Investment Banking - Assessor of Risk

By Iqbal, Zafar | Economic Review, November 1997 | Go to article overview

Investment Banking - Assessor of Risk


Iqbal, Zafar, Economic Review


Investment banking has been very much in the news since a 28 year-old trader recently sank Baring Brothers, the oldest investment bank in Britain. It is in some ways a profession for the young. I don't know what they (the traders) do with themselves if and when they grow up. Although the work investment banks are supposed to do has been handled for many years by banks and financial institutions, investment banking as such is a new phenomenon in Pakistan. We have sort of walked into it backwards.

When the government came under pressure to open up banking to the private sector, the sanctioning of investment banks represented the first tentative step in that direction. Instead of allowing the private sector into full-fledged banking, the government gave it a limited mandate to offer some banking and financial services. The two main differences were that the new (investment) banks could not keep current or savings bank accounts, and were limited to deposits of fixed maturity. Secondly, they could not directly deal in foreign exchange.

As a compensatory feature their liquidity requirements were lower, but on the other hand they could not go to the SBP as lender of last resort. As far as the concept went, for all practical purposes, they were simply second class banks. By definition, investment banks are supposed to perform services related to the financial management of investment. In this connection their services are normally:

a) Syndication of loans or bonds;

b) Placing of shares (equity);

c) Underwriting shares;

d) Issuing guarantees;

e) Giving financial advice; and

f) Managing funds.

Since one person or even a few persons do not normally have the financial capability to provide all the necessary funds to finance an investment, the methods adopted are:

a) To borrow from the pool of individual savings deposited with banks and financial institutions, either in the shape of loans or bonds. This is called syndication. In this arrangement one institution is designated as a lead manager who manages borrowing from other banks, financial institutions or individuals, and charges a fee for performing this service.

b) To raise equity in addition to that being contributed by the sponsors. This is done through: (i) placement with institutions or individuals and (ii) through a general share offering to the public. This general share offering is normally underwritten by banks and financial institutions. The role of the underwriter is to buy any shares which are not bought by the public. For this service he charges a fee.

The process of giving financial advice is implicit in the above activities. The first element is judging the quality of the investment i.e. forecasting. It's likely profitability (generally referred to as due diligence). The second element is assessment of market sentiment at any given moment in time. Financial advice relates both to price at which shares or other financial investments are to be offered and the timing of when they should be offered to potential customers/subscribers in order to obtain the best price. The success and reputation of an investment bank depends upon its ability to assess these two factors realistically.

Investment banking is still in its infancy in Pakistan and the services offered by such banks and financial institutions are relatively straightforward. There is not much trading activity in bonds or futures or derivatives of any kind. So anyone choosing a career in investment ban king is normally not in a position to emulate Mr. Leeson of Singapore fame, and run up huge profits or huge losses. What potential investment bankers should bear in mind is that any activity which can generate huge profits (unless they can rig the market) also has the potential to generate huge losses. The successful investment banker has to be good at assessing risk. Accordingly, risk management has become the current buzz word in banking circles. …

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