The origin of merchant banking goes back to the middle age. It was in the 13th century when several firm owners engaged in purchasing and selling commodities. Gradually they started acting as a bank. However, this banking activity was much different than today’s banking, but the concept was similar.
To earn high profits margins, banks started to invest funds where they can get high returns. Naturally, this came with high risks. With little diversification, bank owners lost a handsome amount by keeping their entire fund in risky portfolios. Many of the first merchant banks went bankrupt, but some were able to persevere. Thus, the very concept of merchant banking survived and continued success. Though the participants were limited and the practice was mainly limited in the coastal region, the ray of hope was still there.
Later on, merchant bankers earned a name called “commission agents”. They handled coastal trading and finance on a commission basis. Further, they provided capital to the suppliers and owners of the goods. They made huge profits by investing in the business. This enabled them to finance several continental wars. The main goal of these merchant bankers was to earn power by maximizing profits. For that, they started to make investments in riskier projects that yielded high returns.
After this, comes the age of the industrial revolution in England. It broadened the scope of trade and finance. International trade expanded its range to include various continents along with North America. People all around the globe became interested in merchant banking activities due to its attractive profitability. They started to transfer machine-made and industrial goods from European countries to various colonies and nations. In exchange, they used to bring raw materials from these colonies and nations. This enabled them to finance and expand their trade.
Then during the early 19th century, these merchants gradually became involved in overseas trading and earned a reputation. They approved bills from the less known traders and posed as the guarantors. Due to their popularity and good conduct, they received full payment well in advance. This activity gradually became a crucial part of the merchant banks.
The very meaning of merchant banking considers the merchant bank as an institution. It is the authorized body to write security codes and corporation advises for the clients and involved parties. Nevertheless, the term ‘merchant banking’ has different connotations in different places of the world. For instance, in the USA it is referred to as investment banking. On the other hand, in the UK, it is known as an ‘accepting and issuing house’.
The term is widely used in the world. The usage of the term has crossed the limit of the dictionary definition. Nowadays, it also denotes the banks that don’t deal with merchants or even the merchants who have nothing to do with banks. It also comprises of some intermediaries who have no connection with either banks or merchants.
In the United Kingdom, the term merchant banking first came from the merchants of London. They started financing various foreign trades by accepting merchant bills. Gradually they started to help governments of several colonies and underdeveloped countries. They helped to raise long-term heavy funds by making bonds in the money market of London.
Later in 1914, these merchants made an organization called ‘Merchant Banking & Securities House Association’. This time on wards, the merchant banks started to expand their activities. They moved on to various domestic business and loan syndication for long and short term requirements.
These banks exist till to the day. However, their range of service has significantly increased.
Nowadays, they offer a diverse array of services including the following:
- portfolio management,
- issue management,
- act as registrars, asset management,
- share transfer agents,
- underwriting of new issues,
- project consultation,
- create trustees,
- advice on mergers,
- determine the value of Euro credits for transactions,
- provide leasing and
- arrange for amalgamations
In the United States, investment banking is also concerned with directing the cash flow to the enterprises and garnering profits. Such bankers are mainly the intermediaries who offer special services in the domains of security. They follow a strategic practice. Also, they don’t invest their own money in high-risk funds for a long time. They take the money from the small business entrepreneurs and use them in funds. Therefore, merchant banking can be considered as a financial activity (both banking and non-banking) developed and sustained in Europe.
Initially, ‘Hundi’ was the primary mode of credit. Indigenous bankers and western merchants used this instrument. The bankers established an Agency house in London to keep a track of all activities. These houses took deposits at a cheap rate of interest like 4 to 5%. Then they sold these at a high charge to the native merchants at around 10 to 12%. Naturally, it could earn a high-profit margin and satisfy their worldwide clients.
These agency houses raised deposits at cheaper rates of interest via. 4 to 5% from their home and made advances to native merchants at 10 to 12% and in addition, they charged high commissions on every kind of service provided to the clients.
Since money-making seemed to be easy with them, many native merchants from around the world got interested in it. This flourished their banking activity. However, the British East India Company foresaw trouble with the emergence of merchant banks. The problem is, money is the gateway to power. Gradually, merchant bankers were becoming powerful and operating world trade. This was troublesome for the legislative council so they tried to put an end to their activity.
Nevertheless, their members moved into various kinds of businesses including cotton mills, rubber and tea plantation etc. Their extensive resources made their way through any kind of business.
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