What Is a Merchant Bank?

A merchant bank is a company that conducts underwriting, loan services, financial advising, and fundraising services for large corporations and high net worth individuals. Unlike retail or commercial banks, merchant banks do not provide services to the general public. They do not provide regular banking services like checking accounts and do not take deposits.

These banks are experts in international trade, which makes them specialists in dealing with multinational corporations. Some of the largest merchant banks in the world include J.P. Morgan, Goldman Sachs, and Citigroup.

Understanding Merchant Banks

The term merchant bank used in the United Kingdom to describe investment banks, but has a more narrow focus in the United States. They 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.

Merchant banks in the U.S. are financial institutions that deal with international finance for multinational corporations. Merchant banks traditionally perform international financing and underwriting including real estate, trade finance, foreign investment, and other international transactions. They may be involved in issuing letters of credit and in the transfer of funds. They may also consult on trades and trading technology.

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.

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Merchant Bank

How Merchant Banks Facilitate Trade

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 (LOC).

Using the example above, the sellers in Germany receive an 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

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.

Investment banks, on the other hand, 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 and provide investment research to clients.

Merchant banks are also different from commercial banks, which serve the general public and business 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, 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 outside 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.

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.
  • Examples of the world's largest merchant banks include J.P. Morgan, Goldman Sachs, and Citigroup.