What Is a Merchant Bank?

The term merchant bank refers to a financial institution that conducts underwriting, loan services, financial advising, and fundraising services for large corporations and high-net-worth individuals (HWNIs). Merchant banks are experts in international trade, which makes them specialists in dealing with multinational corporations. Unlike retail or commercial banks, merchant banks do not provide financial services to the general public. Some of the largest merchant banks in the world include J.P. Morgan Chase, Goldman Sachs, and Citigroup.

1:07

Merchant Bank

Understanding Merchant Banks

Merchant banks are financial institutions and companies that deal with international finance for multinational corporations. These banks differ from other types of financial institutions. As such, they don't deal with the general public. They don't provide everyday financial services such as checking accounts, bill payments, or basic investments and don't take deposits or make withdrawals for their customers.

Although they don't deal with the general public, some of the biggest merchant banks also have retail and commercial banking operations.

Instead, merchant banks traditionally perform international financing and underwriting including real estate, trade finance, and foreign investment. They may be involved in issuing letters of credit (LOCs) and in the transfer of funds. They may also consult on trades and trading technology. Merchant banks use more creative forms of financing. They typically work with companies that may not be large enough to raise funds from the public through an initial public offering (IPO). Merchant banks help corporations issue securities through private placement, which require less regulatory disclosure and are sold to sophisticated investors.

Merchant banks may also be involved in arranging other international transactions. Let's say Company ABC–based in the United States—wants to buy Company XYZ in Germany, it would hire a merchant bank to facilitate the process. That bank would advise Company ABC on how to structure the transaction. It may also help ABC in the financing and underwriting process.

The term merchant bank is used to describe investment banks in the United Kingdom but has a more narrow focus in the United States. Merchant banks may act like investment banks in the U.S. but tend to focus on services tailored to multinational corporations and high net worth individuals who do business in more than one country.

Key Takeaways

  • Merchant banks conduct underwriting, loan services, financial advising, and fundraising services for large corporations and high net worth individuals.
  • They do not provide services for the general public like checking accounts.
  • Some of the world's largest banks include J.P. Morgan Chase, Goldman Sachs, and Citigroup.

Special Considerations

If a multinational corporation operates in many different countries, a merchant bank can finance business operations in all those countries and manage the currency exchanges as funds are transferred and provide the funds to make the purchase using a letter of credit. Using the example above, the sellers in Germany receive a LOC issued by the merchant bank hired by Company ABC as payment for the purchase. The merchant can also help the Company ABC work through the legal and regulatory issues required to do business in Germany.

Merchant Banks vs. Investment Banks

There's a very fine line between merchant and investment banks. Investment banks underwrite and sell securities to the general public through IPOs. The bank’s clients are large corporations that are willing to invest the time and money necessary to register securities for sale to the public. Investment banks also provide advisory services to companies about mergers and acquisitions (M&A) and provide investment research to clients.

While merchant banks are fee-based, investment banks have a two-fold income structure. They may collect fees based on the advisory services they provide to their clients, but may also be fund-based, meaning they can earn income from interest and other leases.

Regardless of how a company sells securities, there are some minimum disclosure requirements to inform investors. Both IPOs and private placements require a company audit by an external certified public accountant (CPA) firm, which provides an opinion on the financial statements. Audited financial statements must include several years of financial data along with disclosures. Potential investors can use this information about the risks and potential rewards of buying the securities.