Investment bank

What is an investment bank?

An investment bank or investment bank is a bank that helps companies and governments to raise money by issuing and selling securities in the capital markets, both equity (holdings) and bonds (debt). In addition, investment banks give a lot of advice on transactions such as mergers and acquisitions and trade in derivatives, bonds, foreign currencies, commodities and shares.

Organizational structure of an investment bank

The primary task of the bank is to buy and sell products. Banks try to maximize their profits given a certain level of risk on their balance sheet.
An investment bank is divided into the so-called Front Office, Middle Office, and Back Office.

Front Office

  • Investment banking is the traditional aspect of the investment bank and involves helping clients attract money in the capital market and advise on mergers and acquisitions.
  • Investment management is the professional management of funds and various securities such as shares and bonds but also real estate to make a profit for the customer, the investor. These investors can be institutions such as insurance companies or pension funds or they can be private investors. The investment management branch of an investment bank is generally divided into private wealth management and asset management. Asset management manages the money of institutional investors while private wealth management manages the money of wealthy individuals.
  • Sales / Trading Traders buy and sell products with the aim of making a small profit on every transaction. Sales is the term for the investment bank department that deals with selling ideas and products to institutional and private investors. Sales communicates the wishes of the customers to the traders who carry out the desired transactions.
  • Structuring is a fairly new activity in which new complex products are developed. These are products that are derived from simpler effects and are therefore derivatives. The banks can often earn more on this than on regular securities. Because this activity is very complex and requires employees with a quantitative mathematical background, many PhD students in nature and mathematics are recruited for this, the so-called quants.
  • Merchant banking is the private equity arm of an investment bank.

Middle Office

  • Research is the department that examines companies and their potential and writes reports on this basis and gives “buy” or “sales” advice. Although the research department itself does not make a profit, the reports and conclusions are used by traders and sellers in advising their clients.
  • Strategy is the department that advises both external and internal clients on strategies in different markets. From derivatives to specific sectors strategists companies and sectors place in a quantitative framework compliance with macroeconomic conditions.
  • Risk Management involves analyzing market risk and credit risk that traders place on their balance sheets in their daily transactions and setting limits on the amount of capital that traders are allowed to trade to prevent bad deals from having a detrimental effect on the entire bank.
  • Finance is the department responsible for the management of the capital of the investment bank. By following and analyzing the capital flows in the company, the Finance department is an important advisor to the management of the company in essential elements such as the management of the company’s total exposure to risk and the profit opportunities of the various departments. In the United States and the United Kingdom, a Financial Controller is often a senior position, often advising the Chief Financial Officer.
  • The Compliance department is responsible for the conformity of the daily activities of a bank with the prescribed regulations of the government and other authorities.

Back Office

  • Operations
  • Technology

Role in credit crisis

Investment banks played a major role in the emergence of the credit crisis. In the US, the majority of subprime mortgages (or bad mortgages) were loaned to bankers by the lenders. They have packaged these claims and repackaged them in complex and opaque financial products. By means of securitization, collateralised assets, such as mortgages, were put together in packages and traded between the financial institutions. This gives spread of risks but also uncertainty where the risks lie and how large they are.

When the subprime mortgages could not be paid off, these claims proved to be worth less. For the investment banks in the US, the income from securitization largely disappeared. Other sources of income could not absorb this. Lehman brothers was not saved by the government and went bankrupt. Other investment banks in the US received credit from the government, but Merrill Lynch and Bear Stearns were taken over and Goldman Sachs and Morgan Stanley were transformed into ‘ordinary’ banks.

As a result of the credit crisis, students are studying for measures that can prevent a recurrence. This includes, among other things, the intervention in the bonus culture at the investment banks, the tightening of the supervision of the banks and stricter capital requirements.

Large investment banks

Large investment banks include:

  • JPMorgan Chase
  • Bear Stearns (acquired by JPMorgan Chase)
  • Deutsche Bank
  • Citigroup
  • Merrill Lynch
  • Goldman Sachs
  • Morgan Stanley
  • Barclays
  • HSBC
  • UBS
  • Credit Suisse
  • Royal Bank of Scotland
  • Lehman Brothers (bankrupt)
  • BNP Paribas
  • Société Générale
  • Macquarie Group
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