Merchant Banking and Financial Services

BLOCK - I INTRODUCTION, ISSUE

MANAGEMENT UNDERWRITING AND NOTES
BROKERAGE
UNIT - I MERCHANT BANKING &
FINANCIAL SERVICES
Structure
1.1 Introduction
1.2 Origin of Merchant Banking
1.3 Merchant Banking in India
1.4 Merchant Banks and Commercial Banks
1.5 Services of merchant Banks (Developments)
1.6 Process of Merchant Banking in India
1.7 Main Functions of Financial System
1.8 Financial System and Economic Development
1.9 Weaknesses of Indian financial Systems
1.10Guidelines for Merchant Bankers
1.11 Terminologies
1.12 Model Questions
1.13 Reference Books
1.1 INTRODUCTION
The term merchant banking is used differently in different countries and so
there is no precise definition for it. In London, merchant banker refers to those
who are members of British Merchant Banking and Securities House
Association who carry on consultation, leasing, portfolio services, assets
management, euro credit, loan syndication, etc. In America, merchant banking
is concerned with mobilising savings of people and directing the funds to
business enterprise.
DEFINITION
Merchant banking
There is no universal definition for merchant banking. It assumes diverse
functions in different countries. So, merchant banking may be defined as, 'an
institution which covers a wide range of activities such as management of
customer services, portfolio management, credit syndication, acceptance
credit, counselling, insurance, etc.'

The Notification of the Ministry of Finance defines a merchant banker as,

'any person who is engaged in the business of issue management either by
making arrangements regarding selling, buying or subscribing to the securities
as manager, consultant, advisor or rendering corporate advisory service in
relation to such issue management.
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Merchant Banking and Financial Services Financial services

Financial services has also been called ―Financial intermediation‖. The

NOTES financial intermediation is a process by which funds are mobilized from a
large number of savers and make them available to all those who are in need
of it and particularly to corporate customer.And it is very vital for industry
development. As well developed financial service industry is absolutely
necessary to mobilize the saving to allocate them to various investable
channels and there by to promote industrial development country.

1.2 ORIGIN OF MERCHANT BANKING

Merchant banking originated through the entering of London merchants in
financing foreign trade through acceptance of bill. Later, the merchants
assisted the government of underdeveloped countries in raising long-term
funds through flotation of bonds in London money market. Over a period, they
extended their activities to domestic business of syndication of long-term and
short-term finance, underwriting of new issues, acting as registrars and share
transfer agents, debenture trustees, portfolio managers, negotiating agents for
mergers, takeover, etc. The post-war period witnessed the rapid growth of
merchant banking through the innovative instrument like Euro, Dollar and the
growth of various financial centers like Singapore, Hong Kong, Bahrain,
Kuwait, Dubai, etc.
1.3 MERCHANT BANKING IN INDIA
In India prior to the enactment of Indian Companies Act, 1956, managing
agents acted as issue houses for securities, evaluated project reports, planned
capital structure and to some extent provided venture capital for new firms.
Few share broking firms also functioned as merchant bankers.
The need for specialised merchant banking service was felt in India with the
rapid growth in the number and size of the issues made in the primary market.
The merchant banking services were started by foreign banks, namely the
National Grindlays Bank in 1967 and the Citibank in 1970. The Banking
Commission in its report in 1972 recommended the setting up of merchant
banking institutions by commercial banks and financial institutions. This
marked the beginning of specialised merchant banking in India.

To begin with, merchant banking services were offered along with other
traditional banking services. In the mid-eighties, the Banking Regulations Act
was amended permitting commercial banks to offer wide range of financial
services through the subsidiary route. The State Bank of India was the first
Indian Bank to set up Merchant Banking Division in 1972. Later ICICI set up
its Merchant Banking Division followed by Bank of India, Bank of Baroda,
Canara Bank, Punjab National Bank and UCO Bank. The merchant banking
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 Merchant Banking and Financial Services
1.4 MERCHANT BANKS AND COMMERCIAL BANKS
There are differences in approach, attitude and areas of operations between
commercial banks and merchant banks. The differences between merchant NOTES
banks and commercial banks are summarised below:
1. Commercial banks basically deal in debt and debt-related finance and their
activitiesare appropriately arrayed around credit proposals, credit appraisal and
loan sanctions. On the other hand, the area of activity of merchant bankers is
'equity and equity- related finance'. They deal with mainly funds raised
through money market and capital market.

2. Commercial banks are asset-oriented and their lending decisions are based
on detailed credit analysis of loan proposals and the value of security offered
against loans. They generally avoid risks. The merchant bankers are
management-oriented. They are willing to accept risks of business.

2. Commercial bankers aremerely financiers. The activities of merchant

bankers includeproject counselling, corporate counselling in areas of capital
restructuring, amalgamations, mergers, takeover, etc., discounting and
rediscounting of short-term paper in money markets, managing, underwriting
and supporting public issues in new issue market and acting as brokers and
advisors on portfolio management in stock exchange. Merchant banking
activities have impact on growth, stability and liquidity of money markets.

1.5 SERVICES OF MERCHANT BANKS(Development)

The financial institutions in India could not meet the demand for long-term
funds required by the ever expanding industry and trade. The corporate sector
enterprises, therefore, meet their requirements through issue of shares and
debentures in the capital market. To raise money from capital market,
promoters bank upon merchant bankers who manage the whole show by
rendering multifarious services. The merchant bankers also advise the
investors regarding incentives available in the form of tax reliefs and other
statutory obligations.
The services of merchant bankers are described in detail in the following
section.

1. Corporate Counseling

Corporate counselling covers the entire field of merchant banking activities,

viz., project counselling, capital restructuring, project management, public
issue management, loan syndication, working capital, fixed deposit, lease
financing, acceptance credit, etc. The scope of corporate counselling is limited
to giving suggestions and opinions to the clients and help taking actions to
solve their problems. It is provided to a corporate unit with a view to ensure
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Merchant Banking and Financial Services better performance, maintain steady growth and create better image among
investors.

NOTES 2. Project counselling

Project counselling includes preparation of project reports, deciding upon the

financing pattern to finance the cost of the project and appraising project
report with the financial institutions or banks. Project reports are prepared to
obtain government approval, get financial assistance from institutions and plan
for the public issue. The financing mix is to be decided keeping in view the
rules, regulations and norms prescribed by the government or followed by
financial institutions The projects are appraised, as to the location, technical,
commercial and financial viability of the project. Project counselling also
includes filling up of application forms with relevant information for obtaining
funds from financial institutions.

3. Loan syndication

Loan syndication refers to assistance rendered by merchant banks to get

mainly term loans for projects. Such loans may be obtained from a single
development finance institution or a syndicate or consortium. Merchant
Bankers help corporate clients to raise syndicated loans from commercial
banks.

Merchant banks help clients approach financial institutions for term loans. The
decision as to which financial institution should be approached depends on
industry, location of the unit and size of project cost. The Merchant Bankers,
first, make an appraisal of the project to satisfy that it is viable. The next step
is designing capital structure, determining the promoter's contribution and
arriving at a figure of approximate amount of term loan to be raised. The
merchant banker has to ensure that the project adheres to the guidelines for
financing industrial projects. After verifications that the project would be
eligible for term loan, a preliminary meeting is fixed with financial institution.
If the financial institution agrees to consider the proposal, the application is
filled in and submitted along with other documents. The Merchant Bankers
involvement enables the company to state that it has exercised due diligence in
the exercise of obligations under various regulations.

4. Issue management

Management of issue involves marketing of corporate securities, viz., equity

shares, preference shares and debentures or bonds by offering them to public.
Merchant banks act as intermediary whose main job is to transfer capital from
those who own it to those who need it.
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The issue function may be broadly divided into pre-issue management and Merchant Banking and Financial Services

post-issue management. In both the stages, legal requirements have to be

complied with and several activities connected with the issue have to be
NOTES
coordinated.

The pre-issue management is divided into:

(i) Issue through prospectus, offer for sale and private placement.

(ii) Marketing and underwriting.

(iii) Pricing of Issues.

(i) Public issue through prospectus

(a) The most common method of public issue is through prospectus.

(b) Offers for sale are offers through the intermediary of issue house or firm of
stock broker. The company sells the entire issue of shares or debentures to the
issue house at an agreed price which is generally below the par value.

(c) The direct sale of securities by a company to investors is called private

placement. The investors include LIC, UTI, GlC, SFC, etc.

To bring out a public issue, merchant bankers have to coordinate the activities
relating to issue with different government and public bodies, professionals
and private agencies. They have to ensure that the information required by the
Companies Act and SEBI are furnished in the prospectus and get it vetted by
reputed solicitor.

The copies of consent of experts, legal advisor, attorney, solicitor, bankers,

bankers to the issue, brokers and underwriters are to be obtained from the
company making the issue, to be filed along with prospectus to the Registrar
of Companies. After the prospectus is ready, it has to be sent to SEBI for
vetting. It is only after clearance by SEBI, the prospectus can be filed with the
Registrar of Companies.

Brokers to the issue canvass subscription by mailing the literature to the clients
undertaking wide publicity. Members of stock exchange are appointed as
brokers to the issue.

Principal brokers, in addition to the functions of brokers assist merchant

bankers to devise strategy for success of the public issue, keep liaison between
merchant banker and stock exchanges and canvass support for the issue among
stock brokers. Sometimes, they undertake centralised mailing of prospectus,
application forms and other publicity material at the instant of the merchant
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banker.
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Merchant Banking and Financial Services Bankers to the issue accept applications along with subscriptions tendered at
their designated branches and forward them to the Registrar.

NOTES The brokers to the issue, principal agent and bankers to the issue are appointed
by merchant bankers.

(ii) Marketing

After despatch of prospectus to SEBI, the merchant bankers arrange a

meeting with company representatives and advertising agents to finalise
arrangements relating to date of opening and closing of issue, registration of
prospectus, launching publicity campaign and fixing date of board meeting to
approve and sign prospectus and pass the necessary resolutions.

Publicity campaign covers the preparation of all publicity material and

brochures, prospectus, announcement, advertisement in the press, radio. TV,
investors' conference, etc. The merchant bankers help choosing the media,
determining the size and publications in which the advertisement should
appear.

The merchant banker's role is limited to deciding the number of copies to be

printed, checking accuracy of statements made and ensure that the size of the
application form and prospectus conform to the standard prescribed by the
stock exchange. The merchant banker has to ensure that the material is
delivered te the stock exchange at least 21 days before the issue opens and to
brokers to the issue, branches of brokers to the issue and underwriters on time.

Security issues are underwritten to ensure that in case of under-subscription

the issues are taken up by the underwriters. SEBI has made underwriting
mandatory for issues to the public. The underwriting arrangement should be
filed with the stock exchange. Particulars of underwriting arrangement should
be mentioned in the prospectus.

The various activities connected with pre-issue management are a time- bound
programme which has to be promptly attended to. The execution of the
activities with clockwork efficiency would lead to a successful issue.

(iii) Pricing of issues

The SEBI Guidelines 1992 for capital issues have opened the capital market to
free pricing of issues. Pricing of issues is done by companies themselves in
consultation with the merchant bankers. Pricing of issue is part of pre-issue
management.

An existing listed company and a new company set up by existing company

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existing unlisted company going in for public issues for the first time with Merchant Banking and Financial Services

two-and-a-half years track record of constant profitability an freely price the

issue. The premium has to be decided after taking into account can net asset
NOTES
value, profit earning capacity and market price. Justification of price has to be
stated and included in the prospectus.

(iv) Post-issue management

The post-issue management consists of collection of application forms and

statement of account received from bankers, screening applications, deciding
allotment procedure, mailing of allotment letters, share certificates and refund
orders.

Registrars to the issue play a major role in post-issue management. They

receive the applications, verify them and submit the basis of allotment to the
stock exchange. After the basis of allotment is approved by the stock exchange
and allotted by the board, the auditor/ company secretary has to certify that the
allotment has been made by the company as per the basis of allotment
approved by the exchange. Registrars have to ensure that the applications are
processed and allotment/refund orders are sent within 70 days of the close of
the issue. The time limit of 70 days has proved difficult to adhere and
applicants have to wait for anytime between 90 to 180 days. Merchant bankers
assist the company by coordinating the above activities.

(v) Underwriting of public issue

Underwriting is a guarantee given by the underwriter that in the event of

undersubscription, the amount underwritten, would be subscribed by him. It is
an insurance to the company which proposes to make public offer against risk
of undersubscription. The issues packed by well- known underwriters
generally receive a high premium from the public. This enables the issuing
company to sell securities quickly.

All public issues have to be fully underwritten. Only Category I, II and III
merchant bankers are permitted to underwrite an issue subject to the limit that
the outstanding commitments of any such individual merchant banker at any
point of time do not exceed five times of his net worth (paid-up capital and
free reserves excluding revaluation reserves). This criteria is applicable to
brokers also. Lead managers have to underwrite mandatorily 5 per cent of the
issue or 2.5 lakh whichever is less. Banks/merchant banking subsidiaries
cannot underwrite more than 15 per cent of any issue.

By ensuring a direct stake in the underwriting, the merchant bankers make

raising of external resources easy.
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Merchant Banking and Financial Services (vi) Managers, consultants or advisors to the issue

The managers to the issue assist in the drafting of prospectus, application

NOTES forms and completion of formalities under the Companies Act, appointment of
Registrar for dealing with share applications and transfer and listing of shares
of the company on the stock exchange. Companies are free to appoint one or
more agencies as managers to the issue. SEBI guide lines insist that all issues
should be managed by at least one authorised merchant banker. Ordinarily, not
more than two merchant bankers should be associated as lead managers,
advisers and consultants to a public issue. In issues of over 100 crore, up to a
maximum of four merchant bankers could be associated as managers.

5. Portfolio management

Portfolio refers to investment in different kinds of securities such as shares,

debentures or bonds issued by different companies and securities issued by the
government. It is not merely a collection of unrelated assets but a carefully
blended asset combination within a unified framework. Portfolio management
refers to maintaining proper combination of securities in a manner that they
give maximum return with minimum risk.

Merchant bankers provide portfolio management service to their clients.

Today, the investoris very prudent. Every investor is interested in safety,
liquidity and profitability of his investment. But investors cannot study and
choose the appropriate securities. They need expert guidance. Merchant
bankers have a role to play in this regard. They have to conduct regular market
and economic surveys to know:

(i) Monetary and fiscal policies of the government.

(ii) Financial statements of various corporate sectors in which the investments

have to be made by the investors.

(iii) Secondary market position, i.e., how the share market is moving.

(iv) Changing pattern of the industry

(v) The competition faced by the industry with similar type of industries.

The merchant bankers have to analyse the surveys and help the prospective
investors in choosing the shares. The portfolio managers generally will have to
classify the investors based on capacity and risk; they can take and arrange
appropriate investment. Thus, portfolio management plans successful
investment strategies for investors.

The portfolio management service is very important need of the day since one-
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eighth of our investment at present comes from rural areas. Even though there
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are 23 stock exchanges in our country, 28 nationalised banks with network of Merchant Banking and Financial Services

about 50,000 branches, only one-eighth of the savings is mobilised from the
rural areas. By establishing portfolio management centres at various areas,
NOTES
more investments can be augmented from villages. Instead of concentrating on
large investors, there is immediate need to develop small investors which
could be done through portfolio management.

The role which can be played by non-resident Indians in the economic

development of a country is not small. With their technical skill and foreign
exchange and also with their knowledge of foreign market, they can contribute
much for the country. In order to utilise this opportunity, government is
offering number of facilities and incentives. But the NRI investment is not
showing any signs of substantial improvement for corporate sector. This is due
to the NRJ accounts being scattered with various branches of banks throughout
the country and no institution is taking action to pool these resources. The non-
resident themselves for investment will have to follow many rules and
regulations which are complicated. In this regard, merchant bankers should
help the NRI in selecting right type of securities and offering expertise
guidance in fulfilling government regulations. By this service to NRI
accountholders, merchant bankers can mobilise more resources for the
corporate sector.

6. Advisory service relating to mergers and takeovers

A merger is a combination of two or more companies into a single company

where one survives and others lose their corporate existence. A takeover is the
purchase by one company acquiring controlling interest in the share capital of
another existing company. Merchant bankers are the middlemen in setting
negotiation between the offeree and offeror. Being a professional expert, they
are apt to safeguard the interest of the shareholders in both the companies.
Once the merger partner is proposed, the merchant banker appraises
merger/takeover proposal with respect to financial viability and technical
feasibility. He negotiates purchase consideration and mode of payment. He
gets approval from the government/RBI, drafts scheme of amalgamation and
obtains approval from financial institutions.

7.Off shore finance

The merchant bankers help their clients in the following areas involving
foreign currency.

(i) Long-term foreign currency loans,

(ii) Joint venture abroad,

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Merchant Banking and Financial Services (iii) Financing exports and imports, and

(iv) Foreign collaboration arrangements.

NOTES
The bankers render other financial services such as appraisal, negotiations and
compliance with procedural and legal aspects.

8. Non-resident investment

The services of merchant bankers include investment advisory services to NRI

in terms of identification of investment opportunities, selection of securities,
investment management, etc. They also take care of the operational details like
purchase and sale of securities, securing necessary clearance from RBI for
repatriation of interest and dividend.

1.6 PROCESS OF MERCHANT BANKING IN INDIA

Up to 1970, there were only two foreign banks which performed merchant
banking operations in the country. SBI was the first Indian commercial bank
ICICI the first financial institution to take up the activities in 1972 and 1973
respectively. As a result of buoyancy in the capital market in 1980s some
commercial banks set up their subsidiaries to operate exclusively in merchant
banking industry .In addition, a number of large stock broking firms and
financial consultants also entered in to business. Thus, by the end of the 1980,
there were 33 merchant bankers belonging to three major segments, viz.,
commercial banks, all India financial institutions, and private firms. Merchant
banking functions of these institution was related only to management of new
capital issues.
Merchant banking industry which remained almost stagnant and
stereotyped for over two decades, witnessed an astonishing growth after the
process of economic reforms and deregulation of Indian economy in 1991.The
number of merchant banks increased to 115 by the end of 1992-93, 300 by the
end of 1993-94 and 501 by end of august 1994.All merchant bankers
registered with SEBI under four different categories include 50 commercial
banks,6 all India financial institutions-ICICI,IFCI,IDBI,IRBI, tourism finance
corporation of India ,Infrastructure Leasing and financial services Ltd., and
private merchant bankers.

The number of registered intermediaries operating in India is shown in the

following Table.

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 Merchant Banking and Financial Services
REGISTERED INTERMEDIARIES OTHER THAN STOCK
BROKERS AND SUB-BROKERS
NOTES
Type of Intermediary 2015-2016 2016-2017
Registrar to issue and share transfer 71 73
Agents 189 189
Merchant bankers 2 2
DPs-NSDL 585 588
DPs-NSDL 7 7
Credit Rating Agency 62 64
Debenture Trustees 31 32
Debenture Trustees 5 5
KYC (Know your client) Registration
Agencies(KRA)
Source: SEBI Annual Report 2016-2017.

In addition to Indian merchant bankers, a large number of reputed

international merchant bankers like Merrill lynch, Morgan Stanley, Goldman
Sachs, Jardie Fleming , Kleinwort Benson, etc., are operating in India under
authorisation of SEBI. As a result of proliferation, Indian merchant bankers re
faced with severe competition not only among themselves but also with the
well- developed global players.
1.7 MAIN FUNCTIONS OF FINANCIAL SYSTEM:
 The financial system works as on effective conduit for optimum
allocation of financial resource in an economy.
 It helps in establishing a link between the savers and investors.
 The financial system allows ―asset-liability transformation‖ banks
create a claims against themselves when they accept deposit from
the customers then also creates assets they provide loans to clients.
 Economic resources(fund)are transferred from one party to another
through financial system.
 The financial system ensures the efficient functioning of the
payment mechanism in an economic.
 All transaction between the buyers and sellers of

goods and services are effected smoothly because of financial system.

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Merchant Banking and Financial Services  The financial system helps in risk transformation by diversification
as in case of mutual funds.
 The financial system enhances liquidly of financial clients.
NOTES
 Financial system helps price discovery of financial assets resulting
price from the interaction of buyers and sellers.
Ex:
The prices of security are determined by demand and supply forces in the
capital market.

 The Financial system helps reducing the cost of transaction.

 as discussed above the financial market play a significant role
in economic growth through there role of allocation of capital,
monetary managers, mobilizing savings and promoting
technological changes among others.
 financial development can be designed as the ability of the
financial sector acquired effectively information enforce
contract, facilitate transaction and create incentives for the
emergence of financial contracts, markets and intermediataries
and all should be and low cost.
 the financial function or services may influences savings and
investment decisions of an economic through capital
accumulation and technological innovation and hence economic
growth.

1.8 FINANCIAL SYSTEM AND ECONOMIC

DEVELOPMENT:
The financial system plays a significant role in the process economic
development of a country. The financial system comprise of a network of
commercial bank. Non banking companies development banks and other
financial institutions of a varieties of financial product and services suit to
the varied requirements of different category of people.
The economic growth in the following ways

1. Mobilizing savings
2. Promoting investments
3. Encouraging investments in financial assets
4. Allocating savings on the basis of national priorities.
5. Creating credit
6. Providing a spectrum of financial assets.
7. Financing trade, industry, and agriculture
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 9. Providing financial services. Merchant Banking and Financial Services

10.Developing backward areas.

1.Mobilising savings:
NOTES

The financial system mobilizes the savings of the people by offering

appropriate incentives and by deepening and widening in the financial
structure. In another words the financial systems creates varieties of forms of
savings. So that savings can take place according to the varying asset
preferences of different classes of savers.

2.Ppromoting investments:
For the economic growth of nation, investment is absolutely essential.
The investments has to flow from the financial system.

Infact the levels of investment determines the increase in output o goods

and services income in the countries. The investment which contribute
positively economic power.

3. Encouraging investment in financial assets

The dynamic role of the financial system the economic development is that
encourages savings to flow into financial assets. Such as money and monetary
assets, physical assets land, gold & other goods & services.

4. Allocating savings on the basis of national priorities.

The larger the proportion of the financial assets, greater is the scope for
economic growth of the allocating savings on the basis of national priority
above all the financial system allocates the savings a more efficient manner so
that the scarce capital may be more efficiently utilized among various
alternative investments.

5. Creating credit:
Large financial resources are needed for the economic development of a
nation. These resources are supplied by the financial system not only in the
form of liquid cash bur also in the form of created money (or) deposit money
by creating credit and there by making available large resources to finance
trade, production distribution etc.. on a large scale.

6. providing a spectrum of financial assets

The financial system provides a spectrum of financial assets. so,as to meet the
varied requirements and preferences of households and there asset portfolios in
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Merchant Banking and Financial Services such a way as to achieve a preferred mix of return, liquity and risk. Thus, with
contributes to the economic development of the country.

NOTES 7.financing trade, industry and agriculture

All the financial institution operating in a financial system take all efforts to
ensure that no worth while project be with trade or agriculture or industries
suffers due to lack of funds. Thus the promote industrial and agricultural
development which have greater say on the economic development of a
country.

8. encouraging entrepreneurial talents:

The financial institution encourage the managerial and entrepreneurial
talents in the economy by promoting spirit of enterprise and risk title capacity.
They also furnish necessary technical consultancy services to the
entrepreneurs so that they may succeed in there innovative ventures.

9. providing financial services:

Sophistication and innovations now started appearing in the arena of
financial intermediaries as well. The financial institution play a very dynamic
role in the economic development of a country not only provided of finance
but also offering verities of innovative financial product and services to meet
the ever increasing demands both corporate and individuals.

10.developing backward areas

The integral policy of the national Government plans of every
country concentrates on the development of relatively less developed
areas called ―Backward areas‖. The financial institution provides a
package of services, infrastructure in and incentives & conducive to a
healthy growth of industries in such backward areas, the uniform
development of all regions in a country

1.9 WEAKNESSES OF INDIAN FINANCIAL SYSTEMS:

After the introduction of planning rapid industrialization has taken place. It
has in turn led to the growth at the corporate sector and the government sector.
In order to meet the growing requirements of the Government and the
industries many innovative financial instruments have been introduced.
The growth of the financial intermediataries to meet the ever growing financial
requirements of different types of customers. Hence,the Indian financial
system is more developed and integrated. Today, then what it was 50 years
ago. yet it suffers from some weaknesses as listed.
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1. Lack of co ordination between different financial institution. Merchant Banking and Financial Services

2. Monopolistic market structures.

3. Dominance of development banks in industry financial.
NOTES
4. In active and erratic capital market.
5. Imprudent financial practice.

Lack of coordination between different financial institution:

There are a large number of financial intermediataries.most of

the vital financial institutions owned by the Government. At the same time
the Government is also the controlling authority of these institution. In
these circumstances the problem of coordination arises. As there is
multiplicity of institution in the financial system, there is lack of
coordination in the working in this institution.

Monopolistic market structure:

In india some financial institution are large that they have created a
monopolistic market structures in the financial system.

For ex:

A major shares of life insurance business is in the hands of lic. the uti has
more or less monopolistic the mutual fund industry.

The weakness of the large structure is would lead inefficiency in there

working management or lack of referred in mobilizing savings of the
public and so on.

Dominance of development bank in industry financial:

The development banks constitute the backbone of the Indian financial

system occupying on important place in the capital market. The industry
financing today in india is largely through the financial institution created
by the Government both a national and regional levels. As such they fail to
mobilize the savings of the puplic. However,reason times attempt are being
made to raise funds from the public through the issue of bonds, unites and
debentures and so on.

Inactive and errabic capital market:

The important functions of any capital market it should promote

economic development through mobilization of savings and there
distribution productive ventures. As for as industrial finance in india is
concerned the corporate customers are able to raise there financial
resources through development banks. so,they need not go to the capital Self-Instructional Material
market.
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Merchant Banking and Financial Services Moreover they do not resort to capital market since it is very erective
and inactive.

NOTES Imprutent financial practice:

The dominance of development banks has developed imprudent
financial practices among corporate customers. The development banks
provide most of the funds in the form of termloan. When corporate
enterprisesface any financial prises. These financial institution permit a
greater use of debt then warranted. It is a against a traditional concept of a
sound capital structure.
However,in recent times all efforts have been taken who activate the
capital market. The integration is also taking place between the different
financial institution.

The refinance and rediscounting facilities provided by the IDBI aim at

integration. Thus the Indian financial system has become a developed one.

1.10 GUIDELINES FOR MERCHANT BANKERS

Merchant banking has been statutorily brought within the framework of the
Securities and Exchange Board of India under SEBI (Merchant Bankers)
Regulations, 1992.
1. In terms of the guidelines issued during April 1990, all merchant bankers
will require authorisation by SEBI to carry-out business.

The criteria for authorisation include:

(i) Professional qualification in finance, law or business management;

(ii) Infrastructure like adequate office space, equipment and manpower;

(iii) Employment of two persons who have the experience to conduct business
of merchant bankers;

(iv) Capital adequacy;

(v) Past track record, experience, general reputation and fairness in all
transactions.

2. SEBI issued further guidelines classifying the merchant bankers into four
categories based on the nature and range of activities and their responsibilities
to SEBI investors and issuers of securities. SEBI has issued revised guidelines
on December 22, 1992 classifying the activities of merchant hankers as
follows:

The first category consists of merchant bankers who carry on any activity of
Self-Instructional Material issue management which will inter alia consists of preparation of prospectus

16
and other information relating to the issue, determining financial structure, tie- Merchant Banking and Financial Services

up of financiers and final allotment and refund of subscription and to act in the
capacity of managers, advisor or consultant to an issue, portfolio manager and
NOTES
underwriter.

The second category consists of those authorised to act in the capacity of co

manager/advisor, consultant, underwriter to an issue or portfolio manager.

The third category consists of those authorised to act as underwriter, advisor or

consultant to an issue.

The fourth category consists of merchant bankers who act as advisor or

consultant to an issue.

Minimum net worth for first category is 1 crore, second category 50 lakh, third
category 20 lakh and fourth category is nil.

The above classification was valid up to December 1997 only.

3. An initial authorisation fee, an annual fee and renewal fee may be collected
by SEBI

4. All issues must be managed at least by one authorised banker, functioning

as the solemanager or the lead manager. Ordinarily, not more than two
merchant bankers should be associated as lead managers. But, for issues over
100 crore and above, the number of lead managers may go upto a maximum of
four. The specific responsibilities of each lead manager must be submitted to
SEBI prior to the issue.

5. The lead merchant banker holding a certificate under Category I shall accept
a minimum underwriting obligation of 5 per cent of the total underwriting
commitment or 25 lakh whichever is less.

6. Each merchant banker is required to furnish to the SEBI half-yearly

unaudited financial results when required by it with a view to monitor the
capital adequacy of the merchant banker.

7. SEBI has prescribed a code of conduct to the merchant bankers. The banker
must perform his duties with highest standards of integrity and fairness in all
his dealings. He will render at all times high standards of service, exercise due
diligence, ensure proper care and exercise independent professional
judgement. The merchant banker and his personnel will act in an ethical
manner in all his dealings with the investors, clients and fellow bankers. All
merchant bankers must adhere to the code of conduct.

8. The above guidelines will be administered by SEBI and it will supervise the Self-Instructional Material
activities of merchant bankers.
17
Merchant Banking and Financial Services 9. SEBI has been vested with power to suspend or cancel the authorisation in
case of violation of the guidelines.

NOTES 10. To ensure transparency and accountability in the operation of merchant

bankers and to protect the investors, a number of obligations and
responsibilities have been imposed on them. It has been decided to ask
merchant bankers to enter into an agreement with corporate body setting out
their mutual rights, liabilities and obligations relating to an issue particularly
on disclosure, allotment and refund, maintenance of books of accounts and
submission of half-yearly reports to SEBI.

11. Inspections will be conducted by SEBI to ensure that provisions of the

regulations are properly complied with and to investigate the complaints from
customers. It is obligatory on the part of merchant bankers to furnish all the
details sought by the investigating team. The regulations, however, indicate
that the board would give reasonable notice to merchant bankers before
undertaking inspection. On the basis of inspection report, the board will
communicate the contents of the report to the concerned merchant banker to
give him/her an opportunity to put forth his/her submissions. On receipt of the
explanations, if any, of the merchant bankers the SEBI would advise merchant
bankers to take any measures that it may deem fit, and to comply with the
provisions of the regulations.

The notification procedure relating to action to be initiated against merchant

banks in case of default has been detailed out. The regulations empower SEBI
to take action against defaulting banker such as suspension/cancellation of
registration. In case of deliberate manipulation, or price rigging or cornering
activities or deterioration in the financial position, the board is empowered to
cancel the registration of the merchant banker. Under the regulation, the SEBI
is empowered to suspend a registration of a member banker in case the
merchant banker furnishes wrong or false information, fails to resolve the
complaints of the investors, etc. The penalty or suspensation or cancellation of
registration can be imposed by SEBI only after holding heard. Any merchant
banker aggrieved by an enquiry and giving sufficient opportunity to the
merchant banker of being an order of SEBI, can, however, appeal to the Union
Government.

In September 1997, SEBI brought about some major changes in SEBI

(Merchant Bankers) Rules and Regulation,1992. Accordingly, only corporate
bodies will be allowed to function as merchant bankers. Moreover, the
multiple categories of merchant bankers shall be abolished and there will be
just one entity, viz., Merchant banker. The merchant bankers presently
functioning as merchant Bankers category II,III and IV shall have n option to
Self-Instructional Material either upgrade themselves as merchant Bankers (presently merchant banker
18
category I) or seek separate registration as underwriters or portfolio managers Merchant Banking and Financial Services

under the respective regulations. The merchant bankers will be prohibited

from carrying out fund- based activity other than those related ex from
NOTES
carrying out fund- based activity other than those related ex from carrying out
fund- based activity other than those related exclusively to the capital markets
.In effect, the activities undertaken by NBFCs such as accepting deposits,
1easing and bill discounting would not be undertaken by a merchant banker.

1.11 TERMINOLOGIES
1) Bank 2) Financial 3) Merchant4) System 5) Development 6) Market

1.12 MODEL QUESTIONS

1. Explain the Merchant Banking in India?
2. Explain the Process of Merchant banking in India?
3. Explain the Origin of Merchant Banking?
4. State the services of Merchant Banking?
5. Bringout the Financial System and Economic Development?

1.13 REFERENCE BOOKS

1. Dr. Natarajan K, 2009, ―Financial Markets and Services‖, Himalaya
Publishing House Pvt. Ltd., India
2. Dr. Guruswamy S, 2009 ―Financial Service‖, Tata Mc Graw-hill
Education, New Delhi.
3. Prasanna Chandra, 2011 ― Financial Management Theory and Practice‖,
Tata Mc Graw-hill Education, New Delhi.
4. Khan M Y and Jain P K, 2008, ― Financial Management Text, Problems
and Cases‖. Tata Mc Graw-hill Education, New Delhi.

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19
 Issue Management
UNIT- II ISSUE MANAGEMENT
Structure
NOTES 2.1Introduction
2.2 Pre- issue Management
2.3 Post- issue Management
2.4 Merchant Bankers as Lead Manager
2.5 Duties and Responsibilities of Lead Managers
2.6 Qualities Required for Merchant Bankers
2.7 Terminologies
2.8 Model Questions
2.9 Reference Books
2.1 INTORDUCTION
Management of issue involves marketing of corporate securities, viz.,
equity shares, preference shares and debentures or bonds by offering them to
public. Merchant banks act as intermediary whose main job is to transfer
capital from those who own it to those who need it.
The issue function may be broadly divided into pre-issue management and
post-issue management. In both the stages, legal requirements have to be
complied with and several activities connected with the issue have to be
coordinated.

2.1 PRE-ISSUE MANAGEMENT

(i) Issue through prospectus, offer for sale and private placement.
(ii) Marketing and underwriting.

(iii) Pricing of Issues.

(i) Issue through prospectus

(a) The most common method of public issue is through prospectus.

(b) Offers for sale are offers through the intermediary of issue house or firm of
stock broker. The company sells the entire issue of shares or debentures to the
issue house at an agreed price which is generally below the par value.

(c) The direct sale of securities by a company to investors is called private

placement. The investors include LIC, UTI, GlC, SFC, etc.

To bring out a public issue, merchant bankers have to coordinate the activities
relating to issue with different government and public bodies, professionals
and private agencies. They have to ensure that the information required by the
Companies Act and SEBI are furnished in the prospectus and get it vetted by
reputed solicitor.

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20
The copies of consent of experts, legal advisor, attorney, solicitor, bankers, Issue Management

bankers to the issue, brokers and underwriters are to be obtained from the NOTES
company making the issue, to be filed along with prospectus to the Registrar
of Companies. After the prospectus is ready, it has to be sent to SEBI for
vetting. It is only after clearance by SEBI, the prospectus can be filed with the
Registrar of Companies.

Brokers to the issue canvass subscription by mailing the literature to the clients
undertaking wide publicity. Members of stock exchange are appointed as
brokers to the issue.

Principal brokers, in addition to the functions of brokers assist merchant

bankers to devise strategy for success of the public issue, keep liaison between
merchant banker and stock exchanges and canvass support for the issue among
stock brokers. Sometimes, they undertake centralised mailing of prospectus,
application forms and other publicity material at the instant of the merchant
banker.

Bankers to the issue accept applications along with subscriptions tendered at

their designated branches and forward them to the Registrar.

The brokers to the issue, principal agent and bankers to the issue are appointed
by merchant bankers.

(ii) Marketing

After dispatch of prospectus to SEBI, the merchant bankers arrange a

meeting with company representatives and advertising agents to finalize
arrangements relating to date of opening and closing of issue, registration of
prospectus, launching publicity campaign and fixing date of board meeting to
approve and sign prospectus and pass the necessary resolutions.

Publicity campaign covers the preparation of all publicity material and

brochures, prospectus, announcement, advertisement in the press, radio. TV,
investors' conference, etc. The merchant bankers help choosing the media,
determining the size and publications in which the advertisement should
appear.

The merchant banker's role is limited to deciding the number of copies to be

printed, checking accuracy of statements made and ensure that the size of the
application form and prospectus conform to the standard prescribed by the
stock exchange. The merchant banker has to ensure that the material is
delivered te the stock exchange at least 21 days before the issue opens and to
brokers to the issue, branches of brokers to the issue and underwriters on time. Self-Instructional Material

21
 Issue Management Security issues are underwritten to ensure that in case of under-subscription
the issues are taken up by the underwriters. SEBI has made underwriting
mandatory for issues to the public. The underwriting arrangement should be
NOTES
filed with the stock exchange. Particulars of underwriting arrangement should
be mentioned in the prospectus.

The various activities connected with pre-issue management are a time- bound
programme which has to be promptly attended to. The execution of the
activities with clockwork efficiency would lead to a successful issue.

(iii) Pricing of issues

The SEBI Guidelines 1992 for capital issues have opened the capital market to
free pricing of issues. Pricing of issues is done by companies themselves in
consultation with the merchant bankers. Pricing of issue is part of pre-issue
management.

An existing listed company and a new company set up by existing company

with five- year track record and existing private closely held company and
existing unlisted company going in for public issues for the first time with
two-and-a-half years track record of constant profitability an freely price the
issue. The premium has to be decided after taking into account can net asset
value, profit earning capacity and market price. Justification of price has to be
stated and included in the prospectus.

(iv) Post-issue management

The post-issue management consists of collection of application forms and

statement of account received from bankers, screening applications, deciding
allotment procedure, mailing of allotment letters, share certificates and refund
orders.

Registrars to the issue play a major role in post-issue management. They

receive the applications, verify them and submit the basis of allotment to the
stock exchange. After the basis of allotment is approved by the stock exchange
and allotted by the board, the auditor/ company secretary has to certify that the
allotment has been made by the company as per the basis of allotment
approved by the exchange. Registrars have to ensure that the applications are
processed and allotment/refund orders are sent within 70 days of the close of
the issue. The time limit of 70 days has proved difficult to adhere and
applicants have to wait for anytime between 90 to 180 days. Merchant bankers
assist the company by coordinating the above activities.

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(v) Underwriting of public issue Issue Management

NOTES
Underwriting is a guarantee given by the underwriter that in the event of under
subscription, the amount underwritten, would be subscribed by him. It is an
insurance to the company which proposes to make public offer against risk of
under subscription. The issues packed by well- known underwriters generally
receive a high premium from the public. This enables the issuing company to
sell securities quickly.

All public issues have to be fully underwritten. Only Category I, II and III
merchant bankers are permitted to underwrite an issue subject to the limit that
the outstanding commitments of any such individual merchant banker at any
point of time do not exceed five times of his net worth (paid-up capital and
free reserves excluding revaluation reserves). This criteria is applicable to
brokers also. Lead managers have to underwrite mandatorily 5 per cent of the
issue or 2.5 lakh whichever is less. Banks/merchant banking subsidiaries
cannot underwrite more than 15 per cent of any issue.

By ensuring a direct stake in the underwriting, the merchant bankers make

raising of external resources easy.

(vi) Managers, consultants or advisors to the issue

The managers to the issue assist in the drafting of prospectus, application

forms and completion of formalities under the Companies Act, appointment of
Registrar for dealing with share applications and transfer and listing of shares
of the company on the stock exchange. Companies are free to appoint one or
more agencies as managers to the issue. SEBI guide lines insist that all issues
should be managed by at least one authorised merchant banker. Ordinarily, not
more than two merchant bankers should be associated as lead managers,
advisers and consultants to a public issue. In issues of over 100 crore, up to a
maximum of four merchant bankers could be associated as managers.

2.3 POST-ISSUE MANAGEMENT

The post-issue management consists of collection of application forms and

statement of account received from bankers, screening applications, deciding
allotment procedure, mailing of allotment letters, share certificates and refund
orders.

Registrars to the issue play a major role in post-issue management. They

receive the applications, verify them and submit the basis of allotment to the
stock exchange. After the basis of allotment is approved by the stock exchange
and allotted by the board, the auditor/ company secretary has to certify that the Self-Instructional Material

allotment has been made by the company as per the basis of allotment
23
 Issue Management approved by the exchange. Registrars have to ensure that the applications are
processed and allotment/refund orders are sent within 70 days of the close of
the issue. The time limit of 70 days has proved difficult to adhere and
NOTES
applicants have to wait for anytime between 90 to 180 days. Merchant bankers
assist the company by coordinating the above activities.

3.4 MERCHANT BANKERS AS LEAD MANAGERS

As per SEBI guidelines, it is mandatory that all public issues should be
managed by merchant bankers in the capacity of lead managers. Only in the
case of right issues not exceeding 50 lakh, such an obligation is not necessary.
The number of lead managers to be appointed by a company depends upon the
size of the issue as shown below
APPOINTMENT OF LEAD MANAGERS
Sl. No. Size of the Issue Maximum Number of Lead Managers
1 Less than50 crore 2
2 50 crore to100 crore 3
3 100 crore to 200 crore 4
4 200 crore to 400 crore 5
5 Above 400 crore 5 or more asprescribed by SEBI
2.5 DUTIES AND RESPONSIBILITIES OF LEAD
MANAGERS
The most important aspect of merchant banking business is to function as lead
managers to the issue management. As lead managers, they have to exercise
reasonable care and diligence in issue management by paying attention to the
following:
(i) It is the duty of every lead manager to enter into an agreement with the
issuing companies stating the details regarding their responsibilities, liabilities,
mutual rights, functions, disclosures, refund, allotment, etc. A copy of this
agreement should be submitted to the SEBI at least one month before the
opening of the issue for subscription.

(ii) One merchant banker cannot have association with another merchant
banker whodoes not hold a certificate of registration with the SEBI.

(iii) Similarly, a lead manager cannot undertake the work of issue management
if the issuing company is its associate.

(iv) In case there are more than one lead managers to an issue, the
responsibilites of each of them should be clearly defined in the agreement.

(v) A lead manager is under an obligation to accept a minimum underwriting

obligation of 5 per cent of the total underwriting commission or 25 lakh
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whichever is less. If he is not able to comply with the above provision, it is his Issue Management

duty to make managements with another merchant banker associated with that NOTES
issue to underwrite the said amount. Of course, it must be duly intimated to the
SEBI.

(vi) A lead manager has to exercise due care and diligence in the verification
of prospectus or letter of offer.

(vii) He has to submit due diligence certificate rating that the prospectus or
letter of offer is in conformity with the documents relevant to the issue, the
disclosures are true, fair and adequate and all legal requirements connected
with the issue have been duly complied with.

(viii) Every lead manager has to submit all the particulars of an issue, draft
prospectus or letter of offer, etc., to the SEBI at least two weeks before the
date of filing with the Registrar of Companies or regional stock exchanges or
both.

(ix) In case of any suggestions or modifications given by the SEBI, he has to

ensure that they are properly incorporated in the appropriate areas.

x) In the case of development, the lead manager has to ensure the collection of
the specified amount from the underwriters.

(xi) Every lead manager is responsible for ensuring timely refund of excess
application money received from the applicants.

(xii) It is his duty to mail the share/debenture certificate immediately on

allotment or inform it to the depository participant.

2.6 QUALITIES REQUIRED FOR MERCHANT BANKERS

Merchant bankers play a significant role as a catalyst to transform the project
ideas into industrial ventures. They help promotion of the enterprise by
undertaking various activities such as market surveys, choice of suitable
location and its size, preparation of documents and obtaining consent from
various authorities. They help in taking important decisions such as financing
mix, management of public issues, credit syndication, etc. The success of the
merchant bankers depends on the quality of service and soundness of advice to
clients. To perform these services effectively, the merchant bankers are
expected to possess certain qualities which are described below:
1. Ability to analyse various aspects such as technical, financial and economic
aspects concerning the formation of an industrial project.
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 Issue Management 2. Knowledge about the various aspects of capital markets, trends in stock
exchange, psychology of investing public, change in the economic and
technological environment in the country.
NOTES
3. Ability to build-up the bank-client relationship and live up to the clients'
expectations with total involvement in the project assigned to them.

4. Innovative approach in developing capital market instruments to satisfy the

ever- changing needs of investing public.

5. Integrity and maintenance of high professional standards are the essential

requisites for the success of merchant bankers in the present scenario.

2.7 TERMINOLOGIES
1) Issue Management2)Pre-issue 3) Post- issue 4)Activities 5) Merchant
Banks
2.8 MODEL QUESTIONS
1. Explain the Pre- issue Management?
2. State the Post- issue Management?
3. Bring out the Merchant Bankers as Lead Manager?
4. Explain the Duties and Responsibilities of Lead Managers?
5. Explain the Qualities Required for Merchant Bankers?
2.9 REFERENCE BOOKS
1. Dr. Natarajan K, 2009, ―Financial Markets and Services‖, Himalaya
Publishing House Pvt. Ltd., India
2. Dr. Guruswamy S, 2009 ―Financial Service‖, Tata Mc Graw-hill
Education, New Delhi.
3. Prasanna Chandra, 2011 ― Financial Management Theory and Practice‖,
Tata Mc Graw-hill Education, New Delhi.
4. Khan M Y and Jain P K, 2008, ― Financial Management Text, Problems
and Cases‖. Tata Mc Graw-hill Education, New Delhi.

Self-Instructional Material
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