For more than three decades, the investment banking activity was mainly confined to merchant banking services. The foreign banks were the forerunners of merchant banking in India. The erstwhile Grindlays Bank began its merchant banking operations in 1967 after obtaining the required license from RBI. Soon after Citibank followed through. Both the banks focused on syndication of loans and raising of equity apart from other advisory services. In 1972, the Banking Commission report asserted the need for merchant banking activities in India and recommended a separate structure for merchant banks totally different from commercial banks structure. The merchant banks were meant to manage investments and provide advisory services. The SBI set up its merchant banking division in 1972 and the other banks followed suit. ICICI was the first financial institution to set up its merchant banking division in 1973.
The advent of SEBI in 1992 was a major boost to the merchant banking activities in India and the activities were further propelled by the subsequent introduction of free pricing of primary market equity issues in 1992. Post-1992, there was lot of fluctuations in the issue market affecting the merchant banking industry. SEBI started regulating the merchant banking activities in 1992 and a majority of the merchant bankers were registered with it. The number of merchant bankers registered with SEBI began to dwindle after the mid nineties due to the inactivity in the primary market. Many of the merchant bankers were into issue management or associated activity such as underwriting or advisory. Many merchant bankers succumbed to the downturn in the primary market because of the over-dependence on issue management activity in the initial years. Also not all the merchant bankers were able to transform themselves into full-fledged investment banks. Currently bigger industry players who are in investment banking are dominating the industry.
Major Constraints for Investment Banking in India
The major constraints for investment banking in India were:
- The Indian investment banks depended on issue management to a greater extent and so some of them had to perish due to the primary market downturn in the 90’s.
- The bigger industry players were the only ones to survive because of a general lack of institutional financing in a big way to fund capital market activity, which would have otherwise paved way for other smaller players.
- The lack of depth in the secondary market, especially in the corporate debt market could not supplement the primary market for any major development.
Characteristics of Indian Investment Banking Industry
Till the 1980s, the Indian financial services industry was characterized by debt services in the form of term lending by financial institutions and working capital financing by banks and non-banking financial companies. Capital markets was still an unorganized industry and was mostly restricted to stock broking activity. In the early nineties, when the capital markets opened up, merchant banking and asset management services flourished. Many banks, NBFCs and financial institutions entered the merchant banking, underwriting and advisory services driven by the boom in the primary market.
Over the subsequent years, the merchant banking industry had faced a huge downturn due to recession in the capital markets. Also, the capital markets and investment banking activities came under lot of regulatory developments that required separate registration, licensing and capital controls. This proved to be an impediment for the growth of the investment banking industry.
Structure of Investment Banking in India
The Indian investment banking industry has a heterogeneous structure for the following reasons:
- The regulations do not permit all investment banking functions to be performed by a single entity for two reasons:
- To prevent excessive exposure to business risk.
- To prescribe and monitor capital adequacy and risk mitigation mechanisms.
- The commercial banks are prohibited from getting exposed to stock market investments and lending against stocks beyond certain specified limits under the provisions of RBI and Banking Regulation Act.
- Merchant banking activities can be carried out only after obtaining a merchant-banking license from SEBI.
- Merchant bankers other than banks and financial institutions are not authorized to carry out any business other than merchant banking.
- The Equity research activity has to be carried out independent of the merchant banking activity to avoid conflict of interest.
- Stock broking business has to be separated into a different company
Regulatory Framework for Investment Banking in India
An overview of the regulatory framework is furnished below:
- All investment banks incorporated under the Companies Act, 1956 are governed by the provisions of that Act.
- Those investment banks that are incorporated under a separate statute are regulated by their respective statute. Ex: SBI, IDBI.
- Universal banks that function as investment banks are regulated by RBI under the RBI Act, 1934.
- All Non-banking Finance Companies that function as investment banks are regulated by RBI under RBI Act, 1934.
- SEBI governs the functional aspects of Investment banking under the Securities and Exchange Board of India Act, 1992.
- Those investment banks that carry foreign direct investment either through joint ventures or as fully owned subsidiaries are governed by Foreign Exchange Management Act, 1999 with respect to foreign investment.
Major Players in the Indian Industry
Several big investment banks have set many group entities in which the core and non-core business segments are distributed. SBI, IDBI, ICICI, IL&FS, Kotak Mahindra, Citibank and others offer almost all of the investment banking activities permitted in the country. The long-term financial institutions like ICICI and IDBI have converted themselves into full service commercial banks (called as Universal banks). The Indian investment banks have not gone global so far though some banks do have a presence in the overseas. The middle level constitutes of some niche players and a few subsidiaries of the public sector banks. Certain banks like Canara bank and Punjab National bank have had successful merchant banking activities while some other subsidiaries have either closed their operations or sold off their business due to a couple of securities scam in the industry.
There are also merchant banks structures as NBFCs such as Alpic Finance, Rabo India Finance ltd and so on. Some of the pure advisory firms that operate in the Indian market are Lazard Capital, Ernst & Young, KPMG, and Price Water Coopers etc.
Future of Investment Banking in India
The scope for investment banking in India is very big, as much of it has not been exploited so far. This proves to be a significant point for a bright future for the Indian investment banks. A lot of pure merchant banks and advisory firms have an opportunity to convert themselves in to full service investment banks. With this, their markets are bound to broaden and their service deliveries poised to be more efficient. The technological and market developments influencing the capital market will also provide an additional impetus to the growth of the investment banks.