Investment Banking is a field that generates a lot of interest, but for most outsiders, it is also shrouded in mystery. The conventional image of an Ibanker is a young, ambitious guy in a pin-striped designer suit puffing on a Cuban cigar after closing a deal.
But not all investment bankers spend 100-hour weeks chasing money. There are also quite a few kind-hearted ones who want to help others understand this esoteric field.
We discovered one such exceptional star to help us make sense of an opaque and largely misunderstood industry. He prefers to stay behind the scenes, so we’ll just call him ‘MCB I-Banker’ (‘MIB’ has a familiar ring to it).
He is completing his MBA from an elite university. He spent the past three years in the Indian investment banking industry and has worked on deal volume in excess of Rs. 50,000 million. MIB is also a power & green energy infrastructure finance specialist.
Most of the websites and blogs with good I-banking related content focus on the US investment banking industry. So we thought it might be a good idea to launch our own desi I-banking Overview series where we try to retain a balance between domestic and international flavour. MIB kick-starts his Investment Banking 101 Series with the basics. So grab a coffee and join us on the journey.
What is Investment Banking?
by MIB
Unlike commercial banking (what we’re so accustomed to referring to as banking here in India), Investment Banking is a concerted effort to connect the capital markets with firms that need the money.
The capital markets take the form of investors in debt (such as banks who give firms loans) and equities (such as private equity players) and publicly traded equity markets (primary – IPOs and secondary – trading in the stock exchanges).
Investment Banks also advise clients on strategic acquisitions, divestments and restructurings that are connected with enhancements to firms’ balance sheets (if you don’t understand some of this – don’t worry, I will get into this in more detail later in the series).
Thus, investment banks play the role of an advisor and arranger, helping to bring firms an ability to do better by accessing capital and financial advice.
Business Model: Fee-based structure. Fees are paid based on success milestones
On the other hand, Commercial Banking is the process by which firms (banks) take deposits from the public and lend it to various classes of borrowers.
Some of these borrowers could be personal loans, house loans, loans to companies directly, loans to companies on a syndicated [See footnote 1] basis, etc. To put it concisely, commercial banks lend from their own balance sheet.
Business Model: Money that the bank has lent generates interest which counts as revenue for the bank
Investment banking as an industry developed in the United States and as of today, can still be referred to as a US industry.
You can typically infer the stage of development of an industry by looking at the levels of regulation that it is subject to (seems like a backward way to look at it, but it’s a great rule of thumb).
Banking in the US is well-regulated and a tremendously organized activity -you need a license to be an investment banker as well as to operate an investment bank, amongst a whole host of other activities that you need regulatory approval for.
So what does the scenario look like for the major financial centers across the world? Well, here’s a quick breakdown:
London: is seeing an exodus of bankers to New York and Hong Kong. Apparently, excessive government regulation is pushing bankers to move to locales where their compensation could be more directly proportional to the money they bring in to the bank and not limited by some arbitrary cap imposed by the government.
EMEA (excl. London): I don’t know what is happening in the Europe & Middle-East & Africa with regard to finance – but I cannot imagine that it amounts to very much in comparison to NY.
Toronto: The financial district of Toronto houses Canadian banking giants such as CIBC, RBC, as well as probably ever other banking mega-entity you can think of. However, the investment banking market still lacks the complexity and diversity in product that New York is so famous for.
Hong Kong: Poised to be the capital market of choice for Chinese companies. The Hong Kong stock exchange, for example, has stolen the march from the Singaporean stock exchange (prompting the latter to seek top-line growth by trying to buy the Australian stock exchange – a deal which was doomed due to the protectionist tendencies of the Aussies). With things going as they are, you can count on this destination to be the next most exciting financial location to be in after NYC.
Mumbai: Extremely shallow (low liquidity and a small number of participants) investment banking market with comparatively shallow capital market access. Financially insulated from the rest of the world (which also helped protect us from the recent sub-prime melt-down), Mumbai is developing as an investment banking location, but very slowly.
[Note 1] This is when banks get together to fund a single company. Unlike regular single-bank lending, here the loan is shared because either the loan amount is too high and / or the risk is too high for any single bank