What is an Investment Bank?

Most people use ordinary banks for simple transactions with modest sums of money. But larger institutions like governments, corporations and super-wealthy individuals have more intricate financial needs. Investment banks are better suited for their purposes.

What is an investment bank, and what makes investment bankers different from commercial bank tellers and loan officers? Benzinga takes a closer look. 

How Does an Investment Bank Work?

The financial needs of corporations, governments, institutional investors and the super-wealthy are more complex and nuanced than those of normal individuals. As such, they require institutions that can perform a wider range of banking functions.

Investment banks operate in the capital market, providing financial services for large entities and private customers with high net worth. Their services include underwriting new business efforts, portfolio management, advisory services and more.

It’s not easy to qualify for an investment bank account. Because of the high financial stakes, opening an account is a lengthy, complicated process. Investors generally need to be accredited by the U. S. Securities and Exchange Commission (SEC). Since these banks take on risky, volatile efforts, their bar for clients is high.

All the biggest commercial banks, including JPMorgan Chase and Citigroup, have investment banking divisions. Such institutions are called universal banks. However, their investment banking services are separate from their personal and small-business banking functions. 

Understanding the Role of Investment Banks

What is an investment bank’s mission? Here are four of the most unique functions an investment banker provides.

Intermediary

Investment banks are perhaps best known for serving as intermediaries, facilitating interactions between their clients and other large-scale financial institutions. As part of this role, they also act as advisors and risk managers.

The chief intermediary service investment banks provide is raising capital. When a large corporation wants to issue new stocks or bonds, the investment bank usually purchases the securities and resells them to other parties. An investment bank also arranges private capital raising from venture capitalists or angel investors.

Since they deal with substantial assets, investment bank intermediaries must meet unique qualifications. Their analytical skills need to be on point, and they’re held to higher education and experience standards.

Many obtain Master’s degrees in Business Administration. Some also have special certifications unique to investment bank operations, such as a Chartered Financial Analyst (CFA). 

Mergers and Acquisitions

When its clients are about to execute expansion plans, an investment bank brokers the mergers and acquisitions (M&A) process.

The investment banker may help the corporation conduct due diligence and find M&A opportunities or targets. They analyze potential transactions to determine their value. They also work as negotiators in deals and structure them to benefit their clients.

After the merger or acquisition, the investment banker can offer transition assistance. They retain and organize all documentation and stay on top of regulatory requirements, working with legal representatives to ensure that they’re up to standards.

A solid investment banker also helps with the more nuanced, unforeseen aspects of M&A. 

They may help reconcile the companies’ work cultures and improve synergy or contact the company’s suppliers to maintain a solid relationship. They may deal with intellectual property issues, tax liabilities and other surprises.

Financial Advisers

An investment bank provides reliable financial advice to its clients in many respects. Two of their main areas of expertise are raising capital and M&A. But they serve in an advisory capacity in many other areas.

If a company is restructuring, an investment banker can help a client strategize its turnaround, solidify organizational blueprints and rework debt. They can also help raise debt capital and equity through bonds, loans and stock offerings. They’re better situated to find private investors as well.

When a government decides to privatize one of its public enterprises, an investment banker can advise it on structuring and financing.

Similarly, an investment banker can help find Treasury ideas that optimize cash flows, manage foreign exchange issues and organize hedge funds against interest rate changes when a corporation wants to enhance its cash flow and liquidity.

Research Divisions

One of the lesser-known (but inarguably critical) functions of investment banks is research. They study and analyze a broad range of subjects and information pertinent to clients. This is possibly the role that best distinguishes them from commercial banks.

Equity is one area in which research is particularly crucial. Investment banks examine publicly traded companies’ financial statements and survey different industries to identify trends and competitors. They may also help with a client’s investment plans, setting target prices and issuing buy-sell-hold recommendations.

A research team can also handle many other financial issues. For instance, they can analyze or forecast global economic conditions and indicators or look into fixed-income financial instruments like bonds. Investment bankers often generate reports on market conditions, serving as commentators on trends and risks.

Advantages of Investment Banks

An investment bank offers several benefits for clients who meet its minimum requirements. Here are some of the most notable.

Experience With Large Scale and High Risk

When a client needs to raise capital or complete an M&A effort, an investment bank has the scale and risk-management expertise needed to usher them through, with dedicated processes to facilitate complex deals quickly and efficiently.

Worldwide Reach and Networking Potential

The biggest investment banks (and even some of the smaller ones) have a global presence. This factor can be helpful when clients face issues like currency exchange rates and international transactions. In some cases, their relationships with other entities and institutions could provide clients with instant networking opportunities.

Access to High-Level Financial Instruments

An investment bank can be an entry point for many sophisticated financial services, including derivatives, hedge funds, junk bonds, customized investment strategies and private equity. These products are often difficult to obtain through other means. 

Disadvantages of Investment Banks

While these institutions are instrumental in carrying out an array of big-banking tasks, they aren’t without their disadvantages. Some of the potential drawbacks of dealing with an investment bank include:

High Costs

The specialized service an investment bank provides comes with a very high price tag. Hidden costs and fees can quickly pile up, even for the wealthiest clients.

High Risk

Many things can go wrong with large-scale financing. Although good investment banks will factor these risks in, their clients aren’t immune to the possibility of massive losses. Investment banks may not be liable for damages if worst-case scenarios play out.

Limited or Salesy Client Attention

Since an investment bank works with a diverse array of clients — many of whom require near-constant attention — they may not always offer much in the way of customer service.

Furthermore, some investment banks have sales teams that are under pressure to promote their products and service. This pressure could emerge in client service interactions. 

Investment Banks Are Built for Big Business

Investment banks are, by nature, inaccessible to the common investor. For the ultra-wealthy, international businesses and governments, however, they’re indispensable. When those entities need to execute their biggest financial initiatives, an investment banker toils behind the scenes to get it done.

Frequently Asked Questions