Merchant Banking: Importance in India Essay Example

issues like corporate mergers, etc. involved in the ownership of commercial ventures. This organization may be a bank, corporate body, firm or proprietary concern.

HISTORY OF MERCHANT BANKING

During the seventeenth and most of the eighteenth century international finance was centered on Amsterdam. Consequently Amsterdam merchants became the first masters of the various financial techniques and developments which, in the course of time, became identified with the emergent profession of ‘Merchant Bankers’.

Commercial Banking and Investment Banking are often confused with Merchant Banking. In many ways, there may be similarities in their functions. However, in certain ways, Merchant Banking is distinctly different from commercial Banking and Investment Banking. The primary function of a commercial bank is to receive deposits from the public and lend the same to others. Commercial Banks can undertake some of the merchant banking activities like Issue Management whereas Merchant Banking Units can not undertake commercial banking activities. However, the functions of Merchant Banking may not widely vary from Investment Banking.

The Merchant Banker mainly deals with Issue Management, post issue services, corporate adviser services etc. the Investment Banker undertaken trading in securities, Investment advises and Bought out deals which are not the main activities of Merchant Bankers. In today’s Scenario the Merchant banker and management consultants undertake advisory services to the corporate sector. The Merchant Banker advices corporation and firms relating to opening of issues, receiving loans etc, which the management consultants also do. The management consultant have a wide area operations like production, Marketing, Personnel Relations, of finance etc. ut they lack statutory recognition to undertake capital market related activities which has enabled the merchant banker to cater to the needs of

the Corporate Sector. A merchant bank may be considered as an institution which centres its operation on all or most of the following activities:

• Corporate financial advice, on such diverse matters as new share and bond issues, capital reconstructions, mergers and acquisitions;
• The taking of deposits and currency, money market operations including foreign exchange dealing;
• Medium-term lending and syndication of loans;
• Acceptance credits and all forms of export finance;
• The holding and dealing in quoted and unquoted investment;
• Fund management on behalf of clients, most typically pension funds, unit trust, investment trusts and wealthy individuals.

DEFINITION

The first authoritative definition for the term ‘Merchant Banker’ has been given in the Rule 2 (e) of SEBI (Merchant Bankers) Rules, 1922. Accordingly, “A Merchant Banker means any person who is engaged in the business of Issue Management either by making arrangements regarding selling, buying or subscribing to Securities as Manager, Consultant, Adviser of rendering Corporate Advisory Service in relation to such Issue Management”.

Sec/5 (b) of the Banking Regulation Act, 1949 defines Banking as “accepting, for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft, order or otherwise”. The Notification of the Ministry of Finance defines a merchant banker as, “any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to the securities as manager, consult, adviser or rendering corporate advisory service in relation to such issue management”.

Merchant bankers and market making Many successful public issues get listed on the stock exchanges but later do not see any trade i. e liquidity in the market.

Listing remains a formality only and investors practically cannot buy/sell shares of that company for lack of liquidity (volume). In well organized markets, there is a system of market makers who offer two way quotes on any scrip, so that continuous liquidity is provided to all scrips. Market making means that a trader or a company puts both buy and sell orders into the market, and wait for people to trade with him on either sides.

Market making could be made compulsory at least for a period of six to twelve months after listing of issues. Most merchant bankers and brokers are significantly undercapitalized to perform

EVOLUTION & EMERGENCE OF MERCHANT BANKING

India has entered the 21st century 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. Indian economy is no exception 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. The progress of the Securities Industry of any country depends mainly on the flow of funds.

In fact, capital generation is the lifeblood of the capital market without which the health and soundness of the financial system cannot be geared and for which well-developed capital market as well as money market is essential. India’s capital market is among the largest in the developing world. The

market is comprised of 24 stock exchanges transacting long-term debt; debentures and equity shares both electronic and physical forms. Derivatives financial instruments are also be added to the market shortly. The number of firms listed on the Indian Stock Exchange is more than the USA.

Market Capitalization of listed firms is 1980s was similar to Brazil, Malaysia, Singapore and Denmark. The capital market of the country, however, underwent dramatic changes since the beginning of 1980s basically because of a progressive realization that the command economy on which the emphasis was placed could not lead to higher levels of economic development and that a slant towards a market-oriented economy is necessary. 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.

No wonder that the markets have registered a quantum jump judge by any standards. MERCHANT BANKING IN INDIA In India prior to the enactment of Indian Companies Act, 1956,managing agents acted as issue houses for securities, evaluated project reports, planned capital structure and to some extent provided venture capital for new firms. Few share broking firms also functioned as merchant bankers. The need for specialized merchant banking services was felt in India with the rapid growth in the number and size of the issues made in the primary market.

The merchant banking services were started by foreign banks, namely the National Grindlays Bank in 1967 and the City Bank in 1970. The Banking Commission in its report in 1972 recommended the setting up of merchant banking institutions. This marked the beginning of specialized merchant banking in India. To begin with,

merchant banking services were offered along with other traditional banking services. In the mid-Eighties, the Banking Regulation Act was amended permitting commercial banks to offer a wide range of financial services through the subsidy rule.

The State Bank of India was the first India Bank to set up merchant Banking division in 1972. Later ICICI set up its Merchant Banking division followed by Bank of India, Bank of Baroda, Canada Bank, Punjab National Bank and UCO Bank. The merchant banking gained prominence during 1983-84 due to new issue boom.

MERCHANT BANKING: PAST AND PRESENT

Many banks entered merchant banking in the 1960s to take advantage of the economies of scope produced when private equity investing is added to other bank services, particularly commercial lending.

As lenders to small and medium-sized companies, banks become knowledgeable about individual firms’ products and prospects and consequently are natural providers of direct private equity investment to these firms. As mentioned above, commercial banks were the largest providers of venture capital in the 1960s. In the middle to late 1980s, the decision to enter merchant banking was thrust on other banks and bank holding companies by unforeseen events.

In those years, as a result of the LDC (less-developed-country) debt crisis, many banks received private equity from developing nations in return for their defaulted loans. At that time, many of these banks set up merchant banking subsidiaries to try to get some value from this private equity. Also at about that time, most commercial banks began refocusing their private equity investments to middle-market and public companies (often low-tech, already profitable companies) and, rather than providing seed capital, financed expansion or changes in capital structure and ownership.

Most

particularly, they took equity positions in LBOs, takeovers, or recapitalizations or provided subordinated debt in the form of bridge loans to facilitate the transaction. Often they did both. Commercial banks financed much of the LBO activity of the 1980s. Then, in the mid-1990s; major commercial banks began once again focusing on venture capital, where they had substantial expertise from their previous exposure to this kind of investment. Some of these recent venture-capital investments have been spectacularly successful.

For example, the Internet search engine Lycos was a 1998 investment of Chase Manhattan’s venture-capital arm. Commercial banks are permitted to report either realized or unrealized gains on their merchant-banking portfolios, as long as they are consistent in the reporting. This option makes it difficult for one to compare different entities’ financial results and could lead to an overly liberal reporting of profits.

NEED & IMPORTANCE IN INDIA

Important reason for the growth of merchant banking is due to exerting excess demand on the sources of funds forever expanding industry and trade. Corporate sector had the only alternative to avail of the capital market services for meeting their long-term financial requirements through capital issues of equity and debentures. With the growing demand for funds there was pressure on capital market that enthused the commercial banks, share brokers and financial consultancy firms to enter into the field of merchant banking and share the growing capital market.

In India have opened their merchant banking windows and are competing in this field, and also doing advisory functions as merchant bankers as well as managing public issues in syndication with other merchant bankers. Merchant banks can play highly significant role in mobilizing funds of savers

to investible channels assuring promising return on investments activity. With the growth of merchant banking profession corporate enterprises in both public and private, sectors would be able to meet the growing requirements for the funds for establishing new enterprises, undertaking expansion/modernization/diversification of the existing enterprises.

Merchant banks have been procuring impressive support from capital market for the corporate sector for financing their projects.  In view of multitude of enactments, rules and regulations, guidelines and offshoot press release instructions brought out by the Government from time to time imposing statutory obligations upon the corporate sector to comply with all those requirements prescribed therein, the need of skilled agency existed which could provide counseling.

Merchant bankers advise the investors of he incentives available in the form of tax relief’s, other statutory relaxations, good return on investment and capital appreciation in such investment to motivate them to invest their savings in securities.  Thus, the merchant bankers help industry and trade to raise funds, and the investors to invest their saved money in sound and healthy concerns with confidence, safety and organizations for higher yields.

ROLE OF MERCHANT BANKERS

The role of merchant banker is dynamic in the wake of diverse nature of merchant banking services. Merchant banker’s dynamism lies in promptly attending to the corporate problems and suggests ways and means to solve it. The nature of merchant banking services is development oriented and promotional to help the industry and trade to grow and survive. Merchant banker is, therefore, dedicated to achieve this objective through his dynamism. He is always awake to renew his skills, develop expertise in new areas so as to equip himself with the knowledge and techniques to

deal with emerging new problems of corporate business world.

He has to keep pace with the changing environment where Government rules, regulations and policies affecting business conditions frequently change; where science and technology create new innovations in production processes of industries envisaging immediate renovations, diversification, modernizations or replacements of existing plant and machinery or other equipments putting new demands for finances and necessitating overhauling of the capital structure of the firms.

Merchant banker has to think and devise new instruments of financing industrial projects. He has to assume wider responsibilities of saving industrial units from going sick and guiding industries to be set up industrially backward areas to eliminate regional imbalances in industrial development of the country. He has to guide the wider section of the community possessing surplus money to invest in corporate securities and other productive investment channels.

He has to help the industry in different forms to ensure that it runs risk free and devoid of uncertainty by assisting the has to watch the interest and win over the confidence of the Government, its agencies, along with the entrepreneurs, the investors and the whole community. He must bridge the communication gap between different sections and resolve the problem being faced in different areas concerned with the business world. To discharge the above role, a merchant banker has t be dynamic.

For this reason, a merchant banker is sometimes, called M. B i. e. Moving Bottom, i. e. , one who never sits at one place, always moving- attending meetings and meeting clients and constituents, doing business and getting business by attending meetings and conferences, imparting knowledge to others and acquiring new knowledge to maintain his supremacy

in possession of latest information. His role depicts a personality cult, which is unique and envious to be followed by others.

In the days ahead, merchant bankers have very significant role to play tuning their activities to the requirements of the growth pattern of corporate sector, the industry and the economy as a whole, which is, in it, a challenging task and to meet these challenges merchant bankers will have to be more vigorous and strategic in playing their role. They will have also to adopt new ways and means in discharging their role.

ROLE IN THE MARKET

The Securities and Exchange Board of India (SEBI) has stated that merchant bankers must be involved more closely in the market making process as share brokers do not have the requisite expertise to evaluate the fundamentals of the scrips before taking over the role of market makers. Further, share brokers generally being partnership; firms do not have the financial clout which is necessary for market making activity. Resultantly, the SEBI has suggested that any member of the stock exchange along with one merchant banker registered with SEBI could act as a market maker.

The SEBI has felt that to ensure liquidity of scrip it was necessary to facilitate greater movement, which could only be achieved through the institution of market makers. Market makers would also create a market for the scrip’s by offering two way quotes to the investors. A minimum of ten scrip’s has been proposed by SEBI for the market makers.