Management of Financial Services M.COM: Unit 2 [PDF]

Management of Financial Services : Unit 2

Merchant banking refers to a range of financial services provided by banks and financial institutions to corporations, governments, and high-net-worth individuals. These services typically include investment banking, corporate advisory, underwriting, mergers and acquisitions (M&A) advisory, and securities trading.

Merchant banks typically work with large corporations and institutions, helping them raise capital through various means such as issuing stocks or bonds, structuring financing deals, and providing advice on strategic matters like mergers and acquisitions. They may also engage in proprietary trading and invest their own capital in various financial instruments.

Origin of Merchant Banking:-

The origins of merchant banking can be traced back to late medieval Italy, specifically to the 11th century. During this time, Italian merchants, particularly those involved in the grain and cloth trade, began to offer financial services to other merchants. These services included:

  • Lending money: Merchants would lend money to other merchants to finance their trade ventures.
  • Exchanging currency: Merchants would exchange currency for merchants traveling to different countries.
  • Storing valuables: Merchants would store valuables for other merchants who were traveling.
  • Merchants would issue bills of exchange, which were essentially IOUs that could be used to pay for goods or services in other locations.

These early merchant banks played a crucial role in the development of modern banking. They helped to facilitate trade and commerce. And they laid the foundation for the many financial services that we take for granted today.

Merchant Banking Meaning:-

Merchant banking refers to the financial services provided by specialized banks or financial institutions to corporations, governments, and wealthy individuals. These services typically include investment banking, corporate advisory, underwriting, mergers and acquisitions (M&A) advice, and securities trading.

Here are shorter definitions of merchant banking from various authors:

  1. “Merchant banking: financial services offered by banks to corporations and governments, including corporate advisory, underwriting, and securities trading.” – Investopedia
  2. “Merchant banking: specialized financial services provided by banks to large corporations and institutions, encompassing investment banking, corporate advisory, and securities trading.” – The Balance
  3. “Merchant banking: banking activities focused on providing investment and advisory services to businesses, governments, and wealthy individuals.” – Financial Times

Nature/Characteristics of Merchant Banking:-

The nature or characteristics of merchant banking include:

1. Specialization:

Merchant banks specialize in providing a range of financial services tailored to the needs of corporate clients, governments, and high-net-worth individuals.

2. Advisory Services:

Merchant banks offer expert advice on various financial matters, including mergers and acquisitions, capital raising, corporate restructuring, and strategic planning.

3. Underwriting:

Merchant banks often underwrite securities issuances, such as initial public offerings (IPOs) or bond offerings, helping clients raise capital by purchasing and reselling these securities to investors.

4. Risk Capital:

They may invest their own capital alongside clients in various financial ventures, demonstrating a willingness to take on risk and share in potential rewards.

5. Relationship-Oriented:

Merchant banking relies heavily on building and maintaining long-term relationships with clients, understanding their unique financial needs and providing tailored solutions.

6. Global Reach:

Many merchant banks operate internationally, facilitating cross-border transactions and providing access to global markets for their clients.

Functions of Merchant Banks:-

1. Corporate Advisory:

Providing advice to corporations on a wide range of financial matters, including mergers and acquisitions, capital structure optimization, strategic planning, and risk management.

2. Underwriting:

Assisting companies in issuing new securities, such as stocks or bonds, by purchasing them from the issuer and reselling them to investors. This helps companies raise capital for various projects and expansion plans.

3. Capital Raising:

Helping companies raise funds through various means, including initial public offerings (IPOs), rights issues, private placements, and debt offerings. Merchant banks advise on the most suitable financing options and assist in structuring and executing the fundraising process.

4. Mergers and Acquisitions (M&A) Advisory:

Advising companies on mergers, acquisitions, divestitures, joint ventures, and other strategic transactions. Merchant banks assist in identifying potential targets or partners, conducting due diligence, negotiating deals, and structuring transactions to maximize value for clients.

5. Structured Finance:

Designing and executing complex financial transactions tailored to the specific needs of clients, such as project financing, securitization, asset-backed lending, and structured products.

6. Private Equity and Venture Capital:

Investing in private companies or providing growth capital to support their expansion plans. Merchant banks may also manage private equity or venture capital funds on behalf of investors.

7. Risk Management:

Assisting clients in identifying, assessing, and managing financial risks associated with their business activities, including market risk, credit risk, liquidity risk, and operational risk.

8. Wealth Management:

Offering personalized investment management and financial planning services to high-net-worth individuals, families, and institutional investors.


Underwriting is a financial service provided by merchant bankers or investment banks to companies issuing securities, such as stocks or bonds.

Underwriting involves assuming the risk of loss associated with a transaction or investment. In insurance, underwriters agree to indemnify the policyholder against specified risks in exchange for the payment of premiums. In securities markets, underwriters purchase securities from issuers and assume the risk of being unable to sell them to investors at the agreed-upon price or at all. Underwriters may also engage in market making activities to provide liquidity and manage risk.

Features of Underwriting:-

1. Risk Assessment:

Underwriting involves a comprehensive evaluation of the risks associated with a particular transaction or investment. This assessment includes analyzing various factors such as the applicant’s health, financial condition, creditworthiness, and the nature of the transaction itself.

2. Risk Pricing:

Once the risks have been assessed, underwriters determine the appropriate pricing or terms for assuming those risks. This involves setting premiums, interest rates, or offering prices that reflect the level of risk involved and ensure profitability for the underwriter.

3. Assumption of Risk:

Underwriting entails assuming the risk of loss associated with the transaction or investment. In insurance, underwriters agree to indemnify the policyholder against specified risks in exchange for premiums. In securities markets, underwriters purchase securities from issuers and assume the risk of being unable to sell them to investors at the agreed-upon price or at all.

4. Expertise and Knowledge:

Underwriting requires specialized expertise, knowledge, and analytical skills. Underwriters often have a deep understanding of the industry, regulatory requirements, and market conditions relevant to the transaction. They use this expertise to assess risks accurately and make informed decisions.

5. Financial Intermediation:

Underwriting serves as a financial intermediary between parties involved in the transaction. For example, in insurance, underwriters facilitate the transfer of risk from policyholders to insurers. In securities markets, underwriters facilitate the issuance and distribution of securities between issuers and investors.

6. Risk Management:

Underwriting plays a crucial role in risk management by ensuring that risks are properly assessed, priced, and managed. Underwriters use various risk mitigation techniques such as diversification, hedging, and setting appropriate reserves to protect against potential losses.

7. Regulatory Compliance:

Underwriting activities are often subject to regulatory oversight and compliance requirements. Underwriters must adhere to relevant laws, regulations, and industry standards to ensure transparency, fairness, and consumer protection.

SEBI Guidelines With regard to Underwriting:-

The Securities and Exchange Board of India (SEBI) has issued guidelines and regulations governing underwriting activities in India. Some key aspects of SEBI guidelines with regard to underwriting include:

1. Underwriting Regulations:

SEBI has established comprehensive regulations governing underwriting activities through the SEBI (Underwriters) Regulations, 1993. These regulations outline the eligibility criteria, registration process, obligations, and responsibilities of underwriters operating in India.

2. Registration Requirements:

Under SEBI regulations, entities seeking to engage in underwriting activities must obtain registration as an underwriter from SEBI. The registration process involves meeting certain eligibility criteria, such as minimum net worth requirements and compliance with fit and proper criteria for directors and key personnel.

3. Underwriting Commitment:

SEBI regulations require underwriters to make a firm commitment to subscribe to a certain portion of the securities being issued by a company in case of undersubscription by investors during the public offering. Underwriters must disclose the extent of their underwriting commitment in the offer document.

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4. Due Diligence:

Under SEBI guidelines, underwriters are required to conduct thorough due diligence on the issuer and the proposed offering before agreeing to underwrite the securities. This includes assessing the issuer’s financial condition, business prospects, management quality, and compliance with regulatory requirements.

5. Disclosure :

SEBI regulations mandate underwriters to disclose all material information pertaining to the underwriting agreement, including the underwriting commission or fee, any potential conflicts of interest, and the extent of the underwriting commitment, in the offer document and other public disclosures.

6. Underwriting Fees:

SEBI guidelines specify the maximum underwriting commission or fee that underwriters can charge for their services. The underwriting fee must be reasonable and disclosed upfront to investors. Any deviations from the prescribed fee structure require prior approval from SEBI.

7. Monitoring and Compliance:

SEBI monitors the activities of underwriters to ensure compliance with regulatory requirements and investor protection standards. Underwriters are subject to periodic inspections, audits, and scrutiny by SEBI to assess their adherence to underwriting regulations and guidelines.

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