Merchant banking and Investment Banking - Business Concept and Regulation

Investment banking and Investment Bank

At a very macro level, ‘Investment Banking’ as the term suggests, is concerned with the primary function of assisting the securities market in its function of capital intermediation, i.e. the movement of financial resources from those who have them(the investors), to those who need to make use of them for generating GDP (the Issuers)[1].

Banking and financial institutions on the one hand and securities markets on the other hand are the two broad platforms of institutional intermediation for capital flows in the economy. Therefore, investment banks are the counterparts of banks in financial markets in the function of intermediation in resource allocation.

The term ‘investment banking’ is of American origin. Their counterparts in UK were termed as ‘merchant banks’ and they had confined themselves to security market intermediation whereas American investment banks undertook both fund-based and advisory roles. American investment banks entered the UK and European markets and extended the scope of merchant banking to investment banking. In India also, SEBI declared regulations for merchant banks only. But the entry of American investment banks is changing the profile of merchant banks.

Responsibility of Merchant Banker: Merchant banking is not merely about marketing of securities in an agency capability. The regulatory authorities require the merchant banking firms to promote quality issues, maintain integrity and ensure compliance with the law on own account and on behalf of the issuers as well.

Heart of investment banking consists of advising corporations on how best to configure their balance sheets – wit the aim of maximizing shareholder value and executing the transactions that flow from that advice [2].

The title “investment banker” is usually reserved for those individuals within an investment banking firm who are responsible for the firm’s relationship with the issuer, as opposed to the investor clients, i.e., with clients who engage investment banks to issue new securities, restructuring existing liabilities; either increasing or decreasing leverage, moving from public to private ownership.

Business Portfolio of Investment Banks

Globally, investment banks handle significant fund-based business of their own in the capital market along with their non-fund service portfolio which is offered to clients. However, various services or segments of services are handled either on the same balance sheet or through subsidiaries and affiliates depending upon the regulatory requirements in the operating environments of each country. All these activities are segmented across three broad platforms-equity market activity, debt market activity, and mergers and acquisitions (M&A) activity.

Investment banking

Core business portfolio

Fund based

Equity: Underwriting, market making
Debt: Underwriting, market making
M & A: Investing in private equity, LBOs and MBOs


Non-fund based

Equity: Merchant banking (Public issue management), Private placement
Debt: Public issue management, Private placement, Securitisation for finance companies and banks
M&A: M&A advisory, Corporate Advisory, Project Advisory

Support business portfolio

Fund based

Equity: Proprietory trading and portfolio investing, private equity funds and asset management funds
Debt: Proprietory trading and investing, asset management funds
Derivatives: Proprietory trading, hedgefund investments

Non-fund based

Equity: Equity broking, distribution, asset management, custodial services, wealth management (private banking), research and analysis.
Debt: Debt market broking, distribution, asset management, research
Derivatives: Derivative broking, risk management services, custodial services


References

1. Pratap Subramanyan, Investment Banking, Tata McGraw-Hill Pub., New Delhi, 2005
2. Kenneth C. Froewiss, "Investment Banking," Chapter A2 in Handbook of Modern Finance, Edited by Dennis Logue and James K. Seward, Warren Gorham and Lamont, 2007



For SEBI Regulations for Merchant Bankers in India go to

http://nrao-mgmt-smi-handbook.blogspot.com/2007/10/merchant-banking-regulations-in-india.html