Investment banking

Classification of Banks

Banks is a common term that most people are familiar with. While most people are aware of only one branch of the bank, which is the commercial bank; there is another category of banks that work for bigger firms, governments, and entities. The term coined for such banks is investment banks.

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As per the classification of banks, there are two kinds- commercial banks and investment banks. The difference lies in the functionality and clients. Commercial banks deal with small players- everyday people like you and me. Contrastingly, Investment Banks engage with big players like corporate firms, governments, and other big entities.

Commercial Banks VS Investment Banks

?Commercial banks work on a small scale with everyday customers. The banks that you visit often like HDFC, SBI, ICICI, Axis Bank, etc come under the class of commercial banks. How do they work? Commercial banks act as an intermediary between people who deposit money in banks and people who leverage loans from banks. Normally, there is a tad difference between the interest rates for depositing money and loan money, and this money counts as their personal income. For more clarity, let’s bifurcate things with an example.

Person A made a fixed deposit in a bank at an interest rate of 7%. Another person B pulled a loan, for which the bank adjusted an interest rate of 12%. The difference of 5% is the source of income for the banks. That’s how things work in commercial banks.

Proportionately, Investment banks are gigantic banks that work at both domestic and global levels. They usually deal with big players like companies, governments, and other business entities. On the surface level, investment banks have two main services- raising capital in the form of debt or equity and advisory services, primarily for mergers and acquisitions .

How do they make money? Basically, they help organizations to raise capital in the form of debt or equity, for which they get paid as per standard commissions. Likewise, they get commissioned compensation for breaking deals for profitable mergers and acquisitions. More on this in the upcoming section. Continue reading.

What is Investment Banking (IB)?

We can certainly define investment banking as a special division of banking operations that facilitates and guides hefty transactions for firms, governments, and other entities.

On a deeper level, IB is one of the most intricate financial mechanisms that attend to multiple services and business entities. Indeed, the scope of area for investment banking goes well beyond the primary activities of debt financing and issuing of equity securities such as in an IPO and advising big companies for mergers and acquisitions.

It further involves proprietary trading or brokering trades, leveraging finance by lending money to firms to purchase assets and close deals, security sales, and stock placement for corporate clients, governments, and high-net-worth individuals. More so, investment banks are the principal advisors, planners, & managers for restructuring and reorganization purposes. They also help organizations to go public or issue an initial public offering (IPO).

How Investment Banks Make Money by Advisory?

Let’s say there is a company A that plans to buy company B but is unsure about the real worth of the target company (company B). Additionally, company A is also interested to decode the long-term benefits like revenue, growth, costs, etc in regard to the deal. Here investment banks come into action.

The banks will carry out due diligence to determine the valuation of the target company, settle the deal, and prepare the necessary documents on the behalf of company A. The way there is an investment bank working on the buy side, there would be another investment bank working on the sell-side. As per the deal size, the commission will be compensated to the investment bank. The bigger the deal, the more compassion they will make.

Types of Investment Banks

Varied factors such as the size of the bank, coverage area, and type of services provided go into the proper classification of investment banks. Typically, the investment banks are structured into four levels, which are discussed below:

Bulge Bracket Investment Banks:?

Bulge Bracket investment banks are the largest of all types. They are international investment banking firms having a global as well as domestic presence. Limitless in the zone, they provide services around the world. Examples of bulge bracket banks are Goldmann Sachs, Morgan Stanley Deutsche Bank, Credit Suisse, Bank of America, etc. These mammoth banks have a huge number of employees and cater to all types of IB services.

Bulge bracket banks have a wide scope in terms of services, and that’s one reason they are typically called full-service investment banks. The gamut of their services extends to majorly all types of IB services including trading, financing, asset management, equity research, issuance, and merger and acquisitions deal services. Other than that, most banks have commercial and retail banking divisions, which act as an additional source of income by cross-selling financial products. Notably, such banks specialize in all the services that they provide.

The gigantic banks have big corporate clients, most of which belong to Fortune 500 companies. Most likely, they handle multibillion-dollar M&A projects. However, liable to the general state of the economy, they may take up smaller deals of low hundreds of millions.

Elite Investment Banks:

Elite banks closely resemble bulge bracket banks in terms of size and presence. Parallel to bulge bracket banks, they have a sizeable nationwide and global presence, with offices operating in multiple, if not all countries. Lazard LLC, Evercore Group LLC, and Moelis & Company are some of the popular elite investment banks.

In terms of the dollar value of the deal size, they have a lot in common with bulge bracket banks. Commonly, the deal size is over $1 billion, however, they may take part in smaller deals as well. Talking about the differences, elite banks have a much smaller pool of employees in sharp contrast to thousands of employees in bulge bracket banks.

These elite banks may offer a whole wide range of investment activities but excel only in one or a few of them. In some cases, they may limit their scope to M&A activities, which are the bread and butter of all investment banking divisions. Additionally, they may offer restructuring, equity/debt capital, and asset management facilities.

Broadly speaking, most elite banks start off as regional boutique banks and make their way up to elite banks. While they may indulge in multiple services, yet their specializations lie in one particular sector. Take, for example, an elite bank specializing in M&A activities related to the oil and gas industry.

Middle Market Investment Banks:

Reminiscent of the name, middle-market banks occupy the space between the enormous bulge bracket banks and small regional boutique banks. In terms of size, they have more room than regional banks but less room compared to bulge bracket banks. Geographically, they may spread across multiple regions, but lack the stature of a multi-national level bank.

Concerning financial services, they deal in a wide range of IB operations akin to bulge bracket banks- that includes equity and debt capital market servicing, all types of financing, asset management services, restructuring deals, and M&A activities. But then again, they specialize in only a few.

Comparatively, the deal size in such banks range from 50 million to 500 million, which is far less than the billion-dollar deals in bulge bracket banks. Some of the prominent banks listed under middle-market banks are Spark Capital, Equirus, William Blair Co, etc.

Regional Investment Banks:

On the lowest level come the regional investment banks that operate at the regional level. Compared to all other banks, they are the smallest in size and extend across small geography. Typically, they are the smallest in terms of bank size and deal size.

Normally, such banks have a limited number of employees, a dozen at best. Due to their small size, they do not offer all the IB services. They specialize in one or two services, most probably M&A deals, which are the breadwinner for investment bankers.

In the matter of deal size, the number goes up to a maximum of 100 million, which is nowhere close to bulge bracket banks. Possible examples of such banks are MAPE, O3 Capital, Avendus capital, etc.

Top-notch Investment Banks Around the World

In this section, we will have a look at the most reputed names in Investment Bank Industry. Without much ado, let’s ponder over the dominant names in the industry:

Goldman Sachs:

Established in the year 1869 in New York City, Goldman Sachs is a leading name for over a century now. The potent bank operates in 4 divisions- namely investment banking, institutional client services, investment management, and trading & lending. Due to its central hold over the industry, the company is a dream job for many.

JP Morgan Chase:

With an estimated market share of 8%, JP Morgan is one of the king-sized investment banks in terms of size and reach. Stronghold over the industry on a global level reflects in its wide-scale reach in over 60+ countries. As large as the reach, the services unfold investment banking, treasury, security, asset management, private banking, merchant banking, commercial banking, and many more.

Barclays:

Relatively as old as Goldman Sachs, Barclays initiated its services in the year 1896 in London. Being a universal bank, it extends its support to both investment banking as well as commercial banking services. As of today, Barclays is a global provider of financial services such as retail banking, corporate banking, wealth management, and credit cards.

Morgan Stanley:

With its headquarters in New York, Morgan Stanley has a robust presence worldwide with its principal offices in London, Hong Kong, Tokyo, and other financial hubs of the world. The tangent company primarily operates from three central units, namely investment banking, wealth management, and institutional securities. Among other things, it offers diversified services like brokerage, settlement, custodian, clearing, etc.

CitiBank:

Established in 1812, Citibank has a worldwide presence in over 160 countries. Classified as a universal bank, it has its wings spread into both investment banking as well as commercial banking. Apparently, it is assorted into major divisions namely capital market origination, corporate & investment banking, market & securities services, treasury, and trading solutions.

Divisions of Investment Banks

This section walks you through the varied divisions or floors of a full-fledged investment bank. The broad classification of divisions applies to the mammoth bulge bracket banks that provide all range of investment banking services.

Investment Bank Division:

Traditionally, the investment banking division (IBD) was the first step that established the foundation of investment banking businesses. IBD is technically the oldest division of this industry. Primarily, IBD has two main functions- raising capital in the form of debt or equity or executing mergers and acquisitions deals.

First things first, M&A deals are the main source of income for investment banks. Investment bankers help corporate clients, governments, and organizations to buy or sell stocks and companies. How do they help? They facilitate by determining valuations, financial modeling , and due diligence activities to lead up the framework for a successful deal.

Due diligence refers to the process of doing a background check to ensure that the information provided by the target company is accurate and authentic. It can be financial due diligence, tax-related due diligence, patent and copyright issues, technical due diligence, or legal matters.

Secondly, IBD officials raise capital for their clients and entities. What do they actually do? They land in the market and raise funds for clients in the form of debt or equity. In case of debt capital raising, the bankers will reach out to banks and financial institutions to provide loans to their respective clients. Equity capital rising involves selling the shares and stocks of the company to raise capital.

These were majorly the key roles of the conventional investment banks, working under the IBD floor. As this domain evolved, their portfolio extended up to distinct divisions with other roles and responsibilities.

Wealth Management:

Wealth management simply said, is the management of money in all its aspects. Most certainly, wealth management is usually required by high-net-worth-individual (HNWI) clients. Clients approach investment banks for wealth management- to which banks provide all the services. These include client investment, tax planning, estate planning, retirement planning, etc.

In the sphere of investment services, clients are sold managed accounts, and discretionary accounts, which are traded by the investment specialist on behalf of their clients. Additionally, they provide the clients with brokerage accounts, using which clients can access any type of investment virtually.

Trading and Brokerage:

In this particular division, there are two methods of coining money. Proprietary trading and trading for clients.

As far as proprietary trading is concerned, investment bank put out their own money in the market for trading and generate a whopping number of profits. Along the process, they trade their own stocks, bonds, and other financial instruments to avail of huge benefits.

Trading for clients involves trading on clients’ funds and stocks to generate profits for their clients. If profit goes into the client’s pocket, what do invesment banks get? Based on the set commission for the deal, the IB firms get their cut and that’s how they earn.

Research:

Lastly, there is a research team that plunges into various research-related tasks for clients. The most important and popular activity under the research segment is the equity research team. An equity research analyst team analyses the stock market to look for opportunities for buying, retaining, and disposing of stocks to generate revenue in the whole process. Basically, the equity research team charges commission from clients by facilitating them with buying stock or selling stock decisions.

Commodity research is another subdivision of the research team, that digs into the depths of precious metals, agricultural products, oil, natural gas, etc. The researched reports are delivered to clients, who use them for their own purposes such as hedging and trading.

Then, there is a currency research team that tracks, records, and analyses the local as well as global events and their impressionable impacts on the market trends. Take, for example, how the pandemic is going to affect the market and how companies can leverage it in the best of their interests. That’s what they really do.

Another evident branch of the research team is the credit team. A credit research team studies estimates, and make investment recommendation on debt and equity derivates to the clients. It can be better understood with an example. Say, for example, a firm is hesitant to invest all money in equity and is seeking debt derivates. Then, the bank provides them with the best possible advice to make investments and maximize their profits.

Investment Banking Roles

Investment banking itself is a huge industry with a myriad of roles and responsibilities. Broadly speaking, one can assort IB roles into three major categories, enumerated:

Front Office Roles:?

In the most general sense, the front office implies revenue-generating roles. People here work as traders, brokers, and researchers, and are often involved in face-to-face interactions with the clients. For that simple reason, they are also called client-facing roles. As of the front office is concerned, there are two main specializations-which are mergers and acquisitions and capital raising strategies.

Middle Office Roles:

As the name speaks for itself, the middle office roles sit between the front and the back office. While the individuals working in the middle office roles do not directly contribute to the revenue generation, they play a vital role to back up the deal. Due diligence, risk management, profit & losses, and compliance are the typical work areas for middle office roles. Since they scrutinize the deals made by the front office before reconciliation with the back office, they utilize all the resources of the front and back offices.

Back Office Roles:

The back-office roles of the IB services comprise administration and support personnel and have no direct interaction with the clients. On the face of it, the back-office includes departmental functions like Accounting, HR, record maintenance, settlements, clearances, regulatory complaints, and IT services. Similar to middle-office roles, they have little say in direct revenue generation, but they form a major part of the support personnel that leads to the success of the deal.

These are the three arms of IB firms and each has a specific crucial role to play. The front office deals directly with the clients and catches the deals; middle and back-office jobs are intrinsic for risk management and to ensure proper execution of the transactions. Thus, all three are significant components of the company infrastructure.

Investment Banking Salaries

On an average basis, investment banking is one of the highest-paid profiles as per age. As a first-time hire, an investment banker can expect a lucrative package of $100,000 straight out of college, which is substantially higher than most other profile jobs. Whatsoever, if you compute an hour-based income for investment bankers, it’s a different story.

As most analysts and associates work 100 hours per week, they are compensated on a scale of $25-$35 per hour. Not entirely bad, but it doesn’t sound as promising as $100,000 a year. Right? So, we can say, technically, investment bankers are not paid overwhelmingly well on an hourly basis.

The Below-table Mentions the Salaries of Different Investment Banking Profiles:

Title NameApprox. AgeBase SalaryTotal SalaryAnalyst22-27$100-$125K$150-$250KAssociate25-35$175-$225K$300-$550KVice President28-40$250-$300K$500-$900KDirector32-45$300-$350K$800-$1200KManaging Director35-50$400-$600K$1000-$3000K+

Source: Mergers and Inquisitions

As it is clear from the above-mentioned table, investment banker salaries are a blend of two components- base salary and bonus. Indeed, the bonus contributes a large part to the total remuneration at all positions. The significance of the bonus heightens as we move up the ladder to senior-level positions, where the bonus could double or quadruple the base salary.

Now, one question that sticks up in the back of the mind of most individuals is- why are investment bankers paid so much? Let’s find out in the next section.