What is a Merchant Bank? | Definition, Working vs Types

Key Takeaways

1. A merchant bank is a financial institution that provides advisory and investment services to businesses, governments, and wealthy individuals.
2. It specializes in private equity, underwriting, mergers and acquisitions, and project financing.
3. Unlike commercial banks, merchant banks do not take deposits or provide retail banking services.

What is Merchant Bank

1. Merchant banks are financial institutions and companies that deal with international finance for multinational corporations and high-net-worth individuals (HWNIs) by providing legal and financial advice, loan services, fundraising services, and investing equity capital.
2. Generally, banks provide services like checking accounts, investments, bill payments, etc. These banks focus more on services for large corporations than the general public.
3.  Merchant banks for small-scale institutions raise money by raising initial public offerings (IPO) through corporate credit products providing bridge, equity, and mezzanine financing. They consult on trading and trade technology. They also issue and sell securities on behalf of corporations to investors.
4.  Large merchant banks, however, place equity by acquiring a considerable share of the company’s ownership. The ownership is acquired keeping in mind the company’s future growth rate. This seals the gap between venture capital and public stock. The regulatory disclosure by merchant banks isn’t required, while acquiring ownership is very less.

The traditional functions include:

1. It provides financial and underwriting to real estate.
2. Trade finance is also provided along with foreign investment.
3. Issuance of letter of credit (LOCs)
4. Transfer of funds
5. They issue securities to sophisticated investors through private placements.
6. Merchant banks provide financial advising, portfolio management, loan, and fundraising services for large corporations and high-net-worth individuals.
7. Merchant banks do not provide services like checking accounts.

 How does it work?

1. They are mostly involved in the financial dealings of multinational companies (MNCs).
2. A global corporation willing to purchase a smaller business in a foreign region approaches a merchant bank.
3. The merchant bank gives guidance on how to handle the sourcing phase.
4. The merchant bank may also facilitate funding and lending services.
5. They also work to collect money for big corporations.
6. They also work in cross-border transactions.
7. Merchant Bank works to provide the right approach to customers and assesses all key parameters for building a financial plan considering the present economic conditions.
8. Merchant banks are service providers to large-scale corporations and wealth management services to rich individuals.

Advantages and Disadvantages of Merchant Banks:

Advantages	Disadvantages
Merchant Banking customers get the most honest advice as they deal with experts and get counselling sessions fit for their respective businesses.	Merchant banking services are very costly; this is one of the major disadvantages. The customer will be required to pay fees, including counsellors, not just normal bankers but experts in their fields.
The customers get other services like information on the company’s status, portfolio management, and lease financing, which is beneficial for companies that need constant funding for their business.	Merchant banking involves undertaking lots of risks for the future. Many different kinds of risks are involved, even with banks offering underwritings. The customer is not guaranteed 100% returns if the business goes down.

Examples of Merchant Banks:

Leading Banks

1. Goldman Sachs
2. Bank of America Merrill Lynch
3. Morgan Stanley
4. Citigroup
5. J.P. Morgan

Excellent Banks

1. Barclays Capital
2. Credit Suisse
3. Deutsche Bank AG
4. Evercore

Highly Recommended Banks

1. Jefferies International Ltd
2. Lazard
3. SG CIB
4. Stifel
5. RBC Capital Markets
6. UBS Investment Bank

References

1. https://ideas.repec.org/b/oxp/obooks/9780198283065.html