What is investment banking?
Investment banking is a way for organizations and people to invest in long-term options. However, it can seem like a complex process, and with investment banks working across a range of complex products and services, it isn’t always easy to understand. We take a closer look at investment banking, how it works, and some common examples of investment banking.
What is investment banking?
Investment banking is a branch of high finance and is a way for governments, institutions, and businesses to raise money. Investment banking covers a range of different services, usually consisting of the following:
Underwriting: Underwriting is the process of verification undertaken by an organization that is preparing to offer someone a loan or financial service. Investment banks usually conduct underwriting when preparing to help a business launch an initial public offering (IPO).
Mergers and acquisitions: Investment banks can serve as advisors when businesses want to carry out takeovers.
Trading: As well as carrying out their financial trades, banks can connect buyers and sellers in secondary markets.
Equity research: Research teams can offer timely advice and guidance to investors looking to make investments.
Asset management: Many banks have teams that manage the investments made by depositors.
In short, investment banking involves banks using depositors' money to help them achieve their long-term objectives.
What do investment banks do?
It can be easier to understand investment banking by understanding investment banks themselves. In a nutshell, investment banks are intermediaries between organizations and people looking to invest money.
This means that if a government is looking to raise funds to finance a project, it could turn to an investment bank to oversee the issuing and selling of a government bond. Or, if a business is looking to acquire another company in a complex takeover, an investment bank could offer important guidance on how the buyer could maximize its investment.
Investment banks play an important role in managing some of the most complex financial transactions. For this reason, they have become an important source of expertise and financial services for organizations. Today, many of the biggest banks in the world are investment banks or are divisions of other, larger firms.
What are the different types of investment banks?
Full-service investment banks are slightly different from the investment banking division of a commercial bank. For example, an investment banking division usually focuses on and underwriting mergers and acquisitions. Full-service investment banks offer these services and a much broader range of services.
But in addition to offering a comprehensive range of investment services, investment banks can also be targeted toward certain consumers and locations. The largest investment banks, for example, operate globally, while middle-market banks may be more locally or regionally focused. On the other hand, boutique investment banks tend to specialize in one specific area of corporate finance, meaning that they are a better match for a smaller range of potential customers.
How are investment banks regulated?
From helping governments finance spending to supporting the investments of some of the biggest businesses in the world, investment banks play an important role in the economy and have a sizable impact on both companies and people. Due to their size and importance, however, they are important pieces in the global economy, meaning that if investment banks start to perform badly, there can be ramifications.
For this reason, almost every aspect of investment banking is subject to regulation by the Securities and Exchange Commission (SEC), which enforces various regulations often subject to change.
For example, for many decades after the 1929 stock market crash, the Glass Steagall Act prevented banks from mixing both investment and commercial banking services – something widely considered to have worsened the stock market crash and economic crisis. At the time, banks were allowed to offer investment banking to clients and carry out commercial banking of their own. Unfortunately, when investors rushed to pull their money out of their investment portfolios, they found that banks had also invested their deposits and couldn’t return their money.
This act was repealed in 1999. Yet after the 2008 financial crisis, new regulations were implemented, such as Basel 3, which meant banks had to increase the minimum amount of reserve capital they held; the Dodd-Frank Act, which created an independent financial regulator; and the Volcker Act, which prevented investment banks from offering risky investments to commercial banks.
Examples of investment banking
Some of the most common cases of investment banking occur when a business wants to launch an IPO and raise additional money through investment. Companies can strike a deal with investment banks to sell a number of shares to the bank, who will then attempt to sell these shares to public investors. This is the same process as a bank helping a government raise finance for a project.
Investment banks can also offer important guidance to businesses and governments looking to acquire another entity. Banks have dedicated research teams and significant experience handling complex financial transactions, meaning that they offer vital insights when advising on mergers and takeovers. Banks can help businesses determine how best to finance a takeover and help companies sell to the right party.
Size is one of an investment bank’s greatest assets. The larger the organization, the more expertise, connections, and services it can offer. The greater the amount of work banks can take on helps them to work across an ever-wider set of sectors and services.
Investment banking can help businesses and people achieve their financial goals. But while they represent one way of managing finances, there are many others too. Speaking to a financial advisor can help you find the best way to manage your investment portfolio. Find your next advisor on Unbiased.
Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.