Investment banking is one of the most profitable fields in the financial industry. In 2018 investment banks measured the revenue of $39,000,000,000 and it was just in the United States. The yearly income of an investment banker is $140,000. It’s uncommon that so many people dream of becoming the next wolf of the wall street.
By reading this it looks so good but there are so many hours of hectic pressure to be handled by the investment banker and it is not that easy to achieve the mentioned amount. So to know more about how this glamorous industry works we have to first study how this industry started.
In the early 19th century commercial banks in the U.S. Performed functions associated with investment banks, but during the civil war this all changed. Investment banking began with Philadelphia financier Jay Cooke. In 1961 Cooke established the first ever investment bank to help fund the federal government’s war efforts. As such, the US government became one of the first clients. Back then the government had to issue bonds to raise enough money to support its rapid growing economy and complete infrastructure projects like building the railways. Bonds are like I.O.U used between lenders and borrowers and are typically used to finance expensive projects. In many cases investment banks would buy these bonds and sell them on to private investors for a profit.
TODAYS INVESTMENT BANKING:
Investment banks practically do the same just with different parties involved. The question is – where are those billions and dollars in revenue coming from? Well, the business model is actually pretty simple. Investment banks purchase assets that hold monetary value – otherwise known as securities and sell them on to third parties for a fee. This process is called “underwriting”.
So why don’t clients investors just save money and make the deal themselves? One of the biggest perks of making this kind of deal is that the middleman is responsible for distributing the securities. If they can’t find enough investors they have to keep some securities themselves. When you think about it, investment bankers are basically taking risk as the middlemen between clients and investors. Now, this isn’t exclusive to investment banks.
Now the question arises in mind: what is the difference between the commercial banks and the investment banks?
Commercial banks take on risks as well but here’s where the difference lies. Commercial banks deal with individual and small to mid-sized companies, giving out smaller sums of money like individual mortgages and small business loans. They make their profits though the interest they charge.
On the other hand, investment banks take much larger risks. They deal with huge companies and high-risk startups, acting as a bridge between companies and investors. In this process, they can earn a huge amount in fees. All of this sounds great in theory but let’s be honest investment banking does not have a great reputation. We all live through one of the worst financial disasters in history: the Subprime Mortgages Crisis of 2008.
Here’s what happened. In 2001, the Federal Reserves increased the bank’s liquidity by lowering the federal funds rate. This enables banks to give out more loans. In order to do this banks lowered their standards and started giving loans to pretty much anyone regardless of whether they have a job or any money at all. These are known as “Subprime Mortgages”. But you may think of them as less than desirable loans. Of course, commercial banks couldn’t just give out loans endlessly.
So, to make room for new borrowers they sold their old loans onto investment banks. Investment banks repackaged those subprime loans and sold them onto investors without disclosing how insecure those loans were. At the time, that didn’t seem to matter. It was one big party : borrowers were buying homes, investors were profiting, and banks kept on selling their loans so they could give out new ones.
But after every massive party comes an equally massive hangover. After good times, interest rates started rising. Suddenly, Subprime borrowers couldn’t afford to pay back their loans and started filing for bankruptcy, causing everyone involved to start panicking. In the space of a few months, the economy had been crushed by the greatest banking collapse since the Great Depression. What happened was that investment bankers had created a massive bubble with their irresponsible trading. And when that bubble burst everyone felt the effect.
So, as to point out, you’re probably convinced that investment banks are evil and we’d be better off without them. Right? Wrong! The 2008 Subprime Mortgage Crisis is just one of many crisis throughout banking history. The market has crashed before and it will undoubtedly crash again. But it’s worth remembering that investment banking, for all its flaws, helped build countries. The railroads mines and IT would never have seen the light of day if it weren’t for the support for the investment banks. And as we look towards an environmentally sustainable future, we’ll need investment to help us rebuild countries too.
How does the future hold for investment banking?
Many have speculated the crowdfunding platforms like kickstarter will take over as the preferred method for funding innovative projects. But, that’s not going to happen. While crowd funding certainly can help small projects get off the ground, it’s not reliable enough to support the renewable energy revolution the world so desperately needs. On the other hand, investment banks are already pouring billions of dollars into alternative energy projects. Of course, it’s not just renewable energy projects that stand to benefit. We can expect investment banking to play a role in every world-changing innovation in the near future. Companies will always need large investors and investors will always be on the lookout for new opportunities. That’s why investment banking is here to stay.
Main Investment Banks:
The main banks, also known as the bulge bracket banks in investment banking, are:
- Bank of America Merrill Lynch
- Barclays Capital
- Credit Suisse
- Deutsche Bank
- Goldman Sachs
- P. Morgan
- Morgan Stanley