Unit 2: Merchant Banking

Introduction: Merchant banking is a professional service provided by the merchant

banks to their customers considering their financial needs, for adequate
consideration in the form of fee. Merchant banks are banks that conduct fundraising,
financial advising and loan services to large corporations.
These banks are experts in international trade, which makes them experts in dealing
with large corporations and industries. Merchant banking provides funds to the
multinational businesses and large business entities in the country which helps to
boost the country’s economic strength. Merchant banks do not provide services to
the general public; their services are limited to business entities and large business
corporations.

Merchant banker is a person who provides assistance for the subscription of

securities. The merchant banker plays an important role and carries a lot of
responsibilities like, private placement of securities, managing public issue of
securities, stock broking, international financial advisory services, etc.
The term merchant bank refers to a financial institution that conducts underwriting,
loan services, financial advising, and fundraising services for large corporations
and high-net-worth individuals (HWNIs).

Merchant banks are experts in international trade, which makes them specialists in
dealing with multinational corporations. Unlike retail or commercial banks,
merchant banks do not provide financial services to the general public. Some of the
largest merchant banks in the world include J.P. Morgan Chase, Goldman Sachs,
and Citigroup.

Merchant banks are financial institutions and companies that deal with
international finance for multinational corporations. These banks differ from other
types of financial institutions. As such, they don't deal with the general public. They
don't provide everyday financial services such as checking accounts, bill payments,
or basic investments and don't take deposits or make withdrawals for their
customers.

Instead, merchant banks traditionally perform international financing and

underwriting including real estate, trade finance, and foreign investment. They may
be involved in issuing letters of credit (LOCs) and in the transfer of funds. They
may also consult on trades and trading technology. Merchant banks use more
creative forms of financing. They typically work with companies that may not be
large enough to raise funds from the public through an initial public offering (IPO).
Merchant banks help corporations issue securities through private placement,
which require less regulatory disclosure and are sold to sophisticated investors.

Merchant Banks vs. Investment Banks

There's a very fine line between merchant and investment banks. Investment banks
underwrite and sell securities to the general public through IPOs. The bank’s clients
are large corporations that are willing to invest the time and money necessary to
register securities for sale to the public. Investment banks also provide advisory
services to companies about mergers and acquisitions (M&A) and provide
investment research to clients.

While merchant banks are fee-based, investment banks have a two-fold income
structure. They may collect fees based on the advisory services they provide to their
clients, but may also be fund-based, meaning they can
earn income from interest and other leases. Regardless of how a company sells
securities, there are some minimum disclosure requirements to inform investors.
Both IPOs and private placements require a company audit by an external certified
public accountant (CPA) firm, which provides an opinion on the financial
statements. Audited financial statements must include several years of financial
data along with disclosures. Potential investors can use this information about the
risks and potential rewards of buying the securities.

Merchant Banking: Origin, Meaning and Evolution

Origin of Merchant Banking:
The origin of merchant banking can be traced back to 13th century when a few
family owned and managed firms engaged in sale and purchase of commodities
were also found to be engaged in banking activity. And firms not only acted as
bankers to the kings of European States, financed coastal trade but also borne
exchange risk.

In order to earn profits, they invested their funds where they expected higher
returns despite high degree of risk involved. They charged very high rates of interest
for financing highly risky projects. In turn, they suffered heavy losses and had to
close down. Some of them restarted the same activity after gaining financial
strength. Thus merchant Banking survived and continued during the 13th century.

Later, merchant Bankers were known as “commission agents” who handled the
coastal trade on commission basis and provided finance to the owners or supplier of
goods. They made investments in goods manufactured by sellers and made huge
profits. They also financed continental wars. The sole objective of these merchant
bankers was profit maximisation by making investments in risky projects.

Then came the industrial revolution in England. The scope of international trade
widened to include North America and other continents. Many people were
attracted to take up merchant banking activities to transfer the machine made goods
from European nations to other nations and colonies and bringing raw material from
other nations and colonies to Europe and to finance such trade.

During the early nineteenth century, merchants indulged in overseas trade and
earned good reputation. They accepted bills of the lesser reputed traders by
guaranteeing the holder to receive full payment on due date. This practice of
accepting bills has grown over the years with expansion in trade and has become
part of the merchant banking activity.

Meaning of Merchant Banking:

Dictionary meaning of merchant banking points at merchant bank as an organisation
that underwrites securities for corporations advises such clients on mergers and is
involved in the ownership of commercial ventures.
The term ‘merchant banking’ has been used differently in different parts of the
world. While in UK, a merchant banking refers to the ‘accepting and issuing houses’,
in USA it is known as ‘investment banking’.

The word merchant banking has been so widely used that sometimes, it is applied to
neither banks who are not merchants, sometimes to merchants who are not banks
and sometimes to those intermediaries who are neither merchants nor banks.
In UK, the term merchant banking originated from merchants in London who
started financing of foreign trade through acceptance of bills. After sometimes, the
merchants began to help governments of underdeveloped countries in raising long-
term funds through floating of bonds in the London Money Market.

In 1914, these merchants formed an association which is now called ‘Merchant

Banking and Securities House Association’. The merchant banks then extended their
activity to the domestic business of loan syndication both for short-term as well as
long-term purposes. Today, these banks provide a variety of services, such as issue
management, portfolio management, asset management, underwriting of new
issues, act as registrars, share transfer agents, trustees, and provide leasing, project
consultation, advice on mergers and amalgamations, Euro credits, etc.
In USA, investment banking is concerned with ‘garnering savings and directing the
flow of funds to business enterprises. ‘Investment bankers are primarily the
intermediaries who provide specialised service in the marketing of securities. These
banks do not invest their own funds in securities for a long-term.
They simply buy the securities in bulk with a purpose of selling the same shortly to
the investors at large. They also provide other services involved in marketing of
securities including underwriting of capital issues.

Thus, merchant banking can be defined as a non-banking financial activity

resembling banking, originated, grown and sustained in Europe, got enriched under
American influence and now being performed all over the world by both banking
and non-banking institutions.

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 a separate merchant banking Division in 1972. Since
then, a number of other banks, financial institutions and other organisations are also
engaged in providing merchant banking services.
But merchant banks in India have been primarily operating as issue houses than full-
fledged merchant banks as in other countries.
In view of the above, we can define merchant bank 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 and project counselling, etc.

It would also be necessary to make a distinction between merchant banking and

commercial banking for a better understanding of the nature of merchant-banking.
The merchant banks mainly offer financial services for a fee, while commercial banks
accept deposits and grant loans.
The merchants do not act as repositories for savings of the individuals. Even when
merchant banks engage themselves in fund-based activities and act as commercial
banks, they function only as whole-sale bankers for a few selected industrial houses
and not as retail banks for the general public.

The merchant banks are also different from the dealers, traders and brokers of
securities. The merchant banks mainly deal in new issues while the dealers, traders
and brokers deal mainly in secondary market.
Evolution of Merchant Banking:
‘Hundi’ was the main instrument of credit used by indigenous bankers before the
coming of western merchants in India. It was in 1813, when merchants came from
European countries to trade with India. Agency houses were set up by merchant
bankers based at London.
These agency houses raised deposits at cheaper rates of interest viz. 4% to 5% from
their home and made advances to native merchants at 10% to 12% and in addition
they charged high commissions on every kind of service provided to the clients.
Easy availability of money at the spot from the agency houses had completely
eliminated the role of acceptance house or the merchant banking in India. It was
only with the entrance of East India Company that restrictions were put on
operation of agency houses.

During 19th century, foreign merchant bankers operated in India through ‘East India
House’. East India House members moved into real estate business viz. tea and
rubber plantation, cotton mills etc. They faced tough competition from Persian
finance houses that were willing to grant credit to the trade with India.
It was in 1860 when the merchant’s interest in joint stock banking started growing
and with their own investments they floated joint stock banks. Some new banks
were founded which included Orient Bank in 1845, Chartered Bank of India and
Asia in 1853, Chartered Mercantile Bank of India, London & China in 1857 and so on.
These banks financed the trade transactions. The control and management of these
banks lied with managing agents.

The managing agency system enabled a single firm to look after a number of firms in
complementary industries. With the result, the banking industry flourished in India
on the support of London based merchant bankers and the merchants who had full
control on the Board. Telegraphic transfers improved banking links and the
business.
The managing agents acted as merchants banks and performed functions of
promoting financing and marketing of securities. They developed strong roots in
depth of India’s economic, commercial and industrial structure. They served the
industry, trade and commerce as the merchant bankers were doing in UK and
European countries or the investment bankers were doing in USA.

Managing agents acquired large share of investible capital initially and later on
dispose off the shares once the company gets established. In other words, Managing
Agency Houses acted as issue house for securities. It was found that 600 industrial
establishments were managed under the managing agency system in 1951.
Few Indian managing agency houses were also established in the pre-World War II
who started as family business later on, converted into partnership and public
limited companies.

Examples of prominent managing agency houses included:

1. Tatas,
2. Birlas,
3. Dalmias,
4. Singhanias,
5. Thapars,
6. Narangs etc.

These managing houses had necessary skills and expertise which helped in the
development of projects. Functions performed include:
(i) Investing funds as venture capital in promoting the enterprise.
(ii) Assist the enterprises in procuring finance by guaranteeing the bank loans and
advances.
(iii) Raising public deposits.
(iv) Enter into negotiation with foreign capitalists.

Thus, they acted as intermediaries of investment by holding the shares of new

companies, motivating people to invest and keep deposits for investment.
In Post-World War II, Amendments in the Companies Act, 1956 led to the
streamlining of the procedure for capital issues and facilitated the growth of capital
market in India.

In order to speed up the pace of economic development, efforts were made to

channelize the household savings into investment in industry and trade. Significant
amendments were made in Companies Act, Capital Issues (Control) Act, Banking
Companies Act to regulate the growth of business enterprises.

In 1948, Industrial Finance Corporation of India (IFCI) was set up to provide long
and medium term finance to industrial enterprises and underwrite new securities.
At state level, State Financial Corporations were also established in 1951 to provide
financial assistance to industry.

In 1955, the Industrial Credit and Investment Corporation of India (ICICI) were set
up to provide developmental finance to industrial concerns. ICICI makes investment
in equity by way of direct subscription and also underwrites shares and debentures.
Many more financial and investment institutions emerged at national and state
levels e.g. LIC, RCI (Refinance Corporation for Industry), Industrial Development
Bank of India (IDBI), Unit Trust of India (UTI), State Industrial Development
Corporation (SIDC) etc. over the years.

The basic objectives of setting up all these institutions was to boost industrial sector,
improve capital market, make finance easily available and support the investment
climate in the country. These institutions also underwrite the capital issues besides
lending support of broking houses.

The need for merchant banking services was widely felt. It was during this period
that National & Grindlays Bank (now Grindlays Bank) took a lead by taking up
merchant banking activities and announced inauguration of its “Merchant Banking
Division” in January, 1969.

The Evolution of Merchant Banking in the Indian Scenario:

With the advent of the industrial boom in India, there has been a growing need of
Merchant Bankers. Businesses often require specialised banking services which are
concentrated in nature. Hence, commercial bankers set up their merchant
banking subsidiaries to cater financial services for the corporate sector.
The first Merchant Banker was set up in 1967 by Grindlay’s Bank, after that, there
were a number of merchant banks incorporated. There are multiple factors that have
accelerated the importance of Merchant Banking in the country. These could be
enlisted in the following pointers:

Globalization of Economy: Post the 1991 reforms, the Indian economy opened its
gates to overseas organizations. This encouraged funding coming in from abroad
and thereby pivoting the importance of Merchant Bankers.

Increased Competition: With favourable business options and lucrative market

scenarios, the Indian corporate buckled up their games and were on an expansion
spree. This encouraged the Merchant Bankers to play substantial roles with their
specialized services towards Corporate.

Change in Consumer Trends: With multiple foreign players setting shop on Indian
soil, there has been a boost in the quality of products that were being offered to the
Indian masses. This in turn transformed the strategies of the Indian counterparts.
Financial products and instruments became more prominent in the prevailing
environments.
Government Reforms: With a reduction in Government intervention and
privatization, there was a boost in the private corporate sector. Also, increasing the
limits on investments and reduction in direct interventions proved to be a lucrative
proposition of foreign players.

These factors, along with the enhancement of the ease of doing business have paved
the way for Merchant Bankers to gain a considerable position. In addition, SEBI has
served to be an effective watchdog for merchant banking activities.

Developments in Merchant Banking Establishment in India

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: Development # 2.

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.

Scope of Merchant Banking

The various scope / Features of merchant banking are follows:
1) Growth of New Issues Market:
As the India market is among the largest growing market so the various domestic
and foreign investors are entering the market for doing business. The various types’
public and private problems are also arising.
 2) Entry of Foreign Institutional Investment:
The globalization in the Indian capital market is permission given to the foreign
institutional invest in India as they require the suggestion from merchant banks for
the business in India. The various number of joint venture also needs different types
of services of Merchant Banks.

3) Changing Policy of Foreign Investment:

There is liberalization in the policy making. The foreign investments need the
services Merchant Banks for project appraisal, financial management, financial re-
structuring, etc.

4) Development of Debt Market:

The debt instrument helps in raising large amount of capital for the business. The
making of debts market is also done by merchant banks.

5) Innovations in Financial Instruments:

The innovative financial instrument has increased. The merchant banks are the
origin of the innovative type of financial instruments.

6) Corporate Re-Structuring:
The liberalization and globalization are the reason for the capital structuring. The
presence of competition in f corporate sector is the reason for corporate structuring.
The companies also adopt corporate re-structuring if they want to change their
strategies, structure and working.

Merchant Bankers in India

There are more than 130 merchant bankers who are registered with SEBI. Here is the
list of some significant ones:
Public Sector Merchant Bankers
▪ State Bank of Bikaner and Jaipur
▪ Karur Vysya Bank
▪ SBI Capital markets Ltd.
▪ IFCI Financial Services Ltd.
▪ Punjab National Bank
▪ Bank of Maharashtra
Private Sector Merchant Bankers
▪ Yes, Bank Ltd.
▪ ICICI Securities Ltd.
▪ Kotak Mahindra Capital Company Ltd.
▪ Axis Bank Ltd.
▪ Tata Capital Markets Ltd.
▪ Reliance Securities Ltd.
▪ Bajaj Capital Ltd.
▪ ICICI Bank Ltd.

Foreign Players in Merchant Banking

▪ FedEx Securities Ltd.
▪ Goldman Sachs (India) Securities Pvt. Ltd.
▪ DSP Merrill Lynch Ltd.
▪ Deutsche Equities India Private Limited
▪ Morgan Stanley India Company Pvt. Ltd.
▪ Citigroup Global Markets India Pvt. Ltd.
▪ Barclays Securities (India) Pvt. Ltd.
▪ Barclays Bank Plc
▪ Deutsche Bank

Classification of Merchant Bankers

Merchant bankers have been divided into four categories for registration-
1. Category 1: The role of merchant bankers in this category is to act as a consultant,
advisor, issue manager, portfolio manager, and underwriter.
2. Category 2: Merchant Bankers in this category act as a consultant, advisor,
portfolio manager, and underwriter. They cannot be an issue manager of their
own but can act as co-manager.
3. Category 3: In this category, merchant bankers cannot do activities related to
portfolio management, plus they can neither take issue management of their own
nor act as a co-manager. They can act as a consultant, advisor, and underwriter.
4. Category 4: If the merchant banker lies in this category, then they can just act as a
consultant or advisor to an issue of capital.

Regulations for Merchant Banking in India

SEBI was established in 1992 as a regulatory body for protecting the interests of
investors in the securities market. They made a few rules and guidelines for
merchant bankers so that there is no monopoly, plus the interest of the customers is
not harmed.
They are called Securities Exchange Board of India (SEBI) Regulations, 1992. These
guidelines are amended regularly as per the dynamic market conditions:

Rules and regulations for merchant banks in India have been classified into five
chapters and four schedules:
1. The first chapter comprises the definitions and meanings of numerous terms that
are frequently used in merchant banking.
2. In the second chapter, you would locate the Registration and Certification
of Merchant Bankers in India. It also holds several Operational Capabilities and
Capital Requirements required to be finished for registering as a merchant banker.
3. The third chapter deals with the General Obligations and Responsibilities that the
merchant banker would have to undertake. Some of the major things are the
General Code of Conduct, disclosure of information, auditing of accounts, and other
important operating guidelines.
4. The fourth chapter, which comprises the right of the Board to examine the
merchant bankers and the actions that can be taken based on the report.
5. In the fifth chapter, you will find the cases of defaults and the actions that are
taken if anything wrong is done or if the guidelines are not followed.
This was about the chapters; the schedule by SEBI comprises of the format of forms
and reports, which are substantial and also states the fees that are required to be
paid for different purposes.

One of the most important things to remember is that no organization would be able
to become a merchant banker until and unless they get a certificate of registration
from SEBI. Plus, he must get himself registered under these regulations if they want
to persevere any of the merchant banker activities.

For getting the certificate of registration, you would have to apply through the form
and complete two sets of norms, which are:
▪ Operational capabilities
▪ Capital Adequacy norms
1. Operational capabilities: As per operational capabilities, merchant bankers are
divided as per their roles.
2. Capital Adequacy Norms: For registration of the different categories of a
merchant banker, SEBI has laid a few norms. Capital adequacy is calculated by
taking capital contributed to the business plus free reserves.

Capital Adequacy Norms by SEBI:

Category of Merchant
Minimum Net Worth
Banker
Category 1 Rs. 5 Crore
Category 2 Rs. 50 Lakhs
Category 3 Rs. 20 Lakhs
Category 4 Nil
Fee- As per SEBI Amendment Regulations, each merchant banker would have to pay
a registration fee of Rs. 5 lakh when getting a certificate from the Board. The
merchant banker would have to pay the fee within 15 days of the notice from the
court.
Also, a merchant banker to keep the registration in force would have to pay a
renewal fee of Rs. 2.5 lakhs every three years from the fourth year from the date of
actual registration.

Organizational set up of merchant bankers in India:

In India a common organizational set up of merchant bankers to operate is in the
form of divisions of Indian and Foreign banks and financial institutions, subsidiary
companies established by bankers like SBI, Canada Bank, Punjab National Bank,
Bank of India, etc. some firms are also organized by financial and technical
consultants and professionals. Securities and exchanges Board of India (SEBI) has
divided the merchant bankers into four categories based on their capital adequacy.
Each category is authorized to perform certain functions. From the point of
Organizational set up India’s merchant banking organizations can be categorized
into 4 groups on the basis of their linkage with parent activity. They are:

a) Institutional Base: - Where merchant banks function as an independent wing or

as subsidiary of various Private/ Central Governments/State Governments
Financial institutions. Most of the financial institutions in India are in public sector
and therefore such set up plays a role on the lines of governmental priorities and
policies.

b) Banker Base: - These merchant bankers function as division/ subsidiary of

banking organization. The parent banks are either nationalized commercial banks or
the foreign banks operating in India. These organizations have brought
professionalism in merchant banking sector and they help their parent organization
to make a presence in capital market.

c) Broker Base:-In the recent past there has been an inflow of Qualified and
professionally skilled brokers in various Stock Exchanges of India. These brokers
undertake merchant banking related operating also like providing investment and
portfolio management services.

d) Private Base: - These merchant banking firms are originated in private sectors.
These organizations are the outcome of opportunities and scope in merchant
banking business and they are providing skill oriented specialized services to their
clients. Some foreign merchant bankers are also entering either independently or
through some collaboration with their Indian counterparts. Private Sectors merchant
banking firms have come up either as sole proprietorship, partnership, private
limited or public limited companies. Many of these firms were in existence for quite
some time before they added a new activity in the form of merchant banking
services by opening new division on the lines of commercial banks and All India
Financial Institution (AIFI).

Here are a few points that you should review before choosing a merchant banker-
▪ Competence to examine and determine
▪ Plentiful of knowledge
▪ The capability of building a relationship
▪ Creative approach
▪ Contacts
▪ Honesty and transparency
▪ Capital Market facilities
▪ Helpfulness and friendliness
▪ Attitude towards problem-Solving

Merchant Bank vs. Commercial Bank

It is paramount to understand the difference between the two banks as it will make it
easier for you to understand the merchant banking in India as compared to the
other banks-
1. Merchant banks work primarily for corporate firms, whereas commercial banks
cater to the needs of individual customers.
2. Merchant Banks are always open to take risks, but commercial banks usually
avert taking any kind of risk.
3. In merchant banks, everyone cannot open an account, whereas commercial banks
are open for everyone.
4. Merchant banks are management-oriented, but commercial banks are asset-
oriented.
5. Merchant banks usually do business with equities, but commercial banks usually
buy and sell debt-related finance such as loan approvals, credit proposals, etc.
6. The major activities done by merchant bankers are underwriting, portfolio
management, consultant, and advisor, whereas commercial banks mostly play the
role of financers only.
7. Merchant banks are more related to the primary market and the commercial
banks to the secondary market.
Difference between Merchant banking and Investment banking
A lot of people get confused between Merchant and Investment banking; therefore,
below is the difference between them so that it makes it easy for you to understand
their roles and interests-
1. Merchant banks deal with international financing activities; on the contrary,
Investment banks usually deal with underwriting and issuance of securities
2. Merchant banks mostly work with medium-sized organizations, whereas
investment banks deal with large companies
3. The work of a Merchant Banker is associated with trading finance, real estate
investment, and corporate investment. Investment banking work with established
enterprises and helps them in getting long-term capital requirement by becoming a
mediator between the investors and the organization
4. All the merchant banks offer trade facilities to their clients, but there are very less
investment banks that offer trade financing facilities.
5. A merchant bank is an institute that is both fee and fund-based as it offers
custodial, banking, and advisory service to its customers. On the other hand, an
investment bank is just fee-based as it earns money from services offered, lease
rentals, and interest.

Merchant Banker and Management of Public Issues:

SEBI regulation 1992 defines ‘merchant banker’ 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 service in relation to such issue management. A
merchant banker provides various services such as Promotional activities, Credit
syndication, Project counselling, and Portfolio management, etc.

However, one of the primary functions of the merchant banker is issue management,
be it IPO, FPO, or right issue. The purpose of this article is to practically analyze the
role of a merchant banker in IPO management right from due diligence aspect to
allotment/refund of the securities while also discussing applicable provision of
SEBI(ICDR) Regulations,2018 and relevant notifications or circulars by SEBI. The
Roles and obligation of the merchant banker can be classified into three groups- Pre-
issue role Post issue role Operational guidelines prescribed by SEBI

Pre-issue role of Merchant Banker in IPO Management The pre-issue stage is the
stage before issuing the securities to the subs. The pre-issue role and obligation of
the merchant banker generally involve activities such as due diligence, requisite fee,
submission of documents, the appointment of intermediaries, underwriting, etc.
Some of the major activities done by the merchant banker in relation to IPO
management at this stage are- ♦ Due Diligence of the issuer– Regulation 24 of SEBI
(ICDR) Regulation, 2018 mandate that lead manager shall exercise due diligence and
satisfy themselves about all aspects of the issue including the veracity and adequacy
of disclosure in the draft offer document and the offer document which means
merchant banker shall ensure that the framework provided by the SEBI shall be
complied with and implemented in draft offer documents.
A checklist that may be useful for conducting pre-issue due diligence is-
• Check whether the issuer fulfils the eligibility criteria relating to a minimum
tangible asset, Net worth, and average operating profit limited mentioned in
regulation 6 of ICDR Regulations.
• Check whether the issuer is not ineligible to make an IPO under regulation 5
of ICDR Regulations.
• Check whether the issuer satisfies the general conditions for IPO mentioned
in Regulation 7 of ICDR regulation.
• Check whether the issuer has made all the material disclosure in draft offer
documents and verifying the content of offer documents.
• Check whether the minimum promoter contribution requirement mentioned
in Regulation 14 is fulfilled Merchant banker is obligated to submit a due
diligence certificate along with a Draft offer document to SEBI.

♦ Appointment of intermediaries- Regulation 23 of the ICDR Regulation imposes the

duty to appoint merchant bankers and other intermediaries with merchant banker
consultation on the issuer. However, practically it is the merchant who gets the
issuer in touch with other intermediaries. This regulation also imposes an obligation
on the merchant banker to assess the capability and independence of the
intermediaries. As per ICDR Regulation, some of the intermediaries involved in an
IPO are- Merchant banker Underwriters Banker to the issue Registrar to the issue
Compliance officer Depositories Monitoring agency if issue size exceeds 100 crore.

♦ Filling draft offer document with requisite document In accordance with

Regulation 25 of the ICDR Regulation and other applicable guidelines, the lead
manager along with a draft offer letter shall file the following documents with SEBI-
Due diligence certificate as per schedule V Memorandum of Understanding entered
between the issuer and the merchant banker In case a public or rights issue is
managed by more than one merchant banker the rights, obligations, and
responsibilities of each merchant banker shall be demarcated as specified in
Schedule II.

Details of Promoter of the issuer and list of the promoter group an undertaking to
the Board by the issuer to the effect that transactions in securities by the `promoter’
the ‘promoter group’ and the immediate relatives of the `promoters during the
period between the date of filing the offer documents with the Registrar of
Companies or Stock Exchange as the case may be and the date of closure of the issue
shall be reported to the Stock exchanges concerned within 24 hours of the
transaction(s).
♦ Making public the offer document and advertisement of the issue As per
regulation 26 of ICDR merchant banker should ensure that draft offer letter is
available for the public on SEBI and stock exchange website for at least 21 days from
the date of filling. A public announcement is also needed to be made within 2 days
of the filling of the offer document in an English and Hindi national newspaper
inviting the public to give their comments to the SEBI. A pre-issue advertisement is
also required to be made as per regulation 43 after registering the prospectus with
ROC containing the disclosure specified in part A of Schedule X. After 21 days of
filing the draft offer document, the merchant banker shall file a statement showing
the complaints received by the public and highlights of the proposed amendments to
SEBI.

♦ setting up mandatory collection centre and authorized collection agents As per

regulation 23 read with schedule XII, a merchant banker needs to ensure that the
issuer designates a collection centre in Mumbai, Kolkata, Delhi, Chennai, and at such
place where the recognized stock exchange is located. The issuer company can also
appoint authorized collection agents in consultation with the Lead Merchant Banker
subject to necessary disclosures including the names and addresses of such agents
made in the offer document.

Calculating requisite fee and ensuring legal compliances It is the duty of the
merchant banker to calculate the required fee needed to be paid with the draft offer
document mentioned in Schedule III and ensure that the issue complies with all the
relevant legal compliance Post-issue role of Merchant Banker in IPO Management
The post-issue obligation is the stage after the securities are issued to the subscribers.
The major post-issue obligations relate to association with allotment procedure, post-
issue monitoring reports, redressal of investor grievances and coordination with
intermediaries, etc.

This includes-
Allotment procedure and basis of allotment Merchant banker along with MD of the
recognized stock exchange and registrar of the issue is responsible to ensure that the
basis of allotment is finalized in a fair and proper manner in accordance with
Regulation 49 of ICDR Regulations. The allotment of such shares should be in such a
way that the minimum allotment would be equal to the minimum application size as
determined and disclosed in the offer document.

♦ Post issue monitoring report the merchant banker in case of IPO shall submit a
post-issue monitoring report on the 3rd day from the date of closure of the
subscription of the issue.
 ♦ Post-issue advertisement Regulation 51 of ICDR regulation impose a duty on
merchant banker to ensure that a post-issue advertisement giving details relating to
subscription, the basis of allotment, value, and percentage of all applicants, date of
filing of listing application, etc is released within ten days from the date of various
activities in at least one nationwide English and Hindi newspaper.
Redressal of investors’ grievance The Post -issue Lead Merchant Banker shall
actively associate himself with post-issue activities namely, allotment, refund and
despatch and shall regularly monitor redressal of investor grievances arising there
from.

♦ Coordination with intermediaries It includes coordinating with various agencies

connected with the post-issue activity such as registrar to issue, bankers to the issue,
bankers to the issue, self-certified banks, and underwriter.

♦ Certificate regarding the realization of stock investors and other requirement The
Post-Issue Lead Merchant Banker shall submit within two weeks from the date of
allotment, a Certificate to the Board certifying that the stock invests on the basis of
which allotment was finalized, has been realized Operational guidelines prescribed
by SEBI The compliance requirements of merchant banker(s) in relation to
operational guidelines cover submission of the draft and final offer documents,
instruction on post-obligations, issue of penalty points, and so on. These guidelines
can be accessed on the website of SEBI.

Functions of Merchant Banking

Role of merchant banking / the important activities undertaken by merchant banks
and various services provided by them are as follows:
1. Underwriter:
Underwriters may be defined as a group of financial institutions/entities, which give
an assurance not only for getting an issue fully subscribed, but also to absorb the
balance securities, in case of failure of the issue to get fully subscribed by the public.
Underwriters are duly paid for the services rendered by them in the form of
commission as agreed upon between the security issuer and the underwriter, which
are subject to various terms and conditions stipulated under the Companies Act.
Underwriting services are provided by the commercial banks, term lending
institutions, investment companies, brokers, etc.

In the overall development of the primary market, the role played by underwriters is
very crucial, although underwriting per-se is not mandatory for an issuer. Before
coming out with the issue, the issuer appoints underwriter/s, with due discussion
with the merchant banker/lead manager. The details with regard to underwriters
are mentioned in the prospectus issued by the company.
2) Banker:
Bankers are yet another constituent of the primary market, who performs an
important role in the market function and its development. 'Bankers to an issue are
the bankers, who are responsible for the acceptance of application money, from the
prospective investors, for the issue of securities. They also take the responsibility for
the refund of application money to those applicants, whom no security could be
allotted.

3) Broker:
Brokers are individuals/entities who are primarily engaged in the business of
obtaining subscriptions to an issue by approaching the prospective investors and
convincing them suitably. Appointment of brokers by an issuing company is not
mandatory under the existing law. They are at liberty to appoint as many brokers as
they deem fit, or not appoint any broker, if they decide to do so. Brokers to an issue
are required to give their willingness by way of a consent letter, copy/copies of
which need to be filed, along with the prospectus, to the Registrar of Companies
(RoC).

The broker/s. appointed by the issuer/manager of the issue manages the

preliminary distribution of securities in a coordinated manner. They attempt to
secure as much direct subscription as possible from a wide range of potential
investors. The maximum brokerage payable in respect of all the public issues of
industrial securities is @1.5% irrespective of the fact whether the issue is
underwritten or not. The maximum brokerage payable in respect of the listed
companies, on private placement basis is @0.5%.

As far as the promoters' quota is concerned (including the amount taken up by the
directors, their friends and employees, and in respect of rights issue taken
by/renounced by the existing shareholders), no brokerage is allowed to be paid.
Similarly, no brokerage is permitted to be paid i in respect of the following cases :
• If the applications are made by the institutions/banks as their part of
underwriting obligations.
• If, as a result of under-subscription of the issue, amounts are devolved on the
underwriters.

4) Registrar:
The registrar to an issue is essentially an intermediary in the primary market, who
undertakes the following activities:
• Collection of applications along with the application money from the investors.
• Maintenance of a proper record of the applications/monies received from the
investors.
• Maintenance of a proper record of monies paid to the seller of the securities.
• Advising the issuers in taking decision with regard to the basis of allotment of
securities in consultation with the stock exchanges.
• Finalization of the allotment of securities and issuance of allotment letters.
• Other processes associated with the issue of capital, e.g. refund order certificates
and other related documents.

5) Debenture Trustee:
They are the trustees specifically appointed and entrusted with the responsibility of
keeping a watch on and protecting the interests of debenture holders. Their
appointment is made by the issuer of the debenture before the actual issue.
Debenture trustees are required to get themselves registered as such with the SEBI,
before they get any assignment as debenture trustees.

6) Portfolio Manager:
The term 'portfolio' refers to the total securities held by an individual/entity.
Portfolio managers, as the nomenclature suggests, are the managers of portfolios of
their clients, by the virtue of a contract entered into between them and their clients.
Their activities are governed by the terms and conditions of the said contract,
Portfolio managers are generally authorized by their clients to manage, in a judicious
manner, the securities/funds held by them under their portfolio.

Services of Merchant Banks

Merchant banks offer a wide range of services to their clients, some of which have
been discussed in the following points:
1) Corporate Counselling: Corporate counselling one of the fundamental services
offered by a merchant bank. Due to abundant demand for this service from each and
every industrial unit, whether new or old, the scope for this activity is unlimited.
Corporate counselling includes a number of merchant banking activities, e.g. project
counselling, project management, loan syndication, working capital management,
capital re-structuring, public issue management, fixed deposit, lease financing etc.

2) Project Counselling: Project counselling is one of the constituents of corporate

counselling activity undertaken by the merchant banks. The services associated with
project counselling pertain to project finance, including the preparation of project
reports, cost of f the project and management of the financing design. Appraisals of
various projects are carried out on the basis of their location, marketing/technical
feasibility, financial viability, etc.

3) Loan Syndication:
Under the loan syndication, a loan is arranged by a merchant bank for its client, who
may be a big corporate, Government department, or a local authority. To start with,
the merchant bank has to arrive at/finalize the project cost, which is followed by the
next step. I.e designing the capital structure, deciding the level of the promoters'
stake/contribution in the project, and estimating the amount of term loan to be
raised from the financial institutions. In this connection, it is relevant to ensure that
various guidelines and other requirements pertaining to the financing of industrial
projects are meticulously adhered to. A comprehensive service, covering all the
activities associated with the loan syndication, is extended by the merchant bankers.
4) Management of Capital Issues:
Management of capital issue involves a number of activities, which go much beyond
simply selling of various securities, viz. equity shares, preference shares and
debentures or bonds to the investors. Some of such activities are as follows :
• Preparation of the action plan and budget for all the expenses associated with the
issues.
• Obtaining the consent letter from SEBI, and finalizing the draft prospectus.
• Identifying and picking-up the brokers/underwriters.
• Selection of the advertising agency for the publicity of pre-issue and post-issue
matters.
• Co-ordination with the 'bankers to the issue, 'stock exchanges'. 'Underwriters’ and
'brokers'.
• Merchant bankers also act as advisors to the issuer with regard to the appropriate
kind of the security which needs to be issued.
• Maintenance of a close liaison among-st various agencies associated with the
issue.
• Finally, a merchant banker is responsible for overall management of the issue, so
that it is fully subscribed.

5) Portfolio Management:
Management of their client’s portfolio is yet another service offered by the merchant
bankers. Portfolio management envisages handling of the clients' portfolio in an
efficient manner so as to achieve the twin objectives of investment, viz. keeping the
risk at the lowest level and returns at the highest. Portfolio of a client may contain a
variety of financial securities, such as equity, debentures, units of mutual funds,
derivative products, etc. In addition to managing the existing portfolios, the
merchant bankers also advise their clients with regard to the fresh investments in
financial instruments, keeping in view the safety, liquidity and return. It is,
therefore, necessary for a merchant banker to keep themselves updated with the
latest developments taking place in the market.

6) Advisory Services to Mergers and Takeovers:

In the cases of mergers and takeovers, the merchant bankers play the role of
intermediaries, safeguarding the interests of both the entities. They also facilitate
necessary authorizations from Government/RBI/any other agency. The terms
mergers and takeovers are mostly used simultaneously giving an impression
similarity between the two. However, they differ from each other; the term 'merger'
denotes amalgamation of two companies in such a way that after the merger, only
one company continues, whereas the other dissolves. Under the takeover, one
company is purchased by another by way of procuring the controlling interest in the
share capital of the company which is being taken over.

7) Consultancy to Sick Industrial Units:

Merchant banker act as consultant and guide not only to the healthy industrial units
for their further progress and expansion, but also to the sick units by evaluating their
technology & processes, and restructuring their capital base. They also facilitate
finalizing the rehabilitation programmes for the sick industrial units keeping in view
the guidelines issued by the banks, so that the same may be accepted by them.
Further, they ensure to get necessary authorization from the Board of Industrial and
Financial Re construction (BIFR) under Sick Industrial Companies (special
provisions) Act 1985 (SICA), for such sick units' financial re-construction and
technical rehabilitation.

8) Leasing:
The merchant bankers’ role in extending services to leasing companies include
arranging lease finance for them, advising on profitable structuring of the lease
transaction, facilitating the legal documentation and tax counselling.

9) Foreign Currency Financing:

Merchant bankers undertake the job of arranging foreign currency finance, Le. funds
for foreign trades. Such finance may be in the shape of export-import trade finance,
euro currency loans, Indian joint venture abroad or foreign collaborations Major
areas pertaining to the foreign currency financing, which are carried out by the
merchant bankers are:
• Providing support for undertaking the study of turn-key and construction
contract projects.
• Helping out the working groups with various Government agencies including
Reserve Bank of India (RBI) and Exchange Credit and Guarantee Department
(ECGD).
• Facilitating their clients in opening and operating banks accounts overseas.
• Arranging export credit facilities from the Export and Import Bank (EXIM Bank)
for the export of capital goods. They also facilitate required authorizations from
Government departments.
• They manage the exchange risks, their clients are exposed to, by guiding them in
respect of getting forward cover.
• Making arrangements of foreign currency guarantees' and 'performance bonds for
their exporter-clients.

10) Providing Venture Capital Financing:

Companies desirous of venturing into novel projects are assisted by the merchant
bankers in obtaining necessary venture capital finance.

11) Corporate Advisory Services:

Merchant bankers provide corporate advisory services to their corporate clients
through the branches specifically designed and set up for the purpose. Corporate
advisory services are the services which are provided to various corporate bodies in
respect of the financial matters pertaining to their operations. Providers of such
services may range from the advisory boards of the companies to professional
bodies, including the merchant bankers, who have expertise in providing such
services.
Some examples of the corporate advisory services provided by them are:
• Corporate Finance in Solutions related to Problems of Business Operations.
• Corporate Finance in Mergers and Acquisitions.
• Corporate Finance in Planning of Business Services.
• Corporate Finance in Generating Funds.

Advantages of Merchant Banking:

1) Utilize the Financial Surplus:
Merchant bankers facilitate directing the surplus funds available with the general
public towards the merchant avenues for their meaningful utilization.

2) Synchronized the Activities:

A number of mediators are involved in the process of 'share issue', e.g. the registrar,
bankers, advertising agency, underwriters, brokers, etc. Merchant bankers act as a
coordinating agency ensuring their cohesive activities in a synchronized manner.

3) Compliance with Rules and Regulations:

They play an important role in ensuring that various rules and regulations
pertaining to the securities markets are adhered to by the corporate participants of
the market.

4) Identification of Investment Prospects:

They identify and exploit various investment prospects available at domestic and
global level.

5) Analysis of Risk:
Merchant bankers undertake the analysis of inbuilt risks at macro and micro
economic levels, which are associated with specific countries/industries/companies
and real estate assets. This is achieved by them through the process of extensive due
diligence.

6) Execution of Activities:
Organizing the complicated investment proposals and implementation thereof,
which involve activities like detailed financial analysis, deal negotiation, transaction
execution, etc.

7) Supporting Management and Partners:

Merchant banks support the management and partners of a company in building
their value and developing their core businesses or portfolios. This may be
accomplished, inter-alia, through:
• The representation on the companies Boards.
• Management oversight.
• Assessing a suitable time and manner in which to reap the benefits of an
investment.
Disadvantages of Merchant Banking
The advantages notwithstanding, there are following shortcomings of merchant
banking. List of the Disadvantages / Problems of merchant banking are as follows:
1. The services offered by Merchant banks can be meant for the large corporate
clients or smaller business entities with exceptionally rich financial background, held
by individuals.
2. The cases undertaken by the merchant bankers are likely to meet with partial
success or in some cases total disaster.
3. The nature of services offered by merchant bankers is fraught with risks.