Investment Banking

An investment bank is a financial institution tasked with helping corporations, governments and individuals raise capital by underwriting loans and offering them fiscal security. Investment banks aid with mergers and acquisitions by offering businesses assistance with market making, trading of derivatives, foreign exchange commodities and equity securities. This service is offered to both corporations issuing securities and investors who are interested in buying them. Investment banking is also commonly referred to as corporate finance because businesses rely on the information provided by bankers to successfully invest in the market place. To gain a merger an investment bank puts together a pitch book of financial information to market the bank to a potential client. And unlike commercial banks, investment banks do not take deposits. According to financial specialists Bloomberg, the best paid investment bank in 2010 was JP Morgan Chase & Co, which ranked first in the Bloomberg 20 for the third year in a row, boasting total fees of $4.14 billion.

Investment banking has two ways of conducting business for clients. The first is trading, known as ‘the sell.' Also called industry coverage, it mainly deals with the trading of securities for cash or other market making (this is the buying and selling of financial products such as shares with the view to making a profit with each trade) and the promotion of securities such as underwriting and research. The industry coverage division usually focuses on a specific industry such as healthcare or technology. Bankers working within this field maintain relationships with corporations to bring in business for their company. The other main component of investment banking is the ‘buy' side, which is known as product coverage. This is when investment banks deal with pension funds, mutual funds and hedge funds for consumers of their goods, known as the investing public. Investment bankers in this field work alongside specialist industry groups to provide the needs of their clients. Larger banks focus on both sides of the business. Smaller banks focus on investment first, then sales, trading and research. There are also two further functions investment banking can serve. The first is private functions, including using insider information in their dealings which can never be disclosed. The second is serving the public function of the operation by analyzing stocks, which does not have to be kept secret. However, at no time can those working in either of these separate areas share information with each other.

Most investment banking firms are split into three offices, front, middle and back. The front office deals with sales, trading, mergers and acquisitions. The middle office deals with risk management by analyzing the market credit risks, ensuring their compliance guidelines are followed and helping to capture economic risks to clients accurately. The back office deals mainly with data-checking trades which have already been conducted and providing technological support to workers. In terms of job security, this is seen as the safest in the industry but it not considered as exciting as the other, more high-risk branches.

In the United States, commercial banks and investment banks remained separated under the Banking Act of 1933, more commonly known as the Glass-Steagall Act. It was established to prevent any financial institution from acting as any combination of an investment bank, commercial bank or insurance company. The Act was put in place to halt deflation and expand the Federal Reserve's ability to offer rediscounts on more types of assets including government bonds. This was an unusual move because most industrialized countries, including G8 countries, have not historically maintained a separation. This continued to be the case until 1999, when the Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act, signaled an end to this practice. This effectively removed the separation which previously existed between Wall Street banks and commercial banks, although the act was later blamed for contributing to the 2008-2009 American capital markets crisis.

There are strict rules governing the conduct of advisors working in investment banking in the United States. To be allowed to operate, they must be a licensed broker-dealer and are held accountable by the Financial Industry Regulatory Authority (FINRA). They are required to follow the rules set out by the Securities and Exchange Commission (SEC). However in 2010 investment banks faced criticism and mounting pressure over sales of complex derivatives contracts (a financial instrument whose worth depends on underlying variables) to local municipalities in Europe and the United States.

Investment Banking: Selected full-text books and articles

Firm Reputation and Insider Trading: The Investment Banking Industry By Ramirez, Garbriel G.; Yung, Kenneth K.; Tin, Jan Quarterly Journal of Business and Economics, Vol. 39, No. 3, Summer 2000
Universal Banking: International Comparisons and Theoretical Perspectives By Jordi Canals Oxford University Press, 1997
Librarian's tip: Chap. 3 "The Separation between Commercial and Investment Banking in the United States"
Power and Conflicts of Interest in Professional Firms: Evidence from Investment Banking By Hayward, Mathew L. A.; Boeker, Warren Administrative Science Quarterly, Vol. 43, No. 1, March 1998
Peer-reviewed publications on Questia are publications containing articles which were subject to evaluation for accuracy and substance by professional peers of the article's author(s).
Monopolies in America: Empire Builders and Their Enemies, from Jay Gould to Bill Gates By Charles R. Geisst Oxford University Press, 2000
Librarian's tip: Discussion of investment banking begins on p. 198
Visionary Capitalism: Financial Markets and the American Dream in the Twentieth Century By Charles R. Geisst Praeger Publishers, 1990
Librarian's tip: Discussion of investment banking begins on p. 18
The Evolution of U.S. Finance By Jane W. D'Arista M.E. Sharpe, vol.2, 1994
Librarian's tip: "Commercial and Investment Banking in the United States" begins on p. 65
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