Merchant Banking

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Merchant Banking
MB originated in India in 13th century. A few family owned firms started banking activities. These firms not only acted as bankers to the kings of European states, financed coastal trade and 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 high rates of interest for financing highly risky projects. In turn they suffered heavy losses and closed down. Some of them restarted after gaining financial strength. Thus, MB survived and continued during 13th century. MB were also known as commission agents who• Handled the costal trade on commission basis • Made investments in goods manufactured by sellers • Financed continental wars The sole objective of MB was to earn profits by investing in risky projects. After the industrial revolution in England, the scope of international trade widened to include North America and other places. People were attracted to take up MB activity to transfer the machine made goods to European nations and colonies and bringing raw material from other nations to Europe and to finance such trade. During the nineteenth century, MB indulged in overseas trade. They accepted bills of lesser-reputed traders. This practice of accepting bills has grown with the expansion of trade and has become part of MB activity. Meaning and Concept MB are organizations that underwrite securities for corporations, advises clients on mergers and is involved in the ownership of commercial ventures. This word is used differently in the world. In UK, MB refers to ‘accepting and Issuing Houses.

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In India, National Grindlays Bank, followed by Citibank in 1970, started the MB services in 1967. SBI was the first Indian commercial bank having set up a separate MB division in 1972. Since then, a no. of other banks and FI are engaged in MB. They are operating in India largely as Issue Houses. MB can be defined as an institution, which provides a large no. of services including mgt. of securities issue, portfolio services, underwriting of capital issues, insurance, credit syndication, financial advise and project counseling etc. Commercial Banks and MB Services provided by commercial banks • • • • • • Accepting deposits of various types Providing WC finance Meeting short term credit needs of commercial enterprises Allowing customers to withdraw money by cheques Availing of cash credit, OD, Discounting of BOE Issuing credit cards

Services provided by MB • • • • • • • • • Corporate counseling Project advisory services Corporate restructuring Issue Mgt. Managing mergers, amalgamations and takeovers Loan syndication Portfolio mgt Leasing services Providing assistance for technical and financial collaboration Besides the services provided, the two also differ in respect to regulations. CB are governed by the Banking Regulation Act, 1949 and operate under the directives issued by RBI. They are required to maintain SLR and CRR. There is no regulatory framework for MB.

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They are governed by the MN rules issued by the Ministry of Finance and regulations issued by SEBI. MB and Investment Banking IB channelizes the savings of individuals into security investment. They act as an intermediary who provides specialized services in marketing of securities. They do not invest their own funds in the in securities but buy securities in bulk and sell them at retail to the investors. Their functions are• • • • • Preliminary investigation of the issue Identification of the total fund requirement of the client co. Assessing financial strengths and weakness Appraisal of client’s present and future earning Attending BOD meetings and locate weakness of financial and operating mgt.

MB are FI which provide services in corporate finance. MB and Development Banks DB are specialized FI which are established to accomplish certain targets. Their role is important because of the following reasons• • • • • • Absence of organized capital market Lack of entrepreneurial talent Low capital formation Shyness in capital investment Inadequacy of financial facilities Planned economic development

The main objectives of DB are• Promote the development of agriculture and industry • Provide medium and long term loans in rupee or foreign currency • Offering concessional loans for setting up industries in backwar areas
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Evolution of MB
Hundi was the main credit instrument used by indigenous bankers before the coming of western bankers to India. During 19th century, foreign MB operated in India through the East India House. In 1860 merchants with their own investments floated joint stock banks. Some of these banks were Oriental Bank in 1845, Charted Bank Of India and Asia in 1853, Charted Mercantile Bank of India etc. These banks used to finance trade transactions. Their control and mgt. lied with the managing agent. The managing agents acted as MB and performed functions of promoting financing and marketing of securities. They acquired large share of investible capital initially and later on disposed off the shares once the co. gets established. In other words, they acted as issue house for securities. These managing houses had necessary skills and expertise which helped in the development of the projects. Functions performed includes Investing funds as venture capital in promoting the enterprise  Assists the enterprises in procuring finance by guaranteeing bank loans and advances  Raising public deposits In the post world war II phase, amendments in the co. 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 process of economic development, efforts were made to channelize the household savings into investments in industry and trade. Amendments were made in co. act, Capital Issue (Control) Act etc to regulate the growth of business enterprises. In 1948, IFCI was set to provide medium and long term finance to industrial enterprises and underwrite new securities. At the State level, SFC were established in 1951. In 1955, ICICI was set up to provide development finance to industrial concerns. Many more financial and investment institutions emerged at national and state level like LIC, RCI (Refinance Corporation for Industry), IDBI and UTI etc. The basic objectives of setting up all these
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institutions was to boost industrial sector, improve capital market make finance easily available and support the investment climate of the country. The need for MB services was widely felt and during this period the National & Grindlays Bank (now Grindlays Bank) took up MB activities and started its MB division in 1969. Functions of MB The basic function of MB is marketing of corporate and other securities. Their activities include: 1. Project Promotion Services 2. Project Finance 3. Mgt. & Mktg. Of new issue 4. Underwriting of new issue 5. Credit Syndication 6. Leasing services 7. Corporate Advisory Services 8. Providing Venture Capital 9. Operating MF 10.Portfolio Mgt. 11.Bought out deals 12.Providing assistance for technical and financial collaboration 13.Investment services for NRIs Their activities can be divided into the following categories: i. Corporate Counseling: This service is provided free to a corporate unit. Advise is provided to improve performance and build better image among investors and to increase MV of shares. Areas of counseling includes: 1. Considering GOI economic and licensing policies, areas of diversification are explored. 2. Detailed market analysis is done so as to evaluate profitability of each product line, its growth and demand prospects at present and in future. On the basis of such advice, it is decided that a product should be continued or dropped.
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3. Revival of old-line projects or sick units by assessing their requirements, manufacturing processes and technology etc. Based on such studies restructuring or reorganization of the capital base is undertaken. ii. Project Counseling: It covers the study of project and services on project viability and steps for project implementation. It covers the following aspects1. Development of an idea of the project 2. Preparation of project report after considering its financial, economic and market feasibility 3. Estimation of the cost of project 4. Deciding the means of financing 5. Studying the procedural aspects of project implementation 6. Providing assistance in obtaining government consent for project implementation 7. Identification of potential investment opportunities 8. Capital structuring 9. Negotiating with foreign collaborations and making necessary arrangements 10. Assisting the clients in preparing application for financial assistance to FI and Banks. iii. Capital Restructuring Services: 1. Examination of the existing capital structure of the firm 2. In case of bonus issue, help is provided in preparation of Memorandum 3. For co. governed by FEMA, MB suggests capital structure which is in confirmation with the legal needs. iv. Portfolio Mgt.: MB advises the clients, mostly the institutional ones, regarding the type of security to invest in and the quantum of investments etc. They help the clients in forming their optimum capital mix after considering the following• Objectives of the investment • Tax Bracket applicable
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• Need for maximizing returns • Capital appreciation etc. Services provided to Indian Citizens: • Sale and purchase of securities • Investing and managing FD • Safe custody of securities in India and Abroad • Reinvesting the returns collected from investments in some profitable avenue Services to NRI: In order to attract Foreign Investment in India, GOI has provided various incentives to NRIs and PIORA. MB offers various services to them which includes• • • • • • • Advice on selection of investment Critical evaluation of securities Securing RBI approval for trading in securities Hold securities in safe custody Maintaining investment records and complying with the ceilings Collecting and remitting interest and dividend on investment Providing tax counseling and filing tax returns v. Issue Mgt. Traditionally, functions of MB had been confined to the mgt. of new public issues of corporate securities by the newly formed co., existing co. (further issue) etc. MB use to act as sponsors of the issue. Now a days, they offer various other services which includes1. Preparation of the prospectus 2. Preparation of plan and budget to estimate total expenditure of the issue 3. Preparation of CCI application and getting its consent 4. Appointment of Brokers, underwriters and agreements with them
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5. Appointment of registrars, BRLM and Bankers to the issue etc. 6. Advertising and publicity for pre and post issue activities 7. Compliance and listing with the SE 8. Advice the clients regardinga. Fresh Issue b. Additional Issue c. Bonus Issue d. Right Issue of equity or preference or both and the proportion vi. Credit Syndication: 1. Estimation of the total project cost 2. Preparing financial plan to meet the cost of the project keeping into the consideration the requirements of promoters, govt. agencies, banks, FI, underwriters etc. 3. Assisting the clients in preparation of loan applications and monitoring their progress 4. Arrange bridge finance v. Bills Discounting: A BOE accepted by a house of established reputation automatically becomes acceptable to the seller of the goods and to the lenders. This function would include the following1. Analyzing the reputation and financial standing of the acceptor 2. Existence of a system for collection of information on borrowers.

vi. Lease Finance:

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Leasing is an arrangement that provides a firm with the use and control over assets without buying and owning the same. It is a contract between the owner of the asset (lessor) and the user of the asset (lessee), whereby, the lessor gives the right to use the asset to the lessee over a specified period of time for a consideration called lease rent. The lessee pays the lease rent as per the contract. At the expiry of the lease contract, the lessee reverts back to the lessor who is the legal owner of the asset. The lessee can also be given option to buy or renew the lease. vii. Venture capital: MB provides funds to assist the entrepreneurs who lack capital to be risked. It is a form of equity finance designed for funding high risk and high reward projects.

Recent Developments in MB Establishments in India:
1. Setting up of Bank Subsidiaries: in order to meet the increasing

demand for financial services from the corporate sector, the MB division of nationalized banks have started forming independent subsidiaries. E.g., SBI Capital Markets Ltd. was incorporated as the subsidiary of SBI in 1986. Canbank Financial Services was established as subsidiary of Canara Bank in 1987. PNB Capital Services Ltd., established in 1988 is promoted by PNB.
2. Reorganization of Private Firms: On the lines of nationalized

banks, private firms have also started reorganizing themselves. These firms have adopted modern techniques to compete with their international counterparts and have adopted various measures to provide professional services to their clients.
3. Establishment of SUA: Stockbroker Underwriters Association

(SUA) was established in 1984, which works in co ordination with MB and take steps to promote the activities of capital market. It has the following objectives: i) Educate and protect the interest of investors
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ii) iii) iv)

Provide information about new issues to the capital market Evolve a code of conduct for underwriters Render legal and other services to the clients

4. SEBI: to develop and regulate securities market, investor

protection and to formulate rules and guidelines for regulation of securities market, the central govt. constituted SEBI on 4th Apr, 1988.
5. Discount and Finance House of India (DFHI): IT was established

as a co. under the co. act 1956 with an authorized and paid up capital of 100 crores. Out of this, 51 crore has been contributed by RBI, 16 crore by FI and 33 crore by public sector banks. It will also have lines of credit from public sector banks and refinance facility from RBI in order to meet the WC requirements. It provides liquidity to the money market as it deals with commercial banks.
6. Credit Rating Information Services of India Ltd. (CRISIL): it has

been set up in 1987 to provide assistance to investors, MB underwriters etc. It rates various instruments such as debt, equity and fixed return securities offered to the public.
7. Stock Holding Corporation of India Ltd.: SHCIL was set up in

1986 to take care of safe custody, delivery of shares and collection of sales proceeds of the securities. MB in India: The FERA regulation of 1973, which required a large no. of foreign companies, to dilute their shareholding in India, gave a boost to MB activities in India. Since then, a no. of development banks and FI have also entered in this field. Private brokers and financial consultancies have also remained active in this field. At present, following types of organizations- provides MB services1. Commercial banks and their subsidiaries 2. Foreign banks like National Grindlays, Citi bank etc.

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3. All India FI such as State Industrial Development Corporation and State Financial Corporation. 4. Private Financial Consultancy Firms and Brokers like DSP Merill Lynch, Enam Financial Consultancy, Kotak Mahindra etc. 5. Technical Consultancy Organizations 6. Professional MB Houses MB in India can be categorized in 4 major categories: 1. To provide long term sources of funds required by the corporate sector 2. Project counseling which includes credit syndication and the WC 3. Capital structuring 4. Portfolio Mgt. The buoyancy in the capital market in 1980’s created a lot of scope for MB activities in our country. The year 1985 was an epoch making year in the history of MB when a large no. of issues were over subscribed by several times and the importance of MB activities were made evident in managing issues and their underwriting. Deregulation and liberalization of the industry in India has led to changes in the financial sector. Since Aug. 1990, MB engaged in issue mgt., corporate advisory services, under writing and portfolio mgt. has to obtain authorization from SEBI after meeting the requirements of capital adequacy norms. In 1993, there were 568 MB in India out of which 312 were authorized by SEBI. The no. of registered MB with SEBI increased to 422 in 1994. The total no. of MB in all categories increased to 1163 by the end of 1998. MB Regulation: SEBI (Merchant Bankers’) Regulation Act, 1992 defines a MB as “ any person who is engaged in the business of issue mgt. either by making arrangements regarding selling, buying and subscribing to the securities or acting as a manager, consultant, advisor or rendering corporate advisory services in relation to such issue mgt.” At present no organization can act as a MB without obtaining a certificate of registration from SEBI. It must be noted that a person has to get himself registered under these regulations if he wants to carry on or undertake any of the authorized activities. To obtain this certificate, one
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has to apply in the prescribed from and fulfill two sets of norms: operational and capital adequacy. Classification of MB:
1) Category 1 MB: These can act as issue managers,

underwriters, advisors, consultants and portfolio managers. 2) Category II MB: These can act as advisors, consultants, underwriters and portfolio managers. They cannot act as issue managers. 3) Category III MB: They are allowed to act as underwriters, advisors and consultants only. They can neither undertake issue mgt. or portfolio mgt. 4) Category IV MB: They can cat only as consultants or advisors to a capital issue. Capital Adequacy Norms: SEBI has prescribed these norms for registration in various categories of MB. These norms are expressed in terms of net worth. The Capital Adequacy Requirement (CAR) shall not be less than the net worth of the person making the application for grant of registration. The net worth shall be as follows, namely: Category Minimum Amount 1) Category I Rs. 5, 00, 00, 000 2) Category II Rs. 50, 00, 000 3) Category III Rs. 20, 00, 000 4) Category IV Nil Explanation: For the purposes of this regulation "net worth" means in the case of an applicant, who is a partnership firm or a body corporate, the value of the capital contributed to the business of such firm or the paid up capital of such body corporate plus free reserves as the case may be at the time of making application.

Fees:
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According to SEBI (MB) Amendment Regulations, 1999, every MB shall pay a sum of ` 5 lac as the registration fees at the time of granting certificate by the board. The MB shall pay the fees within 15 days of the receipt of the intimation from the board. Further, in order to keep the registration in force, the MB shall pay renewal fees of ` 2.5 lac every 3 yrs. from the fourth year from the date of initial registration. The following code of conduct has been issued by SEBI for MB w.e.f. 1.10.031. MB shall make all efforts to protect the interests of investors. 2. MB shall exercise due diligence and ensure proper care and exercise professional judgment 3. MB shall endeavor to ensure thata) Enquiries from investors are adequately dealt b) Grievances from investors are addressed 4. MB shall ensure that adequate disclosures are made to the investors in a timely manner in accordance with the applicable regulations and guidelines so as to enable them to make a balanced and informed decision.

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