Investment Banking in India

Learning Objective
Nature and

Scope of Merchant Banking

Regulation of Merchant Banking Activity
Overview of Current Indian Merchant
Banking Scene
Structure of Merchant Banking Industry
Professional Ethics and Code of Conduct
Current Development

1. Nature and Scope of Merchant Banking

Merchant banking (MB) is a non-banking financial activity,
resembles

banking

function.

The

word

Merchant

Banking originated by the Dutch and the Scottish traders

and was later developed and professionalized in Britain.
Functions of MB were enriched by Americans and now
being provided throughout the world.
The MB functions in UK and Europe are the same as
functions of investment banking in US. In India, the term
MB is more often used due to the inheritance of the
financial system from UK and the mention in SEBI
(Merchant Bankers) Rule 1992.

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1. Nature and Scope of Merchant Banking

According to SEBI (Merchant Bankers) Rule 1992, a
merchant banker is defined as any person who is engaged
in the business of issue management either by making
arrangements regarding selling, buying or subscribing to
securities or acting as manager, consultant, advisor or
rendering corporate advisory services in relation to such
issue management.
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1. Nature and Scope of Merchant Banking

Merchant banks are generally engaged in providing
specialized services such as issue underwriting, credit
syndication, M&A advisory, portfolio management,
acceptance of bills of exchange, corporate finance and
other services. It is not necessary for a merchant banker
to carry out all these activities. A merchant banker may
specialize in one activity and take up other activities,
which may be complimentary or supportive to the
specialized activity.
MBs also arrange funds or negotiate financial deals for their
clients for a fee as arrangers, brokers or intermediaries.

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Scope of Merchant Banking

MB being a service-oriented industry, renders following
services to its customers.

Management of Debt and Equity

Corporate Counseling

Project Counseling

Credit Syndication and Project Finance

Mergers, Acquisitions and Corporate Restructuring

Venture Capital

Financial Engineering
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Management of Debt and Equity

Instrument Designing
Pricing the Issue
Registration of the offer document
Underwriting support
Marketing of the issue
Allotment and refund
Listing on the stock exchange

Corporate Advisory Services

IB offer customized solutions to financial problems of their clients.
Financial restructuring: D/E
Asset turnover ratio: whether over / under trading
Working capital policy: suggestions (Financing)
Refinancing of high cost funds by low cost funds
Turnaround management
Revival of sick units
Management of risk advisory, hedging strategies

Project Advisory Services

Early stages of projects advisory
Project ideas
Initial feasibility studies and viability
Detailed project report
Project appraisal service

Loan Syndication
IBs arrange to tie-up loans for their clients.
Cash flow analysis and requirements
Important loan parameters include amount, currency, tenure,
amortization.
Prepares loan memorandum, circulated to various banks and invited
for syndication.
Banks decide the amounts and interest rates.
Loan documentation process.

Venture Financing
VC business evolved from individuals to institutionalized
sector.
Number and size of deals increasing.
Returns are expected more.

Private Equity
Stages of VC, then PE
Company becomes profitable, establishes track record.
Exit with IPO

M&A
Increased M&A activities.
Pre-liberalization era, M&As in unrelated areas
Post liberalization era, M&As growth, consolidation in core
competence.
Advisory on acquisitions
Financial; Tax shields like carried forward losses or unclaimed
depreciation
Marketing: Growth in market share, eliminating competition
Production: Horizontal or vertical integration

Financial Engineering
Design new financial products, develop superior processes and
implement structured solutions to complex financial problems.
The factors accelerated the financial innovations
Interest rate volatility
Exchange rate volatility
Asset price volatility
Regulatory and Tax changes
Globalization of the markets
Increased competition

Merchant Banking
Other Functions of Merchant Banks
Accepting Credit and Bill Discounting
Lease Financing
Foreign Currency Finance
Pre-investment Studies
Capital Restructuring
Portfolio Management

2. Regulation of Merchant Banking Activity

Regulations
MBs are governed by the SEBI (Merchant Bankers) Rules
and Regulations, 1992.
MB must register with SEBI to carry out MB activities,
even if MB is bank sponsored it need to register with SEBI.
MB has to be incorporated under the Companies Act 1956.
As a company it comes under the jurisdiction of the
Registration of Companies and the formalities of the
Companies Act have to be approved including
Memorandum and Articles of Association, authorized and
the paid up capital.
MB undertaking fund based activities need to register with
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2. Regulation of Merchant Banking Activity

Underwriter business is regulated by SEBI (Underwriters)
Rules and Regulations, 1993.
Activities of secondary market operations including stock
broking are regulated by stock exchange and SEBI (Stock
Brokers and Sub Brokers) Rules and Regulations, 1992.
Business of portfolio management is regulated under SEBI
(Portfolio Managers) Rules and Regulations, 1993.
Business of venture capital and private equity funds are
regulated by SEBI (Venture Capital Funds) Regulations,
1996.
MBs should fulfill the eligibility criteria on an on-going

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2. Regulation of Merchant Banking Activity

Initially, SEBI classified the MBs into four categories.
Later modified the rules to have only Category I merchant
banker with minimum net worth Rs. 5 Crore and initial
registration fee Rs. 5 Lakh. MB shall pay a renewal fee of
Rs. 2.5 Lakh every three years from fourth year of the
registration.
MBs cannot accept deposits from public.

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2. Regulation of Merchant Banking Activity

MB not to associate with any business other than that of

the securities market.

MB shall keep and maintain the books of account, records

and documents.

While registration as MB, SEBI ensures the professional

qualification in finance, law or business management,
adequate office space, manpower, office equipment, other
infrastructure, office staff having competency in MB
business, minimum stipulated capital and previous
experience as MB.

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2. Regulation of Merchant Banking Activity

Lead MBs: All issues should be managed by at least one

MB functioning as a lead MB, except in case of a rights
issue and the issue size not exceeding Rs. 50 Lakh. Every
lead MB should enter into an agreement with corporate
setting their rights, liabilities and obligations relating to
such issues on disclosures, allotment and refund. Number
of lead MBs should not exceed than stated below.
Size of Issue

Number of lead MBs

Less than Rs. 50 Crore

Above Rs. 50 Crore but less than Rs. 100 Crore

Above Rs. 100 Crore but less than Rs. 200 Crore

Above Rs. 200 Crore but less than Rs. 400 Crore

Above Rs. 400 Crore

5 or more as agreed by SEBI

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2. Regulation of Merchant Banking Activity

Remuneration of MBs: MBs generate income, classified

based on their activities as fund based and fee based
income.

Fund based activities generate a spread being the

difference between the cost of funds and the yield from the
funds.

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3. Overview of Current Indian Merchant Banking

Scene
In India, first MB division was set up in 1967 by Grindlays
Bank (merged with Standard Chartered Bank), followed
by Citibank in 1970.
In 1972, SBI set up a MB division namely SBI Capital
Markets Ltd (SBICAP). Other banks followed to set up
MB divisions such as Bank of India, Central Bank of
India, Canara Bank, Bank of Baroda, Punjab National
Bank and Syndicate Bank.

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3. Overview of Current Indian Merchant Banking

Scene
In 1974, ICICI set up a MB division, later IFCI and IDBI
also entered this field. Private firms such as DSP financial
consultants Ltd., J M Financial Services Ltd. and Credit
Capital Finance Corporation Ltd. have also started MB
activities.
During economic reforms period, post 1991, number of MBs
increased drastically. The number of MBs rose to about
thousand in 1990s. Later due to SEBI restrictions, many
MBs have closed down and the number reduced to 124 in
2003.

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3. Overview of Current Indian Merchant Banking

Scene
Currently, major MBs in India are
SBI Capital Markets Ltd.
Kotak Mahindra Capital Company
ICICI Securities Ltd.
IDBI Capital Markets Ltd.
Enam Financial Consultants Ltd.
JM Morgan Stanley Ltd.
DSP Merrill Lynch Ltd.

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4. Structure of Merchant Banking Industry

Indian MBs follow a conglomerate structure by keeping their
business segments in different corporate entities. For
example, MB business has to be in a separate company as
it requires a separate MB licensing from the SEBI. MBs
are prohibited from undertaking any business other than
the securities market.
Asset management business in the form of mutual fund
requires a three-tier structure under the SEBI regulations.
Equity research should be independent of the MB business to
avoid the conflict of interest faced by American
investment banks.
Securities business has to be separated into a different
company as it requires a stock exchange membership and
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4. Structure of Merchant Banking Industry

Post 1991, due to financial liberalization & primary market
boom, many banks, FIs, financial business houses and
NBFCs entered the MB, underwriting and advisory
business. Due to the gradual regulatory developments in
the capital markets, MB activities came under regulations
which required separate registration, licensing and capital
requirements.
Due to the above reason, Indian MB industry has a
heterogeneous structure. Bigger MBs have several group
entities in which the core and non-core business segments
are distributed. Other MBs have one or more entities
depending activities.
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Structural Analysis of Investment Banking Industry

Given the industry structure, competition in the industry has its
basis in the economic structure.
Reviewing the competition, the framework is developed by
Michael Porter to examine the competitive advantage to IBs.
Five forces which determine profit potential in the industry
Threat of entry
Competition
Pressure from substitute products
Bargaining power of buyers
Bargaining power of suppliers
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7. Current Development
Business of MB is undergoing rapid transformation in
response to the growing sophistication in the financial
markets and the needs of clients. Consolidation and
globalization is the key for success and growth. Financial
conglomerates with equal presence in commercial
banking, investment banking, insurance and financial
advisory are the way to go for one-stop shopping for all
financial needs. Most US universal banks are shaping up
to be financial conglomerates that would eventually
threaten the supremacy of pure investment banks on Wall
Street.

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7. Current Development
Future therefore lies in full service investment banking
comprising of core investment banking (managing and
underwriting security issues of all types, M&A advisory),
asset management (mutual funds, portfolio management,
private banking), private equity and venture capital,
brokerage, sales and distribution, research and analysis,
proprietary trading and investment, primary dealing in
fixed income securities, structured financing and
corporate advisory services. Universal banks can add all
their banking products in both corporate and retail
banking segments to the long list of services offered as full
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7. Current Development
A step forward would be the financial conglomerates of the
future that can even add on insurance and pension
products to make them one-stop financial shops. Large
financial conglomerates such as the Citigroup or ING
would be the models of growth in the years to come.

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