CHAPTER- I

INTRODUCTION
The financial system of a country is a complex and closely integrated set of
sub 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

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