounting’ means activities relating to acceptance and discounting of bills
of exchange and advancement of loans on the strength of such instruments.
10. 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. The
activities relating to merger and acquisition are:
➢➢ 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.
11. Venture Capital
Financing Venture capital is the seed capital in the form of equity financing
for high-risk and high-reward projects.
12. 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.
13. 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. The role of merchant bankers in this regard is:
➢➢ 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.
14. Brokering Fixed
Deposits The merchant bankers render the following services
➢➢ Working out the
quantum of procurement of fund in the form of deposits from the public
➢➢ Drafting of
advertisement for inviting deposits and filing a copy of it with the registrar
of Companies for registration.
➢➢ Arranging payment of
interest amounts.
➢➢ Advising on the terms
and conditions of fixed deposits the company.
15. Mutual Funds
Mutual funds are institutions that mobilize the savings of innumerable
investors for the purpose of channeling them into productive investments in a
wide variety of corporate and other securities. Investment of the fund is in a
diversified portfolio of shares and debentures belonging to well managed and
growing companies.
SEBI Regulations
on merchant bankers
SEBI
has brought about a effective regulative measures for the purpose of
disciplining the functioning of the merchant bankers in India. The objective is
to ensure an era of regulated financial markets and thus streamline the
development of the capital market in India. The measures were introduced by the
SEBI in the year 1992. The measures were revised by SEBI in 1997.
SEBI
has made the following reforms for the merchant banker
1.
Multiple categories of merchant banker will be abolished and there will be only
one equity merchant banker.
2.
The merchant banker is allowed to perform underwriting activity. For performing
portfolio manager, the merchant banker has to seek separate registration from
SEBI.
3.
A merchant banker cannot undertake the function of a non-banking financial
company, such as accepting deposits, financing others’ business, etc.
4. A merchant banker
has to confine himself only to capital market activities.
SEBI (Merchant
Bankers) Regulations, 1992
This
regulation has five chapters pertaining to definitions, compulsory registration
with SEBI, renewal of certificate and fee payable to SEBI, capital adequacy
requirements, obligations and responsibilities, code of conduct, procedure for
inspection by SEBI, of documents, records and books of accounts, procedure in
case of default, i.e. the action to be taken against concerned merchant banker
(cancellation or suspension of registration by SEBI)
Classification
of Merchant Bankers
The
SEBI has classified merchant bankers under four categories for the purpose of registration.
•
Category-I can act as issue manager, advisor, consultant, underwriter and
portfolio manager.
•
Category-II can act as advisor, consultant, underwriter and portfolio manager.
•
Category-III can act as underwriter, advisor and consultant only.
• Category-IV can act
as consultant or advisor to the issue of capital.
Thus, only
Category-I merchant bankers could act as lead managers to an issue. However,
with effect from December 9, 1997, different categories of merchant bankers
were abolished and only Category-I merchant bankers are registered by the SEBI.
Capital
Adequacy Requirement
According
to the regulations, the capital adequacy requirement shall not be less than the
net worth of the person making the application for grant of registration. For
this purpose, the net worth shall be as follows:
Category Minimum Amount
Category I Rs.5, 00, 00,000
Category II Rs.50, 00,000
Category III Rs.20, 00,000
Category
IV Nil
Conditions for
Registration of Merchant Bankers (Rule 4)
The
Board may grant or renew a certificate to a merchant banker subject to the
following conditions, namely;
a.
the merchant banker, in case of any change in its status and constitution,
shall obtain
the
prior permission of the Board to carry on its activities as a merchant banker'
b.
he shall pay the amount of fees for registration or renewal, as the case may
be, in the
manner
provided in the regulations;
c.
he shall take adequate steps for redressal of grievances of the investors
within one month of the date of the receipt of the complaint and keep the Board
informed about the number, nature and other particulars of the complaints
received;
d.
he shall abide by the rules and regulations made under the Act in respect of
the activities carried on by the merchant banker.
e.
The certificate of registration or its renewal, as the case may be, issued
under rule 4
shall
be valid for a period of three years from the date of its issue to the applicant
as
per Rule 5.
Restriction on
Appointment of Lead Managers
The regulations
state that the number of lead merchant bankers (issue manager to the
issue) may not exceed in the case of any
issue of –
Size of the
issue No. of lead managers
(a) Less than
Rs. 50 crore Two
(b) Rs. 50 crore
but less than Rs. 100 crore Three
(c) Rs. Rs. 100
crore but less than Rs. 200 crore
Four
(d) Rs. 200
crore but less than Rs. 400 crore Five
(e) Above Rs. 400 crore Five
Essential
Requirements & Procedure for Registration as Merchant Banker (Regulation 3)
1.
An application by a person for grant of a certificate shall be made to the
Board in Form A given in the Schedule of the Regulations
2. The application under sub- regulation (1) shall
be made for any one of the following categories of the merchant banker namely:-
a. Category I, that is -
o
i. to carry on any activity of the issue
management, which will inter-alia
consist
of preparation of prospectus and other information relating to
the
issue, determining financial structure, tie-up of financiers and final
allotment
and refund of the subscription; and
o
ii. to act as adviser, consultant,
manager, underwriter, portfolio manager.
b. Category II, that is, to act as
adviser, consultant, co- manager, underwriter, portfolio manager;
o
c. Category III, that is to act as
underwriter, adviser, consultant to an issue;
o
d. Category IV, that is to act only as
adviser or consultant to an issue.
·
A) Notwithstanding anything contained in
this regulation, with effect from 9th December,1997,
I. an application under sub-regulation
(2) can be made only for carrying on the activities mentioned in clause (a)
therein, and
II. an applicant can carry on the
activity as underwriter only if he obtains separate
certificate of registration under the
provisions of Securities and Exchange Board of India (Underwriters)
Regulations, 1993, and
III. an applicant can carry on the
activity as portfolio manager only if he obtains separate certificate of
registration under the provisions of Securities and Exchange Board of India
(Portfolio Manager) Regulations, 1993.
Other guidelines
in the SEBI (Merchant Bankers) Regulations, 1992
SEBI has laid
down several other guidelines in that are a must to be complied with. These are
as follows:
·
Submission of the half-yearly unaudited
result of financial documents to SEBI
·
Compulsory Appointment of Compliance
Officer.
·
SEBI may send in an officer for
inspection of records, books, etc.
·
SEBI may collect an authorization fee
followed by annual or renewal fees.
·
There exists a minimum underwriting
obligation upon lead managers to the extent of 5% of the size of the issue or
of Rs. 25 lakh, whichever is lesser.
SEBI (Merchant
Bankers) (Amendment) Regulations, 1997
CRB
Scam in the capital market in 1997 led to the amendment in the SEBI (Merchant
Bankers) Regulations, 1992. CRB Capital Market, which was registered with SEBI
as category-I merchant banker and had also obtained license to act as
non-banking financial company from RBI collapsed in May 1997 due to bouncing of
cheques issued by the company in favour of its fixed deposit investors.
With
the enactment of SEBI (Merchant Bankers) Amendment Regulation in 1997, the
number of merchant bankers registered with SEBI also declined due to
segregation of fund based and fee based activities, tightening regulations,
increase in the requirement of net worth to rupees five crore and eligibility
of only body corporate to be the merchant bankers. The number of merchant
bankers declined from 802 in 1997-98 to 415 in 1998-99 and further to 186 in
1999-2000. From 2001-02 onward, the number of SEBI registered merchant bankers
varied from 145 to 150. On March 31, 2008, their number stood at 155 which
increased to 164 at the end of March 2010. As a result, there has been a
quantitative and qualitative change in merchant banking scenario in India and
only professional merchant bankers, committed to the profession remained in the
field due to tight control of SEBI.
After
the above amendments, measures like more transparency in disclosure requirements
in offer documents, submission of prospectus to SEBI for approval, size of the
issue, its firm allotment to different categories of investors, free pricing
through book building process and mandatory underwriting by lead managers have
been introduced.
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 fully 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 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.
·
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 Immense
opportunity to the merchant bankers for consultancy jobs.
However the 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 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
The management of the customers securities
Ø The management of the portfolio
Ø The management of projects and
counseling as well as appraisal
Ø The management of underwriting of
shares and debentures
Ø The circumvention of the syndication
of loans
Ø Management of the interest and
dividend etc.
Developments in Merchant Banking
Establishment:
- Setting up
of Banks Subsidiaries
- Re-organisation
of Private Firms
- Establishment
of SUA
- Securities
and Exchange Board of India (SEBI)
- Discount
and Finance House of India (DFHI)
- Credit
Rating Information Services of India Ltd. (CRISIL)
- Stock-Holding
Corporation of India Ltd. (SHC)
Merchant Banking Establishment: Development # 1.
Setting up
of Banks Subsidiaries:
In
order to meet the growing demand for broad-based financial services from the
corporate sector more effectively, the merchant banking divisions of the
nationalised Banks have started forming independent subsidiaries. These
subsidiaries offer more specialised services with professional expertise and
skills.
SBI
Capital Markets Ltd., was incorporated as the first such subsidiary of SBI on
2nd July, 1986. Then Canbank Financial Services Ltd. was set up as wholly owned
subsidiary of Canara Bank in 1987. PNB Capital Services Ltd. was promoted by
PNB during mid-1988. Many more subsidiaries are being set up by other
nationalised banks.
Merchant Banking Establishment: Recent Devleopments
Re-organisation
of Private Firms:
Expecting
tough competition from growing number of merchant banking subsidiary companies
of nationalised banks, private merchant bankers have also started reorganising
their activities e.g., J.M. Financial & Investment Consultancy Ltd., 20th
Century Finance Corporation Lid., LKP Merchant Financing Ltd. etc. are some of
the private sector firms of merchant bankers who have taken steps to reorganise
their activities.
Merchant Banking Establishment: Development # 3.
Establishment
of SUA:
In
order to educate and protect the interest of investors, to provide information
about new issues of capital market, to evolve a code of conduct for
underwriters and to render legal and other services to members and public, the Stockbroker
Underwriters Association (SUA) was established in 1984. SUA works in
co-ordination with merchant bankers and takes steps for promoting the
activities of capital market.
Merchant Banking Establishment: Development # 4.
Securities and
Exchange Board of India (SEBI):
To
develop and regulate securities market, investor protection and to formulate
rules and guidelines for regulation of securities market, the Central
Government constituted Securities and Exchange Board of India on April 4, 1988.
The
Board carries out all functions as may be delegated to the Board/Chairman by
Central Government for the development and regulation of securities market.
Persons dealing in security market, merchant bankers, underwriters,
sub-brokers, portfolio managers, mutual funds etc. have to seek authorisation
from the Board.
Merchant Banking Establishment: Development # 5.
Discount and
Finance House of India (DFHI):
DFHI
was incorporated as a company under the Companies Act, 1956 with an authorised
and paid up capital of Rs. 100 crores. Out of this, Rs. 51 crores has been
contributed by RBI, Rs. 16 crores by financial institutions and 33 crores by
public sector banks.
It
would also have lines of credit from public sector banks; refinance facility
from the Reserve Bank of India in order to meet the working capital
requirements. DFHI aims at providing liquidity in money market as it deals
mainly in commercial bills.
Merchant Banking Establishment: Development # 6.
Credit
Rating Information Services of India Ltd. (CRISIL):
CRISIL
has been set up in 1987 to provide help to investors, merchant bankers,
underwriters, brokers, banks and financial institutions etc. CRISIL rates
various types of instruments such as debt, equity and fixed return securities
offered to the public. It helps the investors in taking investment decisions.
Merchant Banking Establishment: Development # 7.
Stock-Holding
Corporation of India Ltd. (SHC):
SHC
was set up in 1986 by the All India Financial Institutions to take care of safe
custody, delivery of shares and collection of sale proceeds of the securities.
The setting up of SHC is bound to affect the capital market in future.
References:
1. www.pondiuni.edu.in/.../Merchant%20Banking%20and%20Financial%20servicest200...
2. https://www.slideshare.net/taher666/merchant-banking-guidelines
3.
shodhganga.inflibnet.ac.in/jspui/bitstream/10603/155244/9/09_chapter%203.pdf
6. K.Ravichandran, “Merchant Banking & Financial Services”, Himalaya
Publishing House.
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