UNIT –III

MERCHANT BANKING AND UNDERWRITING

INTRODUCTION
Merchant Banking is a combination of Banking and consultancy services. It provides
consultancy to its clients for financial, marketing, managerial and legal matters. The Concept
of Merchant Banking study: Definition of Merchant Banking, Nature of Merchant Banking,
Functions of Merchant Banking, and Characteristics of Merchant Banking! Consultancy
means to provide advice, guidance, and service for a fee. It helps a businessman to start a
business. It helps to raise (collect) finance. It helps to expand and modernize the business. It
helps in the restructuring of a business. It helps to revive sick business units. It also helps
companies to register, buy and sell shares at the stock exchange.
Meaning
A merchant bank is a company that conducts underwriting, loan services, financial
advising, and fundraising services for large corporations and high net worth individuals.
Unlike retail or commercial banks, merchant banks do not provide services to the general
public. They do not provide regular banking services like checking accounts and do not take
deposits.
These banks are experts in international trade, which makes them specialists in
dealing with multinational corporations. Some of the largest merchant banks in the world
include J.P. Morgan, Goldman Sachs, and Citigroup.
Understanding Merchant Banks
The term merchant bank used in the United Kingdom to describe investment banks,
but has a more narrow focus in the United States. They may act like investment banks in the
U.S. but tend to focus on services tailored to multinational corporations and high net worth
individuals who do business in more than one country.
Merchant banks in the U.S. are financial institutions that deal with international
finance for multinational corporations. Merchant banks traditionally perform international
financing and underwriting including real estate, trade finance, foreign investment, and other
international transactions. They may be involved in issuing letters of credit and in the transfer
of funds. They may also consult on trades and trading technology.
Merchant Banking is a combination of Banking and consultancy services. It provides
consultancy to its clients for financial, marketing, managerial and legal matters. Consultancy
means to provide advice, guidance and service for a fee. It helps a businessman to start a
business. It helps to raise (collect) finance. It helps to expand and modernize the business. It
helps in restructuring of a business. It helps to revive sick business units. It also helps
companies to register, buy and sell shares at the stock exchange.
Definition
Merchant banking can be defined as a skill-oriented professional service provided by
merchant banks to their clients, concerning their financial needs, for adequate consideration,
in the form of fee.
NATURE OF MERCHANT BANKING:
Merchant banking is skill-based activities and involves serving every financial need
of every client. It requires focused skill-base to provide for the requirements of the client.
SEBI has made the quality of manpower as one of the criteria for registration as the merchant
banker. These skills should not be concentrated in issue management and underwriting alone,
which may have an adverse impact on business.
Merchant bankers can turn to any of the activities mentioned above depending upon
resources, such as capital, foreign tie-ups for overseas activities and skills. The depth and
sophistication in merchant banking business are improving since the avenues for participating
in capital market activities have widened from issue management and underwriting to private
placement, bought out deals (BODS), buy-back of shares, mergers, and takeovers.
The services of merchant bank cover project counseling, pre-investment activities,
feasibility studies, project reports, the design of the capital structure, issue management,
underwriting, loan syndication, mobilization of funds from Non-Resident Indians, foreign
currency finance, mergers, amalgamation, takeover, venture capital, buyback, and public
deposits. A Category-1 merchant banker can undertake issue management only. Separate
registration is not necessary to carry on the act as the underwriter.
MAIN OBJECTIVES
Merchant bankers render their specialized assistance in achieving the main objectives
which are presented below:
1. To carry on the business of merchant banking, assist in the capital formation,
manage advice, underwrite, provide standby assistance, securities and all kinds of
investments issued, to be issued or guaranteed by any company, corporation, society, firm,
trust person, government, municipality, civil body, public authority established in India.
2. The main object of merchant banker is to create secondary market for bills and
discount or re- discount bills and acts as an acceptance house.
 3. Merchant banker’s another objective is to set up and provide services for the
venture capital technology funds.
4. They also provide services to the finance housing schemes for the construction of
houses and buying of land.
5. They render the services like foreign exchange dealer, money exchange, and
authorized dealer and to buy and sell foreign exchange in all lawful ways in compliance with
the relevant laws of India.
6. They will invest in buying and selling of transfers, hypothecate and deal with
dispose of shares, stocks, debentures, securities and properties of any other company.
CLASSIFICATION OF MERCHANT BANKERS
The SEBI has classified ‘merchant bankers’ under four categories for the purpose of
registration:
1. Category I Merchant Bankers:
These merchant bankers can act as issue manager, advisor, consultant, underwriter
and portfolio manager.
2. Category II Merchant Bankers:
Such merchant bankers can act as advisor, consultant, underwriter and portfolio
manager. They cannot act as issue manager of their own but can act co-manager.
3. Category III Merchant Bankers:
They are allowed to act as underwriter, advisor and consultant only. They can neither
undertake issue management of their own nor they act as co-manager. They cannot undertake
the activities of portfolio management also.
4. Category IV Merchant Bankers:
A category IV merchant banker can merely act as consultant or advisor to an issue of
capital.
Capital Adequacy Norms:
SEBI has prescribed capital adequacy norms for registration of the various categories
of merchant bankers. The capital adequacy is expressed in terms of minimum net worth, i.e.,
capital contributed to the business plus free reserves.
The following are the capital adequacy norms as laid down by SEBI:
Fees:
According to the SEBI (Merchant Bankers) Amendment Regulations, 1999, w.e.f.
30.9.1999, every merchant banker shall pay a sum of Rs. 5 lakhs as registration fees at the
time of grant of certificate by the Board. The fee shall be paid by the merchant banker within
15 days of receipt of intimation from the Board.
Further, a merchant banker to keep registration in force shall pay renewal fee of Rs.
2.5 lakhs every three years from the fourth year from the date of initial registration.
GOVERNMENT POLICY FOR MERCHANT BANKING:
The Government issued policy guidelines for merchant bankers to ensure sufficient
physical infrastructure, necessary expertise, good financial standing, professional integrity
and fairness in their transactions. The merchant bankers have to be competent to serve the
investors also.
On 1st March, 1993 new policy guidelines have been issued by SEBI for the merchant
bankers to ensure greater transparency in their operations and to make them accountable so as
to protect the investor’s interest. The guidelines relate to pre-issue obligations, underwriting,
advertisements and post-issue obligations of the merchant bankers.
SERVICES OFFERED BY MERCHANT BANKS
In modern terms, a merchant bank is a firm or financial institution that invests equity
capital directly in businesses and often provides those businesses with advisory services. A
merchant bank offers the same services as an investment bank, however, it typically services
smaller clients and makes direct equity investments in them.
Merchant Banks offers a range of financial and consultancy services, to the customers,
which are related to:
 Marketing and underwriting of the new issue.
 Merger and acquisition related services.
 Advisory services, for raising funds.
 Management of customer security.
 Project promotion and project finance.
 Investment banking
 Portfolio Services
 Insurance Services.
FUNCTIONS OF MERCHANT BANKING
The basic function of merchant banker or investment banker is marketing of corporate
and other securities. In the process, he performs a number of services concerning various
aspects of marketing, viz., origination, underwriting, and distribution, of securities. During
the regime of erstwhile Controller of Capital Issues in India, when new issues were priced at
a significant discount to their market prices, the merchant banker’s job was limited to
ensuring press coverage and dispatching subscripttion forms to every corner of the country.
Now, merchant bankers are designing innovative instruments and perform a number of other
services both for the issuing companies as well as the investors.
The functions of merchant banking are listed as follows:
1. Raising Finance for Clients : Merchant Banking helps its clients to raise finance
through issue of shares, debentures, bank loans, etc. It helps its clients to raise finance
from the domestic and international market. This finance is used for starting a new
business or project or for modernization or expansion of the business.
2. Broker in Stock Exchange: Merchant bankers act as brokers in the stock exchange.
They buy and sell shares on behalf of their clients. They conduct research on equity
shares. They also advise their clients about which shares to buy, when to buy, how
 much to buy and when to sell. Large brokers, Mutual Funds, Venture capital
companies and Investment Banks offer merchant banking services.
3. Project Management : Merchant bankers help their clients in the many ways. For e.g.
advising about location of a project, preparing a project report, conducting feasibility
studies, making a plan for financing the project, finding out sources of finance,
advising about concessions and incentives from the government.
4. Advice on Expansion and Modernization: Merchant bankers give advice for
expansion and modernization of the business units. They give expert advice on
mergers and amalgamations, acquisition and takeovers, diversification of business,
foreign collaborations and joint-ventures, technology up-gradation, etc.
5. Managing Public Issue of Companies: Merchant bank advice and manage the public
issue of companies. They provide following services:
i. Advise on the timing of the public issue.
ii. Advise on the size and price of the issue.
iii. Acting as manager to the issue, and helping in accepting applications and
allotment of securities.
iv. Help in appointing underwriters and brokers to the issue.
v. Listing of shares on the stock exchange, etc.
6. Handling Government Consent for Industrial Projects: A businessman has to get
government permission for starting of the project. Similarly, a company requires
permission for expansion or modernization activities. For this, many formalities have
to be completed. Merchant banks do all this work for their clients.
7. Special Assistance to Small Companies and Entrepreneurs: Merchant banks advise
small companies about business opportunities, government policies, incentives and
concessions available. It also helps them to take advantage of these opportunities,
concessions, etc.
8. Services to Public Sector Units : Merchant banks offer many services to public sector
units and public utilities. They help in raising long-term capital, marketing of
securities, foreign collaborations and arranging long-term finance from term lending
institutions.
9. Revival of Sick Industrial Units: Merchant banks help to revive (cure) sick industrial
units. It negotiates with different agencies like banks, term lending institutions, and
BIFR (Board for Industrial and Financial Reconstruction). It also plans and executes
the full revival package.
 10. Portfolio Management : A merchant bank manages the portfolios (investments) of its
clients. This makes investments safe, liquid and profitable for the client. It offers
expert guidance to its clients for taking investment decisions.
11. Corporate Restructuring: It includes mergers or acquisitions of existing business units,
sale of existing unit or disinvestment. This requires proper negotiations, preparation
of documents and completion of legal formalities. Merchant bankers offer all these
services to their clients.
12. Money Market Operation : Merchant bankers deal with and underwrite short-term
money market instruments, such as:
i. Government Bonds.
ii. Certificate of deposit issued by banks and financial institutions.
iii. Commercial paper issued by large corporate firms.
iv. Treasury bills issued by the Government (Here in India by RBI).
13. Leasing Services : Merchant bankers also help in leasing services. Lease is a contract
between the lessor and lessee, whereby the lessor allows the use of his specific asset
such as equipment by the lessee for a certain period. The lessor charges a fee called
rentals.
14. Management of Interest and Dividend: Merchant bankers help their clients in the
management of interest on debentures / loans, and dividend on shares. They also
advise their client about the timing (interim / yearly) and rate of dividend.
Thus, at present merchant banking services in our country are provided by the
following types of organisations:
(i) Commercial banks and their subsidiaries.
(ii) Foreign banks including National Grindlays Bank, Citi Bank, Hongkong Bank etc
(iii) All India Financial Institutions and Development Banks such as, ICICI, IFCI, IDBI.
(iv) State Level Financial Institutions, such as, State Industrial Development Corporations
(SIDC’s) and State Financial Corporations.
(v) Private Financial Consultancy Firms and Brokers, such as J.M. Financial and
Investment Services Ltd.; DSP Financial Consultants, Fnam Financial Consultants, Kotak
Mohindra, Ceat Financial Services, etc.
(vi) Technical Consultancy Organisations
(vii) Professional Merchant Banking Houses, such as VMC Project Technologies.
Merchant banking in India can be categorised in four broad sections:
1. To provide long-term source of funds required by the corporate sector. The
merchant banker primarily came into being as corporate counsellors for restructuring base of
capital, thereafter for issue management and underwriting of the same.
2. Project counselling which includes credit-syndication and the working capital.
3. Capital structuring.
4. Portfolio management.
The buoyancy in the capital market in 1980s created a lot of scope for merchant
banking activities in our country. The year 1985 was an epoch-making year in the history of
merchant banking when a large number of issues were oversubscribed by several times and
the importance of merchant banking activities was made evident in managing issues and their
underwriting.
Government Policy for Merchant Banking:
The Government issued policy guidelines for merchant bankers to ensure sufficient
physical infrastructure, necessary expertise, good financial standing, professional integrity
and fairness in their transactions. The merchant bankers have to be competent to serve the
investors also.
On 1st March, 1993 new policy guidelines have been issued by SEBI for the merchant
bankers to ensure greater transparency in their operations and to make them accountable so as
to protect the investor’s interest. The guidelines relate to pre-issue obligations, underwriting,
advertisements and post-issue obligations of the merchant bankers.
IMPORTANCE OF MERCHANT BANKING
Merchant banking has an essential role to play in today’s economy. They assist
companies in numerous ways. All businesses aim at generating the most income out of their
funds. Merchant bankers help these companies to utilize their funds properly and grow.
They can invest a company’s funds in the stock market. Manage funds to decide later whether
to sell them and book profits. Advice large firms on how to increase funds through shares.
Including, when to provide dividends, the number of shares to issue and the price of each
share.
A merchant banker issues advice on the expansion and modernization of a company.
They provide possible expansion options like takeovers, mergers, acquisitions,
amalgamations, joint ventures or other diversification actions.
Important reasons for the growth of merchant banks has been development activities
throughout the country, exerting excess demand on the sources of fund for ever expanding
industries and trade, thus leaving a widening gap unabridged between the supply and demand
of invisible funds. All financial institutions had experienced constrain of resources to meet
ever increasing demands for demands for funds frame corporate sector enterprises. In such
circumstances corporate sector had the only alternative to avail of the capital market service
for meeting their long term financial requirement through capital issue of equity shares and
debentures. Growing demand for funds put pressure on capital market that enthused
commercial banks, share brokers and financial consultancy firms to enter into the field of
merchant banking and share the growing capital market. As a result all the commercial banks
in nationalized and public sector as well as in private sector including foreign banks in India
have opened their merchant banking windows and competing in this field.
Need for merchant banking is felt in the wake of huge public saving lying untapped.
Merchant banker can play highly significant role in mobilizing funds of savers to invisible
channels assuring promising returns on investment and thus can assist in meeting the
widening demand for invisible funds for economic activity. With growth of merchant
banking profession corporate enterprises in both private sectors would be able to raise
required amount of funds annually from the capital market to meet the growing requirement
for funds for establishing new enterprises, undertaking expansion, modernization and
diversification of the existing enterprises. This reinforces the need for a vigorous role to be
played by merchant banking.
Merchant banking helps in reinforcing the economic development of the country, by
acting as a source of funds and information to the business entities.
Merchant banking services are particularly crucial in the modern business world. The
government is constantly changing rules and regulations — imposing statutory obligations on
firms. Merchant banks come in to aid businesses by continuously updating them with the
changes. So what exactly are merchant banks? They are financial institutions which mostly
cater to large firms and people of high net value. They provide them with both banking and
consultancy services.
Difference between an Investment Bank and a Merchant Bank
Although there is somewhat a thin line between traditional merchant banks and
investment banks, the financial institutions differ in several ways. First, merchant banks serve
small-scale companies that may not be big enough to attract funding from venture capitalists
and other large investors. Merchant banks offer such companies creative credit products such
as bridge financing, equity financing, and mezzanine financing. They place equity with other
financial institutions and take ownership of small but promising companies.
 Investment banks, on the other hand, focus on underwriting and selling securities
through initial public offerings (IPO) and share offerings. Unlike merchant banks that focus
on small companies with potential for growth, investment’s bank clientele comprises large
companies with enough resources to finance the sale of securities to the public. Investment
banks advise their clients on mergers and acquisitions, buyouts, and capital restructuring,
among other services.
Traditional merchant banks mainly focus on international financing activities
including trade finance, foreign corporate investing, and foreign real estate investment. Some
of these activities may be shared with investment banks, but there are other functions like
issuing letters of credit and international funds transfer that are predominantly carried out by
merchant banks. Investment banks focus on raising funds for corporations and governments
and issuing debt or equity on the market. This is a transition from their traditional roles of
underwriting and selling securities. Investment banks also help in mergers and acquisitions as
well as buying and selling large companies.
MERCHANT BANKING IN INDIA
The word merchant bank does not have a fixed definition as this term is used
differently in different countries. In United States these are called as “investment bank” and
in UK they are called as “accepting and issuing houses”. The notification of ministry of
finance in India defines 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, adviser in relation to such an issue management”. In
general the merchant banks are the financial institution which provides financial services,
solution, & advice to corporate houses. Some of the world famous merchant banks are
Goldman sachs, credit Suisse & morrgan Stanley etc. In India there are many banks which
are into the field of merchant banking are ICICI, State Bank Of India, Punjab National Bank
etc.
A merchant banking is an institution that deals mostly in international finance,
business loans for companies and underwriting. These banks are experts in international
trade, which makes them specialists in dealing with multinational corporations.
History of Merchant Banking
The history of merchant banking can be dated back to it first started in Italy & France.
This was started by the Italian grain merchants. It comprised of merchant bankers who
intermediated or assisted in financing the transactions of other traders and their own trade
too. With the passage of time the practices in evolved and the merchant banking in the
modern era started from London where the merchants started to finance the foreign trade
through acceptance of bill. Later they extended their extended their services to the
governments of under developed countries to raise the long term funds through the floatation
of bonds in the London money market. Over the period they extended their services to loan
syndication, underwriting the issues, portfollo management etc. the post war period witnessed
huge increase in the merchant banking activities.
Merchant banking activity was officially commenced in to the Indian capital markets
when Grindlays bank received the llcense. From reserve bank in 1967, Grindlas started its
operation with management of capital issues, recognized the requirements of upcoming class
of entrepreneurs for diverse financial services ranging from production planning and system
design to market research. Apart from this it also provides management consulting service to
meet the requirements of small and medium sector rather than large sector.
 Citibank setup its merchant banking division in Indian in 1970.
 Indian banks stared banking services from 1972.
 State bank of India stared the merchant banking division in 1972.
 After that there were many banks which set up the merchant bank division such as;
 ICICI
 Bank of India
 Bank of Baroda
 Canara Bank
 Punjab National Bank
 UCO Bank
The merchant bank got more importance in the year 1983 when there was a huge
boom in the primary market where the companies were going for new issue. Merchant
banking activities are organized and undertaken in several forms. And development
finance institution have organized them through formation divisions, nationalized have
formed subsidiary companies, share brokers and consultancies constituted themselves into
public limited companies or registered themselves as private limited companies. Some
merchant banking companies have entered into collaboration with merchant bankers of
foreign countries abroad with several branches.
Merchant bankers in India
As of now there are 135 merchant bankers who are registered with SEBI in India. It
includes public sector, private sector and foreign players of them are:
Public sector merchant bankers
 SBI capital markets ltd
 Punjab national bank
 Bank of Maharashtra
 Karur vysya bank lid,
 State bank of Bikaner and jaipur
Private sector merchant bankers
 ICICI securities Lid
 Axis bank lid (Formerly UTI Bank Lid).
 Bajaj capital Lid
 Tata capital markets Lid
 ICICI Bank Lid
 Reliance securities limited
 Kotak Mahindra capital company lid
 Yes bank Lid
Foreign players in merchant banking
 Goldman sachs (India) Securities Pvt. Ltd.
 Morgan Stanley India company Pvt. Ltd.
 Barclay’s securities (India) Pvt.Ltd.
 Bank of America, N.A
 Deutsche bank
 Deutsche equities India private limited
 Barclaya BANK Plc
 Citigroup Global Markets India Pvt. Ltd.
 Dsp Merrill Lynch Ltd
 FEDEX securities Ltd
Merchant Bank Vs Commercial Bank
 Commercial banks are catering to the needs of the common man whereas the
merchant banks cater to needs of corporate firmer.
 Any person can open a bank account in the commercial bank whereas it
cannot be done in the merchant bank.
  Merchant bank deals with equities the commercial bank deals with debt
related finance which includes the activities like credit proposals, lone
sanctions etc.
 The merchant bank is exposed to the market so it is more exposed to risk as
compared to commercial banks.
 Merchant bank is related to the primary market whereas the commercial bank
markets are more into secondary markets.
 Merchant banking activities are capital restructuring, portfolio management
etc
Whereas the commercial banks play the role of financers
 The activities of merchant banks have a direct impact on the growth and
liq1uidity of money markets.
 Merchant bank is management oriented whereas the commercial banks are
asset oriented get advice from our money.
 The commercial banks generally avoid risks and on the other hand the
merchant banks are willing to take the risks.
SERVICES PROVIDED BY MERCHANT BANKS
Below mentioned are the major services offered by merchant bankers;
 Project counseling
 Management of debt and equity offerings
 Issue management
 Managers, consultants or advisers to issue
 Underwriting of public issue
 Portfolio management
 Restructuring strategies
 Off shore finance
 Non-resident investment
 Loan syndication
 Corporate counseling and advisory services
 Placement and distribution
Project counselling
 Project counseling comprises preparation of project reports, deciding upon the
financing pattern to finance the cost of the project and appraising the project with the
financial institutions and banks. It also includes filling up of application forms with
significant information for obtaining funds from financial institution and obtaining
government approval.
Management of debt and Equity offerings
This is the major function of the merchant banker. They assist the companies in raise
funds from the market. The main areas of work in this regard include;
 Instrument designing
 Pricing the issue
 Registration of the offer document
 Underwriting support
 Marketing of the issue
 Allotment and refund
 Listing on stock exchanges.
Issue Management
` Management of issue involves marketing of corporate securities like equity shares,
preference shares and debentures or bonds by offering them to public. Merchant banks act as
an intermediary to transfer capital from those who own it to those who need it. After taking
action as per SEBI guidelines, the merchant banker organizes a meeting with company and
closing of issue, registration of prospectus, launching publicity campaign and fixing dada of
board meeting to approve and sign prospectus and pass the necessary resolutions. Pricing of
issues is done by the companies in consultant with the merchant bankers.
Managers, consultants or advisers 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 can appoint one or more agencies as managers to the issue.
Underwriting of public issue
Underwriting is a guarantee given by the underwriter that in the occurrence of under
subscription the amount underwritten would be subscribed by him. Banks/ Merchant banking
institutions cannot underwrite more than 15 %v of any issue
Portfolio management:
 Portfolio indicates investment in different types of securities such as shares
debentures or bonds issued by different companies. Portfolio management means maintaining
proper combinations of securities in a mode that they give maximum return with minimum
risk.
Restructuring strategies
A merger is a blending of two companies into a single company where one survives
and other loses its corporate existence. A takeover is the purchase by one company obtaining
controlling interest in the share capital of another existing company. Merchant bankers act as
the middlemen in setting negotiation between the two companies. Merchant bankers assist the
management of the client company to successfully restructure various activities such as
mergers and acquisitions, divestitures management buyouts joints venture among others.
Off shore finance
The merchant bankers help their clients in the following areas involving foreign currency.
 Long term foreign currency loans
 Joint venture abroad
 Financing exports and imports
 Foreign collaboration arrangements
Non- resident investment
The services of merchant bankers include investment advisory services to NRI in
terms of classification of investment opportunities selection of securities investment
management and operational services like purchase and sale of securities.
Loan syndication
Loan syndication is an assistance provided by merchant bankers to get mainly terms
of loans for projects. such as 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 banks and other financial institutions.
Corporate counseling and advisory services
Corporate counseling involves the entire field merchant banking activities such as
project counseling capital restructuring public issue management, loan syndication, working
capital, fixed deposit lease financing acceptance credit etc,. Merchant bankers also provide
customized solutions to their client and evaluate cheaper sources of funds. Rehabilitation and
turnaround management is another area of advice. A merchant banker advises the client on
different hedging strategies and suggested the appropriate strategy.
Placement and distribution
The merchant banker helps in distributing securities like equity share, debt
instruments, insurance protects, commercial papers, etc. The distribution network of the
merchant banker Can be classified as institutional and retail in character, the institution
network consists of mutual funds foreign institutional investors, private equity funds, pension
funds .financial institutions etc. the size of such a network signifies the wholesale reach of the
merchant banker. The retail network is purely depends on networking with investors.
Difference between merchant banking and investment banking:
 The merchant banks are engaged in international financing activities whereas
the investment banks are concerned with underwriting and issuance securities.
 A merchant bank refers to a banking institute whose work is concerned mainly
with international finance. The merchant bankers work is related to corporate
investment, trade finance and real estate investment. the main functions of
merchant banks are issue management, portfolio management and corporate
counseling, whereas an investment bank is a banking institution that deals with
established firms and helps them gain their long-term capital requirement, by
acting as an intermediary between the company and investors.
 Merchant banks provide trade financing facilities to their clients. But in case
of investment banks, there are only a few banks or institutions that provide
trade financing services to clients.
 An investment bank is a fee based institution that earns income from interest,
lease rentals and services provided. A merchant bank is fee based and fund
based as it provides banking, advisory and custodial services to its clients.
 Investment banks work with large corporations whereas a merchant bank deals
with the companies which are not so big.
UNDERWRITING
Underwriting is the process through which an individual or institution takes on
financial risk for a fee. The risk most typically involves loans, insurance, or investments. The
term underwriter originated from the practice of having each risk-taker write their name
under the total amount of risk they were willing to accept for a specified premium. Although
the mechanics have changed over time, underwriting continues today as a key function in the
financial world.
Underwriting is the process that a lender or other financial service uses to assess the
creditworthiness or risk of a potential customer.
Underwriting services are provided by some large financial institutions, such as
banks, or insurance or investment houses, whereby they guarantee payment in case of
damage or financial loss and accept the financial risk for liability arising from such
guarantee. An underwriting arrangement may be created in a number of situations including
insurance, issue of securities in a public offering, and bank lending, among others. The
person or institution that agrees to sell a minimum number of securities of the company for
commission is called the underwriter.
Definition:
Underwriting is one of the most important functions in the financial world wherein an
individual or an institution undertakes the risk associated with a venture, an investment, or a
loan in lieu of a premium. Underwriters are found in banking, insurance, and stock markets.
According to the Companies Act, when a person agrees to take up shares specified in the
underwriting agreement when the public or others failed to subscribe for them, it is called
underwriting agreement. For this purpose, the underwriter who guarantees for the sale of
shares, is given a commission.
According to SEBI Rules 1993, underwriting means an agreement with or without
conditions to subscribe to the securities of a body corporate when the existing shareholders of
such body corporate or the public do not subscribe to the securities offered to them.
‘Underwriter’ means a person who engages in the business of underwriting of an issue of
securities of a body corporate.
Underwriting involves conducting research and assessing the degree of risk of each
applicant or entity before assuming that risk. This check helps to set fair borrowing rates for
loans, establishes appropriate premiums to adequately cover the true cost of insuring
policyholders, and creates a market for securities by accurately pricing investment risk. If the
risk is deemed too high, an underwriter may refuse coverage.
Forms of Underwriting:
The nature and form of underwriting transactions depend mainly upon the nature of
the project, the state of the capital market, the general response of the investors to the new
issues, the reputation of the promoters and capacity of the underwriters. It may be undertaken
on a commission basis. An issuing company may get underwriting from a single underwriter
but where the size of the issue is so large that it is unmanageable by a single underwriter and
the risk involved is also high, the company may approach a number of underwriters.
1. Full Underwriting:
It is an agreement under which the underwriter undertakes the guarantee of buying the
whole of shares or debentures placed before the public in the event of non-subscription. The
liability of the underwriter is to buy and pay for the entire unsubscribed portion of the issue.
2. Partial Underwriting:
Under this type of agreement, the underwriter undertakes the guarantee for only part
of the issue offered to the public and his liability is limited to the extent of unsubscribed
portion of the issue underwritten by him.
3. Joint Underwriting:
In case of a large issue which is unmanageable by a single underwriter and where the
risk involved is too high, the issuing company may enter into underwriting agreement with
more than one underwriter. Each underwriter undertakes the guarantee for the issue of a
certain portion of the whole issue offered to the public.
4. Syndicate Underwriting:
Syndicate underwriting is essentially different from joint underwriting so far as the
agreement among the underwriters is concerned. Thus, in syndicate underwriting two types of
separate agreements take place, one between the issuing company and the syndicate of
underwriters, and the other among the underwriters who are members of the syndicate.
5. Firm Underwriting:
When an underwriter undertakes to buy or subscribe a certain number of shares or
debentures irrespective of the subscription from the public, it is called firm underwriting.
The liability of underwriters in case of firm underwriting is both for shares underwritten as
well as such part of the shares as the public has not applied for. Firm underwriting generates
confidence among investors and increases the chances of success of the issue.
6. Sub-Underwriting:
 The sub-underwriters have no agreement with the issuing company and work under
the main underwriter who pays them some commission out of his underwriting commission.
7. Outright Purchases of Issues:
In all the six forms of underwriting agreements discussed above, the underwriters
provide the services on commission basis.
However, in some cases the underwriters, instead of undertaking guarantee to buy
shares or debentures not subscribed by the public, may enter into an agreement to out-rightly
purchase the issue (shares or debentures) at an agreed price and arrange to sell the same latter
through their own arrangements.
NEED AND SIGNIFICANCE OF UNDERWRITING:
Whenever new issues of capital are made, there is always certain risk of non-
subscription or under- subscription of securities by the public. The plans of the promoters of
the companies remain unimplemented and their reputation adversely affected if the issues are
not successful.
Underwriting is a safer way of marketing securities for new issues of capital. It is an
insurance in the sense that it provides protection against such risks. Thus, it is a very useful
method of raising finance through issue of securities (shares and debentures). It is not only
the issues of equity share capital that need be underwritten. The analysis of underwriting of
issues indicates that almost 100 percent of the issues of preference share capital and
debentures are underwritten in India.
Although, the need for underwriting of initial issues is more, especially in case of new
un-experienced promoters; the further issues of capital are also underwritten. The extent of
underwriting required depends upon the nature of the project, the state of the capital market,
the general response of the investors and the reputation of the promoters. Thus, underwriting
plays a very significant role in corporate financing.
THE IMPORTANCE OF UNDERWRITING
The persons responsible for issuing shares in the company, known as issuers, have the
option of deciding for the underwriting of shares. If the issue is not underwritten, there is a
possibility of the issue eiting under subscribed and even if 90% of minimum subscription is
not received, the money has to be refunded in full. Hence, there is an urgent need on the part
of the issuer, to seek the assistance of underwriters for a successful completion of issue of
shares.
1. Assurance of Adequate Finance:
 Underwriting is an act of undertaking guarantee by an underwriter to buy and pay for
the shares or debentures placed before the public in the event of their non-subscription. Thus,
through underwriting, an issuing company is assured of procuring the required funds from the
issue of shares or debentures. In the event of non-subscription by the public, underwriters
purchase the unsubscribed part of the issue and provide finance to the company.
2. Supplying Valuable Information to Companies:
In addition to the protection of risk of the issuing companies with regard to the
success of the issue, the underwriters supply valuable information in regard to capital market
conditions, general response of the investors, etc. to the issuing companies. These companies
are, usually, benefited from the expert-advice of the underwriters.
3. Distribution of Securities:
After purchasing securities, underwriters distribute the same to the real investors. The
underwriters, through agents and others diffuse the issue over a large number of investors
scattered in different part of the country. Thus, underwriting helps promoters to retain control
over the management of the company.
4. Increase in Goodwill of the Issuing Company:
The underwriting of capital issues by prestigious institutions generates confidence
among investors and improves their response to the issues. Investors in advanced countries
are influenced more by the prestige of the underwriting agencies than by the prestige of the
issuing company. Underwriting, thus, ultimately increases the goodwill of the issuing
company.
5. Service to Prospective Investors:
Underwriters provide essential information about the issuing companies to the
prospective investors and also advise them about various issues. They encourage people to
save more and direct their savings in corporate securities. Thus, investors are also benefited
through underwriting.
6. Service to the Society:
The pace of industrialisation of a country depends to a great extent upon the
successful flotation of capital issues. By mobilising resources and providing adequate
finance, underwriters play a very important role in setting up of new projects, increasing
employment, production and per capita income. Thus, it is not only the corporate enterprises
but also the society at large which is benefited by underwriting.
SEBI’S GUIDELINES ON UNDERWRITING:
(a) As per the original Guidelines issued by SEBI on 11.6.1992, underwriting was
mandatory for full issue and minimum requirement of 90% subscription was also mandatory
for each issue of capital to public. However, as per the Revised Guidelines issued by SEBI on
10.10.94, underwriting is not mandatory now and the issuers have the option of deciding
whether the issue is to be underwritten or not.
Number of underwriters would also be decided by the issuers.
(b) If the issue is not underwritten and if the minimum subscription of 90% of the
offer to the public is not received, the entire amount received as subscription would have to
be returned in full.
(c) If the issue is underwritten and if the company does not receive 90% of the issued
amount from public subscription plus accepted development from underwriters, within 60
days of the opening of the issue, the company should refund the amount of subscription. In
case of disputed devolvement, the company should refund the subscription if the above
conditions are not met.
(d) The lead manager(s) must satisfy themselves about the net worth of the
underwriters and the outstanding commitment and disclose the same to SEBI. A statement to
this effect should be incorporated in the prospectus.
(e) The underwriting agreement may be filed to SEBI.
SEBI has instructed companies to allot to three major categories of allotees, namely,
 QIB
 HNI
 Retailers
QIB refers to qualified institutional bidders ( Mutual Funds, banks, etc.).
HNI refers to high net worth individuals, investing more than Rs. 1 lakh in a single company
security.
Retailers are individuals who are investing less than Rs. one lakh.
TYPES OF UNDERWRITERS
There are two types of underwriters. They are
1. Institutional underwriters – IDBI, IFCI, UTI, SBI Capital Market
2. Non-Institutional underwriters – Any NBFC.
Institutional underwriting in India helps companies to raise capital in their early stages. In
fact, many companies which may not come to the notice of the public were promoted due to
the support given by institutional underwriters.
Many institutional underwriters were responsible for the promotion of infrastructure
companies in the area of steel, chemicals, fertilizer, etc.

RESPONSIBILITIES OF UNDERWRITERS
1. An underwriter, not only has to underwrite the securities but has to subscribe within
45 days that part of shares which remain unsubscribed by the public.
2. His underwriting obligations should not exceed, at any time, 20 times of his net
worth.
3. The underwriter cannot derive any other benefit except the underwriting
commission which is 5% for shares and 2½% for debentures.
MERITS OF UNDERWRITING
1. Underwriting ensures success of the proposed issue of shares since it provides an
insurance against the risk.
2. Underwriting enables a company to get the required minimum subscription. Even if
the public fail to subscribe, the underwriters will fulfill their commitments.
3. The reputation of the underwriter acts as a confidence to investors. The
underwriters who are called the lead managers provide financial recognition to the company,
whose shares are issued to the public. Thus, the reputation of the issuing company also
improves because of the reputation of underwriters.
MODEL QUESTIONS
1. What is merchant banking
2. Write a concept of merchant banking
3. State the objective of merchant banking
4. What are the types of merchant banking
5. Explain the importance of merchant banking
6. Discuss the functions of merchant banking
7. What is underwriting
8. Write a concept of underwriting
9. State the objective of underwriting
10. What are the types of underwriting
11. Explain the importance of underwriting
12. Discuss the functions of underwriting