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Merchant Banking

EXECUTIVE SUMMARY

Although merchant banking activity was ushered in two decades ago, it was only in 1992 after the formation of Securities and Exchange Board of India that it is defined and a set of rules and regulations in place. Today a merchant is who has the ability to merchandise that is, create or expand a need and fulfill capital requirements.

I have given an overview about the financial markets and the role of merchant bankers in the growth of these markets. My project covers how the merchant works, rules & regulations laid by SEBI & its impact on the merchant banking activities. Their importance in the economy is expected to grow even further in the coming years with an increasing proportion of household savings getting invested in corporate & other securities. Hence, my project covers the challenges and advantages, which India will get and is getting by merchant banking activities. I have covered several services provided by Merchant Bankers & the role of Merchant bankers in providing those services to the business world. Finally, the top players, which exist in merchant banking, are also covered; their services are also been focused. To get the practical knowledge about merchant banking activities I have interviewed visited State of India, Kotak mahindra bank and SPA Merchant bankers ltd.

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INDEX

SR.NO. CONTENTS PAGE NO. 1. Introduction 1 2. History 2 3. Definition 4 4. Evolution & Emergence of Merchant 5 Banking 5. Merchant Banking in India 6. Merchant banking past and present 7 7. Need & Importance in India 8 8. Role of Merchant Bankers 9 9. Merchant Bankers Commission 11 10. Commercial Banks & Merchant Baks 12 11. Growth of Merchant Banks in India 13 12. Problems of Merchant Bankers 14 13. Current Scenario 15 14. Merchant Banking Indian Scenario 16 15. Merchant Banking International 17 Scenario 16. Merchant Banking Organisation 19 17. Qualities of good Merchant Bankers 20 18. Responsibilities of Merchant banker 22 19. Registration of Merchant Banker 24 20. Scope of services 26 21. Services Rendered by Merchant 27 Bankers 22. Recent Trends 39 23. Players in Merchant Banking 41 24. Merchant Banking – Future 48 Development 25. Questionnaire 51 26. Annexure 53 27. Conclussion 62 28. Bibliography 63

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INTRODUCTION

The term Merchant Banking has its origin in the trading methods of countries in the late eighteenth and early nineteenth century when trade-taking place was financed by bill of exchange drawn by merchanting houses. At that time the merchants were merely financing their own activities. As international trade grew and other lesser- known names wanted to import goods from abroad, the established merchants ‘lent

3 Merchant Banking their names’ to the newcomers by agreeing to accept bills of exchange on their behalf. The acceptance houses would charge a commission for this service and thus there grew up the business of accepting bills of finance trade not merely of themselves, but of others. Acceptance business thus became and to a degree always has been hallmark of true Merchant Banks.

The second historical of Merchant Banks was the raising of capital for foreign Government. In many cases, the Merchant Banks have been trading in the countries concerned and gained the confidence of Governments and other authorities in those countries. Thus the second principal ingredient of Merchant Banking became and still is raising of capital through the issue of stocks and bonds. Therefore, Merchant Banks can be accepting houses or issuing houses or both. Merchant Banking started in the beginning of 20th century in UK and USA. More recently, the services offered by Merchant Banks have entered into the other areas of operations. Their role is wide ranging and they can now provide most of the required by a company, touching almost all aspects of establishing and running of industrial units on sound financial footing.

Dictionary meaning of ‘merchant bank’ refers to an organization that underwrites corporate securities and advises such clients on 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’.

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Commercial Banking and 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 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 and firms relating to opening of issues, receiving etc, which the management consultants also do. The management consultant have a wide area operations like production, Marketing, Personnel Relations, of finance etc. but 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. (1) Corporate financial advice, on such diverse matters as new share and issues, capital reconstructions, ; (2) The taking of deposits and currency, operations including foreign exchange dealing; (3) Medium-term lending and syndication of loans; (4) Acceptance credits and all forms of export finance; (5) The holding and dealing in quoted and unquoted investment; and (6) Fund management on behalf of clients, most typically pension funds, unit trust, investment trusts and wealthy individuals.

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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”.

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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 , 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

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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 ; 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.

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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 and to some extent provided 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 and UCO Bank. The merchant banking gained prominence during 1983-84 due to new issue boom.

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MERCHANT BANKING: PAST AND PRESENT

Many banks entered merchant banking in the 1960s to take advantage of the economies of scope produced when 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

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