(Image Source: Moneycontrol)
The Securities and Exchange Board of India has torn up the old merchant banker rulebook and written a new one that will fundamentally change how investment banking works in the country. The regulator introduced a capital adequacy framework that raises the minimum net worth requirement from ₹5 crore to as much as ₹50 crore for top-tier players, along with a host of other changes aimed at improving financial stability and risk management.
Until now, any firm with ₹5 crore net worth could get a merchant banker license and handle everything from IPOs to debt issues. That framework, dating back to 1992, simply couldn’t cope with today’s complex market. With IPOs getting bigger, more SME listings, and increasingly sophisticated financial instruments, SEBI decided the old rules had to go.
Two Categories, Much Higher Bar
The new system splits merchant bankers into two categories. Category 1 needs a net worth of at least ₹50 crore and can handle all permitted activities, including main-board equity issues. Category 2 requires ₹10 crore net worth but cannot manage main-board equity IPOs. Both categories face a new liquid net worth requirement, they must keep 25 percent of their minimum net worth in liquid assets at all times. That’s a big shift from the old days when capital adequacy was just a paper requirement.
SEBI has also imposed minimum revenue criteria. Category 1 bankers must show ₹12.5 crore in cumulative revenue from permitted activities over the past three financial years. For Category 2, the figure is ₹2.5 crore. Firms that only handle debt securities, commercial papers, REITs and InvITs get an exemption from this revenue test.
Underwriting Limits and Risk Management
The regulator has capped underwriting obligations at 20 times a merchant banker’s liquid net worth. Earlier, the limit was seven times net worth or twenty times liquid net worth, whichever was lower. The new rule creates a direct link between how much risk a banker can take and how much liquid capital they actually hold. This should prevent over-leveraging and protect investors if deals go sour.
Existing merchant bankers aren’t left in the lurch. SEBI is giving them two years to gradually increase their net worth to meet the new standards. The liquid net worth requirement will also be phased in through a glide path, giving firms time to adjust their capital structures.
Other Key Changes
The overhaul touches several other areas. SEBI has replaced merchant bankers with independent registered valuers for pricing Employee Stock Option Plans and sweat equity, removing a potential conflict of interest. Banks must now maintain records in India for eight years and cannot outsource core merchant banking functions. If they want to offer other financial services, they have to create separate business units with ring-fenced net worth.
New conflict-of-interest rules bar merchant bankers from managing their own issues and restrict roles where key managerial personnel or their relatives hold significant shareholdings. These changes aim to prevent the kind of self-dealing that can hurt minority investors.
What This Means for the Industry
The new rules effectively mean that merchant banking will become a club for well-capitalized, serious players. The ₹5 crore era is over. New entrants will need at least ₹10 crore just to get into Category 2, and ₹50 crore if they want to handle main-board IPOs. This will likely lead to consolidation, smaller firms may merge with larger ones or exit the business entirely.
For the capital markets, the changes should bring more stability and professionalism. Investors can expect merchant bankers to have stronger balance sheets and better risk management systems. The quality of advice and execution should improve, though clients may have to pay more for these services.
SEBI’s message is clear: merchant banking is a serious business that requires serious capital. The regulator has raised the bar significantly, betting that a well-capitalized industry will serve investors better and handle market stresses more effectively. Market participants now have two years to get their houses in order. After that, only the well-funded and well-managed will survive.
