Merchant Bank | Merchant Bank Functions, Objectives and Importance (2024)

What is a Merchant Bank?

A merchant bank can be classified as a financial intermediary or bank that deals with and handles investments and commercial loans for small and medium-sized businesses. Their existence dates back to the medieval period when commodities were traded actively.

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Explanation

In modern-day scenarios, they are often regarded as investment banks. This bank can be classified as a bank or a company that performs underwriting provides services on loans, and conducts consultations on critical financial projects and investment matters for small-sized businesses. It additionally helps in fundraising activity for institutional investors and large corporations. They generally don’t offer traditional banking services such as accepting deposits and lending them to a smaller group of borrowers.

Objectives of Merchant Bank

The broad objectives of this bank are to offer credit services and perform underwriting for its institutional and corporate clients. Additionally, their main objective is to help businesses in capital formation by providing standby credit services and underwriting securities generally backed by guarantees.

They also aim to create secondary markets wherein the bills are exchanged or traded, and the merchant banks are the central accepting house. They additionally provide dealer services regarding buy and sell transactions of financial instruments.

Examples of Merchant Bank

The world-renowned underwriters normally comprise Macquarie, JP Morgan, Citigroup, and Goldman Sachs. Small companies who wish to acquire finance either through debt or equity can get in touch with any one of the merchant bankers. These bankers may then set up a series of meetings to gather the requirements of the companies.

Once they gather the desired information, they undertake counseling and advisory sessions for the small client. They tell them about the pros and cons of the available finance methods. They additionally make the business understand the cost structure concerning the available modes of finance.

Services of Merchant Bank

The merchant banks offer their services to medium and small-scale enterprises that cannot raise funds from the initial public offering. They provide their services in bridge financing, mezzanine financing, etc. They also help in private placements for corporations who look out for minimum disclosures on regulations and compliances.

Additionally, they provide advisory and corporate counseling. For project-based financing, they provide prompt project counseling, which broadly covers the format of reports for preparing projects and how they acquire finance for the project.

Functions of Merchant Bank

The broad function of the merchant bank is to offer portfolio management services to corporate clients, medium-scale businesses, and institutional investors. To enhance the value of underlying instruments, they provide services for managing financial assets. They facilitate buy and sell transactions of the financial claims to help their clients achieve their investment objectives.

They also help underwrite large businesses that wish to acquire capital from the stock markets. They help prepare and file technical documentation and prospectus on behalf of the business. And collaborate with the company’s marketing department so that they can market the stock offering of the business.

The bankers additionally help acquire loans from banks and financial institutions. They formulate financial plans and budgets on behalf of the business and determine the total costs involved in acquiring loans that are of bigger ticket size. They liaison with the lenders to receive bridge finance for the business with the intent of meeting up towards the working capital requirements.

Importance of Merchant Bank

The bankers help small and medium-sized businesses acquire finance for businesses that are not big enough to raise finance from venture capitalists and investment bankers. They additionally play a critical role for these companies that cannot afford the high floatation costs of the capital markets and bigger investment banks.

Merchant bankers are always required for corporate counseling as well as for project counseling. They act as a bridge or an intermediary between the savers who wish to have high returns on their invested sums and users who want to use the funds for better utility.

Merchant Bank vs Investment Bank

There is fundamentally little difference between an investment bank and a merchant bank. The merchant bank deals with medium-sized and small-sized businesses, whereas the investment banks deal with large companies. The bankers offer innovative lending solutions for small businesses and help them with equity, bridge, and mezzanine financing.

Investment bankers, on the other hand, help businesses of large size to acquire finance and capital from the capital markets through the means of the initial public offering. They additionally provide big companies and clients with strategic advice on mergers and acquisitions with potential companies. They help in the capital restructuring of a large business.

On the other hand, merchant bankers focus on corporate investing, investments in real estate, and trade finance activities specifically for medium to small businesses. Investment banks help companies issue debt securities with guarantees in the debt market and help them in raising additional funds. At times, investment banks also play the role of the depository, which is usually not played by investment bankers.

Advantages and Disadvantages

Below are the advantages and disadvantages listed:

Advantages

• They provide regular counseling on projects as well as investments for small clients.
• They help small business raise finance easily.
• They play a critical role in reviving the weak and sick business.
• They help businesses in the distribution of profits to the residual investors.
• They help in cash management and leasing operations as well.

Disadvantages

• At times, merchant bankers charge hefty fees and commissions for helping small business raise finance, making it an expensive affair for the business itself.
• The business delays the shares allotment process, making it difficult for the bankers to sell such stocks.
• Due to compliance and restrictions imposed by the regulatory authority, merchant bankers may have to limit their scope of business.
• They may have to separate their business activities and ensure that the activities do not break laws, wherein they may have to float a new subsidiary.

Conclusion

Merchant bankers are individuals or entities who help channel funds from market participants who have surplus funds to individuals who need finance for their businesses. They help small businesses raise finance through bridge or mezzanine financing.

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