MERCHANT BANKING AND

FINANCIAL SERVICES
UNIT – I
 FINANCIAL SYSTEM
 A system that aims at establishing and providing
a regular, smooth, efficient and cost effective
linkage between depositors and investors is
known as financial system. A set of complex and
closely connected instructions, agents,
practices, markets, transactions, claims and
liabilities relating to financial aspects of an
economy may be referred to as financial system.
 A well-developed financial system allows for the
transfer of resources from depositors to
investors and thus plays a crucial role in the
functioning of the economy.
 Features:
 Financial system provides an ideal linkage
between depositors and investors, thus
encouraging both savings and investments.
 Financial system facilitates expansion of
financial markets over space and time.
 Financial system promotes efficient allocation
of financial resources for socially desirable and
economically productive purposes.
 Financial system influences both the quality
and the pace of economic development.
 Constituents:
 A financial system comprises of
1. financial institutions,
2. Financial services,
3. Financial markets and
4. Financial instruments.
 1. Financial Institutions

 Financial institutions operate in financial

market – generating, purchasing and
selling financial instruments, and rendering
various financial services in accordance
with the practices and procedures
established by law or tradition.
 2. Financial Services
 Financial services comprises of various
functions and services that are provided by
financial institutions in a financial system.
 Financial services are offered by both asset
management companies, which include leasing
companies, mutual funds, merchant bankers,
issue/portfolio managers and liability
management companies which include bill
discounting houses and acceptance houses.
 Following are some of the
examples of financial services:
 Leasing, credit cards, factoring, portfolio management,
technical and economic consultancy, credit
information.
 Underwriting, discounting and rediscounting of bills
 Acceptances, brokerage and stock-holding
 Depository, housing finance and book building
 Hire purchase and installment credit
 Deposit insurance
 Financial and performance guarantees
 E-Commerce and securitization of debts
 Loan syndicating and credit rating
 3. Financial Markets
 Financial markets facilitate buying and selling of
financial claims, assets, services and securities.
 In financial markets, funds or savings are
transferred from surplus units to deficit units.
 A financial market comprises of players such as
banking and non-banking financial institutions,
dealers, borrowers and lenders, investors and
depositors, and agents.
 Financial market is said to exist wherever
financial transactions take place.
 Classification:
1. Organized markets
2. Unorganized markets
3. Money market – (Short term – maximum one year)
4. Capital Market – (Capital market deals with financial
assets which have maturity period of more than a
year).
5. Primary Market – Markets that deals with new issue of
securities
6. Secondary Market – Markets deal in securities, which
are already issued and available in the market for
trading.
 4. Financial Instruments
 Financial instruments include ownership securities such
as shares, Creditorship securities. Creditorship securities
include debentures and deposit certificates, short-term
securities(less than 1 year), medium-term securities (1 to
5 years), and long-term securities (more than 5 years).

 Examples: Public sector tax-free bonds, public sector

taxable bonds, certificates of deposits(CDs), Commercial
Papers(CPs), commercial bills, corporate bonds, floating
rate bonds, state government loans, 91-days treasury
bills etc.
INDIAN FINANCIAL SYSTEM
 INDIAN FINANCIAL SYSTEM
 The legal and institutional framework for
bank supervision in India was provided
under the Banking Regulations Act, 1949.
 In 1994 Board for Financial Supervision
was set up under the aegis of RBI as part
of the Reserve Bank of India (Board for
Financial Supervision) Regulations, 1994.
 DEPARTMENT OF BANKING SUPERVISION
(DBS)
– SUPERVISORY ROLE
 Preparing independent inspection programmes
for different institutions
 Undertaking scheduled and special on-site
inspections and of-site surveillance, besides
ensuring follow-up and compliance
 Determining the criteria for appointment of
statutory and special auditors, and assessing
audit performance and disclosure standards,
 Dealing with financial sector frauds
 DEPARTMENT OF NON-BANKING
SUPERVISION (DNBS)
– Regulatory role
1. Administering Chapter III B of the RBI Act, formulating
regulatory framework and issuing directions to NBFCs
(Non-Banking Financial Companies).
2. Administering Chapter III-C of the RBI Act to
unincorporated bodies, the Chit Funds Act to chit fund
companies, the Prize Chits and Money Circulation
Schemes (Bannking) Act to prize chits
3. Identification and classification of NBFCs
4. Registration of NBFCs under section 45-IA of the RBI Act
5. On-site inspection and follow up
6. Off-site surveillance and scrutiny of various returns
7. Attending to complaints relating to NBFCs
8. Initiating action against errant companies
 SUPERVISORY
PROCESS
Inspection - on site inspection:
 1. Local Bank Branches
a. Rating system – CAMELS (Capital adequacy, Asset quality, Earnings
appraisal, Liquidity and Systems & Controls). It envisages a rating system
on standing and performance of domestic and foreign banks based on the
international CAMELS model.
b. Customer audit - To evaluate the quality of customer services
c. Quarterly monitoring system – Any private bank displaying systematic
weaknesses is subjected to quarterly monitoring.
d. Quarterly informal meeting system – with the Department of Banking
Supervision for discussing compliance related issues.
e. Special monitoring – with Deputy Governor with the CEOs of banks where
the inspection reports mention serious deficiencies.
f. Inspection manual – Manual for assessing the Assets Liability
Management (ALM) of banks
g. Detailed guidelines – on risk control systems in computerized banks about
electronic records
h. Supervision of overseas branches – it is left largely to the parent banks.
 Off-Site Monitoring &
Surveillance System (OSMOS)
1. Local Banks: Quarterly Reporting about assts,
liabilities and off balance sheet expenditures,
Capital to Risk Assets Ration (CRAR),
Operating results for the quarter, asset quality
and large credit expenditures.
2. Financial Institutions: Quarterly Returns have
been submitted.
3. Non-banking financial companies: Statutory
returns, balance sheets, profit and loss
account, auditors’ reports etc.
 BOARD FOR FINANCIAL
SUPERVISION (BFS)
 The first Board of Financial Supervision (BFS)
was constituted on November 16, 1994 by the
Governor as a committee of the Central Board of
Directors of the RBI.
 Supervision Strategies
 Setting up an off-site surveillance function
 Restructuring the system of bank inspections
 Strengthening the statutory audit of banks
 Strengthening the internal defenses within the
management information and risk control
systems.
 INTERNAL CONTROL AND
HOUSEKEEPING IN BANKS
1. Reconciliation of inter-branch accounts
2. Reconciliation of inter-bank accounts
3. Reconciliation of Nostro accounts (A
nostro is our account of our money,
held by you)
4. Status of balancing of books of accounts
5. Reconciliation of clearing differences
Merchant Banking
Merchant Banking –Definition
 SEBI (Merchant Bankers Rules) 1992, “A
MB has been defined 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 services in relation to
such issue management.”
 Functions of a Merchant Banker
 Corporate counseling: A merchant banker, as a managerial economist,
guides the client, on aspects of organizational goals, location factors,
organization size and operational scale, choice of product and market
survey, forecasting for the product, cost control, pricing methods and
marketing strategy, etc.
 Project Counselling: It relates to Project finance. Study of project, offering
advisory assistance on the viability etc.
 Pre-investment Studies: Feasibility studies to evaluate alternative avenues
of capital investment in terms of growth and profit prospects.
 Capital Restructuring: Activities that are carried out to suggest strategies
to widen and restructure the capital base, diversify operations and
implement schemes for amalgamations, mergers or change in business
status.
 Credit Syndication and Project Finance: 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’.
 Continues.,
 Issue Management and Underwriting: Issue management and underwriting
connotes activities that are concerned with the management of the public
issues of corporate securities, viz. equity shares, preference shares, and
debentures or bonds, and are aimed at mobilization of money from the capital
market.
 Portfolio Management: Making decisions relating to the investment of the
cash resources of a corporate enterprise in marketable securities by deciding
the quantum, timing and the type of security to be bought, is known as
‘Portfolio Management’. It involves making the right choice of investment,
aimed at obtaining an optimum investment mix, taking into account factors
such as the objectives of the investment, tax bracket of the investor, need for
maximizing yield and capital appreciation, etc.
 Working Capital Finance: The finance required for meeting the day-to-day
expenses of an enterprise is known as ‘Working Capital Finance’. Merchant
bankers undertake various activities as part of providing this type of finance.
 Acceptance Credit and Bill Discounting: Activities relating to the
acceptance and the discounting of bills of exchange, besides the
advancement of loans to business concerns on the strength of such
instruments, are collectively known as ‘Acceptance Credit and Bill
Discounting’.
 Continues.,
 Mergers, Amalgamations and Takeovers: This is a specialized service
provided by the merchant banker who arranges for negotiating acquisitions
and mergers by offering expert valuation regarding the quantum and the
nature of consideration, and other related matters.
 Venture Capital: A specially designed capital, as a form of equity financing
for funding high-risk and high-reward projects, is known as ‘Venture Capital’.
The concept of venture capital originated in the USA in the 1950s. in India
IFCI, IDBI, and ICICI are engaged in venture capital financing, and have
developed a number of special schemes for this purpose.
 Lease Financing: A merchant banking activity whereby financial facilities
are provided to companies that undertake leasing, is known as ‘Lease
Financing’. Leasing involves letting out assets on lease for a particular time
period for use by the lessee.
 Foreign Currency Finance: The finance provided to fund foreign trade
transactions is called ‘Foreign Currency Finance’. Eg. Export-import finance,
euro currency loans, Indian joint ventures abroad and foreign collaborations.
 Continues.,
 Fixed Deposit Broking: Computation of the amount that could be
raised by a company in the form of deposits from the public and
loans from shareholders, drafting, arranging of advertisements for
inviting deposits, etc.
 Mutual Funds: Institutions and agencies that are engaged in the
mobilization of the savings of innumerable investors for the purpose
of channeling them into productive investments of a wide variety of
corporate and other securities, are called ‘Mutual Funds’. UTI is the
first and the largest mutual fund in the country.
 Relief to Sick Industries: Rejuvenating old-lines and ailing units by
appraising their technology and process, assessing their
requirements and restructuring their capital base, evolving
rehabilitation packages which are acceptable to financial institutions
and banks, exploring the possibilities for mergers, etc.
 Project Appraisal: evaluation of the industrial; projects in terms of
alternative variants in technology, raw materials, production
capacity, and location of plant is known as ‘Project Appraisal’.
Categories of Merchant Bankers:
 Category I – Issue Management and to act as
advisor, consultant, manager, underwriter and
portfolio manager
 Category II - to act as advisor, consultant,
manager, underwriter and portfolio manager
 Category III - to act as advisor, consultant
underwriter to an issue
 Category IV- to act only as advisor or consultant
to an issue
 SEBI Guidelines for Lead
Merchant Banker
 Any issue less than Rs.50 L no Lead MB
necessary
Size of Issue Number of Merchant Bankers

<Rs.50 Crores (Cr) 2

> Rs.50 Cr but <Rs.100 Cr 3

> Rs.100 Cr but <Rs.200 Cr 4

> Rs.200 Cr but <Rs.400 Cr 5

> Rs.400 Cr 5 or more as agreed by SEBI

 Merchant bankers’ code of
Conduct
 Merchant Bankers have to abide by the following Code of Conduct
by the SEBI:
 Integrity (fairness in all dealings)
 Quality service
 Fair practice
 Responsible statement (not making any exaggerated statements)
 Best advice
 Secrecy
 Information (true and adequate information)
 Prospectus (making available)
 Fair Allotment
 True market (no false market, price rigging or manipulation)
 Compliance (Abiding by the provisions of Act, rules and regulations)
REGULATORY
FRAMEWORK
 Operational Guidelines:
 SEBI has pronounced the following guidelines for compliance by the
eligible merchant bankers:
 Submission of offer document
 Dispatch of issue materials – to investors & NRIs
 Underwriting (careful in selecting underwriters)
 Compliance obligations: post-issue obligations
 Association of resource personnel (in case of over-subscription in public
issues, public representative shall be associated in the process of
allotment)
 Redressal of investor grievances
 Submission of post issue monitoring reports to SEBI
 Issue of no objection certificate (NOC) from the stock exchanges
 Registration of merchant bankers – renewal of certificate of registration
 Reporting requirements – half yearly report to SEBI
 Impositions of penalty points – for violations of any of the provisions for
operational guidelines.
 PRE-ISSUE OBLIGATIONS
1. Obligations
 The merchant banker shall exercise due
diligence
 He shall be satisfied about all the aspects of
offering, and adequacy of disclosure in the
offer documents
 The liability of Merchant Banker shall continue
even after the completion of the issue process.
 The merchant banker shall pay the requisite
fee in accordance with Regulation 24A of SEBI
Rules and Regulations, 1992.
 Continues.,
2. Documents to be submitted: The following
documents are to be submitted along with the
Offer Document by the Lead Manager:
 Memorandum of Understanding (MOU) (between
merchant banker and issuing company)
 Due Diligence Certificate – to be submitted to SEBI
along with draft prospectus.
 Certificates signed by professionals (Company
Secretaries or Chartered Accountants) about
refunds of previous issues, dispatch of certificates
to allottees.
 Continues.,
3. Appointment of intermediaries
 Appointment of merchant bankers
 Appointment of co-managers to an issue
 Appointment of other intermediaries – Registrars,
Directors
4. Underwriting – Merchant bankers should
satisfy themselves about the ability of the
underwriters in discharge their underwriting
obligations.
5. Order document to be made public for a
period of 21 days
 Continues.,
6. Dispatch of issue material – to stock
exchanges, brokers, underwriters, bankers to
the issue, investors associations, etc in
advance.
7. No complaints certificate – after a period of
21 days from the date the draft offer document
is made public, the lead merchant banker shall
file a statement with the Board giving a list of
complaints received by it, a statement by it
whether it is proposed to amend the draft offer
document or not, and highlight those
amendments.
 Continues.,
8. Mandatory Collection Centers –
Minimum number of collection centres for
an issue of capital shall be the four
metropolitan centers situated in Mumbai,
Delhi, Calcutta, and Chennai.
9. Authorized collection agents – can be
appointed in consultation with merchant
banker.
 Continues.,
10. Advertisement for rights post issues – an advertisement giving
the date of completion of dispatch of offer letters, shall be
released in at least one English National Daily with wide
circulation, one Hindi National Paper, and a Regional Language
Daily circulated at the place where registered office of the issuer
company is situated, at least 7 days before the date of opening of
the issue.
11. Appointment of compliance officer – an issuer company shall
appoint a compliance officer who shall directly liaise with the
Board regarding compliance with various laws, rules, regulations
and other directives issued by the Board, besides matter related
to investors complaints.
12. Abridged prospectus (to be sent along with application to the
investors)
13. Agreements with depositories – for dematerialization of
securities. (DEMAT accounts)
 POST-ISSUE OBLIGATIONS:
1. Post-issue monitoring reports – Irrespective of the
level of subscription, the post-issue lead merchant
banker shall ensure the submission of the post-issue
monitoring reports in the formats specified. Those
reports shall be submitted within 3 working days from
the due dates.
1. 3-day-post-issue monitoring report – 3 days from the date of
closure of subscription of the issue.
2. 78 day post issue monitoring report – 78 days
2. Redressal of investor grievances –
3. Coordination with intermediaries – registrars to the
issue, appointment of collecting bank branches, etc.
 Continues.,
4. Stock-invest – To ensure compliance with the instructions
by RBI on handling of stock invest by any person including
registrars.
5. Dealing with Underwriters
6. Bankers to issue – the money received pursuant to the
issue and kept in a separate bank (i.e. bankers to an
issue).
7. Post-issue advertisements – giving details to over-
subscription, basis of allotment, number, value and
percentage of applications received, date of completion of
dispatch of refund orders, date of dispatch of certificates,
and date of filing listing application, is released within 10
days from the date of completion of the various activities, in
at least one English national Daily with wide circulation,
one Hindi National Paper and a Regional language daily.
 Continues.,
8. Basis of allotment – fair and proper proportionate
allotment
9. Reservation for small individual applicants -
minimum 50% to the public investors.
10. Other Responsibilities – payment of interest to
applicants for delayed dispatch of refund, etc. to
continue to be responsible for post issue activities
11. Certificate regarding realization of stock-invests –
within two weeks – from allotment – a certificate to the
board certifying that the stock invests on the basis of
which allotment was finalized, have been realized.
 OVER THE COUNTER
EXCHANGE OF INDIA (OTCEI)
 OTCEI was incorporated in 1990 as a Section 25 company
under the Companies Act 1956 and is recognized as a stock
exchange under Section 4 of the Securities Contracts
Regulation Act, 1956.
 The Exchange was set up to aid enterprising promoters in
raising finance for new projects in a cost effective manner and
to provide investors with a transparent & efficient mode of
trading.
 OTCEI introduced many novel concepts to the Indian capital
markets such as screen-based nationwide trading, sponsorship
of companies, and market making.
 As a measure of success of these efforts, the Exchange today
has 115 listings and has assisted in providing capital for
enterprises that have gone on to build successful brands for
themselves like VIP Advanta, Sonora Tiles & Brilliant mineral
water, etc.
Questions?!