January 18, 2008

What is a Merchant Bank and what will be Centurion's role.

A question I am often asked is, 'What exactly is Merchant Banking' and what will Centurion look like when the restructure is completed. Therefore I felt an overview explanation might be a useful way to answer some of your questions. Keep in mind Centurion’s focus is the health care industry.

Before defining Merchant Banking and it’s origins, probably a good place to start is asking the question; ‘WHEN DID MODERN BANKING AS WE KNOW IT TODAY BEGIN’ ?

Many people still confuse the introduction of currency as the beginning of modern banking, but the two are not connected. Coins were minted for centuries before banking began in England, even the Celts were using coins before the Romans introduced their coinage system in fifty five (55) BC. For the Romans, the magic number of division for coins was Twelve (12), and coins were always issued as a unit of weight, for example the English term pound appeared as Pondus in Latin, Pfund in the Germanic, Pund in Old Norse, and in the Roman Empire, the unit of weight was called a ‘Libra’, which represented Twelve (12) Unciae or ounces.

The principal Roman unit of weight for what we know as a pound, was the Libra, after the small Constellation, 7th sign of the Zodiac or, ‘The Scales or Balance’. Roman coinage was made up of the Solidus (gold) and the Denarius (silver). One Denarius equalled one ounce of silver, and it required 12 Denarius or (12 ounces of Silver) to equal one ounce of gold (i.e.) One Solidus, and 12 Solidus or (12 ounces of gold) to provide sufficient weight to equal One Libra. Britons, after 4 centuries under Roman domination, became so familiar with this economic structure and culture, that the Libra, Solidus and Denarius abbreviated to L.S.D. became shorthand for its system of Pounds, Shillings and Pence, which survived almost 2,000 years.

Conversely on Banking, William the Third of England and Ireland (William of Orange) introduced banking by an Act of Parliament in 1694, William needed to finance his war against France, and he knew raising these monies through taxation would not be popular, so he issued debt instruments in the same way governments today issue treasury bills, and similar, placing them out on the open investment market, and thus was created the Bank of England, (i.e.) ‘The Central Bank of England’. In this manner William raised what was an extraordinary sum of money for the time, One Million Two Hundred Thousand Pounds (GBP 1,200,000.00) and thus started the tradition of government debt. The Bank of England was nationalised in 1946, and the British Government is now it’s chief customer.

Merchant Banking is a fee based business, where the bank assumes Market Risk but no long term Credit Risk. Fundamentally, merchant banks originate commercial loans, and then sell them to investors rather than hold them as portfolio investments. The French term for a Merchant Bank is a ‘Banque d’ Affaire’. Aside from debt financing, Merchant Bankers are involved in Corporate Finance - Venture Capital, (risk capital), where the bank advances capital in exchange for equity in the business, or simply places funds into such risk based ventures. These funds typically come from backers in it’s own portfolio who receive an acceptable equity percentage, the bank making it’s money through a fee based structure.

Note: Merchant banks need to be very careful in getting the right mix of investment in their risk portfolio to avoid financial ruin. For example if the portfolio consists of say US$ 10 million to invest in equity, a fool can recognise, that it is better to spread this equally over say Ten (10) companies, than to get excited and invest the entire portfolio in One (1) company. In London after the October 20 1987 stock market collapse, several merchant banks went bankrupt because they ignored fundamental rules, or did not maintain sufficient cash reserves. The competences of management are vital - one needs to know where to emphasize efforts.

Origins of Merchant Banking - Private Banking
German Financier Meyer Amschel ( 1743-1812 ), founded the Rothschild dynasty when he established the Rothschild banking house in Frankfurt. By the time of his death he had already conducted significant financial transactions for European Governments, and left the business to his five (5) sons who set up branches across western Europe.

Notable amongst the sons was Nathan Meyer ‘Baron de Rothschild’ ( 1777 - 1836 ) who founded Rothschild in London in 1804. During the Napoleonic wars, staff were stationed on the battlefields with homing pigeons, where they swiftly reported the fortunes of the British and French armies, often days before the official dispatches had reached Paris or London. In this manner he was able to intervene in the stock market to great financial success, and in fact upon news of Napoleons defeat by Wellington at Waterloo, he was able to sell vulnerable stocks at their high, and a few days later bought them all back at rock bottom prices. The result from this one battle netted Rothschild GBP 5 million which was an enormous fortune in those days.

Baron Rothschild, had interests in businesses other than banking. In trying to simplify his method of getting paid on transactions overseas, he developed what would become known as the forfaiting system to finance his merchant transactions. Very soon all his merchant friends were asking him to help them finance their merchant transactions through forfaiting, and thus began the birth of Merchant Banking. Today Rothschilds remain official gold broker to the ‘Bank of England’ and the Rothschild’s still make gold bars in the family’s private refinery near the Tower of London. It is known as the Royal Mint Refinery and was once part of Great Britain’s Royal Mint.

Merchant Banking is Conversion of Dreams into Reality with the Help of Money, and where Merchant Banking Is a Vision, Investment Banking is a Technique.
Merchant bankers took audacious risks and made enormous profits, but of all their assets, integrity and common sense were the most important. Character was prized more than wealth, and they would rather suffer loss, than tarnish the good name of the firm by any unworthy act. Eventually, the role of the Merchant banker changed from money lender to modern financier, and the private banker then became the intermediary between lender and borrower.

Merchant banking is not a science it is an abstract art, and merchant bankers are laconic people who rarely say more than Ten percent (10%) of what they think. When the banker is an hereditary merchant banker, they say even less, and the credit of these banks falls from Father to Son, with inherited wealth bringing inherited refinement.