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CHAPTER- I

INTRODUCTION
The financial system of a country is a complex and closely integrated set of
sub systems of financial institutions, markets, instruments and financial services
which facilitate the transfer and allocation of funds efficiently and effectively. The
Indian financial system consists of both organized (formal) and unorganized
(informal) segments. The formal financial system comes under the purview of
Ministry of Finance, Reserve Bank of India, Securities and Exchange Board of India
and other regulatory bodies.
Financial institutions are the intermediaries who facilitate in mobilizing
savings and allocation of funds in an efficient manner and include banking and non
banking institutions. Financial markets provide the transmission mechanism whereby
various participants demands and requirements interact to set a price for financial
claims. The main financial markets in India include the market for short term
securities (money market) and for long term securities (capital market). Financial
markets are also classified as primary and secondary markets. While the primary
market deals in new issue of securities, the secondary market is meant for trading in
existing securities (stock exchange and over the counter market). Primary equity
market includes public issues, right issues, offer for shares and private placement of
shares. Financial instruments represent the claims against a person or an institution for
the payment at a future date, a sum of money and/or a periodic payment in the form of
interest or dividend. Financial securities are classified as primary (direct) and
secondary (indirect) securities. The primary securities are issued by the ultimate
borrower of funds to the ultimate investor as shares and debentures while secondary
securities are issued by the financial intermediaries to the ultimate savers (bank
deposits, insurance policies, mutual funds etc.).
Financial services are the services which facilitate financial transactions of
individuals and institutional investors resulting in the resource allocation activities
through time. These services bridge the gap between lack of knowledge on the part of
investors and increasing sophistication of financial instruments and markets. Since the
liberalization and deregulation of Indian economy, the financial services have found
more scope of growth serving the investors and corporates in a big way. The Indian

economy, as a matter of fact, has experienced the last decade of 20th century as the
decade of financial services. There has been a major shift from bank finance to capital
market for meeting the financial requirements of the corporate sector during this
period. The emergence of different financial institutions and regulatory agencies has
transformed the financial service sector from being a conservative industry to a very
dynamic one. The financial service today is emerging as a strong industry world over
and is termed as a Sunrise industry.
One of the oldest and specialized financial services in the Indian capital
market has been merchant banking service. The merchant bankers have not only
helped in promoting trade and commerce between nations, but have also served the
financial needs of the Kings, Monarchs and State Governments engaged in the
continental wars.

1.1

Origin of Merchant Banking


The origin of merchant banking is traceable to the developments of foreign

trade and finance during the 13th century. During this period, a few firms engaged in
coastal trade and finance spread throughout the European continent were engaged
both in commercial activities and banking activities. These firms also acted as the
bankers to the Kings of the European States, financial coastal trade among European
nations, bore exchange risk and security risk in financing the Kings, Monarchs and
Governments engaged in continental wars. The main centre for world trade and
finance at that time was Amsterdam, where the Dutch traders relied upon the expertise
of merchant bankers (then known as commission agents) for financing of trade.
During the seventeenth and eighteenth century, the Italian grain merchants also
started merchant banking activities in Italy and France. It comprised of merchant
bankers who intermediated in financing the transactions of the traders and their own
trade also. The Italian merchant bankers introduced into England not only the bill of
exchange, but also all the institutions and techniques connected with the organized
money market. Thus, the modern merchant banking started from London where the
merchants started to finance the foreign trade through acceptance of bill of exchange.
The industrial revolution in England gave further boost to the merchant banking due
to the growth of the home industry.

1.2

Meaning of Merchant Banking


The term merchant banking is easier to understand than to define because one

can only make an attempt to identify the services and activities coming within its
purview. Very commonly, the merchant banking has been defined as to what a
merchant banker does.1 As stated by Sir Edward Reid, the term merchant bank is
sometimes applied to banks who are not merchants, sometimes to merchants who are
not banks, and sometimes to houses who are neither merchants nor banks2. According
to Michael T. Skully, Merchant banking within the same country may cover wide
range of financial activities and in process include a number of different financial
institutions3. John Dick was of the view that due to the dynamic nature of functions
of merchant banks, the meaning and definition of merchant banking has been
changing. He has stated, of its very nature as merchant banking is always evolving
the definitions supplied today would perhaps not be the same as they were three or
four years ago4. Hans- Peter Bauer has suggested that merchant bank should contain
some eleven characteristics: high portion of decision-makers as a percentage of total
staff, quick decision process, high density of information, intense contact with the
environment, loose organizational structure, concentration of short and medium term
engagements, emphasis on fee and commission income, innovative instead of
repetitive operation, sophistical services on national and international level, low rate
of profit distribution and high liquidity ratio5.
In the Indian context, merchant bank has been defined by V. Gangadhar and
M. Sunder as a service activity. Accordingly, banking departments rendering non-fund
based services of arranging funds rather than providing them to the needing industrial
concerns is called merchant banking6. As per the Securities and Exchange Board of
India (Merchant Banker) Regulation, 1992, a merchant banker has been defined as
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 or rendering corporate advisory services in relation to such issue
management.
It is not necessary that merchant banker should do all activities associated with
a merchant banker. One merchant banker may specialize in one activity only, and take
up other activities also, which may be complementary, supportive or specialized
activity.

Merchant banks are known as Accepting and issuing houses in UK and as


Investment banks in USA. However, the services provided by these institutions
differ from country to country.

1.2.1 Merchant Banks and Investment Banks


Merchant banking and investment banking are interchangeable terms, but the
practices and procedures followed in USA for selling the securities distinguish it with
the rest of the world. Merchant banking is the function of intermediation in the capital
market and is purely a fee based activity (except underwriting), whereas, investment
banking is both fee and fund based activity.
Merchant bankers assist issuer to raise capital and are responsible for
successful management of capital issues. They have also the responsibility towards
investors. The regulatory authorities require the merchant banking firms to observe a
code of conduct and ensure compliance with the law on account and on behalf of
issuer.
Investment banking, however, is wider term. It provides capital by buying
whole issues of securities and distributing them to the public. Thus, they perform the
function of a middleman as originator of new issues, wholesaler of securities and
responsible for sharing risk through underwriting operations. Investment banks also
provide a host of specialized corporate advisory services in the area of project
counseling, business and financial counseling and merger and acquisitions.

1.3

Merchant Banking in India


Agency houses were the traditional name given to the merchant trading in

India and Far East. During 1813, trade and commerce developed in India through the
agency houses based in London. John Palmer & Co. was the leading agency house
during this period and it operated the banking activities from Calcutta. These agency
houses had employed their growing capital in trade and commerce.
Thomas Skinners annual directories London Banks (1880) traces the origin
and growth of merchant banking activities in India and Far East. An Anglo-American
merchant bank (Baring Brothers) moved into the financing of India and Far Eastern
trade during 1830. When the First World War broke out, there were as many as twenty
one financial firms with considerable commitment in Central Europe and at least
eighteen firms with major interest in India and Far East.

Crooper Benson & Co, the premier cotton importer of Europe was operating in
India during 1820s and conducted major trade for about three generations through
Calcutta. They were followed by Ogilvy Gillanden & Co. in 1824 and Hong-Kong &
Shanghai Bank in 1864.
The foreign merchant bankers operated in India through an agency house
which was known as East India House. It was representing a group that produced
several merchant bankers during the 19th century; two of them, that is, Gladstone and
the Arbuthnot remained in East India trade. But the merchant bankers had to face stiff
competition from Persian Finance House and ultimately failed.
In the late 1860s, East India merchants had enough capital to invest in trade
and they floated joint stock banks with their own investments. Despite the opposition
from East India Company, some new banks were founded which included: Orient
Bank in 1845, Chartered Bank of India and Chartered bank of Asia in 1853, Chartered
Mercantile Bank of India, London; and Agra & United Provinces Bank in 1857.
These banks were operating not only in the area of banking, but were also
financing trade transactions. London based merchant bankers had full control over the
management of these banks through their Managing Agents. The managing agency
system devised by these merchant bankers gave major fillip to trading and banking
activities of foreign merchants in India. The managing agency system enabled a single
firm to look after a number of firms in complimentary industries7. As a result, the
banking industry developed in India on the full support of London based merchant
bankers.

1.3.1 Managing Agency System as Merchant Banking


The London based merchants and merchant

bankers entered into

manufacturing and trading activities through managing agents and they owned large
proportions of securities of the companies floated by them. They also distributed a
large number of securities amongst their friends and relatives. Merchant banking did
not develop in India because of the monopoly of these managing agents and managing
agency houses performed the functions to be performed by merchant bankers in India.
They acted as issue houses of securities, planning for long term investment, providing
risk capital and undertook preliminary investigation of projects.
In 1951, more than 600 industrial establishments were managed under the
managing agency system out of which 200 establishments were controlled and

managed by nine leading British managing agency houses, namely, Andrew Yule,
Meleods, Martin Bird, Jardine, Henderson, Duncan, Octavins, Gillanders and British
India Corporation.
In the pre world war-II era, Indian managing agency houses were established
on the British pattern and started as family business but later on, these converted into
partnership and public limited companies. These managing agency houses included
Tatas, Birlas, Dalmias, Singhanias, Thapars, Bhadanis, Narangs, Ruias Podders and
JKs8.
With a view to provide adequate information to investors, an amendment was
made in Indian Companies Act, 1936 which made it obligatory to include in the
prospectus, the names of the underwriters, commission payable to them and a
statement by the directors that underwriters have requisite financial resources. The
contracts between the company and the underwriters were also made accessible to the
shareholders9. As a result, capital market in India witnessed the emergence of
increasing number of stock brokers in post world war-II period. Companies Act was
further amended to streamline the procedure for capital issues and it further facilitated
the growth of capital market in India.

1.3.2 Merchant Banking in Post Independence Period


India inherited an underdeveloped capital market from the British rulers.
Managing agency system was more driven by their personal gains rather than being
helpful in the development of capital market in the economy.
After independence, Government of India adopted the model of planned
economic development for the country and a need was felt to have a strong industrial
base in the economy. Growth of Indian capital market was considered as one of the
key areas for accelerating the pace of economic development by mobilising savings
from household and business sector into the channel of investment for trade and
industry. Drastic amendments were made in the legislative framework relating to
growth of corporate sector, viz, Companies Act, Capital Issues (Control) Act, Banking
Companies Act etc. The managing agency system was sought to be abolished.
Post independence period up to the year 1969 saw the emergence of All India
financial institutions like IFCI, ICICI, IDBI, LIC, UTI and commercial banks playing,
in one way or other, the role of merchant banking in the Indian financial system. They
had a significant role in underwriting the capital issues besides lending support to

broking houses for placing the issue through prospectus before the public for
subscription. But the growth of the capital market remained limited during this period.
So the need for broad based merchant banking services was felt to meet the growing
need for capital.
The formal merchant banking service in Indian capital market was initiated in
1967, when Reserve Bank of India (RBI) granted licence to The National Grindlays
Bank to perform the services relating to issue management. The Bank started
merchant banking services by opening merchant banking Division within the bank in
1969. The First National City Bank followed the Grindlays Bank by opening a
Management Consultant Division in 1970. Both these banks acted as managers to
the issues.
In 1971, Stock Exchange Division under the Ministry of Finance examined the
merchant banking role of these foreign banks vis--vis the old existing organization of
stock brokers. It came to the conclusion that the services rendered by these foreign
merchant

bankers were not different from those what the Indian investment broking

firms have been extending to new issues. These banks did not handle any issue
promoted by new entrepreneurs or any small issues during this period. Also, they
could not provide any new skill and expertise in the area of merchant banking
activities.
With a view to end monopoly of these foreign banks in merchant banking
activities, the Govt. traced out the possibility of commercial banks to undertake the
management and underwriting of public issues. Banking Commission 1972, in its
report considered the need for specialized financial institutions and banks which could
provide facilities like backing the issue, underwriting and distribution of capital
issues. The Commission suggested not only the commercial banks, but also other
institutions may also be allowed to set up merchant banking institutions subject to
proper safeguards to ensure integrity to the operations.
On the recommendations of Banking Commission, State Bank of India (SBI)
became the first Indian bank to start with the merchant banking activities in 1972-73
by opening Merchant Banking Division at its head office in Bombay and sub offices
as management banking bureau at the other major cities. The other commercial
banks that followed the SBI were Central Bank of India, Bank of India and Syndicate
Bank who started merchant banking services in 1977; Bank of Baroda, Chartered
Bank and Mercantile Bank in 1978; Union Bank of India, UCO Bank, Punjab
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National Bank, Canara Bank and Indian Overseas Bank undertook merchant banking
activities in late 1970s and the early 1980s. Among the development banks, ICICI
started merchant banking activities in 1973, followed by IFCI (1986) and IDBI
(1991).
Merchant banking divisions of commercial banks have been active in a narrow
range of traditional merchant banking services, which mainly included issue
management, underwriting and syndication of loans and provision of advisory
services to corporate clients on fund raising and other financial aspects.
Corresponding to the growth of capital market, the development of merchant
bank scenario has been significant. Following the notification under section 6(1) (o)
of the Banking Regulation Act, 1949, commercial banks were permitted during 1984
to set up subsidiaries for undertaking equipment leasing or investments in shares
within the limits specified in section 19(2) of the above Act. The notification provided
the real impetus to commercial banks and consequently a number of subsidiaries were
established by them to undertake merchant banking activities.
On August 1, 1986, State Bank of India established a wholly owned subsidiary
namely, SBI Capital Market Ltd. to handle the merchant banking activities of the bank
hitherto handled by its merchant

banking division. The lead taken by SBI in

launching a subsidiary exclusively for performing the merchant banking services has
attracted the attention of other leading commercial banks in India. At the end of June
1992, there were nine merchant banking subsidiaries set up by commercial banks with
prior approval of RBI.

1.3.3 Merchant Banking under SEBI Regulations


SEBI, in exercise of the powers conferred under section 30 of the SEBI Act,
1992 has made the different regulations for almost all aspects of capital market. For
regulating the activities of merchant bankers, the Board has enacted SEBI (Merchant
Bankers) Regulations, 1992. The objectives of the merchant banking regulations has
been stated by H.R.Machiraju11 as follows:
The merchant bankers regulations which seek to regulate the raising of funds
in the primary market would assure for the issuer a market for raising resources at low
cost, effectively and easily, ensure a high degree of protection of the interest of the
investors and provide for the merchant bankers dynamic and competitive market with
high standard of professional competence, honesty, integrity and solvency. The

regulations would promote a primary market which is fair, efficient, flexible and
inspire confidence.

1.3.3.1 SEBI (Merchant Bankers) Regulations, 1992


SEBI (Merchant Bankers) Regulations, 1992 have provided five chapters.
Chapter first states the definitions relating to the subject, chapter II contains the
provisions for compulsory registration of merchant bankers with SEBI, capital
adequacy requirements, renewal of certificate and fee payable to SEBI. Chapter III
deals with the general obligations and responsibilities of merchant bankers including
code of conduct to be observed while performing merchant banking activities. In
chapter IV, procedure for inspection of books of accounts, records and documents of
the merchant bankers by SEBI has been specified. Chapter V states the procedure for
action against merchant bankers in case of default: suspension or cancellation of
registration of merchant bankers by SEBI. Important provisions of the above
regulations have been explained below:(i)

Classification of Merchant Bankers


The SEBI has classified merchant bankers under four categories for the

purpose of registration.
Category-I

can act as issue manager, advisor, consultant, underwriter and portfolio


manager.

Category-II

can act as advisor, consultant, underwriter and portfolio manager.

Category-III

can act as underwriter, advisor and consultant only.

Category-IV can act as consultant or advisor to the issue of capital.


Thus, only Category-I merchant bankers could act as lead managers to an
issue. However, with effect from December 9, 1997, different categories of merchant
bankers were abolished and only Category-I merchant bankers are registered by the
SEBI.
(ii)

Capital Adequacy Norms


For registration of merchant bankers of various categories, SEBI has

prescribed capital adequacy norms. Minimum net worth of category I was fixed at
Rs. 1.00 crore which was further raised to Rs. 5.00 crore by an amendment in the
regulations in 1995. For category II, the minimum net worth was fixed as Rs. 50.00
lakhs, while for category III, this amount was Rs. 20.00 lakhs. Category IV was not
required to have any capital or net worth.

(iii)

Restriction on Appointment of Lead Managers


The regulations state that the number of lead merchant bankers (issue manager

to the issue) may not exceed in the case of any issue of


Size of the issue

No. of lead managers

(a)

Less than Rs. 50 crore

Two

(b)

Rs. 50 crore but less than Rs. 100 crore

Three

(c)

Rs. Rs. 100 crore but less than Rs. 200 crore

Four

(d)

Rs. 200 crore but less than Rs. 400 crore

Five

(e)

Above Rs. 400 crore

Five or more as may be


agreed by the board.

This restriction on the number of lead managers for an issue was omitted by an
amendment in regulations on April 19, 2006.
(iv)

Responsibilities of Lead Managers


The Regulations state that no lead manager shall agree to manage or be

associated with any issue unless his responsibilities relating to issue mainly those of
disclosures, allotment and refund are clearly defined, allocated and determined and a
statement specifying such responsibilities is furnished to the Board at least one month
before the opening of the issue for subscription:
Provided that where there are more than one lead merchant bankers to the
issue, the responsibilities of each of such lead merchant banker shall clearly be
demarcated and a statement specifying such responsibilities shall be furnished to the
Board at least one month before opening of the issue for subscription.
(v)

Underwriting Obligations
In respect of every issue to be managed, the lead merchant banker holding a

certificate under category I shall accept a minimum underwriting obligation of five


percent of the total underwriting commitment or rupees twenty five lakhs, whichever
is less:
Provided that, if the lead merchant banker is unable to accept the minimum
underwriting obligation, that lead merchant banker shall make arrangement for having
the issue underwritten to that extent by a merchant banker associated with the issue,
shall keep the Board informed of such arrangement.

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(vi)

Appointment of Compliance Officer

(a)

Every merchant banker shall appoint a compliance officer who shall be


responsible for monitoring the compliance of the Act, rules and regulations,
notifications, guidelines, instructions etc., issued by SEBI or the Central
Government and for redressal of investors grievances.

(b)

The compliance officer shall immediately and independently report to SEBI


any non-compliance observed by him and ensure that the observations made
or deficiencies pointed out by SEBI on/in the draft prospectus or the letter of
offer as the case may be, do not recur.
However, during the period from 1992-97, there was mushrooming of

merchant bankers registered with SEBI. This was due to low entry barriers (i.e.
minimum net worth of Rs. 1.00 crore for category I merchant bankers up to 1995).
The number of merchant bankers in 1992-93 was only 74. However, the number of
merchant bankers registered with SEBI rose to 422 in 1993-94, 790 in 1994-95, 1012
in 1995-96 and 1163 at the end of 1996-97. Out of the total 1163 merchant bankers at
the end of 1996-97, as many as 720 did not handle any assignment in any capacity
and only 234 category I merchant bankers out of 435, were active in business of issue
management. 130 merchant bankers were also issued show cause notice for their
failure to meet underwriting commitments during 1996-97.
During this period, merchant bankers in India were involved in many
malpractices and they did not bother about the quality of issue, connived with
promoters in floating bad issues and also in cheating investors through price rigging.
Due to intense competition, merchant bankers vied with one another to attract issuing
companies by assuring a good public response to even overpriced issues. There was a
lack of proper appraisal of the issues by the merchant bankers.

1.3.3.2 SEBI (Merchant Bankers) (Amendment) Regulations, 1997


CRB Scam in the capital market in 1997 led to the amendment in the SEBI
(Merchant Bankers) Regulations, 1992. CRB Capital Market, which was registered
with SEBI as category-I merchant banker and had also obtained licence to act as non
banking financial company from RBI collapsed in May 1997 due to bouncing of
cheques issued by the company in favour of its fixed deposit investors. Then came the
end of CRB group, which had floated around 133 subsidiaries and unlisted companies
and had managed to raise around Rs. 900 crore from the public. Then came to light

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the various irregularities on the part of RBI and loopholes in the regulatory frame
work in context of merchant bankers functioning as a non banking financial
institutions also.
There was a lack of co-ordination between RBI and SEBI as in case of Non
banking financial company performing fund based activities (Leasing, hire-purchase
etc.) are controlled by RBI and their fee based activities ( merchant banking activities
and underwriting) are regulated by SEBI. Consequently, SEBI (Merchant bankers)
Amendment Regulations, 1997 was enacted w.e.f. 9th December, 1997. Under this
amendment, only body corporate was allowed to function as merchant bankers and
multiple categories of merchant bankers were abolished. The new entity (merchant
banker) was allowed to undertake only those activities which were related to
securities market including issue management activities and was prohibited from
carrying on fund based activities other than those related exclusively to the capital
market. The SEBI regulations required that the applicant for the regulations of
merchant banker should be a fit and proper person.
In USA, The Glass-Steagall Act, 1933 separated commercial banking (i.e.
deposit taking and loan granting functions) from investment banking (i.e.
underwriting and trading functions). It prohibited any institution from having both the
business. The main purpose behind the segregation was to prevent commercial banks
from taking an extra-ordinary risk. However, this Act was repealed in November,
1999.
With the enactment of SEBI ( Merchant Bankers) Amendment Regulation in
1997, the number of merchant bankers registered with SEBI also declined due to
segregation of fund based and fee based activities, tightening regulations, increase in
the requirement of

net worth to rupees five crore and eligibility of only body

corporate to be the merchant bankers. The number of merchant bankers declined from
802 in 1997-98 to 415 in 1998-99 and further to 186 in 1999-2000. From 2001-02
onward, the number of SEBI registered merchant bankers varied from 145 to 150. On
March 31, 2008, their number stood at 155 which increased to 164 at the end of
March 2010. As a result, there has been a quantitative and qualitative change in
merchant banking scenario in India and only professional merchant bankers,
committed to the profession remained in the field due to tight control of SEBI.
After the above amendments, measures like more transparency in disclosure
requirements in offer documents, submission of prospectus to SEBI for approval, size
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of the issue, its firm allotment to different categories of investors, free pricing through
book building process and mandatory underwriting by lead managers have been
introduced.

1.4

Functions/ Service of Merchant Bankers


Merchant banking is dynamic in nature and so are the services provided by

merchant bankers. Starting from meeting the financial requirements of the merchants
engaged in overseas trade, the services provided by merchant bankers have increased
manifold and are continuously changing. Changes in the types of services performed
by merchant bankers can be attributed partly due to the changing economic
environment and partly due to changing regulatory measures by the regulators.
With the SEBI (Merchant Bankers) Amendment Regulations, 1997, the fee
based and fund based services of merchant bankers have been segregated and
merchant bankers are allowed to carry on the fee based services only. So now-a-days,
the functions performed by merchaqnt bankers in India can be broadly classified as
follows:
i.

Management of capital issues.

ii.

Consultant, adviser of the capital issues.

iii.

Corporate counseling

iv.

Project counseling.

v.

Underwriting of capital issues.

vi.

Capital restructuring services.

vii.

Portfolio management.

viii.

Loan/Credit syndication

ix.

Arranging working capital finance

x.

Arranging foreign currency finance.

xi.

Investment services to non-Indian residents.

xii.

Merger and acquisition services

xiii.

Arranging venture capital

xiv.

Private placement of shares

xv.

Issue manager for PSUs divestment.

xvi.

Financial engineering.

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1.4.1 Issue Management Activities of Merchant Bankers


Mobilisation of resources from the capital market by way of public
issues\offers for sale etc. calls an expert study and proper evaluation of the prevailing
market conditions for which the companies seek the advice of merchant banks.
Management of capital issues constitutes the most important aspect of the services of
the merchant bankers in India. The managing agents for a particular corporate house
used to manage public issues and raise capital from the market with the help of stock
brokers. With the abolition of management agency system, this function has been
taken over by the merchant bankers.
From 1969 onwards, The National Grindlays Bank and Citi Bank introduced
new procedures and techniques in the issue management services. They made the
merchant banking as professional institution in the area of issue management through
separate divisions in their banks known as Merchant Banking Division in Grindlays
Bank and Investment Banking Division in Citi Bank. From 1969 to 1992, merchant
bankers performed issue management activities under the legislative framework of
Capital Issues (Control) Act, 1947. Under the SEBI (Merchant Bankers) Regulations,
1992, SEBI has made it mandatory for every public issue to be managed only by a
registered merchant banker.
The public issue of corporate securities involves basically three functions,
namely (1) origination of the issue (2) risk bearing and risk averting and (3) marketing
of the securities. The public issues are managed by the involvement of various
intermediaries like underwriters, registrar to the issue, bankers to the issue, brokers,
advertising agency, printers and legal advisers. Merchant banker as issue manager
to the public issue plan, coordinate and control the entire issue activities and direct
different intermediaries to contribute to the success of the issue.
As merchant bankers play the role of apex intermediary in the issue
management process, they are called lead manager(s) or lead merchant banker. In case
of book building mechanism, the merchant banker has the primary responsibility of
preparing and maintaining records of book building process. So, merchant banker is
called book runner lead manager (BRLM). The issuer company can appoint more
than one merchant banker as lead manager/BRLM for its issue.
Presently, public issue management activities by merchant bankers are
regulated and monitored by SEBI through the guidelines and clarifications thereto;

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circulars containing instructions to merchant bankers, stock exchanges and other


constituents of the capital market.
The procedure of the managing of public issue by a merchant banker is
divided into two phases:
1.

Pre Issue Management

2.

Post Issue Management

1.4.1.1 Pre Issue Management


Steps required to be undertaken for pre issue management are as follows:
i.

Memorandum of Understanding with the issuer.

ii.

Obtaining stock exchange approval.

iii.

Acting as per SEBI guidelines.

iv.

Appointment of other intermediaries like Registrar to the issue, Bankers to the


issue, Underwriter, Advertising agency and Printers etc.

v.

Drafting the prospectus and application from.

vi.

Obtaining approvals of draft prospectus from the companys legal advisers,


underwriters, financial institutions/banks.

vii.

Appointment of Compliance Officer.

viii.

Filing the draft prospectus with SEBI.

ix.

Incorporating the suggestions/ comments of SEBI in the prospectus.

x.

Finalisation of prospectus.

xi.

Filing the final prospectus with SEBI and Registrar of Companies.

xii.

Agreement with Depositories for dematerialization of securities.

xiii.

Grading the IPO from credit rating agency.

xiv.

Publicity of the issue with road shows and advertisement.

xv.

Due diligence certificate.

xvi.

Fixing the dates for opening and closing the issue.

xvii.

Dispatch of issue material.

xviii. Filing no complaints certificate with SEBI


xix.

Opening the subscription list.

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1.4.1.2 Post Issue Management


Post issue management activities of merchant bankers can be stated as
follows:
i.

Confirmation of minimum subscription (90% of total issue amount) including


devolvement from underwriters.

ii.

Supervision and co-ordination of allotment procedure.

iii.

Ensuring dispatch of allotment letters and refund order.

iv.

Listing of securities with stock exchange(s).

v.

To attend to the investors grievances regarding public issue.

vi.

Submission of post issue monitoring reports to SEBI.

1.5

Primary Capital Market in India


Primary market is that constituent of capital market that deals with the issue of

new securities such as equity shares, preference shares, debentures and bonds by the
companies, governments or public sector institutions to the investors. This market is
also called new issue market (NIM) and is composed of institutions through which
funds can be obtained directly or indirectly.
Primary market can be classified in various ways. The first category of new
issues is by new companies and old companies. This classification was first suggested
by R.F. Henderson.12 The securities issued by companies for the first time either after
the incorporation or conversion from private to public companies are designated as
initial public offerings (IPOs), while those issued by listed companies which already
have stock exchange quotation, either by public issue or by way of rights to existing
shareholders, are referred as further public offers (FPOs).
Public issue of securities dilutes the ownership stake and corporate control as
it provides ownership to investors in the form of equity shares. It can be used as
finance strategy or as exit strategy. As a finance strategy, its main purpose is to raise
funds for the company for additional capital investment. It contributes towards
economic development of the country. When used as an exit strategy, the existing
shareholders (promoters, government. holding company etc.) can offload their equity
holdings to the public. Govt. of India has been using the exit strategy in case of offer
for sale of public sector undertakings shares to public (PSUs disinvestment).
From the operational point of view, three types of services are performed in
the functioning of primary market for channeling the investible funds into industrial

16

enterprises. These are origination, underwriting and distribution. The term


origination refers to the work of investigation, and analysis and processing of new
proposals. It includes the advice to the issuing company for determining the class of
security and its price, timing and size of issue, method of flotation of security and so
on. Underwriting in primary market is in the form of guarantee to the issuer to
subscribe for the shares in case of under subscription by the public. The sale of
securities to the ultimate investors is referred to as distribution. SEBI registered
merchant banker(s) is appointed by the issuer company as lead manager (issue
manager) to co-ordinate the performing of all these services in the primary market.

1.5.1 Methods of Issue of Securities in Primary Market


Under the SEBI guidelines, the securities can be offered for sale in the primary
market in different ways. Each method of issue has got its own procedure and
mechanism. The various methods by which new issues are made include:
(i)

Public Issue through Prospectus


It is a common method followed by corporate bodies to raise capital through

the issue of securities. Under this method, a prospectus is issued to investing public
for inviting subscription of securities. The issuing companies themselves offer directly
to the general public, a fixed number of shares at the stated price. The shares may be
issued at par, at premium or at discount. The prospectus, which is prepared as per the
requirements of chapter VI of the SEBI guidelines, 2000 and the Companies Act,
1956 contains the details of all material information of the company and the issue.
SEBI guidelines provide for and ensure through lead merchant banker, the full
disclosure and transparency in the prospectus. The application forms together with a
copy of prospectus are distributed among the public investors, who offer to buy a
specific number of securities being issued by the companies. Now-a-days, a copy of
prospectus is also put on the websites of SEBI, issuing company, designated stock
exchange and lead merchant banker.
A serious drawback of this method is that, it is very expensive. A high cost of
floatation including underwriting expenses, brokerage and fee to other intermediaries
and the administrative expenses are involved under this method.
(ii)

Offer through Book Building Method


Public issue of securities through the book building process is relatively new

concept in Indian capital market. It is a process of price discovery. As defined under

17

SEBI guidelines, book building means a process undertaken by which a demand for
securities proposed to be issued by a body corporate is elicited as built up and the
price for such securities is assessed for the determination of a quantum of such
securities to be issued by means of a notice, circular, advertisement, document or
information memoranda or offer document.
So, issue price is not determined at the time of issue of securities under this
process. Instead, price band (minimum and maximum limit of price) is determined.
Bids are invited from prospective buyers stating the price as well as the number of
shares, the investors are ready to buy. On the basis of bids received from the investors,
the issue price is determined by the issuing company in consultation with book runner
lead manager (merchant banker). So the issue price is fixed after the closure of the
book. The order book remains open for a minimum period of five days.
Specific guidelines have been issued by the SEBI in respect of book building
process. Companies issuing securities through this process are required to issue red
herring prospectus. On the recommendations of Malegam Committee, SEBI
introduced the option of book building in October 1995. Initially this option of book
building was available only for issues exceeding Rs. 100 crore. However, the
requirement of Rs. 100 crore issue size was removed in November 1996. On the basis
of recommendations made by the Informal Group on Primary Market, SEBI
introduced 100 percent book building in respect of issues of Rs. 25 crore and above in
1998-99.
So book building is a fair, transparent and market driven way of pricing and
allocation of securities.
(iii)

Private Placement Method


Another method to float new issues of capital is the placing method defined by

London

Stock Exchange as, sale by an issue house or broker or their own clients of

securities which have been previously purchased or subscribed13.


Under this method, securities are purchased by the issue houses and are placed
with the clients of issue houses, both individuals and institutional investors. Thus, the
floatation of the securities involves two stages; at the first stage, shares are acquired
by the issuing houses and at the second stage these are made available to their
investor clients. The issue houses place the securities at a higher price than the price
they pay and the difference, called the turn, is their remuneration.

18

Alternatively the issuing houses may arrange the placing of securities in return
for a fee and act merely as an agent and not principal. Placing the securities that are
unquoted is known as private placement. The securities are usually of small
companies, but these may occasionally be of large companies as well. When the
securities to be placed are newly quoted, the market is officially known as stock
exchange placing14.
(iv)

Offer for Sale


Under this method, the issuing companies do not offer the securities directly to

the public. Instead, the securities are issued to an issue house\merchant


banker\investment bank or firms of stockbrokers, who will subsequently offer the
securities for sale to the public.
Sometimes, the existing shareholders (a holding company, government,
promoters) may offer to offload their holding to the investors. This offer is made to
the general public through offer for sale. The difference between the issue price by the
company and the offer price by the issue house is the gain to the latter. Disinvestment
of shares in PSUs by the government is offer for sale.
This method is similar to public issue method in that the prospectus with
strictly prescribed minimum contents which constitutes the foundation for the sale of
securities and a known quantity of shares are distributed to the applicants in a non
discriminatory manner. Contents of the letter of offer are given in chapter VI (sectionIII) of the SEBI guidelines, 2000.
(v)

Rights Issue
The shares offered to the existing shareholders of a company are called rights

issue. Under this method of capital issue, the existing shareholders are offered the
right to subscribe shares in proportion to the number of shares they already hold.
Section 81 of the Companies Act, 1956 provides that where a company
increases its subscribed capital by the issue of new shares, either after two years of its
formation or after one year of first issue of shares, whichever is earlier, these have to
be first offered to the existing shareholders with a right to renounce them in favour of
a nominee. A company can, however, dispense with this requirement by passing a
special resolution to the same effect. Rights issues are normally not underwritten. This
method of capital issues is comparably inexpensive than public issues through
prospectus.

19

1.5.2 Regulatory Framework of Primary Market in India


Primary securities market is regulated by the following governing bodies:(i)

Securities & Exchange Board of India

(ii)

Department of Economic Affairs

(iii)

Department of Company Affairs

(iv)

Stock Exchanges

The significant legislations for the securities market are as follow:(i)

The Companies Act, 1956 - It deals with issue, allotment and transfer of
securities and various aspects relating to company management. It provides
norms for disclosures in the public issues, regulations for underwriting and the
issues pertaining to use of premium and discount on various issues. Powers
under this Act are exercised by SEBI in case of listed companies.

(ii)

The Securities Contract (Regulation) Act, 1956 - It provides regulation for


direct and indirect control over stock exchanges. It aims at prevention of
undesirable transactions in securities. The Act mainly governs the recognized
stock exchanges, contracts in securities and listing of securities by public
companies. Most of the powers under this Act are exercised by Department of
Economic Affairs and SEBI.

(iii)

The SEBI Act, 1992 - The Act empowers SEBI to protect the interest of
investors in the securities market and to regulate the securities market. SEBI
regulates the business of stock exchange and the intermediaries working in
primary and secondary market.

(iv)

The Depositories Act, 1996 - It provides for electronic maintenance and


transfer of ownership of dematerialized securities. SEBI administers the
regulations of this Act.

1.5.3 Growth and Development of Public Issue Market in India


Under the Capital Issues (Control) Act, 1947, companies were required to
obtain prior approval from the Controller of Capital Issues (CCI) for raising capital.
CCIs permission was required with regard to the timing of the issue, size of the issue
and the determination of price at which the securities were to be issued. New
companies were allowed to issue shares only at par. Only existing companies with
substantial reserves could issue shares at a premium, which had to be calculated in
accordance with CCI norms which were based on the estimate of fair value and not

20

on the prevailing market price. This often led to extreme under pricing and heavy over
subscription. This extent of under pricing of public issues deterred firms from going
public. Debt played a major role in financing projects.
The total amount of capital raised during 1961 was only Rs. 74 crore which
increased to Rs. 87.7 crore during 1971 and further to Rs. 301.10 crore in 1981. The
new issue market received an encouraging response in 1976 in the form of a number
of issues and amount raised due to dilution of foreign equity holding to Indian
investors under Foreign Exchange Regulation Act (FERA)
Liberalization of industrial policy in 1984-85 gave a boost to the securities
market in India. Further the relaxation of norms relating to foreign investment and
incentives provided by the government helped to sustain the impetus of growth in the
capital market. The total amount of capital raised by non government public
companies rose to Rs. 780.10 crore in 1984, Rs. 858.30 crore in 1985 and further Rs.
2793 core in 1989-90.
As a part of liberalization and privatization policy in 1992, Government of
India emphasized the need for a developed capital market and decided to have a
separate statutory authority to regulate the capital market. Consequently, SEBI Act,
1992 was passed in Parliament and SEBI was made a statutory authority. The Capital
Issues (Control) Act, 1947 was repealed and the office of CCI was abolished in May,
1992. As a result, governments control over the determination of issue size, time and
price of securities ceased and the market was allowed to allocate resources on
competitive basis. The initial set of guidelines issued by SEBI allowed almost all
firms to freely price their issues and decide on the size of the issue in consultation
with merchant bankers. Only firms without a three year track record of profitability
and not belonging to a group with existing profitable firms were subject to price
controls. The easing of norms made it easier for firms to access the capital market
leading to a boom in Indian capital market.
The period 1992-93 to 1996-97 saw a high increase in the number of public
issues in India. During these five years, the total number of public issues floated was
4,822 with an annual average of 964 issues. The total amount offered through
prospectus during this period stood at Rs. 56,286 crore with an annual average of Rs.
11,257 crore. The year 1995-96 saw a highest number of public issues (1428) raising
an amount of Rs. 11,822 crore from the market. On the other hand, the highest amount
of Rs. 13,443 crore was raised from 770 public issues in the year 1993-94.
21

However, the easy market entry norms were widely misused by the companies
during this period. Many companies entered the market with issues at sky-high prices.
Instead of business opportunities driving the IPO market, IPO became a business
itself. It led to mushrooming of merchant bankers and other market intermediaries.
So, when the stock market crashed, a number of companies vanished from the scene
and consequently, the investors lost heavily on their investments.
A study conducted by Prime Database revealed that out of 3,872 issues made
during the four year period ending on March 31, 1996, as many as 205 issues were not
traded at all and 118 issuing companies vanished from the scene. On the other hand,
2,987 issues were traded below offer price as on January 14, 1997. Prices of only 562
issues were quoted above the offer price. As per a report of the Informal Group on
Primary Market headed by Dr. Shankar Acharya, Chief Economic Adviser in the
Finance Ministry, Indian investors suffered an erosion of nearly Rs. 15,000 crore on
their investment in subscription to the public and rights issues since 1993-94. The
group has found that select Indian companies raised an amount of Rs. 45,264 crore
through a combination of public and rights issues in the primary market. On the other
hand, the market value of these shares as assessed at Rs. 30,787 crore in February
1998 translated into a loss of Rs. 14,475 crore to the investors since the time of
subscription to these issues. As per the report, overpricing of issues in the past has
contributed to the depressed state of primary market. Investors, who had subscribed to
primary market offerings were struck with their holdings as there was no easy exit
route.

1.5.3.1 Public Issue Market during the Period of Study


Primary capital market during the period under review started with a dismal
note. While a total of 753 public issues were floated mobilizing a total amount of Rs.
11,648 crore during 1996-97, it suddenly fell to 62 issues with an aggregate amount of
just Rs. 3,061 crore in 1997-98.
Various factors which adversely affected the primary market included
declining industrial growth rate, lack of demand for investment goods, decline in
investors confidence in the market and above all the stringent entry barriers imposed
by SEBI. A line of demarcation was drawn in the services provided by merchant
bankers and they were prohibited from carrying on fund based activities other than
those related exclusively to the capital market. The main focus of reforms in the

22

primary market was to safeguard and stimulate investors interests in capital issues by
strengthening norms for raising standards of disclosures and streamlining procedures
with a view to reduce the cost of issues.
The overview of the public issue floated by joint stock companies during the
study period has been presented in table 1.1
Table 1.1
Public Issues Floated by Joint Stock Companies
(Amount in Rs. crore)
Years

Equity Issues
No.

Amount

Debt Issues
No.

Amount

Total Issues
No.

Amount

1997-98

58
1,132.00
04
1,929.22
62
3,061.22
(93.5)
(37)
(6.5)
(63)
1998-99
22
504.02
10
7,406.72
32
7,910.74
(68.8)
(6.0)
(31.2)
(94.0)
1999-00
55
2,975.25
10
4,697.89
65
7,673.14
(84.6)
(38.8)
(15.4)
(61.2)
2000-01
115
2,483.76
09
4,139.14
124
6,622.90
(92.7)
(37.5)
(7.3)
(62.5)
2001-02
06
1,082.00
13
5,340.57
19
6,422.57
(31.8)
(16.8)
(68.2)
(83.2)
2002-03
06
1,038.68
08
4,692.89
14
5,731.57
(42.9)
(18.0)
(57.1)
(82.0)
2003-04
29
17,820.98
06
4,323.58
35
22,144.56
(82.9)
(80.5)
(17.1)
(19.5)
2004-05
29
21,431.56
05
4,094.85
34
25,526.41
(85.3)
(84.0)
(14.7)
(16.0)
2005-06
102
23,675.7
102
23,675.70
(100)
(100)
2006-07
85
24,993.37
85
24,993.37
(100)
(100)
2007-08
90
52,219.00
01
1,000.00
91
53,219.00
(98.9)
(98.1)
(1.1)
(1.9)
2008-09
21
2,034.00
01
1,500.00
22
3,534.00
(95.5)
(57.56)
(4.5)
(42.44)
Total
618
1,51,390.32
67
39,124.86
685
1,90,515.18
(90.2)
(79.46)
(9.8)
(20.54)
Note: - Figures in parentheses show the percentage of number and amount of
public issues with respect to annual total.
Source: - Compiled from offer documents of issuing companies, Prime Database and
SEBI website.
As has been presented in the table, a total of 685 public issues were floated
with an aggregate amount of Rs. 1,90,515.18 crore during the period under review.
This included 618 (90.2%) equity issues for an amount of Rs.1,51,390.32 crore and
23

67 (9.8%) debt issues with a total amount of Rs. 39,124.86 crore. On the basis of
amount raised through public issues, debt issues dominated the new issue market from
1997-98 to 2002-03. Debt issues consisted of 94% of total amount raised in 1998-99,
83.2% in 2001-02 and 82% in 2002-03. All the debt issues, except two, during this
period have been that of bond issues by ICICI Ltd and IDBI Ltd. However, from
2003-04 onward, equity issues dominated the primary capital market. While the
proportion of equity issues stood at 80.5% of amount raised in 2003-04, it was 84% in
2004-05. Not even a single issue of debt came to market during 2005-06 and 2006-07.
In 2008-09 again, one debt issue consisted of 42.44% of total amount mobilized
through public issues.
Analysis of equity issues from the table showed the negligible presence of
equity shares in 2001-02 and 2002-03, when only 6 equity issues each were floated,
having a meager amount. Software and information technology companies dominated
the public issues of equity issues during 1999-2000 and 2000-01.
The year 2003-04 witnessed an upsurge in primary market activities due to the
buoyant secondary market. During this year, 35 companies came to the market with
public issues and raised an amount of Rs. 22,144.56 crore. 2004-05 has been the year
of PSUs disinvestment. Starting with the public issue of Maruti Udyog Ltd, six
divestment offers dominated the market. The amount from public issues stood at Rs.
25,526.41 crore. However, the largest annual amount of Rs. 52,219 crore was
mobilized through equity issues in 2007-08.
Stable political conditions, buoyant secondary market and favourable
economic conditions in the economy resulted in the high confidence of investors and
emergence of equity cult in primary market during 2005-06, 2006-07 and 2007-08.
A total of 102 public issues of equity opened during the year 2005-06 raising
Rs. 23675.70 crore and amount raised though equity issues stood at Rs. 2499.37 crore
during 2006-07. In 2008-09, only one debt issue comprised of Rs. 1500 crore
(42.44% of total amount) was floated.

1.5.3.2 Initial Public Offerings and Further Public Offerings


Public issue market consists of IPOs and FPOs of equity and debt securities.
Initial Public Offering refers to the selling of securities by a company to the public for
the first time. It is a source of funds raised from the primary market. All subsequent
public offerings by a company are known as follow on public offerings.

24

The number and amount of IPOs and FPOs with their percentage in the total
equity amount raised has been shown in the following table:
Table 1.2
IPOs and FPOs of Equity Issues Floated by Joint Stock Companies
(Amount in Rs. crore)
Year

Initial Public Offers

Further Public Offers

Average No.
Size
(Rs.)
17.31
7

Total Equity Issues

1,132.00

Average
Size
(Rs.)
19.51

22

504.02

22.91

127.10

55

2,975.25

54.09

10.00
(0.4)
-

10.00

115

2,483.76

21.60

1,082.00

180.33

1,038.68

173.11

17,820.98

614.52

21,431.56

739.02

23,675.70

232.11

24,993.37

294.03

52,219.00

580.21

2,034.00

96.86

Amount

1997-98

51

882.90
(78)

1998-99

18

379.30

21.07

31.18

1999-00

52

(75.3)
2,593.76

124.72
(24.7)

49.88

381.49
(12.9)

21.70

2000-01 114
2001-02

2002-03

2003-04

19

2004-05

23

2005-06

76

2006-07

76

2007-08

84

2008-09

21

Total

546

(87.1)
2,473.76
(99.6)
1,082.00
(100)
1,038.68
(100)
3,191.10
(17.9)
14,662.32
(68.4)
10,807.88
(45.6)
23,706.17
(94.8)
41,323.00
(79.1)
2,034.00
(100)
1,04,174.87
(68.8)

Amount

Average No.
Size
(Rs.)
35.58
58

No.

249.10
(22)

180.33
173.11

167.94

10

637.49

142.21

26

311.92

491.94

06

96.86

190.8

72

14,629.88 1,462.99 29
(82.1)
6,769.24 1,128.21 29
(31.6)
12,867.82 494.91 102
(54.4)
1,287.20
143.02
85
(5.2)
10,896.00 1,816.00 90
(20.9)
21
47,215.45
(31.2)

655.77

Amount

618 1,51,390.32

244.97

Note: -

Figures in parentheses show the percentage amount of IPOs and FPOs to


the annual amount raised through equity.
Source: - Compiled from offer documents of Issuing companies, Prime Database and
SEBI website.
As depicted in the table 1.2, the number of equity IPO issues remained
dominated as compared to further public offerings during the period of study. A large
number of unlisted companies compared to listed companies preferred public issue
route to raise funds from the market. A total number of 618 public issues of equity
was floated during this period. This consisted of 546 IPOs raising an aggregate

25

amount of Rs. 1,04,174.87 crore and 72 FPOs raising a total amount of Rs. 47,215.45
crore. Largest annual amount of Rs. 52,219 crore was mobilized in 2007-08 while the
amount mobilized through public issues was only 504.02 crore in 1998-99. However,
average amount of equity issues through IPOs and FPOs showed that the average size
of FPOs of equity has been higher than the average size of IPOs in all the years except
in 2000-01 and 2006-07. So, further equity issues have been larger in size as
compared to initial public issues of equity.
On the basis of percentage amount of equity issues raised through IPOs and
FPOs, it has been found that 68.8% of total amount raised through equity shares
comprised of IPOs while 31.2% has been raised through FPOs.
In 2006-07, only 9 listed companies entered the primary market for equity
issues for an aggregate amount of Rs. 1,287.20 crore only. On the other hand, 76
unlisted companies raised an aggregate amount of Rs. 23,706.17 crore through equity
issues. Thus, IPOs comprised a very high percentage of amount raised up to the year
2000-01 as well as 2006-07. There has not been a single equity issue through listed
companies during 2001-02, 2002-03 and 2008-09.

1.5.3.3 Public Issues of Equities at Par and at Premium


Free pricing norms of SEBI for public issues of equity have been followed by
the issuer companies during the period under review. In contrast to CCI era, the post
liberalization period saw the companies deciding their own price for equity issues in
consultation with merchant banker. During the period of study, a large number of
companies have been found to have issued equity shares at premium. Table 1.3
depicts the number and amount of equity issues floated at par and at premium.

26

Table 1.3
Public Issues of Equity at Par and at Premium
(Amount in Rs. crore)
Year

At Par Issues
No.

1997-98

46
(79.3)
1998-99
14
(63.6)
1999-2000 20
(36.4)
2000-01
70
(60.9)
2001-02
4
(66.7)
2002-03
1
(16.7)
2003-04
7
(24.1)
2004-05
1
(3.4)
2005-06
3
(2.9)
2006-07
2007-08
2008-09
Total

01
(1.11)
01
(4.8)
168
(27.2)

At Premium Issues

Amount Average
size
252.23
5.48
(22.3)
164.231
11.73
(32.6)
266.45
13.32
(8.9)
544.20
7.77
(21.9)
83.50
20.87
(7.7)
100.00
100.00
(9.6)
63.97
9.14
(0.35)
8.00
8.00
58.19
19.40
15.00
(0.03)
9.83
(0.48)
1565.68
(1.03)

15.00
9.83
9.32

No.

Amount

12
879.77
(20.7)
(77.7)
8
339.71
(36.4)
(67.4)
36
2708.80
(63.6)
(91.1)
45
1939.56
(39.1)
(78.1)
2
998.50
(33.3)
(92.3)
5
938.68
(83.3)
(90.4)
22
17757.01
(75.9)
(99.65)
28
21423.56
(96.6)
(100)
99
23617.51
(97.1)
(100)
85
24993.37
(100)
(100)
89
52,214.00
(98.89)
(99.97)
20
2,024.17
(95.2)
(99.52)
450
1,49,824.64
(72.8)
(98.97)

Total Equity Issues

Average
size
73.31

No.

Amount

Average

58

1,132.00

19.51

42.46

22

504.02

22.91

75.22

55

2,975.25

54.09

43.10

115

2,483.76

21.60

499.25

1,082.00

180.33

187.74

1,038.68

173.11

807.14

29

17,820.98

614.52

765.13

29

21,431.56

739.02

238.56

102

23,675.70

232.11

294.03

85

24,993.37

294.03

586.67

90

52,219.00

580.21

101.21

21

2,034.00

96.86

332.94

618

1,51,390.32

244.97

Note: -

Figures in parentheses show the percentage of number and amount of


equity issues to total annual equity issues.
Source: - Compiled from Offer Documents of Companies, SEBI website and Prime
Directories of various years.
Table 1.3 presents the number and amount of equity issues floated at par and at
premium. Out of 618 equity issues during the period under review, 168 (27.2%) issues
were floated at par while 450 (72.8%) equity issues were at premium. However, the
figures for the amount showed that only Rs.1565.68 crore (1.03%) was raised at par
as compared to Rs. 1,49,824.64 crore (98.97%) raised through premium issues. The
percentage of amount mobilized through par issues has declined over the time, the
same being highest at 32.6% in 1998-99. After 2002-03, only a negligible amount has
been raised at par and the percentage of amount raised through premium issues was
nearly 100% during this period.

27

Similar trend has been found in the number of equity issues floated during the
period under review. In 1997-98, 79.3% of equity issues have been at par. These
declined to 63.6% in 1998-99 and further to 36.4% in 1999-2000. Period after 200203 found a very less number of equity issues at par.
Comparison of average size of equity issues at par and at premium showed
that at par issues have been of small size as compared to equity issues at premium
over the period under study.

1.5.3.4 Public Issues of Debt


All the public issues of debt except two have been by two domestic financial
institutions viz, ICICI Ltd and IDBI Ltd during the period under study. These
institutions floated bonds with different options, suitable to every type of investors in
the market. The issues of bonds were made in different tranches and all public issues
of debt were further public offerings. There was only one IPO of debt issue made in
1997-98 by Ahmedabad Municipal Corporation for Rs. 25 crore

1.6

Gross Domestic Savings and Investment in Shares and


Debentures

Saving practices in an economy have a major impact on the development of capital


market. High saving rate results in more resources to be invested in the economy.
Gross domestic savings consist of savings from household sector, private and public
sector. Savings from household sector constituted a major part of gross domestic
savings during the period under review.
The economic definition of household savings is the share of national income
accruing to the household sector that is not consumed and is therefore available to
finance assets (financial savings) and physical assets (physical savings). Financial
savings consist of investment in bank deposits, insurance sector, provident fund,
currency, claims on government, and shares and debentures. Deposits with banks and
non-banking financial institutions formed the largest percentage of financial savings.
Table 1.4 presents the gross domestic savings rate, household savings rate,
investment in financial assets and investment in shares and debentures as a percentage
of GDP and as a percentage of financial savings.

28

Table 1.4
Gross Domestic Savings and Investment in Financial Assets
Year

Gross
Household
Domestic
Savings
Savings

(As a percentage of GDP)


Investment in
Investment in
shares &
Shares & Deb.
Deb.
(as % of
financial assets)
0.3
2.9

1997-98

23.8

17.7

Investment in
Financial
Assets
( Fin. Savings)
11.3

1998-99

22.3

18.8

11.9

0.4

3.4

1999-00

24.8

21.1

12.2

0.9

7.7

2000-01

23.7

21.6

11.9

0.5

4.1

2001-02

23.5

22.1

12.7

0.3

2.7

2002-03

26.3

22.9

13.1

0.2

1.7

2003-04

29.8

24.1

13.8

0.1

0.1

2004-05

32.2

23.3

14

0.2

1.1

2005-06

33.1

23.2

16.7

0.8

4.9

2006-07

34.4

22.9

15.8

1.4

9.0

2007-08

36.4

22.6

15.2

1.9

12.4

2008-09

32.5

22.6

14.0

0.4

2.6

Note: -

Investment in Shares and debentures includes amount invested in mutual


funds other than UTI.
Source: - Economic Survey 2009-10, RBI, SEBI Handbook of Statistics on the
Indian Securities Market, 2009.
Table 1.4 exhibits that gross domestic savings as a percentage of GDP
remained stagnant at nearly 24% from the period 1997-98 to 2001-02. After 2002-03,
it has been showing an increasing trend with the highest rate of 34.4% in 2006-07 and
36.4% in 2007-08. Trend of savings from household sector go side by side with the
trend of gross domestic savings. As shown in the table, household savings formed a
major share in gross domestic savings. It has been highest at 24.1% in 2003-04, but
declined to 23.2% in 2005-06 and further to 22.6% in 2007-08 and 2008-09. A major
part of household savings has been invested in financial assets as shown in the table.
Financial savings stood at 11.3% of GDP in 1997-98, 11.9% in 1998-99,
13.8% in 2003-04, 15.8% in 2006-07 and 14% in 2008-09. The investment in
financial assets has shown an increasing trend from 2001-02 onward, with the highest
percentage at 16.7 in 2005-06.

29

However, investment in shares and debentures including mutual funds other


than UTI as a percentage of GDP and as a percentage of financial assets showed a
dismal picture during the period under review. The portion of investment in shares
and debentures as percentage of GDP remained less than one percent during this
period under study. It was just 0.1% in 2003-04, 0.2% in 2002-03 and in 2004-05.
However, it increased to 0.8% in 2005-06, 1.2% in 2006-07 and further 1.9% in 200708, but declined to 0.4% of GDP in 2008-09 again.
The table further shows that 2.9% of financial assets have been employed in
shares and debentures in 1997-98. This share rose to 7.7% in 1999-2000 but declined
to 4.1% in 2000-01, 2.7% in 2001-02 and just 1.1% in 2003-04. It showed a
remarkable increase at 4.9% in 2005-06, 6.3% in 2006-07 and 12.4% in 2007-08. It
further declined to 2.6% in 2008-09. This showed that a negligible portion of financial
savings has been invested in shares and debenture.
Despite significant reforms and improvements, the role of Indian capital
market has remained less significant as has been reflected in the savings in the form
of capital market instruments and resources raised by the corporate sector.

1.7

Investors in India
The investors are one of the most important constituents in the capital market.

The development of capital market is largely influenced by the risk-return, liquidity,


preference and confidence of the investors in the market.
A survey conducted in India by SEBI-NCAER15 has revealed that about 13.1
million investor households directly invested in equity shares or debentures or both in
2000-01. Out of 13.1 million, while 9.6 million households owned bonds/debentures,
6.5 million households owned equity. Thus, the number of debenture owning
households far exceeded equity owning households. Further, 19.5 million individual
investors invested in equity/debentures/both in 2000-01. There has been roughly 177
million households in India out of which only 13.1 million (7.4%) directly invested in
equities and bonds.
While the number of household investors owning equity shares declined from
12.1 million to 6.5 million between 1998-99 and 2000-01, the number of households
owning debentures shot up from 3.7 million to 9.6 million during the same period.
Thus, there has been a definite migration of investors from equity to bond market in
the period up to 2002-03.

30

The participation of investors in the capital market can be judged from the
number of demat accounts with two depositories, that is,

National Securities

Depository Services Ltd. and Central Depository Services (India) Ltd.


The number of Demat accounts with NSDL stood at 36.58 lakhs at the end of
the year 2001, 38.13 lakhs in 2002, and 46.12 lakhs in 2003 and further increased to
59.69 lakhs at the end the year 200416. The number of demat accounts with two
depository services stood at 99.0 lakhs at on December 31, 2006. The number of
demat accounts with two depository organizations further increased to 1.433 crore as
on December 31, 2008 and 1.45 crore as on March 31, 2009.
The Indian equity market may be one of the best performers in terms of
returns. However, the equity cult is yet to spread in the country as the number of
investors is just one percent of the total population of India.

Conclusion
The merchant banking originated to meet the financial needs of foreign trade
during the 13th century. However, modern merchant banking started from London
where the merchants started to finance the foreign trade through acceptance of bills of
exchange. The industrial revolution in England gave further boost to the merchant
banking.
London based merchant bankers had invested money in banks in India and
they exercised full control over these banks through their managing agents. In the pre
World War-II era, Indian firms also operated as managing agency houses similar to
their British counterparts. The managing agency system in India was sought to be
abolished from the horizon of corporate sector vide Companies Act, 1956.
The formal merchant banking services in Indian capital market started with the
setting up of the merchant banking division by Grindlays Bank in 1969. Further, on
the recommendation of Banking Commission, 1972, public sector banks and financial
institutions entered in this field.
With the abolition of CCI and the setting up of SEBI in 1992, the role of
merchant banking in India has become more diverse and encompassing than even the
past. Inspite of diverse nature of merchant banking services and the responsibilities
involved therein, issue management remains the major function performed by
merchant bankers.

31

Primary capital market in India during the period under review witnessed
many ups and downs. From 1997-98 to 2002-03, debt issues dominated the public
issue market and equity cult developed in India after 2003-04. However, Debt issues
remained confined to bond issue by ICICI Ltd and IDBI Ltd. Similarly major part of
total amount was raised by unlisted companies entering the market for the first time.
Investment in shares and debentures as a percentage of GDP and as a percentage of
financial assets showed a dismal picture during the period under review. Thus, low
participation of investors in the capital market remained a challenge for its
development.

32

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