What is Investment Banking?
Investment banking refers to financial services concerning large and complex transactions, investment advice, capital raising, risk management, and other financial solutions. Some investment banks are universal banks, acting as a conglomerate of commercial and investment banking services simultaneously.
An investment banking entity is a bridge between businesses seeking capital and investors, ready to use the funds to reap profitable returns. These banks purchase securities from different entities and sell them to interested investors, keeping the market active and efficient. However, the reputation of the banks plays a great role in attracting more and more investors to a project.
- Investment banking is a division of financial corporations that creates new debt and security instruments, underwrites IPO processes, offers advice on mergers or acquisitions, and helps high-net-worth individuals and banks facilitate high-value investments.
- Investment banks are a mediator between businesses and investors, carrying all the risks and acting as a shield to both parties.
- It helps businesses build capital by raising funds from investors based on the years of reputation that they have built.
- The services offered to customers depend on the type of investment bank, be it bulge bracket, middle market, or boutique bank.
Investment Banking Explained
Investment banking emerged as a concept in the early 19th century when commercial banks dealt with the investment banking requirements of various entities. However, the emergence of the American Civil War made financier Jay Cooke start the first investment bank to fund the US war efforts.
The US government became the first client and started issuing bonds through investment banks to interested investors. The funds raised help the authorities fund their fundamental requirements and pay off investors with a share of the profit earned once the projects were accomplished.
The bonds served as an IOU, a payback promise in writing. Per this, the investment banks bought the bonds and sold the same to investors for profits. The banks continue doing the same even today. However, these banks attract clients and investors based on the reputation they have built over a period. Their history plays a vital role in making the stakeholders trust the businesses they collaborate with.
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The banking services are classified based on the types of banks providing them. The first one is the bulge bracket bank which forms the largest part of the investment banking field. They operate around the world and offer investment and advisory services efficiently.
Middle-market banks are the next on the list, which are comparatively smaller and operate on a limited scale. On the contrary, boutique banks, the third on the list, segment the customers before offering their services. These banks are for elite, regional, and industry-specific clients. While the elite banks take care of the major asset management, mergers and acquisitions, and other bigger deals, the rest two are restricted to offering services to specific regions and industries.
Trading is one of the least talked-about functions of investment banking. The salespeople work as analysts and approach investors with investing opportunities. In turn, traders take up trades and convey to the client when to consider entering and exiting positions.
Underwriting, the next one, makes these banks buy assets and securities having monetary value and sell the same to investors. The parties get involved in such deals as they have a middleman to take care of the risks and become their shield against the losses incurred. This makes the banks keep the securities to themselves until sold as they have already paid the clients for them.
Investment banks offer asset management services through which it helps clients manage their investment funds. The assets are managed using individual accounts for stocks, fixed-income stocks, derivatives, etc.
One of the most vital services of these banking institutions is their advisory functions. They help clients with valuable advice related to major business dealings, especially M&A. In addition, the ones into investment banking jobs help buyers and sellers of entities intending to merge with or acquire/being acquired by businesses.
The examples below help us understand the investment banking meaning and its functions better:
Stella sets up a start-up. However, she is still searching for investors to raise capital. Being a novice in the market, she connects with an investment banking firm, A, which has an established history of helping businesses to operate well. The firm buys the securities from Stella and sells the same to investors to raise funds.
Being the risk-taking middleman, the investment bankers played a crucial role in the Subprime Mortgage Crisis of 2008. As the Federal Reserve increased the bank’s liquidity, it lowered the funds’ rate, leading to commercial banks offering home loans without any strict criteria. With more and more home seekers taking up loans, commercial banks started selling the old financial obligations to investment banks, selling them to investors, and making them appear as secured investments. This allowed them to offer more home loans over time.
This cycle continued for consecutive years until the interest rates started rising, causing borrowers to default and affecting the banking sector. Though the investment bankers were found responsible for creating the bubble that burst, causing the collapse of the American economy, the same entities helped build it again with a far better and more stable infrastructure and economic foundations. Hence, even though it’s a complicated field, investment banking holds a bright future ahead.
With its evolution, two types of banks started – investment banks and commercial banks. While commercial banks dealt with the daily deposits and withdrawals and other simple banking services, investment banks were responsible for bigger financial affairs, including mergers and acquisitions (M&A), underwriting, etc. Then, some conglomerates acted as both investment and commercial banks and came to be referred to as universal banks.
When the functions collided, the universal banks had details of investors, who were also borrowers, which made it convenient for them to sell risky positions out of bias. These concerns made the authorities introduce the US Glass-Steagall Act of 1933, which prohibited commercial banks from offering investment banking facilities. In 1999, however, the act was repealed and replaced with the Gramm-Leach-Bliley Act, allowing commercial banks to offer investment banking services again. This led to mergers, forming global conglomerates like HSBC, J.P. Morgan Chase, etc., while some, like Goldman Sachs, and Morgan Stanley, preferred to function as pure investment banks.
Frequently Asked Questions (FAQs)
Passing a course or having a degree in the field is not enough to enter it. Hence, it is recommended that individuals approach the right people to start at the right time and begin their internship. In addition, being a part of an analyst program helps candidates build a stronger profile. In the process, they build connections and can apply for better opportunities.
Though the field is a bit complicated and crucial, at the same time, one can build a career and be successful. The only thing required is a passion for finance and the ability to work hard and learn with experience to improve with time. Moreover, the investment bank jobs and salaries are at par with the industry. As a result, the one joining would be emotionally and financially satisfied.
Though investment bankers have been accountable for financial crises earlier, including the 2008 financial crisis, they are the ones that help governments sell bonds to investors and finance the infrastructure and other requirements to build the economy. Hence, the presence of these institutions is necessary for an economically stable future.
Investment Banking Video Tutorials
To understand Investment Banking functionsInvestment Banking FunctionsInvestment banks perform various functions for their clients, including initial public offerings (IPOs), mergers and acquisitions, risk management, equity research, structuring of derivatives, merchant banking, and investment management. and their roles in detail, I have prepared 14 parts video tutorial series on “What is Investment Banking?” to help you jump-start on this topic.
Part 1 – Introduction
Part 2 – Investment Banking vs. Commercial Banking
This part 2 video tutorial on Investment Banking vs. Commercial Banking discusses the following important basics-
- What is an investment bank?
- What is a commercial bank?
- Investment banking vs. commercial banking.
Part 3 – Equity Research
This part 3 video tutorial Equity Research discusses the following: –
- What is equity research?
- How equity research makes money?
- What is a typical Equity Research jobEquity Research JobEquity research analysts jobs are competent for the candidates who have a keen interest and understanding in financial analysis of the companies. The profile includes suggesting equities as well as buying and selling the stocks on the clients' behalf. profile?
- Who are the clients of the equity research department?
Part 4 – What is an Asset Management Company
In this part 4 video tutorial on Asset Management Company(AMC), we will discuss the following: –
- What is the Asset Management Company or AMC?
- How does an asset management company work?
Part 5 – Buy Side vs. Sell Side
This part 5 video tutorial on Buy-Side vs. Sell SideBuy-Side Vs. Sell SideSell-Side refers to those corporations, investment banks and advisory firms who engage in the issuance, selling and trade-in of the financial securities. In contrast, the buy-side involves hedge fund companies, pension fund organizations and investment managers who purchase financial securities., we discuss the following: –
- What is the sell-side?
- What is the buy-side?
- Key differences between sell-side and buy-sideBuy SideThe term "buy-side" refers to entities that advise their clients like individual investors and institutional buyers on investments and securities purchases. Private equity firms, mutual fund companies, life insurance companies, unit trusts, hedge fund companies, and pension fund entities are examples of buy-side firms.
Part 6 – Sales and Trading
In this part 6 video tutorial on Sales and Trading, we discuss: –
- What are sales and trading?
- Sales function
- Trading function
Part 7 – Raising Capital
In this part 7 video tutorial on raising capital – how investment bankers help raise money through private placements of shares, IPOs, and FPOs: –
- How do companies raise capital?
- Role of investment bankers in raising capital.
- What is Initial public OfferInitial Public OfferAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange. (IPO) and Follow-on Public Offering or FPO?
- What are private placements?
Part 8 – Underwriters
In this 8th part on Underwriters, we discuss the following:-
- What is Underwriting
- Role of investment bankers in underwriting IPOs
Part 9 – Market Making
In this part 9 on market-making by investment banks, we discuss the following: –
- Market making
- Role of investment bankers in market-making activities
Part 10 – Mergers and Acquisitions
In this part 10 video tutorial on Mergers and Acquisitions, we discuss the following –
- What are Mergers and Acquisitions or M&A?
- How do investment bankers help in M&As?
- Due diligence for M&A.
- Investment Banking PitchBookInvestment Banking PitchBookPitch Book is an information layout or presentation used by investment banks, business brokers, corporate firms, and others to provide potential investors with the firm's main attributes and valuation analysis, which helps them decide whether or not to invest in the client's business. A pitch book is also known as Confidential Information Memorandum, which is used by the firm's sales department to help them sell products and services to a client.
Part 11 – Restructuring and Reorganization
In this part 11 video tutorial on Restructuring and Reorganization, we discuss:-
- What is restructuring?
- What is reorganization?
- Investment banker’s role in Restructuring and ReorganizationRestructuring And ReorganizationRestructuring is defined as actions an organization takes when facing difficulties due to wrong management decisions or changes in demographic conditions. Therefore, tries to align its business with the current profitable trend by a) restructuring its finances by debt issuance/closures, issuance of new equities, selling assets, or b) organizational restructuring, which includes shifting locations, layoffs, etc..
Part 12 – Roles, Positions, and Hierarchy
This part 12 video on Investment Banking Roles and responsibilities discusses this job’s key roles and responsibilities.
- Vice President
- Managing Director
Part 13 – Front Office vs. Back Office vs. Middle Office
In this part 13, we discuss the following –
- What is a front office?
- What is a back office?
- What is a Middle office?
- Front office vs. Middle OfficeFront Office Vs. Middle OfficeFront office is defined as different business processes within the organization where the primary responsibility of interacting with the customers. In contrast, back-office means all the production and background processing of the tasks required to deliver a quality product or service lies with the back office. vs. Back Office
Part 14 – Conclusion
This article is a guide to what is Investment Banking and its meaning. Here, we discuss its types, roles, functions, and regulations, along with examples. You can learn more about tax from the following articles –