The term merchant bank refers to a financial institution that provides capital to companies in exchange for ownership. Merchant banks share in the ownership of companies through the infusion of capital, rather than writing loans.
When a company needs capital to expand its operations, one option it has is to borrow money and repay the loan over time. Instead of writing loans, a merchant bank will provide capital in exchange for receiving an ownership share of the business; this ownership entitles the merchant bank to a share of the business’s profits. These banks are essentially facilitating the private placement of investment in a business in need of capital.
The term merchant banking can refer to any financial institution engaged in the activity of private equity investment. Commercial banks, as well as investment banks, can engage in merchant banking activities. And while the term originally referred to the production or trading of commodities, the scope of merchant banking is much wider today.