“Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway.” The greatest investor of all time, Warren Buffet precisely brought out the relevance of investment banking in today’s world. The investment bank aims to maximize the revenues through the execution of a range of financial transactions. The main objective of investment banks is to advise governments and businesses for the procurement of their finances and the organization of their financial plans. Investment banks provide a plethora of operations like advisory and mediation, they have to play a significant role in mergers & acquisitions as well.
Their clients include institutional fund managers, governments, corporations, exchange-listed companies, and High Net Worth Individuals. They provide a range of services like asset management, risk management, research, and development of products and services. Their products include futures, options, derivatives, FY, bonds, treasury products, collars, swaps, caps, floors, structured finance, FRAs among others.
The main source of revenues of Investment banks is derived from commissions they receive by breaking deals between parties. So, it is directly proportional to the size of the deals they can ensure! They also earn revenues by accruing traders for investing money in capital and derivative markets. Investment banks receive servicing fees for their asset management roles. They get fees for their advisory roles as well. They earn a certain proportion of revenues from dividends also. Another source of income is from underwriting stocks and bonds. A huge source of their funds is diverted towards research and development.
The main distinction between the functioning of a commercial bank and an investment bank is that a normal bank makes money by charging interest on the money lent, whereas an investment bank sells services to the governments, corporations, and fund managers.
One of the main functions of Investment Banks is the underwriting process wherein they raise capital through selling stocks or bonds to the investors on behalf of the firms. Bankers help them raise capital by marketing these firms. A prospectus with a price range is prepared. Then, institutional investors commit at a price. The Book of demand is built and then the price is set to ensure clearance.
In the facilitation of M&A, I-banks work for acquisition strategy, set acquisition criteria, start searching for the target, and then devise a planning strategy. Then they devise valuation. After this, they go on to continue negotiation and due diligence. Finally, they prepare the finance & sale contract, and then it is being implemented. I-bankers work with the government to raise money and sell securities. Similarly, they work with companies to go public (IPO), raise capital, provide research, and financial advice. They work with Institutional Investors to manage money.
Some of the top Investment Banks are Bank of America, Barclays, Citi, Credit Suisse, Deutsche, Goldman Sachs, J. P. Morgan, Morgan Stanley, etc. Investment banks have employed traders, who go on to trade everything from currencies to derivatives. High-quality research attracts firms to a particular bank. And their contacts with Investors make it easy to raise money.
The real estate agents are selling properties ranging from hundreds of thousands of dollars to millions of dollars. They make 5 to 6% on each of the deals. For 1 million $ deal, they would get $50,000. Now Investment Bankers sell companies, with deal values ranging from millions to billions. Deals less than $ 1 billion will fetch 1% of the commission and more than that might lower down to 0.1%. 0.1% of $50 billion is around $50 million. Now if we look at the expenses of these banks, we’ll find they need a workplace and the employees. They don’t need ATMs like a commercial bank or production facilities like a factory. The expenses of meetings are incurred by clients. And even if not, they don’t stand in front of the multi-million profits they make. Around 50-60% of the revenue goes to the bankers themselves. Thus, the low expenses and high revenues are the causes behind Investment banks making super-profits.
A few models that I-banking utilizes are as follows:
Flow Monster: This business model is based on quality-driven research, efficient technology, a competitive pricing model, and strong sales.
Product Specialist: As the name suggests, it is centered around a particular product or service. The managers should have entire knowledge: what distinct features does that particular product have.
Risk Manager: Centred around risk-centric approach. Calculated and intelligent risks are being taken.
Regional Champion: It cross-sells risk management and financing modules to its existing clients.
Primary Markets Powerhouse: It focuses on an advisory role and less frequent deals.
A focussed approach is required to ace in the highly competitive markets of today. Another feature required to survive in the tough market is intense discipline and a detailed understanding of its clients. The functions of Investment banks are quite complex and multi-layered. Financial technology plays an important role in simplifying these functions. I-banks should go with the models that are perfectly suited to the evolving times and in sync with the technological prowess. A keen understanding of the economy and financial ecosystems are necessary as well. The reduction of operational costs with technological advancements might be the way to survive in the hyper-competitive world. A client-centric approach will always ensure increasing returns. It is becoming tougher and tougher to survive in the capital markets and the I-banks have their task cut out.
And as Warren Buffet quotes, “It takes 150 years to build an investment bank and only five minutes to convince you to sell me preferred stock in it at a 10% interest rate.”
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Belonging to Gurgaon, he is currently a student at Kirori Mal College pursuing Economics Hons. Ishaan is a fun loving person, soft at heart and a confident and dedicated soul. You can typically find him working for his endeavours or attending a Model United Nations conference. He likes to keep himself aware about the happenings around the world!