It is common knowledge that to start or continue a business, money is the required fuel. Two primary ways are identified in the financial world to raise money or keep its constant flow for keeping the business running:
-
Debt: This happens when the business takes up a loan from any other entity or a bank with the promise of returning the money and a certain additional percentage as interest.
-
Equity: This happens when a business breaks its parts into shares and sells those shares in the open market in exchange for money. The individuals or entities who buy those shares are paid in terms of dividends or returns.
Where does investment banking come into play?
One must not be confused by the word banking in the term investment banking, because these institutions do not deal with any kind of deposits on a retail or commercial level. Instead, they provide consultancy services to corporates, businesses, and even government entities primarily on raising capital for their respective organizations to function smoothly or open without any hiccups.
The investment banks do so in two ways:
-
Provide underwriting services, where they guarantee payment by accepting the financial risk in case the company undergoes any financial loss or damage.
-
Act as client’s agents and deal with the issuing of securities either from the market or from financial institutions
While the primary function of investment banks is helping corporates, businesses, and government institutions are raising capital for their seamless running there are other sets of ancillary activities, like:
-
Help various corporations in mergers and acquisitions
-
Functioning as a liquidity provider or market maker
-
Equity Securities or derivatives trading
-
Services involving FICC (Fixed Income, Currencies, Commodities)
-
Asset Management Services
-
Prime Brokerages
Apart from these regular ancillary services, the second important area in an investment bank is the branch of investment research, which essentially helps in guiding the bank on advising the client on how to raise money or capital for their opening or functional continuity.
The rise of investment banking
The existence of investment banking in the financial world does not have a defined beginning. The earliest hint of investment banking can be found in the dealing of the Dutch East India Company who introduced the concept of issuing stock shares and bonds to the masses publicly. These practices made the Dutch East India Company become the first-ever company to be traded and open to the public.
It also has the feather of the first-listed company in an officially recognized stock exchange in its cap. Needless to mention these activities laid the foundation of modern-day investment banking for the whole world. The earliest years of Investment Banking in the US essentially saw them as a partnership firm. The focus of such firms was:
-
Security Issue Underwritings like IPOs, brokerage, secondary market offerings, and others
-
Mergers and Acquisitions
However, they evolved and directed their services in many other channels like:
-
Investment and Trading Managements
-
Research in Securities
-
Proprietary Trading
-
Other Advisory Services
Today, most of the major banking houses have a dedicated Investment Banking division for providing the above-listed services. However, some famous financial institutions like Goldman Sachs, Morgan Stanley, etc. still meander only in the Investment Banking arena only.
Mode of the function of Investment Banks
Invest Banker is one of many lucrative career choices amongst job-seeking individuals. ‘How to become an investment banker?’ is one of the most searched sentences in internet search engines.
However, before you choose investment banking as your desired career, you should be aware of the modus operandi of these financial institutions. The investment banking industry is primarily divided into three areas:
-
Bulge Bracket or the Upper Tier: They consist of the major Investment Banks on an International Level with clientele comprising of Major Corporation houses acknowledged globally
-
Middle Market or the Mid-level Businesses: They consist of institutions that do not have a global acknowledgment as that of the upper-tier ones but have a strong domestic presence.
-
Boutique market or the Specialized Businesses: They consist of Investment Banking services specializing in a single aspect only. The usual aspect that they specialize in is Corporate Finance. However, other specialized aspects also exist in Boutique markets.
All these three areas of investment banking have two major activities:
-
Sell-side: This side involves securities trading either by cash, exchange for other securities, or by promoting securities. The main functions on the sell-side include transaction facilitation, market making, research, underwriting, etc.
-
Buy-side: This side involves advice provisioning to multiple institutions who intend to purchase investment services. The major buy-side entities include Insurance Companies, Hedge funds, Private equity funds, unit trusts, mutual funds, etc.
While all of these activities form the day-to-day functions of any investment bank, one of the major areas that any investment bank invests heavily is in its risk management. The global financial meltdown of 2007 and 2008 has poked such institutions to cater heavily to risk analysis, mitigation, and its subsequent management.
The business of investment banking is often frowned upon in the world of economics. The main reason for such behavior is the perception of conflicts of interest. Besides several other factors like their dubious opacity in transactions or their clientele, dominating or cartel-like behavior, along with dipping their fingers in mutual sides of the transactions have gained them quite a negative reputation in the financial world.
Another factor that has attracted the attention of the whole world to the investment banking section is the pay-packages. The skyrocketing compensations that the CEOs or the high management officials of an investment bank derive are often criticized and have been topics of multiple discussions.
Given the criticisms are partially true to some extent, one must remember that the market that investment banks deal with is a high-risk zone. It is evident the higher the risk the greater is the payout. Needless to mention that to maintain one’s position in the cutthroat business, sometimes a high-handed approach is needed. However, investment banks should ensure that their transactions are transparent and should not involve any fraudulent or money-laundering activities.