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Summary mn30209 investment banking: lecture notes summarized [revision for exam]
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mn30209 investment banking
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A. Lecture 1: Overview:• Commercial banking:
(Singh, 2013) The primary functions of a commercial bank are accepting deposits
and also lending funds. Deposits are savings, current, or time deposits. Also, a
commercial bank lends funds to its customers in the form of loans and advances,
cash credit, overdraft and discounting of bills, etc.
The secondary functions of a commercial bank are acting as an agent to its
customers and also providing utility services.
- high leverage (ie a small layer of equity and large layers of debt)
- short-term debt in the form deposits – often payable on demand
- funds are used to extend loans to firms and individuals
- screening can be employed before lending, and monitoring after lending, both
of which are costly activities
- repeated interactions between a bank and borrower can create a long-term
bank-borrower relationship
• Investment banking:
(Fohlin, 2014)
Investment banking involves providing advice and management services for
large, complex financial transactions, and providing services involved with capital
creation for corporations, organisations or even governments. Two of the primary
activities of investment banks are underwriting debt financing and the issuance
of equity securities, as in an initial public offering (IPO), and advising and
facilitating mergers and acquisitions (M&A) for companies, including leveraged
buyouts.
Additionally, investment banks provide help in securities sales and stock
placement, along with handling investments and brokering trades for corporate
clients, sovereign entities or high-net-worth individuals. Investment banks are
also the primary advisors, planners and managers for corporate restructuring or
reorganization, such as handling divestitures.
Typical divisions within investment banks include industry coverage groups and
financial product groups.
An investment bank may have product groups designated as equity capital
markets, debt capital, M&As, sales and trading, asset management, and equity
research.
- Core or traditional investment banking:
+ underwriting services: assisting firms raising capital
+ advisory services: assisting firms in M&As, asset restructuring (eg spin-off),
debt restructuring (eg amending the terms of a loan)
- Trading and brokerage:
+ proprietary trading: involves bank’s own money
+ brokerage: involves client’s money
- Asset management: managing investors’ money
- Research: supports investment decisions (trading and brokerage and asset
management) as well as the core investment banking activities
- Morgan Stanley: ‘’Morgan Stanley offers its investment banking clients,
, including corporations, governments and other entities, underwriting and
distribution services for debt and equity offerings in addition to financial advisory
services regarding key strategic matters, such as mergers and acquisitions,
restructuring, real estate and project finance.’’
• Universal banking:
- Universal banks perform both commercial banking and investment banking
activities
- 2 criticisms:
1. Direct involvement of commercial banks in the securities business increases
the riskiness of banks and the financial system
2. Abusive practices (eg the investment side underwriting poor securities to pay
off debt to the commercial side)
• Types of investment banks:
(Pearl et al., 2013):
The classification of investment banks is primarily based on size; however, “size”
may refer to the size of the bank in terms of the number of employees or offices,
or to the average size of M&A deals handled by the bank.
1. Full service: engage in all kinds of investment banking activities
eg Goldman Sachs, Morgan Stanley, and financial holding companies
2. Boutique: focus on particular segments:
eg Sandler O’Neil (financial institutions), Lazard (asset management, advisory)
→ One notable post-financial crisis shift in the investment banking marketplace is
the number of high-net-worth and Fortune 500 clients that have opted to retain
the services of boutique investment banking firms over the full-service firms.
3. Financial holding companies: financial institutions that offer a wide range of
financial services, including investment banking. They also generate additional
revenue by cross-selling financial products.
eg Citigroup, JP Morgan Chase, HSBC, Credit Suisse, etc
→ The majority of clients of full-service investment banks and financial holding
companies are Fortune 500, if not Fortune 100, firms.
• League tables:
- who are the big players in the investment banking industry?
→ the answer is in league tables – rankings of investment banks in a given
business
- marketing tool for successful IBs
- rankings tend to be sticky in the short run – except when there are mergers,
splits, bankruptcies, etc
B. Lecture 2: Development of investment banking:
1. Historical overview:
• (Fohlin, 2014)
The term ‘investment bank’ came into common usage in the late 19th – early
20th centuries, particularly in the US. Most of the oldest investment banks
originated as merchants, who traded in grains, spices, silk, metals,… on their
own account. The earliest examples appeared in Siena, and more grew up in
Florence, Genoa, and other cities engaged in medieval trade. Amsterdam
, arose as a merchant banking center in the 17th century, while London took the
lead soon after.
• US: Separation of investment banking from commercial banking following the
Glass-Steagall Act (1933) until the Gramm-Leach-Bliley Act (1999)
• Continental Europe: Universal banks (banques d’afffaires, Universalbanken)
dominated the scene since the late 19th century
• UK: securities distribution by stockbrokers, secondary market trading by
jobbers, advisory services by merchant banks
Big Bang (1986) threw them altogether
• Japan: commercial banks were barred from underwriting and marketing
securities until the late 1990s
• By the late 80s and early 90s, the rapidly-integrating US IBs developed the
global business model:
- full product array across advisory, debt and equity products
- global distribution through units in key markets
- global research covering thousands of companies
- client coverage of the world’s largest generators of fee income
• In particular, GS, ML, and MS first assaulted London and Tokyo before moving
on to other large markets
→ their strong position at home subsidized a massively expensive, long-term
penetration of these markets
• Introduction of the euro (1999) challenged the dominance of the local
universal banks in their domestic markets
→ an opportunity for newcomers who were now able to compete on equal
terms in the new European currency
2. 1920s and 30s
• (Fohlin, 2014)
By the time World War I hit, essentially all industrialised countries had
developed investment banking of a modern type, and a large proportion of
these systems involved universal or mixed financial institutions of some sort
along with financial markets in which investment bankers operated.
• With the growth of the equity and bond markets during this period,
commercial banks began to lose some of their traditional lending business to
the public markets (in 1920s).
• Concerned about disintermediation, commercial banks began to engage in
securities business – often via affiliates
The Union Trust Company of Detroit, for example, incorporated an affiliate
named the Union Commerce Investment Company under a Delaware charter
• Many affiliates operated from the same premises as the parent bank. Since
they generally shared the same name, affiliates enjoyed the ‘’full benefit of
the goodwill of their parent banks’’
• The Glass-Steagall Act (1933)
- Linkages between commercial and investment banking were believed to
have been responsible for the 1929 market crash. The universal banking
model was under criticism:
+ direct involvement of commercial banks in the securities business increases
the riskiness of banks and the financial system
, + abusive practices (eg the investment side underwriting poor securities to
pay off debt to the commercial side)
- The G-S Act prohibited commercial banks from underwriting, holding, or
dealing in corporate securities, either directly or through securities affiliates
Following the act, JP Morgan & Co, for example, chose to operate as a
commercial bank. Soon after it spun off its investment banking operations
and Morgan Stanley was born.
- (Fohlin, 2014) the 1956 Bank Holding Company Act extended restrictions on
banks, making it even harder for commercial banks to engage in investment
banking. Belgium, Greece, Italy and Japan also enacted similar provisions.
3. 1980s and 90s:
• Big Bang (1986):
Big Bang is the sudden deregulation of financial markets in the UK
Minimum fixed commission charges were removed
Abolition of the difference between stockjobbers (market makers) and
stockbrokers (connection between buyers and sellers)
Switch from open-outcry to electronic trading
• After Big Bang introduced electronic trading, the London exchange’s trading
floor became redundant
• Post Big Bang, UK banks failed to meet the US global competition
• Merchant banks suffered from limited capital base, integration problems,
and lack of experience in combing advisory, trading and distribution functions
Culture conflicts between brokers, jobbers, and bankers
• The sale of Britain’s leading bank, SG Warburg, to Swiss bank Corporation in
1995 was seen as the ultimate defeat
“S. G. Warburg of Britain, its aspirations of becoming a global financial
powerhouse in tatters, agreed yesterday to sell its investment banking
operations to the Swiss Bank Corporation for $1.37 billion. The deal,
assuming it is approved by Warburg's shareholders, would leave Britain with
no independently owned investment banks of any size less than a decade
after the nation threw its financial services industry open to worldwide
competition.” – NY Times.
• The Gramm-Leach-Bliley Act (1999):
- (Fohlin, 2014) With pressure from the financial sector mounting over the
years, and with de facto activities already moving toward universal banking,
the US fomally ended Glass-teagall separations with this new Act.
- it repealed parts of the Glass-Steagall Act, removing barriers in the market
among banking companies, securities companies and insurance companies
- after the GLBA, commercial banks could transform their bank holding
companies into financial holding companies to engage in investment banking
and insurance activities through nonbank subsidiaries
eg:
Citicorp (commercial bank holding company)
+ Travelers Group (insurance company)
+ Salomon Smith Barney (investment banking arm within the Travelers
Group)
= Citigroup
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