What does Investment Banking mean? Investment banks are essentially financial intermediaries, who primarily help businesses and governments with raising capital, corporate mergers and acquisitions, and securities trade. Investment Banking: Introduction, Concept, and Types; Investment banking is a much wider term than merchant banking as it implies significant fund based exposure to the capital market.
Investment Banking is explained their concept of what they are?
Internationally, investment banking has progressed both in the fund based & fee-based segments of the industry. In India, the dependence is heavily on merchant banking, more particularly with issue management & underwriting. In the USA, such banks are the most important participants in the direct market by bringing financial claims for sale. They help interested parties in raising capital, whether debt or equity in the primary market to finance capital expenditure.
Once the securities are sold, investment bankers make secondary markets for the securities as brokers and dealers. In 1990, there were 2500 investment banking firms in the USA doing underwriting business. About 100 firms are so large that they dominate the industry. In recent years some investment banking firms have diversified or merged with other financial institutions to become full-service financial firms.
Introduction to Investment Banking:
Banking and financial institution on the one hand and the capital market on the other are the two broad platforms of institutional that investment for capital flows in the economy. Therefore, it could be inferred that investment banks are those institutions that are counterparts of banks in the capital markets in the function of intermediation in the resource allocation.
Investment bankers have always enjoyed celebrity status, but at times, they have paid the price for the price for excessive flamboyance as well. Investment banks help companies, governments, and their agencies to raise money by issuing and selling securities in the primary market. They assist public and private corporations in raising funds in the capital markets, as well as in providing strategic advisory services for mergers acquisitions and other types of financial transactions.
However downturn in the primary market has forced merchant banks to diversify & become full-fledged investment banks. Over the decades, backed by evolution & also fuelled by recent technological developments, investment banking has transformed repeatedly to suit the needs of the finance community & thus become one of the vibrant & exciting segments of financial services.
The future for investment banks is bright with scope for merchant banks to convert themselves into investment banks. Much of the investment banking in its present form, thus owes its origins to the financial market in U.S.A due to which, American investment banks have been the leader in the American & Euro market as well.
Therefore, the term “Investment banking” can be said to be of American origin. Their counterparts in U.K were termed as “Merchant banks” since they had confined themselves to capital market intermediation until the U.K & European markets & extended the scope of such businesses.
Investment Banking in India:
For more than three decades, investment banking activity was mainly confined to merchant banking services. The foreign banks were the forerunners of merchant banking in India. The erstwhile Grindlays Bank began its merchant banking operations in 1967 after obtaining the required license from RBI. Soon after Citibank followed through. Both the banks focused on syndication of loans and raising of equity apart from other advisory services.
In 1972, the Banking Commission report asserted the need for merchant banking activities in India and recommended a separate structure for merchant banks totally different from commercial banks structure. The merchant banks were meant to manage investments and provide advisory services. The SBI set up its merchant banking division in 1972 and the other banks followed suit. ICICI was the first financial institution to set up its merchant banking division in 1973.
The advent of SEBI in 1992 was a major boost to the merchant banking activities in India and the activities were further propelled by the subsequent introduction of free pricing of primary market equity issues in 1992. Post-1992, there was a lot of fluctuations in the issue market affecting the merchant banking industry. SEBI started regulating the merchant banking activities in 1992 and a majority of the merchant bankers were registered with it. The number of merchant bankers registered with SEBI began to dwindle after the mid-nineties due to the inactivity in the primary market.
Many of the merchant bankers were into issue management or associated activity such as underwriting or advisory. Many merchant bankers succumbed to the downturn in the primary market because of the over-dependence on issue management activity in the initial years. Also, not all the merchant bankers were able to transform themselves into full-fledged investment banks. Currently, bigger industry players who are in investment banking are dominating the industry.
Scenario for Investment Banking in India?
In India commercial banks are restricted from buying and selling securities beyond five percent of their net incremental deposits of the previous year. They can subscribe to securities in the primary market and trade in shares and debentures in the secondary market.
Further, acceptance of deposits is limited to commercial banks. Non-bank financial intermediaries accept deposits for a fixed term are restricted to financing leasing/hire purchase, investment and loan activities and housing finance.
They cannot act as issue managers or merchant banks. Only merchant bankers registered with the Securities and Exchange Board of India (SEBI) can undertake issue management and underwriting, arrange mergers and offer portfolio services. Merchant banking in India is non-fund based except underwriting.
Structure of Investment Banking in India:
The Indian investment banking industry has a heterogeneous structure for the following reasons:
- The regulations do not permit all investment banking functions to be performed by a single entity for two reasons: 1) To prevent excessive exposure to business risk, and. 2) To prescribe and monitor capital adequacy and risk mitigation mechanisms.
- The commercial banks are prohibited from getting exposed to stock market investments and lending against stocks beyond certain specified limits under the provisions of RBI and Banking Regulation Act.
- Merchant banking activities can be carried out only after obtaining a merchant-banking license from SEBI.
- Merchant bankers other than banks and financial institutions are not authorized to carry out any business other than merchant banking.
- The Equity research activity has to be carried out independent of the merchant banking activity to avoid conflict of interest, and.
- Stockbroking business has to be separated into a different company.
Regulatory Framework for Investment Banking in India:
An overview of the regulatory framework is furnished below:
- All investment banks incorporated under the Companies Act, 1956 are governed by the provisions of that Act.
- Those investment banks that are incorporated under a separate statute are regulated by their respective statute. Ex: SBI, IDBI.
- Universal banks that function as investment banks are regulated by RBI under the RBI Act, 1934.
- All Non-banking Finance Companies that function as investment banks are regulated by RBI under RBI Act, 1934.
- SEBI governs the functional aspects of Investment banking under the Securities and Exchange Board of India Act, 1992.
- Those investment banks that carry foreign direct investment either through joint ventures or as fully owned subsidiaries are governed by the Foreign Exchange Management Act, 1999 with respect to foreign investment.
Types of Players in Investment Banking:
The following Types of Players below are:
These are the type of investment banks who have a significant presence in all areas like underwriting, distribution, M&A, brokerage, structured instruments, asset management etc. They are all rounder 0f the game.
Commercial Banks operating through “Section 20” subsidiaries referring to the subsidiaries formed under section 20 of the Glass- Steagall Act which were allowed to carry on limited investment banking services.
These are the type of players who specialize in particular areas of investment banking.
These firms offer only trading services to retail & institutional clients. They have a huge investor base which is also used by underwriters to place issues.
Asset Management Firms:
These firms offer investment services. This includes activities like fund management, wealth management, cash management, portfolio management depending on the type of investors, Tenure of the corpus, purpose of investments, type of instrument invested in etc.