Overview of investment Banking
Investment banks perform two basic, critical functions. First, investment banks act as intermediaries between those entities that demand capital (e.g. corporations) and those that supply it (e.g. investors). This is mainly facilitated through debt and equity offerings by companies. Second, investment banks advise corporations on mergers, acquisitions, restructurings, and other major corporate actions. While the majority of investment banks perform these two functions, it is important to know which products and services each bank specializes in.
INVESTMENT BANKING VS. COMMERCIAL BANKING
One distinction that is important to understand is the fundamental difference between an “investment bank” and a “commercial bank.” Investment banks perform advisory services and securities underwriting, while commercial banks manage deposit accounts, such as checking and savings, for individuals and businesses (but primarily for businesses—similar transaction accounts for individuals are often handled by a retail bank). This distinction is important to understand, because the U.S. enacted the Glass-Steagall Act in 1933 in response to the Stock Market Crash of 1929 and the Great Depression. The Glass-Steagall Act essentially prohibited banks from performing both “investment banking” and “commercial banking” activities within the same entity. This was done in order to prevent banks from making implicit bets on the direction of the market, at the potential expense of depositors. Banks were forced to choose between investment banking and commercial banking, and that continued until the Glass-Steagall Act was repealed in 1999.
GLOBAL ECONOMIC CRISIS
After the Glass-Steagall Act repeal, investment banks started to participate in both investment and commercial banking activities, and thereby take on a considerable amount of risk (on behalf of both the bank and its clients). This high level of risk-taking, combined with high leverage, led to several major investment banks failing during the global economic meltdown in 2008. Huge losses were recorded and the remaining major investment banks were forced to either change their business models or consolidate with other banks in an industry-wide effort to reduce leverage ratios and stabilize the banking system.
CORE ACTIVITIES AT INVESTMENT BANKS
- Corporate Finance (this function is most commonly referred to as “Investment Banking”): Assist corporations in raising capital through debt and equity capital markets, and provide advisory services on mergers and acquisitions (M&A) and other corporate transactions.
- Sales and Trading: Buy and sell securities and other financial instruments as an intermediary on behalf of its clients.
- Research: Provide detailed company and industry research reports and make recommendations on whether to buy, sell, or hold public securities.
- Asset Management: Provide equity, fixed income, money market, and alternative investment products and services to individual and institutional clients.
CORPORATE FINANCE/INVESTMENT BANKING GROUP STRUCTURE
Corporate Finance is broken down into several types of groups, but the primary distinction is between Product groups and Industry/Coverage groups. Each group handles its own client accounts, and is responsible for a designated product or industry sector.