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CHAPTER- I

INTRODUCTION

The financial system of a country is a complex and closely integrated set ofsub systems of financial institutions, markets, instruments and financial services

which facilitate the transfer and allocation of funds efficiently and effectively. The

Indian financial system consists of both organized (formal) and unorganized

(informal) segments. The formal financial system comes under the purview of

Ministry of Finance, Reserve Bank of India, Securities and Exchange Board of India

and other regulatory bodies.

Financial institutions are the intermediaries who facilitate in mobilizing

savings and allocation of funds in an efficient manner and include banking and non

 banking institutions. Financial markets provide the transmission mechanism whereby

various participants’ demands and requirements interact to set a price for financial

claims. The main financial markets in India include the market for short term

securities (money market) and for long term securities (capital market). Financial

markets are also classified as primary and secondary markets. While the primary

market deals in new issue of securities, the secondary market is meant for trading in

existing securities (stock exchange and over the counter market). Primary equity

market includes public issues, right issues, offer for shares and private placement of

shares. Financial instruments represent the claims against a person or an institution for

the payment at a future date, a sum of money and/or a periodic payment in the form of

interest or dividend. Financial securities are classified as primary (direct) and

secondary (indirect) securities. The primary securities are issued by the ultimate

 borrower of funds to the ultimate investor as shares and debentures while secondary

securities are issued by the financial intermediaries to the ultimate savers (bank

deposits, insurance policies, mutual funds etc.).

Financial services are the services which facilitate financial transactions of

individuals and institutional investors resulting in the resource allocation activities

through time. These services bridge the gap between lack of knowledge on the part of

investors and increasing sophistication of financial instruments and markets. Since the

liberalization and deregulation of Indian economy, the financial services have found

more scope of growth serving the investors and corporates in a big way. The Indian

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economy, as a matter of fact, has experienced the last decade of 20 th  century as the

decade of financial services. There has been a major shift from bank finance to capital

market for meeting the financial requirements of the corporate sector during this

 period. The emergence of different financial institutions and regulatory agencies has

transformed the financial service sector from being a conservative industry to a very

dynamic one. The financial service today is emerging as a strong industry world over

and is termed as a ‘Sunrise’ industry.

One of the oldest and specialized financial services in the Indian capital

market has been merchant banking service. The merchant bankers have not only

helped in promoting trade and commerce between nations, but have also served the

financial needs of the Kings, Monarchs and State Governments engaged in the

continental wars.

1.1 Origin of Merchant Banking

The origin of merchant banking is traceable to the developments of foreign

trade and finance during the 13th century. During this period, a few firms engaged in

coastal trade and finance spread throughout the European continent were engaged

 both in commercial activities and banking activities. These firms also acted as the

 bankers to the Kings of the European States, financial coastal trade among European

nations, bore exchange risk and security risk in financing the Kings, Monarchs and

Governments engaged in continental wars. The main centre for world trade and

finance at that time was Amsterdam, where the Dutch traders relied upon the expertise

of merchant bankers (then known as commission agents) for financing of trade.

During the seventeenth and eighteenth century, the Italian grain merchants also

started merchant banking activities in Italy and France. It comprised of merchant

 bankers who intermediated in financing the transactions of the traders and their own

trade also. The Italian merchant bankers introduced into England not only the bill of

exchange, but also all the institutions and techniques connected with the organized

money market. Thus, the modern merchant banking started from London where the

merchants started to finance the foreign trade through acceptance of bill of exchange.

The industrial revolution in England gave further boost to the merchant banking due

to the growth of the home industry.