History of Investment Banking

1. Investment Banking
Dr. Anu Thakur

2. Investment Banking
Investment Banking is a method of controlling the flow of money.
Channeling cash from investors (looking for returns)
=
the hands of entrepreneurs and business builders (who are long on ideas,
but short on bucks).

3. Investment Banking
Investment Bankers raise money from investors, by selling securities, and
then transferring that money to people who need cash to start businesses,
run cities or bring other costly projects to reality.

4. Investment Banking
IB is concerned with the primary function of assisting the capital market in
its function of capital intermediation i.e. the movement of financial
resources from those who have them (the investors) to those who need to
make use of them for generating GDP (the issuers).
Banks and FIs on one hand and the capital market on the other, are the two
broad platforms of institutional intermediation for capital flows in the
economy.
Investment banks are the counterparts of banks in the capital market in
discharging the critical function of pooling and allocation of capital.

5. Investment Banking
Investment Banks are involved in virtually all large financial
transactions, including M&A, IPO, private placements and other
securities offerings.
Most large Investment Banks operate on both the buy side and the sell
side of securities trading.
Buy side, they represent individuals/investors (advising).
Sell side, they represent the companies looking for raising money
(finding investors).

6. Definitions
Investment bank as a term used in the US to mean a bank which deals
with the underwriting of new issues and advises corporations on their
financial affairs.
The Equivalent term in UK for such function is Issue House.

7. Definitions
John F. Marhsal and M.E. Eillis, “Investment Banking is what Investment
banks do.”
Bloomberg, “Investment Banking as a financial intermediary that
performs a variety of services, including aiding in the same of securities,
facilitating mergers and other corporate re-organizations, acting as
brokers to both individual and institutional clients and trading for its
own account.”

8. Role Investment Banking Plays
Investment bankers are typically contacted by people, companies, or
governments who need cash to start businesses, expand factories,
and build schools or bridges.
Investment banks also offer advice regarding what investment
securities should be bought or the ones an investor may want to buy.
One of the trickiest parts of understanding investment banking is that
it’s typically a menu of financial services.

9. Role Investment Banking Plays
• Capital raising – selling shares
• Financial advisory – decisions on managing their financial
resources (M&A advisory)
• Corporate lending – short-term loan
• Sales and trading – on behalf of clients or using their own money.
• Brokerage services
• Research – assist investors
• Investments – own money in promising companies or projects
(private equity)

10. Evolution of Investment Banking
• To the end of World War 1, Commercial Banks in the USA were
preparing for an economic recovery and consequently, to the
significant demand for corporate finance.
• It was expected that American companies would shift their
dependence from commercial banks to the stock and bond markets
wherein funds were available at lower cost and for longer periods of
time.

11. Evolution of Investment Banking
• In preparation for a boom in the capital markets in the 1920s,
commercial banks started to acquire stock broking businesses in a
bid to have a presence in such markets.
• The stock and bond market boom of the 1920s was an opportunity
that banks could not miss. But since they could not underwrite and
sell securities directly, they owned security affiliates through holding
companies.
• While the boom lasted, IB affiliates made huge profits as
underwriting fees, especially in the segment called Yankee Bonds,
issued by overseas issuers in US market.

12. Evolution of Investment Banking
• In the stock market, the banks mainly conducted broking operations
through their subsidiaries and lent margin money to customers.
• The stock market got over-heated with IBs borrowing money from
the parent banks in order to speculate, mainly for short selling.
• Once the general public joined, the price earning ratios reached
absurd limits and the bubble eventually burst in October 1929,
wiping out millions of dollars of bank depositors' funds.

13. Regulation of the Industry
• In order to restore confidence in banking and financial system,
several legislative measures were proposed.
• That restricted Commercial Banks from engaging in securities
underwriting and taking positions or acting as agents for other in
securities transactions and vice varsa. These activities were
segregated as the exclusive domain of Investment banks.
• By 1935, Investment Banking became one of the most heavily
regulated industries in USA.

14. Regulation of the Industry
• The Securities Exchange Act, 1934 led to the establishment of the
Securities Exchange Commission (SEC).
• The Investment Company Act, 1940 brought mutual funds within the
regulatory and the Investment Advisers Act, 1940, regulated the
business of investment advisers and wealth managers.

16. US Investment Bank Crisis in 2008
The investment banking crisis in the US in 2008 triggered a global
financial crisis which led to closure and bail out of several banks; and
led to a global recessionary phase for several years, thereafter,
resulting in lower employment generation and GDP growth across
nations.
• Sub-prime lending
• CDOs (Collateralized Debt obligation)
• CDS (Credit Default Swaps)
• AIG was the largest US insurance company.

17. Evolution of Indian Investment Banking
Origin
• The forerunners of Merchant Banks in India were the foreign banks.
• Grindlays Bank began Merchant Bank operation in 1967 with a license from the
RBI followed by the Citibank in 1970.
• In 1972, the banking commission report asserted the need for Merchant Banks
services in India by public-sector banks.
• The commission recommended a separate structure for Merchant Banks distinct
from commercial banks and financial institutions.
• Merchant Banking were meant to manage investments and provide advisory
services.

18. Evolution of Indian IB
Origin
• Following the recommendations of the report, the SBI set up its Merchant
Bank division in 1972, followed by Bank of India, Central Bank of India,
Bank of Baroda, Syndicate Bank, Punjab National Bank and Canara Bank.
• ICICI was the first financial institution to set up its Merchant Banking
division in 1973.
• The later entrants were IFCI and IDBI for setting up its Merchant Banking
division in 1992.
• By Mid-80s and 90s, most of the Merchant Banking divisions were spun off
as separate subsidiaries like SBI set-up SBI Capital Markets Ltd. in 1986.

19. Evolution of Indian IB
Constraints to Investment Banking
• Due to the over-dependence on issue management activity in the
initial years, most Merchant Banks perished in the Primary Market
downturn. To stabilize their business, many Merchant Banks
diversified to offer a broader spectrum of capital market services.
• Due to the lower availability of institutional financing to fund capital
market activity, it is only the bigger industry players that are in full-
service Investment banking.

20. Characteristics of Indian IB Industry
• Indian regulatory regime does not allow all Investment Banking
functions to be performed under one legal entity for 2 reasons:
1. To prevent excessive exposure to business risk under one entity;
2. To prescribe and monitor capital adequacy and risk mitigation
mechanisms.
The capital adequacy requirements for each business line have been
prescribed differently under relevant provisions of law.

21. Characteristics of Indian IB Industry
• The Commercial Banks in India must follow the provisions of the
Banking Regulations Act and the RBI Regulations, which prohibit them
from exposing themselves to stock market investment and lending
against stocks beyond specified limits.
• Indian investment banks follow a conglomerate structure by keeping
their business segments in different corporate entities to meet
regulatory norms.

27. THANK YOU