Understanding the Role of Investment Banks in Financial System

Understanding the Role of Investment Banks in Financial System

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Rashmi
Rashmi Karan
Manager - Content
Updated on Jan 9, 2024 17:10 IST

Investment banks play a critical role in the global financial system and are major players in high finance. These banks are specialized institutions that provide financial services to corporations, governments, and other large organizations, including underwriting securities, offering advice on mergers and acquisitions, and managing assets. This article introduces investment banks and their role in the global financial system.

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What are Investment Banks?

An investment bank is a financial institution that raises capital, trades in financial markets, manages IPOs and takeover bids and manages mergers and acquisitions of large companies. They do not have a large branch network throughout the country but a few huge offices in large financial centres.

Commercial banking profits tend to be more stable than investment banking; they depend on the country’s economy, and if they lose money, the situation in that country is difficult. In contrast, the benefits of investment banking are more variable, depending on the economic cycle and the evolution of financial markets.

What is Investment Banking?

Investment banking is a type of banking mainly responsible for obtaining funds, raising capital, or other financial resources so that different entities can make short or long-term investments. It is also in charge of negotiating with large companies for client profitability and investing shareholders to trade in countries’ capital markets.

Investment banking is completely differentiated and separated from commercial banking since it has different social objectives: It focuses on small savers. While the investment in large companies. Negotiate with them for profitability and better business conditions for shareholders and investors. In the same way, investment banks can invest in SMEs they see as having the potential to generate results.

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What Services Do Investment Banks Offer?

What is Investment banking for? Investment banks have many functions, such as advising or consulting their clients, issuing securities, diversifying or structuring investment portfolios, etc. 

Listed below are the main tasks of investment banks.

Underwriting

Investment banks serve as intermediaries and help corporations raise capital by underwriting new securities offerings, meaning they purchase securities from the issuing company and then sell them to investors.

Advice on Mergers and Acquisitions

This advice can be comprehensive, from tracking the market in search of a company to or punctual for the moment of negotiation and purchase. And is that when a company buys another or merges, it needs to carry out risk studies, propose formulas to finance the purchase and close all legal issues.

Asset Management

Some investment banks also offer asset management services. Their main job is to manage the investment portfolios of their clients.

Risk Management

Investment banks help their clients manage risk by providing hedging strategies and other risk management solutions.

Issuance and Creation of Structured Products

This would fall within the advisory part and is much less complex than it may seem. These services are used when a company wants to offer financial products to the general public or to structural investors that go beyond debt issues for use. Business banks can take charge of designing these debt issuances and even go further with the creation of structured products.

Private Wealth Management (PWM) 

Investment banks provide customized investment and financial management services to high-net-worth individuals. Several banks have specialized divisions or subsidiaries offering such services to their clients. Private wealth management typically includes services such as investment planning, portfolio management, tax planning, and estate planning.

Financing of New Projects

Financing projects is another of the activities that characterize investment banks. In these activities, the bank intervenes to create an attractive design that allows partners to be found who can provide the necessary resources for the project.

Design Financial structure

Investment banks are also in charge of designing an appropriate financial structure, seeking sources for the necessary financing, intervening in negotiations, managing the procedures related to the guarantees demanded by investors, and executing contracts, among others.

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Challenges Faced by Investment Banks and their Solutions

Investment banks must be highly transparent, compliant with cybersecurity initiatives, and offer advanced solutions for the ever-changing needs of consumers. Here are some of the challenges that investment banks face 

Challenge 1 – Containing Costs 

Banking, financial services, and insurance (BFSI) companies regularly evaluate different strategies to control costs better. Depreciating revenues, higher operational costs, lowering costs of goods & services leading to fewer margins, and reduced capital costs with banks make investors unwilling to invest. Banks are facing this issue of reduction in interest rates and the cost of equity.  

Solutions – To overcome this challenge, the banking domain needs to balance optimizing the existing main tasks through robotic processes & digitization and investing in new services. They must optimize their technology and data analytics to reduce risk and increase efficiency. Investment banks can also consider moving to a more centralized location or implementing remote work arrangements for employees.

Challenge 2 -Cybersecurity

Investment banking is highly prone to cyber vulnerabilities. Cyber threats are at their peak, and conventional technologies have been proven unable to deal with such challenges. Moreover, the traditional infrastructure acquired by banks through M&A activities can also be prone to cybercrime. Such systems need to be updated and associated with extensive vulnerabilities. Such a task is challenging for the IT teams of these banks.

Solutions – Banks need to invest more in upgraded and smart cybersecurity systems. These banks need to incorporate more modular solutions to deal with cyber threats. Hiring skilled and experienced cybersecurity professionals is another crucial aspect of this move.

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Challenge 3 – Improving Client Experience 

Increasing demands of the clients make it difficult for investment banks to sometimes achieve client-focused experiences in B2C and B2B models. 

Solutions – To overcome this challenge, banks must evaluate their existing processes, understand client's needs and preferences through client feedback, surveys, and data analysis, and build new and improved delivery models to ensure excellent online and offline client experience. These banks need to prioritize building trust and long-term relationships with clients. They must focus on offering high-quality services, demonstrating industry expertise, and maintaining ethical practices.

Challenge 4 – Fintech As a New Technology Threat

Investment banking is also adopting rapid technological advances, like other industries. However, fintech has changed the dynamics of investment banking by offering the same financial services but effectively using financial technology at lower prices. 

Solutions – The investment banking sector can only stay ahead of the game if it integrates FinTech into its operations and services to remain competitive. They should also focus on offering specialized services that fintech companies may need help to provide, such as complex financial transactions and advisory services for big M&As.

Top Investment Banks in the World

Worldwide there are many investment banks. These banks adhere to the legal stipulations of the countries where they were incorporated. Some of the top investment banks around the globe are – 

  1. JPMorgan
  2. Morgan Stanley
  3. Citigroup Inc.
  4. Well Fargo & Co
  5. ICBC
  6. Bank of America
  7. UBS
  8. Credit Suisse
  9. Deutsche Bank
  10. Evercore

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Conclusion

Investment banks are characterized by important operations influencing companies’ and countries’ economic development. All these functions are oriented to satisfy the needs of large companies to satisfy their needs in terms of improving future profitability.

The future of investment banking will be characterized by rapid change and ongoing disruption but also significant opportunities for those firms that can adapt and innovate in response to these trends. Advances in technology will continue to transform the industry, with increased use of artificial intelligence, blockchain, and other technologies to improve efficiency, reduce costs, and enhance client experiences.


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FAQs

What is an investment bank?

An investment bank is a financial institution that provides various financial services to corporations, governments, and other large organizations.

What services do investment banks provide?

Investment banks offer several services, including underwriting and selling securities, advice on mergers and acquisitions, facilitating large-scale financial transactions, and offering other specialized services such as risk management and asset management.

How are investment banks different from commercial banks?

Commercial banks take deposits or provide traditional banking services such as loans and checking accounts. On the other hand, investment banks specialize in providing financial services to corporations and other large organizations.

What is the role of investment banks in the global financial system?

Investment banks help companies and governments raise capital, facilitate mergers and acquisitions, and provide other financial services that contribute to the growth and stability of the economy.

What qualifications do you need to work in an investment bank?

You need a strong academic background in finance, economics, or a related field, relevant work experience and technical skills, such as financial modelling and data analysis, to work in an investment bank.

About the Author
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Rashmi Karan
Manager - Content

Rashmi is a postgraduate in Biotechnology with a flair for research-oriented work and has an experience of over 13 years in content creation and social media handling. She has a diversified writing portfolio and aim... Read Full Bio