What is Merchant Banking – Services, Features, Functions and Example
What is Merchant Banking?
Merchant banking is a set of select banking and financial services offered by merchant banks to large corporations, institutional investors, and high net worth individuals (HNIs). Some of the most common merchant banking services include, fundraising, financial advisory, lending, underwriting, corporate portfolio management, international trade advisory, mergers and acquisitions, and asset sale and management advisory.
Typically, merchant banks avoid retail banking and depository services, which means their services are mostly limited to large companies, and multinational businesses.
Example of Merchant Banking
Say, Company A wants to raise funds worth ₹10,000 Crore from the market and decides to issue debentures and preference shares worth the same amount. Now, they hire Merchant Bank Z to oversee the issue and sale of shares.
Merchant Bank Z will use its expertise to create a detailed action plan and budget for the entire exercise. They will also hire and coordinate with equity underwriters, who will use their own distribution networks to sell the debentures and preference shares of Company A to investors.
As part of the action plan, Merchant Bank Z may also hire advertising and marketing agencies to drum up support and publicity before and after the issue of shares.
In addition, this merchant bank will obtain regulatory clearances from the relevant authorities and handle the associated paperwork.
Trivia Corner
Did you know that the functions and operations of a merchant bank in India are regulated by SEBI? And that the capital adequacy mandated for a merchant bank is ₹5 Crore?
Functions of Merchant Banking
The primary functions of merchant banking are as follows:
1. Portfolio Management
Merchant banks offer portfolio management and advisory services to help investors make better decisions. Furthermore, merchant banks can even make trading and investing decisions on behalf of their clients.
2. Raise Capital
Merchant banks help their clients raise funds from the domestic and international markets by issuing securities, such as debentures, preference shares, equities, and bonds.
3. Promotional Activities
These act as financial intermediaries for promoting new enterprises in their initial phases and getting approval from the government.
4. Loan Syndication
Merchant banks can help and guide their clients on raising capital from banks and financial institutions via the loan route.
5. Leasing Services
Merchant banks extend leasing services wherein the clients lease assets and equipment to generate rental income.
6. Equity Underwriting
Merchant banks offer equity underwriting as a premium service. These banks assess the levels of price and risk involved in a particular asset and initiate public issues and distribution of stocks.
7. Issue Management
Merchant banks help clients issue equity shares, preference shares, debentures, and other types of securities to the general public.
Also Read
Services Offered by Merchant Banks
- Marketing and underwriting of new issues
- Merger and acquisitions
- Corporate finance management and advisory
- Project financing and management
- Management of customer security
- Portfolio services
- Investment banking
- Trade finance and advisory
- Venture capital fundraising and advisory
- Management of assets
Features of Merchant Banks
- Merchant banks are non-depository banks that generally do not cater to the banking and finance needs of the general public.
- Merchant banking is a select set of professional services available to large corporations, HNIs, institutional investors, and venture capitalists, among others.
- These banks usually make money through commissions and consultation charges.
- However, the profit distribution of these banks generally tends to be poor.
- These banks tend to be cash-rich.
- Merchant banks are known for their premium services, speed of decision-making, and customer-centricity.
- Merchant banks have a strong network, a large team of financial experts, and generally sit on a huge pile of data.
- These banks can even advise their customers on matters of international trade, and overseas acquisitions or mergers.
Differences Between Merchant Banking and Investment Banking
| Merchant Banking | Investment Banking |
| Helps companies raise funds by offering capital issues management services | Usually acts as an intermediary between a company issuing securities and investors |
| Generally focuses on internal trade, expansion through strategic partnerships, acquisitions, and mergers, etc. | Focuses primarily on equity issue and underwriting activities |
| Generally caters to the financing and banking needs of small companies and wealthy individuals | Their client list usually involves large corporations and institutional investors |
| Offers international trade financing services | Rarely offers this service |
| Usually earns by offering advisory, trade finance, custodial, and safekeeping services | Usually earns through commissions, lease rentals, and interest charges |
Final Word
Merchant banks are non-depository financial institutions that offer services to wealthy individuals and enterprises that require capital raising, financial advisory, or assistance with international trade. Currently, there are 135 SEBI-registered merchant banks in India, who are working relentlessly to meet the financing and banking needs of their customers.
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FAQs
The two most common types of merchant banking are public and private sector merchant banks.
The primary objectives of merchant banking include providing funds to companies, underwriting, managing their portfolios, offering corporate advisory, and managing corporate issues.
The primary characteristics of merchant banking include a quick decision process, high density of information, loose organisational structure, the concentration of short and medium-term engagements, emphasis on fee and commission income, low-profit distribution rate, high liquidity ratio, and more.
Merchant banks process short-term and long-term credit applications from financial institutions. In addition to estimating the total costs involved, they develop a financial plan for the entire project and prepare a loan application for lenders.
Disclaimer
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
