Activities of Merchant Banks

by | Nov 9, 2011 | Money And Finance

A merchant bank is a financial institution that provides fee based financial services and advice to corporations, high net worth individuals and government to grow their business including counsel on mergers and acquisitions. Merchant banking also involves general management consulting, supervision of an existing investment, a joint venture assistance and effectively handle all transaction elements, while remaining within the company’s cost limitation.

Merchant banking primarily involves dealing with other merchant banks and other large financial institutions. It invests its own capital in a client company and primarily deals with the commercial banking requirement of international finance, long-term loans for companies and stock underwriting. Merchant banking does not take place in retail offices which requires one to go and open a savings or checking account. Most merchant banks deal primarily with other merchant banks and large financial institutions. Merchant banks take far greater risks than traditional banks as they do not invest against collateral and are not regulated.

Stock underwriting is the most common role of a merchant bank. In other words, merchant banking helps in the process of implementation and underwriting of stocks of large companies that wish to raise money from investors through the stock market. Merchant banks offer a full understanding of all aspect of the capital markets including all types of debt and equity financing available from both the domestic and international markets. Merchant banks are well acquainted with substituting one type of capital for another and generate cash from upgrading in working capital. Merchant banking also often involves managing the marketing of the new stock of the company.

The primary source of income in merchant banking is financing of private investment in public entities and international trade. However, it also derives incomes from several other sources including fees from investment banking types of activities, fees for arranging financing and indirect capital, and returns from its own capital.

Since a merchant bank’s total stake comprising of both direct and indirect capital in a client firm tends to be significant, the bank also plays a more active role in the management of the firm. A merchant bank also plays a more active role in the company’s business as it has a longer period of engagement per transaction with the company and outside investors. These banks may serve on or even control the corporate board. Due to their close monitoring and active involvement in the management of the company, a merchant bank can have an early warning of the company’s likelihood to fail. This helps them to recommend clients to plan for survival or make the optimal liquidation decision, thus preserving the value of the firm.

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