What is merchant banking?

Merchant bankers are called by different names across the world. In the USA they are called Investment bankers and in the UK they are called ‘accepting and issuing houses’.

In India, National Grindlays Bank initiated merchant banking services in 1969. Then Citibank joined the financial service in 1970. The State Bank of India was the first Indian commercial bank (SBI capital market) to set up a separate Merchant Banking Division in 1973, followed by ICICI followed it in 1974. Some of the other large merchant banks in India include Kotak Mahindra Capital, JM Financial, CITI group, Morgan Stanley India, Goldman Sach India, Axis Capital Limited, BNP Paribas, Bob Capital Markets Limited, Bank of America Securities India, Nomura Financial Advisory and Securities India. The major objectives of these bankers are to provide corporations with access to capital and specialized financial expertise and to help them achieve their strategic objectives through customized financial solutions.

Merchant banking is a professional service that may be in the form of a bank or a firm that is licensed by SEBI to undertake non-financial services (rather than providing funds) such as the issue of stocks, funds rising and management, advisory services, and counsel on mergers and acquisitions. However, they do not provide regular banking services, except specialized services, generally dealing with large corporate clients. Whenever new securities are issued, it is managed by Merchant Bankers. Merchant Bankers have to be registered under SEBI to carry out such activities. After 1980, new industries came up and equity financing became popular. As per SEBI guidelines, Merchant banker services are essential for making an issue of securities. This is done to regularize and make the security issue safe and transparent. Therefore, hiring merchant banking services is mandatory for the company.

A merchant banker underwrites corporate securities and provides guidelines to clients on issues like corporate mergers. These banks need separate registration from SEBI for performing as portfolio managers. Merchant Banking Company must not engage in any other financial activities as mentioned in section 45I(c) of the RBI Act 1934. To open a merchant banking company a minimum capital required is 5 crore rupees for Category 1, Rs 50 Lakhs for Category 2, Rs 20 Lakhs for Category 3, and for Category 4 nil capital requirement. Category1 to carry on the activity of issue management and to act as adviser, consultant, manager, underwriter, or portfolio manager, Category 2 to act as adviser, consultant, co-manager, underwriter, or portfolio manager, Category 3 to act as the underwriter, adviser or consultant to an issue, and Category 4 to act only as adviser or consultant to an issue.

The key difference between commercial banks and Merchant Banks

Code of conduct for Merchant Bankers specified by SEBI.

• Must make efforts to protect the interests of investors and act in their best interest.
• Must maintain high standards of integrity, dignity, and fairness in the conduct of its business.
• Must work towards ensuring that copies of the prospectus, offer document, letter of offer, or any other related literature is made available to the investors at the time of issue.
• Must fulfill their obligations in a prompt, ethical, and professional manner.
• Must ensure that at all times they exercise due diligence, ensure proper care, and exercise independent professional judgment.
• Must ensure that investors can make timely and accurate decisions by providing them with adequate disclosures by the applicable regulations and guidelines.
• They should not make any statement, either oral or written, that would misrepresent the services that the merchant banker is capable of performing for the client.
• They should try to avoid conflict of interest and make adequate disclosure of their interests to the investors along with devising a mechanism to resolve any conflict of interest that may arise in the conduct of their business.

SEBI, as per the rules given in the SEBI Intermediaries Regulation 2004, shall determine whether an applicant is a fit and proper person or not based on the following;  Merchant banker should be a body corporate other than a non-banking financial company. However, in case a merchant banker who has been granted registration by the RBI to act as a Primary Dealer may carry on such activity provided that it would not accept/hold any public deposit. They must fulfill the capital adequacy requirement (as per the category they belong to,) of a minimum net worth of Rs.5 crore. They must maintain adequate infrastructure like adequate office space, equipment, and manpower to effectively discharge the functions. They should have employed at least two persons with experience to conduct business. The merchant banker /partners/directors/principal offices should not be convicted or involved in any litigation concerning the securities market, which hurts their business. They should have attained professional qualifications in finance, law, or business.

Originally posted on Sept 7, 2017, edited and re-posted on 5.2.2024

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