UNIT III

• Merchant Banking
• Leasing
MERCHANT BANKING
As per SEBI rules, a merchant banker refers to,

“any person who is engaged in the business of

issue management either by making
arrangement regarding buying, selling or
subscribing to securities or acting as manager,
consultant or rendering corporate advisory
services in relation to such issue management”.
 History of Merchant Banking in India

• 1967 - National Grindlays Bank

• 1970 - Citi Bank
• 1972 - The State Bank of India was the first Indian commercial bank to set up a
separate merchant banking division
• 1973 -The ICICI set up its merchant banking division, followed by a number of
other commercial banks like Canara Bank, Bank of Broada, Bank of India,
Syndicate Bank, Punjab National Bank, Central Bank of India, UCO Bank, etc.
• The FERA regulations(1973) - Since then, a number of development banks and
financial institutions such as IFCI and IDBI have also entered this field.
• Some leading banks, Private brokers and financial consultancy firms have given a
tough competition to the commercial banks
 Categories of Merchant Bankers

• Category I – can carry on all activities relating to management of

issues and to provide advice on: mergers and amalgamations, loan
syndication, technology tie-ups, portfolio management of mutual
funds, rehabilitation of sick units etc.
• Category II – to act as advisor, consultant, co-manager,
underwriter and portfolio manager to the company
• Category III – to act as underwriter, advisor and consultant to a
particular issue.
• Category IV – to act only as advisor or consultant to an issue.
 Regulation of Merchant Bankers

• A) no person shall carry on any activity as a merchant banker unless he holds a certificate granted by
SEBI.
• B) SEBI would grant the certificate:
• On payment of the registration fee.
• On condition that the merchant banker would redress investor grievances
• Only if the applicant has the necessary infrastructure and manpower
• A minimum of two persons who have the experience to conduct the business of merchant banking
should be under the employment of the applicant.
• The applicant fulfills the capital adequacy requirements.
• Rs.5,00,00,000 for category I merchant banking
• Rs.50,00,000 for category II
• Rs.20,00,000 for category III.
• The applicant should be professionally qualified.
• The applicant should not have been involved in any litigation involving the securities market.
Stockbroker Underwriters Association (SUA)

• To educate and protect the interest of investors

• To provide information about new issues of capital market
• To evolve a code of conduct for underwriters
• To render legal and other services to members and public
• Established in 1984.
• SUA works in co-ordination with merchant bankers and takes steps
for promoting the activities of capital market
 Functions of Merchant Bankers
• Project counseling
• Market survey and forecasting
• Estimating the amount of funds required.
• Raising funds from capital market.
• Raising of funds through new instruments.
• Bought out deals.
• OTC market operations.
• Mergers and amalgamations.
• Loan syndication.
• Technology tie-ups.
• Working Capital Finance.
• Venture Capital.
• Lease Finance.
• Fixed deposit management.
• Factoring
• Portfolio management of mutual funds.
• Rehabilitation of sick units.
 SEBI GUIDELINES FOR MERCHANT BANKING
• Every merchant banker should maintain copies of balance sheet,Profit and loss
account,statement of financial position
• Half-yearly unaudited result should be submitted to SEBI
• SEBI has been vested with the power to suspend or cancel the authorization in case of violation
of the guidelines
• Every merchant banker shall appoint a ‘Compliance Officer‘ to monitor compliance of the Act
• SEBI has the right to send inspecting authority to inspect books of accounts,records etc… of
merchant bankers
• Inspections will be conducted by SEBI to ensure that provisions of the regulations are properly
complied.
• An initial authorization fee,an annual fee and renewal fee may be collected by SEBI.
• A lead manager holding a certificate under category I shall accept a minimum underwriting
obligation of 5% of size of issue or Rs.25 lakhs whichever is less
 CODE OF CONDUCT FOR MERCHANT BANKERS

A merchant banker shall make all efforts to protect the interests of investors.
• A Merchant Banker shall maintain high standards of integrity, dignity and fairness in the conduct of its business.
• A Merchant Banker shall fulfill its obligations in a prompt, ethical, and professional manner.
• A Merchant Banker shall at all times exercise due diligence, ensure proper care and exercise independent professional
judgment.
• A Merchant Banker shall Endeavour to ensure that enquiries from the investors are adequately dealt with, grievances of
investors are redressed in a timely and appropriate manner, where a complaint is not remedied promptly, the investor is advised
of any further steps which may be available to the investor under the regulatory system.
• A Merchant Banker shall ensure that adequate disclosures are made to the investors in a timely manner in accordance with the
applicable regulations and guidelines so as to enable them to make a balanced and informed decision.
• A Merchant Banker shall endeavor to ensure that the investors are provided with true and adequate information without
making any misleading or exaggerated claims or any misrepresentation and are made aware of the attendant risks before taking
any investment decision.
• A Merchant Banker shall endeavor to ensure that copies of the prospectus, offer document, letter of offer or any other related
literature is made available to the investors at the time of issue of the offer.
• A Merchant Banker shall not discriminate amongst its clients, save and except on ethical and commercial considerations.
• A Merchant Banker shall not make any statement, either oral or written, which would misrepresent the services that the
Merchant Banker is capable of performing for any client or has rendered to any client.
• A Merchant Banker shall avoid conflict of interest and make adequate disclosure of its interest. • A Merchant Banker shall put
in place a mechanism to resolve any conflict of interest situation that may arise in the conduct of its business or where any
conflict of interest arises, shall take reasonable steps to resolve the same in an equitable manner.
• Merchant Banker shall make appropriate disclosure to the client of its possible source or potential areas of conflict of duties
and interest while acting as Merchant Banker which would impair its ability to render fair, objective and unbiased services.
• A Merchant Banker shall always endeavor to render the best possible advice to the clients having regard to their needs.
• A Merchant Banker shall not divulge to anybody either oral or in writing, directly or indirectly, any confidential information
about its clients which has come to its knowledge, without taking prior permission of its client, except where such disclosures
are required to be made in compliance with any law for the time being in force.
• A Merchant Banker shall ensure that any change in registration status/any penal action taken by the Board or any material
change in the Merchant Banker‗s financial status, which may adversely affect the interests of clients/investors is promptly
informed to the clients and any business remaining outstanding is transferred to another registered intermediary in accordance
with any instructions of the affected clients.
• A Merchant Banker shall not indulge in any unfair competition, such as weaning away the clients on assurance of higher
premium or advantageous offer price or which is likely to harm the interests of other Merchant Bankers or investors or is likely
to place such other Merchant Bankers in a disadvantageous position while competing for or executing any assignment.
• A Merchant Banker shall maintain arms length relationship between its merchant banking activity and any other activity.
• A Merchant Banker shall have internal control procedures and financial and operational capabilities which can be reasonably
expected to protect its operations, its clients, investors and other registered entities from financial loss arising from theft, fraud,
and other dishonest acts, professional misconduct or omissions.
• A Merchant Banker shall not make untrue statement or suppress any material fact in any documents, reports or information
furnished to the Board.
• A Merchant Bankers shall maintain an appropriate level of knowledge and competence and abide by the provisions of the Act,
regulations made there under, circulars and guidance, which may be applicable and relevant to the activities carried on by it.
The merchant banker shall also comply with the award of the Ombudsman passed under Securities and Exchange Board of India
(Ombudsman) Regulations, 2003.
• A Merchant Banker shall ensure that the Board is promptly informed about any action, legal proceedings etc., initiated
against it in respect of material breach or non-compliance by it, of any law, rules, regulations, directions of the Board or of
any other regulatory body.
A Merchant Banker shall provide adequate freedom and powers to its compliance officer for the effective discharge of the
compliance officer’s duties.
• A Merchant Banker shall develop its own internal code of conduct for governing its internal operations and laying down its
standards of appropriate conduct for its employees and officers in carrying out their duties. Such a code may extend to the
maintenance of professional excellence and standards, integrity, confidentiality, objectivity, avoidance or resolution of conflict of
interests, disclosure of shareholdings and interests etc.
• A Merchant Banker shall ensure that good corporate policies and corporate governance are in place.
• A Merchant Banker shall ensure that any person it employs or appoints to conduct business is fit and proper and otherwise
qualified to act in the capacity so employed or appointed
• A Merchant Banker shall ensure that it has adequate resources to supervise diligently and does supervise diligently persons
employed if appointed by it in the conduct of its business, in respect of dealings in securities market.
• A Merchant Banker shall be responsible for the acts or omissions of its employees and agents in respect of the conduct of its
business.
• A Merchant Banker shall ensure that the senior management, particularly decision makers have access to all relevant information
about the business on a timely basis.
• A Merchant Banker shall not be a party to or instrumental for creation of false market; price rigging or manipulation; or passing
of unpublished price sensitive information in respect of securities which are listed and proposed to be listed in any stock exchange
to any person or intermediary in the securities market.
LEASING
 LEASE FINANCING
Lease financing is one of the important sources of medium- and long-term
financing where the owner of an asset gives another person, the right to use that
asset against periodical payments
IMPORTANT TERMS:
• The owner of the asset is known as lessor and the user is called lessee
• The periodical payment made by the lessee to the lessor is known as lease
rental
• Ownership lies with the lessor
• At the end, the asset is returned to the lessor or an option is given to the lessee
either to purchase the asset or to renew the lease agreement
 Essentials Elements of A Lease contract

•Parties: The parties to a lease are the lessor and the lessee. The lessor is also called the owner of the
asset and the lessee the user of an asset.

•Subject matter of lease: The subject matter of lease must be movable/immovable property. Eg: A
mining lease is lease and not a sale of minerals.

•Duration of lease: The lease should commence either in the present or on some date in future or on
the happening of some contingency, which is bound to happen.

•Consideration:. The consideration for lease is either premium or rent, which is the price paid or
promised in consideration of the demise. This premium or rent is known as lease rental.
Myths of Leasing

• Leasing is Expensive
• Leasing is Complex
• Leasing Prohibits Ownership
• Lease Contracts are Non-Cancelable
• Leasing Reduces Tax Benefits
• Leasing Lowers EBITDA
• Leasing Prohibits Company’s Ability to Control Assets
• Leasing is off balance sheet
Types of Leasing

Financial Lease

Operating Lease
 Financial Lease

The lessor transfers substantially all the risks and rewards of ownership of assets to the lessee for
lease rentals. It puts the lessee in the same con­dition as he/she would have been if he/she had
purchased the asset.

Features of Finance Lease:

1. A finance lease is a device that gives the lessee a right to use an asset.
2. The lease rental charged by the lessor during the primary period of lease is sufficient to recover
his/her investment.
3. The lease rental for the secondary period is much smaller. This is often known as peppercorn
rental.
4. Lessee is responsible for the maintenance of asset.
5. No asset-based risk and rewards is taken by lessor.
6. Such type of lease is non-cancellable; the lessor’s investment is assured.
 Operating Lease

Lease other than finance lease is called operating lease. Here risks and rewards incidental to the
ownership of asset are not transferred by the lessor to the lessee. The term of such lease is much less
than the economic life of the asset and thus the total investment of the lessor is not recovered through
lease rental during the primary period of lease. In case of operating lease, the lessor usually provides
advice to the lessee for repair, maintenance and technical knowhow of the leased asset and that is why
this type of lease is also known as service lease.
Features of Operating Lease:
1. The lease term is much lower than the economic life of the asset.:
2. The lessee has the right to terminate the lease by giving a short notice and no penalty is charged for
that.
3. The lessor provides the technical knowhow of the leased asset to the lessee.
4. Risks and rewards incidental to the ownership of asset are borne by the lessor.
5. Lessor has to depend on leasing of an asset to different lessee for recovery of his/her investment.
 LEASE BUYBACK

• Lease buybacks allow a business owner to sell equipment he owns already to a leasing company for
cash.
• The leasing company, in turn, leases the same equipment back to the original owner.
• This gives the business owner access to the equipment he needs for daily operation and also cash
needed to expand or purchase new equipment, without affecting the businesses profits or going
into debt.
There are other major benefits from lease buybacks.
• The business owner will no longer have to be concerned about the cost of maintenance and repair
of the equipment.
• With the lease contract the responsibility of maintenance now falls to the leasing company.
• Leasing also opens opportunities for equipment upgrades.
• When the lease contract expires the leasing company will give the business the choice to renew
with the existing equipment or take advantage of any upgraded models instead. This allows the
business to have access to the most state of the art tools.
 LEVERAGED LEASE

• A leveraged lease is a tax-advantaged lease arrangement in which a lessor

borrows funds to acquire an asset that is then leased to a lessee. In this
situation, the lender holds title to the leased asset, while all lessee payments
are collected by the lessor and passed to the lender. The lender can repossess
the asset in the event of a lessee payment default. In this arrangement, the
lessor can recognize depreciation expense on the asset for tax purposes, while
the lessee can deduct its lease payments from taxable income.
• The name of this lease refers to the financing position of the lessor, which has
used debt (leverage) to pay for most of the cost of the asset that is being
leased.
 DOMESTIC/INTERNATIONAL LEASE

• The Domestic Lease and International Lease are the types of leases classified on the
basis of the places where the parties to the lease agreement reside.
• Domestic Lease: When all the parties to the lease agreement Viz. Lessor, lessee and
the equipment supplier are domiciled or belongs to the same country, is called as a
domestic lease.
• International Lease: The international lease refers to the type of lease agreement
where one or more parties to the lease agreement reside or are domiciled in different
countries.
• There are two types of international lease: the Import Lease and the Cross Border
Lease. In the former type of lease, both the lessor and the lessee belong to the same
country, but the equipment supplier stays in some other country. In the case of a
cross-border lease, both the lessor and the lessee stay in different countries,
irrespective of where the equipment supplier stays.
 ADVANTAGES OF LEASE FINANCING
a. To Lessor:

• Assured Regular Income

• Preservation of Ownership
• Benefit of Tax
• High Profitability
• High Potentiality of Growth
• Recovery of Investment

b. To Lessee:

• Use of Capital Goods

• Tax Benefits
• Cheaper
• Technical Assistance
• Inflation Friendly
• Ownership
DISADVANTAGES OF LEASE FINANCING

a. To Lessor:
• Unprofitable in Case of Inflation
• Double Taxation
• Sales tax may be charged twice
• Greater Chance of Damage of Asset

b. To Lessee:
• Compulsion
• Ownership
• Costly
• Understatement of Asset
 PROCESS OF LEASING

• Lease Selection – Type of Asset, Lessor

• Lessor’s Appraisal – Attendant’s Lease documents
• Lessor’s Approval – Letter of Offer to Lessee
• Acceptance of the offer – return signed copy of offer
letter
• Agreement – Terms and Conditions
 LEASING CONSTITUENTS

• Private Sector: Public Sector:

• Specialised Leasing companies 1) Financial Institutions
• Leasing and Hire Purchase financing Cos 2) Banks
• Subsidiaries 3) Other
• Captive Leasing
• Vendor Leasing
EVALUATION OF LEASE BY LESSEE
EVALUATION BY NPV
DIFFERENCES BETWEEN LEASING AND HIRE
PURCHASE
Notes

https://www.yourarticlelibrary.com/financial-management/lease-fi
nancing-types-advantages-and-disadvantages/43833
https://www.dynamictutorialsandservices.org/2020/09/hire-purcha
se-and-installment-purchase.html