Investment Banking &

Financial Services

Course Code: NHS 001

Unit 3
*This course is part of Minor in
Business Analytics Program.

Course Instructor:
Ms. Sonal Mehrotra
Humanities Department,
SoHSS,
HBTU, Kanpur.
Unit III: Commercial Banking & Merchant Banking B.Tech 2nd: 2023-24
Unit- 3: Commercial & Merchant Banking
Commercial Banking
Introduction, Functions /Services by commercial bankers, Types of Commercial Banks, The
concept of Merchant Banking Services in India, Functions of Merchant Bank, Difference
between Investment and Merchant Bank. General guidelines of merchant bankers.

Introduction to Commercial Bank

Definition: A financial institution that provides its customers with services like accepting
deposits, providing loans, and making investments, with the objective of earning profits is
known as a Commercial Bank.

The two primary characteristics of a commercial bank are lending and borrowing. The bank
receives the deposits and gives money to various projects to earn interest (profit). The rate
of interest that a bank offers to the depositors is known as the borrowing rate, while the
rate at which a bank lends money is known as the lending rate. The difference between
the borrowing rate and the lending rate is known as Spread. It is the profit earned by
commercial banks.

Commercial Banks are important for an economy because they create capital, credit, and
liquidity in the market. Commercial banks have traditionally been located in physical
locations, but nowadays a number of banks also operate online.

Bank of Calcutta is the oldest commercial bank in India. It was established in the year 1806.
It was later renamed the Bank of Bengal. Currently it is known as State Bank of India.
What is the main purpose of commercial banks?

The main purpose of commercial banks is to provide financial services to the general public
and also provide loan facilities to the business, thereby making money by earning interests
and fees. This is called credit creation which helps in increase in production, employment,
and consumer spending, thereby boosting the economy.

Commercial banks have traditionally been located in buildings where customers come to
use teller window services and automated teller machines (ATMs) to do their routine
banking. With the rise in internet technology, most banks now allow their customers to do
most of the same services online that they could do in person, including transfers,
deposits, and bill payments.

Commercial banks are heavily regulated by a central bank in their country or region. For
instance, central banks impose reserve requirements on commercial banks. This means
that banks are required to hold a certain percentage of their consumer deposits at the
central bank as a cushion if there’s a rush to withdraw funds by the general public.

Course Instructor: Ms. Sonal Mehrotra 2

Unit III: Commercial Banking & Merchant Banking B.Tech 2nd: 2023-24
Functions of Commercial Bank
The functions of commercial banks are classified into two main divisions.

Primary Secondary
Discounting bills of
Accepts deposit
exchange

Provides loan and

Overdraft facility
advances

Purchasing and selling of

Cash Credit
the securities

Locker facilities

Paying and gathering the

credit

1. Primary functions
a. Accepts deposit: The bank takes deposits in the form of saving, current, and fixed
deposits. The surplus balances collected from the firm and individuals are lent to the
temporary requirements of the commercial transactions.

b. Provides Loan and Advances: Another critical function of the banks is to offer loans and
advances to the entrepreneurs and business people and collect interest. For every bank, it
is the primary source of making profits. In this process, a bank retains a small number of
deposits as a reserve and offers (lends) the remaining amount to the borrowers in demand
loans, overdraft, cash credit, short-run loans, etc.
c. Cash Credit: The loan given to the borrowers against their current assets like stocks,
bonds, shares, etc., is known as cash credit. For this, a credit limit is sanctioned to the
borrower, and money is credited to this account. The borrower can now withdraw any
amount at any time within his credit limit. Interest is charged from the borrower on the
amount actually withdrawn by him. This process allows the bank to create money.

[Remember: When a customer is provided with credit or loan, they are not provided with
liquid cash. First, a bank account is opened for the customer and then the money is
transferred to the account.]

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Unit III: Commercial Banking & Merchant Banking B.Tech 2nd: 2023-24
2. Secondary functions
1. Discounting bills of exchange: It is a written agreement acknowledging the amount of
money to be paid (to the seller) against the goods purchased (by the buyer) at some fixed
date in future. It is a method of short term financing by the bank and payment can be
made to the seller before the date of its maturity. The bank makes payment on behalf of
its client (buyer) after deducting some interest called a “discount” in this case.

[Understand: There are three parties- seller, buyer and bank. Usually, in international
trade, when seller offers goods and services to the buyer and requires immediate cash,
seller can submits bills of exchange to the bank (buyer’s bank) and get the bill’s present
value in return by discounting its future value at current interest rate and remaining time
to maturity. Bank deducts the difference as a discount or a fee and gets entire amount
from buyer when bill matures. ]

2. Overdraft facility: It is an advance given to a customer by keeping the current account to

overdraw up to the given limit. This service is usually provided to reputable and trustworthy
consumers for a limited time. Customers must pay interest to the bank on any amounts
they have overdrawn.

3. Purchase and Sale of the securities: Commercial banks on behalf of their customers,
purchase and sell government securities and stocks and shares of private companies.

4. Locker Facilities: A bank provides locker facilities to the customers to keep their
valuables or documents safely. The banks charge a minimum of an annual fee for this
service.
5. Collection and Payment of Various Items: Commercial banks provide their customers
with the service of collecting bills, interest, subscriptions, rents, and other periodical
receipts on their behalf. They also make payments for insurance premiums, taxes, etc., on
their customer’s standing instructions.

Types of Commercial Banks

There are three different types of commercial banks.

 Private bank –: It is a type of commercial banks where private individuals and

businesses own a majority of the share capital. All private banks are recorded as
companies with limited liability. Such as Housing Development Finance Corporation
(HDFC) Bank, Industrial Credit and Investment Corporation of India (ICICI) Bank, Yes
Bank, and more such banks.

 Public bank –: It is a type of bank that is nationalised, and the government holds a
significant stake. For example, Bank of Baroda, State Bank of India (SBI), Dena Bank,
Corporation Bank, and Punjab National Bank.
Course Instructor: Ms. Sonal Mehrotra 4
Unit III: Commercial Banking & Merchant Banking B.Tech 2nd: 2023-24
 Foreign bank –: These banks are established in foreign countries and have branches
in other countries. For instance: American Express Bank, Hong Kong and Shanghai
Banking Corporation (HSBC), Standard & Chartered Bank, Citibank, and more such
banks.

 Regional Rural Banks (RRBs) are government owned scheduled commercial banks of
India that operate at regional level in different states of India. They primarily serve
rural areas of India with basic banking and financial services. The main objective of
the RRBs is to provide credit to the small, marginal farmers, agricultural laborers,
small artisans, etc. At present, there are 43 RRBs in India. Each RRB is sponsored by
the Central government, the State government, and the sponsor bank in the ratio
50%, 15% and 35% respectively. Example: Gramin Bank of Aryavart, Prathama UP
Gramin Bank, Purvanchal Bank, Punjab Gramin Bank, Bihar Gramin Bank etc.

Types of Deposits of a Commercial Bank

1. Demand Deposits or Current Account Deposits: The deposits which are repayable
on demand by the banks are known as demand deposits or current account
deposits. In general, these kinds of deposits are maintained by businessmen to
make transactions with these deposits. One can get the amount deposited as
demand deposits by a cheque without any restriction. Besides, commercial banks
do not pay any interest to the depositors on these accounts; instead, they charge
some amount as a service charge for running these accounts.
2. Fixed Deposits or Time Deposits: The deposits in which the depositor, deposits
money with the bank for a fixed time period are known as fixed deposits or time
deposits. These deposits do not enjoy a cheque facility and carry a high interest
rate.
3. Saving Deposits: The deposits, which include combined features of demand
deposits and fixed deposits are known as saving deposits. The depositors have the
cheque facility to withdraw money from their accounts, but there are some
restrictions on the number and amount of withdrawals. The restrictions are
imposed to discourage the frequent use of saving deposits. Besides, the interest
rate on saving deposits is less than the interest rate on fixed deposits.
4. Recurring Deposits: A recurring deposit (RD) is a special kind of term deposit
offered by Indian banks and Post Office which helps people with regular deposit a
fixed amount every month into their recurring deposit account until a fixed sum is
deposited over a fixed period of time. It can help earn interest at the rate applicable
to fixed deposits.
Available in flexible tenure options ranging from 6 months to 10 years, this
investment tool offered by multiple banks and NBFCs helps channelize monthly
savings for long or short-term corpus creation.
Course Instructor: Ms. Sonal Mehrotra 5
Unit III: Commercial Banking & Merchant Banking B.Tech 2nd: 2023-24

Merchant Banking

Definition: A financial institution that deals primarily in International Financial and Trade
activities. Merchant banks provide loan services, financial advising, private equity, and
fundraising services to private corporations and HNI (High Net-worth Individuals) clients.

Concept: Merchant Banking is a combination of Banking and Consultancy services.

Merchant banks are non-depository financial institutions that specialize in providing
financial services to private corporations or specialty clients.

 Consultancy means to provide advice, guidance and service for a fee. Merchant
banks provide financial advice on mergers, acquisitions and takeovers.

 Merchant banks do not generally provide services for the general public, although
they may have retail and commercial arms.

 Merchant banks act as an intermediary between companies and the investors.

 It helps a businessman to start a business. It helps to raise (collect) finance. It helps to

expand and modernize the business. It helps in restructuring of a business.

 It helps to revive sick business units.

 It also helps companies to register, buy and sell shares at the stock exchange.

In short, merchant banking provides a wide range of services for starting until running a
business. It acts as Financial Engineer for a business.

 Merchant banking was first started in India in 1967 by Grindlays Bank. It has made
rapid progress since 1970.
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Unit III: Commercial Banking & Merchant Banking B.Tech 2nd: 2023-24

Understanding Merchant Banking (Example)

Company ABC–based in the U.S., wants to buy Company XYZ in Germany. ABC would hire a
merchant bank to facilitate the process. That bank would advise Company ABC on how to
structure the transaction. It may also help ABC in the financing and underwriting process.

Using the example above, the sellers in Germany would receive a letter of credit issued by
the merchant bank hired by Company ABC as payment for the purchase. The merchant can
also help Company ABC work through the legal and regulatory issues required to do
business in Germany.

Functions of Merchant Banking

The important functions of merchant banking are listed as below.
1. Raising Finance for Clients: Merchant Banking helps its clients to raise finance through
issue of shares, debentures, bank loans, etc. It helps its clients to raise finance from the
domestic and international market. This finance is used for starting a new business or
project or for modernization or expansion of the business.
2. Broker in Stock Exchange: Merchant bankers act as brokers in the stock exchange. They
buy and sell shares on behalf of their clients. They conduct research on equity shares.
They also advise their clients about which shares to buy, when to buy, how much to
buy and when to sell. Large brokers, Mutual Funds, Venture capital companies
and Investment Banks offer merchant banking services.
3. Project Management: Merchant bankers help their clients in the many ways. For e.g.
advising about location of a project, preparing a project report, conducting feasibility
studies, making a plan for financing the project, finding out sources of finance,
advising about concessions and incentives from the government.
4. Managing Public Issue of Companies: Merchant bank advice and manage the public
issue of companies. They provide following services:
i. Advise on the timing of the public issue.
ii. Advise on the size and price of the issue.
iii. Acting as manager to the issue, and helping in allotment of securities.
iv. Help in appointing underwriters and brokers to the issue.
v. Listing of shares on the stock exchange, etc.

5. Services to Public Sector Units: Merchant banks offer many services to public sector
units and public utilities. They help in raising long-term capital, marketing of securities,
foreign collaborations and arranging long-term finance from term lending institutions.

Course Instructor: Ms. Sonal Mehrotra 7

Unit III: Commercial Banking & Merchant Banking B.Tech 2nd: 2023-24
6. Portfolio Management: A merchant bank manages the portfolios (investments) of its
clients. This makes investments safe, liquid and profitable for the client. It offers expert
guidance to its clients for taking investment decisions.
7. Corporate Restructuring: It includes mergers or acquisitions of existing business units,
sale of existing unit or disinvestment. This requires proper negotiations, preparation of
documents and completion of legal formalities. Merchant bankers offer all these
services to their clients.
Real life Examples of Merchant Banks

 Foreign Banks: J.P. Morgan & Co., Credit Suisse, Morgan Stanley, Merrill Lynch, Bank
of America, Morgan Stanley India, Goldman Sachs India, Citigroup Global Markets
India, Bank of America Securities India etc.
 Public Sector Merchant Bankers: SBI Capital Markets, Punjab National bank, IFCI
Financial Services, Bank of Maharashtra, Karur Vysya Bank Ltd, State Bank of Bikaner
and Jaipur.
 Private Sector Merchant Bankers: ICICI Securities, Axis Bank, Bajaj Capital, Tata
Capital Markets, Kotak Mahindra Capital Company, Reliance Securities, Yes Bank

Difference between Merchant Bank and Investment Bank

The scope of the Investment Banks is wide in comparison to a Merchant Bank. Investment
Banks mostly deal with large companies and High Net-worth Individuals (HNIs). Merchant
Banks deal with medium-small companies and HNI clients.

Investment Banks are extensively involved in the underwriting and issuance of securities. At
the same time, Merchant Banks are extensively involved in International Financial and
Trade activities. In simple words, their basis of working is different.

Feature Merchant Bank Investment Bank

Focus International finance, business loans Underwriting and issuance of securities on behalf
for companies, and underwriting of large corporations

Clients Small and medium-sized businesses,
high-net-worth individuals, and
family offices.
Services Mergers and acquisitions (M&A),
project finance, trade finance,
leasing, and advisory services
Large corporations and government entities
Underwriting, private placement, initial public
offering (IPO) management, debt and equity
securities issuance, and financial restructuring

Risk Higher risk appetite since they deal Lower risk appetite, generally not open to doing
appetite with smaller businesses business with riskier, high-growth businesses

Profit Fee-based Commission-based

model

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Unit III: Commercial Banking & Merchant Banking B.Tech 2nd: 2023-24
Basic Requirements of Merchant Banking Company

 Merchant Banking Company shall comply with the provisions of the SEBI Act 1992.
 Merchant Banking Company cannot accept or hold public deposits.
 SEBI has classified merchant bankers into four categories based on nature and range
of activities and the responsibilities.
1. Category I Merchant Bankers: These merchant bankers can act as issue manager,
advisor, consultant, underwriter and portfolio manager.
2. Category II Merchant Bankers: Such merchant bankers can act as advisor, consultant,
underwriter and portfolio manager. They cannot act as issue manager of their own but can
act co-manager.
3. Category III Merchant Bankers: They are allowed to act as underwriter, advisor and
consultant only. They can neither undertake issue management of their own nor they act as
co-manager. They cannot undertake the activities of portfolio management also.
4. Category IV Merchant Bankers: A category IV merchant banker can merely act as
consultant or advisor to an issue of capital.
Capital Adequacy Norms: SEBI has prescribed capital adequacy norms for registration of
the various categories of merchant bankers. The capital adequacy is expressed in terms of
minimum net worth, i.e., capital contributed to the business plus free reserves.
Category Amount
Category I Rs. 1 Crore
Category II Rs. 50 Lakhs
Category III Rs. 20 Lakhs
Category IV Nil
From 9th Dec’1997, all categories except category I was abolished. The minimum net worth
of category I was fixed 1 Crore and later raised to 5 Crores through an amendment of
regulation act in 1995.
Merchant Banking Commission: Merchant bankers are eligible to charge commission from
their clients as detailed below:

1. A merchant banker can charge 0.5% as the maximum commission for the whole
issue.
2. They can charge project appraisal fees.
3. Brokerage commission 1.5%.
4. Underwriting commission.

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Course Instructor: Ms. Sonal Mehrotra 9