Merchant banking differs from traditional banking because it provides capital to companies in the form of shares instead of cash. As well as providing share ownership to companies a merchant bank will also provide advice related to various corporate matters. Merchant banks are also involved with the launch of a new company onto the stock exchange and help deal with issues related to stock exchange regulation and compliance. In fact both commercial and investment banks can carry out merchant banking activities.
All banks started life as merchant banks, as they carried out activities similar to those described above. Merchant banking was the brain child of Italian grain merchants in the middle ages who set up benches in the largest trading halls to trade their crops. A situation developed where the traders were securing grain sale rights based on the future harvest. Advanced payments started to be made against the future delivery of grain at distant ports. The trader’s profits were made from the difference in price between the current discounted rate of grain and the future price of grain. Although over the years merchant banking practices have altered and changed some what, the idea of merchant banking was born then and there in the trading halls of Italy.
Many people confuse merchant banks with investment banks and although sometimes the lines tend to blur between the two types of financial institution, there is in fact a difference between them and their primary activities. Merchant banks branch into securities underwriting and are not as involved in trade financing as investment banks. Investment banks are often involved in raising funds for organizations and governments too. They do this by issuing debt or equity and then selling this on the open market. Investment banks are heavily involved with the merger and acquisition process and facilitate the whole process.
Merchant banking on the other hand is often involved with financing activities on an international level. This can include international corporate investing, real estate investments and even trade finance. Sometimes merchant banking can lend itself to trade consulting, co-investment between trades and transferring funds internationally. Investment banks tend to be primarily focused on initial public offerings (also known as IPOs) as well as private and public share offerings. Merchant banking is more focused on offering equity financing and various corporate products based on credit. Merchant banks bridge the gap between companies too large to be serviced by venture capitalist firms but too small to be able to make a public share offerings. Sometimes merchant banks will take on portions of ownership of companies in order to provide the equity financing being sought. They will only do so however in companies with strong growth potential.
The activities involved in merchant banking have altered over the years and throughout the modern banking era the boundaries of all the different types of bank have altered significantly. It is not always completely clear cut as to what type of financial institution carries out what tasks as many overlap with each other. However, hopefully this article has given you a brief introduction into the main concepts behind merchant banks.