How are Investment Banks different from Commercial Banks?
Such questions are often asked by the common people who know a little about the banking system.
Banking is something that everyone has to deal with, especially in India. High profile businessmen, Middle-class people or BPL workers, every person in India has an account in the banks. This is because people perform transactions such as making deposits, retrieving cash for their daily needs only through banks.
Banks are the licensed financial institutions that receive deposits from the customer and make loans.
The deposit amount is reused in the banks to generate huge money. They also provide several financial services such as currency exchange, wealth management, safe deposit boxes and more.
Investment banking is different from commercial banking in many ways. Investment banks help organizations raise capital and provide financial consultancy services to them. In other words, investment banks act as intermediary deals with users and investors who help new organizations to go public.
Their primary work is to bring together those who require money (corporations, SMEs) with those who have money to invest (HNIs, angel investors). Also, they allocate capital and regulate the price in these financial transactions.
Here, the financing can be done through underwriting (a process where investment banks raise capital for corporations, government etc in the form of stocks or bonds).
Thus, when you hear about an organization going public for the first time and offering its shares to the shareholders via SME-IPO, investment banks are the ones who are handling the whole IPO process.
While managing an IPO, an investment bank has too many things such as creating and managing a prospectus which includes all the company details, stock’s detail, handling complex issues such as legal and compliance issues, deciding a stock price that would attract investor’s attention to raise capital with a sufficient amount a company wants to.
Setting an initial IPO stock price could be a challenging job for any investment bank as they have to make a delicate balance in finding an optimal price that not only provides the funding to their clients but also attracts multiple investor’s attraction.
If the stock price is too high, it will fail to catch investor’s attraction, on the other hand, a low price is insufficient to provide an adequate amount of capital.
In the case of bond offerings, investment banks provide similar services to those for IPO. But again, the primary element is pricing which is determined by the interest rate offered.
Mergers and Acquisition
Investment banks also cover the merger and acquisition where one organization is about to acquire the other or when a company is offered for a sale. Based on the company valuation, an investment bank decides what one company is willing to pay for the others.
The companies who are about to make an acquisition, investment banks mainly advise their clients on the value of the company and the most favorable way to structure the offer.
Investment banks whose clients are top-notch companies, which are ready for the acquisition, determine the reasonable asking price or value of the company. The advice is on the favorable or unfavorable structure structures of the sale.
Acquisitions involve cash, stocks or a combination of cash and stock.
In a nutshell, investment bankers are financial advisors who provide capital for their clients through the sale of equities or debt.
Financial Advisory
Investment banks also provide financial advisory services for top-notch clients. They primarily work on hedge funds and private equity and control millions of dollars. Their services included: capital raising for general funds, IPOs of portfolio companies owned by the funds and more.
Risk Management
Investment banks work on risk management by hedging position in interest rates, foreign currency exchange and commodity position through F&O, swaps. Swapping is a way through which two parties exchange their debt obligations to minimize the risk profile.
Swapping work because different companies have different categories of debt in the financial market. Parties having different financial needs often exchange their obligation to structure their finance strategy.
Wealth Management
Institutional investors accumulate vast wealth which leads to wealth management. Investment banks compete with one another and with commercial banks and specialized money management firms in accumulating assets under management.
Alternative Investment
Investment bankers also do alternative investments that include private equity, real estate, arbitrage, international funds and more.
Number of Jobs in Investment Banking
Investment banking is not a single job instead, it is a broad category that includes several jobs.
Below are the roles an investment banker do:
1) Analysts and Associates
Analysts and associates; both work as an executive at an investment bank. Analysts are individuals, who have just passed out from college who may have some sort of experience in the finance industry but are new to the investment banking industry.
After gaining experience of 3-4 years, investment bankers become associates in the investment banking industry. Their job role starts with doing thorough research and writing reports. Also, they are responsible for handling the supervisor’s schedule and attending phone calls of clients.
2) Vice President, Directors and Managing Directors
Vice presidents are the middle man who supervises associates and analysts. They have direct contact with the clients. Apart from supervising the team of analysts and associates, they are also involved in managing client relationships, deciding the structure of a capital fund like whether it will be done through equity for sale or debt offering.
3) Corporate Finance Work
Corporate finance in an investment bank helps clients to generate capital that is necessary for their future growth or to finance the ongoing project. Also, their other work includes obtaining financing from a plethora of sources such as equity, debt, convertible bonds, debentures, derivatives.
4) Industry Coverage Work
Investment banks divide their staff into working groups that are assigned to cover specific market sectors. Here, the team’s main job is to bring new client business and operate existing clients within their assigned sector of the market.
Takeaway
Investment banks play a vital role to facilitate funds and allocation of capital for companies and government entities. They serve as financial advisors to their clients by helping them to allocate resources, manage instruments and price the capital.
