Business, Legal & Accounting Glossary
An investment bank is an institution that performs a variety of financial services for corporations, individuals, and the government. The primary function of an investment bank is to raise capital for growing companies and the government by issuing equity and debt securities. In essence, the role of an investment bank is to operate as an agent between companies in need of funding and the public markets. The chief difference between an investment bank and retail bank is that an investment bank does not accept deposits or originate loans. An investment bank also offers advisory and strategic services related to mergers, acquisitions, and corporate restructuring. Today, a typical investment bank may offer risk management and broker-dealer services as well. An investment bank is also known as an underwriter.
Investment Banks help companies and governments raise money by issuing and selling securities in the capital markets (both equity and debt), as well as providing advice on transactions such as mergers and acquisitions. Until the late 1980’s, the United States and Canada maintained a separation between investment banking and commercial banks.
A majority of investment banks also offer strategic advisory services for mergers, acquisitions, divestiture or other financial services for clients, such as the trading of derivatives, fixed income, foreign exchange, commodity, and equity securities.
Trading securities for cash or securities (i.e., facilitating transactions, market-making), or the promotion of securities (i.e., underwriting, research, etc.) is referred to as the “sell side”.
Dealing with the pension funds, mutual funds, hedge funds, and the investing public who consume the products and services of the sell-side in order to maximize their return on investment constitutes the “buy side”. Many firms have both buy and sell side components.
Investment bank refers to an institution or individual that behaves as an agent or underwriter for municipalities and corporations engaged in the issuance of securities. A number of investment banking entities are engaged in dealer and broking operations. Investment bankers also offer advisory services to their respective client investors. The principal distinguishing factor of investment banks as compared to their traditional bank counterparts is that they do not accept deposits and grant loans of any kind to individuals.
An investment bank plays a major role in assisting corporate restructuring, mergers and acquisitions and private equity placements.
The primary function of an investment bank is buying and selling products both on behalf of the bank’s clients and also for the bank itself. Banks undertake risk through proprietary trading, done by a special set of traders who do not interface with clients and through Principal Risk, risk undertaken by a trader after he buys or sells a product to a client and does not hedge his total exposure. Banks seek to maximize profitability for a given amount of risk on their balance sheet.
An investment bank is split into the so-called Front Office, Middle Office, and Back Office.
An investment bank can also be split into private and public functions with a Chinese wall which separates the two to prevent information from crossing. The private areas of the bank deal with private insider information that may not be publically disclosed, while the public areas such as stock analysis deal with public information.
In the UK more graduates apply to Investment Banks than for any other career because of the exciting city-based work, large pay packet and prestige of firms such as Deutsche Bank, Goldman Sachs and JP Morgan. In 2007 a survey by WikiJob.co.uk found that over 40% of all UK graduates held an interest in a career in investment banking and that almost 20% made one or more applications for graduate roles at Investment Banks after leaving University.
Global investment banking revenue increased for the third year running in 2005, to $52.8 billion. This was up 14% on the previous year, but 7% below the 2000 peak. The recovery in the global economy and capital markets resulted in an increase in M&A activity, which has been the primary source of investment banking revenue in recent years. Credit spreads are tightening and intense competition within the field has ensured that the banking industry is on its toes.
The US was the primary source of investment banking income in 2005, with 51% of the total, a proportion which has fallen somewhat during the past decade. Europe (with the Middle East and Africa) generated 31% of the total, slightly up on its 30% share a decade ago. Asian countries generated the remaining 18%. Between 2002 and 2005, fee income from Asia increased by 98%. This compares with a 55% increase in Europe, and a 46% increase in the US, during this time period.
Investment banking is one of the most global industries and is hence continuously challenged to respond to new developments and innovation in the global financial markets. Throughout the history of investment banking, it is only known that many have theorized that all investment banking products and services would be commoditized. New products with higher margins are constantly invented and manufactured by bankers in hopes of winning over clients and developing trading know-how in new markets. However, since these can usually not be patented or copyrighted, they are very often copied quickly by competing banks, pushing down trading margins.
For example, trading bonds and equities for customers is now a commodity business, but structuring and trading derivatives is highly profitable. Each OTC contract has to be uniquely structured and could involve complex pay-off and risk profiles. Listed option contracts are traded through major exchanges, such as the CBOE, and are almost as commoditized as general equity securities.
In addition, while many products have been commoditized, an increasing amount of profit within investment banks has come from proprietary trading, where size creates a positive network benefit (since the more trades an investment bank does, the more it knows about the market flow, allowing it to theoretically make better trades and pass on better guidance to clients).
The fastest-growing segment of the Investment Banking Industry are called PIPEs, otherwise known as Private Investments into Public Companies (otherwise known as Regulation D or Regulation S). Such transactions are privately negotiated between companies and accredited investors. These PIPE transactions are non-rule 144A transactions. Large Buldge Bracket Brokerage firms and smaller boutique firms compete in this sector. SPACs (Special Purpose Acquisition Companies or Blank Check Corporations) have been created from this industry.
In the US, the Glass-Steagall Act, initially created in the wake of the Stock Market Crash of 1929, prohibited banks from both accepting deposits and underwriting securities which led to the segregation of investment banks from commercial banks. Glass-Steagall was effectively repealed for many large financial institutions by the Gramm-Leach-Bliley Act in 1999.
Another development in recent years has been the vertical integration of debt securitization. Previously, investment banks had assisted lenders in raising more lending funds and having the ability to offer longer-term fixed interest rates by converting the lenders’ outstanding loans into bonds. For example, a mortgage lender would make a house loan, and then use the investment bank to sell bonds to fund the debt, the money from the sale of the bonds can be used to make new loans, while the lender accepts loan payments and passes the payments on to the bondholders. This process is called securitization. However, lenders have begun to securitize loans themselves, especially in the areas of mortgage loans. Because of this, and because of the fear that this will continue, many Investment Banks have focused on becoming lenders themselves, making loans with the goal of securitizing them. In fact, in the areas of commercial mortgages, many Investment Banks lend at loss leader interest rates in order to make money securitizing the loans, causing them to be a very popular financing option for commercial property investors and developers.
Potential conflicts of interest may arise between different parts of a bank, creating the potential for financial movements that could be market manipulation. Authorities that regulate investment banking (the FSA in the United Kingdom and the SEC in the United States) require that banks impose a Chinese wall which prohibits communication between investment banking on one side and equity research and trading on the other.
Some of the conflicts of interest that can be found in investment banking are listed here:
It is described as a banking division that covers business entities managing with creating capital for other companies. Investment banking also apprises companies on business matters like issue and placement of equity securities or stock.
An investment banking group is described as a cluster of investment banks that collectively underwrite and distribute new securities. The group may also lend money to a particular borrower. Investment banking groups generally do not exist on a permanent basis. Investment banks are bought together for particular deals that are considered too risky or hard for a single borrower or underwriter to manage. An Investment banking group is also known as a banking syndicate or distributing syndicate.
It is described as the technique by which investment bankers obtain investment capital from investors for utilization by governments and corporations that are issuing securities. Both debt and equity securities are applicable.
Sterile investments are those that do not offer any interest or dividends to the investor. Any kind of return is exclusively through capital gains. Gold and silver investments are one of the more prominent examples of sterile investments.
The hidden reserves of a financial institution that does not appear on public documents like a balance sheet. They are, however, tangible assets and are accepted as such by banks and other financial institutions.
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This glossary post was last updated: 6th August, 2021 | 0 Views.