Merchant Banking: Functions, Meaning, and Its Role in India

The financial crisis of 2007–2008 caused significant stress on banks around the world. The failure of a large number of major banks resulted in government bail-outs. The collapse and fire sale of Bear Stearns to JPMorgan Chase in March 2008 and the collapse of Lehman Brothers in September that same year led to a credit crunch and global banking crises. In response governments around the world bailed-out, nationalised or arranged fire sales for a large number of major banks. Starting with the Irish government on 29 September 2008,[210] governments around the world provided wholesale guarantees to underwriting banks to avoid panic of systemic failure to the whole banking system. These events spawned the term 'too big to fail’ and resulted in a lot of discussion about the moral hazard of these actions.

  • As part of the appraisal exercise, available options are compared making use of various techniques, like economic appraisal and decision analysis.
  • Modern banking practice, including fractional reserve banking and the issue of banknotes, emerged in the 17th century.
  • In order to speed up the pace of economic development, efforts were made to channelise the household savings into investment in industry and trade.
  • Industrial Finance Corporation of India (IFCI) did set up to provide long and medium-term finance to industrial enterprises and underwrite new securities.

To discharge this function the merchant bankers have to exercise due diligence independent by verifying the contents of the prospectus and the reasonableness of the views expressed therein. On 1st March, 1993 new policy guidelines have been issued by SEBI for the merchant bankers to ensure greater transparency in their operations and to make them accountable so as to protect the investor’s interest. The guidelines relate to pre-issue obligations, underwriting, advertisements and post-issue obligations of the merchant bankers. The U.S. established the Securities and Exchange Commission in 1933, and passed the Glass–Steagall Act, which separated investment banking and commercial banking. This was to avoid more risky investment banking activities from ever again causing commercial bank failures.

History of Merchant Banking

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. Rapid urbanization in the 1980s and the LPG reforms of the 90s increased the importance of merchant banks.

  • During the early nineteenth century, merchants indulged in overseas trade and earned a good reputation.
  • It is in the
    context of fast expanding economy and a liberalized and deregulated atmosphere that the growth of
    the Indian Stock Market activities has to be viewed.
  • The sole objective of these merchant bankers was profit maximisation by making investments in risky projects.
  • Unlike their counterparts, merchant banks are often privately owned and focus on investment banking, corporate finance, and other financial market-related activities.

The basic objectives of setting up all these institutions were to boost the industrial sector, improve the capital market; make finance easily available and support the investment climate in the country. These institutions also underwrite the capital issues besides the lending support of broking houses. India has entered the 21stcentury as one of the Asia‘s most dynamic economies. This is the part of the
assessment made by International Financial and Capital Market Institutions based on India‘s economic and
financial reforms initiated in 1991 and brought to fruition in various budget. The progress of any economy
mainly depends on the efficient financial system of the country. The importance of the financial sector reforms affirms an effective means for solving the
problems of economic, financial and social in India and elsewhere In the Developing nations of the world.

What is Merchant Banking?

Now, with increased formal merchant banking activities in india was originated in activities in all avenues, more and more merchant bankers, with their expertise, are going to be needed to facilitate their transactions. Its capitalization, including the owners funds (capital, reserves, etc.) and various-long sources of funds, e.g. institutional borrowings and market borrowings in the form of equity/debt issues. Merchant bankers take the responsibility of raising the funds from all the above external sources. They also provide tailor-made solutions to the financial problems faced by their clients, including the financial restructuring.

Major events in the history of banking

Let us also know the services that merchant banking offers to corporate and big business houses. It is an institution that primarily offers consultancy to its customers regarding financial, managerial, marketing, and legal concerns. They usually offer assistance to business loans for big companies, international finance, and underwriting. 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. They simply buy the securities in bulk with a purpose of selling the same shortly to the investors at large.

Companies desirous of venturing into novel projects are assisted by the merchant bankers in obtaining necessary venture capital finance. In the area of fund-based activities also, merchant bankers offer their services. 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. The major activities done by merchant bankers are underwriting, portfolio management, consultant, and advisor, whereas commercial banks mostly play the role of financers only. After a couple of years, the practice of merchant banking evolved in the modern era from London.

Managing the ensuing public issue of the client is also very important service offered by the Merchant Bankers. Merchant banking provides a lot of support and opportunities for new businesses. Formal Merchant Banking activity in India originated with the setting up of n Merchant Banking division by the Grindlays Bank in 1969.

Merchant Banking in India

They, infact, have given a tough competition to the commercial banks in the operations of merchant banking. Merchant banking services, in India, were started only in 1967 by National Grindlays. The State Bank of India was the first Indian commercial bank to set up a separate merchant banking division in 1972. If they are
unwilling to supply investment banking bridge loans, they have a
low cost strategy for taking your company public.  They do private investment in public equities
 They can advise or help with a company’s M&A strategy.

For example, the Dutch
merchant adventurers were active in what are now Indonesia; the French and Portuguese acted
similarly in their respective colonies. The scope of international trade widened to include North America and other continents. Merchant Bankers were known as “Commission agents” who handled the coastal trade on a commission basis and provided finance to the owners or supplier of goods. The sole objective of these merchant bankers was profit maximization by making investments in risky projects.

‘Investment bankers are primarily the intermediaries who provide specialised service in the marketing of securities. The precautions by the merchant bankers would ensure that all the fake companies, whose intention is to defraud the investors, don‘t have access to the market. The fourth category consists of merchant bankers who act as advisor or consultant to an issue.

To earn profits, they invested their funds where they expected higher returns despite the high degree of risk involved. They charged very high rates of interest for financing highly risky projects. The basic function of a merchant banker is marketing corporate and other securities. Such merchant bankers can act as advisor, consultant, underwriter and portfolio manager. 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.

The Government issued policy guidelines for merchant bankers to ensure sufficient physical infrastructure, necessary expertise, good financial standing, professional integrity and fairness in their transactions. 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. These were some of the causes that hastened the increase of Merchant Banking in India.

It was in 1813 when merchants came from European countries to trade with India. Some leading banks have floated wholly owned subsidiaries for carrying out these activities. Private brokers and financial consultancy firms have also been quite active in the field of merchant banking.