Merchant Banking

Merchant banking refers to specialized financial services provided to corporate clients, high-net-worth individuals, and institutions, mainly related to raising capital and offering financial advice. Unlike commercial banks, merchant bankers do not accept public deposits or provide routine loans.

Their income is primarily fee-based, earned through services such as issue management, underwriting, and corporate advisory. In essence, a merchant banker acts as an intermediary and advisor in the capital market, helping companies mobilize funds and take strategic financial decisions. Under Indian regulations, a merchant banker is broadly defined as an entity engaged in issue management and related advisory services.

Key Characteristics of Merchant Banking

Merchant banking has distinct features that differentiate it from traditional banking.

• Fee-based services: Merchant bankers earn income through advisory fees, commissions, and underwriting charges rather than interest from lending.
• No public deposits: They do not accept demand or savings deposits and are not involved in retail banking activities.
• Corporate-focused clientele: Clients mainly include companies, corporations, government bodies, institutions, and HNIs rather than individual customers.
• Capital market expertise: Merchant bankers specialize in primary market activities and corporate finance, with strong knowledge of securities regulations, market conditions, and investment finance.
• Overlap with investment banking: Globally, merchant banking and investment banking functions largely overlap. In India, merchant bankers are SEBI-registered entities performing capital market and advisory roles similar to investment banks.

Functions of Merchant Bankers

Merchant bankers perform a wide range of corporate finance services.

• Issue management: They manage the issuance of securities such as shares, debentures, and bonds, including IPOs, FPOs, rights issues, and public debt issues, covering planning, compliance, pricing, and marketing.
• Underwriting of securities: They commit to subscribe to any unsubscribed portion of an issue, ensuring fund mobilisation and improving investor confidence.
• Corporate advisory services: These include project counselling, feasibility studies, loan syndication, capital restructuring, and advice on financial strategy, expansion, diversification, and regulatory matters.
• Mergers and acquisitions (M&A): Merchant bankers assist in identifying targets, valuing firms, negotiating terms, and managing mergers, acquisitions, and takeovers.
• Portfolio management: Many merchant bankers offer portfolio management services for wealthy investors and institutions, managing customized investment portfolios.
• Other services: These include foreign fund raising through international markets, offshore fund management, advisory services for NRIs and foreign investors, lease and finance syndication, and venture capital or private equity advisory.

Evolution and Background of Merchant Banking

Merchant banking originated in the medieval trading centres of Europe, where wealthy merchant families financed trade routes, extended credit, and facilitated international commerce. Over time, these activities expanded beyond trade finance to include funding governments and emerging industrial enterprises. By the twentieth century, merchant banking had evolved into a structured financial function supporting corporate fund raising, capital restructuring, and public issue management.

In many Commonwealth countries, including India and the United Kingdom, the term “merchant banker” became closely associated with institutions authorised to manage capital issues, provide underwriting support, and advise companies on mergers, acquisitions, and long-term financial planning. The development of regulatory frameworks strengthened transparency, investor protection, and efficiency in capital markets, shaping the modern role of merchant banking.

Merchant Banking in India: Evolution

Merchant banking in India developed alongside the growth of the capital market.

• It began in the late 1960s with foreign banks offering issue management services.
• In the early 1970s, Indian commercial banks and financial institutions entered the field, institutionalising merchant banking activities.
• During the 1980s, services expanded rapidly with increased public issues and corporate financing needs.
• Initially governed by informal guidelines, merchant banking came under a formal regulatory framework with the establishment of SEBI.
• The SEBI (Merchant Bankers) Regulations introduced mandatory registration, capital adequacy norms, and professional standards.
• In the post-liberalisation period, many merchant bankers evolved into full-fledged investment banking entities handling large public issues, debt offerings, and complex advisory assignments.

Regulatory Environment

Merchant banking activities are governed by strict regulatory guidelines to protect investors and maintain market integrity.

• In India, merchant bankers are regulated by SEBI under the SEBI (Merchant Bankers) Regulations, which mandate registration, capital adequacy, and periodic compliance audits.
• In the United Kingdom, merchant banking activities fall within the broader investment banking framework and are regulated by the Financial Conduct Authority.
• Compliance responsibilities include due diligence, accurate disclosures, proper record maintenance, avoidance of conflicts of interest, and adherence to prescribed codes of conduct.
  These regulations ensure transparency, fairness, and accountability in handling sensitive financial information and high-value transactions.

Merchant Banking vs Commercial Banking

Commercial banks accept public deposits and provide loans, earning income through interest. They cater to everyday banking and credit needs. Merchant banks, in contrast, do not accept deposits or provide retail loans. They focus on capital market activities and advisory services, earning fee-based income. A commercial bank may fund expansion through a loan, whereas a merchant bank helps raise funds through equity or debt issues.

Merchant Banking vs Investment Banking

Internationally, investment banking is the commonly used term and includes underwriting, trading, brokerage, and asset management. Historically, merchant banking had a narrower scope, but functions have largely converged. In India, “merchant banker” is the regulatory term for entities performing primary market and corporate advisory functions.

Role of Merchant Bankers in Issue Management

Issue management is one of the most important functions of merchant bankers. It involves planning, coordinating, and executing the process of raising funds through the issue of securities.

Initial Public Offer (IPO)

In an IPO, a company offers its shares to the public for the first time and becomes listed on a stock exchange. Merchant bankers act as Lead Managers or Book Running Lead Managers and handle the entire IPO process.
Their role includes conducting due diligence, advising on issue size, pricing, and timing, preparing and filing offer documents such as the Draft Red Herring Prospectus, coordinating with SEBI and stock exchanges, marketing the issue through roadshows, managing the book-building process, arranging underwriting, and ensuring allotment, refunds, listing, and post-issue compliance.

Follow-on Public Offer (FPO)

An FPO is a public issue of shares by an already listed company. Merchant bankers advise on the structure and pricing of the issue, update offer documents, ensure regulatory approvals, market the issue to investors, manage subscriptions, and oversee allotment and listing. Since the company is already known to the market, FPOs generally involve lower informational risk compared to IPOs.

Bond and Debenture Issues

Merchant bankers also manage debt issues such as bonds and debentures. Their responsibilities include advising on the structure of the instrument (interest rate, tenure, security), ensuring regulatory compliance, assisting in obtaining credit ratings, appointing debenture trustees, preparing offer documents, marketing the issue, arranging underwriting if required, and ensuring allotment, demat credit, and listing of debt securities.
Overall, in issue management, merchant bankers act as project managers who ensure smooth fund mobilisation, regulatory compliance, and investor confidence.

Underwriting of Securities

Underwriting refers to the commitment to subscribe to any portion of a security issue that remains unsubscribed by the public. Merchant bankers either underwrite issues themselves or arrange underwriting through a syndicate.
Their role includes assessing the risk of the issue, deciding the extent of underwriting, negotiating underwriting commissions, and ensuring that funds are raised even in case of weak investor response. Underwriting enhances the credibility of an issue and provides assurance to the issuer regarding successful capital mobilisation.

Role in Mergers, Acquisitions, and Takeovers

Merchant bankers play a critical advisory role in mergers, acquisitions, and takeovers. They assist companies in identifying suitable targets or buyers, conducting valuation of businesses, advising on deal structure, and supporting negotiations between parties.
They also manage regulatory compliance, prepare transaction documentation, and coordinate the execution of the deal. In takeover situations, merchant bankers ensure compliance with takeover regulations and protect the interests of shareholders. Their role is essential in facilitating corporate restructuring and strategic growth.

Corporate Advisory Services

Corporate advisory is a broad function that involves advising companies on financial strategy and decision-making. Merchant bankers provide services such as project appraisal and feasibility studies, capital structuring, balance sheet restructuring, loan syndication, and advice on expansion, diversification, and joint ventures.
They guide firms in selecting optimal sources of finance, managing financial risk, and complying with regulatory requirements. These advisory services support long-term financial planning and corporate sustainability.

Private Placement

Private placement involves raising capital by issuing securities to a select group of investors rather than to the general public. Merchant bankers advise on structuring private placement deals, identifying suitable institutional or high-net-worth investors, negotiating terms, and ensuring regulatory compliance.
Compared to public issues, private placements are faster, involve lower disclosure requirements, and are cost-effective. Merchant bankers act as arrangers and intermediaries, ensuring efficient fund raising for issuers.

Portfolio Management

Many merchant bankers offer portfolio management services, especially to high-net-worth individuals and institutions. Under this function, they design and manage customized investment portfolios based on the client’s risk appetite, return objectives, and investment horizon.
Their role includes asset allocation, security selection, continuous monitoring, and periodic reporting. Portfolio management reflects the advisory and investment expertise of merchant bankers in capital markets.