Merchant Banking (Complete Guide) Objective, Types, Structure 2020

What Is a Merchant Banking?

Banks are one of the important institutions in every economy. They provide financial assistance and other kinds of services relating to money to almost everyone.

There are different kinds of banks that cater to different kinds of needs. There are investment banks, commercial banks, and merchant banks. Each category offers its own specialization in assisting their clients financially.

Merchant banking involves transactions that deal with corporations. Most of their clients are business people and these kinds of banks do not deal with just any kind of client. Hence, their services cannot be applied to the general public.

Some of their services include providing loans for startup businesses, giving financial advice for some companies and fundraising activities for their elite members. They are also involved in international trade which is not common in other kinds of banks.

Who is a Merchant Banker?

A merchant banker is someone who works in a Merchant bank that specializes in service benefits for their clients. Basically, their main business relates to issue management.

Some of the responsibilities they have include acting as a consultant and giving financial advice to their clients on how to raise more funds. They also act as brokers for their clients in stock exchange markets.

They also offer legal assistance to their clients whenever needed. They basically help their clients, which are business people, in making their businesses successful. They make sure they offer clients different options to make it through the business world. Merchant bankers are not just any kind of banker. They need to have the knowledge when it comes to business and the experience to make sure they can offer the best kind of service to their clients.           

Objectives of Merchant Banking

Objectives of Merchant Banking
Objectives of Merchant Banking

Here are some of the objectives of merchant banks:

  1. Provide funds to companies – this usually includes loans for startup companies. They decide how much money a company needs to function through proposals created by these companies. They also help their clients raise funds through the stock exchange and other activities. Merchant banks act as a foundation for small scale companies in terms of their finances.
  2. Underwriting – this is like insurance where banks sign into documents that agree to provide financial payment to their clients in case of any damage or losses. This is very important for clients to ensure that the bank will help them gain more income. If not, in case they would incur losses, the bank will pay them for the losses.
  3. Manage their portfolios – the bank will look into the companies’ assets and will do the computation of their credits and debits to ensure they are not incurring any losses. They also provide other kinds of services to check on the liquidation of assets to track the income made by these companies and study how they can make it better.
  4. Offering corporate advisory – they offer advises especially to starting companies and those that would want to expand. This advice involves financial aid to ensure that the company will be successful and will not have any problems along the way.
  5. Managing corporate issues – help incorporate securities management, they also serve as an intermediary bank in transferring capitals.

Structure of Merchant Banking

Structure of Merchant Banking
Structure of Merchant Banking

The general structure of Merchant Bank includes three layers. The topmost that covers all other sectors is the Merchant Bank itself. On the second layer are the Public Sector, the Private sector, and the International Banks.

Under the Public sector, there are three categories which include commercial banks, financial institutions, and state institutions. These are banks that cater to the general public and most anyone can do any transactions with these banks.

Under the Private sector are Banks, and Finance and Investment. These are the sectors that cater to specific private clients and not just anyone can be assisted. Basically, Merchant banks are the general umbrella that covers the other bank categories.

Scope of Merchant Banking

The scope of merchant banking is very simple, it covers services that are targeted to small and medium scale companies. They cannot assist any other clients that do not fall under this category.

For example, if a person wishes to open a personal savings account, they cannot do so with merchant banks. Also, if a person wants to get assistance on large public offerings, merchant banks cannot assist them.

Merchant banks are limited to providing services and counseling to certain people. They would also require specific documents from their clients to prove that they are covered within the scope of clients any merchant bank can assist.

Basically, not everyone can avail of services from merchant banks but are only limited to small and medium scale businesses.

However, in terms of geographical aspects, the scope of Merchant banking is international. They can create transactions with other countries, unlike the other banks.

If their clients own companies in different countries, they can also provide services to all the places where the company has a property. They can also offer services to clients who would like to expand their business abroad.

Importance of Merchant Banking

Merchant Banking is very important in any economy. A good economy means there are many successful businesses in their area and these businesses are usually successful because they have merchant banks that help them.

Almost all of the services offered by merchant banks are beneficial for their clients. They make sure that all their clients would have high success rates in their business. They assist them from the start and still helps them along the way.

If the businesses are successful, it means that the economy is growing which is good, not only for the merchant banks, for the business people, but also for the entire economy because they have high capital for their area.

Types of Merchant Banking

There are a few types of merchant banking

  1. Merchant Bankers who can act as a consultant or advisor. This is the lowest type of merchant banking.
  2. Merchant bankers who can be a consultant, advisor, and underwriter.
  3. Merchant bankers who can be an advisor, consultant, portfolio manager and underwriter.
  4. Merchant bankers who can act as an advisor, issue manager, consultant, portfolio manager, and underwriter. Basically, someone who can do all the foundations of merchant banking.

Examples of Merchant Banking

As mentioned earlier, Merchant Banks are divided into three sectors which include the public sector, the private one, and the international banks.

Some examples of private sector merchant banks include Punjab National Bank, State bank of Bikaner and Jaipur, and Bank of Maharashtra.

Bajaj Capital Ltd., ICICI Bank Ltd., and Reliance Securities Ltd. are some examples of the Private sector of Merchant banks.

International banks include JP Morgan, Goldman and Sachs and Citigroup.

How Merchant Banks Facilitate Trade

Merchant banks facilitate trade internationally. In cases where a certain company wants to do business with another company that is based in a different country, their financial transaction will be possible with the help of a merchant bank.

All they need to do it to get the merchant bank to produce a letter of credit to the other party so the transaction can commence. This is also true if the company wishes to buy a company abroad. Merchant banks are very important in helping businesses internationally as they have the power to conduct transactions abroad unlike other banks which are very limited to their scope and area.

Advantages and Disadvantages

One advantage of Merchant Banking is that you get to have the best and most honest advice there are. Since you will be dealing with experts, they can offer counseling that will be fit for the business. They will also be honest and will let you know the status of the company.

They also offer portfolio management which is very helpful in any kind of corporation. They also offer services like lease financing which will be beneficial for companies that need more funding for the business.

One disadvantage of merchant banking is the expense. It is more expensive since you will be paying for the services given by experts and not just any kind of banker.

You also need to take risks since the future is not certain. There are many different kinds of risks with merchant banking, although they offer underwritings, this does not guarantee that you can get all your expenses back in case the business goes down.

Merchant Banks vs. Investment Banks

Parameter of ComparisonMerchant BankInvestment Bank
PurposeGive business loans, provide underwriting, facilitate international financeCreate capital for entities like the government and commercial ones
ActivitiesInternational financial activitiesUnderwriting and issuance of shares
Client FocusSmall Scale CompaniesLarge Public and Private Offerings
OriginActivities in Trade FinanceActivities in Capital Market
Acquisition and MergesDoes not offer this serviceOffers this service

Difference Between Merchant Bank and Commercial Bank

Parameter of ComparisonMerchant BankCommercial Bank
Target ClientsCorporate FirmsCommon people
People who can open accountsOnly those with proper corporate documentsAnyone from the general public
Risk at handHigh exposure to risk since they deal with businessesLess exposure to risks
OrientationMore oriented towards managementOrientation is geared towards assets
FunctionsDifferent functions like managing a portfolio, underwriting, etc.Functions as financers to clients

FAQ

  1. How do merchant banks make money?

    Merchant banks gain money through fees from the services they offer. Since they offer, a lot of services, some of them have high rates while the other is only for a minimal fee.
    Unlike investment banks that earn money through interests made from loans and the likes, merchant banks do not earn the same. What they usually do is they offer their expertise for a certain amount.

    That is why it is very important that merchant bankers have all the knowledge and skills required for the job so that they can produce good results. If not, their clients will not be happy and may not continue with their services.

    Also, since merchant banks offer underwritings, which is like insurance, they need to make sure their services are good so the company there is handling will not incur losses and they will not have to pay for the damage.

  2. Who can be a merchant banker?

    Anyone can be a merchant banker as long as they have all the requirements necessary for the position. Different banks have different requirements for this position.
    Some would require applicants to have a bachelor’s degree that is related to banking while others require experience in the same field.

    Others may require a certain license in order to become a merchant banker. Although different banks have different requirements, all of them will require training for their employees to be familiar with the job.

    With the help of this training, anyone will be able to become a merchant banker. However, having a background in banking and their services will be an advantage since it will be easier and faster for them to understand the job.

  3. What are the services of merchant banks?

    Merchant Banking covers a lot of services. One is Corporate Counseling which offers advice to companies and gives them suggestions on how to earn more, how to resolve issues and the likes.

    They also offer services like estimating the funds and raising the funds needed for a certain company. Raising of funds can come from the capital market or other new ideas that the bank can offer.

    Another scope covers Project counseling which includes projects that need to be submitted to the government, financial assistance projects and many other projects that companies need assistance on.

    They also cover issue management, underwriting, portfolio management which were already discussed earlier and many other services that will help companies and businesses like loan syndication, technology tie-ups, lease finance.

Learn More With the Help of Video

Conclusion

Merchant Banking

Merchant banks are one of the many different kinds of banks that are helping the economy worldwide. They offer services to small and medium corporates.

Some of their main services include portfolio management, structuring the company’s capital, counseling and providing companies with long-term plans required.

They are targeting specific clients and not everyone can avail of their services. Their main goal is to help and assist their clients financially. Merchant banks are important for any economy to grow since they assist in financial aspects of small and medium corporates which is good for the economy’s money flow.

References

  1. https://heinonline.org/hol-cgi-bin/get_pdf.cgi?handle=hein.journals/fdicbnkrv14&section=6
  2. https://www.jstor.org/stable/590970
  3. https://www.tandfonline.com/doi/pdf/10.1080/00076798600000055