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 *HNWI).

Merchant banks specialize in providing services for private corporations. Unlike retail or commercial banks, merchant banks do not typically provide financial services to the general public. Unlike investment banks, they focus on private companies not public companies. Examples of large merchant banks include JPMorgan Chase, Goldman Sachs, and Citigroup.

How Merchant Banks Work

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 in that they offer financial services such as private equity, fundraising, and business loans to private companies.

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. They may have a retail banking arm, but they do not provide, for example, checking accounts.

The term merchant bank describes investment banks in the United Kingdom. Still, it has a more narrow definition in the U.S. Merchant banks may act like investment banks in the U.S. Still, they 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

Company ABC–based in the U.S., 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

Merchant and investment banks are similar. 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 can require a company audit by an external certified public accountant (CPA) firm, which provides an opinion on the financial statements. Potential investors can use this information about the risks and potential rewards to make decisions about buying or selling 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. They may have retail banking divisions, but they typically don't provide banking services to the general public.