Description of Investment Banking - Essay Example

Investment banking Investment banking differs from the traditional commercial bank in a way that it does not accept deposits in its banking functions. This separation of function between commercial banking and investment banking is spelled in Glass-Steagal Act of 1933 and Gramm-Leach-Biley Act. This separation of function in banking however is unique in US banking because such separation is not present in its G8 counterparts. Investment banking deals mainly in helping individuals, companies and governmetns to raise money by underwriting and acting as its middle person in the issuance marketable securities. In addition, investment banks can also assist the mergers and acquisitions of companies and provide services such as trading of derivatives and securities. It trade and promote securities for assets or other securities (i.e. derivatives) on its selling side. On the other hand, it aslo advise indivdividuals and companies on how to invest their monies as its buying function. Advise typically dispensed by investment banking usually involves equity, insurance companies, mutual funds and hedge funds. An investment banker or the person who provides investment banking services to his or her clients is licensed and subject to the regulations of the Securities and Exchange Commission (SEC) and Financal Regulatory Authority (SEC). Functions The function of investment banks are usually divided between its front office, middle office and back office activities; a. Front office – is the most common function of investment banking where it help its client to raise capital for their business or give advise during acquisitions and mergers. Raising funds for its clients could take in the form of issuing marketable securities (such as stocks), coordinate ad negotiate with the company to be acquired or merged with and coordinate with biders. Investment banks do not take in deposits from the general public and instead, it involves itself in the buying and selling of investment securities and other tradable securities. The investment banker assumes the role of a trader as he or she buys and then sell securities with a spread or margin on every trade completed. This function of investment banking however was blamed as the culprit of the recent financial crisis because the “financial bubble” that burst and precipitated the crisis came from reselling of complex derivates and debts that cannot collected until ultimately, it took its toll on the US financial system. b. Middle office – the middle office involves the research function of investment banking. This is the function where investment banks do their homeworks about companies as they study their financial health and rate them on what opportunity it could present to the bank or their clients. This function helps both the sell side and buy side of investment banking make prudent economic decisions in trading securities, raising capital for their clients or dispensing advise about the company that will be acquired or merged to. It is also in this function that invesment banks do their strategy in controlling their client’s risk and profitability through its product control teams. This function mainly tackles profit and risk strategy which may not directly involve in the profit generation of buy and sell function of tradable securites but still is considered as a key function of investment banking (Goldman Sachs). Interestingly, investment banking also does risk management albeit this function became questionable after the recent financial crisis because the crisis originated from investment banks beginning with the collapse of Lehman Brothers. This function typically involves the analysis of the risk involved that their clients take during a trade (either in the buy or sell side). Credit risk on the other hand focuses on the capital market such as issuance of tradable securities and bond issuance, loan syndication and restructuring. Investment banks also do risk monitoring of their clients global exposure as well as liquidity risks. c. Back office function – back office function of investment banking basically involves the checking and ensuring the integrity of the data it used or rely in its other functions such as buying and selling of tradable securiteis, dispensing advise on merger and acquisition and raising capital for their clients. Traditionally, this function is critically because an error or miscalculation have an adverse economic consequence on the firm and its clients. The financial crisis of 2008 It is interesting to note and worth discussing the recent financial crisis of late 2008 that precipitated the global crisis that we are still experiencing today because it originated from investment banking. The crisis begun with the collaase of Lehman Brothers and sale of Merrill Lynch and Bear Stearns. This precipitated the crisis and effected other industries as well as other economies. It almost took out of proportion that the Treasury Secretary at that time remarked that if Morgan Stanley and Goldman Sachs would be lost next, the financial system might vaporize (The Economist). This compelled the government to initiate the rescue package dubbed as the Troubled Asset Relief Program (TARP) to bail out investment banks such as Goldman Sachs and Morgan Stanley to prevent the financial market from totally collapsing. The crisis resulted in $100billion lost of revenue which equivalent of a third of Wall Street’s total annual revenue. Jobs were lost with a 100,000 job cuts were initiated during the crisis. The huge returns by investment banks before the crisis came to an almost nil and the massive perks given to executives and employees were also severely cut (The Economist). Recent development in investing banking Investment banking had been traditionally dominated by US banks. The recent financial crisis in late 2008 however changed the investment banking landscape as US banks collapsed or showed vulnerability during the crisis due to its poor ethical practices and relatively relax regulation. The collapsed of the infamous investment house Lehman Brothers provided its Euroean counterparts to get into the American investment market which had been traditionally impregnable to European banks. It was described as an incredible opportunity by Bob Diamond the head of investment bank of Barclays when it bought Lehman Brothers in the aftermath of its collapsed (The Economist). Works Cited “Our Divisions Finance”. Goldman Sachs. May 09, 2013. Retrieved from http://www.goldmansachs.com/careers/why-goldman-sachs/our-divisions/finance/index.html “Securities and Exchange Commission”. GOVERNMENT-BUSINESS FORUM ON SMALL BUSINESS CAPITAL FORMATION. 2004. http://www.sec.gov/info/smallbus/hmakens.pdf “The Economist”. Wall Street is back. May 1, 2013. Retrieved from http://www.economist.com/news/leaders/21577370-american-investment-banks-dominate-global-finance-once-more-thats-not-necessarily-good Read More