Investment Banking Meaning – A Complete Guide
Suppose there is a company or any government organization that requires money for any large project. On the other sides, some investors want to buy securities through bonds. In such cases, the company or government organization will not go to the general public for money lending. At the same time, the investors will not go to any government institution to buy bonds. In such cases, the middleman or the intermediary is the investment bank. Investment banks raise capital for any individual or any organization. They also provide financial consultancies to the companies. This article will give you a comprehensive guide on the meaning of investment banking and how it can be a great career option for you.
In this blog, we will understand the complete meaning of investment banking with other necessary information, like how investment banks make money.
What is the Meaning of Investment Banking?
So, you have massive investment banks like Goldman Sachs, Morgan Stanley, and JP Morgan Chase. These are big investment banks, and most of them are headquartered either in London or us. They do a wide range of work, so let me explain and give two specific examples that will help you understand the type of work that investment banks generally do. So you might have heard that Zomato launched its IPO, initial public offering, which means that Zomato, from being a private company, will become a listed public company.
So, taking this company from private to being in the public domain and getting it traded on the stock market is a work that investment bankers frequently do. They help with the listing of the company, so this is one of the works that investment bankers frequently engage in. How do they make money by taking a commission? Now, here is another example: HUL: Hindustan Unilever Ltd, which is a massive FMCG( fast-moving consumer goods) company in India. It merged with GSK now; in this merger process, investment banks were working on the buy side and the sell side. So both from the GSK side and the HUL side, HUL was acquiring GSK, by the way, so they had buy-side analysts and buy-side investment banks.
Then, there was sell-side analyst and sell-side investment banks involved, so this is typically the type of work that investment banks usually do. And they work on commissions, so what other types of work do investment banks do? They do a wide range of work. I always love to give this analogy of the way honey bees get attracted to flowers. Similarly, investment bankers are attracted to money. So wherever there is money to be made, you will find investment bankers doing that work, so it’s very difficult for me to give you an exact point-by-point output of what investment banks exactly do, but hopefully, these examples should help you understand the nature of work that they generally engage in.
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Commercial Bank versus Investment Bank
Now let’s move on, and let’s understand more than what the difference is between commercial banks and investment banks and so on. On one hand side of this spectrum, you have commercial banks like HDFC, ICICI, SBI, etc., and on the other hand, you have Morgan Stanley and JP Morgan.
So, how are these two different? So, let me, first and foremost, help you understand what commercial banks do. Commercial banks act as middlemen between people like us. For example, if I have a bank account in HDFC Bank, I will go and deposit money in the HDFC account, and this money is given out as loans to you or someone else. So essentially, in this entire process, banks make money by being an intermediary. Now, essentially, commercial banks deal with small businesses and small people and retailers like I and you.
On the other side, if we take a look at investment banks, investment banks deal with big players; so, for example, they will have commercial banks as one of their clients. So investment banks deal at a massive level, for example, big tech firms big banks. The primary difference between commercial banks is that commercial banks are for small players and small businesses, and investment banks deal at an institutional level with really big players.
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And I think there is a very good case study here, which I’ll just quickly take you through.
It’s the 2008 subprime prices, so how are commercial banks and investment banks working in confidence? So let me just quickly explain it. So what happened was that since 2001, the housing market has been on a boom. So, the prices of the housing properties were going up everywhere. If you were in Delhi, you would have seen that as well that prices were going up massively everywhere all across the world. Now, in this hoopla, what happened was that the US government decided that, you know what, we are going to increase the liquidity in the market.
So, to increase liquidity, usually what happens is that the governments ask the banks to drop the interest rate. Now, when the banks, I mean commercial banks, drop down the interest rate, they start finding more and more people to give out home loans. So you had this commercial bank. They were finding more and more people to take home loans because the rate of interest went down. They started approaching bad people. They did not have a very good credit history. They had no mechanism to repay the loans, so all these banks crashed.
So this was the entire dynamics in a very simplified format of what happened in the 2008 crisis. Now, how do investment banks come into the picture? Now, many of these commercial banks were the clients of investment banks. This process is called securitization when these commercial banks start approaching investment banks.
Why would they approach it very simply that they wanted this entire loan to be securitized? This loan acts as an asset for a commercial bank, and this asset is passed on to an investment bank at an institutional level. Hence, thousands, billions, and billions of dollars of loans were passed on as an asset to an investment bank or a bunch of investment banks. Then, they were asked to hedge the risk, so to say so, without getting into the complexities of the entire financial mechanism. These commercial banks were the clients of investment banks, and these commercial banks made a lot of mistakes.
These investment banks sold a lot of securities to a bunch of people, which eventually backfired, so both the commercial banks and investment banks were at fault in this entire episode, which led to subprime prices. Hence, I just brought this example for you to understand more about the difference between commercial banks and investment banks.
Why Are Investment Banks Profitable?
Investment banks generally are much more profitable compared to management consulting firms. The reason is very simple: investment banks number one deal in a wide range of work. Let’s say investment banks, for example, Goldman Sachs, work on a commissions model mostly, so they don’t need to put a lot of people in their workforce to get that work done because, for example, if you have to go and sell mortgage securities which are one worth one billion.
Probably you’ll need a team of five people to do that. On the flip side, if you’re selling security of five billion dollars, then again, you don’t need to expand your team massively, but if in consulting, your team is working on a, let’s say one-million-dollar project. Then you need five teammates, but if it goes to five million dollars, then you need to expand your team proportionately.
So, the point is that in finance, people make a lot of money for the simple fact that you don’t need to throw more bodies in terms of getting the work done. This is the primary reason why investment banks are so massively popular. The number one is they deal with large chunks of lines, and their recruiting is very light. So, they pass on a larger amount of money to a small set of people who are involved in the investment banking industry. I hope this point is clear.
Degree Required for Investment Banking
Now, moving on to the interesting titbits of what degrees you require. Now, if you look at it from a bachelor’s level perspective, if you study business or economics or commerce. Even engineers can get into investment banking. There is no harm, essentially, to cut the long story short. At an undergraduate level, you can pursue a degree in anything. You can still become an investment banker if you have done certain things. Eventually, you will need to understand and develop your understanding of businesses. At a master’s level, traditionally, an MBA is preferred whether you are an undergrad in engineering finance or economics; It doesn’t matter. But eventually, you have to pick up something business. It could be a master’s in financial engineering, a master’s in finance, or an MBA. MBA is generally preferred, so that is about the degree required.
Investment Banking: India and Abroad
If we look at the work that is done in India versus abroad in terms of investment banking, then there is a huge difference between the two. In India, you have something called back office work, and abroad, you have something called Front-end office work. Now, front-end work means that you are engaging with the client directly, you are getting face time with the client, and you are solving their issues directly. So that is the type of work that would usually happen in the US or Europe.
You could work with a lot of clients in the past who, after graduating from any IIM. They ended up pursuing another MBA just to get a job in investment banking in New York and London. So the idea was very simple: they simply wanted to move from a back-end office role to a front-end office role. Now, in India, most of the work is back-end office-related.
For example, a front-end office role would involve taking Bumble to the New York Stock Exchange. Now, Bumble, which is an American company taking it to the stock exchange in New York, involves mostly consultants or investment bankers based in New York. Taking up that role now is a front-end rule, but a lot of documentation is needed for due diligence, and a bunch of filing needs to be done. You need to work with the lawyers to get the entire process set up, so this is back-end work that mostly happens in geographies like India.
So, to cut the long story short, if you want to do front-end work, then you need to move to developed markets like Singapore, the US, and Europe. That is where you will find the majority of the work being done in the investment banking domain.
Investment Banking: Skills Required
Now, let’s finally take a look at the skills required in investment banking, and this is something that you can start acting upon. The first and foremost skills that investment banks require are called quantitative skills, so you need to have a very high GMAT GPA. You must have some kind of an undergrad, which is engineering heavy or math heavy or economics heavy; that helps. I’m not saying that this is the only way, but if you are from a non-quant background at an undergrad level, then doing CFA FRM helps. So these type of skills or number skills is very important.
Now, why do I say that those number skills are very important? I have taken out some of the questions that have been asked at major investment banking interviews. And their interview can be segregated into three parts, so the first part is usually called technical questions. Now, here they will ask you questions like that, hey! How will you value a company? So, you need to be quick in terms of doing that computation. Then the interviewer might turn around and say hey ‘Ajay’ explain what the three valuation methods are. And how will you value a company like Zomato from these three valuation methods?
Therefore, having this number talk is very important, and this is the first key skill required in investment banking. The second type of question that is usually asked in an IB or investment banking interview is personal fit-related interviews. So here you would get questions like walk me through your resume, talk about your leadership experience, what is your leadership philosophy, and what is something interesting about you? so you need to have a personality, and you need to be a people person because you’ll need to be quick in terms of hitting your elevator pitch in 60 seconds and talking very very quickly about you.
There are three things that you should start away with. Number one, please learn about valuations and develop your valuation skills because, as I was speaking earlier during your IB interview, they might ask you how you will value Zomato or how you will value cases over coffee, which is one of the companies that I (interviewer) run.
So, you need to have a valuation methodology and an understanding of how valuation works. This is something that you should learn and start investing your time away. The number two skill that you need to pick is that you need to learn more about business and develop a fundamental business understanding because investment bankers work with a wide range of businesses. It’s not as if they only work with tech firms or they only work with FMCG firms. But when you’re starved on a case in the investment banking domain, you need to be quick in terms of understanding their business.
You must generally develop your overall understanding of the business world, which will help you smooth out the processes. The third and final point is that you must learn how to communicate because if you’re not an effective communicator, you might struggle in terms of giving relevant and sharp inputs. You might struggle to hold conversations not only in the interview, but even if you somehow get through the interview stage, you will struggle to communicate with clients effectively, so work on these three skills if you’re a college student or a young professional aspiring to get into investment banking.
5 Reasons to Join Investment Banking
Genuine Interest in Finance:
If you are not interested in nonfinance roles, for example, you can’t do taxation, audit, or accounting. I am not saying these are bad profiles at all, but you want to do a job where there are no more repetitive tasks like filing ITR; rather, every opportunity will come as a unique learning experience for you. If you need to work in different industries with various niches, then investment baking is for you.
Strong Skillset Building:
There are two times when we need skill sets in investment banking. You need valuation and financial modelling skillsets before joining investment banking. After entering the investment banking field, you have to develop communication skills(written and oral), negotiation skills, and people management skills. These two types of skills will make you a gem in your own life. Suppose you will take retirement at the age of sixty. Then, after retirement, in many professions, if you want to start a new venture, you need to start with a zero base, but in investment banking, you will have communication and network to crack a deal immediately. You know how things work in the business world. If you want to be an investment consulting agent, then you know what needs to be done.
Suppose Anusha has cracked two jobs within a year, and now she is confused about which job she should join and which job she should leave. She asked her uncle about that, and he advised Anushka about the exit opportunity of the two jobs. It is a deciding factor. For example, she cracked a debt syndication job and a merger & acquisition job. Then, the opportunity to take an exit in debt syndication is limited because you can aim for other companies’ debt syndication departments only. Whereas if you join M&A, you can go for the M&A role of any company, strategist role of any company, or corporate role of a company. You can also join private equity or management consulting of any company. The one opportunity you will get after joining investment banking is you are loaded with exit opportunities because, most of the time, you work with ‘C-level’ corporate people like CEOs and CFOs. You will build an outstanding networking connection. One thing here you should remember is that private equity firms don’t usually hire fresher people, although there are exceptions. The firms look for candidates who have worked for one or two years in the industry. In that case, you have the upper hand with exit opportunities for the future.
Expertise in Industry:
Once you are into investment banking, for the first two years, you will work as a support agent for a larger team. You will do research for your team. You will build financial modelling for your team. You will be a pitchbook maker for the team. But once you complete the first years, you will get industry knowledge. In a big investment banking corporation, every team is dedicated to being industry-specific, like TMT or technology media and telecommunication or green energy. You need to have patience in the industry with a slow pace of progression.
Personal and Professional Growth:
In investment banking, there is a huge chunk of money flowing in the form of bonuses and salary; therefore, there is always room for personal growth. Your professional growth will increase because you start spending time with intelligent people. You will begin to have a sharp mindset.
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Investment Banking: Training Institutes
|Institutes’ Name||Duration||Fees||Mode of Training|
|IIM SKILLS||3 month+1month Internship||39900 INR, excluding tax||Online|
|Imarticus||2 months on regular mode but 3 months on part-time mode||140000 INR, including tax||Classroom/Online|
|BSE institute||7 months||85000 INR, excluding tax||Online|
|The Wall Street School||1.5 months||120000 INR, excluding tax||Online+Classroom|
|Intellipaat||9 months||148000 INR, including tax||Online|
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Q. Can an investment banker earn in crores?
It is one of the most asked questions in investment banking. The short answer will be yes, you can earn in crores with investment banking, but it doesn’t mean as a fresher, you can earn in crores. But if you have at least 10 years of experience, then you can earn that hefty amount in a month.
Q. Does investment banking have a great future?
Yes, investment banking has an outstanding feature because it deals with giant businesses. There will be no time when business will be stopped in the future, so it is a recession-proof industry.
Q. Will the investment banking be replaced by AI?
No, investment banking will not be replaced by AI because it is not a desk job. It incorporates several analogue factors like client dealing, valuation, and financial modelling into the business; therefore, AI can’t replace it in the future.
Investment banking is as wide as a sea; therefore, not any single article can cover this topic ultimately. Although I know the article is not perfect. I skipped lots of stuff about the topic. Let me know below which are the areas of investment banking you are interested in. Hopefully, I will try to address it in the following articles.