Investment banks
Overview
An investment bank is a financial services company that provides a wide array of financial services primarily involved with raising capital and providing advice for governments, corporations, and high-net-worth individuals.
As transactions that involve capital markets tend to be very complicated and involve numerous regulations to work around, corporations and other organisations often hire investment banks to help complete them.
Examples
The four major investment banks, often called the “Big Four” are Goldman Sachs, Morgan Stanley, JP Morgan Chase, and Bank of America. Others include Citigroup, and Deutsche Bank.
- Goldman Sachs is known for its high-profile deals and significant role in the industry. It offers a wide range of investment banking services, including asset management, underwriting and advisory services.
- Morgan Stanley is a key player in the investment banking sector and provides capital raising services, wealth management and mergers and acquisitions.
- JP Morgan Chase & Co is one of the largest and oldest investment banks and offers comprehensive services which include investment banking, commercial banking, and asset management.
- Bank of America Merrill Lynch is known for its powerful presence in both retail and investment banking, offering a wide range of financial services to its clients worldwide.
How does an investment bank work?
Most investment banking activities fall into one of two categories: mergers and acquisitions (M&A) and/or corporate financing.
With M&A, banks provide advice to corporations regarding mergers with other companies or acquiring other businesses. These tend to be valuation calculations, negotiation assistance and “fairness opinions.”
With corporate financing, there are two main ways for businesses to raise capital. They can either take on debt (through a bond offering) or can issue equity (through an initial public offering or secondary offering). Investment banks aid both processes.
Advisory divisions of an investment bank are paid fees for their services and Trading divisions earn commission based on their market performance.
Furthermore, Investment banks also undergo a wide range of other services: Trading, Investment research and analysis, Lending and Asset Management.
The role of an investment bank in terms of the intermediary role
Investment banks help corporations issue shares of stock in an Initial Public Offering (IPO) or additional stock offering. They can also provide debt financing for businesses by locating large-scale investors for corporate bonds.
Investment banks analyse companies’ financial statements for precision and publish overviews that depict the offerings in detail to investors before they can buy shares. Investment Bank clients include governments, hedge funds, corporations, and other institutions such as pension funds.
The role of financial advisers in investment banking
Investment banks function as financial advisors to large institutional investors and provide calculated advice on a wide array of financial dealings.
They achieve this by combining a thorough understanding of their client’s targets and current global and industry market affairs, enabling them to identify and evaluate short and long-term opportunities and challenges.
M&A in investment banking
Mergers and Acquisitions is one of the two main elements of an Investment Bank. The largest Investment Banks such as the Big Four will work with any sector in any industry. Whereas smaller (boutique) investment banks, such as Greenhill & Co, may focus on singular sectors such as Healthcare.
Research and analysis in investment banking
Research divisions often provide investment advice and ideas to clientele who can complete trades through the bank’s respective trading desks, generating more revenue for the bank. Additionally, research divisions can assist its traders and sales department by reviewing companies or writing reports about potential prospects.
Research enables banks to continuously top up their institutional knowledge of fixed incomes, credit, macroeconomic affairs, and quantitative analysis which can they be used internally and externally to advise clients.
Trading in investment banking
Investment banks generally have trading divisions who buy and sell derivatives and securities for both client and firm accounts. Their sales and trading teams assist clients with executing trades, managing risks, and accessing liquidity in the markets.
The size of an investment bank acts as a great asset in this division, as the biggest investment banks are able to rely on a global network to connect buyers and sellers of a security or derivative together.
Lending in investment banking
Although lending is typically a much larger field in commercial banking, investment banks tend to have some lending operations. Securities lending is one of these operations.
Securities lending is the practice of loaning shares of commodities, stocks or other securities to investors or firms. It requires the borrower to put up collateral, whether cash, other securities, or a letter of credit. Securities lending provides liquidity to markets and is able to generate additional interest income for long-term holders of securities. It also enables short selling to occur.
Asset management in investment banking
Investment banks usually provide advice to high-net-worth individuals and corporations on how to use their capital. The largest investment banks have hundreds of billions and even trillions of dollars of client assets that they are currently managing.
Regulation in investment banks
In the US, investment banks are regulated by the Securities and Exchange commission, known as the SEC. As the SEC overviews the securities industry, and practically all investment banking activities are related to the securities industry, the SEC has oversight of the investment banking business.
Criticisms of investment banks
As investment banks advise their clients in one division (research division) and trade their own accounts in another division (sales & trading), this could create a potential conflict of interest. To stop this, investment banks have to maintain a barrier called an “ethical wall” between the divisions. This figurative barrier is designed to prevent the sharing of information between divisions, which may allow one side or the other to unfairly profit at the expense of its own clients.