Merchant Bank: Functions, Services, and Examples

What Is a Merchant Bank?

A merchant bank is a financial institution that conducts underwriting, loan services, financial advising, and fundraising services for large corporations and high-net-worth individuals (HWNIs).

Merchant banks specialize in international trade, providing services for 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.

Understanding Merchant Banks

Merchant banks are non-depository financial institutions and companies that deal with international finance for multinational corporations. These banks differ from other types of financial institutions.

As such, most of their services are not targeted at the general public. While they may offer some banking services to wealthy individuals, merchant banks are more oriented toward corporate clients.

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.

Functions of a Merchant Bank

Merchant banks provide financial and advisory services to help corporate clients conduct business. They often work with companies that may not be large enough to raise funds from the public through an initial public offering (IPO).

Financing and Loans

Merchant banks traditionally perform international financing and underwriting including real estate, trade finance, and foreign investment. They may also issue letters of credit (LOCs).

Merchant banks can also provide more creative forms of financing. They can help corporations issue securities through private placement, which requires less regulatory disclosure and are sold to sophisticated investors.

International Transactions

If a multinational corporation operates in many different countries, a merchant bank can finance business operations in all of those countries and manage the currency exchanges. When a company seeks to make a major purchase in another country, it will seek a merchant bank that can transfer the funds to make the purchase using a letter of credit.

Example of Merchant Banking

Let's say Company ABC–based in the United States—wants to buy Company XYZ in Germany. ABC 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.

Using the example above, the sellers in Germany would receive a letter of credit issued by the merchant bank hired by Company ABC as payment for the purchase. The merchant can also help 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.

The Bottom Line

Merchant banks are institutions that provide loans and capital for business enterprises. They may also provide consulting services, or help their clients structure large international transactions. Merchant banks provide different services from both retail and investment banks.