There are three types of banking services based on the individuals or institutions they serve. It includes investment banking, commercial or retail banking, and merchant banking. While investment banking serves financial institutions and companies to raise capital and facilitate services on a similar line, and retail banking serves individual consumers, merchant banking provides services related to the capital requirement and cross-border trade to large financial corporations and high net worth individuals (HNIs).
This article will focus on what merchant banking is with examples, how it functions, its services, and how it is different from investment banking.
Merchant banking in India
The concept of merchant banking emerged in the 17th-18th century in France and Italy. However, in India, this term was brought by National Grindlays Bank in 1967 when they launched a new merchant banking division. Following in the same footsteps, Citibank established its merchant banking division in 1970, and the State Bank of India did the same in 1972. Today, after more than 50 years of merchant banking in India, most public and private sector banks and many institutions have evolved to provide merchant banking services.
Meaning of merchant banking
Merchant banking refers to the specific branch of banking services that serves only large multinational companies/corporations and HNIs for their financial needs. They do not cater to the requirements of the general public. Merchant banks are experts in international trade and trade finance, leading to providing high-quality and concentrated services to their large clients. A few examples of merchant banks are Goldman Sachs, Citigroup, J.P. Morgan Chase, etc.
The typical responsibilities of merchant banking include fundraising, underwriting, lending, and financial advisory. The organizational structure of these types of banks is not that subtle. The same can be said for their profit margin as they have a very thin margin to survive on. Merchant banks receive a fee for providing banking and consultancy services to their clients. Merchant banking plays a crucial role for large companies to grow their business and raise enough funds to undertake international expansion.
Characteristics of merchant banking
- They cater to large or multinational companies and HNIs
- The decision-making process is faster.
- Skilled decision makers make the most of the hired staff to serve clients
- Its organizational structure is not that bound or subtle.
- The focus point is the short or medium-term requirements of clients.
- International trade is their specialty.
- The liquidity ratio is quite high.
- These banks focus on fees or commission to make money; however, their profit margins and distribution is low.
How does merchant banking function?
Merchant banks function quite distinctly from commercial banks. That is because commercial banks allow customers to deposit and withdraw funds and give out loans for personal, educational, house needs, etc., but merchant banking is limited to business entities and large corporations; the general public does not have access to it. In India, banks like SBI, ICICI, CITIBANK, etc., provide merchant banking services.
These banks serve specific needs of large institutions for financial consulting, fundraising, lending, broking, etc., and help them assess different key parameters to sustain in current financial and economic conditions.
Let’s understand how a merchant bank functions with an example. If a large institute in India requires funding to expand in South Africa, merchant banking will help the institute source the funding. After analyzing the project proposal and the risks and rewards involved, the merchant bank will guide the company to raise funds via private equity, venture capital money, or loan. It depends on the requirement of the client. In return, the bank will receive a fee.
What are the primary services that merchant banking offers?
Here are some of the services that merchant banking provides to its clients.
- Cross-border transactions: This is one of the most important functions of merchant banks. It helps MNCs and HNIs to manage their global business and look after currency exchange for cross-border transactions using different means such as a letter of credit.
- Loan Syndication: To assist in various projects, merchant banks provide several ways for clients to get loans and fulfill their working and capital requirements.
- Issue Management: Merchant banking consults corporations and HNIs on matters of issue of shares like preference shares, equity shares, debentures, etc. The bank helps in the transaction of capital between businesses and investors.
- Leasing: Merchant banking also helps businesses lease certain assets for use for a fixed period on a suitable rental fee. This can be the lease of a factory, office space, or event space.
- Portfolio Management: The merchant banks will assess the assets and liabilities of the company and then propose investments in suitable instruments that will help keep their capital supply steady and also diversify the extent of their operations. They help diversify and create profits from the existing resources available to companies by guiding them on where to invest and manage risks.
- Project Counselling: Merchant banks play a big role in assisting companies with their management of long-term and short-term projects. The bank helps set up a plan which aligns with their financial, entrepreneurial, and social goals and ensures that the company has the right resources to execute it.
Corporate consulting: This service plays a major role in the success of companies that are clients of merchant banks. Merchant banks help companies diversify their operations and keep track of long-term goals to ensure their success. These consulting services extend to the matters of marketing, legal, and financial aspects.
What is the difference between merchant banking and investment banking?
While the goal of both these banking services is to help their clients succeed in their financial and business goals, they both are quite different. Investment banks help clients with issuing securities, underwriting services, mergers & acquisitions, and more. On the other hand, merchant banks cater to large organizations and HNIs for cross-border trade, fundraising, consultancy, lending, and more.
Additionally, the fee structure of both these banks differs. While merchant banks receive a fee or commission on the services they provide, investment banks have a two-stage income structure which includes fees from the clients as well as from interest and leases. There are multiple services provided by both banking services, but the primary functions remain unique and essential for their respective customers.
Conclusion
Merchant banking refers to banks that cater to capital requirements and management of large companies and HNIs, in addition to helping them secure international transactions. Merchant banks receive fees or commissions for providing fundraising and consultancy services to their clients. However, their profit margin is low. Other lines of services provided by merchant banks also include loan syndication, project, and corporate consultation, leasing or properties, issue management, and portfolio management.
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